SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended June 30, 1996Commission file No. 0-18866
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FIRST NATIONAL ENTERTAINMENT CORP.
(Exact name of small business issuer as specified in its charter)
Colorado 93-1004651
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
600 Enterprise Drive, Suite 109, Oak Brook, Illinois 60521
(Address of principal executive offices)
2443 Warrenville Road, Suite 600, Lisle, Illinois 60532
(Address of previous executive offices)
(630) 573-8209
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $0.005 Par Value
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-B is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference of Part
III of this Form 10-KSB, or any amendment to this Form 10-KSB. [
]
Registrant's revenues for the 1996 Fiscal Year: $1,153,542.
As of October 1, 1996 the registrant had 16,898,458 shares of its
$.005 par value Common Stock outstanding. The aggregate market value
of shares of Common Stock held by non-affiliates was $4,224,615 as
of this date.
INDEX
Part I.
Page
Item 1. Business......................................... 2
Item 2. Properties....................................... 5
Item 3. Legal 5
Proceedings......................................
Item 4. Submission of Matters to a Vote of Security 5
Holders..........................................
Part II
Item 5. Market for Registrant's Common Equity and Related 5
Stockholder Matters...................
Item 6. Management's Discussion and 7
Analysis.........................................
Item 7. Financial Statements and Supplementary 10
Data.............................................
Item 8. Disagreements on Accounting and Financial 10
Disclosures......................................
Part III.
Item 9 Incorporated by 10- 12
Reference...............................
Part IV
Item 13 Exhibits, Financial Statements and Reports on 15
Form 8- K.......................................
PART I
Item 1 - Business
General
The Company was incorporated on January 10, 1985, under the
name of Power Capital Inc., a Colorado corporation. In November of
1989, Power Capital became a public company. On October 26, 1990
Power Capital acquired 100% of the stock of 1st National Film Corp.,
a California corporation (1st National Film - California) in a tax-
free, stock-for-stock exchange. For financial reporting purposes
this acquisition was considered a reverse acquisition, in which 1st
National Film - California was deemed the acquiring or successor
parent corporation. In December of 1990 the name of the Company was
changed to 1st National Film Corp. (the "Company"), and 1st National
Film - California's inception date of July 7, 1989 is considered the
Company's inception date. In October of 1994, the Company changed
its name to First National Entertainment Corp. Since July of 1991,
the Company's Common Stock has been listed and traded on the NASDAQ.
In December, 1991 the Company completed the acquisition of all
U.S. and Canadian distribution, merchandising and ancillary
licensing rights to the completed animated film property Happily
Ever After from Mr. Lou Scheimer for approximately $1.35 million.
Mr. Scheimer is a world-renowned animator and was the founder and
former president of Filmation Associates, which was a California-
based animation studio acquired by French conglomerate L'Oreal.
Happily Ever After is an animated sequel to the classic Snow White
fairy tale, and includes one of the largest all-star casts of voices
ever assembled for an animated motion picture. Mr. Scheimer is
entitled to certain residual royalties based upon revenues earned by
the Company from this property. (See Financial Statements - Note 10
"Commitments and Contingencies").
On May 28, 1993, Happily Ever After was independently released
by the Company in over 1,000 theaters in the U.S. The film ran for
approximately two months, and generated gross box office receipts of
approximately $3.6 million, which netted the Company approximately
$1.5 million. These results allowed the Company to graduate from the
development stage, but were significantly below former management's
revenue expectations.
In July of 1993 the Company awarded its Happily Ever After home
video distribution rights to Worldvision Enterprises Inc., a unit of
Spelling Entertainment Group, which is principally owned by
Blockbuster Entertainment (which, since the video release, has
merged with Republic Pictures, "Republic"). The Company and Republic
released the Happily Ever After video on October 19, 1993, and
through June 30, 1996, the Company has recognized approximately $7.0
million in producer royalties from home video sales of this film.
In July of 1993 the Company entered into a manufacturing and
distribution agreement with American Softworks Corporation ("ASC"),
a leading video game software company, for the development of a
state-of-the-art video game for Nintendo and Sega hardware
platforms. Nintendo has since approved this game for sale on its
hardware platform. The Company's ASC agreement has initially
focused on the development of a video game for Happily Ever After.
In addition, the game has been uniquely designed to be played from
either a boy's or girl's perspective, which may provide crossover
sales appeal to players of both genders.
In June of 1994 the Company entered into a revised television
exhibition agreement with Technovision Industries, Inc. ("TVI"), a
New York based distributor of entertainment properties, for the
distribution of Happily Ever After into U.S. and Canadian television
markets. TVI acted as the Company's agent through August 1, 1995 in
seeking television broadcast and cable opportunities. No contracts
were entered into as a result of the agreement and the Company did
not extend the agreement after August 1, 1995.
On October 4, 1995 the Company signed an agreement with SeaGull
Entertainment, Inc., a New York and Los Angeles based distributor,
for the distribution of Happily Ever After. SeaGull Entertainment
was to act as the Company's agent through June 30, 2001. The
Company retained the right to terminate this agreement at the end of
any fiscal year in which certain performance goals are not met. On
June 30, 1996, the Company elected to terminate the agreement with
SeaGull Entertainment. The Company is currently interviewing for a
replacement distributor.
Family Classics
In January of 1994 the Company announced the formation of its
Family Classics division, which is dedicated to the production of
feature films based on classic tales. Concurrently, the Company
announced that it had acquired all worldwide media rights to Nigel
Miles-Thomas' stage production of Cinderella. As of the date of
this filing, based on the lack of a renegotiated songwriting
contract, inability to secure a funding partner, as well as
competitive offerings going into production by Hollywood studios,
the Company has elected to write off the pre-production costs of
Cinderella.
The Company is currently in negotiations to produce several new
animated features similar to HEA for direct to video release.
However, these productions will call for the Company to raise
significant additional capital, the availability of which cannot be
assured.
Stylus Records
In April of 1994 the Company acquired an 80% ownership in
Stylus Records Inc. ("Stylus") from Lewin & Rosenthal and Frontline
Records, which are an entertainment law firm and music distributor,
respectively. Pursuant to the Stylus Founder's Agreement, the
Company agreed to capitalize Stylus with 160,000 shares of its
Common Stock, assumed $105,000 of long-term liabilities from Stylus
and agreed to provide a line of credit for up to $500,000. Stylus in
turn issued these shares to Lewin & Rosenthal and Frontline, and
agreed to reimburse $105,000 to Lewin & Rosenthal and Frontline for
their initial contributions. The Company retains an 80% ownership in
Stylus, with Lewin & Rosenthal (15%) and Frontline (5%) as minority
investment partners in Stylus. Currently the Company is negotiating
with both minority partners to acquire their interests in Stylus.
Additionally, the Company has elected to write off the remaining
unamortized portion of goodwill related to Stylus.
In addition to its initial acquisition costs, Stylus has
advanced over $308,000 for the development and promotion of Ms.
Della Miles, most of which is contractually recoupable to Stylus
from Ms. Miles' future royalties. However, there can be no
assurance of any future royalties derived from Ms. Miles' efforts,
and thus, there can be no assurance of any recoupment of Stylus'
advances to date. Therefore, in accordance with the Statement of
Financial Accounting Standards No. 50, ("FAS 50") Financial
Reporting in the Record and Music Industry, the advance royalties
have been expensed. Currently Ms. Miles continues to dispute the
recoupment under her contract with the Company. (See Financial
Statement, Note 7 "Stylus Records").
Diversification Plan
In August 1995, the Company announced plans to begin a
diversification plan into the retail video store industry. Several
acquisition transactions were closed during the first half of fiscal
year 1996, however, these acquisitions were later unwound due to the
unavailability of debt financing during the second half of fiscal
year 1996.
The Company still intends to enter the retail video store industry
and continues to hold discussions with video store chain owners who
desire to work with the Company to build a new publicly held chain.
The Company is reevaluating its pricing model as well as seeking
alternative financing for its acquisition plans, taking into account
the current conditions in the retail video store industry. The
Company is currently in negotiations to acquire a new platform video
store chain to serve as a base for its video store operations. Of
course, no assurance can be given as to the ultimate acceptance of
the Company's acquisition strategy and financing structure by the
market place.
In September 1996, the Company announced that it had exclusively
optioned the screenplay "Chicago Blues" from a local screenwriter.
Financing for this live action feature is budgeted at $1,000,000 and
will be offered via the formation of Windy City Pictures I, LLC.
The Company will serve as executive producer of this movie and
intends to produce two to three such productions a year in Chicago.
However, no assurance can be given that the funding for this project
or additional movies will be available.
The Company continues to aggressively seek additional opportunities
in the animation, live action movies and retail video store arenas.
Financial Information About Industry Segments
Not applicable.
Competition
The Company competes with many other entertainment companies
that have greater industry experience, acceptance, and financial
resources than the Company. The Company faces significant
competition from other companies in the areas of acquiring,
financing, developing, producing, marketing, and distributing
quality entertainment products into related markets.
Seasonality
The Company's entertainment businesses may be affected by
industry seasonal factors. Theatrical attendance generally increases
during summer months and Christmas holiday period. Home video and
related merchandising sales are typically the strongest during the
Christmas selling season, from October through December. Music and
other entertainment property sales are not as seasonal as theatrical
and home video sales, but generally experience their strongest sales
during the Christmas selling season.
.
Employees
As of September 30, 1996 the Company had three permanent
employees, including two officers and one professional staff. No
employee of the Company is represented by a labor union or is
subject to a collective bargaining agreement. The Company believes
that its relationship with its employees is good.
Research and Development
The Company did not incur any research and development (R&D)
costs in fiscal years 1996 and 1995. The Company does not expect to
generate any significant R&D costs in fiscal 1997.
Regulation
The Code and Ratings Administration of the Motion Picture
Association of America, an independent industry trade association,
assigns ratings for age suitability for viewing of motion pictures.
The Company has and will continue to submit its films for ratings.
United States television stations and networks, as well as
foreign governments, impose restrictions on the content of motion
pictures and other entertainment properties. There can be no
assurance that future restrictions on entertainment properties
released by the Company may not affect the Company's ability to
exhibit or sell such entertainment properties.
Item 2 - Properties
The Company's principal executive offices are located at 600
Enterprise Drive, Suite 109, Oak Brook, Illinois 60521, telephone
(630) 573-8209. The Company leases approximately 900 square feet of
office space in an executive office complex. This lease commenced
June 1, 1996 and expires May 31, 1997.
The Company does not own production studios or warehouses,
sound stages, music studios or any other related production
facilities. As such, the Company does not have the fixed payroll,
overhead and other operating costs associated with ownership and
operation of such production facilities.
Item 3 - Legal Proceedings
The Company and its former executive officers and directors
were defendants in a class action lawsuit which commenced in the
United States District Court for the Eastern District of
Pennsylvania. The action was commenced on July 8, 1993, certified as
a class action on September 8, 1994, and alleged fraud and various
violations of securities laws in connection with the Company's
public disclosures during the period preceding and through the
theatrical release of the film Happily Ever After. The Company's
motion for a change of venue from Philadelphia to the Western
District of Texas was granted on January 31, 1995. The class
incorporates all persons who acquired the Company's Common Stock
between March 9, 1993 and June 2, 1993, inclusive. On June 30, 1995,
a second shareholder lawsuit was filed in the United States District
Court for the Western District of Texas (seeking to be certified as
a class action) covering the same facts as the previous shareholder
suit. On December 28, 1995 the Company settled the first suit for
$50,000 in cash and 4,000,000 shares of common stock, valued at
$0.50/share. These amounts plus legal costs have been recorded in
the 1996 statement of operations as settlement of litigation. The
second class action lawsuit filed on June 30, 1995 has been
dismissed by the plaintiffs based on the settlement of the previous
suit.
Item 4 - Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during
the fourth quarter of fiscal year 1996.
Part II
Item 5 - Market for the Registrant's Common Stock and Related
Stockholder Matters
The Company's $.005 par value Common Stock shares are traded on
the NASDAQ 'Small Cap' Market System under the symbol "FNAT." The
following table shows the range of reported high and low bid
quotations for the Company's Common shares, for the fiscal periods
indicated, as reported on the NASDAQ Regular Market System through
the National Quotation Bureau and NASDAQ Monthly Reports.
High Low
Fiscal 1996:
July - September $2.06 $0.28
October - December $1.69 $0.34
January - March $0.78 $0.19
March - June $0.59 $0.16
As of October 1, 1996, the Company had 1,081 shareholders of
record. The Company has never paid a cash dividend on its Common
Stock and does not expect to pay a cash dividend on its Common Stock
in the foreseeable future.
The Company has previously issued 200,000 Class A Warrants and
200,000 Class B Warrants, each exercisable for one share of the
Company's Common Stock at a price of $12.50 per share. There is no
current active market for trading in these securities, which expired
on April 1, 1996.
On October 6, 1996 the Company's Board of Directors approved
and issued an Extension and Optional New Pricing Offer to the
holders of Warrants from its Private Placement of 1,260,000 of the
Company's common stock in December 1995. These 1,260,000 Warrants
originally entitled the holders to purchase an additional share each
of the Company's common stock at a price of $1.00 through an
expiration date of December 15, 1997. The Extension and Optional
New Pricing Offer allows an extension at the same price until
December 31, 1998 for no additional consideration OR an extension
until December 31, 1999 at a share price of $.15 for additional
consideration of $.05 per Warrant OR an extension until December 31,
2000 at a share price of $.05 for additional consideration of $.10
per Warrant.
Item 6 - Management's Discussion and Analysis
Overview
First National Film Corp. was founded to pursue the
acquisition, distribution, and marketing of high quality
entertainment properties targeted at the family market in all forms
of media. The Company left the development stage and entered the
operational stage in 1993 concurrent with the national theatrical
release of its animated motion picture Happily Ever After and the
resultant generation of revenues.
The Company initiates the recognition of revenues from its
entertainment properties when it releases them for sale into their
primary and/or secondary markets. Revenue recognition often precedes
revenue collection due to substantial collection cycles, which are
common for the entertainment industry. Extended collection periods
could adversely affect the Company's liquidity. Revenues and results
of operations for any period are significantly dependent upon the
public acceptance of the Company's entertainment properties and
products, and, as such, may materially fluctuate from period to
period, and may not be indicative of results in future periods.
For theatrical, video, merchandising, television, and other
film-related revenues, the Company uses the individual-film-forecast
computation method as promulgated under Statement of Financial
Accounting Standards No. 53, Financial Reporting by Producers and
Distributors of Motion Picture Films. Under this method, film costs
for each period are amortized in proportion to the revenue earned in
the current period, relative to management's estimate of the total
revenue to be realized from all markets for a given film over its
commercial life. Film costs include acquisition costs, distribution
costs, print and certain advertising costs, and all other related
exploitation costs which benefit future periods. Management reviews
its total revenue estimates for its film properties on a regular
basis, which may result in changes of projections of film revenues,
costs, and rate of cost amortization. Net income for any period may
therefore be affected by the Company's revenue projections and
amortization of film costs.
The Company's unamortized film costs associated with Happily
Ever After totaled approximately $2.7 million at June 30, 1996. To
date, the Company has amortized over 74% of its total capitalized
costs for this film, the majority of which have been matched against
home video producer royalties earned from the Company's Republic
contract.
For future album, soundtrack, merchandising, publishing, music
video, and mechanical revenues, the Company will use the accounting
standards provided for in FAS 50. Under these standards, the
Company will recognize license fee revenues when the earning process
is complete and minimum guaranteed revenues are earned. The Company
will record advance royalty payments to its recording artists as an
asset when paid and as an expense when actually earned by the
artists, provided it is reasonable to consider these costs will be
recoupable by the Company. The cost of record masters which are
reasonably considered to be recoupable will be treated as an asset
of the Company. (See Financial Statements - Note 7 "Stylus
Records").
Liquidity and Capital Resources
The Company's operations were burdened by over $3.7 million of
non-cash costs, approximately $1.7 million of which were amortized
film and goodwill costs, with the balance made up by the issuance of
stock in settlement of a class action shareholders' suit
During its history the Company has recognized over $23.6
million in accumulated deficits, most of which should be available
to be used as tax loss carryforwards. However, under Internal
Revenue Code ("IRC") Section 382, Limitation on Net Operating Loss
Carryforwards, the Company is somewhat limited in its annual
utilization of accumulated tax losses based on certain changes in
ownership. (See Financial Statements - Note 5 "Income Taxes"). A
majority of the Company's deficit was incurred during the Company's
development stage through May 1993, prior to the release of Happily
Ever After. A significant portion of the Company's losses have been
derived from non-cash costs.
During fiscal 1996, the Company collected no cash from
theatrical and home video revenues earned by its animated motion
picture property Happily Ever After. As a result, the Company has
not been able to internally finance its operations during the year.
The Company has substantially reduced its overhead expense and
believes it will be able to increase cash revenues in fiscal year
1997 via the television exploitation of Happily Ever After. (See
Item 1 "Business - General"). In addition, the Company is currently
seeking to produce its first live action movie in an effort to
diversify its operations and to increase its cash flow. (See
Financial Statements Note 11 "Continuing Operations").
In July 1995, the Company moved its corporate offices
to an executive suite in Chicago, Illinois and sold all of the
Company's office furniture, furnishings and equipment to the former
Chief Executive Officer, Milton Verret, for $600,000 to be paid in
equal monthly installments commencing on July 15, 1995. In
addition, Mr. Verret agreed to assume all capital and operating
leases entered into by the Company prior to June 30, 1995. The
Company later agreed to a discount of $50,000 on the principal of
this note in exchange for an acceleration of payments. Mr. Verret
satisfied the note during fiscal year 1996.
As of June 30, 1996, the Company had approximately $157,000 in
unrestricted cash and cash equivalents as compared to $75,000 at the
end of fiscal 1995. The Company had $27,000 net accounts receivable
and $2.7 million in film inventory at the end of fiscal 1996, as
compared to zero and $4.2 million at the end of fiscal 1995,
respectively. A majority of the Company's receivables and inventory
balances are based on Happily Ever After sales and capitalized
costs, respectively. To date, the Company has amortized over $7.8
million (or 74%) of Happily Ever After's total capitalized costs,
and expects to amortize a majority of the remaining balance by 2001.
(Animated films often have relatively long revenue producing lives
from ancillary sources). The Company expects to generate revenues
from Happily Ever After at least into fiscal 2003. The Company
invested approximately $14,000 in property and equipment during
fiscal 1996.
The Company had approximately $3.1 million in total assets and
$519,000 in total current liabilities at the end of fiscal 1996, as
compared to $4.9 million and $401,000 at the end of fiscal 1995,
respectively. The Company issued approximately $2.8 million of its
Common Stock in fiscal 1996 as compared to $490,000 in fiscal 1995,
$2 million of which was for litigation settlement and the balance
substantially for cash. On October 13, 1995 the Company announced
that its Board of Directors had approved a private stock offering of
up to 10,000,000 shares of its par value $0.005 Common Stock at
$0.50 per share. The offering was made only to a limited number of
Accredited Investors (as that term is defined in the federal
securities laws). The shares offered were not registered under the
federal securities laws or the securities laws of any state and
accordingly will not be tradable and may not be reoffered or resold
in the United States unless they are subsequently registered or an
applicable exemption from registration is available.
Results of Operations
The Company incurred a net loss during the fiscal year ended
June 30, 1996 of ($4.76) million or ($0.33) per share as compared to
($4.95) million or ($0.43) per share for fiscal 1995. Approximately
$1.7 million of the fiscal 1996 loss was attributed to write downs
of the unamortized film costs for the Company's feature film Happily
Ever After, pre-production costs of Cinderella and the unamortized
goodwill of Stylus Records. Almost $2.1 million of the fiscal 1996
loss was attributable to settlement of the class action litigation
which commenced in 1993. These two categories in total contributed
over 80% of the year's loss. From inception through fiscal 1996,
the Company incurred an accumulated deficit of ($23.6) million, as
compared to ($18.8) million from inception through the end of fiscal
1995. A majority of the accumulated deficit and the resultant loss
per share since the Company's inception occurred during the
Company's development stage prior to the theatrical release of
Happily Ever After in May of 1993, which includes start-up expenses,
film acquisition and marketing costs, movie prints and advertising
campaigns, employment contract stock issuances for certain key
management, and settlement of debts resulting from attempted earlier
theatrical releases of Happily Ever After in the early 1990's. A
majority of these costs were paid through the issuance of the
Company's Common Stock. Management believes that most of these
expenses were unusual in nature and/or amount, and does not expect a
recurrence of these items at previous expense levels in future
periods, although there can be no assurance.
Comparison of Fiscal 1996 to Fiscal 1995. Total revenue
increased to approximately $1,153,000 in fiscal 1996 from $806,000
in fiscal 1995 as a result of an increase in the number of home
video sales recognized in 1996. Total revenue from the current and
previous year were comprised primarily of royalties from sales of
the Company's home video version of its Happily Ever After title.
The Company graduated from the development stage when it
commenced operations as an independent film distributor in the
fourth quarter of fiscal 1993 with the national theatrical release
of its film Happily Ever After in over 1,000 theaters nationwide.
The Company expects to continue generating sales from secondary
revenue sources for this film title over the next seven fiscal
years, primarily in the home video, television, video game,
merchandising, and premium sales markets, although there is no
assurance that such sales will be generated. A change in
management's lifetime revenue estimate for Happily Ever After made
at the end of fiscal 1996 had the effect of accelerating
approximately $500,000 of amortized film costs into fiscal 1996.
(See Financial Statements - Note 1 "Summary of Significant
Accounting Polices.")
Direct film costs associated with revenues (including a
writedown of $500,000 in fiscal 1996 and $1.8 million in fiscal
1995) totaled $1.1 million in fiscal 1996 and $2.5 million in fiscal
1995. These costs reflect an amortized portion of the total
capitalized costs associated with the acquisition and marketing
campaign required to bring Happily Ever After to market and position
it for sales in ancillary markets. Unamortized costs related to the
film totaled $2.7 million at the end of fiscal 1996 and $3.8 million
at the end of fiscal 1995. (See Financial Statements - Note 3 "Film
Inventory").
Operating expenses totaled $4.7 million in fiscal 1996, up from
$2.8 million in fiscal 1995. This increase was primarily
attributable to the write off of Cinderella of $400,000, and an
increased reserve for uncollectable receivables of $600,000 over
that reserved in fiscal 1995.
Marketing, selling and royalties expenses fell over 50% to
$253,000 in fiscal 1996 from $554,000 in fiscal 1995. This decline
was primarily due to the reduction of sales efforts to only include
that associated with the exploitation of Happily Ever After.
General and administrative expenses were $2.2 million in fiscal
1996 and fiscal 1995.
The Company incurred no income tax liabilities in fiscal 1996
or 1995. The Company hopes to utilize its tax loss carryforwards of
approximately $22.4 million in the future against taxable income,
which would allow the Company to avoid having to pay federal income
taxes against an equivalent amount of otherwise taxable income.
However, there is no assurance that the Company will generate
sufficient taxable income to offset any or all of its tax loss
carryforwards in the statutory time frame allowed for such
carryforwards. Further, the Company is limited in its annual
utilization of tax loss carryforwards under IRC Section 382,
Limitation on Net Operating Loss Carryforwards, based on certain
changes in ownership. (See Financial Statements - Note 5 "Income
Taxes").
Item 7 - Financial Statements and Supplementary Data
The financial statements listed in the accompanying index to
financial statements are filed as an attachment to this Report.
Item 8 - Disagreements on Accounting and Financial Disclosures
For fiscal year 1996, the Company engaged Crowe, Chizek and Company
LLP as its independent accountants. For fiscal years 1994 and 1995,
Ernst & Young LLP had served as its independent accountants. Ernst
& Young LLP resigned as the Company's independent accountants on
June 10, 1996. Through the date of resignation there were no
reportable events or disagreements with Ernst & Young LLP on any
matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which disagreements if
not resolved to the satisfaction of Ernst & Young LLP would have
caused them to make reference thereto in their report on the
financial statement for such periods. The reports of Ernst & Young
LLP on the financial statements for fiscal years 1995 and 1994
contained no adverse opinion or disclaimer of opinion and were not
qualified as to uncertainty, audit scope or accounting principles.
The Company's Board of Directors participated in and approved the
decision to change independent accountants.
Part III
Item 9 - Directors and Executive Officers
Directors and Executive Officers
The following table sets forth the Executive Officers and Directors
of the Board for the Company, their ages, positions held with the
Company and term of service as Director of the Company, as of June
30, 1996.
ame Age Positions Held With Periods of Service
Company as Company Director
Stephen J. 43 President, Acting May 1995 to Present
Denari Chief Financial Officer,
Chief Operating Officer
and Director
Joanne K.
Fabere 39 Controller, Secretary February 1996 to
and Director Present
Eugene Denari, Jr., age 70, served as Chairman of the Board and
Chief Executive Officer from June 1995 until his resignation in
February of 1996.
All Directors serve until the next annual meeting of
stockholders and the concurrent election of directors. All officers
serve at the pleasure of the Board of Directors. No Director holds
directorships in other reporting companies.
Business Experience of Nominees and Executive Officers
Stephen J. Denari - As President and Chief Operating Officer, Mr.
Denari participates in the formulation of and is responsible for the
overall operation and implementation of corporate strategy. His 20
years of business experience began with various positions at large
organizations such as Coopers & Lybrand, IBM and National
Semiconductor. His corporate turnaround experience began in the
early 1980's, as President of Harley Davidson Finance Company and
Vice President of Harley Davidson.
Joanne K. Fabere - As Controller, Ms. Fabere is involved in the day
to day operations of the Company. Her 14 years of business
experience range from banking, operations management, quality
assurance and business process re-engineering in various
organizations. Ms. Fabere has worked with Mr. Denari in his
corporate turnaround efforts for several years.
Item 10 - Executive Compensation
Summary Compensation Table
The following table summarizes the compensation paid during the last
three fiscal years to the Company's executive officers and
directors.
Annual Compensation Long-Term Compensation
Restricted Securities
Name and Fiscal Stock Underlying All Other
Principal Position Year Salary Awards Options/SARs(#) Compensation
Eugene
Denari,Jr. CEO 1995 $30,199 $ 0 500,000(a) 0
1996 50,769
Stephen J.
Denari President 1995 $14,487 $ 0 800,000(b) 0
Chief
Operating
Officer & 1996 $103,846
Acting CFO
Joanne K.
Fabere Controller1996 $29,230 $ 0 0 0
Company
Secretary
NOTES:
(a) Mr. Eugene Denari, Jr. received an option to purchase 500,000
shares of Company stock in June 1995 at the exercise price of $0.40
per share which vest over a period from July 1, 1995 through July 1,
1996. This option was canceled in its entirety after his
resignation from the Company in February 1996.
(b) Mr. Stephen J. Denari received an option to purchase 800,000
shares of Company stock in June 1995 at the exercise price of $0.40
per share which vested over a period from July 1, 1995 through July
1, 1996.
Options/SAR Grants in the Last Fiscal Year
The Company has one stock option plan in place: the 1993 Stock
Option Plan, under which up to 3,500,000 shares may be issued. The
plan authorizes the grant of incentive stock options with exercise
prices no lower than the fair market value of the underlying stock
on the date of the grant, and also non-qualified stock options at
exercise prices no lower than par value. As of June 30, 1996,
options to purchase 25,000 shares had been issued under this plan.
The grant was made to a former officer of the Company in August of
1993 at an exercise price of $1.53 per share. The following table
sets forth information regarding the stock option grants the Company
has made to the named executive officers during fiscal 1995. None
were granted during fiscal 1996.
Number of % of Total
Securities Options/SARs
Underlying Granted to Exercise or Expiration
Options/SARs Employees in Base Price Date
Granted Fiscal Year ($/Share)
Name
Eugene
Denari, Jr. 500,000(a) 38% $0.40 7/1/2006
Stephen J.
Denari 800,000(b) 62% $0.40 7/1/2006
(a) Mr. Eugene Denari, Jr. received an option to purchase 500,000
shares of Company stock in June 1995 at the exercise price of $0.40
per share which vest over a period from July 1, 1995 through July 1,
1996. These options were not issued pursuant to the 1993 Stock
Option Plan or any other plan. This option was canceled in its
entirety after his resignation from the Company in February 1996.
(See Note 6 - Shareholders' Equity)
(b) Mr. Stephen J. Denari received an option to purchase 800,000
shares of Company stock in June 1995 at the exercise price of $0.40
per share which vest over a period from July 1, 1995 through July 1,
1996. These options were not issued pursuant to the 1993 Stock
Option Plan or any other plan.
Aggregated Option/SAR Exercises in the Last Fiscal Year and Fiscal
Year-End Option/SAR Values.
The following table provides information about the options exercised
by the named executive officers during fiscal 1996 and about
unexercised stock options held by the named executive officers as of
June 30, 1996.
Number of Securities
Underlying Unexer- In-the-Money
cised Options/SARs Options/SARs at
Shares at Fiscal Year-End (#) Fiscal Year-
Acquired on Value Exercisable(E)/ Exercisable (E)/
Name Exercise(#) Ralized Unexercisable(U) Unexercisable(U)
Eugene
Denari, Jr. 0 0 0 0
Stephen J.
Denari 0 0 800,000(E) 0
Item 11 - Security Ownership of Certain Beneficial Owners and
Management
Principal Stockholders and Stock Holdings of Management
The following table sets forth as of October 1, 1996 all persons
known by the Company to be a beneficial owner of more than five
percent of any class of the Company's voting securities and the
security ownership in the Company or its affiliates, directly or
indirectly by all directors and nominees, executive officers and all
directors and officers of the Company as a group. Unless otherwise
stated, the nature of beneficial ownership is that of sole voting
power and sole investment power.
Name and Address Amount and Percent
of Beneficial Nature of of Class(1)
Owner Beneficial
Ownership
Stephen J. Denari 800,000(2) 4.7%
600 Enterprise
Drive, Ste 109,
Oak Brook, IL
60521
Joanne K. Fabere 1,000 .01%
600 Enterprise
Drive, Ste 109,
Oak Brook, IL
60521
Officers and 801,000 4.71%
Directors as a
Group (two
people)
1 Calculated based upon 16,898,458 shares of Common Stock issued
and outstanding as of the Record Date of October 1, 1996. In
addition to its Common Stock, the Company had outstanding as of
October 1, 1996, 1,260,000 Warrants to purchase one share of common
stock, $0.005 par value each. None of the holders of the Warrants
are entitled to vote, receive dividends, receive notices of meetings
or to any other shareholder rights on account of the Warrants prior
to exercise thereof.
2 Mr. Stephen J. Denari received an option to purchase 800,000
shares of Company stock in June 1995 at the exercise price of $0.40
per share which vest over a period from July 1, 1995 through July 1,
1996. This table includes the underlying securities for options
vesting within 60 days of the Company's fiscal year end (June 30,
1996.).
Item 12 - Certain Relationships and Related Transactions
Certain Relationships and Related Transactions
For the years ended June 30, 1996 and 1995, the Company incurred and
paid consulting fees of $2,000, in 1996 and interest payments of
$6,571 in 1995, which were substantially to related parties
Additionally, during fiscal year 1996, Eugene Denari and Timothy
Denari, father and brother of Company president Stephen Denari
respectively, worked for the Company, and Eugene served on the Board
of Directors. As of June 30, 1996 both Eugene and Timothy Denari
had resigned all positions with the Company. An independent review
of all compensation and expenses was conducted, and both parties and
the Company have executed mutual releases regarding any further
financial issues related to their work for the Company. (See
Financial Statements Note 8 - "Related Party Transactions").
In December of 1993, the Company issued 556,881 shares of its Common
Stock to Mr. Verret in payment of $587,000 of accumulated cash
advances which he had made to the Company. These shares were
recorded as "Redeemable Common Stock" in the Company's financial
statements for the 1994 Fiscal Year, as Mr. Verret was given the
option to return these shares to the Company for payment in cash of
the original $587,000 obligation owed to him by the Company. In
May of 1994, the Board of Directors approved the payment in cash of
this obligation and in July, 1994, Mr. Verret surrendered these
shares to the Company in exchange for such cash payment.
Further, in December of 1993, the Company paid Mr. Verret 191,743
shares of common stock in lieu of a balance due of $200,000 in
annual salary, subject to the right of Mr. Verret to put back all or
a portion of such shares, if the open market sales of such shares
did not achieve payment in full of the amount owed. Mr. Verret sold
100,000 of these shares and returned the balance of 91,743 shares to
the Company in July of 1994 for cancellation in exchange for Company
payment of the remaining $107,471 owed on his 1993 salary, after
deducting the net sales proceeds from the shares sold.
In April of 1994, the Company paid $100,000 towards its $222,000
note payable to Mr. Thomas Verret, father of the Company's then
Chairman, Mr. Milton Verret. This note was originally issued in
December of 1991 as final payment for the Company's acquisition of
Happily Ever After. The Company paid annual interest of 12% on this
note on a monthly basis. The Company paid this obligation in full
in July of 1994.
The Company had a five-year employment contract with its former
President, Mr. Jeffrey S. Schwaber, for his exclusive services to
the Company. This contract, dated May 1, 1993, provided for an
annual salary for Mr. Schwaber of $204,000. In addition, the
President was to receive 500,000 shares of Company stock in
consideration for services to be rendered over the term of the
contract. These shares vested as follows: 100,000 shares, which
vested on September 26, 1993; 200,000 shares, to vest on April 1,
1995; and 200,000 shares to vest on April 1, 1997. The two blocks of
200,000 shares were to be forfeited if employment was terminated
prior to their respective vesting dates. In November of 1994, Mr.
Schwaber resigned his position as president and pursuant to another
agreement with the Company, he returned 200,000 shares to the
Company. Mr. Schwaber was granted the unearned 200,000 shares by
the Board upon his resignation.
The Company also had a five-year employment contract with its
Executive Vice President, Mr. Rick D. Busby, for his exclusive
services to the Company. This contract, dated January 15, 1993,
provided for escalating annual salary levels to approximately
$165,000 per year by April of 1994, with annual 6% increases
thereafter through April of 1997. The Company also issued 100,000
shares of Common Stock to Mr. Busby, which are fully vested. Mr.
Busby also received an option to purchase 11,500 shares of Common
Stock, payable by the Company, in partial consideration for an
earlier loan to the Company. Mr. Busby exercised this option in
fiscal 1993. In February 1995, Mr. Busby resigned his position as
the Company's Executive Vice President.
Compliance with Section 16 (a) of the Exchange Act
The Securities Exchange Act of 1934 requires all executive
officers, directors and 10% or greater shareholders to report any
changes in their ownership of Company common stock to the Securities
and Exchange Commission, NASDAQ and the Company. Based solely upon
a review of these reports, the Company believes that during fiscal
1996 all Section 16 filing requirements were complied with except as
follows: Joanne K. Fabere failed to timely file an initial report
on Form 3. These filings have now been made.
Part IV
Item 13 - Exhibits, Financial Statements and Reports on Form 8-K
Financial Statements and Schedules:
See Table of Contents at the beginning of attached financial
statements.
Exhibits required by Item 601 of Regulation S-B.
Exhibit Description
No.
3.1 * Articles of Incorporation as Amended on 7/1/93
approved by shareholders on May 21, 1993 (Restated as
Amended). (Incorporated by reference to Exhibit 3.1
of the Company's Annual Report of Form 10-K for the
3.1.1 year ended June 30, 1993, Commission File No. 0-
18866)
Amendment of Articles of Incorporation approved on
October 28, 1994.
3.2 * By-laws approved and adopted March 30, 1989.
(Incorporated by reference to Exhibit 3.2 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1993, Commission File No. 0-18866)
4.1 * Instruments Defining Rights of Security Holders,
Class A and Class B Common Stock Purchase Warrants.
(Incorporated by reference to the Registration
Statement on Form S-18, declared effective on
9/19/89, SEC Reg. No. 33-30153-B)
10.1 * 1993 Non-Statutory Stock Option Plan, April 1, 1993.
(Incorporated by reference to Exhibit 10.1 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1993, Commission File No. 0-18866)
10.2 * 1993 Incentive Stock Option Plan, April 1, 1993.
(Incorporated by reference to Exhibit 10.2 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1993, Commission File No. 0-18866)
10.3 * Employment Agreement with Jeffrey S. Schwaber dated
March 26, 1993. (Incorporated by reference to Exhibit
10.3 of the Company's Annual Report of Form 10-K for
the year ended June 30, 1993, Commission File No.
0-18866)
10.4 * Employment Agreement and option with Rick D. Busby
dated January 15, 1993. (Incorporated by reference to
Exhibit 10.4 of the Company's Annual Report of Form
10-K for the year ended June 30, 1993, Commission
File No. 0-18866)
10.5 * Milton Verret Stock Purchase Arrangement of December
1, 1991 (Written Summary). (Incorporated by reference
to Exhibit 10.5 of the Company's Annual Report of
Form 10-K for the year ended June 30, 1993,
Commission File No. 0-18866)
10.6 * Continental Capital & Equity Corp. Advertising
Consulting Agreement dated March 5, 1993 and Agenda
of May 11, 1993 (Incorporated by reference to Exhibit
10.6 of the Company's Annual Report of Form 10-K for
the year ended June 30, 1993, Commission File No. 0-
18866)
10.7 * Television Distribution Agreement with Technovision
Industries, Inc. dated March 16, 1993 (Incorporated
by reference to Exhibit 10.7 of the Company's Annual
Report of Form 10-K for the year ended June 30, 1993,
Commission File No. 0-18866)
10.8 * Letter Agreement and Amendment Agreement with
Entertainment Marketing & Communications
International dated February 3, 1992 and June 15,
1993, respectively (Incorporated by reference to
Exhibit 10.8 of the Company's Annual Report of Form
10-K for the year ended June 30, 1993, Commission
File No. 0-18866)
10.9 * Agreement with American Softworks Corporation dated
June 17, 1993. (Incorporated by reference to Exhibit
10.9 of the Company's Annual Report of Form 10-K for
the year ended June 30, 1993, Commission File No. 0-
18866)
10.10 * Agreement with Worldvision Enterprises Inc. dated
July 16, 1993. (Incorporated by reference to Exhibit
10.10 of the Company's Annual Report of Form 10-K for
the year ended June 30, 1993, Commission File No. 0-
18866)
10.11*+ 1994 Employee Stock Purchase Plan, dated January 22,
1994 (Incorporated by reference to Exhibit 10.11 of
the Company's Annual Report of Form 10-K for the year
ended June 30, 1994, Commission File No. 0-18866)
10.12* Amendments to Worldvision Enterprises Inc. Agreement,
dated April 13, 1994 and May 23, 1994 (Incorporated
by reference to Exhibit 10.12 of the Company's Annual
Report of Form 10-K for the year ended June 30, 1994,
Commission File No. 0-18866)
10.13* Stylus Records Inc. subsidiary Founder's Agreement
dated April 15, 1994 (Incorporated by reference to
Exhibit 10.13 of the Company's Annual Report of Form
10-K for the year ended June 30, 1994, Commission
File No. 0-18866)
10.14* Replacement Television Program Distribution Agreement
with Technovision Industries, Inc. dated June 10,
1994 (Incorporated by reference to Exhibit 10.14 of
the Company's Annual Report of Form 10-K for the year
ended June 30, 1994, Commission File No. 0-18866)
10.15*+ Employment Agreement with Stephen J. Denari dated May
10, 1995. (Incorporated by reference to Exhibit 10.15
of the Company's Annual Report of Form 10-K for the
year ended June 30, 1995, Commission File No. 0-
18866)
10.16*+ Non-Qualified Stock Option Grant Agreement with
Eugene E. Denari, Jr. dated June 26, 1995.
(Incorporated by reference to Exhibit 10.16 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1995, Commission File No. 0-18866)
10.17*+ Non-Qualified Stock Option Grant Agreement with
Stephen J. Denari dated June 26, 1995.
(Incorporated by reference to Exhibit 10.17 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1995, Commission File No. 0-18866)
10.18* Promissory Note from Milton J. Verret dated July 14,
1995.
(Incorporated by reference to Exhibit 10.18 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1995, Commission File No. 0-18866)
10.19* Distribution Agreement with SeaGull Entertainment ,
Inc. dated October 4, 1995.
(Incorporated by reference to Exhibit 10.19 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1995, Commission File No. 0-18866)
10.20* Amendment to Promissory Note and Collateral Agreement
with Milton Verret, dated July 14, 1995.
(Incorporated by reference to Exhibit 10.20 of the
Company's Annual Report of Form 10-K for the year
ended June 30, 1995, Commission File No. 0-18866)
10.21 Option Agreement with Vivienne Crowe dated September
14, 1996.
16.1* Letter from former accountant regarding concurrence
with registrant's statements in report regarding
dismissal as registrant's principal accountant, dated
June 30, 1994 (Incorporated by reference to Exhibit
16.1 of the Company's Annual Report of Form 10-K for
the year ended June 30, 1994, Commission File No. 0-
18866)
21.1* Subsidiaries of the Registrant, as amended on April
15, 1994 (Incorporated by reference to Exhibit 21.1
of the Company's Annual Report of Form 10-K for the
year ended June 30, 1994, Commission File No. 0-
18866)
* Previously filed with the Commission.
+ Constitutes agreement or plan relating to employment or employee
benefits.
Reports on Form 8-K during the last quarter
On April 16, 1996, the Company filed on Form 8-K, that on April 2,
1996 the Company had announced that it and the owners of Video
Tyme, Inc. of Las Vegas mutually terminated their agreement. Based
on this event, no assets or liabilities or results of operations
related to this acquisition had been recorded in the Company's
financial statements for the quarter ended December 31, 1995.
On May 21, 1996 the Company filed on Form 8-K, that on May 3, 1996
Eugene E. Denari, Jr., former Chief Executive Officer, revised his
resignation agreement with the Company, and on May 7, 1996, the
Company accepted his revised agreement.
On June 17, 1996, the Company filed on Form 8-K, that on June 10,
1996, the Company received notification that its independent
auditor, Ernst & Young LLP was resigning as independent auditor. In
connection with the audit of the Company's financial statement for
each of the two fiscal years ended June 30, 1994 and 1995, and in
the subsequent interim periods, there were no disagrements with
Ernst & Young on any matters of accounting principles or practices,
financial statement disclosure, or auditing scope and procedures,
which, if not resolved to the satisfaction of Ernst & Young would
have caused Ernst & Young to make reference to the matter in their
report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities and Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Dated: October 15, 1996
FIRST NATIONAL ENTERTAINMENT CORP.
By:/s/ Stephen J. Denari
President
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates
indicated.
Signature Title Date
/S/ Stephen J. Denari Director, President,
Chief Operating Officer,
Acting Chief Financial
Officer
October 15, 1996
/S/ Joanne K. Fabere Controller,
Secretary
October 15, 1996
EXHIBIT INDEX
Exhibit No. Description Comment
3.1 * Articles of Incorporation, as Restated as Amended
amended
3.1.1 Articles of Amendment to the Adopted October 28,1994
Articles of Incorporation (Filed concurrently)
3.2 * By-Laws By-laws see Note 1
4.1*** Instruments Defining Rights of Class A & B Warrants
Security Holders
10.1 * Non-Statutory Stock Option Plan April 1, 1993
10.2 * Incentive Stock Option Plan April 1, 1993
10.3 * Employment Agreement with Jeffrey March 26, 1993
Schwaber
10.4 * Employment Agreement with Rick
Busby January 15, 1993
10.5 * Stock Purchase Agreement with
Milton Verret December 1, 1991
10.6 * Continental Capital & Equity
Agreement March 5, 1993 and Addenda
May 11, 1993
10.7 * Technovision Agreement March 16,1993
10.8 * Entertainment Marketing &
Communications Agreement February 3, 1992 & June 15
1993
10.9 * American Softworks Agreement June 17, 1993
10.10* Worldvision Agreement July 16, 1993
10.11** Employee Stock Purchase Plan January 22, 1994
10.12** Worldvision Agreement as amended April 13, 1994 and May 23,
1994
10.13** Stylus Records Founders Agreement April 15, 1994
10.14** Technovision Agreement as amended June 10, 1994
10.15**** Employment Agreement with Stephen May 10,1995(Filed
J. Denari concurrently)
10.16**** Non-Qualified Stock Option Grant
Agreement with Eugene E. Denari, Jr.June 26,1995 (Filed
concurrently)
10.17**** Non-Qualified Stock Option Grant
Agreement with Stephen J. Denari June 26, 1995 (Filed
concurrently)
10.18**** Promissory Note from Milton J. July 14, 1995(Filed
Verret concurrently)
10.19**** Distribution Agreement with
SeaGull Entertainment , Inc. October 4, 1995(Filed)
concurrently
10.20**** Amendment to Promissory Note
and Collateral Agreement with
Milton Verret July 14, 1995
10.21 Option agreement with Viviene Crowe September 14, 1996
16.1** Letter from previous auditor June 30, 1994
21.1** Subsidiaries of the Registrant,
as Amended Restated as amended
* Incorporated by reference to Annual Report on Form 10-KSB-A1 filed
on November 18, 1993.
**Incorporated by reference to Annual Report on Form 10-KSB-A1 filed
on September 27, 1994.
***Incorporated by reference to the Registration Statement on
Form S-18, declared effective on 9/19/89, SEC Reg. No. 33-30153-B
**** Incorporated by reference to Annual Report on Form 10-KSB filed
on October 28, 1995.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Reports of Independent F1
Auditors..................................................
......................................................
Consolidated Balance Sheet as of June 30, 1996 and F2 -F3
1995......................................................
Consolidated Statements of Operations for the years ended
June 30, 1996 and F4
1995......................................................
Consolidated Statements of Cash Flows for Each of the Two
Years Ended F5
June 30,1996 and 1995....................................
Consolidated Statements of Shareholders' Equity for each
of the Two Years Ended June 30, 1996 and 1995
........................................................... F6
Notes to the Consolidated Financial F7-F19
Statements................................................
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
First National Entertainment Corp.
We have audited the accompanying consolidated balance sheet of
First National Entertainment Corp., as of June 30, 1996 and the
related consolidated statements of operations, shareholders'
equity and cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects,
the financial position of First National Entertainment Corp.,
at June 30, 1996, and the results of its operations and its
cash flows for the year then ended in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared
assuming that the Company will continue as a going concern. As
discussed in Note 11 to the consolidated financial statements,
the Company has suffered recurring losses from operations and
has liabilities substantially in excess of current assets that
raise substantial doubt about its ability to continue as a going
concern. Management's plan in regard to these matters are also
described in note 11. The financial statements do not include
any adjustments that might arise from the outcome of this
uncertainty.
/s/ Crowe, Chizek and Company LLP
Oak Brook, Illinois
October 14, 1996 Crowe, Chizek and Company LLP
F-1
Report of Independent Auditors
The Board of Directors
First National Entertainment Corporation
and Subsidiaries
We have audited the consolidated balance sheet of First
National Entertainment Corporation and Subsidiaries as of June
30, 1995 and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for
the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of First National Entertainment Corporation
and Subsidiaries at June 30, 1995 and the consolidated results
of their operations and their cash flows for the year then
ended, in conformity with generally accepted accounting
principles.
October 12, 1995 /s/ Ernst & Young LLP
Austin, Texas
Ernst & Young LLP
FIRST NATIONAL ENTERTAINMENT CORP.
CONSOLIDATED BALANCE SHEET
June 30, 1996 1995
ASSETS
Current Assets
Cash $156,993 $75,248
Accounts receivable,
net of allowance for doubtful
accounts of $1,601,942 (1996)
and $567,246 (1995) 26,945 0
Film inventory 0 405,987
Other 9,514 10,720
Total Current Assets 193,452 491,955
Property and equipment, net 42,064 135,870
Other Assets
Film inventory, net of accumulated
amortization of $7,862,101 (1996)
and $6,722,101 (1995) 2,700,000 3,840,000
Intangible assets, net of
accumulated amortization of
$106,904 (1996) and
$131,489 (1995) and other 145,174 425,719
Total Other Assets 2,845,174 4,265,719
TOTAL ASSETS $3,080,690 $4,893,544
See accompanying notes to consolidated financial statements
F-2
FIRST NATIONAL ENTERTAINMENT CORP.
CONSOLIDATED BALANCE SHEET
June 30, 1996 1995
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $273,285 $216,181
Accrued expenses 225,041 151,978
Obligations under capital
leases 21,081 33,754
Total Current Liabilities 519,407 401,913
Shareholders' Equity
Preferred stock,
$.0001 par value,
authorized 10,000,000 shares,
no shares issued and
outstanding -- --
Common stock, $.005 par value,
authorized 100,000,000 shares,
issued and outstanding:
1996, 16,898,458 shares, and
1995, 11,293,631 shares 84,495 56,468
Paid in capital 26,090,608 23,285,049
Accumulated deficit (23,613,820) (18,849,886)
Total Shareholders' Equity 2,561,283 4,491,631
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $3,080,690 $4,893,544
See accompanying notes to consolidated financial
statements F-3
FIRST NATIONAL ENTERTAINMENT CORP. CONSOLIDATED
STATEMENTS OF OPERATIONS
For the years ended June 30, 1996 1995
TOTAL REVENUES $1,153,542 $806,324
COST OF REVENUES
Amortization of film costs 1,140,000 2,481,430
GROSS PROFIT (LOSS) 13,542 (1,675,106)
OPERATING EXPENSES
Marketing, selling & royalties 253,158 554,300
General and administrative 2,219,111 2,200,117
Gain on sale of furniture
and equipment (427,860)
Settlement of litigation 2,081,040 72,000
Write-off film inventory 405,987 ---
Write-off and amortization
of goodwill 225,000 60,000
TOTAL OPERATING EXPENSES 4,756,436 2,886,417
OPERATING LOSS (4,742,894) (4,561,523)
OTHER (EXPENSE) (21,040) (385,384)
NET LOSS $(4,763,934) $(4,946,907)
NET LOSS PER SHARE $ (.33) $ (.43)
Weighted average shares outstanding14,314,317 11,372,741
See accompanying notes to consolidated financial
statements
F-4
FIRST NATIONAL ENTERTAINMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended June 30, 1996 1995
Cash Flows From Operating Activities
Net loss $(4,763,934) $(4,946,907)
Adjustments to reconcile net
loss to net cash (used in)
operating activities:
Gain on sale of furniture
and equipment (427,860)
Amortization of film costs 1,140,000 2,481,430
Stock issued for services
and compensation, net 3,667 395,230
Provision for doubtful accounts 1,126,097
Other amortization and depreciation 279,880 1,190,915
Decrease (increase) in accounts
receivable (1,153,042) 350,610
Increase (decrease) in accounts
payable 57,103 (95,223)
Changes in other assets &
liabilities, net 472,633 (691,738)
Issuance of common stock in
settlement of class action
lawsuit 2,000,000
Net Cash (Used in) Operating
Activities: (1,265,456) (1,315,683)
Cash Flows From Investing Activities
Proceeds from sale of equipment 531,387
Acquisition of property and equipment (14,186) (27,330)
Net Cash Provided by (Used in)
Investing Activities: 517,201 (27,330)
Cash Flows From Financing Activities
Repayments to Officers (140,794)
Note payable repayments (122,000)
Redemption of redeemable common stock (587,000)
Redemption of common stock (91,743)
Issuance of common stock 830,000 9,464
Net Cash Provided by (Used in)
Financing Activities: 830,000 (932,073)
Net Increase (Decrease) in Cash 81,745 (2,275,086)
Cash - Beginning of Year 75,248 2,350,334
Cash - End of Year $156,993 $75,248
See accompanying notes to consolidated financial
statements
F-5
FIRST NATIONAL ENTERTAINMENT CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional
Number of Paid-In Unearned Accumlated
Shares Amount Capital Compensation (Deficit) TOTAL
Balance
at June 30,
1994 11,178,620 $55,893 $23,913,673 $(1,281,250) $(13,902,979)$8,785,337
Issuance of
Common Stock
for employee
compensation,
services,and
professional
fees, net 369,058 1,846 393,384 395,230
Issuance of
Common Stock 19,801 99 9,365 9,464
Conversion
of Redeemable
Common Stock
to Common
Stock 17,895 89 84,911 85,000
Cancellation
of Common
Stock pursuant
to return
by former
Chairman (91,743) (459) (91,284) (91,743)
Cancellation
of Common
Stock pursuant
to return by
President (200,000) (1,000)(1,025,000) (1,026,000)
Amortization
ofunearned
compensation 1,281,250 1,281,250
Net Loss (4,946,907) (4,946,907)
Balance
at June 30,
1995 11,293,631 $56,468 $23,285,049 $0 $(18,849,886) $4,491,631
Issuance of
Common Stock
for employee
compensation,
services,and
professional
fees, net 4,365 22 3,645 3,667
Issuance of
Common
Stock 1,617,143 8,086 821,914 830,000
Issuance of
Common
Stockin
settlement
of class
action
lawsuit 4,000,000 20,000 1,980,000 2,000,000
Cancellation
of Common
Stock
pursuant to
return by
former
Chairman (16,681) (81) (81)
Net Loss (4,763,934) (4,763,934)
Balance
at
June 30,
1996 16,898,458 $84,495 $26,090,608 $0 $(23,613,820) $2,561,283
See accompanying notes to consolidated financial statements.
F-6
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The financial statements include the accounts of First
National Entertainment Corp. (a Colorado corporation) and
its subsidiaries First National Film Corp. - California and
Stylus Records (collectively referred to as the "Company").
As of June 30, 1996, there were nominal assets and
liabilities in the Company's First National Film Corp. -
California subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation.
The Company's primary business activity has been the
acquisition, distribution and marketing of high quality
entertainment properties targeted at the family market in
film and other media.
The accompanying consolidated financial statements have been
prepared in conformity with generally accepted accounting
principles. The preparation of financial statements in
conformity with generally accpeted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Revenue Recognition
Revenue from the exhibition and sales of Company film
entertainment properties are recorded when earned, based on
the Company's rights under various exhibition/distribution
agreements. Revenues from theatrical properties are recorded
when exhibited, based on a percentage of box office
receipts. Revenues from home video producer royalties are
recorded based on reported sales and collections by the
Company's distributor(s), which is currently Republic
Pictures. (See Note 2 - Accounts Receivable). Revenues
from television, merchandising, and other related markets
for the Company's film entertainment properties are recorded
when the properties are released for sale in these media,
subject to acceptance, collectibility, and other criteria.
The Company's revenues for fiscal years 1996 and 1995 were
comprised of producer participation royalties accrued from
its video distribution partner Republic Pictures for home
video sales of the Company's animated motion picture
property Happily Ever After.
Cost Recognition
Costs associated with the Company's entertainment properties
are generally recognized consistent with associated
revenues. Under Statement of Financial Accounting Standards
No. 53, Financial Reporting by Producers and Distributors of
Motion Picture Films, the Company amortizes film costs for
each period in proportion to the revenue recognized in the
current period, relative to management's estimate of the
total revenue to be realized from all markets for a given
film property over its commercial life. Amortized film costs
include acquisition, distribution, print, advertising,
marketing, and certain other costs that benefit a property
over its entire revenue-producing life. (Certain local
advertising, marketing costs, and direct theatrical costs
for a property are immediately expensed in the period of
theatrical exhibition.)
Management reviews its revenue projections for film
properties on a regular basis, which may result in changes
of projected film revenues, costs, and rate of cost
amortization, which can have a material effect on income for
any current and/or future period. Estimated losses from a
property, if any, are provided for currently.
F-7
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Income Taxes
The Company accounts for income taxes using the deferred
asset and liability method as required by Statement of
Financial Accounting Standards No. 109 ("FAS 109"),
Accounting For Income Taxes. This method was adopted by the
Company effective July 1, 1993. Deferred income taxes are
provided as temporary differences arise between the basis of
assets and liabilities for financial reporting and income
tax reporting.
Earnings/(Loss) Per Share
Earnings/(Loss) per common share is computed by dividing the
net income/(loss) for the period by the weighted average
number of common shares outstanding during the period. The
weighted average number of common shares used in the per
share computations was 14,314,317 for 1996 and 11,372,741
for 1995. Since the Company has experienced net operating
losses, the outstanding options and warrants to purchase
common stock have an anti-dilutive effect. Therefore,
options and warrants were not included in the
earnings/(loss) per share calculation.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company
considers all investments with maturities of three months or
less, when purchased, to be cash equivalents.
Accounts Receivable
Accounts receivable consists of committed receivables from
customers and estimated accrued revenues based on
distributor accounts receivable from shipped but uncollected
entertainment property revenues. Accounts receivable
include an allowance for doubtful accounts, which is based
on management's estimate of potentially uncollectible
accounts.
Film Inventory
Film inventory consists of certain capitalized costs for the
acquisition, production, and exploitation of entertainment
properties. Inventory is stated at the lower of unamortized
cost or estimated net realizable value for each property. In
accordance with Statement of Financial Accounting Standards
No. 53, Financial Reporting by Producers and Distributors of
Motion Picture Films, the Company amortizes its film costs
using the "individual film forecast method," which requires
that cost amortization relate film costs to the estimated
total gross revenues from all lifetime sources on an
individual film basis. Amortization of film costs begins
when a film property is released into its primary market and
revenue generation has begun. Unamortized costs remain as
inventory on the balance sheet, with capitalized costs for
the property's initial (primary) market recorded as current
inventory, and capitalized costs associated with secondary
markets recorded as non-current inventory.
F-8
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Intangible Assets
Intangible assets, which includes goodwill of $300,000 in
1995, and organizational costs of $252,000 are amortized
over 60 months using the straight line method. The carrying
value of goodwill is reviewed annually to determine if the
facts and circumstances suggests that it may be impaired
(See Note 7).
Property and Equipment
Property and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the estimated
useful lives of the assets, generally 3 to 7 years.
Leasehold improvements are amortized over the useful lives
of the improvements or the term of the lease, whichever is
shorter. Capital lease assets are amortized over their
estimated useful lives, and amortization is included in
depreciation expense. Ordinary maintenance and repairs are
expensed as incurred.
NOTE 2 ACCOUNTS RECEIVABLE
On August 16, 1994 the Company received an accounting
statement from Republic Pictures ("Republic"), its film
distributor, that reported video sales and collection
results for Happily Ever After through June 30, 1994. This
statement reflected a lower producer royalty payment than
the Company had anticipated because of certain assumptions,
used by Republic in the accounting statement, that the
Company believes were inconsistent with its distribution
agreement with Republic. The Company communicated these
issues to Republic and conducted a comprehensive third-party
special audit of all reported video results. Republic
subsequently agreed to revise the August 16, 1994 accounting
statement for the number of videos shipped, and on September
26, 1994 delivered payment to the Company for this revised
accounting statement, plus interest. However, according to
the special auditor's report, Republic owes the Company a
producer's bonus of 5% of the first one million units sold,
which approximates $256,000, in addition to amounts owed the
Company for foreign currency adjustments and excess units
held in reserve of $184,000. In 1996, Republic reported
units sold of 389,000 units but, because of certain cost
assumptions used by Republic in submitting its accounting
for these sold units, informed the Company that they have no
liability for producer royalty payments. The Company
maintains that under the terms of the Distributor Agreement
they are entitled to a specific amount for each unit sold or
approximately $1,150,000 for 1996. The Company intends to
vigorously pursue collection efforts with respect to these
receivables, however, due to the uncertainty of the results
of the collection efforts, the Company has provided an
allowance for the entire outstanding amount due at June 30,
1996.
During the third quarter of fiscal 1995 the Company shared
in the net profits from the sale of approximately 15,000
Happily Ever After video games manufactured and distributed
by American Softworks Corporation ("ASC"). The Company
recorded a receivable from ASC for $175,000 (less the amount
paid by ASC) representing advances made to ASC for the
developing of the video game. ASC disputed amounts owed
under the contract. The amount of net receivables (after
costs of collection) due from American Softworks Corporation
at June 30, 1996, in the amount of $26,945, represents the
agreed upon settlement between the parties.
F-9
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 2 ACCOUNTS RECEIVABLE (continued)
The activity in the Company's allowance for doubtful
accounts for the periods ended June 30, 1996 and 1995 is as
follows:
Balance at Charged to Balance
Beginning Costs & Expenses at End of
For the Period of Period Deductions Period
Ended
June 30, 1995 $90,000 $477,246 $0 $567,246
June 30, 1996 567,246 1,126,097 91,401 1,601,942
NOTE 3 FILM INVENTORY
The Company's film inventory is summarized as follows:
1996 1995
Development costs for Cinderella
allocated to the primary market
and recorded as a current asset $ $ 405,987
Unamortized film costs for
Happily Ever After allocated to
the secondary market and recorded
as a non-current asset 2,700,000 3,840,000
Total Film Inventory $2,700,000 4,245,987
======== ========
Amortization of capitalized film property costs is computed
using the individual-film-forecast computation method as
promulgated under Statement of Financial Accounting
Standards No. 53, Financial Reporting by Producers and
Distributors of Motion Picture Films. The Company expects to
amortize the remaining unamortized film costs for its
Happily Ever After property over the next five years.
Market conditions could alter this accounting estimate and
the Company's annual computation of net realizable value
could result in unamortized costs being charged to
operations over a shorter time frame.
During fiscal year 1996, the Company evaluated the potential
future marketability of its film version of the Nigel Miles-
Thomas stage production of Cinderella. Based upon
difficulities in securing satisfactory songwriting and
financing, as well as the production of competitive
properties by major Hollywood studios, the Company has
decided to abandon its effort to produce this version of
Cinderella. Accordingly the previously deferred development
and preproduction costs have been charged against 1996
income.
F-10
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 4 PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1996 and 1995, consisted
of the following:
1996 1995
Office equipment $ 12,610 $98,910
Furniture and fixtures 1,575 58,609
Leasehold improvements 0 26,830
Capital Leases 41,994 41,994
56,179 226,343
Less accumulated depreciation 14,115 90,473
Net Property and Equipment $42,064 $135,870
In July 1995, the Company moved its corporate offices to an
executive suite in Chicago, Illinois and sold all of the
Company's office furniture, furnishings and equipment to the
former Chief Executive Officer, Milton Verret, for $600,000
to be paid in equal monthly installments commencing on July
15, 1995. In addition, Mr. Verret agreed to assume all
capital and operating leases entered into by the Company
prior to June 30, 1995. The Company later agreed to a
discount of $50,000 on the principal of this note in
exchange for an acceleration of payments. Mr. Verret
satisfied the note during fiscal year 1996.
NOTE 5 INCOME TAXES
In 1993, the Company adopted SFAS 109 which requires
recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been
included in the financial statements and tax returns.
The Company had cumulative net operating loss carryforwards
of approximately $22.4 million and $17.6 million at June 30,
1996 and 1995, respectively, for federal tax reporting
purposes. The net operating loss carryforwards expire in
varying amounts beginning in the year 2000.
Due to changes in the Company's ownership, the annual
utilization of the net operating loss carryforwards arising
prior to the ownership changes may be limited. Generally,
the amount of those carryforwards available for annual
utilization is based on the value of the Company at the time
of the ownership change, multiplied by a rate specified by
the Internal Revenue Service.
F-11
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 5 INCOME TAXES (continued)
Significant components of deferred tax assets and
liabilities at June 30, 1996 and 1995, are as follows:
1996 1995
Deferred tax assets:
Net operating loss carryforwards $7,750,000 $6,025,000
Reserves and allowances 375,000 300,000
8,125,000 6,325,000
Valuation allowance 8,125,000 6,325,000
Net deferred taxes $ --- $ ---
=========== ==========
A valuation allowance has been established by the Company
due to the uncertainties of the realization of deferred tax
assets based on the Company's prior history of tax losses.
The valuation reserve increased approximately $1.8 million
in 1996 due to the increase in net deferred tax assets.
Management will continue to re-evaluate the appropriateness
of the valuation allowance in future years.
There were no income tax payments in the years ended 1996
and 1995.
NOTE 6 SHAREHOLDERS' EQUITY
Preferred Stock - The Company has authorized the issuance of
10,000,000 shares of $.0001 par value Preferred Stock. At
June 30, 1996, the Company had not issued any preferred
shares.
Common Stock - The Company issued 4365 shares in 1996 and
369,058 shares during 1995 for employee compensation,
contractual services, and professional fees valued at $3,667
and $395,230, respectively.
In the second quarter of 1996December of 1995, the Company
initiated an equity restructuring program in which the
Company issued 1,260,000 shares of its common stock (par
value $.005) along with warrants to purchase an additional
1,260,000 shares of its common stock (par value $.005) at
$1.00/share. for Total proceeds from the offering amounted
to $830,000. All of the warrants were to expire on December
15, 1997. (See Note 12 "Subsequent Events")
F-12
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 6 SHAREHOLDERS' EQUITY (continued)
Rentrak, Inc., of Portland, Oregon, is a large distributor
of video cassettes on a pay per view basis nationally. On
December 22, 1995, the Company and Rentrak entered into a 10
year Agreement whereby Rentrak purchased 357,143 shares of
common stock for $200,000. Rentrak has also agreed to buy
an additional $10,000 of common stock for each new non-
Rentrak video store acquired by the Company.
On December 28, 1995 the Company issued 4,000,000 shares of
common stock as part of the settlement of a class action
lawsuit. (Note 9 "Settlement of Legal Matters".)
Unearned Compensation - At June 30, 1994, the Company had
($1,281,250) of unearned compensation recorded in its
financial statements. This balance represented the
unamortized portion of a 500,000 share stock grant given to
the Company's then President, Mr. Schwaber, in May 1993 when
he joined the Company (this grant was valued at $2,562,500
on the date of grant). These shares were to vest to Mr.
Schwaber over the term of his five-year employment agreement
with the Company, and the Company recognized a portion as
compensation expense each period, with the unamortized
balance remaining on the balance sheet as a contra-equity
account for future amortization. In November 1994, Mr.
Schwaber resigned as President of the Company. As a result
the Company has written off the remaining unamortized
balance and has received and canceled 200,000 of the shares
originally issued.
Stock Options - On May 21, 1993, shareholders approved an
incentive stock plan which reserved 3,500,000 shares of the
Company's Common Stock for issuance under the 1993 Incentive
Stock Option Plan ("ISO") and the 1993 Non-Qualified Stock
Option Plan ("NQSO") (collectively referred to as the "1993
Plan"). The 1993 Plan provides incentives to officers,
directors, employees, consultants and advisors in the form
of stock options, subject to certain restrictions. The
Company's Board of Directors determines the granting of
options under the 1993 plan, including the exercise period,
contingencies, vesting periods and employee qualifications.
Options to be issued under the ISO are intended to qualify
as "incentive stock options" under section 422 of the 1986
Internal Revenue Code (the "Code"), as amended. Options
granted under the NQSO are subject to fewer restrictions
than the ISO and are considered "Non-statutory Stock
Options" as defined in the Code. As of June 30, 1996,
25,000 option shares had been issued under this Plan. The
25,000 options were issued in August, 1993 at the exercise
price of $1.53 per share. All of the outstanding options
were exercisable at June 30, 1996. No options were
exercised during the fiscal years ended June 30, 1996 and
1995.
F-13
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 6 SHAREHOLDERS' EQUITY (continued)
On May 10, 1995, the Company hired Stephen J. Denari as
President and Director and promoted Eugene E. Denari, Jr.
(father of Stephen) to the position of Senior Vice President
and Director. On June 28, 1995, Eugene Denari, Jr. replaced
Milton Verret as Chief Executive Officer. On June 26, 1995,
the Board approved a stock option grant for 800,000 and
500,000 shares of the Company's Common Stock at an option
price of $0.40 per share (the then current market value) to
Stephen Denari and Eugene Denari, Jr., respectively. These
options may be exercised in accordance with a vesting
schedule which extends over a five quarter period. One
fifth of the options are exercisable each quarter beginning
July 1, 1995 until July 1, 1996 at which time all options
are vested and exercisable. During fiscal year 1996, Eugene
Denari resigned from the Company and its Board; as a part of
his resignation settlement, the stock option grant covering
500,000 shares previously granted was entirely canceled. No
options were exercised during the fiscal year ended June 30,
1996.
Employee Stock Purchase Plan - The Company implemented an
Employee Stock Purchase Plan in 1994 which permits
substantially all employees to acquire Company Common Stock.
Participating employees may acquire stock at the end of each
six-month period (June 30 and December 31 of each year) at a
purchase price of 85% of the lower of fair market value at
the beginning or end of the period. Employees may designate
up to 10% of their base compensation for the purchase of
stock under this plan. There are no charges to income in
connection with this plan.
NOTE 7 STYLUS RECORDS
In April 1994, the Company acquired a majority ownership in
Stylus Records, a Delaware Corporation, for 160,000 shares
of Common Stock and the assumption of $105,000 in
liabilities. The Founder's Agreement calls for the Company
to guarantee certain stock values for 60,000 of these issued
shares relative to their market price as of March 31, 1996.
The Company has the option to issue additional shares to the
extent of any differences between the market price and the
guarantee price. The shares issued for this acquisition,
including the price guarantees, have been valued at
$375,000. The Company maintains an 80% ownership in Stylus,
with its investment partners Lewin & Rosenthal and Frontline
Records maintaining 15% and 5% ownership interests,
respectively. The purchase method of accounting was used to
record this acquisition. The initial investment included
$300,000 of goodwill and $252,078 organizational costs,
which are being amortized on the straight line method over
five years. At June 30, 1996, the Company evaluated the
underlying value of goodwill and the appropriateness of
amortizing this asset over future periods. Based upon this
evaluation, the Company has determined that the original
basis for carrying goodwill has diminished and therefore
there is no basis for carrying this asset forward to future
years. Accordingly, the unamortized balance of $225,000 was
charged against 1996 income.
F-14
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 7 STYLUS RECORDS (continued)
Through June 30, 1995, the Company advanced approximately
$308,000 for the promotion and record production of its
foundation artist, Ms. Della Miles which represents advance
royalties to Ms. Miles and are recoupable from any advances
and/or future royalties earned for the Company by Ms. Miles.
During fiscal year 1995, Ms. Miles informed the Company,
that she disputes the entire amount of advance royalties and
believes her contract has been breached by the Company
rendering it void. In accordance with SFAS No. 50, the
advance royalties have been expensed.
NOTE 8 RELATED PARTY TRANSACTIONS
In July 1994 the Company repaid all outstanding obligations
to its former Chairman, Mr. Verret totaling $140,794 which
was for advances made to the Company in 1994. In addition,
the Company redeemed 648,624 shares of Common Stock for
$678,743 which had previously been issued to Mr. Verret in
consideration for the repayment of past advances and unpaid
salary.
The Company also repaid the remaining $122,000 balance, plus
interest, on its outstanding note payable to a related party
in July 1994.
For the years ended June 30, 1996 and 1995, the Company
incurred and paid consulting fees of $2,000, in 1996 and
interest payments of $6,571 in 1995, which were
substantially to related parties Additionally, during
fiscal year 1996, Eugene Denari and Timothy Denari, father
and brother of Company president Stephen Denari
respectively, worked for the Company, and Eugene served on
the Board of Directors. As of June 30, 1996 both Eugene and
Timothy Denari had resigned all positions with the Company.
An independent review of all compensation and expenses was
conducted, and both parties and the Company have executed
mutual releases regarding any further financial issues
related to their work for the Company.
NOTE 9 SETTLEMENT OF LEGAL MATTERS
On June 27, 1995 the Securities and Exchange Commission
Division of Enforcement filed a complaint against the
Company, its former CEO and several of its former officers
and employees. The suit was the result of an informal
investigation which commenced in fiscal year 1994 and
alleged, among other things, that between the fall of 1992
and June 1993, First National and certain individual members
then in management disseminated materially false and
misleading information to the public regarding projections
of revenue that the Company would earn from the release of
the animated film Happily Ever After.
F-15
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 9 SETTLEMENT OF LEGAL MATTERS (continued)
The Company entered into an agreement with the SEC to settle
the suit on June 27, 1995. As part of the settlement,
Milton J. Verret agreed to resign as the Company's Chief
Executive Officer, Chief Financial Officer and Chairman of
the Board and is prohibited from attempting to influence
First National's management or shareholders in the
nomination of directors or other corporate matters during
the pendency of the litigation against him. In addition,
Mr. Verret agreed to vote his First National Entertainment
Corp. Common Stock in proportion to the votes cast by the
Company's other shareholders. As a result of the SEC
investigation which began in November, 1994, Jeffrey
Schwaber resigned as President (even though he was not
implicated by the SEC), and Ricky D. Busby and Michael
Swingler resigned as officers and directors. On May 10,
1995 the Company hired Stephen J. Denari as President and
Director and promoted Eugene E. Denari, Jr. (father of
Stephen) to the position of Senior Vice President and
Director and on June 27, 1995, Eugene E. Denari, Jr.
replaced Mr. Verret as Chief Executive Officer, who resigned
as an officer and director.
Pursuant to the terms of the settlement, the Company,
without admitting or denying the allegations of the
complaint, consented to the entry by the court of a final
judgment of permanent injunction against it for the
securities law violations alleged in the complaint. The
Company also agreed to cooperate with the SEC in connection
with any discovery request made by the SEC in its ongoing
litigation against the individual defendants.
Class Action Lawsuit - The Company and its former executive
officers and directors were defendants in a class action
lawsuit which commenced in the United States District Court
for the Eastern District of Pennsylvania. The action was
commenced on July 8, 1993, certified as a class action on
September 8, 1994, and alleged fraud and various violations
of securities laws in connection with the Company's public
disclosures during the period preceding and through the
theatrical release of the film Happily Ever After. The
Company's motion for a change of venue from Philadelphia to
the Western District of Texas was granted on January 31,
1995. The class incorporates all persons who acquired the
Company's Common Stock between March 9, 1993 and June 2,
1993, inclusive. On June 30, 1995, a second shareholder
lawsuit was filed in the United States District Court for
the Western District of Texas (seeking to be certified as a
class action) covering the same facts as the previous
shareholder suit. On December 28, 1995 the Company settled
the first suit for $50,000 in cash and 4,000,000 shares of
common stock, valued at $0.50/share. These amounts plus
legal costs have been recorded in the 1996 statement of
operations as settlement of litigation. The second class
action lawsuit filed on June 30, 1995 has been dismissed by
the plaintiffs based on the settlement of the previous suit.
F-16
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 10 COMMITMENTS AND CONTINGENCIES
The Company received notice from the Screen Actors Guild
that supplemental residuals of 4.5% of the first $1,000,000
and 5.4% of all remaining gross producer receipts are due
them. The Company's entertainment counsel is researching
the matter to determine if the Company has a liability
related to this matter. As of the date of this filing there
has been no determination and the Company believes that, if
any residuals are due, they should be the responsibility of
Lou Scheimer and Filmation (the original producer of the
film) or its succesor in interest.
Contingent Liabilities Against Future Revenues - The Company
has agreed to pay compensation to various parties based on
gross revenues from the film Happily Ever After as follows:
Mr. Lou Scheimer, creator and original owner of Happily
Ever After
Home Video - Forty cents ($.40) for each video cassette
unit sold, up to two million units; thereafter,
twenty-five cents ($.25) for each additional home video unit
sold in excess of two million units;
Video Disc - 15% of producer's gross;
Merchandising - 45% of gross revenue received by the
Company after deductions of licensing commissions and fees.
Technovision Industries Inc., marketing consultant for
Happily Ever After
Home Video - 5% of net Company collection proceeds from
Republic, after partial deductions for Scheimer royalties
American Softworks Corp. for Happily Ever After
Video Games - 50% of net proceeds to the Company after
deductions for manufacturing, marketing, and
distribution by the distributor.
F-17
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 11 CONTINUING OPERATIONS
The Company has historically incurred operating losses, and
to date has an accumulated deficit of approximately $23.6
million. Since new management was installed at the end of
fiscal year 1995, the Company has substantially reduced its
operating overhead by reducing full time staff from 14
permanent and 15 temporary employees to 3 full time
professional staff at the end of fiscal year 1996.
Additionally, the Company's move from over 7,000 square feet
of office facility in Austin to under 1,000 square feet in
the Chicago area has substantially reduced administrative
costs. Settlement of the SEC investigation with no
financial penalties at the end of fiscal year 1995 and the
shareholder class action suit for primarily Company issued
equity in fiscal 1996 leaves the Company with no litigation
pending as of this report.
In August 1995, the Company announced plans to begin a
diversification plan into the retail video store industry.
Several acquisition transactions were closed during the
first half of fiscal year 1996, however, these acquisitions
were later unwound due to the unavailability of debt
financing during the second half of fiscal year 1996.
The Company still intends to enter the retail video store
industry and continues to hold discussions with video store
chain owners who desire to work with the Company to build a
new publicly held chain. The Company is reevaluating its
pricing model as well as seeking alternative financing for
its acquisition plans, taking into account the current
conditions in the retail video store industry. The Company
is currently in negotiations to acquire a new platform video
store chain to serve as a base for its video store
operations. Of course, no assurance can be given as to the
ultimate acceptance of the Company's acquisition strategy
and financing structure by the market place.
The Company's distribution agreement with Republic Pictures
covering Happily Ever After (HEA) expires in October 1996.
The television distribution agreement of HEA previously
reported with Seagull Entertainment was canceled as of June
30, 1996 for lack of performance. The Company is currently
in negotiations with another distributor for both TV and
video rights of this property. Additionally, the Company is
currently in negotiations to produce several new animated
features similar to HEA for direct to video release.
However, these productions will call for the Company to
raise significant additional capital, the availability of
which cannot be assured.
In September 1996, the Company announced that it had
exclusively optioned the screenplay "Chicago Blues" from a
local screenwriter. Financing for this live action feature
is budgeted at $1,000,000 and will be offered via the
formation of Windy City Pictures I, LLC. The Company will
serve as executive producer of this movie and intends to
produce two to three such productions a year in Chicago.
However, no assurance can be given that the funding for this
project or additional movies will be available.
The Company continues to aggressively seek additional
opportunities in the animation, live action movies and
retail video store arenas.
F-18
FIRST NATIONAL ENTERTAINMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996 and 1995
NOTE 12 SUBSEQUENT EVENTS
On October 6, 1996 the Company's Board of Directors approved
and issued an Extension and Optional New Pricing Offer to
the holders of Warrants from its Private Placement of
1,260,000 of the Company's common stock in December 1995.
These 1,260,000 Warrants originally entitled the holders to
purchase an additional share each of the Company's common
stock at a price of $1.00 through an expiration date of
December 15, 1997. The Extension and Optional New Pricing
Offer allows an extension at the same price until December
31, 1998 for no additional consideration OR an extension
until December 31, 1999 at a share price of $.15 for
additional consideration of $.05 per Warrant OR an extension
until December 31, 2000 at a share price of $.05 for
additional consideration of $.10 per Warrant.
NOTE 13 FOURTH QUARTER ADJUSTMENT
During the fourth quarter of fiscal 1996, amortization of
film inventory costs was adjusted to reflect changes in
total estimated revenue from Happily Ever After. Based on
the change in revenue estimates and the related costs
associated with those revenues, net film inventory cost was
reduced by approximately $500,000 and the deferred
production costs for Cinderella ($405,987) were written off
to reflect net realizable value write-downs. No other
significant quarter-to-quarter fluctuations were noted
except for the goodwill write-off described in Note 7. The
changes in estimates made during the fourth quarter are
based on management's plans and estimates for the film.
F-19
