UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|XX| Quarterly Report Under Section 13 of 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended September 30, 2005
|__| Transition Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _____________ to ______________
Commission file number 0-10061
AMERICAN VANTAGE COMPANIES
(Exact name of small business issuer as specified in its charter)
Nevada 04-2709807
------ ----------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
4735 S. Durango Dr., Suite #105, Las Vegas, Nevada, 89147
---------------------------------------------------------
(Address of principal executive offices)
(702) 227-9800
--------------
(Issuer's telephone number)
Not Applicable
--------------
(Former name, former address and former fiscal year, if changed since
last report)
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 |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. YES |_| NO |X|
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: The number of shares outstanding of
the issuer's common stock at November 11, 2005 was 5,729,107.
Transitional Small Business Disclosure Format: YES |_| NO |X|
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2005 (unaudited) and
December 31, 2004 3
Condensed Consolidated Statements of Operations
for the Three And Nine Months Ended
September 30, 2005 and 2004 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2005
and 2004 (unaudited) 5
Notes to Condensed Consolidated Financial
Statements (unaudited) 6
Item 2. Management's Discussion and Analysis or Plan of Operation 15
Item 3. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits 27
SIGNATURES
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
AMERICAN VANTAGE COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
September 30, December 31,
2005 2004
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,909,000 $ 1,944,000
Restricted cash and cash equivalents 2,500,000 2,500,000
Equity securities, available for sale, at fair value
(cost of $2,306,000 and $0), current portion 1,896,000 --
Investment in derivative securities (cost of $1,244,000 and $0) 941,000 --
Accounts receivable, net, current portion 90,000 4,758,000
Deferred income tax asset, less valuation allowance of
$2,330,000 and $0, respectively -- 4,517,000
Other 121,000 1,622,000
------------ ------------
8,457,000 15,341,000
Film inventory, net -- 8,218,000
Capitalized film costs, net -- 3,362,000
Accounts receivable, net, less current portion -- 201,000
Investments in unconsolidated investees 670,000 715,000
Equity securities, available for sale, at fair value
(cost of $788,000 and $0), less current portion 648,000 --
Other, net 514,000 2,333,000
------------ ------------
$ 10,289,000 $ 30,170,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other current liabilities $ 757,000 $ 7,729,000
Lines of credit -- 4,649,000
------------ ------------
757,000 12,378,000
Notes payable 523,000 4,523,000
------------ ------------
1,280,000 16,901,000
------------ ------------
Stockholders' equity:
Preferred stock, $.01 par; 10,000,000 shares authorized;
0 shares issued and outstanding -- --
Common stock, $.01 par; 100,000,000 shares authorized;
5,729,107 shares issued and outstanding 57,000 57,000
Additional paid-in capital 5,780,000 5,769,000
Retained earnings 3,524,000 7,443,000
Accumulated other comprehensive loss, net of tax (352,000) --
------------ ------------
9,009,000 13,269,000
------------ ------------
$ 10,289,000 $ 30,170,000
============ ============
See notes to unaudited condensed consolidated financial statements
3
AMERICAN VANTAGE COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenues, net $ 37,000 $ 75,000 $ 281,000 $ 353,000
Cost of services 17,000 37,000 114,000 208,000
----------- ----------- ----------- -----------
Gross profit 20,000 38,000 167,000 145,000
----------- ----------- ----------- -----------
Selling, general and administrative
Payroll and payroll-related expenses 295,000 334,000 914,000 1,121,000
Related parties 53,000 38,000 131,000 118,000
Other 542,000 486,000 1,808,000 1,616,000
----------- ----------- ----------- -----------
890,000 858,000 2,853,000 2,855,000
----------- ----------- ----------- -----------
Operating loss (870,000) (820,000) (2,686,000) (2,710,000)
----------- ----------- ----------- -----------
Non-operating (expense) income
Interest and other (expense) income, net (155,000) (4,000) (211,000) 56,000
Loss on sale of stock (2,601,000) -- (4,642,000) --
Gain on sale of land -- -- -- 3,423,000
----------- ----------- ----------- -----------
(2,756,000) (4,000) (4,853,000) 3,479,000
----------- ----------- ----------- -----------
(Loss) income from continuing operations before
income tax benefit (provision) (3,626,000) (824,000) (7,539,000) 769,000
Income tax benefit (provision) 76,000 143,000 235,000 (537,000)
Equity in income of unconsolidated investees, net 114,000 385,000 509,000 792,000
----------- ----------- ----------- -----------
(Loss) income from continuing operations (3,436,000) (296,000) (6,795,000) 1,024,000
(Loss) income from discontinued operations
(Loss) income from discontinued
operations (including gain
on disposal of $6,536,000) 318,000 (1,166,000) 4,546,000 (4,108,000)
Income tax (provision) benefit (112,000) 379,000 (1,670,000) 1,379,000
----------- ----------- ----------- -----------
Net loss $(3,230,000) $(1,083,000) $(3,919,000) $(1,705,000)
=========== =========== =========== ===========
Net (loss) income per share -- basic and diluted:
Continuing operations $ (0.60) $ (0.05) $ (1.18) $ 0.18
Discontinued operations 0.04 (0.14) 0.50 (0.48)
----------- ----------- ----------- -----------
$ (0.56) $ (0.19) $ (0.68) $ (0.30)
=========== =========== =========== ===========
Weighted average number of common shares
and common share equivalents 5,729,000 5,704,000 5,729,000 5,702,000
=========== =========== =========== ===========
See notes to unaudited condensed consolidated financial statements
4
AMERICAN VANTAGE COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Nine Months
Ended Ended
September 30, September 30,
2005 2004
------------ ------------
Operating activities
Net cash used in operating activities $ (3,584,000) $ (2,786,000)
------------ ------------
Investing activities
Purchase of furniture and equipment -- (13,000)
Proceeds from sale of stock and warrants, net of direct costs 8,592,000 --
Proceeds from sale of land -- 7,007,000
Cash paid for acquisition direct costs -- (14,000)
Purchase certificate of deposit -- (2,500,000)
Proceeds from maturity of certificate of deposit 2,500,000 --
Purchase standby letter of credit -- (350,000)
Cash transferred to an escrow account (2,500,000) --
Cash used in discontinued operations, including payment of direct sales costs (2,220,000) (10,608,000)
Cash distribution from unconsolidated restaurant investee 477,000 921,000
------------ ------------
Net cash provided by (used in) investing activities 6,849,000 (5,557,000)
------------ ------------
Financing activities
Borrowings on line of credit 200,000 2,300,000
Payment of line of credit (2,500,000) --
------------ ------------
Net cash (used in) provided by financing activities (2,300,000) 2,300,000
------------ ------------
Net decrease in cash and cash equivalents 965,000 (6,043,000)
Cash and cash equivalents, at beginning of period 1,944,000 8,628,000
------------ ------------
Cash and cash equivalents, at end of period $ 2,909,000 $ 2,585,000
============ ============
Supplemental schedule of cash flow information:
Cash paid for interest from continuing operations $ 37,000 $ 20,000
============ ============
Taxes paid from continuing operations $ 25,000 $ 13,000
============ ============
Noncash investing and financing activities: Consideration received from March
21, 2005 sale of AVMC:
7,000,000 shares of Genius common stock $ 15,750,000 $ --
1,400,000 warrants to purchase Genius common stock 1,820,000 --
------------ ------------
17,570,000 --
Fair value of disposed assets and liabilities at September 30, 2005:
Assets, net (21,944,000) --
Liabilities 12,670,000 --
Direct costs for the sale of AVMC (1,243,000)
Other (517,000) --
------------ ------------
Gain on disposal $ 6,536,000 $ --
============ ============
See notes to unaudited condensed consolidated financial statements
5
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 1 - Nature of operations and summary of significant accounting policies
Interim financial information. These condensed consolidated financial
statements include the accounts of American Vantage Companies and all of its
controlled subsidiaries (collectively, "AVCS" or the "Company") from the date of
their acquisition or creation. All intercompany accounts and transactions have
been eliminated. The financial information as of September 30, 2005 and for the
three and nine months ended September 30, 2005 and 2004 is unaudited but
includes all adjustments (consisting only of normal recurring adjustments) that
the Company considers necessary for a fair presentation of the financial
position of the Company as of such dates and the operating results and cash
flows of the Company for those periods. Certain information and disclosures
normally included in annual financial statements prepared in accordance with
accounting principles generally accepted in the United States ("U.S. GAAP") have
been condensed or omitted as permitted by the Securities and Exchange Commission
under Item 310(b) of Regulation S-B. However, the Company believes the
disclosures made are adequate for a fair presentation to ensure that the interim
period financial statements are not misleading.
The Company's results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the
entire fiscal year. These condensed consolidated interim financial statements
should be read in conjunction with the audited consolidated financial statements
(and notes thereto) of the Company for the year ended December 31, 2004, which
are included in the Company's Form 10-KSB for the year then ended, the financial
and other information contained in the Company's Forms 10-QSB for the three
months ended June 30, 2005 and March 31, 2005, as well as the Company's Form 8-K
concerning the March 21, 2005 disposal of all of the outstanding common stock of
a wholly-owned subsidiary of the Company, American Vantage Media Corporation
("AVMC"), to Genius Products, Inc. ("Genius" or "GNPI").
Certain amounts as previously reported for the 2004 period have been
reclassified to conform to the current presentation.
Nature of business and business activities. On December 31, 2003, the
Company, acquired substantially all of the assets and business and certain of
the liabilities of Enigma Media, Inc. ("Enigma"), dba Hypnotic ("Hypnotic"), and
began operations effective January 1, 2004. Hypnotic has been structured as a
wholly-owned subsidiary of AVMC.
AVMC acquired from Enigma its television, branded entertainment and
distribution operations and specific intellectual property, including a
short-film library plus an ownership interest in two feature films.
Effective January 1, 2004, AVMC combined the operations of YaYa Media,
Inc. ("YaYa"), a wholly-owned subsidiary of the Company, and the Hypnotic
branded entertainment operations into AVMC's Branded Content segment.
On February 3, 2004, AVMC acquired all of the outstanding common stock of
Wellspring Media, Inc. ("Wellspring"), and began operating Wellspring (Filmed
Entertainment division) as of that date. Wellspring is a distributor of world
cinema and wellness programming. Wellspring's assets include a film library with
over 750 titles distributed via its home video, direct response, worldwide sales
and theatrical divisions.
During December 2004, the Company discontinued its Branded Content
segment. In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
No. 144"), the Company's consolidated condensed statements of operations have
been retroactively adjusted to account for the Branded Content segment as
discontinued operations for all periods presented.
6
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Effective March 21, 2005, the Company sold all of the outstanding common
stock of AVMC to Genius. Genius began operating the AVMC operations effective
March 22, 2005. Consideration included 7,000,000 shares of Genius common stock
and five-year warrants to purchase an additional 1,400,000 shares of Genius
common stock, half at an exercise price of $2.56 per share and half at an
exercise price of $2.78 per share. The consideration also included assumption of
certain liabilities, including a $2,349,000 Atlantic Bank of New York credit
facility and $4,000,000 of promissory notes of AVMC. AVCS has guaranteed the
obligations arising under $3,274,000 of the AVMC promissory notes which mature
on February 3, 2006. AVCS also assumed payment obligations relating to
approximately $1,080,000 of accounts payable incurred in connection with the
direct response operations of AVMC (included in accounts payable and accrued
liabilities in the June 30, 2005 condensed consolidated balance sheet). The
direct response accounts payable obligations will be offset from the proceeds,
if any, from the sale of approximately $328,000 of direct response inventory. In
conjunction with the sale of AVMC, the Company recorded a gain of $6,218,000 at
March 31, 2005.
Of the 7,000,000 shares of GNPI common stock acquired from Genius,
5,625,000 shares were not subject to pledges or other restrictions. Those shares
not subject to pledges or other restrictions, along with the warrants acquired
from Genius, were classified as current assets in the accompanying condensed
consolidated balance sheets at September 30, 2005, while the shares subject to
long-term pledges or other restrictions were recorded as long-term assets. The
Genius common stock is traded on the over-the-counter bulletin board (OTCBB)
under the symbol "GNPI."
Effective June 1, 2005, the Company placed 2,000,000 shares of the Genius
common stock and 180,000 warrants to purchase shares of Genius common stock, at
an exercise price of $2.56 per share, for gross proceeds of $3,500,000.
Effective June 4, 2005, the Company placed 500,000 shares and 45,000 Genius
warrants of the Genius common stock under similar terms as the previous
placement for gross proceeds of $875,000. Direct sales costs for the June 2005
placements totaled $214,000. Related to these placements of the Genius stock,
the Company also surrendered to Genius for cancellation 225,000 warrants to
purchase shares of Genius common stock, at an exercise price of $2.56 per share.
In conjunction with these transactions, the Company recognized a loss of
$2,041,000.
In addition, effective August 17, 2005, the Company placed 3,125,000
shares of the Genius common stock for gross proceeds of $4,688,000 with direct
sales costs of $257,000. In conjunction with this transaction, the Company
recognized a loss of $2,601,000.
Related to the Genius transaction, the Company and Genius also entered
into a pledge agreement, transferring to the Company, certain assets,
liabilities and operations of Hypnotic. The book value of these assets that were
transferred back to the Company was not treated as part of the accounting for
the original sale; but, rather, was treated as assets retained by the Company.
The assets and operations transferred back to the Company encompass the prior
Film and TV Production segment operations of Hypnotic including co-executive
producer fees generated from the television series "The O.C.," but excluding
Hypnotic's `back-end' interest in "The O.C."
Based on the above described transaction, in accordance with SFAS No. 144,
the Company's condensed consolidated statements of operations have been
retroactively adjusted to account for AVMC, Wellspring and applicable Hypnotic
operations as discontinued operations for all periods presented.
In addition to certain Hypnotic assets that constitute the basis for the
remaining Film and TV Production continuing operations, the Company retained its
49% interest in the Las Vegas Border Grill Restaurant (the "Restaurant
Investee") and YaYa. YaYa's assets primarily include a 10% interest in an
unconsolidated investee. The Company has no day-to-day management
responsibilities in connection with the operations of either investee.
7
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Principles of consolidation. The consolidated financial statements include
the accounts of American Vantage Companies and its wholly-owned subsidiaries.
All significant intercompany accounts and transactions have been eliminated.
The Company excludes the accounts of the Restaurant Investee and instead
records its investment using the equity method of accounting (based on the
Company's equity in the Restaurant Investee's net assets, which is 49%, and the
terms of the Restaurant Investee's operating agreement).
The Company also excludes the accounts of its YaYa Investee and, effective
January 1, 2005, records its investment using the cost method of accounting
based on the Company's equity in the YaYa Investee's net assets, which 10%
interest is an unconsolidated investee. Prior to January 1, 2005, the Company
recorded this investment using the equity method of accounting as the Company's
equity in the YaYa Investee's net assets ranged up to 36%.
Use of estimates. The preparation of financial statements in conformity
with U.S. GAAP requires management to make estimates and assumptions that affect
the reported amounts and disclosures, some of which may require revision in
future periods. Actual results could differ from those estimates.
Equity securities. Consideration received from the March 21, 2005 sale of
AVMC to Genius included 7,000,000 shares of Genius common stock and five-year
warrants to purchase an additional 1,400,000 shares of Genius common stock, half
at an exercise price of $2.56 per share and half at an exercise price of $2.78
per share. In August 2005 and June 2005, the Company placed an aggregate of
3,125,000 and 2,500,000 shares, respectively, of the Genius common stock with
unaffiliated third parties. In conjunction with the June 2005 placement, the
Company also placed an aggregate of 225,000 warrants to purchase shares of
Genius common stock, at an exercise price of $2.56 per share. Related to the
June 2005 placements of the Genius stock, the Company also surrendered to Genius
for cancellation 225,000 warrants to purchase shares of Genius common stock, at
an exercise price of $2.56 per share. Gross proceeds from the August 2005 and
June 2005 placements totaled $4,688,000 and $4,375,000, respectively.
At September 30, 2005, in accordance with SFAS No. 115 "Accounting for
Certain Investments in Debt and Equity Securities," the Company classified the
remaining 1,375,000 shares of Genius common stock as "available-for-sale." As
such, unrealized holding gains and losses are excluded from earnings and
reported in other comprehensive loss, net of taxes. As of September 30, 2005,
the fair value of the Genius stock was $2,544,000, including an unrealized
holding loss of $550,000. A total of 675,000 shares of Genius common stock
comprising a portion of the merger consideration are being held in escrow, of
which 350,000 shares have restrictions exceeding one year to secure the
indemnification obligations under the merger agreement. These securities, with a
fair market value of $648,000, at September 30, 2005, are included as long-term
assets in the condensed consolidated balance sheets.
In accordance with SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities," the fair value of the warrants is recorded as $941,000 on
the September 30, 2005 condensed consolidated balance sheet. The warrants have
been accounted for as derivatives as the terms require or permit a cashless
exercise. Gains or losses resulting from fluctuations in the fair value are
recognized in non-operating (expense) income in the Company's condensed
consolidated statement of operations. For the three and nine months ended
September 30, 2005, the Company recognized a loss of $209,000 and $303,000,
respectively, due to the change in the fair value of the warrants at September
30, 2005.
In accordance with Emerging Issues Task Force Issue No. 03-01, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" and SEC Staff Accounting Bulletin Topic 5-M, "Other Than Temporary
Impairment of Certain Investments in Debt and Equity Securities," the Company
assesses whether an other-than-temporary impairment loss on an investment has
occurred due to declines in fair value or other market conditions. The Company
currently has the ability and intent to hold the Genius stock for a sufficient
time to allow for a recovery in the market value to $2.25 per share, which is
the original cost that was recorded in March 2005. There were no
other-than-temporary impairment losses during the three or nine months ended
September 30, 2005.
8
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
FASB has released FASB Staff Position 115-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments." The
proposed guidance addresses the "determination as to when an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss." The effective date for the proposed guidance
is for reporting periods beginning after December 15, 2005. The proposed
guidance is not expected to have a material effect on the Company's consolidated
financial statements.
Revenue recognition. The Company's revenues for the three and nine months
ended September 30, 2005 and 2004 were generated by the Film and TV Production
segment. Revenues from home video, direct response, worldwide sales (television)
and theatrical units previously disclosed as the Filmed Entertainment segment
are included in discontinued operations. In addition, programming development,
advisory services, development of custom software applications and hosting and
reporting services previously disclosed as the Branded Content segment are
included in discontinued operations.
The Film and TV Production revenues primarily are generated from an
agreement to provide executive co-producer services for a television series.
These revenues are generally recognized as services are provided.
Cash advances received are recorded as deferred revenue until all the
conditions of revenue recognition have been met.
Goodwill. In accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"), goodwill and intangible assets with indefinite lives
are no longer amortized but, instead, are evaluated for impairment periodically,
or when events indicate that an impairment could exist. As required by SFAS No.
142, in the Company's impairment test of goodwill, the fair value of the
applicable reporting unit is compared to its carrying value. If the carrying
value of the reporting unit exceeds the estimate of fair value, the Company
calculates the impairment as the excess of the carrying value of goodwill over
its estimated fair value.
At December 31, 2004, the Company's goodwill related to the December 31,
2003 acquisition of the Hypnotic operations totaled $574,000. In connection with
the sale of AVMC to Genius on March 21, 2005, management determined that the
Hypnotic goodwill carrying value of $517,000 was associated with assets sold to
Genius, and therefore, the $517,000 was included in the gain on sale.
Stock-based compensation. The Company accounts for stock-based employee
compensation using the intrinsic value method provided for in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Historically, the Company has granted stock options to its employees with
exercise prices equal to the market value on the date of grant and, accordingly,
no compensation expense is recognized.
Under the intrinsic value method, no compensation cost has been recognized
for employee stock-based compensation under the applicable circumstances. Had
the Company used the fair value-based method of accounting and recognized
compensation expense as provided for in SFAS No. 123, "Stock-Based
Compensation," the net loss and net loss per share for the following periods
would have been as follows:
9
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Net loss, as reported $(3,230,000) $(1,083,000) $(3,919,000) $(1,705,000)
Deduct: Total stock-based employee
compensation expense determined under
fair value method, net of tax (31,000) (71,000) (143,000) (416,000)
----------- ----------- ----------- -----------
Pro forma net loss $(3,261,000) $(1,154,000) $(4,062,000) $(2,121,000)
=========== =========== =========== ===========
Pro forma net loss per share -- basic and diluted $ (0.57) $ (0.20) $ (0.71) $ (0.37)
=========== =========== =========== ===========
Income taxes. The Company accounts for income taxes under the provisions
of SFAS No. 109, "Accounting for Income Taxes." Current income tax expense is
the amount of income taxes expected to be payable for the current year. A
deferred income tax asset or liability is established for the expected future
consequences of temporary differences in the financial reporting and tax bases
of assets and liabilities. The Company considers future taxable income and
ongoing, prudent and feasible tax planning strategies in assessing the value of
its deferred tax assets. If the Company determines that it is more likely than
not that these assets will not be realized, the Company will reduce the value of
these assets to their expected realizable value, thereby decreasing net income.
If the Company subsequently determines that the deferred tax assets, which had
been reduced, would be realized in the future, the value of the deferred tax
assets would be increased, thereby increasing net income in the period when that
determination is made.
For the three and nine months ended September 30, 2005, the Company
recorded an income tax benefit from continuing operations as a result of the tax
effect of the period's pretax losses of $76,000 and $235,000, respectively,
offset by the recording of a valuation allowance of $1,189,000 and $2,294,000
during the three and nine months ended September 30, 2005, respectively. For the
three months ended September 30, 2004, the Company recognized a tax benefit of
$143,000 primarily related to the periods' losses from operations. For the nine
months ended September 30, 2004, the Company recognized a tax provision of
$537,000 primarily related to the gain on the sale of the land.
On July 14, 2005, FASB released an Exposure Draft for its proposed
Interpretation regarding accounting for uncertain tax positions. The proposed
guidance addresses the recognition, measurement, classification and disclosure
issues related to the recording of financial statement benefits for income tax
positions that have some degree of uncertainty. The projected date for issuance
of a final standard is expected the first quarter of 2006. Any adjustments
resulting from the application of the proposed Interpretation would be
recognized as a cumulative effect of a change in accounting principle.
Management is unable to predict the final action by FASB, but is currently
assessing the provisions of this proposed Interpretation.
10
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 2 - Discontinued operations
Effective January 1, 2004, AVMC combined the YaYa operations and the
Hypnotic branded entertainment operations into its Branded Content segment.
During December 2004, the Company discontinued its Branded Content segment. In
accordance with SFAS No. 144, the Company's consolidated statements of
operations for the three and nine months ended September 30, 2004, have been
retroactively adjusted to account for the Branded Content segment as
discontinued operations for the periods presented.
Also, as discussed above, as a result of the March 21, 2005 Genius
transaction, the Company's consolidated condensed statements of operations have
been retroactively adjusted to account for AVMC and Filmed Entertainment
operations as discontinued operations for all periods presented.
(Loss) income from discontinued operations for the Branded Content, Filmed
Entertainment and AVMC operations consist of the following:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues $ -- $ 5,572,000 $ 1,698,000 $ 13,989,000
Cost of sales and services -- 3,451,000 1,794,000 8,622,000
------------ ------------ ------------ ------------
Gross profit -- 2,121,000 (96,000) 5,367,000
------------ ------------ ------------ ------------
Selling, general and administrative -- 3,161,000 1,791,000 9,168,000
Non-operating expense -- (126,000) (103,000) (307,000)
Gain on disposal of AVMC 318,000 -- 6,536,000 --
Income tax (provision) benefit (112,000) 379,000 (1,670,000) 1,379,000
------------ ------------ ------------ ------------
(Loss) income from discontinued operations $ 206,000 $ (787,000) $ 2,876,000 $ (2,729,000)
============ ============ ============ ============
Note 3 - Investments in unconsolidated investees
The Company, through a wholly owned subsidiary, holds a 49% minority
interest in an unconsolidated investee that owns and operates a restaurant in a
casino hotel located on the Las Vegas "Strip." The Company has no day-to-day
management responsibilities in connection with the Restaurant Investee or the
Restaurant Investee's operations. The Company excludes the accounts of the
Restaurant Investee and, instead, records its investment using the equity method
of accounting, as adjusted to reflect the terms of the Restaurant Investee's
operating agreement regarding allocation of profits and losses among the
Restaurant Investee's members.
11
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
The following summarizes the condensed balance sheets of the Restaurant
Investee:
September 30, December 31,
2005 2004
----------- -----------
(unaudited) (unaudited)
Assets $ 1,692,000 $ 1,496,000
Liabilities 495,000 473,000
----------- -----------
Members' capital $ 1,197,000 $ 1,023,000
=========== ===========
The following summarizes the condensed statements of operations of the
Restaurant Investee:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Revenues $ 2,043,000 $ 1,942,000 $ 6,183,000 $ 6,004,000
Expenses 1,686,000 1,621,000 4,985,000 4,861,000
----------- ----------- ----------- -----------
Income from operations $ 357,000 $ 321,000 $ 1,198,000 $ 1,143,000
=========== =========== =========== ===========
In addition, the Company, through YaYa, holds a 10% non-controlling
interest in an unconsolidated investee that has entered into an in-substance
joint venture arrangement to create a promotional event called a video game
touring festival. The Company has no capital requirement in connection with this
joint venture and is not obligated to provide future financing of the joint
venture's activities. If, after good faith efforts by the parties to this joint
venture, there are insufficient corporate sponsors to cover all costs and
expenses of staging the initial event, the joint venture shall dissolve and
liquidate, unless the parties agree to the contrary.
12
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 4 - Comprehensive loss
Comprehensive loss is the total of net loss and all other
non-stockholder changes in equity. Comprehensive loss is as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Net loss, as reported $(3,230,000) $(1,083,000) $(3,919,000) $(1,705,000)
Unrealized gain (loss) on securities,
net of tax benefit of $36,000 and
$198,000, respectively
and net of reclassification adjustments
for realized losses included in net loss (64,000) -- (352,000) --
----------- ----------- ----------- -----------
$(3,294,000) $(1,083,000) $(4,271,000) $(1,705,000)
=========== =========== =========== ===========
Note 5 - Commitments and contingencies
Guarantee. As discussed in "Note 1 - Nature of operations and summary of
significant accounting policies," on March 21, 2005, the Company sold all of the
outstanding common stock of AVMC to Genius. Related to the transaction, the
Company guaranteed to the respective noteholders the obligations arising under
certain secured negotiable AVMC promissory notes and a secured non-negotiable
AVMC promissory note aggregating $3,274,000 in principal amount. The noteholders
received their promissory notes in connection with AVMC's acquisition of
Wellspring on February 3, 2004. The promissory notes bear interest at 7.0% per
annum, payable quarterly, and mature on February 3, 2006. The promissory notes
were guaranteed by Wellspring at the time of their issuance and are secured by
all of the assets of Wellspring and a pledge by AVMC of Wellspring's capital
stock owned by AVMC. The Wellspring guaranty and AVMC pledge remained in effect
after the sale of AVMC to Genius.
During June 2005 and July 2005, the Company funded $2,050,000 and
$450,000, respectively, to an escrow account against the guarantee of the
obligations for the AVMC promissory notes and secured non-negotiable AVMC
promissory note. There is no further commitment by the Company to fund
additional escrow amounts against the guarantee.
Operating lease commitments. The lease obligations for the administrative
offices formerly utilized by AVMC and located in Santa Monica, California, the
direct response offices located in Los Angeles, California and the Wellspring
executive and operations offices located in New York, New York were assumed by
the Company. However, Genius may occupy the Wellspring executive and operations
offices located in New York, for a transitional period, upon reimbursement of
the Company's actual monthly rental cost. At September 30, 2005, Genius
continued to occupy one of the two floors of executive and operations offices
located in New York, New York.
13
AMERICAN VANTAGE COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
During September 2005, for a negotiated payment of $10,000, the Company
was released from future rent payments or other commitments related to the
direct response offices located in Los Angeles, California. In addition, in
September 2005, the Company subleased for the remainder of the lease term one of
the two administrative offices located in Santa Monica, California to an
unaffiliated third party at an amount equal to the Company's rental obligations
under the lease for such office. The Company is in negotiations to sublease the
remaining administrative office located in Santa Monica, California at a rate
and for a term anticipated to equal the Company's existing lease commitment.
Effective September 1, 2005, Genius vacated one floor of the executive and
operations offices located in New York, New York. The Company has is attempting
to sublease this office space.
Rent expense for the three months ended September 30, 2005 and 2004
totaled $160,000 and $261,000, respectively. For the nine months ended September
30, 2005 and 2004, rent expense totaled $301,000 and $718,000, respectively.
Litigation. In connection with the premature termination of the Company's
contracts to provide consulting services to an Indian gaming enterprise, the
Company brought a civil action against the Table Mountain Tribe (the "Tribe").
The lawsuit sought to recover payments due under the agreements, as well as
consulting fees that would have been due during the remainder of the consulting
contract term.
In April 2003, the Tribe filed a motion to dismiss the case based on its
assertion that its contracts with the Company were not properly authorized by
Tribal authorities, and thereby did not constitute a valid waiver of the Tribe's
sovereign immunity to suit.
In September 2005, the California Superior Court granted the motion and
dismissed the Company's complaint. On October 6, 2005, the Company filed a
"Petition for Review" with the California Supreme Court. On October 21, 2005,
the Company and the Tribe settled the claims between the parties. Under this
settlement, the Company received a nominal payment from the Tribe and the
Company and the Tribe each granted the other a release from all claims that
could arise under the various agreements between the parties.
In the ordinary course of its business, the Company may be subject from
time to time to claims and legal actions. The Company has no history of material
claims and, excluding the Tribe civil action, no material actions were pending
or threatened against the Company.
14
Item 2. Management's Discussion and Analysis or Plan of Operation
- -----------------------------------------------------------------
The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and notes included elsewhere in
this Quarterly Report on Form 10-QSB.
Statement on Forward-Looking Statements
In addition to historical information, this Quarterly Report on Form
10-QSB contains certain forward-looking statements. Such statements include
expected financial performance and strategic and operations plans concerning the
Company, as well as assumptions, expectations, predictions, intentions or
beliefs about future events involving the Company, its vendors and customers and
other matters. Although the Company believes that its expectations are based on
reasonable assumptions, there can be no assurance that the Company's financial
goals or expectations will be realized. Forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance, or achievements of the Company, or industry results, to be
materially different from future results, performance, or achievements expressed
or implied by such forward-looking statements. Forward-looking statements may be
identified by the use of forward-looking terminology such as "may," "will,"
"could," "should," "project," "expect," "believe," estimate," "anticipate,"
"intend," "continue," "potential," "opportunity" or similar terms, variations of
those terms or the negative of those terms or other variations of those terms or
comparable words or expressions. Numerous factors may affect the Company's
actual results and may cause results to differ materially from those expressed
in forward-looking statements made by or on behalf of the Company. These risks
and uncertainties include, but are not limited to, those relating to:
o The success of the Company's business strategies and plans of future
operations,
o General economic conditions in the United States and elsewhere, as
well as the economic conditions affecting the industries in which
the Company's operates,
o Dependence on existing management,
o Television viewer habits,
o Demand for the Film and TV Production division's television and film
projects,
o Trends within the gaming and restaurant industries,
o Management's ability to identify and acquire appropriate companies
and ability to successfully integrate such acquirees, if any, into
the Company's existing operations,
o Management's ability to combine the Company's various operations so
that they may work together and grow successfully,
o Changes in federal and state tax laws or the administration of such
laws,
o Ability to dispose of Genius stock acquired in connection with the
AVMC transaction, and
o The other risks detailed elsewhere in this Form 10-QSB and in the
Company's other filings with the Securities and Exchange Commission.
Readers are urged to carefully review and consider the various disclosures
made by the Company in this Quarterly Report on Form 10-QSB and other Company
filings with the SEC. These reports attempt to advise interested parties of the
risks and factors that may affect the Company's business, financial condition
and results of operations and prospects. The forward-looking statements made in
this Form 10-QSB speak only as of the date hereof. The Company assumes no
obligation to update or revise any such forward-looking statements or the
factors listed above to reflect events or circumstances that may arise after
this Form 10-QSB is filed, or that may have an effect on the Company's overall
performance or financial position.
Results of Operations
Overview. On December 31, 2003, the Company acquired substantially all of
the assets and business and certain of the liabilities of Enigma Media, Inc.,
dba Hypnotic, and began operations effective January 1, 2004. Hypnotic has been
structured as a wholly-owned subsidiary of AVMC.
AVMC acquired from Enigma its television, branded entertainment and
distribution operations and specific intellectual property, including a
short-film library, plus an ownership interest in two feature films and a
television development and production arrangement with Warner Bros. TV. Together
with Warner Bros., Hypnotic currently provides executive co-producer services
for a television series for the FOX broadcasting network, "The O.C."
15
Effective January 1, 2004, AVMC combined the operations of YaYa, a
wholly-owned subsidiary of the Company, and the Hypnotic branded entertainment
operations into AVMC's Branded Content segment. The remaining Hypnotic
operations were established primarily as the Company's Film and TV Production
segment.
On February 3, 2004, AVMC acquired all of the outstanding common stock of
Wellspring and began operating Wellspring, as the Filmed Entertainment segment,
effective February 3, 2004.
During December 2004, the Company discontinued its Branded Content
segment. In accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," the Branded Content operating results for the
three and nine months ended September 30, 2004 have been retroactively adjusted
to account for the Branded Content segment as discontinued operations.
Effective March 21, 2005, Genius acquired all of the outstanding common
stock of AVMC. Related to the transaction, the Company and Genius also entered
into a pledge agreement transferring to the Company certain assets, liabilities
and operations of Hypnotic. The assets transferred to the Company include
co-executive producer fees generated from the television series, "The O.C.," but
exclude Hypnotic's `back-end' interest in "The O.C." The assets transferred to
the Company represent primarily the operations of the Film and TV Production
segment. The Company continues to operate the Film and TV Production segment.
For the nine months ended September 30, 2005 and the three and nine months
ended September 30, 2004, the Company's consolidated condensed statements of
operations have been retroactively adjusted to account for AVMC and the Filmed
Entertainment segment as discontinued operations for all periods presented.
The Post-Disposition of AVMC Operations and Assets of the Company
AVMC constituted the vast majority of the operating assets of the Company
for the year ended December 31, 2004 and period ended March 21, 2005. The
Company disposed of AVMC to Genius effective March 21, 2005. In connection with
such disposition, Genius transferred certain assets, liabilities and operations
held by Hypnotic and certain liabilities of Wellspring back to the Company.
At September 30, 2005, the assets of the Company following the disposition
of AVMC primarily consist of the following:
o The equity securities acquired from Genius;
o The assets and operations of the Film and TV Production segment retained
by the Company in connection with the disposition of AVMC;
o Cash and cash equivalents;
o A 49% membership interest in the Restaurant Investee that operates the
Border Grill, which generated approximately $558,000 of equity income for
the Company and cash distributions of $1,055,000 during the year ended
December 31, 2004, and $509,000 of equity income and cash distributions of
$477,000 during the nine months ended September 30, 2005;
o The Company's ownership of YaYa which holds a 10% interest in Games Media,
LLC, a joint venture that creates a promotional event called a video game
touring festival, which generated nominal revenues during the year ended
December 31, 2004; and
o Various other assets, including prepaid expenses and furniture and
fixtures.
At September 30, 2005, the liabilities of the Company following the
disposition of AVMC primarily consist of the following:
16
o Contingent liabilities of Hypnotic under its employment agreements with
two individuals;
o A contingent liability relating to the Company's guaranty of certain
promissory notes of AVMC in the aggregate principal amount of $3,274,000;
o Contingent liabilities relating to the Company's leased premises formerly
utilized by AVMC;
o Any tax liability resulting from the placement of the GNPI common stock
and warrants that the Company acquired in connection with the disposition
of AVMC; and
o Various other liabilities for operating expenses, including office leases,
and direct costs associated with the disposition of AVMC and any placement
of the GNPI stock.
The listing of the Company's assets and liabilities following the
disposition of AVMC set forth above is merely a summary of such assets and
liabilities at September 30, 2005. Reference is hereby made to the Company's
Current Report on Form 8-K/A (Date of Report: March 21, 2005), filed with the
SEC on June 6, 2006 (Commission File No.: 0-10061), which includes pro forma
financial information giving effect to the disposition of AVMC.
For the Three and Nine Months Ended September 30, 2005, Compared with the Three
and Nine Months Ended September 30, 2004
Revenues. The Film and TV Production segment revenues primarily are
generated from an agreement to provide executive co-producer services on a
television series. These revenues, totaling $37,000 and $281,000 for the three
and nine months ended June 30, 2005, respectively, as compared to $75,000 and
$353,000 for the comparable 2004 periods, are generally recognized in
installments as services are provided. Revenues decreased in 2005 due to
executive co-producer fees being reduced for the 2005 television season.
Cost of services. Cost of services primarily consists of television agency
fees and internal labor, if any, associated with providing the Film and TV
Production segment services.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $858,000 for the three months ended
September 30, 2004 to $890,000 for the three months ended September 30, 2005 for
a total increase of $32,000 or 3.7%. The net increase primarily is attributable
to higher tax preparation fees due to the increase in AVMC taxable entities and
additional tax reporting requirements.
Selling, general and administrative expenses for the nine months ended
September 30, 2005 and 2004 totaled $2,853,000 and $2,855,000, respectively, for
a total decrease of $2,000 or 0.7%. Selling, general and administrative expenses
primarily include payroll and payroll-related expenses, legal, accounting, rent,
travel and other related expenses.
Non-operating (expense) income
In June 2005, the Company placed 2,500,000 shares of the Genius common
stock and 225,000 warrants to purchase shares of Genius common stock, at an
exercise price of $2.56 per share, for gross proceeds of $4,375,000. Related to
these placements of the Genius stock, the Company also surrendered to Genius for
cancellation 225,000 warrants to purchase shares of Genius common stock, at an
exercise price of $2.56 per share. The Company recognized a loss of $2,041,000
on the June 2005 placements of the Genius shares and warrants and cancellation
of the Genius warrants.
In August 2005, the Company placed an additional 3,125,000 shares of the
Genius common stock for gross proceeds of $4,688,000. In conjunction with this
transaction, for the three months ended September 30, 2005, the Company
recognized a loss of $2,601,000.
17
In accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," the fair value of the Genius warrants is recorded as
$941,000 on the September 30, 2005 condensed consolidated balance sheet. The
warrants have been accounted for as derivatives as the warrant terms require or
permit a cashless exercise. Gains or losses resulting from fluctuations in the
fair value are recognized in interest and other (expense) income in the
Company's condensed consolidated statement of operations. For the three and nine
months ended September 30, 2005, the Company recognized a loss of $209,000 and
$303,000, respectively, due to the change in the fair value of the warrants
during the periods.
On January 30, 2004, the Company completed the sale of approximately 40
acres of undeveloped land owned by the Company and located in North Las Vegas,
Nevada. The Company recognized a pre-tax gain of $3,423,000 upon consummation of
this land sale transaction.
Income tax benefit (provision)
For the three and nine months ended September 30, 2005, the Company
recorded an income tax benefit from continuing operations as a result of the tax
effect of the period's pretax losses of $76,000 and $235,000, respectively,
offset by the recording of a valuation allowance of $1,189,000 and $2,294,000
during the three and nine months ended September 30, 2005, respectively. For the
three months ended September 30, 2004, the Company recognized a tax benefit of
$143,000 primarily related to the periods' losses from operations. For the nine
months ended September 30, 2004, the Company recognized a tax provision of
$537,000 primarily related to the gain on the sale of the land.
Equity in income of unconsolidated investees, net
The Company, through a wholly owned subsidiary, holds a 49% minority
interest in an unconsolidated investee (the "Restaurant Investee") that owns and
operates the Border Grill Las Vegas Restaurant in a casino hotel located on the
Las Vegas Strip. The Company's portion of income from the Restaurant Investee
decreased from $158,000 for the three months ended September 30, 2004 to
$114,000 for the three months ended September 30, 2005. Income from the
Restaurant Investee decreased from $565,000 for the nine months ended September
30, 2004 to $509,000 for the nine months ended September 30, 2005. The Company
has no day-to-day management responsibilities in connection with the Restaurant
Investee or its operations. As a result, and in accordance with U.S. GAAP, the
Company excludes the accounts of the Restaurant Investee in reporting its
operating results. Rather, the Company records the results of its investment in
the Restaurant Investee using the equity method of accounting. Future reported
income from the Company's Restaurant Investee may differ from cash
distributions, as further discussed in the Liquidity and Capital Resources
section.
During fiscal 2004, YaYa held a 36% non-controlling interest in an
unconsolidated investee that entered into an in-substance joint venture
arrangement to create promotional events called video game touring festivals.
The Company has no capital requirement in connection with this joint venture and
is not obligated to provide future financing of the joint venture's activities.
If, after good faith efforts by the parties to this joint venture, there are
insufficient corporate sponsors to cover all costs and expenses of staging the
initial event, the joint venture shall dissolve and liquidate, unless the
parties agree to the contrary. Revenues generated by this unconsolidated
investee generally occur during the summer months due to the timing of the video
game touring festivals. For the three and nine months ended September 30, 2004,
income from this investment totaled $227,000 for both periods. Under the cost
method, no income was recorded for this investee for the three and nine months
ended September 30, 2005 as YaYa's non-controlling interest has been reduced to
10%.
(Loss) income from discontinued operations
As discussed previously, effective January 1, 2004, AVMC combined the YaYa
operations and the Hypnotic branded entertainment operations into its Branded
Content segment. During December 2004, the Company discontinued its Branded
Content segment. In accordance with SFAS No. 144, the Branded Content operating
results for the three and nine months ended September 30, 2004 have been
retroactively adjusted to account for the Branded Content segment as
discontinued operations.
18
AVMC constituted a vast majority of the operating assets of the Company
during the three and nine months ended September 30, 2004, as well as the three
months ended March 31, 2005. The Company disposed of AVMC to Genius effective
March 21, 2005. The Company received 7,000,000 shares of Genius common stock and
warrants to purchase an additional 1,400,000 shares of Genius common stock in
connection with the disposition of AVMC to Genius in March 2005. At March 21,
2005, the fair market value of the total consideration was $17,570,000. The
Company recognized a pre-tax gain of $6,218,000 from the sale of AVMC in the
quarter ended March 31, 2005.
Related to the sale of AVMC at March 21, 2005, AVCS assumed payment
obligations relating to approximately $1,080,000 of accounts payable incurred in
connection with the direct response operations of AVMC. From April 2005 through
July 2005, the Company made various payments against the direct response
obligations. During August 2005, the Company and Genius negotiated a final
settlement payment of $586,000 for the direct response obligations. The
settlement resulted in a net gain adjustment of $218,000 to the previously
recognized March 21, 2005 pre-tax gain of $6,218,000. At September 30, 2005, the
gain on sale of AVMC was also increased by $100,000, for a total net gain
adjustment of $318,000, due to renegotiation of certain direct sales costs.
In conjunction with the final settlement of the direct response
obligations, Genius also released 700,000 shares of Genius common stock
previously held in escrow to secure the payment of the direct response
obligations. The direct response accounts payable obligations may be further
offset from the proceeds, if any, from the sale of approximately $328,000 of
direct response inventory and/or if actual payments to the direct response
vendors are less than the total amount funded by AVCS.
In addition, due to the sale of AVMC to Genius on March 21, 2005, for the
three months ended September 30, 2004 and the nine months ended September 30,
2005 and 2004, the Company's consolidated condensed statements of operations
have been retroactively adjusted to account for the portion of AVMC and Filmed
Entertainment segment that were sold to Genius as discontinued operations for
all periods presented.
Critical accounting policies and estimates
The discussion and analysis of the Company's financial condition and
results of operations are based upon the Company's condensed consolidated
financial statements included in this Quarterly Report on Form 10-QSB, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates, assumptions and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities.
The Company believes that the estimates, assumptions and judgments
involved in applying the accounting policies described below are critical with
regards to their potential impact on the condensed consolidated financial
statements, so these are considered to be the critical accounting policies.
Because of the uncertainty inherent in these matters, actual results could
differ from the estimates used in applying the critical accounting policies.
Certain of these critical accounting policies affect working capital account
balances, including the policies for revenue recognition and accounts
receivable.
Within the context of these critical accounting policies and estimates,
the Company currently is not aware of any reasonably likely events or
circumstances that would result in materially different estimates or other
amounts being reported, with the exception of valuation of equity securities.
Equity securities are valued at current market value at the end of each quarter
and could fluctuate between quarters. See also Liquidity and Capital Resources.
Principles of consolidation. The Company, through a wholly-owned
subsidiary, has a 49% minority interest in a Restaurant Investee that owns and
operates the Border Grill Restaurant in Las Vegas, Nevada. The Company has no
management responsibilities in connection with the Restaurant Investee or its
operations. As a result, and in accordance with U.S. GAAP, the Company excludes
the accounts of the Restaurant Investee in reporting its operating results.
Rather, the Company records the results of its investment in the Restaurant
Investee using the equity method of accounting.
19
Equity securities. Consideration received from the March 21, 2005 sale of
AVMC to Genius included 7,000,000 shares of Genius common stock and five-year
warrants to purchase an additional 1,400,000 shares of Genius common stock, half
at an exercise price of $2.56 per share and half at an exercise price of $2.78
per share. The Genius common stock is traded on the over-the-counter bulletin
board (OTCBB) under the symbol "GNPI."
In accordance with SFAS No. 115, the Company classifies these equity
securities as "available-for-sale." As such, unrealized holding gains and losses
are excluded from earnings and reported in other comprehensive loss, net of
taxes. A total of 675,000 shares of Genius common stock comprising a portion of
the merger consideration are being held in escrow, of which 350,000 shares have
restrictions exceeding one year to secure the indemnification obligations under
the merger agreement. These securities are included as long-term assets in the
condensed consolidated balance sheets.
In accordance with SFAS No. 133, the fair value of the Genius warrants is
recorded on the condensed consolidated balance sheet. The warrants have been
accounted for as derivatives as the terms require or permit a cashless exercise.
Gains or losses resulting from fluctuations in the fair value are recognized in
non-operating (expense) income in the Company's condensed consolidated statement
of operations.
In accordance with Emerging Issues Task Force Issue No. 03-01 and SEC
Staff Accounting Bulletin Topic 5-M, the Company assesses whether an
other-than-temporary impairment loss on an investment has occurred due to
declines in fair value or other market conditions. The periodic assessment is
based on several criteria including volatility of market share prices, intent of
the Company to place shares, as well as operations, current business activities,
transactions or other trends related to the investee. The Company currently has
the intent and ability to hold the Genius stock for a sufficient time to allow
for a recovery in the market value to $2.25 per share, which is the original
cost that was recorded in March 2005. There were no other-than-temporary
impairment losses during the three or nine months ended September 30, 2005.
FASB has released FASB Staff Position 115-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments." The
proposed guidance addresses the "determination as to when an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss." The effective date for the proposed guidance
is for reporting periods beginning after December 15, 2005. The proposed
guidance is not expected to have a material effect on the Company's consolidated
financial statements.
Revenue recognition. The Company's revenues from operations for the three
and nine months ended September 30, 2005 and 2004 were generated by the Film and
TV Production segment. Revenues from home video, direct response, worldwide
sales (television) and theatrical units previously disclosed as the Filmed
Entertainment segment are included in discontinued operations. In addition,
programming development, advisory services, development of custom software
applications and hosting and reporting services previously disclosed as the
Branded Content segment are included in discontinued operations.
The Film and TV Production revenues primarily are generated from an
agreement to provide executive co-producer services for a television series.
These revenues are generally recognized as services are provided.
Cash advances received are recorded as deferred revenue until all the
conditions of revenue recognition have been met.
Income taxes. Current income tax expense is the amount of income taxes
expected to be payable for the current year. A deferred income tax asset or
liability is established for the expected future consequences of temporary
differences in the financial reporting and tax bases of assets and liabilities.
The Company is required to record a valuation allowance to reduce its deferred
tax assets to the amount that it believes is more likely than not to be
realized. If the Company determines that it is more likely than not that these
assets will not be realized, the Company will reduce the value of these assets
to their expected realizable value, thereby decreasing net income. In assessing
the need for a valuation allowance, the Company considers all positive and
negative evidence, including scheduled reversals of deferred tax liabilities,
projected future taxable income, ongoing, prudent and feasible tax planning
strategies and recent financial performance. The valuation allowance is in no
way indicative of the availability of income tax losses or other timing
differences to offset future profits earned. Rather, the valuation allowance
reduces the future income tax asset to management's estimate of the future tax
asset that will be realized as a reduction of cash income taxes paid in the
future. If the Company subsequently determined that the deferred tax assets,
which had been written down, would be realized in the future, the value of the
deferred tax assets would be increased, thereby increasing net income in the
period when that determination was made.
20
The Company believes it has adequately provided for income tax issues not
yet resolved with federal and state tax authorities. Although not probable, the
most adverse resolution of these issues could result in additional charges to
earnings in future periods. Based upon a consideration of all relevant facts and
circumstances, the Company does not believe the ultimate resolution of tax
issues for all open tax periods will have a material adverse effect upon its
results of operations or financial condition.
On July 14, 2005, FASB released an Exposure Draft for its proposed
Interpretation regarding accounting for uncertain tax positions. The proposed
guidance addresses the recognition, measurement, classification and disclosure
issues related to the recording of financial statement benefits for income tax
positions that have some degree of uncertainty. The projected date for issuance
of a final standard is expected the first quarter of 2006. Any adjustments
resulting from the application of the proposed Interpretation would be
recognized as a cumulative effect of a change in accounting principle.
Management is unable to predict the final action by FASB, but is currently
assessing the provisions of this proposed Interpretation.
Other contingencies. In the ordinary course of business, the Company may
be involved in legal proceedings regarding contractual and employment
relationships, trademark or patent rights, and a variety of other matters.
Contingent liabilities are recorded when it is probable that a liability has
been incurred and the amount of the loss is reasonably estimable. The Company
discloses contingent liabilities when there is a reasonable possibility that the
ultimate loss will materially exceed the recorded liability. Estimating probable
losses requires analysis of multiple factors, in some cases including judgments
about the potential actions of third party claimants and courts. Therefore,
actual losses in any future period are inherently uncertain. Currently, the
Company believes that no pending legal proceedings or claims, in the ordinary
course of business, will have a material impact on the Company's financial
position or results of operations. However, if actual or estimated probable
future losses exceed the recorded liability for such claims, additional charges
may be recorded as other expense in the Company's condensed consolidated
statement of operations during the period in which the actual loss or change in
estimate occurs.
Significant related party transactions
The Company's current non-employee directors were paid an aggregate of
$53,000 and $23,000 during the three months ended September 30, 2005 and 2004,
and $131,000 and $73,000 during the nine months ended September 30, 2005 and
2004, respectively, for serving on the Board of Directors of the Company.
Jay Brown is an outside attorney utilized from time-to-time by the Company
and is the beneficial owner of more than 5% of the Company's common stock. For
Mr. Brown's services rendered to the Company, the Company paid him legal
retainers of $0 for the three and nine months ended September 30, 2005, and
$15,000 and $45,000, respectively, during the three and nine months ended
September 30, 2004, respectively.
Effective June 30, 2004, the Company arranged with SouthwestUSA Bank a
$2,500,000 credit facility. Jeanne Hood, a director of the Company, is a
director of SouthwestUSA. At April 5, 2005, the Company paid the SouthwestUSA
Line of Credit principal balance of $2,500,000 by converting the $2,500,000
certificate of deposit held as collateral for the SouthwestUSA Line of Credit.
Liquidity and Capital Resources
As of September 30, 2005, the Company had cash and cash equivalents
totaling $2,909,000. The Company also had working capital of $7,700,000 at
September 30, 2005, as compared with working capital of $2,963,000 at December
31, 2004. Included in the working capital balance at September 30, 2005, are
Genius stock and warrants with a fair value of $2,837,000 and restricted cash
and cash equivalents of $2,500,000. The $4,737,000 net increase in working
capital primarily is the result of the March 21, 2005 sale of AVMC and the June
2005 and August 2005 placements of Genius equity and derivative securities.
21
At September 30, 2005, the Company holds 1,375,000 Genius shares, 250,000
warrants to purchase shares of Genius common stock, at an exercise price of
$2.56 per share, and 700,000 warrants to purchase shares of Genius common stock,
at an exercise price of $2.78 per share of which 700,000 Genius shares, and all
Genius warrants are available-for-sale. The Company believes that, when the
Company chooses to do so, the Company will be successful in its efforts to place
the Genius securities; however, no assurance can be given as to when the
remaining shares will become available for placement and/or the amount of
proceeds that may be received upon such placement(s).
The Genius common stock is traded on the over-the-counter bulletin board
(OTCBB) under the symbol "GNPI." As of September 30, 2005, the fair market value
of the Genius common stock held by the Company is $2,544,000, including an
unrealized holding loss of $550,000. The available-for-sale securities are
valued at their current market value as of the end of each fiscal quarter which
could fluctuate between quarters and impact the Company's future results of
operations when the securities are sold. Factors that may affect the current
market value include, but are not limited to, (i) fluctuation in market prices;
and (ii) Genius entering into another transaction causing dilution to the Genius
outstanding stock including the shares held by the Company.
The Company intends to fund its future operating costs and merger and
acquisition activities from its existing working capital resources and/or
placement of the Genius securities. The Company currently has the intent and
ability to hold the Genius stock for a sufficient time to allow for a recovery
in the market value to $2.25 per share, which is the original cost that was
recorded in March 2005. It is possible that future operations and merger and
acquisition opportunities may require additional financing resources. The
Company may provide for such requirements with financing from financial
institutions and/or the issuance of equity and/or debt securities. No assurance
can be given that such financing will be available on advantageous terms to the
Company, or at all.
Net cash used in operating activities was $3,584,000 and $2,786,000 for
the nine months ended September 30, 2005 and 2004, respectively.
Net cash provided by investing activities of $6,849,000 for the nine
months ended September 30, 2005 consists primarily of $9,063,000 in cash
proceeds, net of $471,000 in direct costs, generated from the placements of the
Genius stock and warrants, $2,500,000 in cash proceeds received from conversion
of a certificate of deposit and cash used in discontinued operations. See
further discussion of the certificate of deposit in net cash used in financing
activities.
On February 3, 2004, AVMC acquired all of the capital stock of Wellspring.
The aggregate purchase price for the shares of Wellspring capital stock was
$8,000,000, of which $4,000,000 was paid in cash and $4,000,000 in the form of
AVMC secured negotiable and non-negotiable notes. These notes were assumed by
the purchaser of AVMC effective March 21, 2005. However, the Company has
guaranteed the obligations arising under notes aggregating to $3,274,000 in
principal. The promissory notes were guaranteed by Wellspring at the time of
their issuance and are secured by all of the assets of Wellspring and a pledge
by AVMC of Wellspring's capital stock owned by AVMC. The Wellspring guaranty and
AVMC pledge remain in effect. Through July 2005, the Company funded $2,500,000
to an escrow account against its guarantee of the obligations for the AVMC
promissory notes. The $2,500,000 is included as an investing activity in the
September 30, 2005 consolidated statement of cash flows. There is no further
commitment by the Company to fund additional escrow amounts against its
guarantee.
For the nine months ended September 30, 2004, net cash used in investing
activities primarily consists of the purchase of a $2,500,000 certificate of
deposit and $350,000 standby letter of credit, and $10,608,000 used in
discontinued operations. The cash outlays in investing activities were offset by
the cash proceeds from the January 30, 2004 sale of the land classified on the
consolidated balance sheet as "land held for development or sale." The net
proceeds from the sale of the land (excluding legal and consulting expenses),
totaling $7,007,000, were utilized in the Company's operations and in the
previously announced strategy of expanding into areas of interest in the gaming,
entertainment, media and lifestyle industries through mergers or acquisitions.
For the nine months ended September 30, 2005 and 2004, the Company
received cash distributions from the Restaurant Investee totaling $477,000 and
$921,000, respectively. The Operating Agreement of the Restaurant Investee does
not provide for guaranteed cash distributions. Therefore, future distributions
from the Restaurant Investee are subject to fluctuation.
22
Net cash used in financing activities was $2,300,000 for the nine months
ended September 30, 2005 as compared to net cash provided by financing
activities of $2,300,000 for the comparable 2004 period. Effective June 30,
2004, the Company arranged with SouthwestUSA Bank ("SouthwestUSA") a $2,500,000
credit facility (the "SouthwestUSA Line of Credit"). At September 30, 2004, the
Company had borrowings of $2,300,000 from the SouthwestUSA Line of Credit, with
additional borrowings of $200,000 during the first quarter of 2005. On April 5,
2005, the Company paid the SouthwestUSA Line of Credit principal balance of
$2,500,000 by converting the $2,500,000 certificate of deposit held as
collateral for the SouthwestUSA Line of Credit. The SouthwestUSA Line of Credit
has been cancelled.
Impact of Inflation
The Company believes that inflation has not had a material impact on its
operations.
Factors That May Affect Future Results
As noted previously, effective March 21, 2005, Genius acquired all of the
outstanding common stock of AVMC. Related to the transaction, the Company and
Genius also entered into a pledge agreement transferring to the Company certain
assets, liabilities and operations held by Hypnotic. The assets transferred to
the Company encompass the prior Film and TV Production segment operations of
Hypnotic including co-executive producer fees generated from the television
series "The O.C.," but exclude Hypnotic's `back-end' interest in "The O.C." For
the three and nine months ended September 30, 2005, the Film and TV Production
segment incurred a net operating loss of $301,000 and $1,068,000, respectively,
and a net operating loss of $447,000 and $1,489,000, respectively, for the three
and nine months ended September 30, 2004. The Film and TV Production segment
generates revenues from relatively few contracts. A decline in the size or
number of these contracts could adversely affect its future operations. In
addition, despite the Company's efforts to increase Film and TV Production
segment revenues and/or decrease the segment operating costs, there is no
assurance that the Film and TV Production segment will be successful in its
efforts to attain profitability in Fiscal 2005 or thereafter.
Related to the Genius transaction, the AVMC lease obligations for the
administrative offices formerly utilized by AVMC and located in Santa Monica,
California, the direct response offices located in Los Angeles, California and
the Wellspring executive and operations offices located in New York, New York
were assumed by the Company. However, Genius may occupy the Wellspring executive
and operations offices located on two floors in New York, for a transitional
period, upon reimbursement of the Company's actual monthly rental cost. At
September 30, 2005, Genius continued to occupy one of the two floors of
executive and operations offices located in New York.
During September 2005, for a negotiated payment of $10,000, the Company
was released from future rent payments or other commitments related to the
direct response offices located in Los Angeles, California. In addition, in
September 2005, the Company subleased for the remainder of the lease term one of
the two administrative offices located in Santa Monica, California to an
unaffiliated third party at an amount equal to the Company's rental obligations
under the lease for such office. The Company is in negotiations to sublease the
remaining administrative office located in Santa Monica, California at a rate
and for a term anticipated to equal the Company's existing lease commitment.
Effective September 1, 2005, Genius vacated one floor of the executive and
operations offices located in New York, New York. The Company has is attempting
to sublease this office space.
At September 30, 2005, excluding sublease rental amounts, the total annual
base rental cost for all facilities lease obligations is approximately $840,000.
At September 30, 2005, the Company was holding 1,375,000 shares of Genius
common stock and warrants to purchase 950,000 additional Genius shares, of which
675,000 of the Genius shares are subject to pledges or other restrictions. The
1,375,000 Genius shares are valued at their then current market value as of the
end of each fiscal quarter which could fluctuate between quarters and impact the
Company's future results of operations until sold. The Company believes that, as
the remaining shares become available for placement, the Company will be
successful in its efforts to place those Genius securities; however, no
assurance can be given as to when the remaining shares will become available for
placement and/or the amount of proceeds that may be received upon such
placement(s).
23
The Company intends to use a significant portion of such net proceeds
possibly along with its other cash and outside financing, to seek new merger and
acquisition candidates, including those that may complement the operations of
the Film and TV Production division or the Border Grill Las Vegas Restaurant, as
well as other merger and acquisition opportunities.
The Company's common stock currently is traded on the NASD
Over-the-Counter Bulletin Board under the symbol "AVCS.OB." The Company's common
stock previously (through August 23, 2005) was traded on The Nasdaq Small Cap
Market under the symbol "AVCS."
By trading on the NASD Over-The-Counter Bulletin Board, an investor could
find it more difficult to dispose, or to obtain accurate quotations as to the
market value, of the common stock. In addition, trading in the common stock
could also be subject to the requirements of certain rules promulgated under the
Securities Exchange Act of 1934, which require additional disclosure by
broker-dealers in connection with any trades involving a stock defined as a
"penny stock." Such rules require the delivery, prior to any penny stock
transaction, of a disclosure schedule explaining the penny stock market and the
risks associated therewith, and impose various sales practice requirements on
broker-dealers who sell penny stocks to persons other than established customers
and accredited investors. For these types of transactions, the broker-dealer
must make a special suitability determination for the purchaser and have
received the purchaser's written consent to the transaction prior to sale. The
additional burdens imposed upon broker-dealers by such requirements may
discourage broker-dealers from effecting transactions in the Company's common
stock, which could severely limit the market price and liquidity of the common
stock and the Company's ability to raise capital through private placements of
its securities, when and as needed, due to the effect of the limitations on
purchasers in such private placements to dispose of such securities thereafter.
The Company's success depends in large part on the continued services of
its executive officers and consultants. The loss of such personnel or any key
person could have a material adverse impact on the Company's results of
operations. Also, operating results may be adversely impacted by the Company's
inability to attract and retain highly skilled personnel.
Qualitative and Quantitative Disclosures About Market and Interest Rate Risk
Except for exceeding insured deposit limits (which deposits totaled
approximately $2,635,000 at September 30, 2005), the Company is exposed to
minimal market risks as its cash and cash equivalents investment policy allows
only short-term, highly-rated securities. At September 30, 2005, the Company's
cash and cash equivalents approximate their fair values due to the short-term
nature of these instruments.
Consideration received from the March 21, 2005 sale of AVMC to Genius
included 7,000,000 shares of Genius common stock and five-year warrants to
purchase an additional 1,400,000 shares of Genius common stock, half at an
exercise price of $2.56 per share and half at an exercise price of $2.78 per
share. The Company classifies the shares of Genius common stock, including those
shares subject to pledges or escrow, as "available-for-sale." Accordingly, to
reflect fair value at period end, the Company may record an unrealized gain or
loss which is subject to fluctuations in the market price of the Genius
securities. The Genius common stock is traded on the over-the-counter bulletin
board (OTCBB) under the symbol "GNPI."
In accordance with SFAS No. 133, gains or losses resulting from
fluctuations in the fair value of the warrants are recognized in non-operating
(expense) income in the Company's condensed consolidated statement of
operations.
During the next 12 months, the Company may enter into financing
arrangements which would expose it to interest rate risk.
24
The Company has guaranteed the obligations arising under certain secured
promissory notes in the aggregate principal amount of $3,274,000 pursuant to a
guaranty with the holders of such promissory notes. The noteholders received
their promissory notes in connection with AVMC's acquisition of Wellspring on
February 3, 2004. The promissory notes bear interest at 7% per annum, payable
quarterly, and mature on February 3, 2006. The promissory notes were guaranteed
by Wellspring at the time of their issuance and are secured by all of the assets
of Wellspring and a pledge by AVMC of Wellspring's capital stock owned by AVMC.
The Wellspring guaranty and AVMC pledge remained in effect following the sale of
AVMC to Genius on March 21, 2005.
25
Item 3. Controls and Procedures
- -------------------------------
The Company maintains disclosure controls and procedures (as such term is
defined in Rule 13a-15(e)) that are designed to ensure that information required
to be disclosed in its Exchange Act reports is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to management to allow
timely decisions regarding required disclosure.
An evaluation was performed, as of September 30, 2005, under the
supervision and with the participation of the Company's management, including
its President and Chief Executive Officer and Chief Accounting Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on such evaluation, the Company's management concluded
that the Company's disclosure controls and procedures were effective to ensure
that information the Company is required to disclose in reports that the
Company's files or submits under the Exchange Act are recorded, processed,
summarized and reported within the time periods specified in the SEC's rule and
forms, and that such information is accumulated and communicated to the
Company's management, including the President and Chief Executive Officer and
Chief Accounting Officer, as appropriate, to allow timely decisions regarding
required disclosure.
There has been no change in the Company's internal controls over financial
reporting that occurred during the third quarter of 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
controls over financial reporting.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- -------------------------
Reference is hereby made to Item 3 of the Company's Annual Report on Form
10-KSB, for the year ended December 31, 2004, filed with the Securities and
Exchange Commission on May 10, 2005 (Commission File No.: 0-10061), and to the
references made in such item for a discussion of all material pending legal
proceedings to which the Company or any of its subsidiaries are parties.
In connection with the premature termination of the Company's contracts to
provide consulting services to an Indian gaming enterprise, the Company brought
a civil action against the Table Mountain Tribe (the "Tribe"). The lawsuit
sought to recover payments due under the agreements, as well as consulting fees
that would have been due during the remainder of the consulting contract term.
In April 2003, the Tribe filed a motion to dismiss the case based on its
assertion that its contracts with the Company were not properly authorized by
Tribal authorities, and thereby did not constitute a valid waiver of the Tribe's
sovereign immunity to suit.
In September 2005, the California Superior Court granted the motion and
dismissed the Company's complaint. On October 6, 2005, the Company filed a
"Petition for Review" with the California Supreme Court. On October 21, 2005,
the Company and the Tribe settled the claims between the parties. Under this
settlement, the Company received a nominal payment from the Tribe and the
Company and the Tribe each granted the other a release from all claims that
could arise under the various agreements between the parties.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
- -------------------------------------------------------------------
None.
Item 3. Defaults Upon Senior Securities
- ---------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
None.
Item 5. Other Information
- -------------------------
The Compensation Committee of the Board of Directors approved the
extension of the term of Ronald J. Tassinari's employment with the Company for
one year through February 1, 2007.
Item 6. Exhibits
- ----------------
(a) Exhibits
31.1 Certification of Ronald J. Tassinari pursuant to Exchange Act Rule
13a-14(a) **
31.2 Certification of Anna M. Morrison pursuant to Exchange Act Rule
13a-14(a) **
32.1 Certification of Ronald J. Tassinari pursuant to 18 U.S.C. Section
1350 **
32.2 Certification of Anna M. Morrison pursuant to 18 U.S.C. Section 1350
**
- -------------------
** Filed herewith.
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
AMERICAN VANTAGE COMPANIES
Dated: November 11, 2005 By: /s/ Ronald J. Tassinari
-------------------------------------
Ronald J. Tassinari,
President and Chief Executive Officer
Dated: November 11, 2005 By: /s/ Anna M. Morrison
-------------------------------------
Anna M. Morrison,
Chief Accounting Officer
28