InCapta Inc (INCT)

[thehope1]

Form 10QSB for GAMEZNFLIX INC 7-Aug-2006
Quarterly Report



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management's discussion and analysis of financial condition and results of operations is based upon, and should be read in conjunction with, our unaudited financial statements and related notes included elsewhere in this Form 10-QSB, which have been prepared in accordance with accounting principles generally accepted in the United States.

Overview.

Our company, through our website www.gameznflix.com, is an online DVD movie and video game rental business dedicated to providing subscribers a quality rental experience. We offer subscribers a reliable, web-based alternative to traditional store-based DVD and video game rentals on a national scale with an extensive library of approximately 40,000 DVD and video game titles. We offer subscribers several different subscription plans ranging from $8.99 per month to $16.99 per month. Our more popular subscription plan of $16.99 per month allows subscribers to have up to three DVD and video game titles out at the same time with no due dates, late fees or shipping charges. Subscribers select titles at our website which are then sent via U.S mail with a prepaid return mailer. Our service is an alternative to store- based video game rentals as we offer a high level of customer service, quality titles, and superior product availability.

In March 2004, we launched our website, http://www.gameznflix.com, and became fully operational in September 2004. In conjunction with the website the Company runs ad campaigns designed to create awareness among our target consumers and to generate traffic to the website.

In October 2005, we entered into an agreement with Circuit City provided for a pilot program in 27 retail stores and on the Circuit City website to promote services offered by us. On March 24, 2006, we entered into a definitive co-marketing agreement with Circuit City that calls for a scheduled rollout of our services to all the Circuit City Stores beginning in May 2006 with an anticipated complete rollout to all the stores by the end of December 2006. Although the overall number of subscribers obtained from the initial pilot program Circuit City service agreement was not considered significant in relation to the number of new subscribers added during the quarter ended December 31, 2005 and first quarter ended March 31, 2006, we believe that our relationship with Circuit City brought more prominence and recognition to our company. We will continue to seek similar relationships with nationally known companies or agencies to further brand our company name.

In September 2006, we will be launching a cross-country tour visiting twelve cities in a motor coach wrapped in GameZnFlix advertisements (mobile advertising). We believe this cross-country tour will allow us a grass roots marketing campaign which will provide a mobile advertising of "GameZnFlix" around the country and specifically in the twelve cities we will be visiting.

Our increasing growth will require us in the future to make more significant capital investment in library content, distribution infrastructure and technology. Our current infrastructure will allow us to service approximately 150,000 monthly subscribers before significant investment as mentioned previously would be required. We currently monitor our monthly growth rate to ensure we properly anticipate the timing of making additional investment in our library content, distribution infrastructure and technology. We currently have seven distribution centers, located in Northern and Southern California, Colorado, Kentucky, Maryland, Massachusetts, and Texas. As our subscriber base grows, we may seek opening additional distribution centers.

We have evaluated and continue to evaluate our operations and operational needs. During 2005, we were able to favorably negotiate a new mailer envelope with the United States Postal Service ("USPS"), which reduced our overall postage cost and increased the delivery turnaround time from about 7 to about 2 days.

We believe that our planned growth and profitability will depend in large part on our ability to promote our services, gain subscribers and expand our relationship with current subscribers. Accordingly, we intend to focus our attention and investment of resources in marketing, strategic partnerships and development of our subscriber base. If we are not successful in promoting our services and expanding our subscriber base, this may have a material adverse effect on our financial condition and the ability to continue to operate the business.

Results of Operations.

(a) Revenues.

We reported gross revenues of $372,299 and $775,909 for the three and six months ended June 30, 2006 compared with $243,982 and $405,755 in the same periods of the prior year, increases of $128,317 and $370,154, or approximately 52% and 91%, respectively. Gross revenues increased significantly during the three and six months ended June 30, 2006 compared to the prior periods primarily due to a greater increase in our subscriber base compared to same period in 2005 fueled by more market awareness of our services.

During the three and six months ended June 30, 2006, our subscriber base averaged approximately 8,300 and 7,400 subscribers per month compared with 3,100 and 3,000 in the same periods of the prior year. We continue to focus on growing our subscriber base through marketing and affiliate partnership programs whereby a referral fee is paid for each new subscriber signed. Our churn rate is approximately 13.6% and 15.3% for the three and six months ended June 30, 2006 as compared with the same periods of the prior year of 41.3% and 62.6%. Churn rate is a monthly measure defined as customer cancellations in the period divided by the sum of beginning subscribers and gross subscriber additions, then divided by the number of months in the period. Customer cancellations in the three and six months ended June 30, 2006, includes cancellations from gross subscriber additions, which is included in the gross subscriber additions in the denominator.

(b) Cost of Revenues.

We reported cost of revenues of approximately $213,646 and $390,259 for the three and six months ended June 30, 2006 compared with $141,283 and $279,543 for the same periods of the prior year, increases of $72,363 and $110,716, or approximately 52% and 39%, respectively. Cost of revenues decreased as a percentage to gross revenues during the first six months of 2006 compared to the same period in 2005 primarily due to a decrease in our mail delivery expense and providing the fulfillment services internally rather than having it outsourced in the prior year. In October 2005, we changed our USPS mailer to better make use of the first class mail rates and have overall reduced our postage costs. During the third quarter of 2005, we terminated our outsourced fulfillment services and internalized it, which provided us better management of costs and fulfilling our subscribers order requests.

(c) Advertising Expenses.

We reported advertising expenses of $455,485 and $693,813 for the three and six months ended June 30, 2006 compared with $136,868 and $166,913 for the same periods in the prior year, increases of $318,617 and $526,900, or approximately 233% and 316%, respectively. Such advertising consisted of direct marketing through print, radio and online internet advertising. We believe advertising expenses will continue to increase by at least 15% during 2006.

(d) Consulting and Professional Fees.

We reported consulting and professional fees of $899,555 and $1,388,822 for the three and six months ended June 30, 2006 compared with $266,977 and $604,883 for the same periods of the prior year, increases of $632,578 and $783,939, or approximately 237% and 130%, respectively. Increases in consulting and professional fees during the three and six months ended June 30, 2006 compared to the same periods in 2005 were primarily a result of additional business consultants utilized during 2006 to aid in developing a more effective marketing program.

(e) Depreciation and Amortization Expenses.

We reported depreciation and amortization expenses of $534,354 and $985,842 for the three and six months ended June 30, 2006 compared with $209,611 and $430,954 for the same periods of the prior year, increases of $324,743 and $554,888, or approximately 155% and 129%, respectively. Increases in depreciation and amortization during the three and six months ended June 30, 2006 compared to the same periods in 2005 were primarily a result of the purchase of additional DVD and games inventory, which are amortized over a period of 12 months.

(f) Selling, General and Administrative Expenses.

We reported selling, general and administrative expenses of $998,437 and $1,657,622 for the three and six months ended June 30, 2006 compared with $310,888 and $561,248 for the same periods of the prior year, increases of $687,549 and $1,096,374, or approximately 221% and 195%, respectively. Increases in selling, general and administrative expenses was principally due to an increase in related payroll expenses and contract services. The increase in related payroll and contract services will continue to increase as the overall growth of our business increases.

(g) Net Loss.

We reported net losses of $2,672,150 and $4,261,098 for the three and six months ended June 30, 2006 compared with $844,689 and $1,660,699 for the same periods of the prior year, increases of $1,827,461 and $2,600,399, or approximately 216% and 157%, respectively. These increases were the result of the foregoing factors mentioned above. We anticipate having a recurring net loss during the remaining months of 2006.

Factors That May Affect Our Operating Results.

Our operating results can vary significantly depending upon a number of factors, many of which are outside our control. General factors that may affect our operating results include:

- market acceptance of and changes in demand for services;

- a small number of customers account for, and may in future periods account for, substantial portions of our revenue, and revenue could decline because of delays of customer orders or the failure to retain customers;

- gain or loss of clients or strategic relationships;

- announcement or introduction of new services by us or by our competitors;

- price competition;

- the ability to upgrade and develop systems and infrastructure to accommodate growth;

- the ability to introduce and market services in accordance with market demand;

- changes in governmental regulation; and

- reduction in or delay of capital spending by clients due to the effects of terrorism, war and political instability.

We believe that our planned growth and profitability will depend in large part on the ability to promote our services, gain clients and expand our relationship with current clients. Accordingly, we intend to invest in marketing, strategic partnerships, and development of our customer base. If we are not successful in promoting our services and expanding our customer base, this may have a material adverse effect on our financial condition and our ability to continue to operate our business.

We are also subject to the following specific factors that may affect our operations:

(a) Our Ability to Attract and Retain Subscribers Will Affect Our Business.

We must continue to attract and retain subscribers. To succeed, we must continue to attract subscribers who have traditionally used video and game retailers, video and game rental outlets, cable channels, such as HBO and Showtime and pay-per-view. Our ability to attract and retain subscribers will depend in part on our ability to consistently provide our subscribers a high quality experience for selecting, viewing or playing, receiving and returning titles. If consumers do not perceive the service offering to be of quality, or if we introduce new services that are not favorably received by them, we may not be able to attract or retain subscribers. If the efforts to satisfy our existing subscribers are not successful, we may not be able to attract new subscribers, and as a result, revenues will be affected adversely.

We must minimize the rate of loss of existing subscribers while adding new subscribers. Subscribers cancel their subscription to our service for many reasons, including a perception that they do not use the service sufficiently, delivery takes too long, the service is a poor value and customer service issues are not satisfactorily resolved. We must continually add new subscribers both to replace subscribers who cancel and to grow the business beyond the current subscriber base. If too many subscribers cancel our service, or if we are unable to attract new subscribers in numbers sufficient to grow the business, operating results will be adversely affected. Further, if excessive numbers of subscribers cancel the service, we may be required to incur significantly higher marketing expenditures than currently anticipated to replace these subscribers with new subscribers.

Subscribers to the service can view as many titles and/or play games as they want every month and, depending on the service plan, may have out between three and six titles at a time. With our use of five shipping centers and the associated software and procedural upgrades, we have reduced the transit time of DVD's and games. As a result, subscribers have been able to exchange more titles each month, which has increased operating costs. As we establish additional planned shipping centers and further refine our distribution process, we may see a continued increase in usage by subscribers. If subscriber retention does not increase or operating margins do not improve to an extent necessary to offset the effect of increased operating costs, operating results will be adversely affected.

Subscriber demand for titles may increase for a variety of other reasons beyond our control, including promotion by studios and seasonal variations in movie watching. Subscriber growth and retention may be affected adversely if we attempt to increase monthly subscription fees to offset any increased costs of acquiring or delivering titles and games.

The "GameZnFlix" brand is young, and we must continue to build strong brand identity. To succeed, we must continue to attract and retain a number of owners of DVD's and video game players who have traditionally relied on store-based rental outlets and persuade them to subscribe to our service through our website. We may be required to incur significantly higher advertising and promotional expenditures than currently anticipated to attract numbers of new subscribers. We believe that the importance of brand loyalty will increase with a proliferation of DVD and game subscription services and other means of distributing titles. If our efforts to promote and maintain our brand are not successful, our operating results and ability to attract and retain subscribers will be affected adversely.

(b) Our Inability to Use Current Marketing Channels May Affect Our Ability to Attract New Subscribers.

We may not be able to continue to support the marketing of our services by current means if such activities are no longer available or are adverse to the business. In addition, we may be foreclosed from certain channels due to competitive reasons. If companies that currently promote our services decide to enter our line of business or a similar business, we may no longer be given access to such channels. If the available marketing channels are curtailed, our ability to attract new subscribers may be affected adversely.

(c) Selection of Certain Titles by Subscribers May Affect Our Costs.

Certain titles cost us more to acquire depending on the source from whom they are acquired and the terms on which they are acquired. If subscribers select these titles more often on a proportional basis compared to all titles selected, DVD or game acquisition expenses could increase, and gross margins could be adversely affected.

(d) Mix of Acquisition Sources May Affect Our Subscriber Levels.

We utilize a mix of incentive-based and fixed-cost marketing programs to promote our service to potential new subscribers. We obtain a portion of our new subscribers through online marketing efforts, including third party banner ads, direct links and an active affiliate program. While we opportunistically adjust our mix of incentive-based and fixed-cost marketing programs, we attempt to manage the marketing expenses to come within a prescribed range of acquisition cost per subscriber. To date, we have been able to manage our acquisition cost per subscriber; however, if it is unable to maintain or replace sources of subscribers with similarly effective sources, or if the cost of existing sources increases, subscriber levels may be affected adversely and the cost of marketing may increase.

(e) Competition May Affect Our Business.

The market for on-line rental of DVD's and games is competitive and we expect competition to continue to increase. In addition, the companies with whom we have relationships could develop products or services, which compete with our services. Also, some competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, and greater brand recognition than we do. We also expect to face additional competition as other established and emerging companies enter the market for on- line rentals. To be competitive, we believe that we must, among other things, invest resources in developing new products, improving current services and maintaining customer satisfaction. Such investment will increase our expenses and may affect our profitability. In addition, if we fail to make this investment, we may not be able to compete successfully with our competitors, which may have a material adverse effect on our revenue and future profitability.

(f) Any Significant Disruption in Service on Our Website Could Result in a Loss of Our Subscribers.

Subscribers and potential subscribers access our service through our website, where the title selection process is integrated with the delivery processing systems and software. Our reputation and ability to attract, retain and serve our subscribers is dependent upon the reliable performance of the website, network infrastructure and fulfilment processes. Interruptions in these systems could make the website unavailable and hinder our ability to fulfil selections. Service interruptions or the unavailability of the website could diminish the overall attractiveness of the subscription service to existing and potential subscribers.

Our servers utilize a number of techniques to track, deter and thwart attacks from computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions and delays in the service and operations as well as loss, misuse or theft of data. We currently use both hardware and software to secure our systems, network and, most importantly, our data from these attacks; this includes several layers of security in place for our protection and that of our members' data. We also have procedures in place to ensure that the latest security patches and software are running on our servers - thus maintaining another level of security.

Any attempts by hackers to disrupt the website service or the internal systems, if successful, could harm the business, be expensive to remedy and damage our reputation. We do not have an insurance policy that covers expenses related to direct attacks on our website or internal systems. Any significant disruption to the website or internal computer systems could result in a loss of subscribers and adversely affect the business and results of operations.

(g) Potential Delivery Issues Could Result in a Loss of Our Subscribers.

We rely exclusively on the USPS to deliver DVD's and games from our shipping centers and to return DVD's and games from subscribers. We are subject to risks associated with using the public mail system to meet our shipping needs, including delays caused by bioterrorism, potential labor activism and inclement weather. Our DVD's and games are also subject to risks of breakage during delivery and handling by the USPS. The risk of breakage is also impacted by the materials and methods used to replicate DVD's and games. If the entities replicating DVD's and games use materials and methods more likely to break during delivery and handling or we fail to timely deliver DVD's and games to subscribers, subscribers could become dissatisfied and cancel the service, which could adversely affect operating results. In addition, increased breakage rates for DVD's and games will increase our cost of acquiring titles.

(h) There May be a Change in Government Regulation of the Internet or Consumer Attitudes Toward Use of the Internet.

The adoption or modification of laws or regulations relating to the Internet or other areas of our business could limit or otherwise adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, which may impose additional burdens on us. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model.

The manner in which Internet and other legislation may be interpreted and enforced cannot be precisely determined and may subject either us or our customers to potential liability, which in turn could have an adverse effect on the business, results of operations and financial condition. The adoption of any laws or regulations that adversely affect the popularity or growth in use of the Internet could decrease the demand for the subscription service and increase the cost of doing business.

In addition, if consumer attitudes toward use of the Internet change, consumers may become unwilling to select their entertainment online or otherwise provide us with information necessary for them to become subscribers. Further, we may not be able to effectively market our services online to users of the Internet. If we are unable to interact with consumers because of changes in their attitude toward use of the Internet, subscriber acquisition and retention may be affected adversely.

(i) Any Required Expenditures by Us as a Result of Indemnification Will Result in a Increased Costs to Us.

The Company's bylaws include provisions to the effect that it may indemnify any director, officer, or employee. In addition, provisions of Nevada law provide for such indemnification, as well as for a limitation of liability of the Company's directors and officers for monetary damages arising from a breach of their fiduciary duties. Any limitation on the liability of any director or officer, or indemnification of any director, officer, or employee, could result in substantial expenditures being made by the Company in covering any liability of such persons or in indemnifying them.

(j) Our Inability to Issue Shares Upon Conversion of Debentures Would Require Us to Pay Penalties to Golden Gate.

If we are unable to issue common stock, or fail to timely deliver common stock on a delivery date, we are required to:

- pay late payments to Golden Gate for late issuance of common stock upon conversion of the convertible debenture, in the amount of $100 per business day after the delivery date for each $10,000 of convertible debenture principal amount being converted or redeemed.

- at the election of Golden Gate, we must pay Golden Gate a sum of money determined by multiplying up to the outstanding principal amount of the convertible debenture designated by Golden Gate by 130%, together with accrued but unpaid interest thereon

- if ten days after the date we are required to deliver common stock to Golden Gate pursuant to a conversion, Golden Gate purchases (in an open market transaction or otherwise) shares of common stock to deliver in satisfaction of a sale by Golden Gate of the common stock which it anticipated receiving upon such conversion (a "Buy-In"), then we are required to pay in cash to Golden Gate the amount by which its total purchase price (including brokerage commissions, if any) for the shares of common stock so purchased exceeds the aggregate principal and/or interest amount of the convertible debenture for which such conversion was not timely honored, together with interest thereon at a rate of 15% per annum, accruing until such amount and any accrued interest thereon is paid in full.

In the event that we are required to pay penalties to Golden Gate or redeem the convertible debentures held by Golden Gate, we may be required to curtail or cease our operations.

(k) Repayment of Debentures, If Required, Would Deplete Our Available Capital.

The convertible debenture issued to Golden Gate is due and payable, with 4 3/4% interest, three years from the date of issuance, unless sooner converted into shares of common stock. In addition, any event of default could require the early repayment of the convertible debentures at a price equal to 125% of the amount due under the debentures. We anticipate that the full amount of the convertible debentures, together with accrued interest, will be converted into shares of our common stock, in accordance with the terms of the debenture. If we were required to repay the debenture, we would be required to use our limited working capital and/or raise additional funds. If we were unable to repay the debentures when required, the debenture holder could commence legal action against us and foreclose on assets to recover the amounts due. Any such action may require us to curtail or cease operations.

Operating Activities.

The net cash used in operating activities was $3,085,924 for the six months ended June 30, 2006 compared with $1,112,887 for the six months ended June 30, 2005, an increase of $1,973,037. This increase is attributed to many changes from period to period, including the payment of stock based compensation and an increase in depreciation and amortization.

Investing Activities.

Net cash used in investing activities was $5,312,493 for the six months ended June 30, 2006 compared with $184,814 for the six months ended June 30, 2005, an increase of $5,117,679. This increase resulted from increased investments of cash that we had as a result of the recent additional funds provided by Golden Gate Investors, Inc. as a result of the Addendum to Convertible Debenture and Warrant to Purchase Common Stock, between that firm and us (as discussed below).

Liquidity and Capital Resources.

As of June 30, 2006, we had total current assets of $8,580,690 and total current liabilities of $676,425, resulting in a working capital surplus of $7,904,265. Our cash and certificates of deposit balances as of June 30, 2006 totaled $3,459,127 and $3,034,935, respectively. Our cash flow from financing activities for the six months ended June 30, 2006 resulted in a surplus of $5,955,149. Overall, our cash and cash equivalents for the six months ended June 30, 2006 decreased by $2,443,268.

Our current cash and cash equivalents balance will be sufficient to fund our operations for the next 24 months. Our ability to continue as a going concern on a longer-term basis will be dependent upon our ability to generate sufficient cash flow from operations to meet our obligations on a timely basis, to retain our current financing, to obtain additional financing, and ultimately attain profitability. We currently have $3,700,000 in stock subscriptions receivable that we believe we will be able to collect in the next nine months.

Our continued operations, as well as the implementation of our business plan (including allocating resources to increase our library content, distribution infrastructure and technology) will depend upon our ability to raise additional funds through bank borrowings and equity or debt financing. In connection with our need for funding, we have entered into a financing arrangement with Golden Gate Investors. We entered into a Securities Purchase Agreement with Golden Gate on November 11, 2004 for the sale of (i) $150,000 in convertible debentures and (ii) warrants to buy 15,000,000 shares of our common stock. This prospectus relates to the resale of the common stock underlying these convertible debentures and warrants.

The investor provided us with an aggregate of $150,000 as follows: