UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1999
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For transition period from _______________ to _______________
Commission File Number: 0-17953
DIAMOND ENTERTAINMENT CORPORATION
(Exact Name of Small business issuer as specified in its charter)
NEW JERSEY 22-2748019
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
800 TUCKER LANE, WALNUT CALIFORNIA 91789
(Address of principal executive offices)
(909) 839-1989
(Issuer's telephone number, including area code)
-------------------------
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES [ X ] NO [ ]
As of February 11, 2000, there were 62,334,029 shares of common stock
outstanding.
Transitional Small Business Disclosure Format (check one): YES [ ] NO [X]
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
PART I. FINANCIAL INFORMATION
- ------- ---------------------
Item 1: Financial Statements
Balance Sheet as of December 31, 1999 [Unaudited]...................1...2
Statements of Operations for the nine months ended
December 31, 1999 and 1998 [Unaudited]..............................3
Statements of Stockholders' Equity for the nine months ended
December 31, 1999 [Unaudited].......................................4
Statements of Cash Flows for nine months ended December 31, 1999
and 1998 [Unaudited]................................................5...7
Notes to Financial Statements [Unaudited]...........................8...31
Item 2: Management's Discussion and Analysis or Plan of Operations......32..42
PART II. OTHER INFORMATION
- -------- -----------------
Item 1: Legal Proceedings...............................................43
Item 2: Changes in Securities...........................................43...44
Item 3: Defaults Upon Senior Securities.................................44
Item 4: Submission of Matters to a Vote of Security Holders.............44
Item 5: Other Information...............................................44
Item 6: Exhibits and Reports on Form 8-K................................45
Signatures...............................................................46
ITEM 1: FINANCIALS STATEMENTS
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999 [UNAUDITED]
- --------------------------------------------------------------
ASSETS:
CURRENT ASSETS:
Cash $ 31
Accounts Receivable - Net 459,097
Inventory 1,280,802
Prepaid Expenses 170,928
----------------
TOTAL CURRENT ASSETS 1,910,858
----------------
PROPERTY AND EQUIPMENT:
Leasehold Improvements 34,759
Furniture, Fixtures and Equipment 1,112,427
----------------
Total - At Cost 1,147,186
Less: Accumulated Depreciation 827,501
----------------
PROPERTY AND EQUIPMENT - NET 319,685
----------------
FILM MASTERS AND ARTWORK 3,894,969
Less: Accumulated Amortization 3,832,890
----------------
TOTAL FILM MASTERS AND ARTWORK - NET 62,079
----------------
OTHER ASSETS:
Investment in ATRE 50,000
Related Party Receivable 91,460
Other Assets 39,071
Deferred Costs --
----------------
TOTAL OTHER ASSETS 180,531
----------------
TOTAL ASSETS $ 2,473,153
================
The Accompanying Notes are an Integral Part of These
Consolidated Financial Statements.
1
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999 [UNAUDITED]
- --------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY [DEFICIT]:
CURRENT LIABILITIES:
Cash Overdraft $ 354,895
Accounts Payable 768,168
Accounts Payable - Related Party [4C] 302,320
Notes Payable 776,098
Convertible Note - Related Party [4C] 809,500
Loan from Officer 90,000
Convertible Debentures - Net 1,276,875
Lease Obligations Payable 6,244
Accrued Expenses 228,490
----------------
TOTAL CURRENT LIABILITIES 4,612,590
----------------
LONG-TERM LIABILITIES:
Lease Obligations Payable 47,819
Notes Payable 52,214
----------------
TOTAL LONG-TERM LIABILITIES 100,033
----------------
TOTAL LIABILITIES 4,712,623
----------------
COMMITMENTS AND CONTINGENCIES [5] [6] --
----------------
STOCKHOLDERS' EQUITY [DEFICIT]:
Convertible Preferred Stock - No Par Value, 5,000,000
Shares Authorized, 483,251 Issued [of which 172,923
are held in Treasury] 376,593
Common Stock - No Par Value, 100,000,000 Shares
Authorized; 62,334,029 Shares Issued and Outstanding 12,387,723
Additional Paid-in Capital (768,581)
Accumulated Deficit (14,094,102)
----------------
Sub-Total (2,098,367)
Less: Treasury Stock [Preferred] - At Cost (48,803)
Deferred Costs (92,300)
----------------
TOTAL STOCKHOLDERS' EQUITY [DEFICIT] (2,239,470)
----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY [DEFICIT] $ 2,473,153
================
The Accompanying Notes are an Integral Part of These
Consolidated Financial Statements.
2
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS [UNAUDITED]
- -------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
1999 1998 1999 1998
----------------- ----------------- ----------------- -----------------
SALES - NET $ 1,521,926 $ 1,593,878 $ 3,195,037 $ 3,671,185
COST OF SALES 1,345,255 751,987 2,505,669 2,159,797
----------------- ----------------- ----------------- -----------------
GROSS PROFIT 176,671 841,891 689,368 1,511,388
----------------- ----------------- ----------------- -----------------
OPERATING EXPENSES:
Selling Expenses 145,579 324,170 654,415 795,656
General and Administrative Expense 271,769 458,729 965,024 1,088,080
Factoring Fees 7,401 9,589 15,940 68,005
Bad Debt Expense 123,980 31,281 189,796 31,387
Non- Cash Consulting and Compensation
Expense 57,939 -- 343,530 --
----------------- ----------------- ----------------- -----------------
TOTAL OPERATING EXPENSES 606,668 823,769 2,168,705 1,983,128
----------------- ----------------- ----------------- -----------------
OPERATING INCOME [LOSS] (429,997) 18,122 (1,479,337) (471,470)
----------------- ----------------- ----------------- -----------------
OTHER EXPENSES [INCOME]:
Interest Expense 40,020 149,151 230,780 331,401
Interest Income - Related Party (137) (60) (248) (913)
Other Income (670) (139,817) (8,262) (152,832)
Valuation Adjustment for ATRE [4B] -- -- -- --
Interest Expense - Non-Cash [7D] 38,750 -- 155,000 --
----------------- ----------------- ----------------- -----------------
OTHER EXPENSES [INCOME] - NET 77,963 9,274 377,270 177,656
----------------- ----------------- ----------------- -----------------
NET INCOME [LOSS] BEFORE
EXTRAORDINARY INCOME (507,960) 8,848 (1,856,607) (649,396)
----------------- ----------------- ----------------- -----------------
EXTRAORDINARY INCOME -- -- -- (66,000)
----------------- ----------------- ----------------- -----------------
NET INCOME [LOSS] $ (507,960) $ 8,848 $ (1,856,607) $ (583,396)
================= ================= ================= =================
NET INCOME [LOSS] PER SHARE BEFORE
EXTRAORDINARY INCOME $ (.01) $ -- $ (.03) $ (.02)
================= ================= ================= =================
NET INCOME [LOSS] PER SHARE $ (.01) $ -- $ (.03) $ (.02)
================= ================= ================= =================
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING 57,959,029 32,766,009 57,231,529 29,258,695
================= ================= ================= =================
The Accompanying Notes are an Integral Part of
These Consolidated Financial Statements.
3
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY [DEFICIT] [UNAUDITED]
- ---------------------------------------------------------------------
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED
------------------ ----------------------- ---------- --------
NUMBER OF NUMBER OF PAID-IN EARNINGS
--------- --------- ------- --------
SHARES AMOUNT SHARES AMOUNT CAPITAL [DEFICIT]
------ ------ ------ ------ ------- -------
BALANCE - APRIL 1, 1999 483,251 $ 376,593 50,619,029 $ 11,801,973 $(1,156,231) $(12,237,495)
Options Issued for 6,000,000 shares
to Consultants In April, 1999 [5F, 13I] -- -- -- -- 120,000 --
Option issued for 1,000,000 to Consultant
In July, 1999 [5H, 13I] 20,000
Options issued for 1,965,000 to Consultants
In August 1999 [5F, 13I] 67,650
Consulting Expense [5D, 5F] -- -- -- -- -- --
Exercise of Options and Warrants [5F, 13G, 13I] -- -- 8,215,000 410,750 -- --
Convertible Debt Converted December 1999 [7D] 3,500,000 175,000
Options Issued to two Officers for 4,500,000 shares
for securing financing, obtaining conversion of
debentures to equity, and securing new customer
contracts [13J] -- -- -- -- 180,000 --
Net [Loss] for nine months ended
December 31, 1999 -- -- -- -- -- (1,856,607)
---------- --------- ----------- ------------ ------------ -------------
BALANCE - DECEMBER 31, 1999 483,251 $ 376,593 62,334,029 $ 12,387,723 $ (768,581) $(14,094,102)
========== ========= =========== ============ ============ =============
TREASURY TOTAL
STOCK STOCKHOLDERS'
----- -------------
[PREFERRED] DEFERRED EQUITY
--------- -------- ------
AT COST COSTS [DEFICIT]
------- ----- -------
BALANCE - APRIL 1, 1999 $ (48,803) $ (48,180) $ (1,312,143)
Options Issued for 6,000,000 shares
to Consultants In April, 1999 [5F, 13I] -- (120,000) --
Option issued for 1,000,000 to Consultant
In July, 1999 [5H, 13I] (20,000)
Options issued for 1,965,000 to Consultants
In August 1999 [5F, 13I] (67,650)
Consulting Expense [5D, 5F] -- 163,530 163,530
Exercise of Options and Warrants [5F, 13G, 13I] -- -- 410,750
Convertible Debt Converted December 1999 [7D] 175,000
Options Issued to two Officers for 4,500,000 share s
for securing financing, obtaining conversion of
debentures to equity, and securing new customer
contracts [13J] -- -- 180,000
Net [Loss] for nine months ended
December 31, 1999 -- -- (1,856,607)
---------- ---------- -------------
BALANCE - DECEMBER 31, 1999 $ (48,803) $ (92,300) $ (2,239,470)
========== ========== =============
The Accompanying Notes are an Integral Part of
These Consolidated Financial Statements.
4
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS [UNAUDITED]
- -------------------------------------------------
NINE MONTHS ENDED
-----------------
DECEMBER 31,
------------
1999 1998
--------------- ---------------
NET CASH - OPERATING ACTIVITIES : $ 514,047 $ (1,810,931)
--------------- ---------------
INVESTING ACTIVITIES:
Advances to ATRE -- (28,946)
Repayments by ATRE 159,400 617,719
Payment of Officers' Loans Receivable -- (215,027)
Repayments of Officers' Loan Receivable -- 214,450
Payment of Employee Loans Receivable -- --
Capital Expenditures (50,948) (110,837)
Masters and Artwork (33,369) (59,686)
Proceeds from Notes Receivable -- --
--------------- ---------------
NET CASH - INVESTING ACTIVITIES 75,083 $ 417,673
--------------- ---------------
FINANCING ACTIVITIES:
Proceeds from Notes Payable 3,046,016 8,569,448
Payments of Related Party Loan (211,500) --
Payments of Notes Payable (4,006,631) (6,991,993)
Payments of Lease Payable (17,831) (24,955)
Cash Overdraft (354,895) (184,672)
Exercise of Options and Warrants 585,750 20,000
Proceeds from Officer's Loan 90,000 --
Proceeds from Related Parties 233,118 --
Advances to Related Parties (1,200) --
--------------- ---------------
NET CASH - FINANCING ACTIVITIES (637,173) 1,387,828
--------------- ---------------
NET DECREASE IN CASH (48,043) (5,430)
CASH - BEGINNING OF PERIODS 48,074 5,530
--------------- ---------------
$ 31 $ 100
CASH - END OF PERIODS =============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the periods for:
Interest $ 230,780 $ 331,401
Income Taxes $ -- $ --
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In September 1997, the two officers agreed to defer 90% of their salaries
until further notice, but not beyond March 31, 1998. As consideration, the
Company granted a total of 3,750,000 shares of common stock and warrants to
purchase 3,750,000 shares of the Company's common stock at an exercise price of
$.10 per share. The common shares granted became fully vested on December 31,
1997 and the warrants are exercisable through August 2002. The Company recorded
$75,000 in deferred costs for the fair value of the shares granted and amortized
$25,000 and $50,000 for the years ended March 31, 1999 and 1998, respectively.
No deferred costs were recorded for the warrants granted as the fair market
value of the underlying common shares was approximately equal to the exercise
price [5D].
The Accompanying Notes are an Integral Part of
These Consolidated Financial Statements.
5
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS [UNAUDITED]
- -------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
[CONTINUED]:
In September of 1997, the Company negotiated a one year extension agreement
for the convertible debentures and agreed to add 15% to the debentures as a
deferred financing cost of $110,721, which was amortized in 1998 and 1999 as
interest expense. In addition, the Company negotiated a $175,000 extension
payment in February of 1999 whereby the Company amortized $20,000 as financing
expense as of March 31, 1999.
During fiscal 1998, the Company granted warrants in connection with
consulting agreements and recorded $100,000 in deferred consulting costs and
expensed $50,000 and $30,820 for the years ended March 31, 1999 and 1998,
respectively [5F and 13E].
In July and August of 1998, the Company granted options to the Chief
Executive Officer for 6,000,000 shares of common stock exercisable at $.10 per
share and recorded non-cash compensation expense of $15,000 [13F].
On July 9, 1998, the Company entered into an consulting agreement that will
terminate on July 8, 2001, whereby the consultant received an option for
1,000,000 shares of common stock which will expire on July 8, 2001 at an
exercise price of $.10 per share [5F].
During fiscal 1999, $994,826 in convertible debentures were converted into
13,841,256 shares of common stock. During fiscal 1998, $229,848 of convertible
debentures were converted into 6,037,668 shares of common stock [7D].
During fiscal 1999, the Company granted options for 4,950,000 shares of
common stock in connection with four consulting agreements executed in the
fourth quarter of fiscal 1999 and recorded $33,000 in deferred consulting costs
whereby $4,000 was expensed in the year ended March 31, 1999 [5F and 13H].
During fiscal 1999 and 1998, there were retirements of film masters and
artwork for approximately $70,686 and $625,000, respectively. In addition in
fiscal 1999, the Company retired an auto with a book value of approximately
$22,000.
During the year ended March 31, 1999, the Company entered into capital lease
agreements for equipment totaling approximately $70,000.
On April 12, 1999 the Company entered into three consulting agreements that
will terminate on April 11, 2000 whereby three consultants each received options
for 2,000,000 shares of common stock each of which will expire on April 11, 2000
at an exercise price of $.05 per share. The agreements can be terminated or
extended as agreed to between the parties. The Company recorded deferred
consulting cost of approximately $120,000 in April of 1999.
[5F and13I]
On May 25, 1999, the Company approved the granting of options for a total of
4,500,000 shares of common stock exercisable over five years at prices of $.05
and $.10 to two officers for their services in securing additional financing,
obtaining conversion of debentures to equity and their securing new contracts
with new customers in April of 1999. The options expire May 2004. The Company
recorded compensation expense of approximately $180,000 in May of 1999. [5F and
13J]
On July 13, 1999 the Company entered into a consulting agreement that will
terminate on July 12, 2002 whereby consultant received an option for 1,000,000
shares of common stock which will expire on July 12, 2002 at an exercise price
of $.10 per share. The agreement can be terminated or extended as agreed to
between the parties. The Company recorded deferred consulting cost of
approximately $20,000 in July of 1999 [5H].
The Accompanying Notes are an Integral Part of
These Consolidated Financial Statements.
6
DIAMOND ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS [UNAUDITED]
- -------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
[CONTINUED]:
The Company negotiated and intended in July of 1999 to convert certain related
party payables totaling approximately $1,900,000 into shares of the Company's
common stock. On August 5, 1999, the option to convert was canceled. During the
quarter ended December 31, 1999, Board of Directors of the Company authorized
the conversion of approximately $1,880,725 in related parties payables into one
year 7% Convertible Promissory Notes of $1,071,225 and $809,500 each, both due
on September 1, 2000. The terms of the new convertible notes, allow the Company
to make partial principal and interest payments from time to time and the
holders of the convertible notes have the option to request such payments of the
indebtedness evidenced by the notes in either in the lawful money of the United
States or in an equivalent value consisting of the Company's common stock, the
number of shares, to determined by dividing the payment amount by the average
twenty day bid price for the Company's common stock during the twenty trading
days prior to the date of such payment date. Also, during the quarter ended
December 31, 1999, the related party to which $1,071,225 in related parties
payable was owed by the Company, transacted a change in ownership its common
stock in which 100% of its outstanding shares of common stock was sold to a
non-related party. Therefore, for the quarter ended December 31, 1999, the
Company's new convertible promissory note of $1,071,225 has been reclassified on
the Company's balance sheet as a convertible note owed to a non related party by
the Company. [4C]
On August 2, 1999, the Company entered into two consulting agreements that
will terminate on August 2, 2000, whereby the consultants received options
totaling 1,965,000 shares of common stock expiring on August 2, 2000. The
agreements can be terminated or extended as agreed to between the parties. The
Company recorded deferred consulting costs of approximately $60,500 in August of
1999 [5F].
The Accompanying Notes are an Integral Part of
These Consolidated Financial Statements.
7
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS - The Company is in the business of distributing and selling
videocassettes, general merchandise, patented toys, furniture, and Cine-Chrome
gift cards, with a web site presence throughout the United States.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements
include the accounts of the Company and its subsidiaries all of which are
wholly-owned. Intercompany transactions and balances have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS - Cash equivalents are comprised of certain highly
liquid investments with a maturity of three months or less when purchased. The
Company has no cash equivalents.
REVENUE RECOGNITION - Sales are recorded by the Company when products are
shipped to customers and are shown net of returns and allowances.
INVENTORIES - Inventories are stated at the lower of cost [under the first-in,
first-out method] or market.
DEPRECIATION - Property and equipment are presented at cost less accumulated
depreciation. Depreciation is computed by the straight-line method for all
furniture, fixtures, and equipment over 5-10 years, which represents the
estimated useful lives of the respective asset.
Leasehold improvements are being amortized over the lesser of their estimated
useful lives or the remaining term of the lease.
Depreciation expense for the nine months ended December 31, 1999 and 1998 is
$69,788 and $75,470 respectively.
On sale or retirement, the asset cost and related accumulated depreciation are
removed from the respective accounts, and any related gain or loss is reflected
in income. Repairs and maintenance are charged to expense when incurred.
FILM MASTERS AND ARTWORK - The cost of film masters and related artwork is
capitalized and amortized using the straight-line method over a three year
period. The Company periodically reviews its estimates of future revenues for
each master and if necessary a revision is made to amortization rates and a
write down to net realizable value may occur. The net film masters and artwork
are presented on the balance sheet at the net realizable value for each master.
Film masters consist of original "masters" which are purchased for the purpose
of reproduction and sale.
Amortization expense for the nine months ended December 31, 1999 and 1998 is
$173,114 and $90,381, respectively.
ADVERTISING COSTS - Advertising cost are expensed as incurred. Advertising costs
of $34,146 and $47,789 were expensed for the nine months ended December 31, 1999
and 1998, respectively.
8
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [CONTINUED]
BAD DEBTS - An allowance for doubtful accounts is computed based on a review of
each individual account receivable and its respective collectibility. The
allowance for doubtful accounts is approximately $273,380 at December 31, 1999.
NET [LOSS] PER SHARE -The FASB issued SFAS No. 128, "Earnings Per Share," in
February 1997. SFAS No. 128 simplifies the earnings per share ["EPS"]
calculations required by Accounting Principles Board ["APB"] Opinion No. 15, and
related interpretations, by replacing the presentation of primary EPS with a
presentation of basic EPS. SFAS No. 128 requires dual presentation of basic and
diluted EPS by entities with complex capital structures. Basic EPS includes no
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution of securities that could share in the
earnings of an entity, similar to the fully diluted EPS of APB Opinion No. 15.
SFAS No. 128 is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods; earlier application is not
permitted. The Company has adopted SFAS No. 128, prior period EPS data have been
restated. Basic EPS is based on average common shares outstanding and diluted
EPS include the effects of potential common stock, such as, options and
warrants, if dilutive. The Company has potentially dilutive securities that were
not included in the computation of diluted earnings per share because to do so
would have been anti-dilutive for the periods presented. Such securities may
dilute EPS in future years [See Notes 5D and 13].
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
STOCK OPTIONS ISSUED TO EMPLOYEES - The Company adopted Statement of Financial
Accounting Standards ["SFAS"] No. 123, "Accounting for Stock-Based Compensation"
on April 1, 1996 for financial note disclosure purposes and will continue to
apply the intrinsic value method of Accounting Principles Board ["APB"] Opinion
No. 25, "Accounting for Stock Issued to Employees" for financial reporting
purposes.
DEFERRED TAXES - There are no material temporary differences that will result in
taxable amounts in future years. The Company has sustained losses in recent
years and has a large net operating loss carryforward. No deferred taxes are
reflected in these financial statements [See Note 9].
CONCENTRATIONS OF CREDIT RISK - Financial instruments that potentially subject
the Company to concentrations of credit risk are cash and cash equivalents and
accounts receivable arising from its normal business activities. The Company
routinely assesses the financial strength of its customers and, based upon
factors surrounding the credit risk, establishes an allowance for uncollectible
accounts and, as a consequence, believes that its accounts receivable credit
risk exposure beyond such allowance is limited. The Company places its cash and
cash equivalents with high credit quality financial institutions. The amount on
deposit in any one institution that exceeds federally insured limits is subject
to credit risk. The Company had no deposits as of December 31, 1999, with
financial institutions subject to a credit risk beyond the insured amount.
9
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[2] ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 1999 net of allowance for doubtful accounts
were approximately $459,097. Substantially all of the accounts receivable at
December 31, 1999, have been pledged as collateral for the line of credit [See
Note 7A].
[3] INVENTORY
Inventory as of December 31, 1999 consists of:
Raw Materials $ 514,333
Finished Goods 842,855
------------
Total 1,357,188
Allowance (76,386)
------------
NET INVENTORY $ 1,280,802
------------- ============
An allowance has been established for the inventory of approximately $76,386.
This reserve is primarily for the anticipated reductions in selling prices
which are lower than the carrying value for inventory which has been (a)
restricted to specified distribution territories as a result of settlements in
the last quarter of fiscal 1999 and (b) a rise in certain inventory which may
have past the peak selling season.
[4A] RELATED PARTIES RECEIVABLES
At March 31, 1998, the Company was owed approximately $69,000 from the President
of the Company for advances and loans. Simple interest was accrued monthly at an
annual rate of 10% on the outstanding balance. For the years ended March 31,
1999 and 1998, the Company recorded interest income of $1,170 and $6,607,
respectively. This loan amount was due in December 2001. On March 15, 1999, the
unpaid balance of approximately $69,000 was forgiven by the Company and treated
as a financing cost on the statement of operations in consideration for the
President's 1998 and 1999 personal guarantees for two leases and promissory
notes.
The Company as of September 30, 1999, has a receivable of $10,800 from an
entity, in which the President of the Company is a major stockholder. This
receivable represented rent due for space at the Company utilized by the entity.
Monthly rental income from this entity is $800. At December 31, 1999, the
receivable balance was zero.
[4B] AMERICAN TOP REAL ESTATE ["ATRE"]
The Company paid $50,000 for a 50% interest in ATRE. This investment is
accounted for on the equity method.
In September 1996, a parcel of land was sold and proceeds were retained for
future sewage construction needed for a 20 acre property. The Company received
$121,600 from ATRE for this parcel of land in fiscal 1997.
During the year ended March 31, 1998, ATRE sold approximately 11 acres. The
Company advanced an additional $80,320 to ATRE and received $220,600 from the
proceeds of the parcel of 10 acres as repayment of the advances to ATRE in
fiscal 1998.
[4B] AMERICAN TOP REAL ESTATE ["ATRE"] [CONTINUED] - The Company also received
approximately $600,000 from ATRE during the period April 1, 1998 through March
31, 1999. At March 31, 1998, ATRE had binding sales contracts for the remaining
parcels of commercial real estate owned by ATRE as these parcels of land were
under development. In addition, the Company was advised by ATRE that proceeds
realized by ATRE during fiscal 1998 were reinvested into other parcels to
improve the ability to list and sell the remaining parcels. ATRE continues to
list these properties.
10
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
Management of the Company received a communication from a real estate
development specialist in 1998 advising the Company that the remaining ATRE
parcels have an aggregate approximate value of $5,200,000 is calculated for the
remaining ATRE parcels. Although the Company believes that final sales contracts
will be able to be consummated, it is not possible to predict with any certainty
when the closing of these sales contracts of real estate may occur or whether
the proceeds expected by the Company for their share in this real estate could
be significantly less than anticipated. Therefore, the ultimate realizable value
of the receivable for advances from ATRE could be substantially less than the
preadjusted carrying value of $1,600,000. At March 31, 1998, the Company
therefore setup a valuation allowance of $1,117,788 and accordingly, charged
operations for that amount so that the amount due from ATRE at March 31, 1998
was presented at the amount of the anticipated 1998 subsequent receipts of
approximately $500,000. Based upon the above circumstances at March 31, 1998,
the Company believed the likelihood that $1,117,788 from future proceeds from
the sale of the ATRE parcels could not be realized with any certainty.
On June 2, 1999, ATRE entered into a sale agreement for approximately $600,000
and in September 1999, entered into a sales agreement for remaining acres of the
larger parcel for approximately $550,000. The ability of the agreements to close
or for the Company to realize as of December 31, 1999, 50% of the net proceeds
to the Company, however, are uncertain and is subject to certain contingencies.
Therefore, the Company has not recorded a receivable for these contracts.
[4C] RELATED PARTIES PAYABLES
In the June 1998 quarter, the Company's subsidiary received a total of
$2,721,860 from related parties to be utilized by the Company to pay a major
supplier of the Company for toy purchases. Subsequently, the related parties
were successful in receiving credits of $743,935 from the toy supplier. These
credits were applied by the related parties to the monies owed by the Company
for the purchases of toys. The Company negotiated and intended in July of 1999,
to convert part of the balance of the related party payables totaling
approximately $1,900,000 into shares of the Company's common stock. On August 5,
1999, the option to convert was canceled.
During the quarter ended December 31, 1999, Board of Directors of the Company
authorized the conversion of approximately $1,880,725 in related parties
payables into one year 7% Convertible Promissory Notes of $1,071,225 and
$809,500 each, both due on September 1, 2000. The terms of the new convertible
notes, allow the Company to make partial principal and interest payments from
time to time and the holders of the convertible notes have the option to request
such payments of the indebtedness evidenced by the notes in either in the lawful
money of the United States or in an equivalent value consisting of the Company's
common stock, the number of shares, to determined by dividing the payment amount
by the average twenty day bid price for the Company's common stock during the
twenty trading days prior to the date of such payment date.
11
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[4C] RELATED PARTIES PAYABLES [CONTINUED] - Also, during the quarter ended
December 31, 1999, the related party to which $1,071,225 in related parties
payable was owed by the Company, transacted a change in ownership its common
stock in which 100% of its outstanding shares of common stock was sold to a
non-related party. Therefore, for the quarter ended December 31, 1999, the
Company's new convertible promissory note of $1,071,225 has been reclassified on
the Company's balance sheet to a non-related convertible note owed by the
Company.
During the nine month period ended December 31, 1999, the Company borrowed from
the related parties approximately $454,000 and repaid them approximately
$274,000. The net outstanding obligations owed to the related parties totaled
$302,320 as of December 31, 1999.
[4D] LOAN FROM OFFICER
In June of 1999, the Company received a loan in the amount of $90,000 from an
officer of the Company which is payable upon demand and as of December 31, 1999,
this amount is outstanding. In October 1999, the Company received a loan in the
amount of $124,100 from the Chief Executive Officer which is payable upon demand
and the balance of this loan was $85,408 as of December 31, 1999.
[5] COMMITMENTS
[A] ROYALTY COMMITMENTS - The Company has entered into various royalty
agreements for licensing of titles for terms of one to seven years. Certain
agreements include minimum guaranteed payments. For the nine months ended
December 31, 1999 and 1998, royalty expense was $54,126 and, $94,348,
respectively, pursuant to these agreements.
[B] VIDEO AGREEMENTS - The Company has entered into various agreements to
manufacture, duplicate and distribute videos. Commissions are paid based upon
the number of videos sold.
[C] ACCOUNTS PAYABLE - The Company is currently delinquent on a significant
amount of its accounts payable.
[D] EMPLOYMENT AGREEMENTS - In 1991, two employment agreements were executed for
two officers for annual compensation totaling $240,000. These agreements
terminate in the year 2001 and are adjusted annually in accordance with the
Consumer Price Index. The Board of Directors agreed on April 23, 1996 to reserve
1,000,000 shares of common stock for distribution to two officers of the
Company. The common stock can be purchased in installment payments with a five
year promissory note with interest at 6% per annum. As of December 31, 1999, the
officers did not purchase these shares.
In September 1997, the two officers agreed to defer 90% of their salaries until
further notice, but not beyond March 31, 1998. As consideration, the Company
granted a total of 3,750,000 shares of common stock and warrants to purchase
3,750,000 shares of the Company's common stock at an exercise price of $.10 per
share. The common shares granted vested during fiscal 1997 and the warrants were
exercisable until March 31, 1999. In March of 1999, the Company extended the
term until August 24, 2002.
The Company recorded $75,000 in deferred costs for the fair value of the shares
granted and amortized $25,000 and $50,000 in the years ended March 31, 1999 and
1998, respectively. No deferred costs were recorded for the warrants granted as
the fair market value of the underlying common shares was approximately equal to
the exercise price. These warrants were not exercised.
12
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[5] COMMITMENTS [CONTINUED]
[D] EMPLOYMENT AGREEMENTS [CONTINUED] - In September 1997, the Company entered
into employment agreements with nine employees holding key positions. The
agreements provide for an aggregate of 550,000 shares of common stock with a
fair value of $11,000 for past services, warrants for 550,000 shares with an
exercise price of $.10 per share and semi-monthly compensation of approximately
$14,000. No deferred costs were recorded for the warrants granted as the fair
market value of the underlying common shares was approximately equal to the
exercise price. These warrants were not exercised as of December 31, 1999.
[E] SALE OF MULTI MEDIA ASSETS - On May 8, 1995, the Company closed a sales
agreement with a Mexican company, Central Video, for $750,000 by allowing credit
to the Company for future duplication services. The general manager of Central
Video is the former President of the Company. The Company received $750,000 of
duplication services and surrendered equipment having a book value of
approximately $630,000. The Company guaranteed Central Video's general manager a
minimum of $2,500,000 a year of production orders for three years and agreed to
pay Central Video's general manager a 3% commission on orders the Company places
with Central Video. The Company satisfied this obligation in fiscal 1996,
however, in 1997, the Company did not fulfill this obligation and was delinquent
in payments to Central Video. The Company settled this contract with Central
Video in September of 1997. The Company agreed to pay Central Video $12,500 a
week until the total obligation of $740,000 was paid. This settlement dissolved
the production contract and all outstanding payable obligation. As of March 31,
1999, there was no balance owed to Central Video.
[F] FINANCIAL CONSULTANT COMMITMENTS - In June of 1996, the Company engaged
three consultants for a period of two years. The Company agreed to reimburse the
consultants' business expenses not to exceed $750 per month. The financial
consultants received a total of 1,000,000 warrants with an exercise price of
$.25 per share in exchange for services to be rendered. The Company recorded
deferred consulting costs of $50,000 for the fair value of the warrants to
purchase the 1,000,000 shares of common stock and expensed $14,858 and $35,142
for the years ended March 31, 1998 and 1997, respectively. The fair value of the
warrants was determined based upon the fair value of services to be rendered by
the consultant.
In August of 1997, the Company engaged a consulting firm to provide financial
advice for a period of six months. The fee for services included a $7,500 cash
payment, a two percent cash fee on refinancing commitments and a five percent,
non-dilutive equity interest in the Company. The consulting firm was also
entitled to a five percent fee based on the transaction value of any concluded
merger or acquisition introduced by the consulting firm. As of March 31, 1998,
the consulting firm had not concluded any merger or refinancing commitment and
received only the $7,500 cash payment from the Company.
In August of 1997, the Company engaged four consultants for a period of two
years to provide assistance in restructuring and designing the Company's
operations and long-term strategic plan. The consultants received warrants to
purchase an aggregate 2,050,000 shares of the Company's common stock at an
exercise price of $.10 per share.
On July 9, 1998, the Company entered into an consulting agreement terminating on
July 8, 2001, to provide consulting services concerning strategic alliances,
marketing and sales, and corporate organization, whereby the consultant received
an option for 1,000,000 shares of common stock which will expire on July 8, 2001
at an exercise price of $.10 per share.
13
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[5] COMMITMENTS [CONTINUED]
[F] FINANCIAL CONSULTANT COMMITMENTS [CONTINUED] - The Company filed a Form S-8
on August 24,1999 for these shares of common stock. This option was not
exercised as of December 31, 1999.
In 1999, the Company reduced the exercise price to $.05 and recorded a non-cash
additional consulting expense of $40,000 in 1999. The warrants expire at the end
of the two year consulting period. The Company recorded deferred consulting
costs of $100,000 for the fair value of the warrants and expensed approximately
$50,000 and $31,000 for the years ended March 31, 1999 and 1998, respectively.
The fair value of the warrants was determined based upon the fair value of
services to be rendered by the consultant. In addition, the Company also issued
250,000 shares of stock to one of the consultants in consideration of entering
into a two year consulting agreement and recorded $5,000 as a signing bonus. In
July of 1998, the Company raised $20,000 from the exercise of warrants for
200,000 shares of the Company's common stock. The Company received in January
and February of 1999 $60,000 from the exercise of 600,000 options at $.10 per
share.
On January 10, 1999, the Company engaged three consultants for a period of one
year to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 4,700,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on December 31, 2000.
The Company recorded deferred consulting cost of $24,000 and amortized
approximately $3,000 for the year ended March 31, 1999 and approximately $17,000
for the nine months ended December 31, 1999. These options were exercised in
February of 1999 for proceeds to the Company of $275,000. The Company filed a
Form S-8 in February of 1999 for these shares of common stock.
In February 1999, the Company engaged a consulting firm to provide internet
media consulting and public relations services for a period of one year. The fee
for the services to be rendered included a monthly cash fee of $3,000. The
consulting firm also received options to purchase a total of 250,000 shares of
the Company's common stock with an exercise price of $0.05 per share in exchange
for services to be rendered and the options shall expire on February 11, 2001.
The Company recorded deferred consulting costs of approximately $9,000 and
amortized approximately $1,000 for the year ended March 31, 1999 and
approximately $7,000 for the nine months ended December 31, 1999. These options
were not exercised as of March 31, 1999. The Company filed a Form S-8 in
February of 1999 for these shares of common stock. During the nine month period
ended September 30, 1999, all of shares were exercised for services rendered by
the consulting firm and the cost incurred totaled $12,500.
On April 12, 1999 the Company entered into three consulting agreements that will
terminate on April 11, 2000 whereby three consultants each received options for
2,000,000 shares of common stock each of which will expire on April 11, 2000 at
an exercise price of $.05 per share. The agreements can be terminated or
extended as agreed to between the parties. The Company recorded deferred
consulting cost of approximately $120,000 in April of 1999, and amortized
approximately $86,000 for the nine months ended December 31, 1999. The Company
filed a Form S-8 on May 19, 1999 registering the 6,000,000 shares of common
stock for these options.
14
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[5] COMMITMENTS [CONTINUED]
[F] FINANCIAL CONSULTANT COMMITMENTS [CONTINUED] - On May 20, 1999, the Company
received $150,000 in cash for the issuance of the 3,000,000 shares and $150,000
from the cancellation of convertible debentures for the consideration for
issuance of 3,000,000 shares of as a result of the options being exercised.
On August 2, 1999, the Company engaged two consultants for a period of one year
to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 1,965,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on August 2, 2000. The
Company recorded deferred consulting cost of approximately $67,700 and amortized
approximately $24,700 for the nine months period ended December 31, 1999. The
Company filed a Form S-8 on August 24,1999 for these shares of common stock. In
August 1999, the Company received $62,000 in cash for the issuance of the
1,240,000 shares and $36,250 from the cancellation of a convertible debenture
including unpaid interest for the consideration for issuance of 725,000 shares
as a result of the options being exercised.
[G] EXCLUSIVE DISTRIBUTION AGREEMENT - In April of 1998, the Company entered
into an agreement with S4C Corporation for the exclusive rights to distribute a
home video tape through December 31, 2003 with total advance payments
aggregating a total commitment of approximately $100,000 and additional
royalties due as a percentage of wholesale prices. The Company paid royalty
advances of $84,300 for the year ended March 31, 1999, whereby $39,745 and has
been earned and expensed. For the nine months ended December 31, 1999, the
Company paid additional royalty advances of $19,803.
[H] MARKETING AND SALES CONSULTANT COMMITMENT - On July 13, 1999 the Company
entered into a consulting agreement that will terminate on July 12, 2002 whereby
consultant shall provide consulting advice concerning the marketing and sales of
computers and computer related products in the United States. For such services,
consultant received an option for 1,000,000 shares of common stock which will
expire on July 12, 2002 at an exercise price of $.10 per share. The Company will
pay consultant a one percent (1%) sale commission on net payments received by
the Company for computer related products that are sold to certain club stores
by the consultant. The agreement can be terminated or extended as agreed to
between the parties. The Company recorded deferred consulting cost of
approximately $20,000 in July of 1999 and amortized approximately $9,000 for the
nine months period ended December 31, 1999. The Company filed a Form S-8 on
August 24,1999 for these shares of common stock. The Company planned to market
and sell personal computers and computer related products during the second half
of fiscal year 2000. The Company was advised in November 1999, that another
company recently acquired the Company's supplier for its computer products. This
change in ownership will preclude the Company from purchasing this line of
product from this supplier. Accordingly, the Company has no current plans to
distribute and sell these computer products. These options were not exercised as
of December 31, 1999.
15
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[6] LEASE COMMITMENTS
[A] OPERATING LEASES - The Company leases various office and storage facilities,
automobiles and equipment under operating leases expiring between 1998 and 2002.
The Company leases office space in Freehold, New Jersey for approximately $2,400
per month which expires in October 2001. Total rent expense for the New Jersey
facility was approximately $29,000 for the year ended March 31, 1999. Commencing
October 1, 1998 and ending June 2002, the Company entered into a lease for
office, manufacturing and warehouse space for approximately $21,800 per month.
Rent expense for this facility for the year ended March 31, 1999 was
approximately $130,000. It also leased for $9,274 per month office and
warehousing space which would expire March 2001. Rent expense for this facility
was approximately $172,000 for the year ended March 31, 1999. The Company has
entered into a sublease for this space with a subtenant beginning January 1,
1999 which requires the subtenant to pay approximately $9,494 per month from
March 1, 1999 through February 2000, and $9,936 per month from March 1, 2000
through March 31, 2001.
The Company also has a one year sublease agreement, for a total of approximately
$10,000 annual rental income, with an entity whose majority stockholder is the
President of the Company. Rent expense for the two California locations for the
year ended March 31, 1998 was approximately $135,000.
The following schedules shows the composition of total rental expense for all
operating leases except those with terms of a month or less that were not
renewed:
Years ended
-----------
March 31,
---------
1 9 9 9 1 9 9 8
------- -------
Minimum Rentals $ 855,952 $ 200,005
Less: Sublease Rentals 227,856 15,000
-------------- --------------
TOTALS $ 628,096 $ 215,005
------ ============== ==============
The following is the approximate aggregate future minimum rentals for the next
five years for operating leases:
March 31,
- ---------
2000 $ 395,911
2001 395,911
2002 64,130
2003 --
2004 --
--------------
TOTAL FUTURE MINIMUM LEASE PAYMENTS $ 855,952
----------------------------------- ==============
The operating leases also provide for cost escalation payments.
The total future minimum lease payments of $855,952 does not include sublease
rental income of approximately $240,000 over the next two years.
16
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[7] DEBT OBLIGATIONS
Notes payable consist of the following:
December 31, 1 9 9 9
--------------------------------------------------------------------
Type of Loan Amount Current Long-Term Rate Due Date
------------ ------ ------- --------- ---- --------
Installment Loan (B) $ -- $ -- $ -- 10% 11/14/99
Notes Payable (C) -- -- -- 8%
Lines of Credit (A) 724,311 724,311 -- Various Revolving Line of
credit
Convertible Debenture (D) 2,086,375 2,086,375 -- 10% 4/30/00
Acquired Debt 40,000 40,000 -- Demand
Loan Payable (E) -- -- -- 10%
Loan Payable (F) 14,001 1,787 12,214 9.75%
Notes Payable (G) 50,000 50,000 -- 12/10/99
------------- ------------- -----------
TOTALS $ 2,914,687 $ 2,902,473 $ 12,214
------ ============= ============= ===========
[A] LINES OF CREDIT - On August 30, 1996, the Company established a line of
credit up to $2,500,000, whereby, $2,000,000 was backed by pledged receivables
and inventory and $500,000 was guaranteed by the Company's President. Interest
was at a prime rate plus 3%. Interest expense from April 1, 1997 through
December 31, 1997 was approximately $148,500. In December 1997, the Company
repaid $469,221 on this line of credit and engaged another financial institution
for a $2,500,000 financing arrangement. This arrangement is also backed by
pledged receivables and inventory. Cost is 1.5% discounted from pledged invoices
for every 30 days for the accounts receivable portion of the line of credit. The
portion of the line of credit backed by inventory is determined by the lesser of
$800,000, 25% of the clients finished toy inventory or 55% of the clients
finished videotape inventory. Interest is charged at 16.18% per annum on this
portion of the debt. This was formalized with the Company in June of 1998.
Interest for the year ended March 31, 1999 was approximately $340,000. Interest
for the nine months ended December 31, 1999 was approximately $168,106.
[B] INSTALLMENT LOAN - In March 1993 a loan was renegotiated for the sum of
$292,058 with principal payments of $5,000 per month with an interest rate of
10% per annum due November 14, 1999. This note was paid in full on July 15,1998
for approximately $60,000. As a result, the Company recorded forgiveness of debt
of approximately $66,000 in July 1998, which is classified as an extraordinary
item on the statement of operations. During the years ended March 31, 1999 and
1998, interest expense was approximately $3,000 and $12,500, respectively.
[C] NOTE PAYABLE FOR EQUIPMENT - On May 8, 1995, the Company closed a sales
agreement with a Mexican company for $750,000 by allowing credit to the Company
for duplication services and received $750,000 of duplication services in
exchange for equipment having a book value of approximately $630,000. The
Company classified the outstanding obligation as notes payable. This note was
repaid in weekly installments of $12,500 with the final payment made in
September of 1998. Interest expense of $4,127 and $40,000 was recorded for the
years ended March 31, 1999 and 1998, respectively.
[D] CONVERTIBLE DEBENTURES PAYABLE - During the quarter ended June 30, 1996, the
Company issued convertible debentures of $1,257,988 with 10% interest per annum
and a 7% commission. The principal amount was convertible in whole or in part
into shares of the common stock of the Company at a conversion price equal to
65% of the average closing bid price for the common stock for five trading days
immediately prior to the conversion.
17
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[7] DEBT OBLIGATIONS [CONTINUED]
[D] CONVERTIBLE DEBENTURES PAYABLE [CONTINUED] - In no event could the
conversion price be less than $.20 per share or more than $.75 per share. In
conjunction with the debentures, the Company granted 1,000,000 warrants
exercisable at $.25 per share to two consultants. Warrants for 46,000 shares
were exercised for $11,500 during the year ended March 31, 1997. The Company
recorded a financing expense of $25,000 for the fair value of the warrants
granted. The fair value of the warrants was determined based upon the fair value
of services received by the Company in May and June of 1996.
Convertible debentures of $290,000 were converted into 1,450,000 shares of the
Company's common stock by several off shore companies under Regulation S during
fiscal 1997 and $967,988 of convertible promissory notes payable were
outstanding and in default by the Company at March 31, 1997. Subsequent to
September 30, 1997, the Company negotiated a one year extension agreement and
agreed to add 15% to the note as a deferred financing cost of $110,721.
During fiscal March of 1998, convertible debentures of $229,848 were converted
into 6,037,668 shares of the Company's common stock.
In June of 1998, a convertible debenture holder converted a note payable with a
balance of $91,750 into 2,823,077 shares of the Company's common stock. This
brought total conversions of $611,598 of debentures into 10,310,745 shares as of
November 2, 1998.
On November 2, 1998, convertible debentures with a balance of $831,436 were
reinvested into a new note for $921,851 for a new two year term expiring October
31, 2000 with interest of 10% and an extension bonus of $175,000, due November
1999, which carries interest of 2.5% per annum payable $50,000 per month after
payment of all prior interest and the restructured note. The repayment term was
a weekly amount of $6,250 in 1998 and $12,500 in the years 1999 and 2000. In
addition, there was an acceleration clause of repayments for certain events and
a 5% late charge for any delinquent payments. The notes contained an option to
convert the principal and interest balance into the common stock of the Company
subject to certain pricing calculations. Collateral security included all the
assets of the Company and a personal collection guarantee as additional security
to holder after subordination to primary lender.
In February of 1999, the Company converted $640,000 of the debentures into
8,000,000 shares of common stock. On February 10, 1999, the Company converted
the remaining note balance of $172,661 and unpaid interest of $90,415 into
3,018,254 shares of common stock. It was also agreed that the $175,000 extension
bonus, which was recorded as a deferred financing cost in February of 1999,
could be converted into shares of common stock at an agreed exercise price
subject to market conditions. During the quarter ended December of 1999, the
Company converted the $175,000 extension bonus into 3,500,000 shares of common
stock. The Company amortized $20,000 and $155,000 of the extension bonus as a
financing expense for the year ended March 31, 1999 and the nine month period
ending December 31, 1999, respectively. In March of 1999, the Company received a
total of $300,000 from an officer and five investors and issued convertible
promissory notes due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per share. In May 1999, $150,000 from the cancellation of
the obligations was utilized to purchase 3,000,000 shares issued upon exercise
of certain options. [See 13I]
In April and June of 1999, the Company received $50,000 from an investor and
$100,000 from an officer and issued additional convertible promissory notes
totaling $150,000 due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per common share.
18
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[7] DEBT OBLIGATIONS [CONTINUED]
[D] CONVERTIBLE DEBENTURES PAYABLE [CONTINUED] - In August 1999, $36,250 from
the cancellation of the obligations owed to the investor for principal and
interest was utilized to purchase 725,000 shares issued upon exercise of his
options.
On June 2, 1999, the Company was advised by one of the convertible debenture
holders of a $100,000 note that the bimonthly principal payments were being
waived and the paying of the bimonthly interest would continue.
For the year ended March 31, 1999 and the five months ended March 31, 1998, the
Company amortized $84,587 and $46,134, respectively as a non-cash financing
cost, for the convertible debentures which is classified as interest expense.
For the nine months ended December 31, 1999, the Company amortized $155,000 as a
non-cash-cash financing cost which is also classified as interest expense. The
convertible notes are secured by the Company's entitlement to any net cash
proceeds derived from its interest in ATRE property [See Note 4B].
During the quarter ended December 31, 1999, Board of Directors of the Company
authorized the conversion of approximately $1,880,725 in related parties
payables into one year 7% Convertible Promissory Notes of $1,071,225 and
$809,500 each, both due on September 1, 2000. The terms of the new convertible
notes, allow the Company to make partial principal and interest payments from
time to time and the holders of the convertible notes have the option to request
such payments of the indebtedness evidenced by the notes in either in the lawful
money of the United States or in an equivalent value consisting of the Company's
common stock, the number of shares, to determined by dividing the payment amount
by the average twenty day bid price for the Company's common stock during the
twenty trading days prior to the date of such payment date. Also, during the
quarter ended December 31, 1999, the related party to which $1,071,225 in
related parties payable was owed by the Company, transacted a change in
ownership its common stock in which 100% of its outstanding shares of common
stock was sold to a non-related party. Therefore, for the quarter ended December
31, 1999, the Company's new convertible promissory note of $1,071,225 has been
reclassified on the Company's balance sheet to a non-related convertible note
owed by the Company.
As of December 31, 1999, the balance of convertible debentures was $2,086,375.
[E] LOAN PAYABLE - In October 1997, the Company borrowed $360,000 from an
unaffiliated entity with interest at 10% per year. At March 31, 1998, $185,208
was outstanding on this obligation, which was repaid in full in September of
1998 by weekly payments of $7,500. Interest expense for the years ended March
31, 1999 and 1998 was $4,712 and $12,708, respectively.
[F] LOAN PAYABLE - In March of 1999, the Company incurred a thirty-six month
secured car loan with interest of 9.75% and monthly payments of $562.
[G] NOTE PAYABLE - In March of 1999, the Company received a promissory note for
$217,094 with ten monthly installments of principal and interest of $23,333 each
commencing March 9, 1999. As of December 31 1999, the Company owed $50,000
principal on this obligation. This note is guaranteed by the President of the
Company and is subordinated to the line of credit.
[8] CAPITAL LEASES
The Company is the lessee of equipment under capital leases expiring in various
years through 2002. The assets and liabilities under capital leases are recorded
at the lower of the present value of the minimum lease payments or the fair
value of the assets.
19
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[8] CAPITAL LEASES [CONTINUED]
The assets are depreciated over the lower of their related lease terms or their
estimated productive lives. Depreciation of assets under capital leases is
included in depreciation expense for 1998 and 1999.
Following is a summary of property held under capital leases as of March 31,
1999:
Furniture, Fixtures and Equipment $ 87,081
Less: Accumulated Depreciation 10,584
--------------
TOTAL $ 76,497
----- ==============
Minimum future lease payments under capital leases as of March 31, 1999 for each
of the next five years and in the aggregate are:
Year Ending
- -----------
March 31,
---------
2000 $ 34,960
2001 34,960
2002 20,179
2003 --
2004 --
-------------
Total Minimum Lease Payments 90,099
Less: Amount Representing Interest 18,205
-------------
PRESENT VALUE OF NET MINIMUM LEASE PAYMENTS $ 71,894
------------------------------------------- =============
[9] INCOME TAXES
The Company has net operating loss carryforwards of approximately $8,387,000
which expire through the year 2013. As a result of these carryforwards, the
Company has a deferred tax asset of approximately $3,354,800, which has been
offset by a valuation allowance of $3,354,800 resulting in a deferred asset of
$-0-. Future tax benefits related to this loss have not been recognized because
its realization is not assured. No current or deferred federal or state income
taxes have been provided for. The increase in the valuation allowance for the
year ended March 31, 1999 was $653,000.
As of March 31, 1999, the approximate amount of the net operating loss income
tax carryforwards and their expiration dates are as follows:
Expiration
----------
in Years ending Net Operating Loss
--------------- ------------------
March 31, Carryforwards
--------- -------------
2007 $ 1,317,000
2008 2,693,000
2009 2,015,000
2010 288,000
2011 1,300,000
2012 150,000
2013 624,000
--------------
TOTAL $ 8,387,000
----- ==============
20
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[10] CAPITAL STOCK
[A] AUTHORIZED SHARES - The Board of Directors agreed on April 23, 1996 to
increase its authorized shares to 100,000,000 shares of common stock and
5,000,000 shares of preferred stock, which was approved at the August 23, 1996
annual shareholders meeting.
[B] PREFERRED STOCK - The preferred stock has no (i) dividend rights, (ii)
sinking fund provisions, (iii) rights of redemption, (iv) classification
provisions for voting, (vi) preemptive rights, (vi) liability to further calls
or to assessments by the Company, or (vii) any provision discriminating against
any existing or prospective holder. Holders of shares of preferred stock are not
entitled to any dividend preference. In the event of liquidation, holders of
shares of preferred stock shall be entitled to a preference of $.01 per share,
and any other remaining proceeds of liquidation shall be distributed shares and
shares alike to holders of all capital stock. The issued and outstanding
preferred stock are restricted and have not been registered.
[C] CONVERSION OF DEBENTURES PAYABLE - During the quarter ended June 30, 1996,
the Company issued convertible debentures of $1,257,988 with 10% interest per
annum and a 7% commission. The principal amount was convertible in whole or in
part into shares of the common stock of the Company at a conversion price equal
to 65% of the average closing bid price for the common stock for five trading
days immediately prior to the conversion. In no event could the conversion price
be less than $.20 per share or more than $.75 per share.
In conjunction with the debentures, the Company granted 1,000,000 warrants
exercisable at $.25 per share to two consultants. Warrants for 46,000 shares
were exercised for $11,500 during the year ended March 31, 1997. The Company
recorded a financing expense of $25,000 for the fair value of the warrants
granted. The fair value of the warrants was determined based upon the fair value
of services received by the Company in May and June of 1996. As of March 31,
1997, convertible debentures of $290,000 were converted into 1,450,000 shares of
the Company's common stock by several off shore companies under Regulation S and
$967,988 of convertible promissory notes payable were outstanding and in default
by the Company. Interest expense of $97,000 and $24,702 was recorded for the
years ended March 31, 1998 and 1997. Subsequent to September 30, 1997, the
Company negotiated a one year extension agreement and agreed to add 15% to the
note as a deferred financing cost of $110,721.
During fiscal March of 1998, convertible debentures of $229,848 were converted
into 6,037,668 shares of the Company's common stock. In June of 1998, a
convertible debenture holder converted a note payable with a balance of $91,750
into 2,823,077 shares of the Company's common stock. This brought total
conversions of $611,598 of debentures into 10,310,745 shares as of November 2,
1998.
On November 2, 1998, convertible debentures with a balance of $831,436 were
reinvested into a new note for $921,851 for a new two year term expiring October
31, 2000 with interest of 10% and an extension bonus of $175,000, due November
1999, which carries interest of 2.5% per annum payable $50,000 per month after
payment of all prior interest and the restructured note. The repayment term was
a weekly amount of $6,250 in 1998 and $12,500 in the years 1999 and 2000. In
addition, there was an acceleration clause of repayments for certain events and
a 5% late charge for any delinquent payments. The notes contained an option to
convert the principal and interest balance into the common stock of the Company
subject to certain pricing calculations. Collateral security included all the
assets of the Company and a personal collection guarantee as additional security
to holder after subordination to primary lender.
21
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[10] CAPITAL STOCK [CONTINUED]
[C] CONVERSION OF DEBENTURES PAYABLE [CONTINUED] - In February of 1999, the
Company converted $640,000 of the debentures into 8,000,000 shares of common
stock. On February 10, 1999, the Company converted the remaining note balance of
$172,661 and unpaid interest of $90,415 into 3,018,254 shares of common stock.
It was also agreed that the $175,000 extension bonus, which was recorded as a
financing cost in February of 1999, could be converted into shares of common
stock at an agreed exercise price subject to market conditions. During the
quarter ended December of 1999, the Company converted the $175,000 extension
bonus into 3,500,000 shares of common stock. The Company amortized $20,000 and
$155,000 of the extension bonus as a financing expense for the year ended March
31, 1999 and the nine month period ending December 31, 1999, respectively.
In March of 1999, the Company additionally received a total of $300,000 from one
officer and five investors and issued convertible promissory notes due in one
year with principal and interest paid bimonthly at an interest rate of 10%. The
notes are convertible immediately into common stock at the rate of $.05 per
share. As of May 20, 1999, the Company recorded payments retiring a total of
$150,000 of these convertible notes.
In April and June of 1999, the Company received $50,000 from an investor and
$100,000 from an officer and issued additional convertible promissory notes
totaling $150,000 due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per common share.
In August 1999, $36,250 from the cancellation of the obligations to owed to the
investor for principal and interest was utilized to purchase 725,000 shares
issued upon exercise of his options.
As of December 31, 1999, the balance of convertible debentures was $2,130,755.
[D] EMPLOYMENT AGREEMENTS - In September 1997, two officers agreed to defer 90%
of their salaries until further notice, but not beyond March 31, 1998. As
consideration, the Company granted a total of 3,750,000 shares of common stock
and warrants to purchase 3,750,000 shares of the Company's common stock at an
exercise price of $.10 per share. The common shares granted vested during fiscal
1997 and the warrants were exercisable until March 31, 1999. In March of 1999,
the Company extended the term until August 24, 2002. The Company recorded
$75,000 in deferred costs for the fair value of the shares granted and amortized
$25,000 and $50,000 in the years ended March 31, 1999 and 1998, respectively. No
deferred costs were recorded for the warrants granted as the fair market value
of the underlying common shares was approximately equal to the exercise price.
In September 1997, the Company entered into employment agreements with nine
employees holding key positions. The agreements provide for an aggregate of
550,000 shares of common stock with a fair value of $11,000 for past services,
warrants for 550,000 shares with an exercise price of $.10 per share, and
semi-monthly compensation of approximately $14,000. The agreements will continue
for an indefinite period of time.
[E] FINANCIAL CONSULTANTS - In fiscal 1998, the Company issued 250,000 shares of
stock to one of its consultants in consideration of entering into a two year
consulting agreement and recorded compensation of $5,000.
[F] STOCK IN LIEU OF COMMISSIONS - On March 11, 1998, the Company issued 347,368
shares of common stock to a salesman in lieu of commissions owed of $66,000. On
February 25, 1999, the Company issued 25,000 shares of common stock to a
salesman's beneficiary in lieu of commissions owed of $4,500.
22
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[10] CAPITAL STOCK [CONTINUED]
[G] ADDITIONAL STOCK ISSUANCES - On October 24, 1998, the Company issued
1,499,523 shares of common stock to the Company's president pursuant to a
settlement agreement for a value of $30,000.
[11] EARNINGS PER SHARE
Earnings per share is based on the weighted average number of common shares
outstanding as restated to include the number of shares issued in the business
combination with TAV reflecting conversion for a preferred share of stock into
1.95 shares of common stock. The effect of warrants and options is included when
dilutive. Exercise of the options and warrants could potentially dilute basic
EPS in the future.
[12] MAJOR SUPPLIER
For the nine months ended December 31, 1999 and 1998, the Company had purchases
from two suppliers that amounted to approximately $319,000 or 60% and $701,000
or 55% of net purchases, respectively.
Loss of these suppliers would not significantly adversely affect the company
because management believes sufficient replacement vendors exist in the open
market.
[13] STOCK OPTIONS AND WARRANTS
[A] 1988 STOCK OPTION PLAN APPROVED - On October 12, 1988, the Company's
directors and stockholders approved the Company's 1988 Stock Option Plan [the
"Option Plan"] authorizing the granting of incentive options and non-qualified
options. The incentive options are intended to qualify under Section 422 of the
Internal Revenue Code of 1986, as amended. Pursuant to the Option Plan, options
to purchase up to 10,000 shares of common stock may be granted to officers,
directors and key employees of the Company. The Stock Option Committee,
consisting of Messrs. Lu and Schillen, is responsible for determining the
individuals who will be granted options, the number of shares to be subject to
each option, the option price per share, and the exercise period of each option.
The option price will not be less than the fair market value of the Company's
common stock on the date the option is granted. Options may be exercised by
payment of cash. No option will have a term in excess of ten years.
[B] CONSULTING AGREEMENT - FISCAL 1997 - In June 1996, the Company issued
1,000,000 common stock warrants at an exercise price of $.25 per share as part
of a consulting agreement entered into, which term ends June 1998. Deferred
compensation of $50,000 resulting from this transaction was recorded at the fair
market value of the services rendered. These warrants expire in April of 1999.
[C] CONVERTIBLE DEBENTURES - CONSULTING AGREEMENTS - In April 1996, in
connection with the convertible debentures, the Company entered into two
separate consulting agreements. As per the terms of both contracts, the Company
issued 1,000,000 common stock warrants [500,000 warrants per contract] at an
exercise price of $.25 per share of which 46,000 shares were issued as a result
of the exercise of warrants during the year ended March 31, 1997. These warrants
expire in April of 1999.
[D] OFFICERS' COMPENSATION - FISCAL 1998 - In September 1997, the two officers
agreed to defer 90% of their salaries until further notice, but not beyond March
31, 1998. As consideration, the Company granted a total of 3,750,000 shares of
common stock and warrants to purchase 3,750,000 shares of the Company's common
stock at an exercise price of $.10 per share.
23
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[13] STOCK OPTIONS AND WARRANTS [CONTINUED]
[D] OFFICERS' COMPENSATION - FISCAL 1998 - The common shares granted vested
during fiscal 1997 and the warrants were exercisable until March 31, 1999. In
March of 1999, the Company extended the term until August 24, 2002. The Company
recorded $75,000 in deferred costs for the fair value of the shares granted and
amortized $25,000 and $50,000 in the years ended March 31, 1999 and 1998,
respectively. No deferred costs were recorded for the warrants granted as the
fair market value of the underlying common shares was approximately equal to the
exercise price. These warrants were not exercised.
[E] CONSULTING AGREEMENT - FISCAL 1998 - In August 1997, the Company issued
2,050,000 common stock warrants at an exercise price of $.10 per share as part
of a consulting agreement entered into, whose term ends August 1999. Deferred
consulting costs of $100,000 resulting from this transaction was recorded at the
fair market value of the services rendered and approximately $50,000 and $31,000
was expensed for the years ended March 31, 1999 and 1998, respectively. In July
of 1998, the Company raised $20,000 from the exercise of warrants for 200,000
shares of the Company's common stock. In January of 1999, the Board reduced the
exercise price for two of the consultants, who each has 600,000 warrants, from
$.10 per share to $.05 per share. The Company recorded additional non-cash
consulting expense of $6,000 for this transaction. The consultants exercised
these warrants in February of 1999 and the Company realized proceeds of $60,000.
[F] OPTIONS ISSUED TO CHIEF EXECUTIVE OFFICER - FISCAL 1999 - In July and August
of 1998, the Company granted options to purchase a total of 6,000,000 shares of
common stock to the Chief Executive Officer for a potential customer, in
consideration of certain fulfillment orders submitted to the Company, and his
personal guarantee on the Company's loan agreements and loans made to the
Company. The Company recorded a $15,000 expense. These options may be exercised
for $.10 per share until March 2003.
[G] CANCELLATION OF OPTIONS - On July 15, 1998, the Company incorporated
Galaxynet International, Inc. ["GalaxyNet"] in the State of Delaware, as a
majority-owned subsidiary of the Company. GalaxyNet intended to develop and sell
internet gaming software and intended to offer its software to internet gaming
companies and provide internet gaming web sites to solicit gambling wages from
primarily, Asian players. The Company also issued 4,000,000 options exercisable
at $.10 per share to an investor and 6,000,000 options to the Chief Executive
Officer exercisable at $.10 in connection with this project. On July 17, 1998,
the Company, along with GalaxyNet, entered into a memorandum of understanding
regarding the raising of capital in a private offering to raise gross proceeds
in the aggregate of between $3,000,000 and $10,000,000 with an enterprise who
would be paid the sum of 15% of the aggregate proceeds and received finders
options for up to 3,750,000 shares of common stock at exercise prices of between
$.10 and $.20 per share. The private offering period ended September 30, 1998,
and was extended until October 31, 1998. The private offering resulted in
raising funding proceeds of only $250,000. The Company subsequently canceled the
project and refunded the $250,000 to the investor and canceled all the project
related options in November 1998. The Company incurred expenses on behalf of
GalaxyNet for fiscal 1999 of approximately $30,000.
[H] CONSULTANT AGREEMENTS - FISCAL 1999 - On January 10, 1999, the Company
engaged three consultants for a period of one year to provide advice to
undertake for and consult with the Company concerning management, marketing,
consulting, strategic planning, corporate organization and structure, financial
matters in connection with the operation of the businesses of the Company,
expansion of services, acquisitions and business opportunities.
24
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[13] STOCK OPTIONS AND WARRANTS [CONTINUED]
[H] CONSULTANT AGREEMENTS - FISCAL 1999 [CONTINUED] - The consultants received
options to purchase a total of 4,700,000 of the Company's common stock
exercisable at $.05 per share in exchange for services to be rendered and the
options shall expire on December 31, 2000. These options were exercised in
February of 1999 for proceeds to the Company of $275,000.
In February 1999, the Company engaged a consulting firm to provide internet
media consulting and public relations services for a period of one year. The fee
for the services to be rendered included a monthly cash fee of $3,000. The
consulting firm also received options to purchase a total of 250,000 shares of
the Company's common stock with an exercise price of $0.05 per share in exchange
for services to be rendered and the options shall expire on February 11, 2001.
During the six month period ended September 30, 1999, all of the options were
exercised for services rendered by the consulting firm and the cost incurred
totaled $12,500.
The Company recorded deferred consulting cost of $33,000 for these 1999
consulting agreements and amortized $4,000 and $24,400 as consulting expense for
the year ended March 31, 1999 and nine months ended December 31, 1999,
respectively
[I] CONSULTING AGREEMENTS - FISCAL 2000 - On April 12, 1999 the Company entered
into three consulting agreements that will terminate on April 11, 2000 whereby
three consultants each received options for 2,000,000 shares of common stock
each which will expire on April 11, 2000 at an exercise price of $.05 per share.
The agreements can be terminated or extended as agreed to between the parties.
The Company recorded deferred consulting cost of approximately $120,000 in April
of 1999, and amortized approximately $86,000 for the nine months ended December
31, 1999. The Company filed a Form S-8 on May 19, 1999 registering the 6,000,000
shares of common stock for these options. On May 20, 1999, the Company received
$150,000 in cash for the issuance of the 3,000,000 shares and $150,000 from the
cancellation of convertible debentures for the consideration for issuance of
3,000,000 shares as a result of the options being exercised. [See Note 7D]
On July 13, 1999 the Company entered into a consulting agreement that will
terminate on July 12, 2002 whereby a consultant shall provide consulting advice
concerning the marketing and sales of computers and computer related products in
the United States. For such services, consultant received an option for
1,000,000 shares of common stock which will expire on July 12, 2002 at an
exercise price of $.10 per share. The Company will pay consultant a one percent
(1%) sale commission on net payments received by the Company for computer
related products that are sold to certain club stores by the consultant. The
agreement can be terminated or extended as agreed to between the parties. The
Company recorded deferred consulting cost of approximately $20,000 in July of
1999 and amortized approximately $9,300 for the nine months period ended
December 31, 1999. The Company filed a Form S-8 on August 24,1999 for these
shares of common stock. These options were not exercised as of December 31,
1999.
On August 2, 1999, the Company engaged two consultants for a period of one year
to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 1,965,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on August 2, 2000. The
Company recorded deferred consulting cost of approximately $67,700 and amortized
approximately $24,700 for the nine months period ended December 31, 1999. The
Company filed a Form S-8 on August 24,1999 for these shares of common stock.
These options were exercised in August 1999.
25
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[13] STOCK OPTIONS AND WARRANTS [CONTINUED]
[I] CONSULTING AGREEMENTS - FISCAL 2000 [CONTINUED] - In August 1999, the
Company received $62,000 in cash for the issuance of the 1,240,000 shares and
$36,250 from the cancellation of a convertible debenture including unpaid
interest for the consideration for issuance of 725,000 shares as a result of the
options being exercised.
[See note 7D]
[J] OFFICERS' COMPENSATION - FISCAL 2000 - On May 25, 1999, the Company approved
the granting of options for a total of 4,500,000 shares of common stock
exercisable over five years at prices of $.05 and $.10 to two officers for their
services in securing additional financing, obtaining conversion of debentures to
equity and their securing new contracts with new customers in April of 1999. The
options expire May 2004. The Company recorded compensation expense of
approximately $180,000 in May of 1999.
[K] SUMMARY - The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations, for
stock warrants issued to officers, employees, and consultants in accounting for
its warrants. Compensation expense has been recognized for the Company's
stock-based compensation in the amounts of $100,000 and $95,678 for the years
ended March 31, 1999 and 1998, respectively. The exercise price for all stock
warrants issued to these individuals during fiscal years 1999 and 1998 were
below the market price of the Company's stock at the date of grant.
A summary of the activity under the plan is as follows:
Weighted Weighted
-------- --------
Average Average
------- -------
Officers and Consultants Exercise Remaining
------------ ----------- -------- ---------
Employees Contractual
--------- -----------
Shares Price Life
------ ----- ----
OUTSTANDING - MARCH 31, 1997 1,000,000 2,000,000 3,000,000 $ .15
- ----------------------------
Granted 4,550,000 2,050,000 6,600,000 .08
Exercised -- (46,000) (46,000) (.08)
Forfeited/Expired -- -- -- --
------------ ------------- ------------
OUTSTANDING - MARCH 31, 1998 5,550,000 4,004,000 9,554,000 .12
----------------------------
Granted 6,000,000 4,950,000 10,950,000 .07
Exercised -- (6,500,000) (6,500,000) .08
Forfeited/Expired -- -- -- --
------------ ------------- ------------
OUTSTANDING - MARCH 31, 1999 11,550,000 2,454,000 14,004,000
---------------------------- ============ ============= ============
Granted [13I and 13J] 4,500,000 8,965,000 13,465,000 .06
Exercised [13H and 13I] -- (8,215,000) (8,215,000) .05
Forfeited/Expired -- -- --
------------ ------------- ------------
OUTSTANDING - DECEMBER 31, 1999 16,050,000 3,204,000 19,254,000
- ------------------------------- ============ ============= ============
EXERCISABLE - DECEMBER 31, 1999 12,050,000 3,204,000 15,254,000 $ .08 4 Years
-------------------------------- ============ ============= ============ ======= =======
26
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[13] STOCK OPTIONS AND WARRANTS [CONTINUED]
[K] SUMMARY [CONTINUED] - Weighted average fair value of options granted during
fiscal 1999, 1998 and the nine months ended December 31, 1999 was $.10, $.12,
and $.06, respectively.
Had compensation cost been determined on the basis of fair value pursuant to
SFAS No. 123, for the shares under employee warrants for the years ended March
31, 1999 and 1998, net loss per share would have been as follows:
1 9 9 9 1 9 9 8
------- -------
Net Loss:
As Reported $ (1,602,652) $ (1,505,442)
============== ==============
Pro Forma $ (2,011,662) $ (1,835,742)
============== ==============
Basic Earnings Per Share:
As Reported $ (.05) $ (.08)
============== ==============
Pro Forma $ (.06) $ (.09)
============== ==============
The fair value used in the pro forma data was estimated by using an option
pricing model which took into account as of the grant date, the exercise price
and the expected life of the option, the current price of the underlying stock
and its expected volatility, expected dividends on the stock and the risk-free
interest rate for the expected term of the option.
The following is the average of the data used for the following items.
Risk-Free Expected Expected
--------- -------- --------
Interest Rate Expected Life Volatility Dividends
------------- ------------- ---------- ---------
6 2.5 Years 144% None
[14] LITIGATION
The Company has in the past been named as defendant and co-defendant in various
legal actions filed against the Company in the normal course of business. All
past litigation have been resolved without material adverse impact on the
Company. For the year ended March 31, 1999, there were three civil actions
against the Company. One action is for alleged copyright infringement whereby
the Company has entered into a settlement agreement in February of 1998 to pay
$208,000 over twenty-four months, whereby the Company has made twenty three of
the required payments due as of December 31, 1999. The second action is for
breach of service whereby the Company settled for two payments of $4,750 each,
which were paid in July and August, 1999. The third action, the Company has
challenged the alleged suit for copyright infringement.
27
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[15] GOING CONCERN
The Company's March 31, 1999 and 1998 financial statements were prepared in
conformity with generally accepted accounting principles, which contemplates the
realization of assets and settlements of liabilities in the normal course of
business and continuation of the Company as a going concern. The Company
incurred net losses of $1,602,652 and $1,505,442 for the years ended March 31,
1999 and 1998, respectively, and had a working capital deficit at March 31, 1999
of $2,154,599.
The Company had also been experiencing difficulties in paying its vendors on a
timely basis. These factors create uncertainty whether the Company can continue
as a going concern.
The Company's plans to mitigate the effects of the uncertainties are (i) to
create new products with better gross profits to include DVD products, whose
market is rapidly expanding, (ii) to continue to negotiate with several reliable
investors to provide the Company with debt and equity financing for working
capital purposes, (iii) to convert debt to equity and (iv) to continue to
negotiate with major vendors for discounts.
Management believes that these plans can be effectively implemented in the next
twelve months. The Company will continue to seek additional financing from
private sources to supplement its cash needs for the next twelve months during
the implementation of these plans to achieve profitability. The Company's
ability to continue as a going concern is dependent on the implementation and
success of these plans. The financial statements do not include any adjustments
in the event the Company is unable to continue as a going concern. There can be
no assurance that management's plans to reduce operating losses or obtain
additional financing to fund operations will be successful.
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets, or the amounts and
classification of liabilities that might be necessary in the event the Company
cannot continue in existence.
[16] MAJOR CUSTOMERS
For the nine months ended December 31, 1999 and 1998, the Company had net sales
to six customers of approximately $1,872,426 or 59% and to seven customers of
approximately $2,,089,895 or 57%, respectively.
[17] SEGMENT INFORMATION
The following information is presented as a result of the Company adopting SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
At December 31, 1999, the Company offers different products which are evaluated
separately in assessing performance and allocating resources. These products
have been reflected as two reportable segments, video products and general
merchandise.
VIDEO PROGRAMS AND OTHER LICENSED PRODUCTS - The Company distributes and sells
videocassette titles including certain public domain programs and certain
licensed programs. The Company markets its video programs to national and
regional mass merchandisers, department stores, drug stores, supermarkets and
other similar retail outlets. Also, in September of 1998, the Company entered
into a distribution agreement for a new product called Cine Chrome utilizing
classic images of licensed properties.
28
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[17] SEGMENT INFORMATION [CONTINUED]
VIDEO PROGRAMS AND OTHER LICENSED PRODUCTS [CONTINUED] -The Company derived
minimal revenues from the sale of Cine Chrome products in fiscal 1999 and for
the nine months ended December 31, 1999.
GENERAL MERCHANDISE - The Company through its wholly-owned subsidiary, Jewel
Products International, Inc. ["JPI"] manufacturers, purchases and distributes
toy products to mass merchandisers in the U.S., commencing fiscal 1999. In
fiscal 2000, the Company anticipates purchasing and distributing furniture
products. The Company offers the toy products for limited sales periods and as
demands for products change, JPI switches to newer and more popular products.
The following financial information is reported on the basis that is used
internally for evaluating segment performance and deciding how to allocate
resources. Interest expense is allocated based on revenues.
Nine months ended December 31, 1999
---------------------------------------------------
Video
Programs
And Other
Licensed General
Products Merchandise Consolidated
-------- ----------- ------------
Revenues 2,956,179 $ 238,858 $ 3,195,037
Operating [Loss] (1,143,530) (335,807) (1,479,337)
Interest Expense 224,593 6,187 230,780
Interest [Income] Expense (8,310) 48 (8,262)
Depreciation and Amortization - Fixed Assets 61,022 8,766 69,788
Amortization Masters and Artwork 173,114 -- 173,114
Capital Expenditures 16,189 -- 16,189
Masters and Artwork - Expenditures 23,369 -- 23,369
Total Assets 1,787,204 685,949 2,473,153
[18] FAIR VALUE OF FINANCIAL INSTRUMENTS
At December 31, 1999, financial instruments include cash, accounts receivable,
accounts payable, loans to and from related parties and debt. The fair values of
cash, accounts receivable, accounts payable and loans to and from related
parties approximates carrying value because of the short-term nature of these
instruments. The fair value of debt approximates carrying value since the
interest rates approximates the Company's cost of capital.
[19] SUBSEQUENT EVENTS
[A] CHANGE IN COMPANY'S CERTIFYING ACCOUNTANT - On January 14, 2000, the
Company's independent public accountants, Moore Stephens, P.C., terminated its
client-auditor relationship with the Company. On January 18, 2000, the Company's
Board of Directors approved the engagement of Merdinger, Fruchter, Rosen &
Corso, P.C. to serve as the Company's independent public accountants and to be
the principal accountants to conduct the audit of the Company's financial
statements for the fiscal year ending March 31, 2000, replacing the firm of
Moore Stephens, P.C.
29
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[19] SUBSEQUENT EVENTS [CONTINUED]
[B] CHANGE OF ADDRESS - On January 31, 2000, the Company completed the move of
its principal executive offices, including all of its other operations, from its
former address located at 16200 Carmenita Road, California 90703 to its new
location at 800 Tucker Lane, Walnut, California 91789.
[20] NEW AUTHORITATIVE PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. SFAS No. 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and how it is designated, for
example, gain or losses related to changes in the fair value of a derivative not
designated as a hedging instrument is recognized in earnings in the period of
the change, while certain types of hedges may be initially reported as a
component of other comprehensive income [outside earnings] until the
consummation of the underlying transaction.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of SFAS No. 133 should be as of the
beginning of a fiscal quarter; on that date, hedging relationships must be
designated anew and documented pursuant to the provisions of SFAS No. 133.
Earlier application of all of the provisions of SFAS No. 133 is encouraged, but
it is permitted only as of the beginning of any fiscal quarter. SFAS No. 133 is
not to be applied retroactively to financial statements of prior periods. The
Company does not currently have any derivative instruments and is not currently
engaged in any hedging activities.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ["SOP"] 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 provides guidance on the financial reporting of start-up
costs and organization costs, and requires that such costs to be expensed as
incurred. SOP 98-5 applies to all nongovernmental entities and is generally
effective for fiscal years beginning after December 15, 1998.
Earlier application is encouraged in fiscal years for which annual financial
statements previously have not been issued. The adoption of SOP 98-5 is not
expected to have a material impact on results of operations, financial position,
or cash flows of the Company as the Company's current policy is substantially in
accordance with SOP 98-5.
The Financial Accounting Standards Board ["FASB"] has had on its agenda a
project to address certain practice issues regarding Accounting Principles Board
["APB"] Opinion No. 25, "Accounting for Stock Issued to Employees." The FASB
plans on issuing various interpretations of APB Opinion No. 25 to address these
practice issues.
The proposed effective date of these interpretations would be the issuance date
of the final Interpretation, which is expected to be in September 1999. If
adopted, the Interpretation would be applied prospectively but would be applied
to plan modification and grants that occur after December 15, 1998. The FASB's
tentative interpretations are as follows:
o APB Opinion No. 25 has been applied in practice to include in its
definition of employees, outside members of the board or directors and
independent contractors.
30
DIAMOND ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [UNAUDITED]
- ------------------------------------------------------
[20] NEW AUTHORITATIVE PRONOUNCEMENTS [CONTINUED]
The FASB's interpretation of APB Opinion No. 25 will limit the definition
of an employee to individuals who meet the common law definition of an
employee [which also is the basis for the distinction between employees
and nonemployees in the current U.S. tax code]. Outside members of the
board of directors and independent contractors would be excluded from the
scope of APB Opinion No. 25 unless they qualify as employees under common
law.
Accordingly, the cost of issuing stock options to board members and independent
contractors not meeting the common law definition of an employee will have to be
determined in accordance with FASB Statement No. 123, "Accounting for
Stock-Based Compensation," and usually recorded as an expense in the period of
the grant [the service period could be prospective, however, see EITF 96-18].
* Options [or other equity instruments] of a parent company issued to
employees of a subsidiary should be considered options, etc. issued by
the employer corporation in the consolidated financial statements, and,
accordingly, APB Opinion No. 25 should continue to be applied in such
situations. This interpretation would apply to subsidiary companies only;
it would not apply to equity method investees or joint ventures.
* If the terms of an option [originally accounted for as a fixed option]
are modified during the option term to directly change the exercise
price, the modified option should be accounted for as a variable option.
Variable grant accounting should be applied to the modified option from
the date of the modification until the date of exercise. Consequently,
the final measurement of compensation expense would occur at the date of
exercise. The cancellation of an option and the issuance of a new option
with a lower exercise price shortly thereafter [for example, within six
months] to the same individual should be considered in substance a
modified [variable] option.
* Additional interpretations will address how to measure compensation
expense when a new measurement date is required.
. . . . . . . . . . . . . .
31
ITEM 2: MANAGEMENT DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
- ------- --------------------------------------------------------
NINE MONTHS ENDED DECEMBER 31, 1999 COMPARED WITH THE NINE MONTHS ENDED DECEMBER
31, 1998:
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE INFORMATION
CONTAINED IN THE FINANCIAL STATEMENTS OF THE COMPANY AND THE NOTES THERETO
APPEARING ELSEWHERE HEREIN AND IN CONJUNCTION WITH THE MANAGEMENT'S DISCUSSION
AND ANALYSIS SET FORTH IN THE COMPANY'S FORM 10-KSB FOR THE YEAR ENDED MARCH 31,
199 AND, FORM 10-QSB FOR THE PERIOD ENDED JUNE 30, 1999 AND SEPTEMBER 30, 1999.
THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS AND INFORMATION RELATING
TO THE COMPANY THAT ARE BASED ON THE BELIEFS OF THE COMPANY OR MANAGEMENT AS
WELL AS ASSUMPTIONS MADE BY AND INFORMATION CURRENTLY AVAILABLE TO THE COMPANY
OR MANAGEMENT. WHEN USED IN THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE,"
"ESTIMATE," "EXPECT" AND "INTEND" AND SIMILAR EXPRESSIONS, AS THEY RELATE TO THE
COMPANY OR ITS MANAGEMENT, ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
SUCH STATEMENTS REFLECT THE CURRENT VIEW OF THE COMPANY REGARDING FUTURE EVENTS
AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS, INCLUDING THE
RISKS AND UNCERTAINTIES NOTED. SHOULD ONE OR MORE OF THESE RISKS OR
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT,
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS ANTICIPATED,
BELIEVED, ESTIMATED, EXPECTED OR INTENDED. IN EACH INSTANCE, FORWARD-LOOKING
INFORMATION SHOULD BE CONSIDERED IN LIGHT OF THE ACCOMPANYING MEANINGFUL
CAUTIONARY STATEMENTS HEREIN
RESULTS OF OPERATIONS
The Company's net loss for the nine months ended December 31, 1999 was
approximately $1,857,000 as compared to a net loss of approximately $583,396 for
the same period last year. The primary reason for the net loss was the Company's
operating loss of approximately $1,479,000.
The Company's operating loss for the nine months ended December 31, 1999 was
approximately $1,479,000 as compared to an operating loss of approximately
$471,000 for the same period last year. The Company's operating loss arose
primarily from an increased operating expenses of approximately $186,000 and
decreased gross profit of approximately $822,000.
The Company's sales for the nine months ended December 31, 1999 and 1998, were
$3,195,037 and $3,671,185, respectively. The Company's sales decreased by
approximately $476,148 from the same period a year earlier with decreased video
product sales and toy sales of approximately $336,000 and $140,000. The lower
video product sales when compared to the same period a year earlier were
primarily the result of the Company experiencing selling and marketing
difficulties, including a temporary reduction in sales orders from principal
customers. The Company intends on marketing furniture in the fourth quarter of
fiscal 2000, although there can be no assurances that the company will be
successful in such efforts. Sales of the Company's products are generally
seasonal which normally results in increased sales starting in the third quarter
of the fiscal year, however the Company experienced lower than expected sales
during the recent Christmas season.
Cost of sales for the nine months ended December 31, 1999 and 1998 were
$2,505,669 and $2,159,797 or 78% and 59% of sales, respectively. The increase in
cost of sales as a percent to sales was primarily the result of selling toy
products with lower margins coupled the cost associated with the write-down of
video related inventory.
32
Gross profit for the nine months ended December 31, 1999 and 1998 were
approximately $689,368 and $1,511,388, or 22% and 41% of sales, respectively.
The decrease percentage for gross profit as a percent to sales was primarily due
to sale of lower margin toy products and the write-down of the Company's
inventory.
Operating expenses for the nine months ended December 31, 1999 and 1998 were
approximately $2,168,705 and $1,983,128, respectively. This increase in
operating expenses of approximately $186,000 was the result of the Company's
higher expense levels in bad debt expense of approximately $158,000, and
non-cash consulting and compensation of approximately $344,000 offset by lower
levels in selling expense, general administrative expenses and factoring fees of
approximately $316,000. Decrease general administrative expenses of
approximately $123,000 were primarily the result of lower expense levels of
wages and other taxes. Selling expenses decreased by approximately $141,000
primarily the result of lower legal settlement expense. Factoring fees were
lower by approximately $52,000 the result of lower levels of borrowing. The
increase of approximately $344,000 in non-cash consulting and compensation was
the result of non-cash expenses associated with the issuance of stock options
issued by the Company.
Bad debt expense for the nine months ended December 31, 1999 and 1998 were
$189,796 and $31,387, respectively.
Interest expense for the nine months ended December 31, 1999 and 1998 were
$230,780 and $331,401 respectively. The decrease in interest expense of
approximately $101,000 was the result lower borrowings. As of December 31, 1999,
the outstanding debt of the Company was approximately $2,914,687 primarily all
of which is classified as current. Interest income for the nine months ended
December 31, 1999 and 1998 were $248 and $913 respectively. The lower accounts
receivable from ATRE at December 31, 1999, resulted in lower accrued interest
income for the nine months ended December 31,1999 when compared to the same
period a year earlier.
The Company's auditors issued a going concern report for the year ended March
31, 1999. There can be no assurance that management's plans to reduce operating
losses will continue or the Company's efforts to obtain additional financing
will be successful.
THREE MONTHS ENDED DECEMBER 31, 1999 COMPARED WITH THE THREE MONTHS ENDED
DECEMBER 31, 1998:
RESULTS OF OPERATIONS
The Company's net loss for the three months ended December 31, 1999 was
approximately $508,000 as compared to a net income of approximately $9,000 for
the same period last year. The primary reason for the net loss was the Company's
operating loss of approximately $430,000.
The Company's operating loss for the three months ended December 31, 1999 was
approximately $430,000 as compared to an operating income of approximately
$18,000 for the same period last year. The Company's operating loss arose
primarily from a decrease gross profit of approximately $665,000 offset by lower
operating expenses of approximately $216,000.
The Company's sales for the three months ended December 31, 1999 and 1998, were
$1,521,926 and $1,593,878, respectively. The Company's sales decreased by
approximately $72,000 from the same period a year earlier with increased video
product sales of approximately $98,000 and decrease toy sales of approximately
$170,000 The lower toy sales when compared to the same period a year earlier was
attributable primarily to the Company experiencing selling and marketing
difficulties. The Company intends on marketing furniture in the forth quarter of
fiscal 2000, although there can be no assurances that the company will be
successful in such efforts. Sales of the Company's products are generally
seasonal.
33
Cost of sales for the three months ended December 31, 1999 and 1998 were
$1,345,255 and $751,987 or 88% and 47% of sales, respectively. The increase in
cost of sales as a percent to sales was primarily the result selling toy
products with lower margins and booking lower margin video duplication business
and the cost associated with the write down of the Company's inventory.
Gross profit for the three months ended December 31, 1999 and 1998 were
approximately $177,000 and $842,000 or 12% and 53% of sales, respectively. The
decrease percentage for gross profit as a percent to sales was primarily due to
sale of lower margin toy products, booking of lower margin video duplication
business and the cost associated with the write down of the Company's inventory.
Operating expenses for the three months ended December 31, 1999 and 1998 were
approximately $607,000 and $824,000, respectively. This decrease in operating
expenses of approximately $217,000 was the result of the Company's lower expense
levels in selling, general and administrative and factoring fees of
approximately $368,000, offset by higher bad debt expenses and non-cash
consulting and compensation expense totaling approximately $151,000. Decreased
selling expenses of approximately $179,000 were primarily the result of lower
salaries, royalty and commission expenses. The decrease of approximately
$187,000 in general and administration was the primarily of lower salaries,
license and permits, consulting and payroll tax expenses. The increase of
approximately $58,000 in non-cash consulting and compensation was the result of
non-cash expenses associated with the issuance of stock options issued by the
Company. The Company realized an increase in bad debt expenses of approximately
$93,000 when compared to the same period a year earlier.
Bad debt expense for the three months ended December 31, 1999 and 1998 were
$123,980 and $31,281, respectively.
Interest expense for the three months ended December 31, 1999 and 1998 were
$40,020 and $149,151, respectively. The decrease in interest expense of
approximately $109,000 was the result of lower levels of borrowings.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital [deficit] at December 31, 1999 was ($2,701,732) as
compared with a working capital [deficit] of ($2,154,599) at March 31, 1999.
This increase in the working capital [deficit] of approximately $547,000 is
primarily the result of the Company's net loss of approximately $1,856,607 and
non-cash adjustments to net income.
OPERATIONS
For the nine months ended December 31, 1999, cash utilized for operations was
approximately $1,810,931 as compared to cash from operations of $514,047 for the
nine months ended December 31, 1998. The Company borrowed in June of 1998,
approximately $2,700,000 in short term loans from related parties and the
borrowings were used primarily to reduce the Company's accounts payable balance.
The Company intends to utilize future debt or equity financing or debt to equity
conversions to help satisfy past due obligations and to pay down its debt
obligations.
The Company has also been experiencing difficulties in paying its vendors on a
timely basis. These factors create uncertainty whether the Company can continue
as a going concern. The Company's plans to mitigate the effects of the
uncertainties are (i) to create new products with better gross profits, (ii) to
continue to negotiate with several reliable investors to provide the Company
with debt and equity financing for working capital purposes, (iii) to convert
debt to equity and (iv) to continue to negotiate with major vendors for
discounts. The Company has negotiated payment arrangements to satisfy certain of
its obligations to principal vendors and service providers.
34
In April of 1998, the Company entered into an agreement with S4C Corporation for
the exclusive rights to distribute a home video tape through December 31, 2003
with total advance payments aggregating a total commitment of approximately
$100,000 and additional royalties due as a percentage of wholesale prices. The
Company paid royalty advances of $84,300 for the year ended March 31, 1999
whereby $39,745 has been earned and expensed. For the nine months ended December
31, 1999, the Company paid additional royalty advances of $15,700.
Beginning in October 1998, the Company entered into a four-year lease expiring
in June 2002, for use as executive offices and manufacturing and warehouse
facilities for approximately $21,800 monthly. The Company leases sales office
space in Freehold, New Jersey for approximately $2,400 per month. This lease
expires on October 31, 2001. Rent expense for this facility was approximately
$28,000 for the year ended March 31, 1999. It also leased for $9,274 per month
office and warehousing space which would expire March 2001. Rent expense for
this facility was approximately $102,000 for the year ended March 31, 1999. The
Company has entered into a sublease for this space with a subtenant beginning
January 1, 1999 which requires the subtenant to pay approximately $9,494 per
month from March 1, 1999 through February 2000, and $9,936 per month from March
1, 2000 through March 31, 2001. The Company also has a one year sublease
agreement, for a total of approximately $10,000 annual rental income, with an
entity whose majority stockholder is the President of the Company.
The Company planned to market and sell personal computers and computer related
products during the second half of fiscal year 2000. The Company was advised in
November 1999, that another company recently acquired the Company's supplier for
its computer products. This change in ownership will preclude the Company from
purchasing this line of product from this supplier. Accordingly, the Company has
no current plans to distribute and sell these computer products.
INVESTING
For the nine months ended December 31, 1999 and 1998, investments in masters and
artwork were $33,369 and $59,686, respectively. Management continues to seek to
acquire new titles to enhance its product lines.
American Top Real Estate, Inc. ["ATRE"] was formed in March 1989 for the
purposes of acquiring, owning and holding real property for commercial
development. ATRE does not engage in any other business operations. The Company
paid $50,000 for a 50% interest in ATRE. The Company's arrangement with its
partners in ATRE requires that all parties contribute capital or loans pro rata
according to their interests whenever required by ATRE for land acquisition,
principal or interest payments, property taxes or other expenses.
Upon sale or development of land, proceeds are used to repay all related loans
and other obligations, with the remaining balance distributed among the
shareholders of ATRE pro rata based on their interests. None of the other
investors in ATRE are otherwise associated or affiliated with the Company, nor
are any of ATRE's co-investors in its real estate holdings associated or
affiliated with the Company. ATRE has interests in two real estate parcels.
Parcel 1 consists of approximately 20 undeveloped acres purchased in two
transactions, in 1989 and 1997. ATRE has a 70% interest in Parcel 1, located in
Clark County, Washington. The total cost of Parcel 1, including financing
expenses and taxes, was approximately $2,300,000 through 1997.
Parcel 2 consists of 5.5 acres of undeveloped property, also in Clark County,
Washington. ATRE's interest in Parcel 2 is 25%. Parcel 2 was purchased in 1989
for $717,000. Approximately 2.5 acres of Parcel 2 were sold in 1996. The Company
received net proceeds of $121,600 from ATRE during fiscal 1997 relating to
Parcel 2 sales. Approximately 3 acres remain unsold as of the date of this
report.
35
During the year ended March 31, 1998, ATRE sold approximately 11 acres. The
Company advanced an additional $80,320 to ATRE and received $220,600 from the
proceeds of the parcel of 10 acres as repayment of the advances to ATRE in
fiscal 1998. The Company also received approximately $600,000 from ATRE during
the period April 1, 1998 through March 31, 1999.
At March 31, 1998, ATRE had no binding sales contracts for the remaining parcels
of real estate owned by ATRE as these parcels of land continue to be developed
for commercial use. Contracts that were pending have not closed due to possible
changes in interest rates or possible overall market conditions. In addition,
the Company was advised by ATRE that proceeds realized by ATRE during fiscal
1998 were reinvested into other parcels to improve the ability to sell the
remaining parcels. In December of 1998, the Company received from a real estate
development specialist an aggregate approximate valuation of $5,200,000 for the
remaining ATRE parcels. Although the Company believes that final sales contracts
will be able to be consummated, at this time it is not possible to predict with
any certainty when the closing of such sales contracts of commercial real estate
may occur or whether the proceeds expected by the Company for their share in
this real estate could be significantly less than anticipated. Therefore, the
ultimate realizable value of the receivable for advances from ATRE could be
substantially less than the preadjusted carrying value of $1,600,000. The
Company setup a valuation allowance in the quarter ended March 31, 1998, of
$1,117,788 and accordingly, charged operations for that amount so that the
amount due from ATRE at March 31, 1998 is presented at the amount of the 1998
subsequent receipts of approximately $500,000. Based upon the above
circumstances the likelihood is that $1,117,788 from future proceeds from the
sale of the ATRE parcels will not be realized by the Company with any certainty.
At March 31, 1999, no monies were due from ATRE.
On June 2, 1999, ATRE entered into a sale agreement for approximately $600,000
and in September 1999, entered into a sales agreement for remaining acres of the
larger parcel for approximately $550,000. The ability of the agreements to close
or for the Company to realize as of September 30, 1999, 50% of the net proceeds
to the Company, however, are uncertain and is subject to certain contingencies.
Therefore, the Company has not recorded a receivable for these contracts.
FINANCING
In March 1993 a loan was renegotiated for the sum of $292,058 with principal
payments of $5,000 per month with an interest rate of 10% per annum due November
14, 1999. This note was paid in full on July 15, 1998 for approximately $60,000.
As a result, the Company recorded forgiveness of debt of approximately $66,000
in July 1998.
On May 8, 1995, the Company closed a sales agreement with a Mexican Company, for
$750,000 by allowing credit to the Company for duplication services and received
$750,000 of duplication services in exchange for equipment having a book value
of approximately $630,000. The Company classified the outstanding obligation of
$288,701 at March 31, 1998 as notes payable. This note was repaid in weekly
installments of $12,500 with the final payment made in September of 1998.
Interest expense of approximately $4,127 was recorded for the year ended March
31, 1999.
On August 30, 1996, the Company established a line of credit up to $2,500,000,
whereby, $2,000,000 was backed by pledged receivables and inventory and $500,000
was guaranteed by the Company's President. Interest was at a prime rate plus 3%.
Interest expense from April 1, 1997 through December 31, 1997 was approximately
$148,500. In December 1997, the Company repaid $469,221 on this line of credit
and engaged another financial institution for a $2,500,000 financing
arrangement. This arrangement is also backed by pledged receivables and
inventory. Cost is 1.5% discounted from pledged invoices for every 30 days for
the accounts receivable portion of the line of credit. The portion of the line
of credit backed by inventory is determined by the lesser of $800,000, 25% of
the clients finished toy inventory or 55% of the clients finished videotape
inventory. Interest is charged at 16.18% per annum on this portion of the debt.
This was formalized with the Company in June of 1998. Interest expense from
December 1997 through March 31, 1998 was approximately $27,500. Interest for the
year ended March 31, 1999 was approximately $310,000.
36
During the quarter ended June 30, 1996, the Company issued convertible
debentures of $1,257,988 with 10% interest per annum and a 7% commission. The
principal amount was convertible in whole or in part into shares of the common
stock of the Company at a conversion price equal to 65% of the average closing
bid price for the common stock for five trading days immediately prior to the
conversion. In no event could the conversion price be less than $.20 per share
or more than $.75 per share. In conjunction with the debentures, the Company
granted 1,000,000 warrants exercisable at $.25 per share to two consultants.
Warrants for 46,000 shares were exercised for $11,500 during the year ended
March 31, 1997. The Company recorded a financing expense of $25,000 for the fair
value of the warrants granted. The fair value of the warrants was determined
based upon the fair value of services received by the Company in May and June of
1996.
As of March 31, 1997, convertible debentures of $290,000 were converted into
1,450,000 shares of the Company's common stock by several off shore companies
under Regulation S and $967,988 of convertible promissory notes payable were
outstanding and in default by the Company. Interest expense of $97,000 and
$24,702 was recorded for the years ended March 31, 1998 and 1997. Subsequent to
September 30, 1997, the Company negotiated a one year extension agreement and
agreed to add 15% to the note as a deferred financing cost of $110,721.
During fiscal March of 1998, convertible debentures of $229,848 were converted
into 6,037,668 shares of the Company's common stock. In June of 1998, a
convertible debenture holder converted a note payable with a balance of $91,750
into 2,823,077 shares of the Company's common stock. This brought total
conversions of $611,598 of debentures into 10,310,745 shares as of November 2,
1998.
On November 2, 1998, convertible debentures with a balance of $848,861 were
reinvested into a new note for $921,851 for a new two year term expiring October
31, 2000 with interest of 10% and an extension bonus of $175,000, which carries
interest of 2.5% per annum payable $50,000 per month after payment of all prior
and interest and the restructured note. The repayment term was a weekly amount
of $6,250 in 1998 and $12,500 in the years 1999 and 2000. In addition, there was
an acceleration clause of repayments for certain events and a 5% late charge for
any delinquent payments. The notes contained an option to convert the principal
and interest balance into the common stock of the Company subject to certain
pricing calculations. Collateral security included all the assets of the Company
and a personal collection guarantee as additional security to holder after
subordination to primary lender.
In February of 1999, the Company converted $640,000 of the debentures into
8,000,000 shares of common stock. On February 10, 1999, the Company converted
the remaining note balance of $172,661 and unpaid interest of $90,415 into
3,018,254 shares of common stock. It was also agreed that the $175,000 extension
bonus, which was recorded as a deferred financing cost in February of 1999,
could be converted into shares of common stock at an agreed exercise price
subject to market conditions. During the quarter ended December of 1999, the
Company converted the $175,000 extension bonus into 3,500,000 shares of common
stock. The Company amortized $20,000 and $155,000 of the extension bonus as a
financing expense for the year ended March 31, 1999 and the nine month period
ending December 31, 1999, respectively. In March of 1999, the Company received a
total of $300,000 from an officer and five investors and issued convertible
promissory notes due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per share. At March 31, 1999, the balance of convertible
debentures was therefore $475,000. In May 1999, $150,000 from the cancellation
of the obligations were utilized to purchase 3,000,000 shares issued upon
exercise of certain options. [See note 13I]
37
In April and June of 1999, the Company received $50,000 from an investor and
$100,000 from an officer and issued additional convertible promissory notes
totaling $150,000 due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per common share. In August 1999, $36,250 from the
cancellation of the obligation owed to the investor for principal and interest
was utilized to purchase 725,000 shares issued upon exercise of his options.
On June 2, 1999, the Company was advised by one of the convertible debenture
holders of a $100,000 note that the bimonthly principal payments were being
waived and the paying of the bimonthly interest would continue.
For the year ended March 31, 1999 and the five months ended March 31, 1998, the
Company amortized $84,587 and $46,134, respectively as a non-cash financing
cost, for the convertible debentures which is classified as interest expense.
For the nine months ended December 31, 1999, the Company amortized $155,000 as a
non-cash-cash financing cost which is also classified as interest expense. The
convertible notes are secured by the Company's entitlement to any net cash
proceeds derived from its interest in ATRE property. [See Note 4B]
In August 1997, the Company issued 2,050,000 common stock warrants at an
exercise price of $.10 per share as part of a consulting agreement entered into,
whose term ends August 1999. Deferred consulting costs of $100,000 resulting
from this transaction were recorded at the fair market value of the services
rendered and approximately $50,000 and $31,000 was expensed for the years ended
March 31, 1999 and 1998, respectively.
In October 1997, the Company borrowed $360,000 from an unaffiliated entity with
interest at 10% per year. At March 31, 1998, $185,208 was outstanding on this
obligation. This note was repaid in September of 1998 by weekly payments of
$7,500. Interest expense for the years ended March 31, 1999 and 1998 was $4,712
and $12,708, respectively.
On March 11, 1998, the Company issued 347,368 shares of common stock to a
salesman in lieu of commissions owed of $66,000. On February 25, 1999, the
Company issued 25,000 shares of common stock to a salesman's beneficiary in lieu
of commissions owed of $4,500.
In the June 1998 quarter, the Company's subsidiary received a total of
$2,721,860 from related parties to be utilized by the Company to pay a major
supplier of the Company for toy purchases. Subsequently, the related parties
were successful in receiving credits of $743,935 from the toy supplier. These
credits were applied by the related parties to the monies owed by the Company
for the purchases of toys. The Company negotiated and intended in July of 1999,
to convert part of the balance of the related party payables totaling
approximately $1,900,000 into shares of the Company's common stock. On August 5,
1999, the option to convert was canceled.
During the quarter ended December 31, 1999, Board of Directors of the Company
authorized the conversion of approximately $1,880,725 in related parties
payables into one year 7% Convertible Promissory Notes of $1,071,225 and
$809,500 each, both due on September 1, 2000. The terms of the new convertible
notes, allow the Company to make partial principal and interest payments from
time to time and the holders of the convertible notes have the option to request
such payments of the indebtedness evidenced by the notes in either in the lawful
money of the United States or in an equivalent value consisting of the Company's
common stock, the number of shares, to determined by dividing the payment amount
by the average twenty day bid price for the Company's common stock during the
twenty trading days prior to the date of such payment date. Also, during the
quarter ended December 31, 1999, the related party to which $1,071,225 in
related parties payable was owed by the Company, transacted a change in
ownership its common stock in which 100% of its outstanding shares of common
stock was sold to a non-related party. Therefore, for the quarter ended December
31, 1999, the Company's new convertible promissory note of $1,071,225 has been
reclassified on the Company's balance sheet as a non-related convertible note
owed by the Company. As of December 31, 1999, the balance of convertible
debentures was $2,130,755.
38
During the nine month period ended December 31, 1999, the Company borrowed from
the related parties approximately $454,000 and repaid them approximately
$274,000. The net outstanding obligations owed to the related parties totaled
$302,320 as of December 31, 1999.
On July 15, 1998, the Company incorporated Galaxynet International, Inc.
["GalaxyNet"] in the State of Delaware, as a majority-owned subsidiary of the
Company. GalaxyNet intended to develop and sell internet gaming software and
intended to offer its software to internet gaming companies and provide internet
gaming web sites to solicit gambling wags from primarily, Asian players. The
Company also issued 4,000,000 options exercisable at $.10 per share to an
investor and 6,000,000 options to the Chief Executive Officer exercisable at
$.10 in connection with this project. On July 17, 1998, the Company, along with
GalaxyNet, entered into a memorandum of understanding regarding the raising of
capital in a private offering to raise gross proceeds in the aggregate of
between and $3,000,000 and $10,000,000 with an enterprise who would be paid the
sum of 15% of the aggregate proceeds and received finders options for up to
3,750,000 shares of common stock at exercise prices of between $.10 and $.20 per
share. The private offering period ended September 30, 1998, and was extended
until October 31, 1998. The private offering resulted in raising funding
proceeds of only $250,000. The Company subsequently canceled the project and
refunded the $250,000 to the investor and canceled all the project related
options in November 1998. The Company incurred expenses on behalf of GalaxyNet
for fiscal 1999 of approximately $30,000.
In July of 1998, the Company raised $80,000 from the exercise of warrants for a
total 1,800,000 shares of the Company's common stock.
In July and August of 1998, the Company granted options to purchase a total of
6,000,000 shares of common stock to the chief executive officer for a new
potential customer, in consideration of certain fulfillment orders submitted to
the Company and loan guarantees. These options may be exercised for $0.10 per
share.
On October 24, 1998, the Company issued 1,499,523 shares of common stock to the
Company's president pursuant to a settlement agreement for a value of $30,000.
On January 10, 1999, the Company engaged three consultants for a period of one
year to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 4,700,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on December 31, 2000. These
options were exercised in February of 1999 for proceeds to the Company of
$275,000.
In February 1999, the Company engaged a consulting firm to provide internet
media consulting and public relations services for a period of one year. The fee
for the services to be rendered included a monthly cash fee of $3,000. The
consulting firm also received options to purchase a total of 250,000 shares of
the Company's common stock with an exercise price of $0.05 per share in exchange
for services to be rendered and the options shall expire on February 11, 2001.
During the six month period ended September 30, 1999, all of shares were
exercised for services rendered by the consulting firm and the cost incurred
totaled $12,500.
The Company recorded deferred consulting cost of $33,000 for these 1999
consulting agreements and amortized $4,000 and $24,400 as consulting expense for
the year ended March 31, 1999 and nine months ended December 31, 1999,
respectively
39
On April 12, 1999 the Company entered into three consulting agreements that will
terminate on April 11, 2000 whereby three consultants each received options for
2,000,000 shares of common stock each which will expire on April 11, 2000 at an
exercise price of $.05 per share. The agreements can be terminated or extended
as agreed to between the parties. The Company recorded deferred consulting cost
of approximately $120,000 in April of 1999, and amortized approximately $86,000
for the nine months ended December 31, 1999. The Company filed a Form S-8 on May
19, 1999 registering the 6,000,000 shares of common stock for these options. On
May 20, 1999, the Company received $150,000 in cash for the issuance of the
3,000,000 shares and $150,000 from the cancellation of convertible debentures
for the consideration for issuance of 3,000,000 shares of as a result of the
options being exercised.
On May 25, 1999, the Company approved the granting of options for a total of
4,500,000 shares of common stock exercisable over five years at prices of $.05
and $.10 to two officers for their services in securing additional financing,
obtaining conversion of debentures to equity and their securing new contracts
with new customers in April of 1999. The options expire May 2004. The Company
recorded compensation expense of approximately $180,000 in May of 1999.
In June of 1999, the Company received a loan in the amount of $90,000 from an
officer of the Company which is payable upon demand.
On July 13, 1999 the Company entered into a consulting agreement that will
terminate on July 12, 2002 whereby consultant shall provide consulting advice
concerning the marketing and sales of computers and computer related products in
the United States. For such services, consultant received an option for
1,000,000 shares of common stock which will expire on July 12, 2002 at an
exercise price of $.10 per share. The Company will pay consultant a one percent
(1%) sale commission on net payments received by the Company for computer
related products that are sold to certain club stores by the consultant. The
agreement can be terminated or extended as agreed to between the parties. The
Company recorded deferred consulting cost of approximately $20,000 in July of
1999 and amortized approximately $9,300 for the nine months period ended
December 31, 1999. The Company filed a Form S-8 on August 24,1999 for these
shares of common stock. These options were not exercised as of December 31,
1999. [5H}
On August 2, 1999, the Company engaged two consultants for a period of one year
to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 1,965,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on August 2, 2000. The
Company recorded deferred consulting cost of approximately $67,700 and amortized
approximately $24,700 for the nine months period ended December 31, 1999. The
Company filed a Form S-8 on August 24,1999 for these shares of common stock. In
August 1999, the Company received $62,000 in cash for the issuance of the
1,240,000 shares and $36,250 from the cancellation of a convertible debenture
including unpaid interest for the consideration for issuance of 725,000 shares
as a result of the options being exercised. [See note 7D]
40
NEW AUTHORITATIVE PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. SFAS No. 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and how it is designated, for
example, gain or losses related to changes in the fair value of a derivative not
designated as a hedging instrument is recognized in earnings in the period of
the change, while certain types of hedges may be initially reported as a
component of other comprehensive income [outside earnings] until the
consummation of the underlying transaction.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application of SFAS No. 133 should be as of the
beginning of a fiscal quarter; on that date, hedging relationships must be
designated anew and documented pursuant to the provisions of SFAS No. 133.
Earlier application of all of the provisions of SFAS No. 133 is encouraged, but
it is permitted only as of the beginning of any fiscal quarter. SFAS No. 133 is
not to be applied retroactively to financial statements of prior periods. The
Company does not currently have any derivative instruments and is not currently
engaged in any hedging activities.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ["SOP"] 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 provides guidance on the financial reporting of start-up
costs and organization costs, and requires that such costs to be expensed as
incurred. SOP 98-5 applies to all nongovernmental entities and is generally
effective for fiscal years beginning after December 15, 1998. Earlier
application is encouraged in fiscal years for which annual financial statements
previously have not been issued. The adoption of SOP 98-5 is not expected to
have a material impact on results of operations, financial position, or cash
flows of the Company as the Company's current policy is substantially in
accordance with SOP 98-5.
The Financial Accounting Standards Board ["FASB"] has had on its agenda a
project to address certain practice issues regarding Accounting Principles Board
["APB"] Opinion No. 25, "Accounting for Stock Issued to Employees." The FASB
plans on issuing various interpretations of APB Opinion No. 25 to address these
practice issues. The proposed effective date of these interpretations would be
the issuance date of the final Interpretation, which is expected to be in
September 1999. If adopted, the Interpretation would be applied prospectively
but would be applied to plan modification and grants that occur after December
15, 1998. The FASB's tentative interpretations are as follows:
* APB Opinion No. 25 has been applied in practice to include in its
definition of employees, outside members of the board or directors and
independent contractors. The FASB's interpretation of APB Opinion No. 25
will limit the definition of an employee to individuals who meet the
common law definition of an employee [which also is the basis for the
distinction between employees and nonemployees in the current U.S. tax
code]. Outside members of the board of directors and independent
contractors would be excluded from the scope of APB Opinion No. 25 unless
they qualify as employees under common law. Accordingly, the cost of
issuing stock options to board members and independent contractors not
meeting the common law definition of an employee will have to be
determined in accordance with FASB Statement No. 123, "Accounting for
Stock-Based Compensation," and usually recorded as an expense in the
period of the grant [the service period could be prospective, however,
see EITF 96-18].
* Options [or other equity instruments] of a parent company issued to
employees of a subsidiary should be considered options, etc. issued by
the employer corporation in the consolidated financial statements, and,
accordingly, APB Opinion No. 25 should continue to be applied in such
situations. This interpretation would apply to subsidiary companies only;
it would not apply to equity method investees or joint ventures.
41
* If the terms of an option [originally accounted for as a fixed option]
are modified during the option term to directly change the exercise
price, the modified option should be accounted for as a variable option.
Variable grant accounting should be applied to the modified option from
the date of the modification until the date of exercise. Consequently,
the final measurement of compensation expense would occur at the date of
exercise. The cancellation of an option and the issuance of a new option
with a lower exercise price shortly thereafter [for example, within six
months] to the same individual should be considered in substance a
modified [variable] option.
* Additional interpretations will address how to measure compensation
expense when a new measurement date is required.
YEAR 2000 ISSUE
The Company has attempted to evaluate the impact of the year 2000 issue on its
business and does not expect the amounts to be expensed over the next 6 months
to be material. No such costs have been expensed to date, since the Company
utilizes an off the shelf software package.
The Company commenced in June 1999 communication with its significant vendors
and customers to determine the extent that year 2000 compliance issues of such
parties may affect the Company. At this time, the Company believes that there
will be no disruption in business due to its customers' or vendors' year 2000
readiness. Also in June 1999, the Company commenced testing of its computer
hardware and software including all equipment posing a potential problem. The
Company has not established a contingency plan. There can be no guarantee that
the systems of such other companies will be timely converted without a material
adverse effect on the Company's business, financial condition or results of
operations.
IMPACT OF INFLATION
The Company does not believe that inflation had an impact on sales or income
during the past several years. Increases in supplies or other operating costs
could adversely affect the Company's operations; however, the Company believes
it could increase prices to offset increases in costs of goods sold or other
operating costs.
42
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company has in the past been named as defendant and co-defendant in various
legal actions filed against the Company in the normal course of business. All
past litigation have been resolved without material adverse impact on the
Company. For the year ended March 31, 1999, there were three civil actions
against the Company. One action is for alleged copyright infringement whereby
the Company has entered into a settlement agreement in February of 1998 to pay
$208,000 over twenty-four months, whereby the Company has made twenty three of
the required payments due as of December 31, 1999. The second action is for
breach of service whereby the Company settled for two payments of $4,750 each,
which were paid in July and August, 1999. The third action, the Company has
challenged the alleged suit for copyright infringement.
ITEM 2. CHANGES IN SECURITIES.
In February 1999, the Company engaged a consulting firm to provide internet
media consulting and public relations services for a period of one year. The fee
for the services to be rendered included a monthly cash fee of $3,000. The
consulting firm also received options to purchase a total of 250,000 shares of
the Company's common stock with an exercise price of $0.05 per share in exchange
for services to be rendered and the options shall expire on February 11, 2001.
During the six month period ended September 30, 1999, all of the options were
exercised for services rendered by the consulting firm and the cost incurred
totaled $12,500.
In February 1999, the Company converted $640,000 of the debentures into
8,000,000 shares of common stock. On February 10, 1999, the Company converted
the remaining note balance of $172,661 and unpaid interest of $90,415 into
3,018,254 shares of common stock. It was also agreed that the $175,000 extension
bonus, which was recorded as a deferred financing cost in February of 1999,
could be converted into shares of common stock at an agreed exercise price
subject to market conditions. During the quarter ended December of 1999, the
Company converted the $175,000 extension bonus into 3,500,000 shares of common
stock. The Company amortized $20,000 and $155,000 of the extension bonus as a
financing expense for the year ended March 31, 1999 and the nine month period
ending December 31, 1999, respectively. In March of 1999, the Company received a
total of $300,000 from an officer and five investors and issued convertible
promissory notes due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per share. In May 1999, $150,000 from the cancellation of
the obligations was utilized to purchase 3,000,000 shares issued upon exercise
of certain options. [See 13I]
In April and June of 1999, the Company received $50,000 from an investor and
$100,000 from an officer and issued additional convertible promissory notes
totaling $150,000 due in one year with principal and interest paid bimonthly at
an interest rate of 10%. The notes are convertible immediately into common stock
at the rate of $.05 per common share. In August 1999, $36,250 from the
cancellation of the obligations owed to the investor for principal and interest
was utilized to purchase 725,000 shares issued upon exercise of his options.
On April 12, 1999 the Company entered into three consulting agreements that will
terminate on April 11, 2000 whereby three consultants each received options for
2,000,000 shares of common stock each which will expire on April 11, 2000 at an
exercise price of $.05 per share. The agreements can be terminated or extended
as agreed to between the parties. The Company recorded deferred consulting cost
of approximately $120,000 in April of 1999, and amortized approximately $86,000
for the nine months ended December 31, 1999. The Company filed a Form S-8 on May
19, 1999 registering the 6,000,000 shares of common stock for these options. On
May 20, 1999, the Company received $150,000 in cash for the issuance of the
3,000,000 shares and $150,000 from the cancellation of convertible debentures
for the consideration for issuance of 3,000,000 shares of as a result of the
options being exercised.
43
On July 13, 1999 the Company entered into a consulting agreement that will
terminate on July 12, 2002 whereby consultant shall provide consulting advice
concerning the marketing and sales of computers and computer related products in
the United States. For such services, consultant received an option for
1,000,000 shares of common stock which will expire on July 12, 2002 at an
exercise price of $.10 per share. The Company will pay consultant a one percent
(1%) sale commission on net payments received by the Company for computer
related products that are sold to certain club stores by the consultant. The
agreement can be terminated or extended as agreed to between the parties. The
Company recorded deferred consulting cost of approximately $20,000 in July of
1999 and amortized approximately $9,300 for the nine months period ended
December 31, 1999. The Company filed a Form S-8 on August 24,1999 for these
shares of common stock. These options were not exercised as of December 31,
1999. The Company planned to market and sell personal computers and computer
related products during the second half of fiscal year 2000. The Company was
advised in November 1999, that another company recently acquired the Company's
supplier for its computer products. This change in ownership will preclude the
Company from purchasing this line of product from this supplier. Accordingly,
the Company has no current plans to distribute and sell these computer products.
On August 2, 1999, the Company engaged two consultants for a period of one year
to provide advice to undertake for and consult with the Company concerning
management, marketing, consulting, strategic planning, corporate organization
and structure, financial matters in connection with the operation of the
businesses of the Company, expansion of services, acquisitions and business
opportunities. The consultants received options to purchase a total of 1,965,000
of the Company's common stock exercisable at $.05 per share in exchange for
services to be rendered and the options shall expire on August 2, 2000. The
Company recorded deferred consulting cost of approximately $67,700 and amortized
approximately $24,700 for the nine months period ended December 31, 1999. The
Company filed a Form S-8 on August 24,1999 for these shares of common stock. In
August 1999, the Company received $62,000 in cash for the issuance of the
1,240,000 shares and $36,250 from the cancellation of a convertible debenture
including unpaid interest for the consideration for issuance of 725,000 shares
as a result of the options being exercised. [See note 7D]
The Company believes that the transactions set forth above were exempt from
registration with the Commission pursuant to either Section 4(2) of the
Securities Act as transactions by an issuer not involving any public offering,
Section 3(a)(9) of the Securities Act as a transaction involving an exchange by
an issuer with existing security holders, or Regulation S under the Securities
Act as a transaction that occurred outside the United States. No broker-dealer
or underwriter was involved in the foregoing transactions. All certificates
representing such securities have been or will be appropriately legended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No.
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27 Financial Data Schedule
(b) Reports on Form 8-K
On January 24, 2000, the Company filed a Current Report on
Form 8-K dated January 14, 2000, to report that the Company's
independent public accountants, Moore Stephens, P.C., terminated its
client-auditor relationship with the Company and reported the
engagement of Merdinger, Fruchter, Rosen & Corso, P.C. to serve as the
Company's independent public accountants to conduct the audit of the
Company's financial statements for the fiscal year ending March 31,
2000, replacing the firm of Moore Stephens. P.C. The Company further
reported its intent move of its principal executive offices effective
January 28, 2000, to its new location at 800 Tucker Lane, Walnut,
California 91789.
* * * * *
45
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: Cerritos, California DIAMOND ENTERTAINMENT CORPORATION
February 21, 1999
By: /s/ James K.T. Lu
---------------------------------
James K.T. Lu
Chairman of the Board,
Chief Executive Officer;
President; Secretary and Director
By: /s/ Fred U. Odaka
---------------------------------
Fred U. Odaka
Chief Financial Officer,
Principal Financial Officer
46
DIAMOND ENTERTAINMENT CORPORATION
EXHIBIT INDEX
EXHIBIT
NUMBER
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27 Financial Data Schedule
47