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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
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Commission File Number 0-28676
GRAPHIX ZONE, INC.
(Name of Registrant as specified in its charter)
DELAWARE 33-0697932
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
42 CORPORATE PARK, SUITE 200
IRVINE, CALIFORNIA 92614
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number (including area code): (714) 833-3838
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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
shorter period that registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
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The number of shares outstanding of the registrant's only class of Common
Stock, no par value, was 10,629,978 on November 8, 1996.
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GRAPHIX ZONE, INC.
Table of Contents
Form 10-Q for the Quarterly Period Ended September 30, 1996
PART I: FINANCIAL INFORMATION PAGE
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Item 1. Financial Statements
Balance Sheet as of September 30, 1996 and June 30, 1996 3
Statements of Operations for the three-month periods
ended September 30, 1996 and 1995 4
Statements of Cash Flow for the three-month periods
ended September 30, 1996 and 1995 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 8
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings 11
Item 2. Changes in Securities 11
Item 3. Defaults Upon Senior Securities 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Other Information 11
Item 6. Exhibits and Reports on Form 8-K 11
Signatures 13
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GRAPHIX ZONE, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
1996 1996
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Assets
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Cash and cash equivalents $ 701,360 $ 1,288,196
Accounts receivable, net 4,814,756 3,867,268
Inventories 890,049 833,700
Other current assets 388,030 281,883
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Total current assets 6,794,195 6,271,047
Property and equipment, net 636,510 653,833
Intangibles, net 807,302 850,186
Other assets, net 670,212 753,619
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$ 8,908,219 $ 8,528,685
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Liabilities and Stockholders' Equity
------------------------------------
Notes payable $ 750,000 $ 750,000
Accounts payable 2,314,480 2,542,806
Accrued royalties 1,387,466 977,764
Accrued liabilities 862,690 1,159,946
Accrued restructuring charge 122,318 573,461
Deferred revenue 172,476 286,701
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Total current liabilities 5,609,430 6,290,678
Other liabilities 72,037 189,278
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Total liabilities 5,681,467 6,479,956
Stockholders' equity
Preferred stock, $.01 par value, 25,000,000
shares authorized, 1,000 and zero issued
and outstanding at September 30, 1996 and
June 30, 1996, respectively 939,950 -
Common stock, $.01 par value, 100,000,000
shares authorized, 10,629,978 and
10,608,748 issued and outstanding at
September 30, 1996 and June 30, 1996,
respectively 40,125,006 40,189,771
Accumulated deficit (37,838,204) (38,141,042)
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Net stockholders' equity 3,226,752 2,048,729
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$ 8,908,219 $ 8,528,685
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See accompanying notes to consolidated financial statements
3
GRAPHIX ZONE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(Unaudited)
1996 1995
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Net revenues $ 3,455,135 $ 910,607
Cost of revenues 871,820 487,711
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Gross Margin 2,583,315 422,896
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Operating expenses:
Research and development 843,903 743,020
Sales and marketing 919,452 476,009
General and administrative 747,052 629,591
Restructuring charge (263,831) -
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Total operating expenses 2,246,576 1,848,620
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Operating income (loss) 336,739 (1,425,724)
Interest expense, net (33,901) (18,276)
Other income (expense), net - 5,574
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Net income (loss) $ 302,838 $ (1,438,426)
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Income (loss) per share of common stock $ 0.03 $ (0.33)
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Weighted average common shares 10,617,968 4,373,469
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See accompanying notes to consolidated financial statements
4
GRAPHIX ZONE, INC.
CONSOLIDATED STATMENTS OF CASH FLOWS
THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(Unaudited)
1996 1995
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Cash flows from operating activities:
Net income (loss) $ 302,838 $ (1,438,426)
Adjustments to reconcile net income
(loss) to net cash used in
operating activities:
Depreciation and amortization 228,937 146,728
Provision for sales returns
and doubtful accounts (229,678) -
Amortization of discount on
convertible debentures - 9,595
Stock option and warrant
compensation expense - 67,244
Change in operating assets and
liabilities:
Increase in accounts receivable (717,810) (338,761)
Decrease (increase) in inventories (56,349) 51,199
Increase in other current assets (106,147) (3,416)
Decrease in other assets 40,697 15,686
Decrease in accounts payable (228,326) (284,367)
Increase in accrued royalties 409,702 -
Decrease in accrued liabilities (297,256) (70,676)
Decrease in accrued restructuring charge (451,143) -
Decrease in deferred revenue (114,225) (9,838)
Decrease in other liabilities (117,241) -
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Net cash used in operating
activities (1,336,001) (1,855,032)
Cash flows from investing activities:
Purchase of property and equipment (126,020) (23,620)
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Net cash used in investing
activities (126,020) (23,620)
Cash flows from financing activities:
Payments for redemption of stock (75,062) -
Payments on notes payable - -
Proceeds from exercise of stock options
and warrants 10,297 3,613
Proceeds from preferred stock issuances,
net. 939,950 -
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Net cash provided by
financing activities 875,185 3,613
Net Decrease in cash (586,836) (1,875,039)
Cash and cash equivalents at beginning of
period 1,288,196 1,919,102
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Cash and cash equivalents at end of period $ 701,360 $ 44,063
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Supplemental disclosure of cash flow
information
Cash paid during the period for interest $ 73,028 $ -
See accompanying notes to consolidated financial statements
5
GRAPHIX ZONE, INC.
Notes to Consolidated Financial Statements
(Unaudited)
(1) BACKGROUND AND ORGANIZATION
Graphix Zone, Inc. (the "Company") is a Delaware corporation and was
incorporated in January 1996 for the purpose of acquiring Graphix Zone,
Inc., a California corporation (GZ-CA), and StarPress, Inc., a Colorado
corporation (StarPress). The Company is engaged in the development,
production and marketing of CD-ROM and on-line products for the personal
computer industry.
On January 3, 1996 the Company's wholly owned subsidiaries GZ-CA and
StarPress, entered into an Agreement and Plan of Reorganization pursuant to
which both companies would become wholly owned subsidiaries of Graphix
Zone, Inc., a Delaware corporation. All conditions to the merger were met
and on June 28, 1996 the shareholders of both GZ-CA and StarPress approved
the merger (the "Reorganization") which was consummated on that date.
Based upon the capitalization of both GZ-CA and StarPress, at the
consummation of the merger, the former shareholder interests of StarPress
comprised a larger percentage of the outstanding shares of the Company than
the former shareholder interests of GZ-CA, and accordingly StarPress was
deemed the acquiring entity for financial accounting purposes. Accordingly
, the historical financial statements presented herein, prior to the
effective date of the Reorganization are the financial statements of
StarPress. All shares have been adjusted to reflect a .14666 : 1 stock
exchange in connection with the Reorganization.
All references to the "Company" prior to June 28, 1996 relate to StarPress
and Graphix Zone, Inc., a Delaware corporation.
(2) BASIS OF PRESENTATION
The financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission (the "Commission"). Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. The Company
believes that the disclosures are adequate to make the information
presented not misleading when read in conjunction with the Company's
financial statements for the year ended June 30, 1996 included in the
Company's Annual Report on Form 10-K filed with the Commission. The
financial information presented reflects all adjustments, consisting only
of normal recurring adjustments, which are, in the opinion of management,
necessary for a fair statement of the results for the interim periods
presented. Results for the three month period ended September 30, 1996 is
not necessarily indicative of results which may be expected for the full
year.
(3) STOCKHOLDERS' EQUITY
On September 25, 1996, the Company sold 1,000 shares of Series A
Convertible Preferred Stock at $1,000 per share to one accredited investor
in a private equity offering. In addition, the Company granted the
investor a warrant to purchase 69,717 shares of common stock. The
preferred stock is convertible into the Company's common stock, at the
option of the holder, commencing 60 days from the date of issuance based
upon, among other things, the average closing bid price of the Company's
common stock at or near the conversion date. The holder of the preferred
stock is entitled to receive $80 per share per annum which shall be fully
cumulative from the date of issuance. The cash proceeds, net of offering
expenses, were $939,950.
(4) SUBSEQUENT EVENTS
On November 1, 1996, the Company sold 1,525 shares of Series A Convertible
Preferred Stock at $1,000 per share to five accredited investors in a
private equity offering. In addition, the Company granted the investors
warrants to purchase 99,674 shares of common stock. The preferred stock is
convertible into the Company's common stock, at the option of the holders,
commencing 60 days from the date of issuance based upon, among
6
other things, the average closing bid price of the Company's common stock
at or near the conversion date. The holders of the preferred stock are
entitled to receive $80 per share per annum which shall be fully cumulative
from the date of issuance. The cash proceeds, net of offering expenses,
were $1,072,910.
On June 28, 1996 the Company entered into a loan agreement with Silicon
Valley Bank for a $750,000 loan bearing interest at the bank's prime rate
plus 300 basis points. The loan was originally due on October 31, 1996 and
is secured by all of the Company's assets. As of December 12, 1996 the
Company has repaid $350,000 of the loan and the balance was extended to
December 31, 1996. The Company expects to be repay the balance of the
Silicon Valley Bank loan with proceeds from a multi-million dollar credit
facility which the Company is currently in the process of securing (see
below).
On December 11, 1996, the Company received a proposal from a fund to extend
a multi-million dollar credit facility to the Company. The Company
anticipates securing the credit facility by December 31, 1996. Proceeds
from the credit facility will be used to repay the balance of the loan due
to Silicon Valley Bank, to augment working capital and repay other
indebtedness.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
THREE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1995
GENERAL
The Company's business focus and strategy is to become an industry leader
in interactive entertainment. The Company develops and distributes interactive
CD-ROM multimedia products for the growing interactive multimedia segment of the
desktop computer industry. In addition, the Company is developing a network of
Internet music web sites which may create additional revenue streams.
In June 1996, the Company acquired all of the outstanding capital stock of
GZ-CA, a developer and publisher of interactive software titles, in exchange for
5,526,543 shares of the Company's common stock. The total purchase price for
GZ-CA was $23,930,957 (which was determined by the fair market value of GZ-CA
common stock) including acquisition costs of $823,932. The acquisition was
accounted for by the purchase method of accounting.
RESULTS OF OPERATIONS
The following table sets forth items from the Company's Consolidated
Statements of Operations as a percentage of net revenues.
Three Months Three Months
Ended Ended
September 30, 1996 September 30, 1995
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Net revenues 100% 100%
Cost of revenues 25% 54%
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Gross margin 75% 46%
Research and development expenses 24% 82%
Sales and marketing expenses 27% 52%
General and administrative expenses 22% 69%
Restructuring charge (8)% -
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Operating income (loss) 10% (157)%
Interest expense, net 1% 1%
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Net income (loss) 9% (158)%
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NET REVENUES
Net revenues for the three months ended September 30, 1996 increased by
$2,544,528 to $3,455,135 as compared to $910,607 for the three months ended
September 30, 1995. The increase in net revenues of 279% for the quarter ended
September 30, 1996 compared to the same prior year period is a result of the
Reorganization and merger of GZ-CA and StarPress, the acquisition of certain
products from Sony Interactive Entertainment, Inc. (Sony) in November 1995 and
the release of seven new titles in the first three months of fiscal 1997. All
of the aforementioned have increased the Company's catalog of products and
corresponding revenues, particularly the Sony products which accounted for
approximately $1,710,000 of net revenues for the three months ended September
30, 1996.
8
The Company's revenues and income may fluctuate periodically as a result of
the timing of new CD-ROM releases, and external factors such as seasonal buying
patterns. The Company grants certain distributors and retailers certain rights
to return unsold inventory. Consequently, although the Company records revenue
upon shipment, it accrues a reserve based on the Company's estimate of expected
returns.
GROSS MARGIN
Gross margin as a percentage of net revenues was 75% for the three months
ended September 30, 1996 compared to 46% for the comparable prior year period.
The increase in gross margin as a percentage of net revenues is primarily a
result of two factors. First, during the latter half of fiscal 1996 and
continuing in the first quarter of fiscal 1997 the Company has decreased per
unit costs as it gained greater experience in the procurement of product
components and has received improved pricing from vendors based upon increased
production volumes associated with the Company's expanded catalog of products.
Second, net revenue for the three months ended September 30, 1996 included
approximately $279,000 of revenue from OEM/bundling deals for which there is no
direct cost of revenue, aside from royalties, associated. Gross margin may
fluctuate depending upon the component costs and royalty structure of the
specific product mix for any given period. Accordingly, the gross margin as a
percentage of net revenues for the three months ended September 30, 1996 may not
be indicative of future period results.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the three months ended September 30,
1996 increased by $100,883 to $843,903 as compared to $743,020 for the three
months ended September 30, 1995. Although the dollar expenditures between the
comparable periods were relatively stable, research and development expenditures
as a percentage of net revenues decreased from 82% in the first quarter of
fiscal 1996 to 24% for the first quarter of fiscal 1997. The significant
decrease is a result of the increase in net revenues of $2,544,528 in the first
quarter of fiscal 1997 over the same period from fiscal 1996. Research and
development costs may fluctuate depending upon the number of projects in process
in a particular period and the degree of internally developed versus externally
developed or acquired content in the related projects. In the near term, the
Company expects research and development costs to increase in amount and as a
percentage of net revenues.
SELLING AND MARKETING EXPENSES
Selling and marketing expenses for the three months ended September 30,
1996 increased by $443,443 to $919,452 and represented 27% of net revenues as
compared to $476,009 and 52% of net revenues for the three months ended
September 30, 1995. The increase in selling and marketing expenses for the
first quarter of fiscal 1997 as compared to the first quarter of fiscal 1996 is
primarily related to increases in personnel as well as increased participation
in cooperative advertising and marketing programs in order to increase product
awareness and sales. The decrease in selling and marketing costs as a
percentage of net revenues for the first quarter of fiscal 1997 compared to the
first quarter of fiscal 1996 is a result of the Company having established the
core infrastructure and personnel in the sales and marketing departments during
the latter part of fiscal 1996 and reaping certain economies of scale as net
revenues increased. If net revenues increase, the Company expects selling and
marketing costs to increase in amount but remain relatively stable as a
percentage of net revenues.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three months ended September
30, 1996 increased by $117,461 to $747,052 and represented 22% of net revenues
compared to $629,591 and 69% of net revenues for the three months ended
September 30, 1995. Although general and administrative expenses increased
modestly in amount, they decreased significantly as a percentage of net revenues
for the first quarter of fiscal 1997 as compared to the first quarter of fiscal
1996. The decrease as a percentage of net revenues is primarily a result of the
increased revenues, resulting in part from the Reorganization and merger of GZ-
CA and StarPress, and the related elimination of certain duplicate
administrative costs including facility rents and accounting personnel. The
Company expects general and administrative expenses to increase in amount in the
near term as the Company continues to develop its infrastructure.
9
RESTRUCTURING CHARGE
During the second quarter of fiscal 1996, in anticipation of the
Reorganization, the Company adopted a restructuring plan to enhance overall
competitiveness, productivity and efficiency through the reduction of overhead
costs. The total estimated cost of the restructuring charged to operations
during fiscal 1996 was $1,900,000. During the first quarter of fiscal 1997 the
Company reversed $263,831 of the remaining reserve for restructuring related to
facility and equipment leases for its San Francisco facility, which the Company
has subsequently sub-leased.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of liquidity is cash. At September 30,
1996, cash and cash equivalents were $701,360, net working capital was
$1,184,765 and net stockholders' equity was $3,226,752. At June 30, 1996, cash
and cash equivalents were $1,288,196, net working capital deficiency was
$(19,631) and net stockholders' equity was $2,048,729. The decrease in cash and
cash equivalents is primarily a result of the payment of certain obligations
related to the Reorganization and the relatively high concentration of the
revenues for the first quarter of fiscal 1997 occurring in the latter part of
the quarter, offset by the equity infusion of $939,950 discussed below. Cash
used in operations for the three months ended September 30, 1996 was $1,336,001.
Due to substantial up-front costs associated with the development of CD-ROM
titles and Internet web sites, the Company has continually needed to locate
outside sources of liquidity. On September 25, 1996, the Company raised
$939,950, net of offering expenses, through a private equity offering of 1,000
shares of convertible preferred stock and a warrant to purchase 69,717 shares of
common stock to one accredited investor. Additionally, on November 1, 1996, the
Company raised $1,072,910, net of offering expenses, through a private equity
offering of 1,525 shares of convertible preferred stock and warrants to purchase
99,674 shares of common stock to five accredited investors. The proceeds from
the Company's private equity and debt offerings have been and will be used as
working capital to fund the development of future CD-ROM products, royalty
payments on existing titles, expected advance royalty payments to entertainment
content owners for future titles, investment in the Company's Internet strategy
and other costs associated with the continued growth and expansion of the
Company.
On June 28, 1996 the Company entered into a loan agreement with Silicon
Valley Bank for a $750,000 loan bearing interest at the bank's prime rate plus
300 basis points. The loan was originally due on October 31, 1996 and is
secured by all of the Company's assets. As of December 12, 1996 the Company has
repaid $350,000 of the loan and the balance was extended to December 31, 1996.
The Company expects to repay the balance of the Silicon Valley Bank loan with
proceeds from a multi-million dollar credit facility which the Company is
currently in the process of securing (see below).
On December 11, 1996, the Company received a proposal from a fund to extend
a multi-million dollar credit facility to the Company. The Company anticipates
securing the credit facility by December 31, 1996. Proceeds from the credit
facility will be used to repay the balance of the loan due to Silicon Valley
Bank, to augment working capital and repay other indebtedness. Additionally,
the Company is in negotiations with another entity to provide a revolving credit
facility, of up to $2,500,000, based upon a percentage of the Company's accounts
receivable.
The Company's long-term liquidity is principally contingent on its ability
to raise funds through private and public debt and equity offerings and securing
one of the above described credit facilities. Additionally, the Company must
improve the collection period and related aging of its accounts receivables.
Having completed the Reorganization, the Company has and believes it will
continue to generate cost savings thus gradually improving liquidity. The
Company's anticipated liquidity needs are based upon a number of factors,
including the size of the business and related working capital needs, the
extent of CD-ROM and Internet development costs and funding requirements, and
the level of corporate operating costs. The Company believes that, if it can
secure one of the above described credit facilities, its present funding
sources, including the proceeds from the aforementioned private equity
offerings are sufficient to sustain these needs through fiscal 1997.
10
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
On September 25, 1996, and November 1, 1996, the Company sold 2,525
shares of Series A Convertible Preferred Stock for $1,000 per share to
six accredited investors in a private placement pursuant to Sections
4(2) and 4(6) of the Securities Act of 1933 and Regulation D
thereunder. In addition, the Company granted the investors warrants
to purchase up to 169,391 shares of common stock for $4.69 per share.
The holders of Series A Convertible Preferred Stock are entitled to
receive dividends of $80 per share per annum, fully cumulative from
the date of issuance. The cash proceeds of the offering, net of
expenses, were $2,012,860. Tanner Unman Securities acted as placement
agent and was paid a commission of 11 1/2 % of the gross proceeds, and
was reimbursed for certain expenses.
The Series A Convertible Preferred Stock is convertible into shares of
common stock, at the option of the holders, commencing 60 days from
the date of issuance, based on a conversion price equal to the lower
of (a) $3.38 or (b) 80% of the average closing bid price of the
Company's common stock on the five days immediately prior to the
conversion date. As of December 16, 1996, the 2,525 shares of Series
A Convertible Preferred Stock are convertible into 1,137,387 shares of
common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
3.3 Amended and Restated Certificate of
Designations of Series A Convertible
Preferred Stock of Graphix Zone, Inc., dated
September 13, 1996
3.4 Certificate of Amendment of Amended and
Restated Certificate of Designations of
Series A Convertible Preferred Stock of
Graphix Zone, Inc., dated October 28, 1996
10.29 Form of Stock Subscription Agreement among
the Company and each of six private placement
investors
10.30 Form of Common Stock Purchase Warrants for
shares of the Company's Common Stock among
the Company and each of six private placement
investors.
11
10.31 Form of Registration Rights Agreement among
the Company and each of six private placement
investors
10.32 1996 Stock Option Plan, as amended
(b) Reports on Form 8-K.
The Company filed a current report on Form 8-K on July 1, 1996, under Item
5 - Other Events, with respect to the Reorganization.
12
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: December 16, 1996 GRAPHIX ZONE, INC.
By: /S/NORMAN H. BLOCK
--------------------------------------
Norman H. Block, President, Chief
Operating Officer, Interim Chief
Financial Officer and Principal
Financial and Accounting Officer.
13