U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to _________________
COMMISSION FILE NO. 0-22908
BIG ENTERTAINMENT, INC.
(Exact name of small business issuer as specified in its charter)
FLORIDA 65-0385686
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2255 GLADES ROAD, SUITE 237 WEST
BOCA RATON, FLORIDA 33431
(Address of principal executive offices) (zip code)
(561) 998-8000
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 __
As of August 11, 1998, the number of shares outstanding of the issuer's
Common Stock, $.01 par value, was 7,641,082.
BIG ENTERTAINMENT, INC.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE(S)
-------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of June 30, 1998
(unaudited) and December 31, 1997.......................................... 3
Consolidated Statements of Operations for the Three
and Six Months ended June 30, 1998 and 1997 (unaudited) ................... 4
Consolidated Statements of Cash Flows for the
Six Months ended June 30, 1998 and 1997 (unaudited)........................ 5
Notes to Consolidated Financial Statements (unaudited)..................... 6-11
Item 2. Management's Discussion of Financial Condition and Results
of Operations....................................................................12-28
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................................ 29
Item 6. Exhibits and Reports on Form 8-K................................................. 29
Signature ................................................................................. 30
2
BIG ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 233,631 $ 887,153
Subscription receivable from shareholders 500,000 -
Receivables, net 286,811 243,168
Merchandise inventories 1,736,042 2,417,224
Prepaid expenses 415,753 548,206
Franchise fee receivable - 350,000
Other current assets 142,911 163,099
------------ ------------
Total current assets 3,315,148 4,608,850
PROPERTY AND EQUIPMENT, net 3,723,311 4,069,171
INVESTMENT IN NETCO PARTNERS 1,491,059 1,533,567
INTANGIBLE ASSETS, net 157,399 163,393
GOODWILL, net 316,097 325,817
OTHER ASSETS 680,838 531,523
DEFERRED TAX ASSET 1,407,600 1,407,600
------------ ------------
TOTAL ASSETS $ 11,091,452 $ 12,639,921
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,137,531 $ 2,108,202
Revolving line of credit 818,405 535,000
Accrued professional fees 137,952 205,313
Other accrued expenses 409,698 559,050
Deferred revenue 269,154 523,301
Current portion of loan from shareholder/officer 970,500 85,000
Current portion of capital lease obligations 1,009,969 768,714
------------ ------------
Total current liabilities 4,753,209 4,784,580
------------ ------------
CAPITAL LEASE OBLIGATIONS, less current portion 1,817,476 1,803,344
------------ ------------
LOAN FROM SHAREHOLDER/OFFICER, less current portion 500,000 -
------------ ------------
DEFERRED REVENUE 241,250 315,783
------------ ------------
CONVERTIBLE DEBENTURE, net - 542,250
------------ ------------
MINORITY INTEREST 179,509 90,111
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred Stock, $.01 par value, 540,177 shares authorized; none outstanding - -
Series A variable rate convertible preferred stock, $6.25 stated
value, 217,600 shares authorized, issued and outstanding.
Liquidation preference of $1,562,912. 1,360,000 1,360,000
Series B variable rate convertible preferred stock, $5.21 stated and
liquidation value, 142,223 shares authorized; 122,846 shares issued and
outstanding. 640,000 640,000
Series C, 4% convertible preferred stock, $100 stated value, 100,000 shares
authorized; 20,000 shares issued and outstanding. Liquidation preference
of $2,000,000. 2,000,000 2,000,000
Common stock, $.01 par value, 25,000,000 shares authorized; 7,455,282 and
6,896,340 shares issued and outstanding at June 30, 1998 and December
31, 1997, respectively. 74,553 68,963
Additional paid-in capital 28,555,872 26,258,500
Accumulated deficit (29,030,417) (25,223,610)
------------ ------------
Total shareholders' equity 3,600,008 5,103,853
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,091,452 $ 12,639,921
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
3
BIG ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(Unaudited)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------ ------------------------------
1998 1997 1998 1997
-------------- ------------- -------------- --------------
NET REVENUES $ 2,558,290 $ 1,910,734 $ 5,268,226 $ 3,614,889
COST OF SALES 1,458,925 1,025,697 2,564,450 1,980,102
-------------- ------------- ------------- -------------
Gross profit 1,099,365 885,037 2,703,776 1,634,787
-------------- ------------- ------------- -------------
OPERATING EXPENSES:
Selling, general and administrative 1,973,875 1,406,592 3,920,281 2,553,172
Salaries and benefits 993,361 837,118 2,079,374 1,787,579
Amortization of goodwill and intangibles 7,861 113,151 15,714 226,296
-------------- ------------- ------------- -------------
Total operating expenses 2,975,097 2,356,861 6,015,369 4,567,047
-------------- ------------- ------------- -------------
Operating loss (1,875,732) (1,471,824) (3,311,593) (2,932,260)
EQUITY IN EARNINGS OF NETCO PARTNERS 121,212 1,819,333 290,394 1,822,500
OTHER:
Interest, net (206,536) (70,514) (441,124) (119,622)
Other, net 10,097 9,974 22,794 20,194
-------------- ------------- ------------- -------------
(Loss) income before minority interest (1,950,959) 286,969 (3,439,529) (1,209,188)
MINORITY INTEREST (148,603) (101,759) (242,977) (133,739)
-------------- ------------- ------------- -------------
Net (loss) income $ (2,099,562) $ 185,210 $ (3,682,506) $ (1,342,927)
============== ============= ============= =============
Basic and diluted (loss) earnings per common share $ (0.29) $ 0.02 $ (0.53) $ (0.25)
============== ============= ============= =============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
4
BIG ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,
(Unaudited)
1998 1997
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,682,506) $ (1,342,927)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 515,532 566,628
Equity in net earnings of Netco Partners, net of
(invested)/return of capital 42,508 (1,850,779)
Issuance of compensatory stock options and warrants 15,578 17,662
Recognition of deferred gain (22,794) (20,194)
Amortization of deferred financing costs 61,262 8,314
Amortization of discount on convertible debentures 107,750 -
Minority interest 242,977 133,739
Changes in assets and liabilities:
Receivables 306,357 (41,117)
Prepaid expenses 132,453 278,020
Merchandise inventories 681,182 (120,283)
Other current assets 9,126 (90,070)
Other assets (136,769) (15,414)
Accounts payable (970,671) 282,943
Accrued professional fees (67,361) (27,500)
Deferred revenue (305,886) (81,507)
Other accrued expenses (165,129) (209,800)
------------ ------------
Net cash used in operating activities (3,236,391) (2,512,285)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (109,906) (141,660)
Investment in patents and trademarks - (19,769)
Return of capital from Tekno Books to minority partner (153,579) (149,548)
------------ ------------
Net cash used in investing activities (263,485) (310,977)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from revolving line of credit 283,405 -
Net proceeds from shareholder/officer loan 1,385,500 912,000
Proceeds from the issuance of preferred stock - 480,000
Proceeds received in advance of issuing convertible debentures - 425,000
Net proceeds from issuance of common stock 999,461 -
Dividends on preferred stock (40,000) (40,000)
Net proceeds (repayments) under capital lease obligations 217,988 (219,085)
------------ ------------
Net cash provided by financing activities 2,846,354 1,557,915
------------ ------------
Net decrease in cash and cash equivalents (653,522) (1,265,347)
CASH AND CASH EQUIVALENTS, beginning of period 887,153 1,675,852
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 233,631 $ 410,505
============ ============
SUPPLEMENTAL SCHEDULE OF CASH RELATED ACTIVITIES:
Interest paid $ 254,323 $ 108,811
============ ============
Non-Cash Investing and Financing Activities:
During the six months ended June 30,1998 the Company entered into capital
lease transactions totaling $37,399.
During the six months ended June 30,1998 the Company recorded dividends on
Series A and B Convertible Preferred Stock in the amount of $84,301 which
were paid through the issuance of 17,251 shares of common stock.
During the six months ended June 30,1998 the Company recorded the
conversion of $650,000 of convertible debentures, plus accrued interest,
into 173,568 shares of common stock.
During the six months ended June 30, 1998 Company issued 100,000 shares of
common stock under a private equity line agreement with two investors for
$500,000, less accrued expenses of $74,315. The Company issued 3,000
shares of common stock to the placement agent as part of this
transaction.
During the six months ended June 30,1998 the Company issued 10,430 shares
of restricted common stock valued at $50,000 to an employee.
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
5
BIG ENTERTAINMENT INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION:
In the opinion of management, the accompanying consolidated financial statements
have been prepared by Big Entertainment, Inc. (the "Company") pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations. However,
the Company believes that the disclosures contained herein are adequate to make
the information presented not misleading.
The financial statements reflect, in the opinion of management, all material
adjustments (which include only normal recurring adjustments) necessary to
present fairly the Company's financial position and results of operations.
The results of operations and cash flows for the three and six months ended June
30, 1998 are not necessarily indicative of the results of operations or cash
flows which may be recorded for the remainder of 1998.
The accompanying consolidated financial statements should be read in conjunction
with the Company's audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1997.
(2) DEBT:
In December 1997, the Company established a $5 million credit facility with
BankBoston, which the Company is using to finance the cost of inventories for
its entertainment retail division. The primary obligor on the credit facility is
the Company's wholly owned subsidiary that constitutes the Company's
entertainment retail division, and the Company is guarantor. Availability under
this credit facility is limited to 50%-55% of the cost of retail inventories and
certain other factors. The term of the facility is 48 months. Interest is
payable monthly at the prime rate plus 1% for the first two years (9.5% at June
30, 1998) and the prime rate plus 1/2% for the third and fourth years. The
credit facility includes an annual commitment fee of 1% and a monthly facility
fee of $2,500. In addition, BankBoston received five-year warrants to buy 30,000
shares of the Company's Common Stock at an exercise price of $9.68 per share. As
of June 30, 1998, the Company's outstanding balance on the line of credit was
$818,405, essentially utilizing the then available borrowing base. The facility
is secured by cash, inventory and accounts receivable of the Company's
entertainment retail division. The loan agreement provides for various financial
performance covenants, including maintaining specified levels of working
capital, inventory, gross margin, and earnings before interest, taxes,
depreciation and amortization covenants, all measured by comparison to the
entertainment retail division's business plan, which is subject to modification
from time to time as may be approved by the lender. The loan agreement also sets
forth certain covenants requiring a minimum level of vendor trade support,
limitations on cash dividends paid by the entertainment retail subsidiary to the
Company (other than for overhead allocations), and limitations on capital
expenditures. The Company is out of compliance with certain covenants described
above and is currently in discussion with BankBoston to modify the business plan
originally submitted to BankBoston and have such plan approved by BankBoston in
order to be in compliance with all such covenants throughout 1998. Although
there can be no assurance such modified plan will be approved, the Company does
not anticipate that such covenants and limitations will materially adversely
affect the Company.
6
The Company's Chairman of the Board and Chief Executive Officer and the
Company's Vice Chairman and President have extended a $1.1 million unsecured
line of credit facility to the Company, of which $500,000 is due subsequent to
July 1, 1999. The line of credit bears interest at the JP Morgan Bank prime rate
of interest. In addition, the Company's Chairman of the Board and Chief
Executive Officer and the Company's Vice Chairman and President, previously
represented that they would provide the Company, if required, with an amount not
to exceed $2.5 million during 1998 in order to enable the Company to meet its
working capital requirements for the balance of 1998; provided, however, that
this commitment would terminate in the event the Company raised no less than
$2.5 million from other sources during the year. As of June 30, 1998, the
Company's Chairman of the Board and Chief Executive Officer and the Company's
Vice Chairman and President had advanced $1,470,500 to the Company pursuant to
the line of credit facility and their additional commitment. In August 1998,
since the Company had at that time raised more than $2.5 million from other
sources during 1998, thereby in effect extinguishing the previous commitment,
the Company's Chairman of the Board and Chief Executive Officer and the
Company's Vice Chairman and President further represented that they would
provide the Company, if required, with an amount not to exceed $1.0 million
during the remainder of 1998, under a similar provision that the commitment will
terminate in the event the Company raises no less than $1.0 million from other
sources during the balance of the year. In the event that the Company raises
less than $1.0 million, the dollar amount of the commitment will be reduced on a
"dollar for dollar" basis to the extent of such funds raised by the Company.
This commitment is in addition to the existing $1.1 million credit facility
extended by these executives and in addition to funds available to the Company
under its private equity line of credit discussed in note 3. Any such working
capital financing provided to the Company by the Company's Chairman and Chief
Executive Officer and the Company's Vice Chairman and President will be upon
terms negotiated and agreed to between them and the Company's Board of
Directors.
During May 1998, the Company entered into a sale/leaseback transaction with
FINOVA Capital Corporation ("FINOVA") for 17 Entertainment Super-Kiosk units.
The Company entered into a similar transaction with FINOVA during 1996 for its
other kiosk units. The terms of the 1998 sale/leaseback transaction are an
aggregate sales price of $600,674, which approximated 75% of the original
invoice cost for the units, a 42-month lease term, monthly payments
approximating $18,300, and a $1 buy-out at the end of the lease term. The net
proceeds to the Company after all transaction costs were $582,640.
In August 1997, the Company issued a $650,000 4% convertible debenture to a
single institutional investor. The debenture was convertible by the holder into
shares of the Company's Common Stock at a conversion price based on the current
market price of the Company's Common Stock at the time of conversion. During the
period from February through May 1998, the debenture holder converted the entire
$650,000 debenture plus accrued interest into a total of 173,568 shares of
Common Stock. In conjunction with issuance of the debenture, the buyer received
warrants to buy 32,499 shares of Common Stock at exercise prices ranging from
$6.00 to $6.53 per share. The warrants expire March 2, 2003. The Company
recorded the convertible debenture net of a discount of $215,500 attributable to
the intrinsic value of the nondetachable conversion feature. The discount was
amortized as interest expense from the date of issuance through April 1998. As
of June 30, 1997, $425,000 had been advanced to the Company by this investor
prior to the issuance of the convertible debenture.
(3) COMMON STOCK:
In March and April, 1998, the Company sold 248,053 shares of its Common Stock to
five accredited investors for gross proceeds of $1,037,500. In conjunction with
the sale of these shares, the Company issued five-year warrants to three
investors to purchase 55,000 shares of the Company's Common Stock at $4.66 per
share. Expenses related to the issuance of these securities totaling $37,500
were accrued. The holders of the above warrants have the right at any time
during the one year period from the date said warrants were issued to exchange
the warrants for an aggregate of 22,145 shares of Common Stock.
On June 30, 1998, the Company entered into a private equity line of credit
agreement with two accredited investors. Pursuant to this agreement, these
investors issued irrevocable commitments to purchase $1,500,000 of Common Stock
of the Company over a one-year period and on June 30, 1998 these investors
purchased an initial 100,000 shares of the Company's Common Stock at the market
price of $5.00 per share. In conjunction with establishment of the equity line
of credit, the Company issued warrants to these investors to purchase 45,000
shares of the Company's Common Stock for an average price of $2.89 per share.
The exercise price of the warrants for 20,000 of the shares is subject to
reduction depending on the number of initial shares of the Company's Common
Stock that the investors still own 6 months subsequent to their initial
purchase. All
7
of the warrants are exercisable for a three-year period beginning December 1,
1998. The gross proceeds of $500,000 from the sale of these securities were
received in July 1998. Expenses related to establishment of the equity line of
credit and for the issuance of the initial securities pursuant to this line of
credit totaling $74,315 were accrued as of June 30, 1998. In addition, the
Company issued 3,000 shares of Common Stock to the placement agent as part of
this transaction. As of June 30, 1998 these investors remain obligated to invest
an additional $1,000,000 in the Company's Common Stock. The Company is under no
obligation to sell these shares to the investors, but may elect to do so in the
future based on its need for capital and the price of the Company's Common
Stock. The remaining shares may be put by the Company to the investors at a
price based on the market price of the Company's Common Stock, subject to
various restrictions and provisions concerning frequency of the puts, maximum
individual put amounts and a minimum market price for the Company's Common
Stock. No additional warrants will be issued in conjunction with the remaining
shares.
(4) FRANCHISE FEE INCOME:
Net revenues for the six months ended June 30, 1998 include franchise fee income
of $350,000 as the Company received $350,000 as a territorial exclusivity fee
under its amended franchise agreement with its franchisee for the Phoenix,
Arizona market. The Company is not obligated to provide any additional support
to the franchisee under this agreement.
(5) NETCO PARTNERS
The Company owns a 50% interest in a joint venture called NetCo Partners. NetCo
Partners is engaged in the publishing and licensing of entertainment properties
including TOM CLANCY'S NET FORCE. NetCo Partners has entered into numerous
licensing agreements for TOM CLANCY'S NET FORCE including book publishing
agreements with The Berkley Publishing Group, Books on Tape, Inc. and various
foreign publishers, an ABC television mini-series agreement, a product placement
agreement with the Dodge division of Chrysler Corporation, and a toy licensing
agreement with Playmates Toys, Inc. NetCo Partners recognizes revenues pursuant
to these contracts when the earnings process has been completed based on the
terms of the various contracts. During the quarter ended June 30, 1997, NetCo
Partners recorded significant revenues related to the TOM CLANCY'S NET FORCE
licensing agreements as this was the quarter in which the project had progressed
to the point where revenues had been earned. The revenues, gross profit and net
income of NetCo Partners for the three and six months ended June 30, 1998 and
1997 are presented below:
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
----------------------------------- ------------------------------
1998 1997 1998 1997
----------- ------------- ----------- ------------
Revenues $ 323,000 $ 4,225,000 $ 780,944 $ 4,231,149
Gross Profit 270,555 3,643,923 637,422 3,650,258
Net Income 242,424 3,638,665 580,789 3,645,000
8
As of June 30, 1998, NetCo Partners has $3,702,714 in accounts receivable.
Management of NetCo Partners believes that these receivables will be collected
in full and no reserves have been established.
Cash flow generated by NetCo Partners is split equally by the Company and its
50% partner. As of June 30, 1998, the Company has received cumulative profit
distributions from NetCo Partners since its formation totaling $1,700,304 in
addition to reimbursement of substantially all amounts advanced by the Company
to fund the operations of NetCo Partners.
(6) EARNINGS (LOSS) PER COMMON SHARE:
Basic earnings (loss) per common share is computed by dividing net earnings
(loss) after deducting dividends applicable to preferred stock, by the weighted
average number of common and common equivalent shares outstanding.
Diluted earnings per common share for the three months ended June 30, 1997 were
determined on the assumption that stock options and warrants outstanding were
exercised during the three months ended June 30, 1997, increasing the weighted
average shares outstanding.
The following table sets forth the computation of basic and diluted earnings
(loss) per share for the three and six months ended June 30, 1998 and 1997:
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE
------------------------------------ --------------------------------
1998 1997 1998 1997
----------- ---------- ------------ -----------
Numerator for Basic and Diluted Earnings (Loss) per Share:
Net Earnings (Loss) $ (2,099,562) $ 185,210 $ (3,682,506) $(1,342,927)
Less: Preferred Stock Dividends (62,383) (52,179) (124,301) (103,502)
------------ ----------- ------------ -----------
Earnings (Loss) Available to
Common Shareholders $ (2,161,945) $ 133,031 $ (3,806,807) $(1,446,429)
============ =========== ============ ===========
Denominator for Diluted Earnings (Loss) per Share:
Weighted Average Shares 7,330,713 5,880,956 7,152,910 5,875,836
Effect of Dilutive Securities:
Stock Options and Warrants - 48,378 - -
------------ ----------- ------------ -----------
Adjusted weighted Average Shares
and Assumed Conversions 7,330,713 5,929,334 7,152,910 5,875,836
============ =========== ============ ===========
Basic and Diluted Earnings
(Loss) per Share $ (0.29) $ 0.02 $ (0.53) $ (0.25)
============ =========== ============ ===========
The inclusion of convertible preferred shares as dilutive securities would have
an antidilutive effect on the earnings per share calculation and has therefore
been excluded from the calculation for the three and six months ended June 30,
1998 and 1997.
9
Options and warrants to purchase shares of Common Stock were not included in the
computation of loss per share for the three and six months ended June 30, 1998
and for the six months ended June 30, 1997 because the result would be
antidilutive.
(7) RECENTLY ISSUED ACCOUNTING STANDARDS:
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income," was issued by the Financial Accounting Standards Board in
June 1997. This Statement establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company has adopted SFAS 130 beginning January, 1
1998. For the periods being reported on, comprehensive income and net income are
the same.
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and Related Information," was issued by the
Financial Accounting Standards Board in June 1997. This Statement establishes
standards for reporting of selected information about operating segments in
annual financial statements and requires reporting of selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company will adopt SFAS 131 beginning
with the annual financial statements for the year ended December 31, 1998. The
Company is currently evaluating the additional disclosure which will be provided
pursuant to SFAS 131.
(8) FORMATION OF HUGE ENTERTAINMENT:
In March 1998, the Company, C.P. Group, and Dr. Martin H. Greenberg, CEO of
Tekno Books and a director of the Company, agreed to contribute certain assets
to a newly formed entity, Huge Entertainment, in exchange for equity ownership
and an aggregate of $8 million in promissory notes from Huge Entertainment. In
exchange for 51.75% of the equity of Huge Entertainment and a promissory note in
the amount of $4,140,000, the Company is contributing (i) 100% of the
intellectual properties presently owned by the Company, (ii) the Company's 50%
ownership interest in NetCo Partners, and (iii) the Company's 51% interest in
Tekno Books. In exchange for 46.05% of the equity of Huge Entertainment and a
promissory note in the amount of $3,684,000, C.P. Group is contributing (i) its
50% ownership interest in NetCo Partners, and (ii) one additional intellectual
property, TOM CLANCY'S TOP SECRET. In addition, the Company and C.P. Group have
agreed that TOM CLANCY'S CYBERNATION, an intellectual property that was created
as part of the creative process of developing TOM CLANCY'S NET FORCE, will also
be contributed to Huge Entertainment. In exchange for 2.20% of the equity in
Huge Entertainment and a promissory note in the amount of $176,000, Dr. Martin
H. Greenberg is contributing a 24.5% ownership interest in Tekno Books. The
formation of Huge Entertainment has been approved by the Company's Board of
Directors. It is anticipated that the transaction will be completed during the
second half of 1998. Plans are for Huge Entertainment to go public via an IPO of
Huge Entertainment securities although there can be no assurance that Huge
Entertainment will successfully complete an IPO or any other financing.
The promissory notes bear interest at the Citibank, N.A. prime rate and mature
in seven years. Any payments on the notes will be made pro rata to all note
holders. The notes provide for optional prepayment without penalty and mandatory
prepayment (except in certain limited circumstances) in the event of an initial
public offering or other issuance of equity by Huge Entertainment.
(9) INCOME TAXES:
A deferred tax asset and income tax benefit of $1,407,600 was recorded in the
fourth quarter of 1997. As a result of the transaction discussed above, net
income of approximately $4.1 million is expected to be generated which will
utilize a portion of the loss carryforward that exists as a result of operating
losses generated from inception (January 22, 1993) to June 30, 1998, thus
generating a deferred tax asset.
10
(10) COMMITMENTS AND CONTINGENCIES:
The Company has aggressively pursued closure of its marginal entertainment
retail kiosks and has closed 13 kiosks since June 30, 1998. The Company is
currently negotiating with a national retail chain that has expressed an
interest in either acquiring or entering into a joint venture for the available
kiosks and kiosk lease locations, and with its lessors to obtain assignment of
and/or release from certain of its lease obligations, which are typically
short-term in duration. Due to the uncertainty surrounding the outcome of these
negotiations, the Company has not established a reserve for the closure of these
kiosks as the Company is unable to estimate the cost associated with termination
of the leases and any write-down of the closed kiosks which may be appropriate
pending the outcome of these negotiations.
(11) RECLASSIFICATION:
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 classification.
(12) SUBSEQUENT EVENT:
In July 1998, several members of the Company's Board of Directors made a direct
investment for consideration totaling $800,000 (or $5.00 per share,
approximating market price at the time) in the Company for the purchase of
160,000 shares of the Company's Common Stock and warrants to acquire 80,000
shares of the Company's Common Stock for $5.00 per share at any time over the
next 5 years.
11
ITEM 2. MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The following discussion contains, in addition to historical information,
"forward-looking statements" with respect to Big Entertainment, Inc. ("Big
Entertainment" or the "Company") which represent the Company's expectations or
beliefs, including, but not limited to, statements concerning industry
performance, the Company's operations, performance, financial condition, growth
and acquisition strategies, margins, and growth in sales of the Company's
products. For this purpose, any statements contained in this report that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the generality of the foregoing, words such as "may," "will,"
"expect," "believe," "anticipate," "intend," "could," "estimate," or "continue"
or the negative or other variations thereof or comparable terminology are
intended to identify forward-looking statements. These statements by their
nature involve substantial risks and uncertainties, certain of which are beyond
the Company's control, and actual results may differ materially depending on a
variety of important factors. Such factors include, but are not limited to, the
Company's limited availability of cash and working capital; operating losses and
accumulated deficit; limited operating history; risks related to retail
operations; competition; risks related to trademarks and proprietary rights;
dependence on management; dependence on licensees; and other factors discussed
in the Company's filings with the Securities and Exchange Commission.
GENERAL
Big Entertainment is a diversified entertainment company engaged in the
development and licensing of intellectual properties, the development and
licensing of books, and the operation of entertainment-related retail stores.
The Company also has two internet-related ventures, an internet studio store,
which sells entertainment-related products which are also available in the
Company's retail stores, and "mysterypages.com." "Mysterypages.com" is a joint
site promoting one of the Company's publications, MYSTERY SCENE MAGAZINE, and
two other mystery publications. With a combined circulation of over 60,000 for
the three publications, this new site is expected to attract many mystery
readers.
Big Entertainment conducts these activities through the Company and its wholly
and majority-owned subsidiaries, as well as through a joint venture known as
NetCo Partners, in which the Company has a 50% ownership interest. The Company
has agreed to contribute its intellectual properties to a newly formed entity,
Huge Entertainment, which is discussed on page 15. Upon consummation of this
transaction, which is anticipated to be completed during the second half of
1998, the Company will have a 51.75% ownership interest in Huge Entertainment,
and it will conduct all of its intellectual properties activities through Huge
Entertainment.
Pending the consummation of the Huge Entertainment transaction, the Company has
two current operating divisions: the intellectual properties division and the
entertainment retail division.
The intellectual properties division owns the exclusive rights to certain
original characters and concepts, created by best-selling authors and media
celebrities, which it licenses across all media, including books, films and
television, multi-media software, toys and other products. The Company and NetCo
Partners acquire the rights to these intellectual properties pursuant to
agreements that generally grant them the exclusive rights to the intellectual
properties and the right to use the creator's name in the titles of the
intellectual properties (such as TOM CLANCY'S NET FORCE, MICKEY SPILLANE'S MIKE
DANGER, and LEONARD NIMOY'S PRIMORTALS). The intellectual properties division
also includes a book development and licensing operation which focuses on
developing and executing book projects, frequently with best-selling authors,
which books are then licensed for publication to book publishers such as
HarperCollins, Bantam Doubleday Dell, Random House, Simon & Schuster, Viking
Press and Warner Books.
The entertainment retail division operates a chain of retail studio stores and
"Entertainment Super-Kiosks" that sell entertainment-related merchandise. In
addition, the Company has an agreement with The ABC Television Network ("ABC"),
a division of The Walt Disney Company ("Disney") pursuant to which the
entertainment retail division runs ABC video clips on the television monitors in
the Entertainment Super-Kiosks in exchange for promotional and advertising spots
on ABC affiliate television stations.
12
INTELLECTUAL PROPERTIES DIVISION
INTELLECTUAL PROPERTIES & LICENSING ACTIVITIES. The Company's intellectual
properties have been acquired and developed pursuant to agreements with
best-selling authors and media celebrities, which agreements generally grant the
Company all rights (including the rights to all media such as print, television,
film, video, on-line, merchandise, etc.) to the original intellectual property.
The Company actively seeks to license the intellectual properties to third
parties including book publishers, film studios, television networks, etc. for
use in various media. The Company is generally obligated to pay the authors or
celebrities fees based on amounts received by the Company from licensing to
third parties the rights to produce other products featuring the intellectual
properties. The Company seeks when possible to license its intellectual
properties on terms that provide to the Company advance payments against
royalties to be earned and that minimize or eliminate the Company's additional
development costs going forward.
The Company's intellectual properties include, among others: LEONARD NIMOY'S
PRIMORTALS; GENE RODDENBERRY'S XANDER IN LOST UNIVERSE; ISAAC ASIMOV'S I-BOTS;
MICKEY SPILLANE'S MIKE DANGER; JOHN JAKES' MULLKON EMPIRE; ANNE MCCAFFREY'S
ACORNA: THE UNICORN GIRL; MARGARET WEIS' TESTAMENT OF THE DRAGON; NEIL GAIMAN'S
MR. HERO - THE NEWMATIC MAN; NEIL GAIMAN'S TEKNOPHAGE; NEIL GAIMAN'S LADY
JUSTICE; NEIL GAIMAN'S ADAM KAIN; and NEIL GAIMAN'S WHEEL OF WORLDS. Gene
Roddenberry is the creator of STAR TREK/Trademark/.
The Company's licensing agreements include:
/bullet/ A joint CD-ROM publishing venture with Sierra On-Line, one of the
largest worldwide publishers of interactive entertainment, productivity
and educational software, for an interactive CD-ROM of LEONARD
NIMOY'S PRIMORTALS.
/bullet/ An initial joint publishing agreement with HarperCollins, one of the
largest publishers in the world and a division of The News Corporation,
to publish hardcover books, paperback books, and/or illustrated novels
for ANNE MCCAFFREY'S ACORNA: THE UNICORN GIRL; ISAAC ASIMOV'S I-BOTS,
and MARGARET WEIS' TESTAMENT OF THE DRAGON, and a second agreement with
HarperCollins for publication of additional novels in the ANNE
MCCAFFREY'S ACORNA series.
/bullet/ A publishing agreement with Warner Books, a division of Time Warner,
Inc., for LEONARD NIMOY'S PRIMORTALS.
/bullet/ A film licensing agreement with Pressman Films for MICKEY SPILLANE'S
MIKE DANGER. (Pressman Films may co-produce and/or co-distribute this
property as a feature film or television series in conjunction with
Miramax Films, a division of Disney.) Pressman Films is expected to
produce this film in 1999.
/bullet/ A joint publishing agreement with Miramax Books and Hyperion Books,
both divisions of Disney, for publication of a book based on MICKEY
SPILLANE'S MIKE DANGER.
/bullet/ A licensing agreement with Books on Tape, Inc. for production of
unabridged audio recordings of two prose novels based on ANNE
MCCAFFREY'S ACORNA: THE UNICORN GIRL.
/bullet/ Various foreign licensing agreements for publication of both LEONARD
NIMOY'S PRIMORTALS and ANNE MCCAFFREY'S ACORNA: THE UNICORN GIRL.
Other significant licensing activities are carried out by the Company through
its NetCo Partners joint venture. These licensing activities are discussed on
pages 17-18 herein.
13
BOOK DEVELOPMENT AND LICENSING. Big Entertainment conducts its book development
and licensing activities through its 51%-owned subsidiary, Tekno Books. Tekno
Books is a leading developer of fiction and non-fiction books, with
approximately 985 books published to date (including approximately 75 books
published during 1997 and approximately 30 books published during the first half
of 1998) and approximately another 180 books under contract that are
forthcoming. Tekno Books is not a book publisher itself, and therefore it does
not bear the expenses and risks of a typical book publisher. Instead, Tekno
Books works to develop concepts, frequently in conjunction with one or more
best-selling authors and/or media celebrities, which it then licenses to a
publisher for publication. In addition, Tekno Books provides the Company with
access to a number of best-selling authors. Tekno Books has worked with
approximately 50 New York Times best-selling authors, including Tom Clancy,
Jonathan Kellerman, Dean Koontz, Tony Hillerman, Robert Ludlum and Scott Turow,
and numerous media celebrities, including David Copperfield, Louis Rukeyser and
Willard Scott. These books have been published with more than 60 publishers
(including HarperCollins, Bantam Doubleday Dell, Random House, Simon & Schuster,
Viking Penguin and Warner Books), translated into 31 languages, and selected by
22 different book clubs. Tekno Books is also a leading producer of novels and
anthologies in the science fiction, fantasy, mystery, horror and western genres.
Tekno Books recently entered into several agreements through which it plans to
expand the scope of its projects. In September 1997, the Company entered into an
agreement with a company owned by Magic Johnson, June Bug Enterprises, Inc.,
which provides for pro basketball star Magic Johnson to develop textbooks,
children's books, novels, and action figure cartoon characters with special
appeal to children. Current plans are for Magic Johnson to work with Tekno Books
to develop a series of educational textbooks with material presented by Magic
Johnson as well as a series of children's books and novels. The textbooks are
expected to use examples from sports to illustrate important concepts and
enliven student interest and enthusiasm. The Company is currently in discussions
with various publishing houses to license these works. To the extent not borne
by the publishers, Tekno Books will advance all costs associated with the
development of these books and projects while the net proceeds (after agent's
fees and reimbursement of costs advanced by Tekno Books) will be divided equally
between Tekno Books and June Bug Enterprises, Inc.
In November 1997, Tekno Books entered into an agreement with MGM Consumer
Products granting Tekno Books the right to publish books based on the past,
present and future properties from the film and television show libraries of
Metro-Goldwyn-Mayer Studios, United Artists Corporation, Orion Pictures
Corporation, and Goldwyn Entertainment, Inc. As part of this contract, Tekno
Books acquired the right to use the MGM name and trademark in connection with
the books published. The initial contract is for 15 months with an automatic
renewal provided Tekno Books is in compliance with the terms of the contract.
Tekno Books will pay MGM a royalty based on the net profits generated from the
books. Several books are currently being developed based on the rights granted
to Tekno Books under the MGM contract. The first three books, which are based on
the MGM property POLTERGEIST: THE LEGACY, which is presently airing on Showtime,
are scheduled to be published beginning in 1999.
Also during 1997, Tekno Books, through its wholly-owned subsidiary, Tekno Books
International, LLC, entered into an agreement with The Classica Foundation, a
Russian charitable organization. The Classica Foundation holds the only
catalogue of archived documents contained in the Russian archives consisting of
millions of documents that were captured by the Soviets from the German archives
at the end of World War II. This agreement with The Classica Foundation grants
Tekno Books International, LLC the exclusive use of this catalogue to the
Russian archives, and the right to copy the materials contained therein for use
in licensing to publishers rights to publication of books and for licensing
rights for CD-ROMs, on-line, documentaries, television specials and feature
films based on these materials. Tekno Books has developed an extensive list of
major book projects that can be developed from these archives including books
about various topics such as the German military, German intelligence activities
before and during World War II, the attempt to kill Hitler in 1944, the Nazi
party, Hitler's personal papers and correspondence, Germany's plan for the
occupation of England and German-Vatican relations. Many of these topics also
have the potential to be developed as CD-ROMs, television specials and feature
films. Work has begun on several
14
book projects based on the archived materials. The Company and Tekno Books
intend to donate copies of any documents related to the Holocaust or any profit
derived therefrom to appropriate Holocaust-related charitable organizations.
Tekno Books paid $100,000 in 1997 and another $100,000 during the first quarter
of 1998 to secure these rights through March 12, 1999. Tekno Books
International, LLC has an option, and under certain circumstances an obligation,
to extend this agreement through 2005 for an additional payment of $300,000,
payable in March 1999. There is one additional 5-year option also available for
another $500,000 payment. One-half of the payments to Classica are advances to
be credited against The Classica Foundation's 50% profit participation.
FORMATION OF HUGE ENTERTAINMENT LLC. In March 1998, the Company, C.P. Group, and
Dr. Martin H. Greenberg, CEO of Tekno Books and a director of the Company,
agreed to contribute certain assets to a newly formed entity, Huge
Entertainment, in exchange for equity ownership in Huge Entertainment and an
aggregate of $8 million in promissory notes from Huge Entertainment. Huge
Entertainment is a pure-play content company that will focus on obtaining
additional intellectual properties and the development and licensing of
intellectual properties in multiple media formats. In exchange for 51.75% of the
equity of Huge Entertainment and a promissory note in the amount of $4,140,000
from Huge Entertainment, the Company is contributing to Huge Entertainment (i)
100% of the intellectual properties presently owned by the Company, (ii) the
Company's 50% ownership interest in NetCo Partners, and (iii) the Company's 51%
interest in Tekno Books. In exchange for 46.05% of the equity of Huge
Entertainment and a promissory note in the amount of $3,684,000, C.P. Group is
contributing to Huge Entertainment (i) its 50% ownership interest in NetCo
Partners and (ii) one additional intellectual property, TOM CLANCY'S TOP SECRET.
In addition, the Company and C.P. Group have agreed that TOM CLANCY'S
CYBERNATION, an intellectual property that was created as part of the creative
process of developing TOM CLANCY'S NET FORCE, will also be contributed to Huge
Entertainment. In exchange for 2.20% of the equity in Huge Entertainment and a
promissory note in the amount of $176,000, Dr. Martin H. Greenberg is
contributing a 24.5% ownership interest in Tekno Books.
The $8 million amount was mutually agreed to by the Company, C.P. Group, and Dr.
Greenberg, and represents an estimate of the portion of the anticipated net
proceeds from an initial public offering ("IPO") of Huge Entertainment that will
be distributed to the Company, C.P. Group, and Dr. Greenberg (subject to
underwriters' consent if paid from any such IPO proceeds), and still leave
adequate liquidity and capital resources in Huge Entertainment for its growth
strategy, and such $8 million is not indicative of the total valuation of Huge
Entertainment. There can be no assurance or guarantee that any such IPO will
occur. The promissory notes bear interest at the Citibank, N.A. prime rate and
mature in seven years. Any payments on the notes will be made pro rata to all
note holders. The notes provide for optional prepayment without penalty and
mandatory prepayment (except in certain limited circumstances) in the event of
an IPO or other issuance of equity by Huge Entertainment.
The formation of Huge Entertainment has been approved by the Company's Board of
Directors. It is anticipated that the transaction will be completed during the
second half of 1998. Plans are for Huge Entertainment to go public via an IPO of
Huge Entertainment securities although there can be no assurances that Huge
Entertainment will successfully complete an IPO or any other financing.
ENTERTAINMENT RETAIL DIVISION
The Company operates mall-based retail stores which sell entertainment-related
merchandise including apparel, jewelry, art, collectibles, novelty items, and
books. The merchandise is based on movies and television shows such as Star
Wars/Trademark/, Star Trek/Trademark/, X-Files/Trademark/, South Park/Trademark/
and Batman/Trademark/. The Company operates two different retail formats -
Entertainment Super-Kiosks and in-line studio stores. The Entertainment
Super-Kiosks feature an innovative futuristic design intended to create an
exciting shopping environment that encourages browsing and impulse purchases.
The Entertainment Super-Kiosks average 166 square feet in size. During the
fourth quarter of 1997, the Company opened three prototype in-line studio
stores. The new format in-line studio store prototype, at approximately 3,000
square feet, is significantly larger than the Entertainment Super-Kiosks and
enables the Company to offer a broader array of merchandise targeted at a wider
segment of the market.
15
The Company currently operates 13 mall-based retail stores consisting of nine
Entertainment Super-Kiosks and four in-line stores, including the three new
prototype studio stores and one mini in-line store. This represents a
significant reduction in the number of locations open, as the Company has
aggressively pursued closing its marginal kiosk locations throughout 1998,
including 13 locations which have been closed since June 30, 1998. To date in
1998, the Company has eliminated approximately 100 positions, primarily store
employees, as a result of the reduction in the number of kiosks. Other expense
savings from the reduction in kiosks include reduced travel and distribution
costs. The benefits of these cost reductions will be realized during the second
half of 1998. Unlike a typical retail store, a closed kiosk can be temporarily
placed in storage and later redeployed to a more desirable location, or possibly
sold. The Company is currently in discussions with a national retail chain that
has expressed an interest in the available kiosks and related leases upon terms
to be negotiated, and with its landlords for assignment of and/or release from
certain of the leased locations. Such discussions could possibly encompass a
sale or joint venture (to be managed and funded by the national retail chain) of
the entire kiosk operation. This would permit the Company to focus its retail
efforts exclusively on the in-line studio stores. There can be no assurances
that such plans will be effectuated. The Company currently plans to open three
in-line studio stores during the balance of 1998 with the primary focus being
expansion of the in-line studio store concept going forward. The Company
believes that its in-line studio store expansion will enable it to more quickly
achieve economies of scale in the entertainment retail division as a result of
the higher average sales per store and through more efficient utilization of
retail field and administrative employees. The Company's retail store strategy
is to seek prime locations in regional and major shopping malls in geographic
areas determined by management as having desirable demographic characteristics.
ABC PROGRAMMING AGREEMENT. In March 1997, the Company entered into an exclusive
programming agreement with ABC, a division of Disney. Under this programming
agreement, on May 1, 1997, the Company commenced running two times each hour on
the video monitors at each of its Entertainment Super-Kiosks, a 12-minute
programming segment provided by ABC and its local affiliate television stations.
The programming is devoted to upcoming television programs to appear on ABC
(including ABC Entertainment, ABC News, ABC Daytime and ABC Sports) and its
affiliate stations and new, non-repetitive programming is provided to the
Company each month. The Company also agreed to display ABC's logo and other
promotional materials complementing the then-current video monitor campaigns. In
exchange for its agreement to run the ABC programming exclusively, ABC affiliate
stations in the markets where the Company's Entertainment Super-Kiosks are
located run promotional and advertising spots on the ABC affiliate stations
featuring the Company's Entertainment Super-Kiosks and in-line studio stores.
The Company also agreed to sell selected ABC products featuring the ABC logo or
its programs (such as "Home Improvement" t-shirts and "Monday Night Football"
caps), in its retail outlets. The Company believes that this arrangement with
ABC provides its Entertainment Super-Kiosks with a steady source of current
programming for the Entertainment Super-Kiosks that appeals to the target
customers, at no cost to the Company. Additionally and most importantly, the
promotional spots featuring the Company's entertainment retail stores run by the
ABC affiliate stations provide the Company with substantial television
advertising in the markets where the retail units are located at no cash expense
to the Company.
FRANCHISING. All of the Big Entertainment retail stores are currently operated
by the Company. As part of its expansion strategy, the Company has entered into
a franchise agreement dated December 1995 between the Company and a private
investor. This agreement was amended in December 1997. Under the amended
agreement, this private investor has the exclusive rights to open Big
Entertainment in-line studio stores in the Phoenix, Arizona market area in
exchange for a $350,000 territorial exclusivity fee. The amended agreement
requires the franchisee to open the first store by December 1999 and to open one
store each year thereafter in order to preserve the exclusivity. The Company has
the option to reacquire rights to the Phoenix, Arizona territory prior to
December 31, 1998, provided no such franchised units have already opened, by
issuing the franchisee 100,000 unregistered shares of the Company's Common
Stock. Management has represented that it does not intend to exercise this
option. The territorial exclusivity fee of $350,000 was received and recorded as
income during the first quarter of 1998. The franchise agreement provides for a
continuing royalty payable to the Company based upon sales.
The Company signed a second franchise agreement on May 1, 1997, for the
Philadelphia area with a private investor.
INTERNET STUDIO STORE. The Company developed an on-line studio store to market a
large number of the products currently sold in the Company's retail outlets over
the internet. The Company tested the online studio store during the fourth
quarter of 1997 and has been working to re-design the store throughout most of
1998. The Company is currently entering into an agreement in principle with an
internet entrepreneur to sell one-third of the Company's internet studio-store
in exchange for $4 million (which will be reinvested in marketing of the
internet studio store on the worldwide web) plus a 50% interest in a related
internet site, "1-800TVPRODUCTS.com." "1-800TVPRODUCTS.com" will market products
featured in direct response television advertisements on the worldwide web.
There are no guarantees or assurances that this transaction will be completed or
be completed on the terms as outlined above.
16
NETCO PARTNERS
The Company also carries out substantial licensing activities through its joint
venture known as NetCo Partners. The Company and CP Group are each 50% partners
in NetCo Partners. Best-selling author Tom Clancy owns 50% of CP Group. NetCo
Partners owns the following intellectual properties: TOM CLANCY'S NET FORCE;
ARTHUR C. CLARKE'S WORLD OF ALEXANDER; TAD WILLIAMS' MIRROR WORLD; CATHY CASH
SPELLMAN'S MILLENIUM; ANNE MCCAFFREY'S SARABAND; and NEIL GAIMAN'S LIFERS.
The most significant licensing agreements currently involve TOM CLANCY'S NET
FORCE, a property owned by NetCo Partners. NetCo Partners reached an agreement
with ABC, a division of Disney, to develop and license a television mini-series
based on TOM CLANCY'S NET FORCE. ABC has hired the executive producers, the
director, the screenwriter and the actors for the mini-series and principal
photography has commenced with actual production scheduled to be completed by
August 31, 1998. The mini-series based on TOM CLANCY'S NET FORCE is currently
scheduled to air for four hours over two nights during the sweeps period in
February 1999 and ABC has begun to sell advertising thereon. The agreement
provides for a license fee to be paid to NetCo Partners when the mini-series
airs plus profit participation for NetCo Partners. All such fees and profit
participation are to be split equally between the Company and C.P. Group, each
of which is a 50% partner of NetCo Partners. ABC advances all costs for
production of the mini-series. In the event that ABC does not air the
mini-series by May 1999, the agreement provides for the payment of $1.6 million
to NetCo Partners. NetCo Partners recognized $1.6 million as income during the
second quarter of 1997 as this was the minimum amount due to NetCo Partners
under the agreement and NetCo Partners has fulfilled all of its obligations to
ABC under the agreement.
In April 1997, NetCo Partners entered into an agreement with The Berkley
Publishing Group ("Berkley"), a division of Penguin Putnam Inc., which is part
of the international media group Pearson plc, to publish a series of up to six
original novels based on TOM CLANCY'S NET FORCE. The contract, with total
maximum advances of $22,000,000, calls for initial publication of the first book
to coincide with the airing of the ABC mini-series referred to above. As of June
30, 1998, NetCo Partners has received cumulative gross advances totaling
$3,000,000 under this contract, which have been distributed as part of NetCo
Partners' normal distributions to the Company and C.P. Group, its partners. An
additional $2,062,500 was received and distributed under this agreement in July
and August 1998. Additional advances become payable based on specific milestones
such as commencement of writing, delivery and acceptance of the manuscripts, and
actual publication of each of the six books. This contract also includes
royalties on paperback sales to be earned by NetCo Partners.
In April 1997, NetCo Partners also entered into a second agreement with Berkley
to publish up to 18 young adult novels based on TOM CLANCY'S NET FORCE. The
contract, with total maximum advances of $900,000, calls for initial publication
of the first book to coincide with the airing of the ABC mini-series referred to
above. An initial advance payment of $450,000 was received by NetCo Partners and
distributed during the quarter ended September 30, 1997, as part of NetCo
Partners' normal distributions to the Company and C.P. Group, its partners.
Additional advances are payable upon publication of each book under this
contract. This contract also includes royalties on paperback sales of the young
adult novels to be earned by NetCo Partners.
Both of the Berkley contracts grant to Berkley only the North American
publishing rights to TOM CLANCY'S NET FORCE. NetCo Partners also plans to
license the rights to TOM CLANCY'S NET FORCE in numerous countries throughout
the world in all major languages. It is currently anticipated that the aggregate
of such foreign licenses will generate approximately 20% to 40% of the revenue
being generated by the North
17
American book licenses referenced above. NetCo Partners has entered into an
agreement with Headline Book Publishing Ltd. ("Headline") for the rights to
publish the first four TOM CLANCY'S NET FORCE novels in the United Kingdom for a
fee of 1.2 million pounds (approximately $2 million). Acceptance of the
manuscripts by Berkley, the North American publisher, is deemed acceptance of
the manuscripts by Headline under this contract. NetCo Partners received gross
advances totaling $489,750 from Headline during the quarter ended March 31, 1998
under this contract, which it distributed to the Company and CP Group, its
partners. This portion of the advances was previously accrued in 1997. NetCo
Partners has also entered into contracts licensing the adult and young adult TOM
CLANCY'S NET FORCE books with four separate licensees for publication of these
books in the German, French, Dutch and Norwegian languages. Total advances under
these agreements aggregate approximately $1,250,000. NetCo Partners continues to
negotiate license agreements for TOM CLANCY'S NET FORCE in other foreign
markets.
NetCo Partners also entered into an agreement with Random House Audio Publishing
to license the audio book rights for the first two TOM CLANCY'S NET FORCE novels
for an aggregate consideration of $600,000. NetCo Partners received gross
advances totaling $300,000 during the quarter ended March 31, 1998 under this
contract, which it distributed to the Company and CP Group, its partners. This
portion of the advances was previously accrued in 1997. NetCo Partners
anticipates licensing additional audio books in the series.
In April 1997, NetCo Partners entered into an agreement with the Dodge division
of Chrysler Corporation regarding placement of Chrysler and Dodge products in
TOM CLANCY'S NET FORCE novels. An initial advance payment of $100,000 was
received by NetCo Partners and distributed during 1997 as part of NetCo
Partners' normal distributions to the Company and C.P. Group, its partners.
NetCo Partners previously entered into an agreement with Playmates Toys, Inc.
("Playmates Toys") to develop, manufacture and market a line of toys based on
TOM CLANCY'S NET FORCE. Playmates Toys, which specializes in boys' action
figures, is currently the master toy licensee of STAR TREK/Trademark/ and
TEENAGE MUTANT NINJA TURTLES/Trademark/. The agreement with Playmates Toys
provides for payment to NetCo Partners of a maximum advance of $1 million. Of
this advance, $250,000 was received and recognized as income during 1997, and
the balance is payable in stages upon meeting certain contingencies. There can
be no assurance that such contingencies can be met, or that the balance of the
advance will be paid. Royalties, which will be offset by any advances so paid,
are based on a percentage of Playmates Toys' receipts on worldwide sales.
NetCo Partners has also entered into an agreement to license TAD WILLIAMS'
MIRRORWORLD to HarperCollins for publication as an illustrated novel.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 ("Q2-98") AS COMPARED TO THE THREE MONTHS ENDED
JUNE 30, 1997 ("Q2-97"), AND SIX MONTHS ENDED JUNE 30, 1998 ("Y2-98") AS
COMPARED TO SIX MONTHS ENDED JUNE 30, 1997 ("Y2-97").
18
The following table summarizes the revenues, cost of sales, gross profit and
equity in earnings of NetCo Partners by division for Q2-98, Q2-97, Y2-98, and
Q2-97, respectively:
INTELLECTUAL ENTERTAINMENT
PROPERTIES RETAIL TOTAL
--------------- --------------- --------------
Q2-98
- -----
Net Revenues $ 750,226 $ 1,808,064 $ 2,558,290
Cost of Sales 397,594 1,061,331 1,458,925
--------------- --------------- --------------
Gross Profit 352,632 746,733 1,099,365
Equity in Earnings of NetCo Partners 121,212 - 121,212
--------------- --------------- --------------
Combined Income $ 473,844 $ 746,733 $ 1,220,577
=============== =============== ==============
Q2-97
- -----
Net Revenues $ 666,677 $ 1,244,057 $ 1,910,734
Cost of Sales 363,133 662,564 1,025,697
--------------- --------------- --------------
Gross Profit 303,544 581,493 885,037
Equity in Earnings of NetCo Partners 1,819,333 - 1,819,333
--------------- --------------- --------------
Combined Income $ 2,122,877 $ 581,493 $ 2,704,370
=============== =============== ==============
Y2-98
- -----
Net Revenues $ 1,145,453 $ 4,122,773 $ 5,268,226
Cost of Sales 533,863 2,030,587 2,564,450
--------------- --------------- --------------
Gross Profit 611,590 2,092,186 2,703,776
Equity in Earnings of NetCo Partners 290,394 - 290,394
--------------- --------------- --------------
Combined Income $ 901,984 $ 2,092,186 $ 2,994,170
=============== =============== ==============
Y2-97
- -----
Net Revenues $ 1,133,679 $ 2,481,210 $ 3,614,889
Cost of Sales 640,004 1,340,098 1,980,102
--------------- --------------- --------------
Gross Profit 493,675 1,141,112 1,634,787
Equity in Earnings of NetCo Partners 1,822,500 - 1,822,500
--------------- --------------- --------------
Combined Income $ 2,316,175 $ 1,141,112 $ 3,457,287
=============== =============== ==============
NET REVENUES
Net revenues (not including revenues attributable to the Company's 50% interest
in NetCo Partners) for Q2-98 increased by 34%, or $647,556, to $2,558,290 from
$1,910,734 for Q2-97. Net revenues for Y2-98 increased by $1,653,337, or 46%, to
$5,268,226 from $3,614,889 for Y2-97. The increase in net revenues is
attributable primarily to growth in the Company's entertainment retail division
coupled with an increase in net revenues in the intellectual properties
division. For Q2-98, revenues generated by the entertainment retail division
comprised 71% of the Company's total revenues while revenues from the
intellectual properties division amounted to 29% of the total. By comparison for
Q2-97, entertainment retail revenues amounted to 65% of the total and
intellectual properties revenues were 35% of the total.
19
GROSS PROFIT
Overall Company gross profit increased by 24%, or $214,328, to $1,099,365 for
Q2-98 from $885,037 in Q2-97. The Company's overall gross profit increased 65%,
or $1,068,989, to $2,703,776 in Y2-98 from $1,634,787 in Y2-97. The increase in
gross profit is primarily due to increases in gross profit in the Company's
entertainment retail division resulting from the impact of the ABC programming
agreement. As a percentage of net revenues, gross profit decreased to 43% in
Q2-98 from 46% in Q2-97.
INTELLECTUAL PROPERTIES DIVISION
The intellectual properties division generates revenues from several different
activities including book development and licensing, licensing, and publishing
MYSTERY SCENE MAGAZINE. In Y2-97, publishing also included minor residual
revenues from publication of comic books, which the Company has discontinued.
The revenue breakdown from these activities is as follows:
Q2-98 Q2-97
--------------------- ---------------------
$ % $ %
------------ ---- ------------ ----
Book Development & Licensing $ 609,293 81% $ 602,102 90%
Licensing 124,571 17 56,092 9
Publishing 16,362 2 8,483 1
------------ ---- ------------ ----
Total $ 750,226 100% $ 666,677 100%
============ ==== ============ ====
Y2-98 Y2-97
--------------------- ---------------------
$ % $ %
------------ ---- ------------ ----
Book Development & Licensing $ 976,904 85% $ 975,592 86%
Licensing 138,171 12 124,146 11
Publishing 30,378 3 33,941 3
------------ ---- ------------ ----
Total $ 1,145,453 100% $ 1,133,679 100%
============ === ============ ====
Book development and licensing represents 81% of the revenues generated by the
intellectual properties division for Q2-98 and 85% for Y2-98. The Company's book
development and licensing activities are conducted through Tekno Books, its 51%
owned subsidiary. Tekno Books focuses on developing and executing book projects,
frequently with best-selling authors, and then licensing the books for
publication with various publishers. Book development and licensing revenues
increased by 1%, or $7,191, to $609,293 for Q2-98 from $602,102 for Q2-97, and
by $1,312, or less than 1%, for Y2-98 from $975,592 for Y2-97 to $976,904 for
Y2-98. While revenues from Tekno Books increased modestly, the Company
anticipates more significant increases in the revenues generated by Tekno Books
in the future due to
20
several new contracts which were entered into during 1997. These contracts
include an agreement with June Bug Enterprises (the "Magic Johnson Agreement"),
an agreement with MGM Consumer Products (the "MGM Agreement"), and an agreement
with The Classica Foundation (the "Tekno Classica Agreement"). Under the Magic
Johnson Agreement, Tekno Books will work with pro basketball star Magic Johnson
to develop a series of educational textbooks with material presented by Magic
Johnson as well as a series of children's books and novels. Under the MGM
Agreement, Tekno Books has the rights to publish books based on the past,
present and future properties from the film and television show libraries of
Metro-Goldwyn-Mayer studios, United Artists Corporation, Orion Pictures
Corporation, and Goldwyn Entertainment, Inc. Several books are currently being
developed pursuant to the MGM Agreement. Under the Tekno Classica Agreement,
Tekno Books, through its wholly-owned subsidiary, may develop books for
licensing to publishers worldwide and license rights to produce CD-ROMs,
documentaries, television specials, and feature films based on archived
documents contained in the Russian archives that were captured from the German
archives at the end of World War II. Tekno Books currently has a lengthy list of
book projects that it plans to develop under the Tekno Classica Agreement, with
several books currently under development.
Licensing revenues (excluding revenues generated by NetCo Partners) increased by
122%, or $68,479, from $56,092 in Q2-97 to $124,571 in Q2-98. Licensing revenues
include advances and royalties received under the Company's various licensing
agreements with HarperCollins, Warner Books, Sierra On-Line, Alliance
Entertainment, Books on Tape, Inc. and various licensees for foreign
publications. Licensing revenues for Q2-98 primarily consisted of advances under
the HarperCollins licensing agreements as two of Big Entertainment's books were
published by HarperCollins in June 1998 - ISAAC ASIMOV'S I-BOTS TIME WAS and the
mass market edition of ANNE MCCAFFREY'S ACORNA: THE UNICORN GIRL. In addition
the manuscript for MARGARET WEIS' DRAGON'S DISCIPLE was delivered to
HarperCollins during Q2-98. The Company also entered into a second agreement
with HarperCollins during Q2-98, pursuant to which two additional books in the
ANNE MCCAFFREY'S ACORNA series will be published. The first book in this series
is in its fourth printing and, after several months in the no. 2 position, it is
still listed on Amazon.com as the no. 6 bestseller in the young adult science
fiction and fantasy category. Advances under the second agreement total
$230,000, of which the $57,500 signature advance was recognized as income during
Q2-98. Licensing revenues for Q2-98 also include secondary publication rights
payments received for publication of ANNE MCCAFFREY'S ACORNA: THE UNICORN GIRL
and LEONARD NIMOY'S PRIMORTALS in various foreign countries. Licensing revenues
for Q2-97 included advances for books to be published by HarperCollins, as well
as royalties from the sales of LEONARD NIMOY'S PRIMORTALS CD-ROM. It is
important to note that licensing revenues generated by NetCo Partners (in which
the Company has a 50% interest) are not included in the above licensing figures,
but rather are included in equity in earnings of NetCo Partners discussed in
more detail on page 23.
Publishing revenues increased by 93%, or $7,879, from $8,483 in Q2-97 to $16,362
in Q2-98. Publishing revenues during Q2-98 consist of revenues from publication
of MYSTERY SCENE MAGAZINE, a mystery-genre trade journal published by the
Company's 51%-owned subsidiary, Fedora, Inc. MYSTERY SCENE MAGAZINE has recently
joined with two other mystery magazines, ELLERY QUEEN MYSTERY MAGAZINE and
ALFRED HITCHCOCK MYSTERY MAGAZINE, in the formation of a combined internet
website called "mysterypages.com," which sells subscriptions to all three
magazines, provides an overview of the current magazine issues, includes
interviews with mystery and suspense authors and contains a message board for
mystery fans to contact their favorite authors. The combined circulation for the
three publications is in excess of 60,000 readers. It will soon be possible to
buy mystery books over the site through an arrangement with Barnes and Noble's
online operation. Publishing revenues decreased by 10%, or $3,563, to $30,378
for Y2-98 from $33,941 for Y2-97. The decrease in publishing revenues on a
year-to-date basis is attributable to the Company's decision to discontinue its
comic book publishing operation due to the sustained losses incurred in the
publication of comic books. The Company began to reduce the number of comic book
titles it published during 1996 and completely ceased publication of all titles
during the first quarter of 1997. The Company has continued to exploit the
intellectual properties which it acquired while publishing comic books through
licensing agreements for illustrated novels with Harper Collins and other media,
as discussed above.
Gross profit for the intellectual properties division (not including the
Company's 50% equity in the earnings of NetCo Partners) increased by 16%, or
$49,088, to $352,632 in Q2-98 from $303,544 in Q2-97 and by 24%, or $117,915, to
$611,590 for Y2-98 from $493,675 for Y2-97. This increase in gross profit for
Q2-98 reflects increased licensing activities with HarperCollins and the
turnaround of publishing to
21
profitability with the elimination of comic book publishing. Cost of goods sold
for Y2-97 included certain residual expenses from the publication of comic
books. While the Company was engaged in comic book publishing, it advanced 100%
of all costs associated with the development of its comic book titles including
character and storyline development, design, writing, and illustration, plus the
Company paid for the printing and distribution of all books, and was responsible
for returns, which are a normal part of the book publishing business. By now
developing its intellectual properties through licensing arrangements, the
Company has essentially limited the costs incurred to payments to writers for
books and teleplays or scripts, and typically funds these costs from advance
payments received from publishers pursuant to licensing agreements. In addition,
Tekno Books provides the editorial function for the books that are licensed,
thereby not requiring additional overhead at the Company's headquarters.
The same holds true for the book development and licensing operation. Production
expenses to publish the books are borne by the publishers. The book development
and licensing operation typically secures the publishing agreements in advance
of determining amounts to be paid to authors and for permissions, thereby
ensuring a profit on the projects based on the up-front advances received, plus
obtaining an ongoing royalty stream for future sales once the advances have been
earned. As a percent of revenues, gross profit increased to 47% in Q2-98 from
46% in the Q2-97, and to 53% in Y2-98 from 43% in Y2-97, reflecting the more
profitable continuing operations of book development and licensing and
licensing.
ENTERTAINMENT RETAIL DIVISION
Net revenues for the Company's entertainment retail division increased by 45%,
or $564,007, to $1,808,064 for Q2-98 from $1,244,057 for Q2-97, and by 66%, or
$1,641,563, to $4,122,773 for Y2-98 from $2,481,210 for Y2-97. Net revenues are
derived from sales of entertainment-related products and merchandise at the
Entertainment Super-Kiosks and in-line studio stores, imputed income from the
ABC programming agreement, and franchise fee income.
The composition of revenues is as follows:
Q2-98 Q2-97
--------------------- ---------------------
$ % $ %
------------ ---- ------------ ----
Retail Sales $ 1,358,064 75% $ 1,244,057 100%
ABC Advertising Income 450,000 25 - -
------------ ---- ------------ ----
$ 1,808,064 100% $ 1,244,057 100%
============ ==== ============ ====
Y2-98 Y2-97
--------------------- ---------------------
$ % $ %
------------ ---- ------------ ----
Retail Sales $ 2,872,773 70% $ 2,481,210 100%
ABC Advertising Income 900,000 22 - -
Franchise Fee Income 350,000 8 - -
------------ ---- ------------ ----
$ 4,122,773 100% $ 2,481,210 100%
============ ==== ============ ====
22
The Company had 26 retail units in operation at June 30, 1998 as compared to 29
units at June 30, 1997. Over the 12 month period from June 30, 1997 to June 30,
1998, the Company closed certain marginal kiosks and opened kiosks in other more
desirable locations. In addition, the Company opened three new in-line studio
stores during the fourth quarter of 1997. These in-line studio stores, which
were not open during Y2-97, are the Company's new prototype retail format.
Retail sales increased by 9%, or $114,007, to $1,358,064 for Q2-98 from
$1,244,057 for Q2-97 and by 16%, or $391,563, to $2,872,773 for Y2-98 from
$2,481,210 for Y2-97. The increase in retail sales was entirely attributable to
the revenues generated by the new in-line studio stores. The additional sales
from the new in-line studio stores were partially offset by the loss of sales
from kiosks that were closed and by a decrease in comparable store sales of 7%
for both Q2-98 and Y2-98. The decline in comparable store sales was principally
caused by lower dollar sales, although unit movement was strong, reflecting
significant mark-downs as part of an effort during the months of March, April
and May of 1998 to move out older merchandise and make room for new merchandise.
In large part as a result of the new fresh merchandise, comparable store sales
for the month of June increased by 11%. Other factors contributing to the sales
turnaround in June include the Company's shift in its merchandising focus to the
core mall customer, quicker reaction to trends in the entertainment industry,
new product sourcing, and an improved merchandise mix.
Net revenues include imputed income from running ABC video clips on the in-store
television monitors in exchange for advertising air time on local ABC affiliate
television stations amounting to $450,000 for Q2-98 and $900,000 for Y2-98. No
revenues were imputed in Q2-97 or Y2-97 as the full barter arrangement with ABC
was not in place at that time. The Company records the estimated fair value of
the air time received from the ABC affiliates as the value of the revenues
earned by playing the ABC video clips in its retail units.
Revenues for the entertainment retail division also include $350,000 of
franchise fee income during Y2-98. This income represents the territorial
exclusivity fee which the Company received during the first quarter of 1998 from
the franchisee for the Phoenix, Arizona territory. Under the Company's agreement
with this franchisee, the franchisee must open at least one store by December
1999 and one store each year thereafter in order to preserve its exclusivity.
The agreement also provides for a continuing royalty based upon sales of the
franchised units, though no franchised units have been opened yet. The Company
is not obligated to provide any additional support to the franchisee under this
agreement.
Gross profit for the entertainment retail division increased by 28%, or
$165,240, to $746,733 for Q2-98 from $581,493 for Q2-97 and by 83%, or $951,074,
to $2,092,186 for Y2-98 from $1,141,112 for Y2-97. As a percentage of
entertainment retail division revenues, gross profit decreased to 41% for Q2-98,
from 47% for Q2-97. The decrease in gross profit margin for Q2-98 stemmed
primarily from the previously discussed mark-downs which were taken in order to
move out older merchandise and make room for new product. For Y2-98, gross
profit margin increased to 51% from 46% in Y2-97 as a result of the impact of
the ABC programming agreement and the franchisee fee income discussed above, for
which there were no offsetting costs included in cost of goods sold. While the
Company contemplates continued promotional activity throughout the remainder of
1998, it believes that the mark-downs for the remainder of the year will not be
as substantial as during the first half of the year.
EQUITY IN EARNINGS OF NETCO PARTNERS
The Company's 50% share in the earnings of NetCo Partners amounted to $121,212
for Q2-98 as compared to $1,819,333 for Q2-97 and $290,394 for Y2-98 as compared
to $1,822,500 for Y2-97. The income in Q2-98 is attributable to revenues
recognized by NetCo Partners from its licensing agreements to publish the first
TOM CLANCY'S NET FORCE novels in the Dutch and Norwegian languages and
additional revenues under the Berkley publishing agreement, net of
product-related and operating expenses. The income in Q2-97 reflects the
revenues recorded for TOM CLANCY'S
23
NET FORCE for the initial signature advances under several of the licensing
agreements (including the ABC mini-series agreement, the Berkley book publishing
agreements, the Playmates Toys agreement and the Dodge product placement
agreement) as Q2-97 was the first quarter in which any revenues were recognized
by NetCo Partners for TOM CLANCY'S NET FORCE. The income recognized by NetCo
Partners during Q2-97 was reflective of the culmination of the efforts to reach
agreements with ABC and Berkley, including acceptance of the ABC teleplay,
thereby enabling NetCo Partners to recognize the sizable signature advances
under the various licensing agreements then in place. NetCo Partners recognizes
revenues when the earnings process has been completed based on the terms of the
various agreements. When advances are received prior to completion of the
earnings process NetCo Partners defers recognition of revenue until the earnings
process has been completed. Costs related to acquisition, development and sales
of intellectual properties and their licensed products are expensed in
proportion to the revenues that have been recognized.
OPERATING EXPENSES
Operating expenses consist of selling, general and administrative expenses,
salaries and benefits and amortization of goodwill and intangibles. Operating
expenses increased by 26%, or $618,236, to $2,975,097 for Q2-98 from $2,356,861
for Q2-97 and by 32%, or $1,448,322, to $6,015,369 for Y2-98 from $4,567,047 for
Y2-97. (Note that $450,000 of the increase in Q2-98 and $900,000 of the increase
in Y2-98 represents non-cash advertising expense imputed under the ABC barter
agreement discussed below. Excluding the non-cash ABC advertising expense
operating expenses increased by $168,236, or 7%, in Q2-98 and $548,322, or 12%,
in Y2-98.) As a percentage of net revenues, total operating expenses decreased
to 116% in Q2-98 from 123% in Q2-97. The Company expects to further reduce this
ratio throughout the balance of 1998 with the closure of its marginal kiosks,
most of which were closed subsequent to June 30, 1998. The increase in total
operating expenses in Q2-98 as compared to total operating expenses in Q2-97
reflects increases in selling, general and administrative expenses and salaries
and benefits of $567,283, or 40%, and $156,243, or 19%, respectively, which were
slightly offset by a $105,290, or 93%, reduction in amortization of goodwill and
intangibles. Of the $567,283 increase in selling, general and administrative
expenses, $242,750, is attributable to occupancy, depreciation and other
store-level expenses for the new in-line studio stores opened during 1997, and
$450,000 of the increase consists of imputed advertising expense under the ABC
barter arrangement. The Company estimates the value of the advertising air spots
that it receives from the ABC affiliate television stations and records this
amount as advertising expense, although the Company does not actually expend any
funds for this advertising. The $156,243 increase in salaries and benefits is
attributable to additional expenses in the entertainment retail division
including the new employees added to staff the new in-line studio stores and the
minimum wage rate increase which was effective September 1, 1997.
INTEREST EXPENSE, NET
Net interest expense increased by 193%, or $136,022, to $206,536 for Q2-98 as
compared to $70,514 for Q2-97 and by 269%, or $321,502, to $441,124 for Y2-98 as
compared to $119,622 for Y2-97, due to additional interest expense for the
inventory line of credit, the shareholder loan, the capital leases entered into
to finance the cost of the new in-line studio stores and the convertible
debenture, including $107,750 of non-cash interest expense pertaining to the
convertible debenture during Y2-98.
NET LOSS
For Q2-98, the Company generated a net loss of $2,099,562 as compared to net
income of $185,210 for Q2-97. For Y2-98, the net loss increased by 174%, or
$2,339,579, to $3,682,506 as compared to a net loss of $1,342,927 for Y2-97. The
single largest factor contributing to the Company's reduced bottom line was the
significant income that was recorded during Q2-97 and Y2-97 as equity in
earnings of NetCo Partners. Q2-97 was the first quarter in which NetCo Partners
recognized any income related to TOM CLANCY'S NET FORCE. The income recognized
by NetCo Partners during Q2-97 was reflective of the culmination of efforts to
reach agreements with ABC and Berkley, including acceptance of the ABC teleplay
for the mini-series, thereby enabling NetCo Partners to recognize sizable
signature advances related to THE TOM CLANCY'S NET FORCE licensing agreements in
place during Q2-97. The Company's 50% share of the income recognized by NetCo
Partners during Q2-97 amounted to $1,819,333. It is anticipated that NetCo
Partners will continue to generate significant revenues from TOM CLANCY'S NET
FORCE, particularly in early 1999 are certain advances payable under the various
TOM CLANCY'S NET FORCE licensing agreements are triggered by the airing of the
ABC television mini-series which is scheduled for February 1999. Other factors
24
contributing to the Company's net loss include an increase in net interest
expense of $136,022 for Q2-98 and $321,502 for Y2-98 and an increase in
operating loss of $403,908 for Q2-98 and $379,333 for Y2-98. Basic and diluted
loss per common share was ($0.29) for Q2-98 as compared to basic and diluted
earnings per share of $0.02 for Q2-97, a decrease of $.31 per share. Basic and
diluted loss per share was ($0.53) for Y2-98 and ($0.25) for Y2-97, a decrease
of $.28 per share.
The Company has made several modifications to its initial business plan in an
effort to reverse the losses that have been sustained since its inception.
During 1997, the Company stopped publishing comic books, an activity that
required a substantial amount of resources and had not proven to be profitable.
Essentially all of the overhead associated with comic book publishing was
eliminated effective with the second quarter of 1997. At the same time, the
Company decided to expand its retail operations with the development of three
prototype in-line studio stores. Substantial resources were devoted to the
development of the three prototype in-line studio stores which opened in the
fourth quarter of 1997, including professional fees and expenses incurred to
design the new stores, the hiring of additional field and administrative
personnel, the selection and acquisition of new hardware and software for a new
retail accounting and merchandising system to be implemented, and the capital
expenditures for the new stores. The Company believes that the in-line studio
store concept will allow it to more quickly achieve economies of scale in its
entertainment retail division as a result of the higher average sales per store
for the in-line studio stores and through more efficient utilization of retail
field and administrative employees. Toward this goal, during the first quarter
of 1998, the Company hired an experienced retail veteran, Andrew S. Bailen, as
Chief Operating Officer for its entertainment retail division. Mr. Bailen has 18
years of progressive retail experience, most recently as Sr. Vice President and
General Merchandise Manager for Blockbuster Entertainment Group. The Company has
also aggressively pursued closing its marginal kiosk locations, and it has
reduced the number of kiosks in operation to nine locations at the present time.
Unlike a typical retail store, a closed kiosk can be temporarily placed in
storage and later redeployed to a more desirable location, or possibly sold. The
Company is currently in discussion with a national retail chain that has
expressed an interest in the available kiosks and related leases upon terms
still to be negotiated and with its landlords for assignment of and/or release
from certain of the leased locations, which leases are typically short-term in
duration. Such discussions could possibly encompass a sale or joint venture
(such joint venture to be managed and funded by the national retail chain) of
the entire kiosk operation, which would permit the Company to focus its retail
efforts exclusively on the in-line studio stores. The Company continues to
acquire and develop its base of intellectual properties, and to negotiate
additional licensing agreements thereon, which while not capital intensive,
requires a substantial amount of time from its senior executives. Most
importantly, the Company has agreed to contribute its intellectual properties to
a newly-formed entity, Huge Entertainment, which is discussed on page 15. The
Company will own 51.75% of Huge Entertainment. Following the formation of Huge
Entertainment, the Company will own an interest in two additional Clancy
properties (in addition to TOM CLANCY'S NET FORCE), one of which was created as
part of the creative process of developing TOM CLANCY'S NET FORCE. The Company
believes that these additional properties will generate significant future
revenues for the Company similar to the revenue stream that NetCo Partners is
currently enjoying from TOM CLANCY'S NET FORCE. While the Company believes that
these measures will ultimately reverse its operating losses, there can be no
assurances that the revenues generated by the intellectual properties and
entertainment retail divisions will be sufficient to offset the associated
expenses incurred.
SHAREHOLDER'S EQUITY
Shareholder's equity decreased 29%, or $1,503,845, to $3,600,008 at June 30,
1998 as compared to shareholder's equity of $5,103,853 as of December 31, 1997.
The decrease in shareholder's equity is attributable to the Company's net loss
for Y2-98 of $3,682,506 offset in part by new shares of Common Stock issued
pursuant to several stock purchase agreements, the equity line of credit, and as
a result of conversion of the Company's $650,000 convertible debenture to Common
Stock.
25
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had cash and cash equivalents of $233,631 and a
working capital deficit of $1,438,061 compared to cash and cash equivalents of
$887,153 and a working capital deficit of $175,730 at December 31, 1997. Net
cash used in operating activities during Y2-98 was $3,236,391 primarily
representing cash used to fund the Company's net loss. Net cash used in
investing activities was $263,485, while $2,846,354 in cash was provided by
financing activities for a total decrease in cash and cash equivalents of
$653,522. During Y2-97, net cash used in operating activities was $2,512,285,
net cash used in investing activities was $310,977, and $1,557,915 in cash was
provided by financing activities.
In December 1997, the Company established a $5 million credit facility with
BankBoston Retail Finance, Inc. ("BankBoston"), which the Company is using to
partially finance the cost of inventories for its entertainment retail division.
The primary obligor on the credit facility is the Company's wholly-owned
subsidiary that constitutes the Company's entertainment retail division, and the
Company is the guarantor. Availability under this credit facility is limited to
50%-55% of the cost of retail inventories and certain other factors. The term of
the facility is 48 months. Interest is payable monthly at the prime rate plus 1%
for the first two years and the prime rate plus 1/2% for the third and fourth
years. In conjunction with the inventory line of credit, the Company issued
5-year warrants to BankBoston to acquire 30,000 shares of the Company's Common
Stock at $9.68 per share. As of June 30, 1998, the Company's outstanding balance
on the line of credit was $818,405, essentially utilizing the then available
borrowing base. The facility is secured by cash, inventory and accounts
receivable of the entertainment retail division. The loan agreement provides for
various financial performance covenants, including maintaining specified levels
of working capital, inventory, gross margin, and earnings before interest,
taxes, depreciation and amortization, all measured by comparison to the
entertainment retail division's business plan, which is subject to modification
from time to time as may be approved by the lender. The loan agreement also sets
forth certain covenants requiring a minimum level of vendor trade support,
limitations on cash dividends paid by the entertainment retail subsidiary to the
Company (other than for overhead allocations), and limitations on capital
expenditures. The Company is out of compliance with certain covenants described
above and is currently in discussion with BankBoston to modify the business plan
originally submitted to BankBoston and have such plan approved by BankBoston in
order to be in compliance with all such covenants throughout 1998. Although
there can be no assurance such modified plan will be approved, the Company does
not anticipate that such covenants and limitations will materially adversely
affect the Company.
In March and April, 1998, the Company issued 248,053 shares of Common Stock to
five accredited investors for gross proceeds of $1,037,500. Expenses related to
the issuance of these securities totaling $37,500 were accrued. In conjunction
with this stock issuance, the Company issued 5-year warrants to three of the
investors to acquire 55,000 shares of the Company's Common Stock at $4.66 per
share. The holders of the above warrants have the right at any time during the
one year period from the date said warrants were issued, to exchange the
warrants for an aggregate of 22,145 shares of Common Stock.
During May 1998, the Company entered into a sale/leaseback transaction with
FINOVA Capital Corporation ("FINOVA") for 17 Entertainment Super-Kiosk units.
The Company entered into a similar transaction with FINOVA during 1996 for its
other kiosk units. The terms of the 1998 sale/leaseback transaction are an
aggregate sales price of $600,674, which approximated 75% of the original
invoice cost for the units, a 42-month lease term, monthly payments
approximating $18,300, and a $1 buy-out at the end of the lease term. The net
proceeds to the Company after all transaction costs were $582,640.
On June 30, 1998 the Company entered into a private equity line of credit
agreement with two accredited investors. Pursuant to this agreement, these
investors issued irrevocable commitments to purchase $1,500,000 of the Company's
Common Stock over a one-year period and on June 30, 1998 these investors
purchased an initial 100,000 shares of the Company's Common Stock at the market
price of $5.00 per share. In conjunction with the establishment of the equity
line of credit, the Company issued warrants to these investors to purchase
45,000 shares of the Company's Common Stock for an average price of $2.89 per
share. The exercise price of the warrants for 20,000 of the
26
shares is subject to reduction to as low as $5.00 per share, depending on the
number of initial shares of the Company's Common Stock that the investors still
own 6 months subsequent to their initial purchase. All of the warrants are
exercisable for a three-year period beginning December 1, 1998. The gross
proceeds of $500,000 from the sale of the 100,000 shares of Common Stock were
received in July 1998. Expenses related to establishment of the equity line of
credit and for the issuance of the initial securities pursuant to this line of
credit totaling $74,315 were accrued as of June 30, 1998. In addition, the
Company issued 3,000 shares of Common Stock to the placement agent as part of
this transaction. As of June 30, 1998 these investors remain obligated to invest
an additional $1,000,000 in the Company's Common Stock. The Company is under no
obligation to sell these shares to the investors, but may elect to do so in the
future based on the Company's need for capital and the price of the Company's
Common Stock. The remaining shares may be put by the Company to the investors at
a price based on the market price of the Company's Common Stock, subject to
various restrictions and provisions concerning frequency of the puts, maximum
individual put amounts and a minimum market price for the Company's Common
Stock. No additional warrants will be issued in conjunction with the remaining
shares.
In July 1998, several members of the Company's Board of Directors made a direct
investment for consideration totaling $800,000 (or $5.00 per share,
approximating market price at the time) in the Company for the purchase of
160,000 shares of the Company's Common Stock and warrants to acquire 80,000
shares of the Company's Common Stock for $5.00 per share at any time over the
next 5 years.
The Company's Chairman of the Board and Chief Executive Officer and the
Company's Vice Chairman and President have extended a $1.1 million unsecured
line of credit facility to the Company, of which $500,000 is due subsequent to
July 1, 1999. The line of credit bears interest at the JP Morgan Bank prime rate
of interest. The Company's Chairman of the Board and Chief Executive Officer and
the Company's Vice Chairman and President had previously committed to provide up
to $2.5 million in additional funds to the Company. This commitment was to be
reduced on a "dollar for dollar" basis to the extent funds were received from
other sources. To date in 1998, the Company has raised gross proceeds in excess
of $2.5 million through the issuance of Common Stock and the FINOVA
sale/leaseback transaction, in effect extinguishing the previous commitment. In
August 1998, the Company's Chairman of the Board and Chief Executive Officer and
the Company's Vice Chairman and President further represented that they would
provide the Company, if required, with an amount not to exceed $1.0 million
during the remainder of 1998 in order to enable the Company to meet its working
capital requirements for the balance of the year; provided, however, that the
commitment will terminate in the event the Company raises no less than $1.0
million from other sources during the balance of the year. In the event that the
Company raises less than $1.0 million, the dollar amount of the commitment will
be reduced on a "dollar for dollar" basis to the extent of such funds raised by
the Company. This commitment is in addition to the existing $1.0 million
available under the equity line of credit. Any such working capital financing
provided to the Company by the Company's Chairman and Chief Executive Officer
and the Company's Vice Chairman and President will be upon terms negotiated and
agreed to between them and the Company's Board of Directors. As of June 30,
1998, the Company's Chairman of the Board and Chief Executive Officer and the
Company's Vice Chairman and President had loaned the Company $1,470,500 pursuant
to the terms of the unsecured line of credit.
The success of the Company's future operations is dependent on its ability to
generate adequate revenue to offset operating expenses. Unless otherwise noted,
the proceeds from the financing transactions described above are for general
corporate purposes. The Company's management expects to require additional
financing for the expansion of its business, and in particular the growth of the
Company's in-line studio stores, and to support working capital requirements of
its retail division in future years. The Company has obtained a commitment for
lease financing for one of the new in-line studio stores opening during the
remainder of 1998 and it is currently exploring financing alternatives for other
future in-line studio store locations, although there can be no assurance that
such financing will be available to the Company or will be implemented on terms
favorable to the Company.
27
YEAR 2000 ISSUES
The Company has initiated, but not completed, its assessment of the impact of
Year 2000 on its business. The majority of the Company's systems consist of
packaged software purchased from vendors, and the critical software is either
already year 2000 compliant or, based on representations from the vendors, on
schedule to be year 2000 compliant by the end of 1998. In addition, the Company
purchased new computer hardware and software during 1997 for its entertainment
retail division as part of the Company's plans to convert to the new studio
store concept. The Company is currently implementing the new retail system, with
implementation scheduled to be complete well in advance of the year 2000. The
new software acquired for the retail division is year 2000 compliant. The
Company is not presently aware of any significant expenditures which will be
necessitated in order to be ready for the year 2000, beyond those already being
incurred to implement the new retail systems.
INFLATION AND SEASONALITY
Although the Company cannot accurately determine the precise effects of
inflation, it does not believe inflation has a material effect on the Company's
sales or results of operations. The Company does, however, consider its business
to be somewhat seasonal and expects net revenues to be generally higher during
the second and fourth quarters of each fiscal year for its Tekno Books book
development and licensing operation as a result of the general publishing
industry practice of paying royalties semi-annually. The Company's entertainment
retail business is also seasonal with the holiday season accounting for the
largest percentage of annual net sales. In addition, although not seasonal, the
Company's intellectual properties division and NetCo Partners both experience
significant fluctuations in their respective revenue streams, earnings and cash
flow as a result of the significant amount of time that is expended in the
creation and development of the intellectual properties and their respective
licensing agreements. While certain of the development costs are incurred as
normal recurring operating expenses, the recognition of licensing revenue is
typically triggered by specific contractual events which occur at different
points in time rather than on a periodic basis. For example, during Q2-97, NetCo
Partners recognized significant revenues attributable to TOM CLANCY'S NET FORCE
as a result of the contractual events which transpired during Q2-97, i.e.,
signature of the Berkely publishing agreement and delivery of the ABC teleplay,
although the efforts to generate these revenues had been expended for over one
year.
28
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company issued an aggregate of 100,000 shares of its Common Stock in
exchange for payment of an aggregate purchase price of $500,000 pursuant to a
Private Equity Line of Credit by and among the Company and two investors dated
June 30, 1998 (the "Private Equity Line of Credit"). Pursuant to the terms of
said Private Equity Line of Credit, up to 333,334 additional shares of the
Company's Common Stock are issuable at a minimum purchase price of $3.00 per
share, such issuances to occur upon the making of puts by the Company during the
one-year period after June 30, 1998. Upon execution of the Private Equity Line
of Credit the Company also issued warrants to purchase an aggregate of 25,000
shares of its Common Stock at an exercise price of $.01 per share and warrants
to purchase an aggregate of 20,000 shares of its Common Stock at a maximum
exercise price of $6.50 per share. The Company issued 3,000 shares of its Common
Stock to an investment banking firm (the "Placement Agent") that placed the
transaction as compensation for their services.
In July 1998 the Company issued an aggregate of 25,800 shares of its Common
Stock to certain of its management-level employees as a stock bonus. The stock
bonus was based on a ratio of three shares of the Company's Common Stock for
every share of the Company's Common Stock purchased by each employee in the open
market.
Additionally, the Company's Chairman and Chief Executive Officer, Vice Chairman
and President, and three of the Company's non-employee directors purchased an
aggregate of 160,000 shares of the Company's Common Stock for a purchase price
of $5.00 per share (the market value of the Company's stock at the time) and
warrants to purchase an aggregate of 80,000 shares of Common Stock at an
exercise price of $5.00 per share pursuant to stock purchase agreements with the
Company.
The foregoing securities were all issued without registration under the
Securities Act of 1933, as amended, by reason of the exemption from registration
afforded by the provisions of Section 4(2) thereof, as transactions by an issuer
not involving a public offering, each recipient of securities having delivered
appropriate investment representations to the Company with respect thereto and
having consented to the imposition of restrictive legends upon the certificates
evidencing such securities. Other than the shares issued to the Placement Agent
in connection with the Private Equity Line of Credit, no placement fees or
commissions were paid in connection with the issuance of such securities.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
10.1 Private Equity Line of Credit (1)
10.2 Form of Stock Purchase Agreement
27.1 Financial Data Schedule
(B) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
June 30, 1998.
- --------------------
(1) Incorporated by reference from the exhibit filed with Amendment No. 1
to the Company's Registration Statement on Form S-3 (No. 333-57855).
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BIG ENTERTAINMENT, INC.
Date: August 14, 1998 By: /s/ Mitchell Rubenstein
---------------------------------------------
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 1998 By: /s/ Marci L. Yunes
---------------------------------------------
Chief Financial Officer
(Principal Financial and Accounting Officer)
30
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
10.2 Form of Stock Purchase Agreement
27.1 Financial Data Schedule