UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2004
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE EXCHANGE ACT
For transition period from _______________ to _______________
Commission File Number: 0-17953
DIAMOND ENTERTAINMENT CORPORATION
(Exact Name of Small Business Issuer as Specified in its Charter)
NEW JERSEY 22-2748019
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
800 Tucker Lane, Walnut California, California 91789
(Address of Principal Executive Offices)
(909) 839-1989
(Issuer's telephone number)
-------------------------
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [ X ] NO [ ]
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of February 11, 2005, there were 595,144,872 shares of common stock, no par value, outstanding, and 483,251 shares of convertible preferred stock, no par value.
Transitional Small Business Disclosure Format (check one):
YES [ ] NO [X]
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
INDEX
Part I. Financial Information
Item 1: Financial Statements
Condensed Consolidated Balance Sheet as of December 31, 2004
[Unaudited] and March 31, 2004
3-4
Condensed Consolidated Statements of Operations for the three months
and nine months ended December 31, 2004 and 2003 [Unaudited]
5
Condensed Consolidated Statements of Cash Flows for nine months ended
December 31, 2004 and 2003 [Unaudited].
6-7
Notes to Condensed Consolidated Financial Statements [Unaudited].
8-19
Item 2: Management's Discussion and Analysis or Plan of Operations
20-26
Item 3: Controls and Procedures.
27
Part II. Other Information
27
Item 6: Exhibits
27
Signatures
28
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, March 31,
2004 2004
------------ -----------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 784,758 $ 109,295
Accounts receivable, net of allowance for
doubtful accounts of $28,241 and $79,462 380,148 878,588
Inventory 628,003 946,925
Due from related parties 121,240 161,111
Prepaid expenses and other current assets 135,095 65,933
------------ -----------
Total current assets 2,049,244 2,161,852
PROPERTY AND EQUIPMENT, less
accumulated depreciation of $812,821 and $762,375 198,898 142,018
FILM MASTERS AND ARTWORK, less
accumulated amortization of $4,475,904 and $4,321,951 510,946 346,883
INVESTMENT IN EQUITY SUBSIDIARY - -
OTHER ASSETS 65,944 39,456
------------ -----------
TOTAL ASSETS $ 2,825,032 $ 2,690,209
============ ===========
The accompanying notes are an integral part of these consolidated financial statements.
3
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
December 31, March 31,
2004 2004
------------ -----------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Bank overdraft $ 47,587 $ 234,365
Accounts payable and accrued expenses 2,056,604 1,986,701
Due to factor 124,515 707,517
Notes payable - current portion 7,577 28,350
Due to related parties - notes payable 515,174 372,374
Customer Deposits 15,722 133,330
------------ -----------
Total current liabilities 2,767,179 3,462,637
Notes payable, Less Current Portion 12,629 -
TOTAL LIABILITIES 2,779,808 3,462,637
------------ -----------
COMMITMENTS AND CONTINGENCIES (Note 5) - -
STOCKHOLDERS' DEFICIENCY
Convertible preferred stock, no par value; 5,000,000 and
5,000,000 shares authorized; 483,251 issued (of which
172,923 are held in treasury) 376,593 376,593
Treasury stock ( 48,803) ( 48,803)
Series A convertible preferred stock, $10,000 per share
stated value; 50 shares authorized; 40 issued and outstanding 471,400 471,400
Series B convertible preferred stock, $10,000 per share
stated value; 87 shares authorized; 0 and 83 issued and
outstanding - 1,101,837
Common stock, no par value; 600,000,000 shares authorized;
595,144,872 and 489,057,359 issued and outstanding 18,569,762 17,319,122
Accumulated deficit (19,323,728) (19,992,577)
------------ -----------
TOTAL STOCKHOLDERS' EQUITY 45,224 ( 772,428)
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS'
DEFICIENCY $ 2,825,032 $ 2,690,209
============ ===========
The accompanying notes are an integral part of these consolidated financial statements.
4
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
December 31, December 31,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
SALES - net $ 2,647,675 $ 1,879,774 $ 5,813,109 $3,698,756
COST OF GOODS SOLD 1,605,120 993,674 3,518,382 2,210,109
----------- ----------- ----------- ----------
GROSS PROFIT 1,042,555 886,100 2,294,727 1,488,647
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 642,751 468,702 1,479,590 1,310,121
----------- ----------- ----------- ----------
PROFIT FROM OPERATIONS 399,804 417,398 815,137 178,526
----------- ----------- ----------- ----------
OTHER INCOME (EXPENSE)
Interest expense (58,596) (76,137) (177,487) (168,680)
Other income (expense) 27,026 - 62,777 -
----------- ----------- ----------- ----------
Total other income (expense) (31,570) ( 76,137) (114,710) (168,680)
----------- ----------- ----------- ----------
NET PROFIT (LOSS) BEFORE PROVISION FOR
INCOME TAXES 368,234 341,261 700,427 9,846
PROVISION FOR INCOME TAXES - - (1,000) -
----------- ----------- ----------- ----------
NET PROFIT $ 368,234 $ 341,261 $ 699,427 $ 9,846
=========== =========== =========== ==========
NET PROFIT PER SHARE -
basic and diluted $ 0.00 $ ( 0.00) $ 0.00 $ ( 0.00)
=========== =========== =========== ==========
WEIGHTED AVERAGE COMMON EQUIVALENT
SHARES OUTSTANDING -
basic and diluted 595,661,883 482,273,653 591,454,417 479,847,405
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
5
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
December 31,
--------------------------
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net profit $ 699,427 $ 9,846
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 204,391 269,280
Provision for doubtful accounts ( 51,221) 27,008
Inventory reserve 183,919 151,142
Changes in certain assets and liabilities (increase) decrease in:
Due from related party 39,871 ( 17,661)
Accounts receivable 549,661 (296,910)
Inventory 135,003 (310,420)
Prepaid expenses and other current assets (69,162) ( 69,144)
Other assets (26,488) ( 5,750)
Increase (decrease) in
Due to factor (583,002) 114,562
Accounts payable and accrued expenses 69,903 720,656
Customer deposits (117,608) ( 22,629)
Other - -
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,034,694 569,980
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (107,326) ( 7,964)
Purchase of film masters and artwork (318,008) (214,059)
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES (425,334) (222,023)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in bank overdraft (186,778) (152,417)
Net repayments of financing agreement -
Proceeds (payments) of notes payable (8,144) ( 28,350)
Proceeds (payments) of notes payable (related party) 142,800 ( 25,000)
Proceeds from the sales of common stock 148,803 -
Payment of Premium for purchase of common stock (30,578) -
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 66,103 205,767
---------- ----------
The accompanying notes are an integral part of these consolidated financial statements.
6
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(UNAUDITED)
For the Nine Months Ended
December 31,
--------------------------
2004 2003
----------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 675,463 142,190
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 109,295 6,900
----------- ----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 784,758 $ 149,090
=========== ==========
SUPPLEMENTAL INFORMATION
CASH PAID FOR:
Interest expense $ 172,452 $ 59,477
=========== ==========
Income taxes $ 16,000 $ 4,602
=========== ==========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Conversion of series B preferred stock into common stock $ 1,100,364 $ (10,000)
Conversion of series B preferred stock into common stock $ 35,000 $ 10,000
The accompanying notes are an integral part of these consolidated financial statements.
7
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Diamond Entertainment Corporation (the "Company"), organized under the laws of the State of New Jersey on April 3, 1986 and its wholly owned subsidiaries:
1) Jewel Products International, Inc. ("JPI") incorporated under the laws of the state of California on November 25, 1991;
2) Saledirect123.com ("Sales Direct") formerly known as Grand Duplication ("Grand"), incorporated under the laws of the state of California on August 13, 1996; and
3) Galaxy Net ("Galaxy"), incorporated under the laws of the state of Delaware on July 15, 1998.
4) E-DMEC Corporation ("e-DMEC") incorporated under the laws of the state of California on April 30,1985.
All intercompany transactions and balances have been eliminated in consolidation.
Interim Financial Statements
The accompanying consolidated financial statements include all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the results of operations for the periods presented. Interim results are not necessarily indicative of the results to be expected for the full year ending March 31, 2005. The consolidated financial statements should be read in conjunction with the consolidated financial statements included in the annual report of the Company on Form 10-KSB for the year ended March 31, 2004.
Nature of Business
The Company is in the business of distributing and selling videocassette/DVD programs, and general merchandise, through normal distribution channels throughout the United States. As of December 31, 2004 and 2003, the Company's management evaluated its operations by two separate product lines to assess performance and the allocation of resources. These product lines have been reflected as two reportable segments as follows:
1. VIDEO/DVD PROGRAMS
The Company distributes and sells videocassette and DVD titles, including certain public domain programs and certain licensed programs. The Company markets its video and DVD programs to national and regional mass merchandisers, department stores, drug stores, supermarkets and other similar retail outlets.
8
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Nature of Business, (Continued)
2. GENERAL MERCHANDISE
The Company, through its wholly owned subsidiary, JPI, purchases and distributes its general merchandise products to mass merchandisers in the U.S. The Company offers its products for limited sale periods and as demand for products change, the Company switches to newer and more popular products. The Company did not record any sales of its general merchandise during the nine months period ended December 31, 2004.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 revenue and expenses during the periods presented. Actual results could differ from those estimates.
Revenue Recognition
The Company records sales when products are shipped to customers and are shown net of estimated returns and allowances. Customer deposits and credits are deferred until such time products are shipped to customers. The Company grants certain distributors limited rights of return and price protection on unsold products. Product revenue on shipments to distributors that have rights of return and price protection is recognized upon shipment by the distributor. The Company also derives sales through consignment arrangements under which it delivers product to the consignment customers' distribution centers and the Company only books sales from consignment sales after such customers deliver the actual funds from consignment sales. Consignment with customers are included in inventory.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.
9
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk are cash and cash equivalents and accounts receivable arising from Company's normal business activities. The Company routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk, establishes an allowance for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited. The Company places its cash with high quality financial institutions and at times may exceed the FDIC $100,000 insurance limit. The Company had deposits as of December 31, 2004 of approximately $612,000 subject to a credit risk with a financial institution and as of March 31, 2004, the Company had no deposits with credit risk beyond the insured amount.
Inventory
Inventory is stated at the lower of cost or market utilizing the first-in, first-out method. Inventory consists primarily of videocassettes, DVDs, general merchandise and patented toys.
Property and Equipment
Property and equipment is presented at historical cost less accumulated depreciation. Depreciation is computed utilizing the straight-line method for all furniture, fixtures and equipment over a five-year period, which represents the estimated useful lives of the respective assets. Leasehold improvements are being amortized over the lesser of their estimated useful lives or the term of the lease.
Film Masters and Artwork
The cost of film masters and related artwork is capitalized and amortized using the straight-line method over a three-year period. Film masters consist of original "masters", which are purchased for the purpose of reproducing videocassettes that are sold to customers. The Company estimates that the approximate useful life of the film masters and artwork is 3 years.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standard ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. Long-lived assets to be disposed of are reported at the lower of carryin g amount or fair value of asset less cost to sell.
10
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Bank Overdraft
The Company maintains overdraft positions at certain banks. Such overdraft positions are included in current liabilities.
Offering Costs
Offering costs consist primarily of professional fees. These costs are charged against the proceeds of the sale of Series A and B convertible preferred stock in the periods in which they occur.
Fair Value of Financial Instruments
For certain of the Company's financial instruments, including accounts receivable, bank overdraft and accounts payable and accrued expenses, the carrying amounts approximate fair value, due to their relatively short maturities. The amounts owed for long-term debt also approximate fair value because current interest rates and terms offered to the Company are at current market rates.
Stock-Based Compensation
The Company accounts for employee stock options in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees". Under APB 25, the Company does not recognize compensation expense related to options issued under the Company's employee stock option plans, unless the option is granted at a price below market price on the date of grant.
In 1996, SFAS No. 123 "Accounting for Stock-Based Compensation", became effective for the Company. SFAS No. 123, which prescribes the recognition of compensation expense based on the fair value of options on the grant date, allows companies to continue applying APB 25 if certain pro forma disclosures are made assuming hypothetical fair value method, for which the Company uses the Black-Scholes option-pricing model.
For non-employee stock based compensation, the Company recognizes an expense in accordance with SFAS No. 123 and values the equity securities based on the fair value of the security on the date of grant. For stock-based awards, the value is based on the market value for the stock on the date of grant and if the stock has restrictions as to transferability, a discount is provided for lack of tradability. Stock option awards are valued using the Black-Scholes option-pricing model.
Income Taxes
Income taxes are provided for based on the liability method of accounting pursuant to SFAS No. 109, "Accounting for Income Taxes." The liability method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the reported amount of assets and liabilities and their tax basis.
11
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net Loss Per Share
SFAS No. 128, "Earnings Per Share," requires presentation of basic loss per share ("Basic LPS") and diluted loss per share ("Diluted LPS"). The computation of basic loss per share is computed by dividing loss available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted loss per share gives effect to all dilutive potential common shares outstanding during the period. The computation of diluted LPS does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on losses.
Segment Disclosure
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," was issued, which changes the way public companies report information about segments. SFAS No. 131, which is based on the selected segment information, requires quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues.
Recent Accounting Pronouncements
On June 29, 2001, SFAS No. 141, "Business Combinations," was approved by the Financial Accounting Standards Board ("FASB"). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Goodwill and certain intangible assets will remain on the balance sheet and not be amortized. On an annual basis, and when there is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. The Company is required to implement SFAS No. 141 on April 1, 2002, and its impact, if any, is not expected to be material, on its financial position or results of operations.
On June 29, 2001, SFAS No. 142, "Goodwill and Other Intangible Assets," was approved by the FASB. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of this statement. The Company is required to implement SFAS No. 142 on April 1, 2002, and its impact on its financial position or results of operations, if any, is not expected to be material.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligation." SFAS No. 143 is effective for fiscal years beginning after June 15, 2002, and will require companies to record a liability for asset retirement obligations in the period in which they are incurred, which typically could be upon completion or shortly thereafter. The FASB decided to limit the scope to legal obligations and the liability will be recorded at fair value. The effect of adoption of this standard on the Company's results of operations and financial positions is being evaluated.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. It provides a single accounting model for long-lived assets to be disposed of and replaces SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." The effect of adoption of this standard on the Company's results of operations and financial positions is being evaluated.
12
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements, (Continued)
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, rather than at the date of commitment to an exit or disposal plan. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect that the adoption of SFAS 146 will have a material impact on the Company's financial position or results of operations, although SFAS 146 may impact the timing of recognition of costs associated with future restructuring, exit or disposal activities.
In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123." SFAS 148 amends Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has included the disclosures required by SFAS 148 in Note 1 - "The Company and Summary of Significant Accounting Policies" and Note 10 - "Stockholders' Equity."
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45") "Guarantor's Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under that guarantee. However, the provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effecti ve for financial statements of interim or annual periods ending after December 15, 2002. The Company has not yet determined the effect of adopting FIN 45 on its results of operations or financial position.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities." Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns. Management is currently evaluating the effect of adopting FIN 46 on its results of operations and financial position.
13
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements, (Continued)
In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables." EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not believe the adoption of EITF 00-21 will have a material impact on its financial position or results of operations.
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus is applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The provisions of this consensus are not expected to have a significant effect on the Company's results of operations or financial position.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities", which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS 149: (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (4) amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be appli ed prospectively. Management does not expect the adoption of SFAS 149 to have a material impact on the Company's financial position, cash flows or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("SFAS 150"). SFAS 150 changes the accounting for certain financial instruments that under previous guidance issuers could account for as equity. It requires that those instruments be classified as liabilities in balance sheets. The guidance in SFAS 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective on July 1, 2003. Management does not expect the adoption of SFAS 150 to have a material impact on the Company's financial position, cash flows or results of operations.
14
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 2 - GOING CONCERN
During the twelve month period ended March 31, 2004 the Company had incurred recurring losses from operations, negative cash flows from operations, a working capital deficit and is delinquent in payment of certain accounts payable. These matters raise substantial doubt about the Company's ability to continue as a going concern.
In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which, in turn, is dependent upon the Company's ability to continue to raise capital and generate positive cash flows from operations. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue its existence.
Management plans to take, or has taken, the following steps that it believes will be sufficient to provide the Company with the ability to continue in existence and mitigate the effects of the uncertainties.
The Company has implemented plans to increase its overall market share of core business and has implemented the following goals and strategies to achieve its plan:
·
Increase its sale of DVD titles by seeking new chain stores and mass merchandiser customers.
·
Attain leadership in the market segment of high quality budget priced distribution of DVD titles.
·
Continue to seek out additional financing sources to support the expected growth in the Company's DVD video product line.
·
Avoid direct competition with larger competitors who sell in the same product categories as the Company, by offering higher quality budgeted price products.
·
Continue to acquire new videocassette and DVD titles for distribution.
The Company believes it can sustain its operations through the fourth quarter of fiscal 2005, when it expects to generate a positive cash flow from operations. The Company is continuing to negotiate with several investors to provide the Company with debt and equity financing for working capital purposes. The principal objective of the Company is to complete the implementation of the above strategies during remaining months of fiscal 2005. Although the Company believes that the outlook is favorable, there can be no assurance that market conditions will continue in a direction favorable to the Company.
NOTE 3 - ACCOUNTS RECEIVABLE
Accounts receivable as of December 31, 2004 and March 31, 2004, net of allowance for doubtful accounts were $380,148 and $878,588, respectively. Substantially all of the accounts receivable as of December 31, 2004 and March 2004 have been factored and pledged as collateral under a factoring agreement.
15
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 3 - ACCOUNTS RECEIVABLE, (Continued)
The Company reviews accounts receivable periodically during the year for collectability. An allowance for bad debt expense and sales returns is established for any receivables whose collection is in doubt or for estimated returns.
As of December 31, 2004 and March 31, 2004, the Company had an allowance for doubtful accounts of $28,241 and $79,462, respectively.
NOTE 4 - INVENTORY
Inventory consisted of the following as of:
December 31,
2004
-------------
Raw materials $ 556,777
Finished goods 483,624
-------------
1,040,401
Less: valuation allowance (412,398)
-------------
Inventory, net $ 628,003
==============
Allowance
An allowance has been established for inventory totaling $412,398. The allowance is primarily for the anticipated reductions in selling prices (which are lower than the carrying value) for inventory which has been:
(a) restricted to specified distribution territories as a result of legal settlements; and
(b) inventory, which has passed its peak selling season.
NOTE 5 - RELATED PARTY TRANSACTIONS
The Company has related party transactions with several officers, directors and other related parties. The following summarizes related party transactions.
Due from related parties:
December 31,
2004
----------
Loan due from - Officer $ 121,240
==========
16
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 5 - RELATED PARTY TRANSACTIONS, (Continued)
Due to related parties - notes payable:
December 31,
2004
------------
a) Note payable - ATRE $ 465,174
b) Convertible note payable - Jeffrey Schillen 50,000
------------
$ 515,174
============
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Royalty Commitments
The Company has entered into various royalty agreements for licensing of titles with terms of one to seven years. Certain agreements include minimum guaranteed payments. For the three months ended December 31, 2004 and 2003, royalty expense was $17,394 and $18,434, respectively, pursuant to these agreements. For the nine months ended December 31, 2004 and 2003, royalty expense was $21,919 and $27,426 respectively, pursuant to these agreements.
Video Agreements
The Company has entered into various agreements to manufacture, duplicate and distribute videos. Commissions are paid based upon the number of videos sold.
NOTE 7 - STOCKHOLDERS’ DEFICIENCY
Common Stock
As of December 31, 2004, the aggregate number of shares of common stock that the Company has authority to issue is 600,000,000 shares with no par value. As of December 31, 2004 and March 31, 2004, 595,144,872 and 489,057,359 shares were issued and outstanding.
For the nine months ended December 31, 2004, the Company had the following significant issuance of its common stock:
On April 15, 2004, the Company concluded several transactions that retired all the outstanding shares of the Company’s Series B Convertible Preferred Shares, noted as follows:
17
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 7 - STOCKHOLDERS’ DEFICIENCY, (Continued)
Common Stock, (Continued)
Three holders of record of the Company’s Series B Convertible Preferred Shares representing an aggregate of 25 Series B Convertible Preferred Shares entered into a Letter Agreement to Convert Preferred Shares, whereby such holders of the Series B Convertible Preferred Shares agreed to convert their respective shares and any liquidated damages and accrued interest in the aggregate amount of approximately $50,000 into shares of the Company’s common stock at $0.01 per share. The holders further agreed to convert their portion of any liquidated damages and accrued interest of approximately $50,000 when the stockholders of the Company approve the increase in the authorized shares of the Company. As part of this letter agreement such holders canceled and returned to the Company warrants to purchase 2,250,000 shares of the Company’s common stock at a price of $.02 per share issued to them in conjun ction with the Series B Convertible Preferred Shares.
Four holders (the “Sellers”) of record of the Company’s Series B Convertible Preferred Shares representing an aggregate of 57 1/2 Series B Convertible Preferred Shares entered into a Securities Purchase Agreement to sell their entire respective portion of the Company’s Series B Convertible Preferred Shares to two accredited investors (the “Buyers”). Under the terms of the Securities Purchase Agreement, the Buyers agreed to convert their respective shares of the Company’s Series B Convertible Preferred Shares into the shares of the Company’s common stock at $0.01 per share. The Sellers canceled and returned to the Company 8,700,000 warrants to purchase the Company’s common stock at price of $0.02 shares in conjunction with the conversion of the Series B Convertible Preferred Shares on the closing date of such purchase agreement, April 15, 2004. The Sellers furthe r agreed to convert liquidated damages and accrued interest in the aggregate amount of approximately $181,000 into shares of the Company’s common stock at $0.01 per share as soon as the stockholders of the Company approve the increase in the authorized shares of the Company. As a result of these conversion transactions, all of the Company’s outstanding Series B Convertible Preferred Shares, which amounted to 82.5 shares, were converted into Approximately 82,353,000 shares of Common Stock at an exercise price of $.01 per share.
On April 1, 2004, the Company sold an aggregate of 22,500,000 shares of the Company’s common stock at a price of $0.01 per share pursuant to subscription agreements dated April 1, 2004. The purchasers were Jeffrey I. Schillen, James Lu and Longview Fund LP, who purchased 2,500,000, 2,500,000 and 17,500,000 shares, respectively.
On April 15, 2004, the Company issued an aggregate of 3,500,000 shares of the Company’s common stock to two of the Company’s consultants for consulting fees owed to the consultants in the aggregate amount of $35,000 pursuant to consulting agreements entered into on December 3, 2001
On October 22, 2004, one of the Company’s stockholders sold 2,265,000 shares of the Company’s common stock to the Company at a price of $.02 per share. The Shareholder owed the Company a note totaling $45,300, which the Company subsequently retired as consideration for the purchase of such shares of common stock it purchased from the stockholder.
The Company issued the foregoing securities in reliance upon the exemption from a registration requirement set forth in Section 4(2) of the Securities Act of 1933.
18
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
NOTE 8 - SEGMENT INFORMATION
The following financial information is reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources. During three months period ended December 31, 2004 and the nine months period ended December 31, 2004, the Company had no activity in its general merchandise segment of its business. During the three months period ended December 31, 2003 and the nine months period ended December 31, 2003, the Company operated in two principal industries:
2004
Video programs and other licensed products
2004
General merchandise
Three Months Ended Nine Months Ended
December 31, December 31,
------------------------ -------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Revenues:
Video programs and other
licensed products $ 2,647,675 $ 1,877,649 $ 5,813,109 $ 3,671,765
Merchandise - 2,125 - 26,991
----------- ----------- ----------- -----------
�� $ 2,647,675 $ 1,879,774 $ 5,813,109 $ 3,698,756
=========== =========== =========== ===========
Cost Of Goods Sold:
Video programs and other
licensed products $ 1,605,120 $ 1,381,936 $ 3,503,382 $ 2,190,561
Merchandise - 314 15,000 19,548
----------- ----------- ----------- -----------
$ 1,605,120 $ 1,382,250 $ 3,518,382 $ 2,210,109
=========== =========== =========== ===========
Profit (Loss) before taxes:
Video programs and other
licensed products $ 372,249 $ 345,470 $ 719,845 $ 50,365
Merchandise ( 4,015) ( 4,209) ( 20,418) (40,519)
----------- ----------- ----------- -----------
$ 368,234 $ 341,261 $ 699,427 $ 9,846
=========== =========== =========== ===========
Depreciation and amortization:
Video programs and other
licensed products $ 75,836 84,143 $ 204,391 $ 271,715
Merchandise - - - -
----------- ----------- ----------- -----------
$ 75,836 $ 84,143 $ 204,391 $ 271,715
=========== =========== =========== ===========
Segment assets:
Video programs and other
licensed products $ 4,041,337 $ 3,905,726 $ 4,041,337 $ 3,905,726
Merchandise ( 1,216,305) (1,569,054) (1,216,305) (1,569,054)
----------- ----------- ----------- -----------
$ 2,825,032 $ 2,336,672 $ 2,825,032 $ 2,279,704
=========== =========== =========== ===========
Expenditure for segment assets:
Video programs and
other licensed products $ 165,439 $ 73,680 $ 425,334 $ 222,023
Merchandise - - - -
----------- ----------- ----------- -----------
$ 165,439 $ 73,680 $ 425,334 $ 222,023
=========== =========== =========== ===========
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Item 2: Management's Discussion and Analysis or Plan of Operations
This Form 10-QSB report contains certain forward-looking statements and information relating to the Company that are based on the beliefs of the Company or management as well as assumptions made by and information currently available to the Company or management. When used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "will," "plan," "should," "seek" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current view of the Company regarding future events and are subject to certain risks, uncertainties and assumptions, including the risks and uncertainties noted. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary m aterially from those described herein as anticipated, believed, estimated, expected or intended. In each instance, forward-looking information should be considered in light of the accompanying meaningful cautionary statements herein.
The following discussion and analysis should be read in conjunction with the Company's consolidated financial statements and related footnotes for the year ended March 31, 2004 included in its Annual Report on Form 10KSB and its Form 10QSB for the three month and six month periods ended June 30, 2004 and September 30, 2004, respectively. The discussion of results, causes and trends should not be construed to imply any conclusion that such results or trends will necessarily continue in the future.
NINE MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH THE NINE MONTHS ENDED DECEMBER 31, 2003:
Results of Operations
EXECUTIVE SUMMARY
During nine months period ended December 31, 2004 and 2003, Diamond Entertainment Corporation d/b/a e-DMEC (the "Company" or "DMEC") operated in two principal industries, a) distribution and sales of DVD/video programs and other licensed programs and b) distribution of certain general merchandise.
DMEC markets and sells a variety of videocassette and DVD (Digital Video Disc) titles to the budget home video and DVD market. Our videocassette and DVD titles include certain public domain programs and certain licensed programs. Public domain programs are video titles that are not subject to copyright protection. Licensed programs are programs that have been licensed by us from a third party for duplication and distribution, generally on a non-exclusive basis. We market our video programs to national and regional mass merchandisers, department stores, drug stores, supermarkets and other similar retail outlets. Our video and DVD products are also offered by consignment arrangements through one large mail order catalog company and one retail chain. Videocassette titles are duplicated in-house and we sub-contract out to U.S. based vendors all replication of our DVD programs.
We are continuing to acquire new licensed video and DVD titles and upgrading the quality of packaging and pre-printed materials in order to enhance our products. During the nine months ended December 31, 2004, DVD program sales and videocassette program sales represented 76% and 24%, respectively, of total sales. For the nine months ended December 31, 2004, Videocassette program sales and DVD program sales increased by 57% and 63%, respectively, when compared to the nine months period ended December 31, 2003.
20
During the nine months ended December 31, 2004, the higher demand for our DVD and videocassette programs from our major customers was the primary reason for our increase in total sales of approximately 57% when compared to the same period a year earlier.
Management believes the higher demand for its Videocassette and DVD product line will continue and increase the overall sales for the Company during the remaining months of fiscal year 2005, however, there is no assurance that this trend will continue nor will the Company be able to maintain its current gross profit margins due to increased competition.
The Company's wholly owned subsidiary Jewel Products International, Inc. ("JPI"), is in the business of distributing certain general merchandise. During the nine months period ended December 31, 2004, JPI did not record any sales of general merchandise products and during the same period a year earlier JPI had minimal sales.
NET SALES
Net sales for the Company were approximately $5,813,000 for the nine month period ended December 31, 2004 as compared to approximately $3,699,000 for the same period a year earlier, an increase of 57%. For the nine months period ended December 31, 2004 and 2003, DVD program net sales were approximately $4,387,000 and $2,802,000 respectively, an increase of 57%. Videocassette net sales, were approximately $1,426,000 and $882,000 respectively, for the nine month period ended December 31, 2004 and 2003, an increase of 62%. The industry shift from videocassette programs to DVD programs together with our expanded DVD library were the primary factors contributing to the increased DVD sales. Increased orders from our major customers contributed to the higher level of videocassette sales.
GROSS PROFIT
Gross profit for the nine months ended December 31, 2004 and 2003 was approximately $2,295,000 and $1,489,000 or 39% and 40% of sales, respectively. The increase in gross profit of approximately $806,000 was primarily the result of increased sales volume. The 1% decrease in the gross profit percentage of sales was primarily the result of lower average sales price of our DVD programs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling expenses for the nine months ended December 31, 2004 and 2003 were approximately $727,000 and $537,000 respectively. The increase in selling expenses of approximately $190,000 (35%) was attributable mainly to higher expense levels in sales commissions, advertising, and freight out arising from higher sales, offset by lower salary expenses and sales. As a percentage to net sales, selling expenses decreased by approximately 2% when compared to the same period a year earlier.
General Administrative expenses for the nine months ended December 31, 2004 and 2003 were approximately $752,000 and $773,000 respectively. The decrease in general administrative expenses of approximately $21,000 (3%) was primarily the result of increases in salaries which were offset by decreases in accounting expenses, provision for bad debts and liquidated damages related to the Company's Series B Preferred Stock.
21
OTHER INCOME AND EXPENSE
Interest expense for the nine months ended December 31, 2004 and 2003 was approximately $177,000 and $169,000 respectively. The increase in interest expense of approximately $8,000 (5%) was primarily the result of increased interest resulting from our factoring arrangement and other short term loans of approximately $36,000 and $17,000 respectively, offset by lower interest of approximately $45,000 resulting from the conversion of all the Series B Preferred Stock. As of December 31, 2004, the outstanding debt of the Company was approximately $660,000 of which approximately $647,000 was classified as current.
Other income for the nine months ended December 31, 2004 was approximately $63,000. The Company did not record any other income in the same period a year earlier. The increase in other income of approximately $63,000 was primarily the result of vendor cash discounts earned and a cash settlement from one of the Company's vendors.
OPERATING PROFIT AND LOSS
Our operating profit for the nine months period ended December 31, 2004 was approximately $815,000 as compared to approximately $179,000 for the same period last year. The increase in the Company's operating profit of approximately $636,000 (355%) arose primarily from an increase in gross profit of approximately $806,000 offset by an increase in operating expenses of approximately $170,000.
NET PROFIT (LOSS) BEFORE PROVISON FOR INCOME TAXES
The Company's net profit before income taxes for the nine months ended December 31, 2004 was approximately $700,000 as compared to a net profit of approximately $10,000 for the same period last year, an increase of 6,900%. The primary reason for the net profit before provision for income taxes at December 31, 2004, was the Company's operating profit of approximately $815,000 and other income and (expense) of approximately ($115,000).
The Company's auditors issued a going concern report for the year ended March 31, 2004. There can be no assurance that management's plans to reduce operating losses will continue or the Company's efforts to obtain additional financing will be successful.
THREE MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH THE THREE MONTHS ENDED DECEMBER 31, 2003:
NET SALES
Net sales for the Company was approximately $2,648,000 for the quarter ended December 31, 2004 as compared to approximately $1,880,000 for the quarter ended December 31, 2003, representing an increase of approximately 41%. DVD program net sales were approximately $1,964,000 for the quarter ended December 31, 2004, as compared to approximately $1,353,000 for the quarter ended December 31, 2003, representing an increase of approximately 45%. Videocassette net sales were approximately $683,000 for the quarter ended December 31, 2004, as compared to approximately $527,000 for the quarter ended December 31, 2003, an increase of approximately 30%. The industry shift from videocassette programs to DVD programs together with our expanded DVD library were the primary factors contributing to the increase DVD sales and increased orders placed by our major customers for videocassette products accounted for such increases. A major customer accounted for approximately 52% of the Company’s net sales for the quarter ended December 31, 2004.
22
GROSS PROFIT
Gross profit was approximately $1,043,000 for the three months ended December 31, 2004 as compared to approximately $886,000 for the three months ended December 31, 2003. The higher gross profit of approximately $157,000 was primarily the result of increased sales. For the three months ended December 31, 2004 and 2003 the gross profit as a percentage of sales was 39% and 47%, respectively. The decrease of the gross profit as a percentage of sales of 8% was primarily the result of lower margins realized from our DVD programs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling expenses for the three months ended December 31, 2004 and 2003 were approximately $319,000 and $243,000 respectively. The increase in selling expenses of approximately $76,000 was primarily caused by the lower salaries, offset by higher expense levels in sales commissions, rent expense, advertising and freight expense.
General and administrative expenses for the three months ended December 31, 2004 and 2003 were approximately $324,000 and $226,000 respectively. The increase in general administrative expenses of approximately $98,000 was primarily the result of increases in salaries, legal fees, accounting expenses and sales taxes which were offset by decreases in health insurance and liquidated damages related to the Company's Series B Preferred Stock.
OTHER INCOME AND EXPENSE
Interest expense for the three months ended December 31, 2004 and 2003 was approximately $59,000 and $76,000 respectively. The decrease in interest expense of approximately $17,000 was primarily the result of decreased interest arising from the conversion of our Series B preferred shares during June 2004.
Other income for the three months ended December 31, 2004 was approximately $27,000. The Company did not record any other income in the same period a year earlier. The increase in other income of approximately $27,000 was primarily the result of vendor cash discounts earned and a cash settlement from one of the Company's vendors.
OPERATING PROFIT
Our operating profit for the three months ended December 31, 2004 was approximately $400,000 as compared to approximately $417,000 for the same period last year. The decrease in the Company's operating profit of approximately $17,000 arose primarily from an increase in gross profit of approximately $157,000, offset by an increase in operating expenses of approximately $174,000.
NET PROFIT (LOSS) BEFORE PROVISON FOR INCOME TAXES
The Company's net profit before income taxes for the three months ended December 31, 2004 was approximately $368,000 as compared to approximately $341,000 for the same period last year. The primary reason for the net profit before provision for income taxes at December 31, 2004, was the Company's operating profit of approximately $400,000 and other income and (expense) of approximately ($32,000).
23
LIQUIDITY AND CAPITAL RESOURCES
The Company has four primary sources of capital which include 1) cash provided by operations, 2) a factoring arrangement with a financial institution to borrow against the Company's trade accounts receivable, 3) funds derived from the sale of its common stock and 4) a loan arrangement with a related party bearing interest at 10%. Although there can be no assurance, management believes that its revenues will continue to increase during fiscal year 2005 and expects to generate positive cash flows from its operations in the third quarter of fiscal 2005. Management anticipates cash flow provided by operations will be adequate to operate the business for the next twelve months.
Factoring Agreements. On August 30, 1996, the Company entered into a financing agreement with a financial institution for a maximum borrowing of up to $2,500,000. The agreement called for a factoring of the Company's accounts receivable, and an asset-based note related to the Company's inventories. Subsequently, on October 29, 1999, the financial institution sold its financing agreement covering the factoring of the Company's accounts receivable to a factoring institution located in Dallas, Texas. The original financial institution retained the asset-based note related to the Company's inventories, which was subsequently retired by the Company. Substantially all assets of the Company have been pledged as collateral for the borrowings. The cost of funds for the accounts receivable portion of the borrowings with the new factor is a 1.5% discount from the stated pledged amount of each invoice for every 30 days the invoic e is outstanding. Substantially all of the accounts receivable as of December 31, 2004 and March 31, 2004 have been factored or pledged as collateral under the factoring agreement.
As of December 31, 2004 and March 31, 2004 the amount due factor was approximately $125,000 and 708,000, respectively. The decrease of approximately $583,000 was the primarily result of the increase sales to non-factorable customers, together with a decrease in sales to customers that are eligible for factoring.
Related party loan. During the nine month period ended December 31, 2004, the Company borrowed from its principal shareholder, American Top Real Estate Co., Inc. ("ATRE"), a net amount approximately $143,000, which was utilized as working capital to primarily purchase inventory required to support the increase sales during the nine month period ended December 31, 2004. The balance owed to ATRE at December 31, 2004 and March 31, 2004 was approximately $465,000 and $322,000, respectively. The Company plans to pay back a substantial portion of the balance owed at December 31, 2004, during the fourth quarter of fiscal 2005.
American Top Real Estate, Inc. ("ATRE") was formed in March 1989 for the purposes of acquiring, owning and holding real property for commercial development. ATRE does not engage in any other business operations. The Company paid $50,000 for 50% of the issued and outstanding common stock of ATRE. Subsequent loan participation by the investors in ATRE reduced the Company's shareholder interest to 7.67%. The Company's 2003 operations include a write-down of its investment in ATRE, which reduced the Company's investment in ATRE to zero, net of taxes. The write-down resulted from the operating results of ATRE which reduced the Company's investment in ATRE to zero and, as a consequence, the Company's future financial results will not be negatively affected by ATRE's ongoing operations. The Company has no obligation to fund future operating losses of ATRE.
On December 31, 2004 the Company had assets of approximately $2,825,000 compared to $2,690,000 on March 31, 2004. The Company had a total stockholders’ equity of $45,000 on December 31, 2004, compared to a deficiency of $772,000 on March 31, 2004, an increase of stockholders’ equity of approximately $817,000. The increase in stockholders’ equity was the result of recording the net profit of approximately $699,000 for the nine months ended December 31, 2004 and the net proceeds from the issuance of the Company's common stock of approximately $118,000.
24
As of December 31, 2004 and March 31, 2004 the Company's inventory was approximately $628,000 and $947,000, respectively. The decrease in inventory of approximately $319,000 was primarily the result of increase provisions for obsolescence.
As of December 31, 2004 the Company's working capital deficit decreased by approximately $583,000 from a working capital deficit of approximately $1,301,000 at March 31, 2004, to a working capital deficit of approximately $718,000 at December 31, 2004. The decrease in working capital deficit was attributable primarily to increases in cash and a decrease in amounts due factor totaling approximately $1,258,000, offset by a decrease in accounts receivable of approximately $499,000, and other miscellaneous areas totaling approximately $176,000.
On April 15, 2004, we concluded several transactions and as part of the restructuring of our equity capital, all the outstanding shares of the Company's Series B Convertible Preferred Shares were retired, noted as follows:
Three holders of record of the Company's Series B Convertible Preferred Shares representing an aggregate of 25 Series B Convertible Preferred Shares entered into a Letter Agreement to Convert Preferred Shares, whereby such holders of the Series B Convertible Preferred Shares agreed to convert their respective shares and any liquidated damages and accrued interest in the aggregate amount of approximately $50,000 into shares of the Company's common stock at $0.01 per share. The holders further agreed to exercise their portion of any liquidated damages and accrued interest of approximately $50,000 when the stockholders of the Company approve the increase in the authorized shares of the Company. As part of this letter agreement such holders canceled and returned to the Company warrants to purchase 2,250,000 shares of the Company's common stock at a price of $.02 per share issued to them in conjunction with the Series B Convertib le Preferred Shares.
Four holders (the "Sellers") of record of the Company's Series B Convertible Preferred Shares representing an aggregate of 57 1/2 Series B Convertible Preferred Shares entered into a Securities Purchase Agreement to sell their entire respective portion of the Company's Series B Convertible Preferred Shares to two accredited investors, (the "Buyers"). Under the terms of the Securities Purchase Agreement the Buyers agreed to convert their respective shares of the Company's Series B Convertible Preferred Shares into the shares of the Company's Common stock at $0.01 per share. The Sellers canceled and returned to the Company 8,700,000 warrants to purchase the Company's common stock exercisable at price of $0.02 shares in conjunction with their respective Series B Convertible Preferred Shares at the closing date of such purchase agreement on April 15, 2004. The Sellers further agreed to convert liquidated dama ges and accrued interest in the aggregate amount of approximately $181,000 into shares of the Company's common stock at $0.01 per share as soon as the stockholders of the Company approve the increase in the authorized shares of the Company.
As a result of these transactions, all of the Company's outstanding Series B Convertible Preferred Shares, which amounted to 82.5 shares, were converted into approximately 82,353,000 shares of Common Stock at a conversion price of $.01 per share.
On April 1, 2004, the Company sold an aggregate of 22,500,000 shares of the Company's common stock at a price of $0.01 per share pursuant to subscription agreements dated April 1, 2004, entered into with Jeffrey I Schillen, James Lu and Longview Fund LP, to purchase 2,500,000, 2,500,000 and 17,500,000 shares, respectively. Cash proceeds from the sales of 22,500,000 shares common stock was $225,000 less financing expenses and legal fees in connection with the sale of such shares of common stock and the conversion of all the Series B Preferred Shares totaled $95,000, which resulted in a net cash proceeds to the Company of $130,000.
25
On October 22, 2004, one of the Company's stockholders sold 2,265,000 shares of the Company's common stock to the Company at a price of $.02 per share. The Shareholder owed the Company a note totaling $45,300, which the Company subsequently retired as consideration for the purchase of such shares of common stock it purchased from the stockholder.
We will require the approval of our stockholders to increase our authorized shares at a meeting of stockholders or as otherwise permitted under New Jersey law. The Company may be unable to effect any equity financing until it has increased its authorized shares of common stock, or otherwise effected a reverse stock split or similar restructuring transaction. There is no assurance that the Company will be successful in obtaining approval of its stockholders for such an increase, reverse stock split or similar restructuring.
Operations
Cash flows provided by operating activities was approximately $1,035,000 during the nine months period ended December 31, 2004 compared to cash flows provided by operating activities of approximately $570,000 during the nine months period ended December 31, 2003. Cash provided by operating activities for the nine months period ended December 31, 2004 was primarily attributable to the Company's net profit and decrease in accounts receivable, offset by decrease in amount due factor.
The Company has also been experiencing difficulties in paying its vendors on a timely basis. These factors create uncertainty as to whether the Company can continue as a going concern.
Investing
For the nine months ended December 31, 2004 and 2003, investments in masters and artwork were approximately $425,000 and $214,000, respectively. Management continues to seek to acquire new titles to enhance its product lines.
Financing
Cash flows provided by financing activities was approximately $66,000 during the nine months period ended December 31, 2004 compared to approximately $206,000 during the nine months period ended December 31, 2003.
Impact of Inflation
The Company does not believe that inflation had an impact on sales or income during the past several years. Increases in supplies or other operating costs could adversely affect the Company's operations, however, the Company believes it could increase prices to offset increases in costs of goods sold or other operating costs.
26
Item 3: Controls and Procedures
The President/Co-CEO and the Chief Financial Officer of the Company have established and are currently maintaining disclosure controls and procedures for the Company. The disclosure controls and procedures have been designed to ensure that material information relating to the Company is made known to them as soon as it is known by others within the Company.
Our President/Co-CEO and our Chief Financial Officer conduct updates and review and evaluate the effectiveness the Company's disclosure controls and procedures and have concluded, based on their evaluation as of the end of the period covered by this Report, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934. During the last fiscal quarter, there has been no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, these controls.
PART II. OTHER INFORMATION
Item 6. Exhibits
31.1
Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) and 15d-14(a), furnished herewith.
31.2
Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) and 15d-14(a), furnished herewith.
32.1
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.2
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
DIAMOND ENTERTAINMENT CORPORATION
Dated: February 14, 2005
By: /s/ James K.T. Lu
James K.T. Lu
President and Co-Chief
Executive Officer
Dated: February 14, 2005
By: /s/ Fred U. Odaka
Fred U. Odaka
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
28
