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MANAGEMENT'S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
(Edgar Glimpses Via Acquire Media NewsEdge) SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS REPORT, INCLUDING STATEMENTS IN THE FOLLOWING
DISCUSSION, ARE WHAT ARE KNOWN AS "FORWARD LOOKING STATEMENTS", WHICH ARE
BASICALLY STATEMENTS ABOUT THE FUTURE. FOR THAT REASON, THESE STATEMENTS INVOLVE
RISK AND UNCERTAINTY SINCE NO ONE CAN ACCURATELY PREDICT THE FUTURE. WORDS SUCH
AS "PLANS," "INTENDS," "WILL," "HOPES," "SEEKS," "ANTICIPATES," "EXPECTS "AND
THE LIKE OFTEN IDENTIFY SUCH FORWARD LOOKING STATEMENTS, BUT ARE NOT THE ONLY
INDICATION THAT A STATEMENT IS A FORWARD LOOKING STATEMENT. SUCH FORWARD LOOKING
STATEMENTS INCLUDE STATEMENTS CONCERNING OUR PLANS AND OBJECTIVES WITH RESPECT
TO THE PRESENT AND FUTURE OPERATIONS OF THE COMPANY, AND STATEMENTS WHICH
EXPRESS OR IMPLY THAT SUCH PRESENT AND FUTURE OPERATIONS WILL OR MAY PRODUCE
REVENUES, INCOME OR PROFITS. NUMEROUS FACTORS AND FUTURE EVENTS COULD CAUSE THE
COMPANY TO CHANGE SUCH PLANS AND OBJECTIVES OR FAIL TO SUCCESSFULLY IMPLEMENT
SUCH PLANS OR ACHIEVE SUCH OBJECTIVES, OR CAUSE SUCH PRESENT AND FUTURE
OPERATIONS TO FAIL TO PRODUCE REVENUES, INCOME OR PROFITS. THEREFORE, THE READER
IS ADVISED THAT THE FOLLOWING DISCUSSION SHOULD BE CONSIDERED IN LIGHT OF THE
DISCUSSION OF RISKS AND OTHER FACTORS CONTAINED IN THIS REPORT ON FORM 10-Q AND
IN THE COMPANY'S OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. NO
STATEMENTS CONTAINED IN THE FOLLOWING DISCUSSION SHOULD BE CONSTRUED AS A
GUARANTEE OR ASSURANCE OF FUTURE PERFORMANCE OR FUTURE RESULTS.
Background
We were incorporated in the State of Colorado on May 22, 2008. Since inception,
we have been engaged in organizational efforts and obtaining initial financing.
The Company was formed as a vehicle to pursue a possible business combination.
On January 3, 2012, we entered into Investment Agreements with all shareholders
of TOE Japan (the "Investors"). Pursuant to the Investment Agreements, each of
the Investors agreed to make a direct investment in the Registrant in the form
of a contribution to the Registrant of all shares of common stock of TOE Japan
owned by the Investor ("TOE Japan Shares"). In consideration for the investment
in the Registrant of the TOE Japan Shares by each Investor, the Registrant
agreed to issue to each of the Investors approximately 6,893 shares of common
stock of the Registrant for each TOE Japan Share invested in the Registrant.
Twenty Investors, who were the holders of one hundred percent (100%) of the
outstanding shares of TOE Japan, invested in the Registrant. At the time of
closing under the Investment Agreements, the Investors invested a total of 4,596
TOE Japan Shares in the Registrant, representing 100% of the outstanding stock
of TOE Japan, and the Registrant issued a total of 31,680,000 shares of common
stock to the Investors. The effect of the transaction was to make TOE Japan and
its subsidiaries ("TOE Group") wholly-owned subsidiaries of the Registrant, and
to cause a change of control of the Registrant.
TOE Japan was formed in 2003. It initially acted as an agent for authors and
cartoonists and was mainly involved in the publishing of books. In 2007 TOE
Japan entered into the production segment of the entertainment industry with the
production of animated films such as Straight Jacket, a co-production with Manga
Entertainment (Starz Entertainment Group)
In 2007, as TOE Japan's growth continued in Japan, it formed its first
subsidiary outside of Japan ("overseas") in the United Kingdom and opened an
office in London. In 2008, TOE set up a branch office in Korea and in 2009, TOE
Japan set up a subsidiary in Singapore and a branch office in Russia
(incorporated in 2011). In 2010 TOE Group set up a sales office in Los Angeles.
These offices were set up in order to facilitate business expansion in those
markets. These offices have limited staff and mainly operate with the
assistance of the main office in Ebisu,
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Japan. Our representative in the London office has recently resigned leaving
the office dormant until we can find a replacement.
Currently we are engaged in two industry segments (i) film entertainment, which
consists principally of production and distribution of animated and live action
feature films, including distribution of such films on DVD's and Blu-ray Discs
(jointly referred to as "DVD"), and (ii) publishing and distribution of books
In addition TOE Group possesses the intellectual property rights of 24 films,
including both animated and live action. TOE Group derives its revenue from
these rights through the receipts of royalties. Depending on the nature of the
intellectual property, royalty revenues can be derived from various distribution
channels as stated below.
We derive our revenue from the production and distribution of animated and live
action films and television programs. We receive a percentage of the ticket
revenue generated by the theatrical release of our films. In addition we
receive revenue from post theatrical release which includes the sale and/or
license of DVD's and Blu-ray Discs. The sale or rental of these products
generally occurs in a variety of retail outlets such as video specialty stores,
mass merchants, and convenience stores, and recently, films have become
available for rental by mail from various companies and by downloading from the
internet.
Normally the post theatrical release occurs 3 to 6 months after the theatrical
release and broadcasting on television.
Additional revenue is generated from pay-per-view television which allows cable
and satellite television subscribers to purchase individual programs, including
recently released films, on a "per use" basis. The subscriber fees are
typically divided among the program distributor, the pay-per-view operator and
the cable system operator; pay television which allows subscribers to view
premium channels that are offered by cable and satellite system operators for a
monthly subscription fee; broadcast television which provides programming over
the air; and basic cable which is a fee based service that provides programming
via cable or satellite transmission. Broadcasters, cable and satellite systems
pay fees to us for the right to air programming a specified number of times.
However, revenue generated from this source is currently rather insignificant
for TOE.
In addition to content produced by us, we may on occasion purchase the license
right to create and distribute DVD and Blu-ray Discs of products produced by
other companies. Distribution is divided between outsources and internal
distribution.
Our profitability is based on our ability to control the cost of production
through careful selection of the production houses and other subcontractors,
monitoring of ongoing projects as to cost and budget, and selection of the most
appropriate distribution channel for our products.
Our initial business was that of representing authors and creative talent. As a
result of the relationships we established, we also began to engage in
publishing their works. In addition to the works that are created by authors we
represent, we also acquire the rights to translate foreign (non-Japanese) titles
to be published in Japan.
In the book publishing sector, our revenues are derived from the sale of books
we publish to publication wholesalers and in some instances also from sales
directly to retailers when such sales will not compete with the distributor.
Our profitability in this portion of our business is based on our ability to
control the cost of production through careful selection of the printers and
publication wholesalers for each book published.
Critical Accounting Policies
Basis of presentation
The condensed consolidated financial statements have been prepared in accordance
with GAAP and are expressed in United States dollars ($). Financial statements
prepared in accordance with GAAP contemplate the realization of assets and the
satisfaction of liabilities in the normal course of business.
As of September 30, 2012 we have an accumulated deficit of $6,617,036, and our
current liabilities exceed our current assets by $6,811,671. Included in
non-current assets at September 30, 2012 is $4,264,962 of film costs which will
be expensed against future revenues and will not require the use of cash.
Included in current liabilities at
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September 30, 2012 is $3,821,529 of deferred revenue, which accounted for
approximately32% of the current liabilities, and represents projects in
production. The deferred revenue does not represent a cash liability. Excluding
the deferred revenue, at September 30, 2012 we would have had working capital
deficit of $2,990,142.
In view of the matters described above, recoverability of a major portion of the
recorded asset amounts and realization of the portion of current liabilities
into revenue shown in the accompanying balance sheets are dependent upon
continued operations of the Company, which in turn are dependent upon the
Company's ability to raise additional financing and to succeed in its future
operations. These financial statements do not include any adjustments relating
to the recoverability and classification of recorded asset amounts or amounts
and classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
Management has taken the steps which it believes are sufficient to revise our
operating and financial requirements and provide us with the ability to continue
as a going concern. We are actively pursuing additional funding which would
enhance capital employed and strategic partners which would increase revenue
bases or reduce production costs. Management believes that the above actions
will allow us to continue our operations throughout the remainder of the current
fiscal year.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America ("GAAP") requires
management to make estimates, judgments and assumptions that affect the amounts
reported in the consolidated financial statements and footnotes thereto. Actual
results could differ from those estimates.
Significant estimates and judgments inherent in the preparation of these
consolidated financial statements include, among other things, accounting for
asset impairments, allowances for doubtful accounts, depreciation and
amortization, the determination of ultimate revenues as it relates to
amortization of capitalized film costs from participations and residuals, books
and DVD sales returns, equity-based compensation, income taxes, and
contingencies.
Foreign Currency Translation
The Company's reporting currency is the United States dollar ("$") and the
accompanying consolidated financial statements have been expressed in United
States dollars. The Company's functional currency is the Japanese Yen ("¥"). In
addition, its operating subsidiaries in the United Kingdom and Singapore
maintain their books and record in their respective local currencies, the
British Pound ("£") and the Singapore dollar ("SG$"), which is a functional
currency as being the primary currency of the economic environment in which
their operations are conducted.
In accordance with ASC Topic 830 "Translation of Financial Statements", capital
accounts of the consolidated financial statements are translated into United
States dollars from JPY at their historical exchange rates when the capital
transactions occurred. Assets and liabilities are translated at the exchange
rates as of balance sheet date. Income and expenditures are translated at the
average exchange rate of the respective year. The resulting exchange
differences are recorded in the consolidated statement of operations.
Translation of amounts from the local currency of our subsidiaries into United
States dollars has been made at the following exchange rates for the six month
periods ended September 30, 2012 and 2011:
2012 2011
Period-end ¥ : $1 exchange rate 77.17 76.33
Average period ¥ : $1 exchange rate 79.37 79.36
Period-end £ : $1 exchange rate 0.63 0.64
Average period £ : $1 exchange rate 0.61 0.61
Period-end SG$ : $1 exchange rate 1.23 1.30
Average period SG$ : $1 exchange rate 1.25 1.23
Period-end Rub:$1 exchange rate 34.45 31.94
Average period Rub : $1 exchange rate 31.49 28.49
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Fair Value
ASC Topic 820 "Fair Value Measurement and Disclosures" establishes a three-tier
fair value hierarchy, which prioritizes the inputs used in measuring fair value.
The hierarchy prioritizes the inputs into three levels based on the extent to
which inputs used in measuring fair value are observable in the market.
These tiers include:
·
Level 1-defined as observable inputs such as quoted prices in active markets;
·
Level 2-defined as inputs other than quoted prices in active markets that are
either directly or indirectly observable; and
·
Level 3-defined as unobservable inputs in which little or no market data exists,
therefore requiring an entity to develop its own assumptions.
The Company's financial instruments consist of cash and cash equivalents, trade
receivables, other receivables, payables, and long term debt. The carrying
values of cash and cash equivalents, trade receivables, other receivables, and
payables approximate their fair value due to their short maturities. The
carrying value of long term debt approximates the fair value of debt of similar
terms and remaining maturities available to the company.
The Company's non-financial assets are measured on a recurring basis. These
non-financial assets are measured for impairment annually on the Company's
measurement date at the reporting unit level using Level 3 inputs. For most
assets, ASC 820 requires that the impact of changes resulting from its
application be applied prospectively in the year in which the statement is
initially applied.
The Company's non-financial assets measured on a non-recurring basis include the
Company's property, plant and equipment and finite-use intangible assets which
are measured for recoverability when indicators for impairment are present. ASC
820 requires companies to disclose assets and liabilities measured on a
non-recurring basis in the period in which the re-measurement at fair value is
performed.
The Company valued the convertible bonds using Level 3 criterion. As of
September 30, 2012, the valuations resulted in a gain on derivatives of $3,086.
Fair Value of Financial Instruments with Conversion Features
In accordance with ASC Topic 815 "Derivatives and Hedging", the conversion
feature of convertible bonds are separated from the debt instrument and
accounted for separately as a derivative instrument. On the date the Company's
convertible bonds are issued, the conversion feature was recorded as a liability
at its fair value, and future decreases in fair value recognized in earnings
while increases in fair values recognized in expenses as interest expense.
The Company used the Black-Scholes-Merton ("Black-Scholes") model to obtain the
fair value of the conversion feature. The Company's expected volatility
assumption is based on the historical volatility of stock prices of
entertainment industry average in Japan. The expected life assumption is
primarily based on the expiration date of the conversion features. The risk-free
interest rate for the expected term of the conversion features is based on the
U.S. Treasury yield curve in effect at the time of measurement.
The convertible bonds reached maturity and were not converted. The conversion
feature has expired and is no longer available.
Investments in Animations Films
Investments in animation films includes the Company's investments in
co-production animation films which are generally less than 50% owned by the
Company and are produced by the other investors of the ventures. Prior to August
1, 2012, the Company accounted for investments in animated films for which it
had an interest greater than 20% and exercised influence over the investment
using the equity . Under the equity method, the initial investment is recorded
at cost and adjusted annually to recognize the Company's share of earnings and
losses of the entity. As a result of the Company's inability to fund certain
requirements of its investment it no longer exercises any influence over the
co-productions. On August 1, 2012, the Company ceased accounting for its
investment in animated films under the equity method, and began accounting for
the investment utilizing the cost method.
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Film Costs and Revenues
Feature films typically are produced for initial exhibition in theaters,
followed by distribution in the home video, electronic sell-through,
video-on-demand, pay cable, basic cable and broadcast network sectors.
Generally, distribution to the home video, video-on-demand, pay cable, basic
cable and broadcast network sectors each commence within a range of
approximately one to five years of initial theatrical release. Theatrical
revenues are recognized as the films are exhibited. Revenues from home video
sales are recognized at the later of the delivery date or the date that video
units are made widely available for sale or rental by retailers based on gross
sales less a provision for estimated returns. A warranty period for six months
are usually provided by the Company on the film produced or arranged by the
Company. Based on management's past experience, no report of defects or claim
for compensation
Upfront or guaranteed payments for the licensing of intellectual property are
recognized as revenue when (i) an arrangement has been signed with a customer,
(ii) the customer's right to use or otherwise exploit the intellectual property
has commenced and there is no requirement for significant continued performance
by the Company, (iii) licensing fees are either fixed or determinable and (iv)
collectability of the fees is reasonably assured. In the event any significant
continued performance is required in these arrangements, revenue is recognized
when the related services are performed.
Film costs include the unamortized cost of completed films, films in production
and film rights in preparation of development. Film costs are stated at the
lower of cost, less accumulated amortization, or fair value. The amount of
capitalized film costs recognized as cost of revenues for a given film as it is
exhibited in various sectors, throughout its life cycle, is determined using the
film forecast computation method. Under this method, the amortization of
capitalized costs and the accrual of participations and residuals are based on
the proportion of the film's revenues recognized for such period to the film's
estimated remaining ultimate revenues. The process of estimating a film's
ultimate revenues (i.e., the total revenue to be received throughout a film's
life cycle) is discussed further under "Film Cost Recognition and Impairments."
Film Cost Recognition and Impairments
Film costs include direct production costs, production overhead and acquisition
costs for films are stated at the lower of unamortized cost or estimated fair
value and classified as noncurrent assets. Accounting for film costs, as well as
related revenues requires the exercise of judgment relates to the process of
estimating a film's ultimate revenues and is important for two reasons. First,
while a film is being produced and the related costs are being capitalized, as
well as at the time the film is released, it is necessary for management to
estimate the ultimate revenues, less additional costs to be incurred (including
exploitation and participation costs), in order to determine whether the value
of a film has been impaired and, thus, requires an immediate write-off of
unrecoverable film costs. Second, it is necessary for management to determine,
using the film forecast computation method, the amount of capitalized film costs
and the amount of participations and residuals to be recognized as costs of
revenues for a given film in a particular period. To the extent that the film's
ultimate revenues are adjusted, the resulting gross margin reported on the
exploitation of that film in a period is also adjusted.
Prior to the theatrical release of a film, management bases its estimates of
ultimate revenues for each film on factors such as the historical performance of
similar films, the rating and genre of the film, pre-release market research
(including test market screenings) and the expected number of theaters in which
the film will be released. Management updates such estimates based on
information available during the film's production and, upon release, the actual
results of each film. Changes in estimates of ultimate revenues from period to
period affect the amount of film costs amortized in a given period and,
therefore, could have an impact on the Company's financial results for that
period. For example, prior to a film's release, the Company often will test
market the film to the film's targeted demographic. If the film is not received
favorably, the Company may (i) reduce the film's estimated ultimate revenues,
(ii) revise the film, which could cause the production costs to increase or
(iii) perform a combination of both. Similarly, a film that generates
lower-than-expected theatrical revenues in its initial weeks of release would
have its theatrical and home video ultimate revenues adjusted downward.
Collaborative Arrangements
The Company has entered into collaborative arrangements in the film business,
with one or more active participants to jointly finance produce and/or
distribute motion picture or television product under which both the Company and
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the other active participants share in the risks and rewards of ownership. These
arrangements are referred to as co-production and distribution arrangements.
The Company typically records an asset for only the portion of the film it owns
and finances. The Company and the other participants typically distribute the
product in different media or markets. Revenues earned and expenses incurred for
the media or markets in which the Company distributes the product are typically
recorded on a gross basis. The Company typically does not record revenues earned
and expenses incurred when the other participants distribute the product. The
Company and the other participants typically share in the profits from the
distribution of the product in all media or markets. For films product, if the
Company is a net receiver of (1) the Company's share of the profits from the
media or markets distributed by the other participants less (2) the other
participants' share of the profits from the media or markets distributed by the
Company then the net amount is recorded as net sales. If the Company is a net
payer then the net amount is recorded in cost of sales.
Comprehensive Income
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, all items that are required to be recognized under current
accounting standards as components of comprehensive income are required to be
reported in a financial statement that is presented with the same prominence as
other financial statements. Comprehensive income includes net income and the
foreign currency translation changes.
Recent Pronouncements
We have reviewed all recently issued, but not yet effective, accounting
pronouncements and do not believe the future adoptions of any such
pronouncements may be expected to cause a material impact on our financial
condition or the results of operations.
Results of Operations
Our revenue for the six and three month periods ended September 30, 2012 and
2011 was $10,110,803, $10,763,932, $3,258,969, and$6,996,674, respectively. Our
net income/(loss) for the six and three month periods ended September 30, 2012
and 2011 was $(1,892,050), $1,094,042, $(1,870,319), and $1,556,921,
respectively. Our comprehensive income/(loss) for the six and three month
periods ended September 30, 2012 and 2011 was $(2,045,531), $816,907,
$(1,924,547), and $1,346,104, respectively. Through September 30, 2012 our
cumulative net losses and cumulative comprehensive loss were $(6,617,036) and
$(708,164), respectively.
RESULTS OF OPERATION FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE
SIX MONTHS ENDED SEPTEMBER 30, 2011
(References to 2012 and 2011 are to the six months ended September 30, 2012 and
2011 respectively, unless otherwise specified.)
Total Revenue decreased $653,029 (6%) from $10,763,832 for 2011 to $10,110,803
for 2012. Revenue from film entertainment decreased $1,795,765 (19%) from
$9,616,117 for 2011 to $7,820,352 for 2012. Revenue from book publishing and
distribution increased $1,142,736 (99%) from $1,147,715 for 2011 to $2,290,451
for 2012.
The decrease in revenue from film entertainment is due to a reduction in the
number of new producing film contracts in 2012 compared to 2011. As a result of
cash flow constraints we were involved in fewer productions.
During 2012 our book division released a total of 26 new books which generated
$1,420,552 of the total book revenue of $2,290,451 as compared to 11 new books
which generated $973,915 of the total book revenue of $1,147,715 in 2011.
We anticipate that our growth in the book publishing segment will continue as we
release more new titles.
Cost of revenue increased $932,137(11%) from $8,287,350 in 2011 to $9,219,487 in
2012. In terms of percentage of revenue, cost of revenue was 91% in 2012 as
compared to 77% in 2011.
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Cost of revenue for our film entertainment segment was approximately 95% for
2012 as compared to 82% in 2011.
Cost of revenue is calculated using a fraction in which the denominator is an
estimate of the ultimate revenue that a production will produce and the
numerator is the revenue achieved for the accounting period. The unamortized
film cost for the project is then multiplied by the percentage calculated. To
the extent that the film's ultimate revenues are adjusted, the resulting gross
margin reported on the exploitation of that film in a period is also adjusted.
Changes in estimates of ultimate revenues from period to period affect the
amount of film costs amortized in a given period and, therefore, have an impact
on our financial results for that period. For example, prior to a film's
release, we often will test market the film to the film's targeted demographic.
If the film is not received favorably, we may then (i) reduce the film's
estimated ultimate revenues, (ii) revise the film, which could cause the
production costs to increase or (iii) perform a combination of both. Similarly,
a film that generates lower-than-expected theatrical revenues in its initial
weeks of release would have its theatrical and home video ultimate revenues
adjusted downward. (See Film Costs and Revenues included in Critical Accounting
Policies and Estimates above for a more detailed explanation of the accounting).
Our estimates of ultimate revenue were lower in 2012 than in 2011. This
resulted in a higher cost of revenue.
Cost of revenue for our book publishing segment was approximately 75% in 2012 as
compared to29% in 2011. The increase/ in cost of revenue is attributable to our
disposal during 2012 of unsold inventories which had been held without sales
for a long period.
Total gross profit decreased $1,585,166 (36%) from $2,476,482 in 2011 to
$891,316 in 2012. In terms of percentage of revenue, the gross profit
percentage decreased to 9% for 2012 as compared to 23% for 2011.Gross profit
decreased in 2012 as compared to 2011 because of the fact that we had both a
decrease in total revenues and an increase in cost of revenue in 2012 as
compared to 2011.
Selling, general and administrative expenses increased $218,683 (17%) from
$1,284,306 for 2011 to $1,502,989 for 2012.
The following is a summary of selling general and administrative expenses for
the six months ended September 30, 2012 and 2011.
2012 2011 Difference
Personnel costs $ 909,719 $ 791,464 $ 118,255
Rental 212,573 193,464 19,109
Professional fees 100,665 6,175 94,490
Travel and entertainment 73,265 99,477 (26,212)
Other 206,767 193,726 13,041
$ 1,502,989 $ 1,284,306 $ 218,683
Our most significant cost is personnel costs which include salaries, benefits
and payroll taxes. These costs increased $118,255 (15%) from $791,464 in 2011
to $909,719 in 2012, primarily as a result of an increase in the number of
employees in the first quarter of our fiscal year. We had an average of 28
employees for the six months ended September 30, 2011 and an average of 35 for
the six months ended September 30, 2012. The increase was minimized by a
decrease in officer compensation. Officer salaries decreased by $46,000. In
future periods our personnel cost should go down as a result of shifting some of
our work to our Okinawa office where salaries are lower.
Rental expenses remained fairly consistent for 2011 and 2102. We are planning
to downsize our office space, thus reducing our rental expense in future
periods.
Legal and professional fees increased $94,490(1530%) from $6,175 in 2011 to
$100,665 in 2012 as a result of the merger which took place in 2012
.
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Travel and entertainment decreased $26,212 (26%) from $99,477 in 2011 to $73,265
in 2012. The decrease directly relates to our efforts to minimize operating
expenses which will be continued through the remainder of the current fiscal
year.
Other selling, general and administrative expenses include items such as office
expenses, software related costs, telephone and a variety of other miscellaneous
costs. Included in other cost were the costs of opening an office in Okinawa,
Japan. Other than the cost of opening the office in Okinawa, which was
approximately $20,000, none of these costs individually increased or decreased
significantly. We opened the office in Okinawa to reduce personnel cost as
salaries are lower than in Tokyo where our main office is located.
We anticipate that we will incur higher general and administrative expenses as a
public company than we incurred in the past as a private company. We expect
that our professional fees, cost of transfer agent, investor relations costs and
other stock related costs will increase. We are currently reviewing all of our
costs in order to reduce overhead expenses.
Our income (loss) from operations decreased $1,802,434 from an income of
$1,168,888 in 2011 to a loss of $(633,546) in 2012. The increase in income from
operations was the result of the fact that we had both a decrease in revenue and
an increase in general and administrative expenses in 2012 as compared to 2011.
Other expense increased $457,082 (612%) from $74,846 in 2011 to $532,928 in
2012. During 2012 we wrote off investments in animated films in the amount of
$465,505 and recorded income from investments of $10,029. There was no income
from this source in 2011.
In light of continued losses, at September 30, 2012 we could no longer be more
than 50% assured that we would receive the benefit from deferred tax assets
carried on our balance sheet. Accordingly, we reserved for 100% of the deferred
tax asset and recorded tax expense of $726,576.
The net (loss) increased $2,986,092 from $1,094,042 in 2011 to $(1,892,050) in
2012.
RESULTS OF OPERATION FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO
THE THREE MONTHS ENDED SEPTEMBER 30, 2011
(References to 2012 and 2011 are to the three months ended September 30, 2012
and 2011 respectively, unless otherwise specified.)
Total Revenue decreased $3,737,705(53%) from $6,996,674 for 2011 to $3,258,969
for 2012 as a result of a decrease in revenue from film entertainment. Revenue
from film entertainment decreased $3,914,132(64%) from $6,044,957for 2011 to
$2,130,825for 2012, while revenue from book publishing and distribution
increased $176,427 (18%) from $951,717for 2011 to $1,128,144 for 2012.
The decrease in revenue in film entertainment is due to a reduction in the
number of new producing film contracts in 2012 as compared to 2011. Our cash
constraints required us to cut back in the number of new film productions.
During the three months ended September 30, 2012, our book division released a
total of 11books. Sales from new releases totaled $843,736 during the period,
and total revenue from book sales was $929,728 for the period.
We do not anticipate significant growth until such time as our cash flow
improves. We estimate that our growth will resume by the end of this fiscal
year.
Cost of revenue decreased $1,482,474(31%) from $4,734,638 in 2011 to $3,252,164
in 2012. In terms of percentage of revenue, cost of revenue was 99% in 2012 as
compared to 33% in 2011.
Cost of revenue for our film entertainment segment was approximately96% for 2012
as compared to75% in 2011.
Cost of revenue is calculated using a fraction in which the denominator is an
estimate of the ultimate revenue that a
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production will produce and the numerator is the revenue achieved for the
accounting period. The unamortized film cost for the project is then multiplied
by the percentage calculated. To the extent that the film's ultimate revenues
are adjusted, the resulting gross margin reported on the exploitation of that
film in a period is also adjusted.
Changes in estimates of ultimate revenues from period to period affect the
amount of film costs amortized in a given period and, therefore, have an impact
on our financial results for that period. For example, prior to a film's
release, we often will test market the film to the film's targeted demographic.
If the film is not received favorably, we may then (i) reduce the film's
estimated ultimate revenues, (ii) revise the film, which could cause the
production costs to increase or (iii) perform a combination of both. Similarly,
a film that generates lower-than-expected theatrical revenues in its initial
weeks of release would have its theatrical and home video ultimate revenues
adjusted downward. (See Film Costs and Revenues included in Critical Accounting
Policies and Estimates above for a more detailed explanation of the accounting).
Our estimates of ultimate revenue were lower in 2012 than in 2011. This
resulted in a higher cost of revenue.
Cost of revenue for our book publishing segment was approximately105% in 2012 as
compared to21% in 2011. The increase in cost of revenue is attributable to our
disposal during 2012 of unsold inventories which had been held without sales for
a long period.
Total gross profit decreased $2,255,231from $2,262,036 in 2011 to $6,805 in
2012. In terms of percentage of revenue, the gross profit percentage decreased
to 0.2% for 2012 as compared to 32% for 2011.
Selling, general and administrative expenses decreased $25,645 (4%) from
$657,594 for 2011 to $631,948 for 2012.
The following is a summary of selling general and administrative expenses for
the three months ended September 30, 2012 and 2011.
2012 2011 Difference
Personnel costs $ 352,325 387,475 $ 35,150
Rental 107,555 88,611 18,944
Professional fees 53,665 3,663 50,002
Travel and entertainment 29,286 61,237 (31,951)
Other 89,117 116,608 (27,491)
$ 631,948 657,594 $ (25,645)
Our most significant cost is personnel costs which include salaries, benefits
and payroll taxes. These costs decreased $17,116 (6%) from $268,275 in 2011 to
$285,391 in 2012. We had an average of34 employees for the three months ended
September 30, 2011 and an average of 29for the three months ended September 30,
2012. In addition to the decrease in number of staff we also had salary cuts
during the period in 2012. The most significant reduction was in officer
salaries.
Rental expenses remained fairly consistent for 2011 and 2102. We are planning
to downsize the office to cut the expenses. This should effect all future
periods.
Professional fees increased $50,002(1365%) from $3,663 in 2011 to $53665 in 2012
as a result of the merger which took place in 2012 and the cost of being a
public company.
Travel and entertainment decreased $31,951 (52%) from $61,237 in 2011 to $29,286
in 2012. The decrease directly relates to our efforts to minimize operating
expenses which will be continued through the remainder of the current fiscal
year.
Other selling, general and administrative expenses include items such as office
expenses, software related costs, telephone and a variety of other miscellaneous
costs. Included in other cost were the costs of opening an office in Okinawa,
Japan. Other than opening the office which was approximately $20,000, none of
these cost individually
27
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increased or decreased significantly.
We anticipate that we will incur higher general and administrative expenses as a
public company than we incurred in the past as a private company. We expect
that our professional fees, cost of transfer agent, investor relations costs and
other stock related costs will increase.
We also anticipate that selling, general and administrative expenses will
concurrently increase with any increased activity in the future but will not
increase in the same proportion to that of revenue. We are currently reviewing
all of our costs in order to reduce overhead expenses.
Our income (loss) from operations decreased $2,228,080 from income of $1,591,052
in 2011 to a loss of $(636,028) in 2012.
Other expense increased $542,846 (1545%) from $35,131 in 2011 to $507,715 in
2012. During 2012 we wrote off investments in animated films in the amount of
$465,505 and recorded income from investments of $10,029. There was no income
from this source in 2011.
In light of continued losses, at September 30, 2012 we could no longer be more
than 50% assured that we would receive the benefit from deferred tax assets
carried on our balance sheet. Accordingly, we reserved for 100% of the deferred
tax asset and recorded tax expense of $726,576.
The net (loss) increased $3,427,240 from $1,556,921 in 2011 to $(1,870,319) in
2012.
Liquidity and Capital Resources
At September 30, 2012, we had a working capital deficit of $6,811,671, as
compared to a working capital deficit of $6,773,922 at March 31, 2012. Of the
working capital deficit at September 30, 2012, $3,821,529 was in deferred
revenue and does not represent a cash liability. This amount will be included
in future revenue. In addition, $4,264,962 was in film costs and this asset
will not result in our receipt of cash. This amount will be used as a cost of
revenue in the future. Excluding the amounts for deferred revenue, we would
have had working capital deficit of $2,990,142 at September 30, 2012.
During the six months ended September 30, 2012, operating activities used cash
of $325,682 and for the six months ended September 30, 2011, we provided cash
from operations of $2,056,982. This was primarily due to the loss in 2012.
During the six months ended September 30, 2012, investing activities used
$297,525 of cash and for the six months ended September 30, 2011, investing
activities used $3,127,444 of cash. In 2011, we invested in excess of
$3,000,000 in animated film projects and in 2012 we only invested approximately
$320,000.
During the six months ended September 30, 2012, financing activities provided
$153,135of cash and for the six months ended September 30, 2011, financing
activities provided $836,942 of cash. For the six months ended September 30,
2012 new bank borrowings, both short and long term, of $1,147,440 were offset by
repayments of $994,305 as compared to borrowings of $1,634,989 and repayments of
$1,060,920 for the six months ended September 30, 2011.
We are dependent on third party financing to provide the liquidity to fund
future projects. In the past this funding has been provided by bank loans which
have been guaranteed by our Chief Executive Officer and some of which have had
an additional guarantee of a third party commercialized credit guarantee
company. There can be no assurances that we will be able to continue financing
projects in this manner. We are currently exploring other alternatives which
might include equity financing.
In addition to the bank financing, in prior years we issued convertible bonds,
to a shareholder of ours, in the original amount of ¥84,000,000 (approximately
US$1,103,758). The bonds bear interest at a fluctuating rate of interest equal
to the prime lending rate for long-term credit established by Mizuho Corp bank
as of the first day of each
28
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interest payment period plus 0.3%, based on prime rate. The convertible bonds
matured on September 30, 2012 and the holder agreed to extend the due date until
March 31, 2013. The bonds are no longer convertible.
Subsequent Event
On November 12, 2012 we borrowed $1,200,000 from an unrelated third party.
The loan was made pursuant to the terms of a Credit Agreement dated as of
October 31, 2012 (the "Credit Agreement"), and made effective as of November 12,
2012, by and is evidenced by a Revolving Note. Under the Credit Agreement, We
may borrow up to an amount equal to the lesser of 80% of its Eligible Accounts
(as defined in the Credit Agreement) and the revolving loan commitment, which
initially is $1,200,000. Upon satisfaction of certain conditions, we may from
time to time, request that the revolving loan commitment be raised up to a
maximum of $5,000,000. The decision to grant any such increase in the revolving
loan commitment is in the Lender's sole discretion.
The loan matures on the earlier of May 12, 2013, which is six (6) months from
the closing date, subject to a six-month extension upon written request of we
made prior to the initial closing date. The maturity date may also be extended
in the Lender's sole discretion, in connection with execution of any
modification, extension or renewal of the Revolving Note evidencing the loan.
The loan bears interest at the rate of 10% per annum. In addition, we are
required to pay certain fees specified in the Credit Agreement. The fees
include due diligence fees, document review and legal fees, an asset monitoring
fee, and a transaction advisory fee, all of which are payable in cash, and an
additional advisory fee payable through issuance to the Lender of three (3)
redeemable warrants to purchase shares of our common stock. Each of the
warrants has a term of 10 years and each of them grants the Lender the right to
purchase a number of shares equal to up to one percent (1%) of our issued and
outstanding common stock at a price of $0.001 per share. Each of the warrants
includes a mandatory redemption provision pursuant to which we are required to
redeem the warrant for a redemption price of $45,000 if the Lender has not
previously elected to exercise the warrant. The mandatory redemption dates of
the three warrants are May 12, 2013, August 12, 2013 and November 12, 2013,
respectively, which dates are 6 months, 9 months and 12 months after the initial
closing date.
Under the terms of the Credit Agreement, we are required to direct all payments
received on account to a lock box account under the control of the Lender. The
Lender is authorized, on a weekly basis, to apply funds in the lock box account
toward payment of fees and interest due and owing by us, to the establishment of
a reserve in the amount of twenty percent (20%) of the amount of the revolving
loan commitment, and, in its sole discretion, to prepayments of the outstanding
principal due on the loan. Any funds remaining on deposit in the lock box
account after payment of the foregoing items are required to be disbursed on a
weekly basis to us.
In addition to the lock box, the loan is secured by a pledge of substantially
all of the our assets, by a pledge of all of the shares of T.O Entertainment,
Inc., a Japan corporation, owned by us, and by the pledge by the officers and
directors of the Company of a total of 8,581,725 shares of our common stock
currently owned by such officers and directors, and representing approximately
26% of our currently issued and outstanding common stock.
The Credit Agreement imposes certain restrictions on us, including restrictions
on its ability to (i) incur any Funded Indebtedness (as defined in the Credit
Agreement), (ii) incur liens, (iii) make investments, (iv) permit a Change in
Control (as defined in the Credit Agreement) or dispose of all or substantially
all of its assets, (v) make capital expenditures not in the ordinary course of
its business, (vi) issue or distribute capital stock, (vii) make distributions
to its shareholders, (viii) engage in any line of business other than the
business engaged in on the date of the Credit Agreement and businesses
reasonably related thereto, and (ix) enter into transactions with any affiliates
except in the ordinary course of business and upon fair and reasonable terms
that are no less favorable to us than we would obtain in an arm-length's basis
with a non-affiliate. Each of these restrictions is subject to certain
exceptions, as specified in the Credit Agreement.
The loan may be accelerated upon the occurrence and during the continuation of
an Event of Default (as defined in the Credit Agreement), including nonpayment
of amounts owed, misrepresentation, failure to perform under the Credit
Agreement or related documents, default under certain other obligations, events
of bankruptcy, the entry of a
29
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judgment in excess of certain specified amounts, the occurrence of a Material
Adverse Effect (as defined in the Credit Agreement), the occurrence of a Change
in Control (as defined in the Credit Agreement), certain impairments of
collateral, and the determination in good faith by the Lender that the prospect
for payment or performance of the Obligations (as defined in the Credit
Agreement) is impaired for any reason.
On January 31, 2013 the Credit Agreement was modified. The Lender agreed to
waive its right to retain any portion of payments received in the lock box
between January 31, 2013 and March 31, 2013 for purposes of establishing a
reserve account equal to 20% of the initial Revolving Loan Commitment of
$1,200,000. All funds held in reserve by Lender prior to January 31, 2013, will
continue to be held in reserve in the lock box account. In consideration for
agreeing to enter into this Amendment, the Company agreed to pay Lender an
additional advisory fee in the form of a redeemable warrant, giving the Lender
the right to purchase, for no additional consideration, one percent (1.0%) of
the issued and outstanding common stock of the Issuing Borrower, which warrant
is in substantially the same form as the Warrants issued under the Credit
Agreement (the "Additional Warrant"). The Additional Warrant includes a
mandatory redemption feature pursuant to which the Company is required to redeem
the warrant for a redemption price of $135,000 if the Lender has not previously
elected to exercise the warrant. The mandatory redemption price is payable in
twelve (12) equal monthly installments of $11,250.00 each, commencing on April
1, 2013, and continuing on the first day of each consecutive calendar month
thereafter until the Additional Warrant is redeemed in full.
There are no material relationships between us or any of our affiliates and the
Lender, other than with respect to the Credit Agreement.
Summary
Generally speaking, the production of video footage such as animation and movies
takes approximately 2 years from planning to being screened to the public. As a
result of our cash flow problems we are currently involved in smaller size
animation productions. We started a number of projects in the six months ended
September 30, 2012 and will continue to see the results in future periods. As
of September 30, 2012 a total of $4,264,962 in costs has been capitalized as
film costs which will be offset against future revenue. We also have deferred
revenue of $3,821,529 which will result in revenue in future periods.
In addition, we do not anticipate increasing the number of DVD's produced nor
the number of books produced. We will begin to increase our activity as our
cash flow improves.
In the entertainment industry, financial success is based upon audience
acceptance of the products produced. Although we are selective in our choice of
projects, there can be no guarantee that our productions will be widely
received.
In order to minimize our risk of acceptance by audiences, we plan to do sequels
of titles that have previously done well and also to prepare new titles with the
same production team that produced the hits. Our main target group, the "Otaku",
are known for their tendency in purchasing of related products.
As a result of our weakened cash flow position caused by delays in closing the
loan discussed above as a subsequent event, we were unable to fund certain
projects that we had planned. Until such time as we can fund additional
projects our growth will be slowed. There is no assurance that we can obtain
additional financing for those projects and we will have to fund them form cash
flow.
Off-Balance Sheet Arrangements
At September 30, 2012, we had no obligations that would qualify to be disclosed
as off-balance sheet arrangements.
ITEM 3.
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