AI
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Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information in this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact made in this report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. Our actual results may differ significantly from management's expectations.
The following discussion and analysis should be read in conjunction with the financial statements and notes thereto included elsewhere in this report and with our annual report on Form 10-KSB for the fiscal year ended December 31, 2007. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.
Results of Operations
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Revenues for the three months ended September 30, 2008 were $3,024,146, compared to $1,700,000 for the three months ended September 30, 2007. This represents an increase of $1,324,146. This increase was primarily attributable to the releases of Summer Athletics and Crashtime over flat fee releases for the same period in 2007.
There was a -23.8% change in gross profit for the three months ended September 30, 2008 which was $604,040, compared to $792,357 for the three months ended September 30, 2007. This decrease in gross profit was primarily the result of our releases of Summer Athletics and Crashtime being conventional type releases where production is part of the cost of goods, whereas our flat fee releases over the same period in 2007 had no productions costs associated with revenue.
For the three months ended September 30, 2008, operating expenses totaled $476,756 as compared to $570,397 for the three months ended September 30, 2007. This was a decrease of $93,641 or 16.4%. The decrease in operating expenses resulted from an decrease in marketing expenses of $106,937 or 59.0% from $181,166 for the three months ended September 30, 2007 to $74,229 for the three months ended September 30, 2008, a releasing two titles in the quarter as compared to 5 over the same period one year ago. In addition outside service decreased $31,117 or 100% from $31,117 for the three months ended September 30, 2007 to $0 for the three months ended September 30, 2008 which was a result of the additional employees hired earlier in the year being able to limit the need for temporary assistance during the quarter. Professional fees decreased from $173,115 for the three months ended September 30, 2007 to $78,740 for the three months ended September 30, 2008, a decrease of 54.5% or $94,375 due to our agreement with consultants to reduce their fees during the year from a percentage base to a fixed fee. However, Auto Expense increased $18,368 or 616.0% from $2,982 for the three months ended September 30, 2007 to $21,350 for the three months ended September 30, 2008 a result of the increased travel activity, and our agreement with consultants to reimburse auto expenses. Entertainment also increased during the quarter from $9,329 for the three months ended September 30, 2007 to $27,096 for the three months ended September 30, 2008 which was an 190.5% increase or $17,768 increase over the same period last year due to our efforts to secure alternate distribution for upcoming titles as well as entertaining several new developers and publishers. Payroll increased 35.6% or $40,787 from $114,630 for the three months ended September 30, 2007 to $155,417 due to additional employees being added to payroll. Office Rent also increased $21,735 or 159.4% from $13,632 for the three months ended September 30, 2007 to $35,367 for the three months ended September 30, 2008 to to our expansion of office space to accommodate additional employees and consultants necessary to assist the company in its growth. Finally, Penalty increased $33,000 or 100% from $0 over the three months ended September 30, 2007 due to fees associated with our tax debt to the Internal Revenue Service.
Interest expense was $62,313 and $40,893 for the three months ended September 30, 2008 and 2007, respectively. This was an increase of $21,420, or 52.4%^%.
We received $4,748,538 in other income for the three months ended September 30, 2008 compared to Other Expense of $6,595,327 for the three months ended September 30, 2007. The difference of $11,343,865 which was a result of adjustments on the valuation of our derivative liablities.
Our net income was $4,875,822 for the three months ended September 30, 2008 compared to a net loss of $6,373,367 for the three months ended September, 2007. The increase in net income for the three months ended September 30, 2008 was due to the adjustments made to the valuation of derivative liability over the three months ended September 30, 2008.
Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Revenues for the nine months ended September 30, 2008 were $7,784,004 compared to $2,519,330 for the nine months ended September 30, 2007. This represents an increase of $5,264,674.
There was a 69.8]% change in gross profit for the nine months ended September 30, 2008 which was $2,096,847, compared to $1,234,857 for the nine months ended September 30, 2007. This increase resulted primarily from the release of conventional titles over flat fee titles and the continued success of Winter Sports: The Ultimate Challenge.
For the nine months ended September 30, 2008, operating expenses totaled $1,722,066 as compared to $1,098,357 for the nine months ended September 30, 2007. This was an increase of $623,709 or 56.8%. The increase in operating expenses resulted from an increase in marketing expenses of $144,361 or 51.0% from $282,986 for the nine months ended September 30, 2007 to $427,348 for the nine months ended September 30, 2008, a result of our IR campaign and efforts to bring more information to current and potential shareholders. In addition, entertainment expenses increased $44,057 or 140.9% from $31,278 for the nine months ended September 30, 2007 to $75,335 for the nine months ended September 30, 2008. Automobile Expense increased from $9,085 for the nine months ended September 30, 2007 to $42,638 for the nine months ended September 30, 2008 due to our agreement to reimburse consultant auto expenses and an increased amount of travel. Payroll Expenses increased from $287,110 for the nine months ended September 30, 2007 to $462,139 for the nine months ended September 30, 2008, an increase of 61.0% or $175,029 due to additional employees hired to help offset the need for temporary services. Penalty increased $98,972 or 100% from $0 for the nine months ended September 30, 2007 a result of the increased fees incurred in relation our to our tax debts. Professional fees increased $99,747 or 39.2% from $254,365 for the nine months ended September 30, 2007 to $354,112 for the nine month due to the fees paid to Consultants and attorneys. Finally Travel increased $41,146 or 129.8% from 31,704 for the nine months ended September 30, 2007 to $72,850 for the nine months ended September 30, 2008 due to Travel fees incurred by consultants as well as our efforts to expand or distribution network and our attempt to acquire future titles from developers and publishers. These increases were offset by decreases in Outside Service of $66,687 or 93.1% from $71,667 for the nine months ended September 30, 2007 to $4,980 for the nine months ended September30, 2008 due to the hiring of additional employees to reduce the need for temporary assistance.
Interest expense was $159,818 and $106,489 for the nine months ended September 30, 2008 and 2007, respectively. This was an increase of $53,329 or 50.1%.
We had $138,073 net gain on the valuation of derivative liabilities for the nine months ended September 30, 2008 compared to a net loss of $3,682,722 for the nine months ended September 30, 2007.
Our net income was $353,701 for the nine months ended September 30, 2008 compared to a net loss of $3,821,614 for the nine months ended September 30, 2007. The increase in net income for the nine months ended September 30, 2008 was due to the gain on valuation of our derivative liabilities of $138,073 as compared to a loss on valuation of our derivative liabilities of $3,682,722 for the nine months ended September 30, 20076.
Liquidity and Capital Resources
As of September 30, 2008 our cash balance was $211,277 compared to $539,990 at December 31, 2007. Total current assets at September 30, 2008 were $370,277 compared to $927,385 at December 31, 2007. We currently plan to use the cash balance and cash generated from operations for increasing our working capital reserves and, along with additional debt financing, for new product development, securing new licenses, building up inventory, hiring more sales staff and funding advertising and marketing. Management believes that the current cash on hand and additional cash expected from operations in fiscal 2008 will be sufficient to cover our working capital requirements for the remainder of fiscal 2008. The Company reached this conclusion by recognizing that a major portion ($2,217,400) of our debt is attributed to convertible notes payable, which we expect to be converted into shares, Deferred Revenue ($2,373,441) will be reclassified as revenue upon the completion of the current projects in development, and Derivative Liability ($3,444,428) would be the amount of cash required should our investors call in our outstanding loans. Although we do not believe that our investors will call in our outstanding loans anytime in the near future. We can provide no assurance that this will not occur. We have informally negotiated with the IRS to pay down our Payroll Taxes liability in the amount of $10,000 per month. The Company is negotiating with several other parties to waive portions of our debt, or to pay the debt with the issuance of company stock including Deferred Compensation ($394,544). In addition, based on our schedule of development for the remainder of the year, we anticipate an increase in sales, profitability and cash receipts in 2008 which will allow the Company to continue to pay down our working capital requirements and help avoid additional need for working capital.
For the nine months ended September 30, 2008, net cash provided in operating activities was $2,024,956 as compared to $3,071,551 used by operating activities for the nine months ended September 30, 2007. The increase in cash provided in operating activities can be attributed to an increase in net profit of $4,175,315 from a loss of $3,821,614 for the nine months ended September 30, 2007 to net income of $353,701 for the nine months ended September 30, 2008. In addition, we had a net gain in the valuation of our derivative liability of $138,073 as compared to a net loss in the valuation of our derivative liability of $3,682,722. Finally we a change in Prepaids of $ 3,085,808 from $2,808,608 reduction for the nine months ended September 30, 2007 as compared to an increase of $277,200 for the nine months ended September 30, 2008.
For the nine months ended September 30, 2008, net cash used in investing activities was $2,598,669, compared to net cash used in investing activities of $944,922 for the nine months ended September 30, 2007. The increase in cash used in investing activities of $1,653,747 for the nine months ending September 30, 2008, was due to the increase in payments for development costs and licenses.
For the nine months ended September 30, 2008, net cash provided by Financing Activities was $245,000 compared to $4,358,992 for the nine months ended September 30, 2007. This decrease in cash provided by financing activities resulted primarily from less proceeds from advances.
Our accounts receivable at September 30, 2008 was $159,000, compared to $110,195 at December 31, 2007. The increase in accounts receivable is primarily attributable to receiving larger orders at the end of the quarter prior as compared to December 31, 2007.
As of September 30, 2008 we had a working capital deficiency of $12,167,676. A major portion of our debt is attributed to consulting fees, attorney fees, and payroll taxes payable. We plan to reduce these debts with proceeds generated from normal operational cash flow as well as the issuance of company stock.
At September 30, 2008 we had no bank debt.
Financings
On January 16, 2004, we received $50,000 from Calluna Capital Corporation under the terms of a February 25, 2003 convertible notes payable agreement bringing the total amount borrowed from Calluna Capital Corporation to $500,000.
On May 17, 2004, we sold 2,792,200 shares of common stock to accredited investors for $.10 per share, or an aggregate of $279,220.
On August 31, 2004, we sold an aggregate of $1,050,000 principal amount of 5% Secured Convertible Debentures, Class A Common Stock Purchase Warrants to purchase 21,000,000 shares of our common stock, and Class B Common Stock Purchase Warrants to purchase 21,000,000 shares of our common stock, to four institutional investors. We received gross proceeds totaling $1,050,000 from the sale of the Debentures and the Warrants.
On September 28, 2004, we sold a $50,000 principal amount 5% Secured Convertible Debenture, Class A Common Stock Purchase Warrants to purchase 1,000,000 shares of our common stock, and Class B Common Stock Purchase Warrants to purchase 1,000,000 shares of our common stock, to one institutional investor. We received gross proceeds totaling $50,000 from the sale of the Debentures and the Warrants.
On February 9, 2005, we sold an aggregate of $650,000 principal amount of 5% Secured Convertible Debentures, 13,000,000 Class A Common Stock Purchase Warrants, and 13,000,000 Class B Common Stock Purchase Warrants, to four accredited institutional investors for gross proceeds totaling $650,000.
On August 11, 2006, we sold an aggregate of $247,000 principal amount of 15% secured convertible notes to two accredited institutional investors for gross proceeds totaling $247,000 less expenses of $4,000.
On March 30, 2007, we sold an aggregate of $80,000 principal amount of 15% secured convertible notes to two accredited institutional investors for gross proceeds of $80,000 less expenses of $12,500.
We do not have any current plans to obtain additional debt or equity financing. We plan to satisfy our capital expenditure commitments and other capital requirements through cash generated from operations and through funds received upon exercise of outstanding warrants. We believe the proceeds from exercise of our outstanding warrants will be sufficient to fund any need for additional capital. We currently have outstanding 35,000,000 Class A Warrants with exercise prices of $0.05 and 35,000,000 Class B Warrants with exercise prices of $0.20. Exercise of all of these warrants would provide gross proceeds of $8,750,000. However, at recent market prices of our common stock, none of these warrants are in the money. Thus, if the market price of our common stock does not increase and warrant holders do not exercise their warrants, we may be required to seek additional debt or equity financing. If additional financing is required and we cannot obtain additional financing in sufficient amounts or on acceptable terms when needed, our financial condition and operating results will be materially adversely affected.
Contractual Obligations
The following table summarizes our contractual obligations as of September 30,
2008:
Payments due by period
Less than More
Contractual Obligations Total One Year Years 1-2 than 2 years
Notes Payable $ 2,630,347 $ 2,630,347
Operating Lease Obligations $ 99,929 $ 99,929 $
License Fee Obligations $ 60,000 $ 60,000
Total $ 2,790,276 $ 2,790,276 $
In March 2007, we entered into a convertible notes agreement totaling $80,000. The notes if called would be payable August 2007.
In August 2006, we entered into a convertible notes agreement totaling $247,000. The notes if called would be payable February 2007.
On August 5, 2005 and August 8, 2005, two accredited investors loaned us an aggregate of $223,600 in gross proceeds in exchange for two notes payable. The notes bear no interest and were due February 1, 2006.
On February 9, 2005, we entered into three convertible notes payable agreements totaling $650,000. To date, these notes are past due and have not been called.
In September and October 2004, we entered into two convertible notes payable agreements totaling $1.1 million. To date, these notes are past due and have not been called.
In August 2003, we obtained an unsecured loan from an individual in the amount of $355,000 including interest. We have repaid approximately $184,872 with the remaining balance to be paid in the year 2007.
We currently lease office space at 612 Santa Monica Boulevard in Santa Monica, California. Through the remainder of the lease term, our minimum lease payments are as follows:
2007 $ 28,331
2008 $ 69,598
Our license agreement with Discovery for "The Jeff Corwin Experience" requires payments of the remaining $80,000 to be paid in full during the year 2005. Although we have only made $20,000 in payments during 2006, we are looking into our options on how to best handle this matter and plan to pay the balance in full by the end of 2007.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Summary of Significant Accounting Policies
Assignment of Accounts Receivable. We regularly assign our receivables to vendors with recourse. Assigned accounts receivable are shown on the accounts receivable section of the balance sheet until collected by the beneficiary. Should the accounts receivable become uncollectible, we are ultimately responsible for paying the vendor and recording an allowance for potential credit losses as deemed necessary. The assigned accounts receivable are generally collected within 90 days; therefore, the balance shown approximates its fair value.
Capitalized Development Costs and Licenses. Capitalized development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products. Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation.
Capitalized Development Costs. For products where proven technology exits, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Prior to a product's release, we expense, as part of cost of sales, development costs when we believe such amounts are not recoverable. Amounts related to capitalized development costs that are not capitalized are charged immediately to cost of sales. We evaluate the future recoverability of capitalized amounts on a quarterly basis. The recoverablility of capitalized development costs is evaluated based on the expected performance of the specific products for which the costs relate. The following criteria are used to evaluate expected product performance: historical performance of comparable products using comparable technology and orders of the product prior to its release. Commencing upon product release, capitalized development costs are amortized to cost of sales - software royalties and amortization is based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of one year or less. For products that have been released in prior periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Capitalized Licenses. Capitalized license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of the products. Depending on the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product over a shorter period of time.
We evaluate the future recoverability of capitalized licenses on a quarterly basis. The recoverability of capitalized license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. Prior to the related product's release, we expense, as part of cost of sales, licenses when we believe such amounts are not recoverable. Capitalized development cost for those products that are cancelled or abandoned are charged to cost of sales. The following criteria are used to evaluate expected product performance: historical performance of comparable products using comparable technology and orders for the product prior to its release.
Commencing upon the related products release, capitalized license costs are amortized to cost of sales - licenses based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed trademark or copyright will be utilized. As license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year. For intellectual property included in products that have been released, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Revenue Recognition. Revenue from video game distribution contracts, which provide for the receipt of non-refundable guaranteed advances, is recognized when the games are delivered to the distributor by the manufacturer under the completed contract method, provided the other conditions of sale are satisfied.
Until all of the conditions of the sale have been met, amounts received on such distribution contracts are recorded as deferred income. Although we regularly enter into the assignment of accounts receivable to vendors, we do not record revenues net versus gross since we:
i. Act as the principal in the transaction.
ii. Take title to the products.
iii. Have risks and rewards of ownership, such as the risk of loss for collection, delivery, or returns.
iv. Do not act as an agent or broker.
At all times, we maintain control of the development process and is responsible for directing the vendor. Other than for payment, the customer does not communicate with the vendor.
We utilize the completed contract method of revenue recognition as opposed to the percentage-of-completion method of revenue recognition for substantially all of its products since the majority of its products are completed within six to eight months. We complete the products in a short period of time since we obtain video games that are partially complete or obtain foreign language video games published by foreign manufacturers that are completed.
Allowance For Doubtful Accounts. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments where applicable. The majority of the Company's sales are done through exclusive distribution which requires advance payments from the distributor. If payments are not received, product will not be published. This eliminates the need for allowance for doubtful accounts for the majority of the Company's receivables. However the Company regularly reviews the adequacy of its accounts receivable allowance for all sales not made under the explained scenario, and after considering the size of the accounts receivable balance, each customer's expected ability to pay and our collection history with each customer an allowance is established if deemed necessary by the Company's findings. The Company reviews significant invoices that are past due to determine if an allowance is appropriate based on the risk category using the factors described above. In addition, the Company maintains a general reserve for certain invoices by applying a percentage based on the age category. The Company also monitors its accounts receivable for concentration to any one customer, industry or geographic region. The allowance for doubtful accounts represents the Company's best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. The balance of the allowance for doubtful accounts as of September 30, 2008 and December 31, 2007 was $0 and $62,500, respectively.
Valuation of Long-Lived Intangible Assets Including Capitalized Development Costs and Licenses. Capitalized development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with SFAS No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation. The accumulation of appropriate costs as a capitalized, long-term asset involves significant judgment and estimates of employee time spent on individual software projects. The accumulation and timing of costs recorded and amortized may differ from actual results.
Our long-lived assets consist primarily of capitalized development costs and licenses. We review such long-lived assets, including certain identifiable intangibles, for impairment whenever events or changes in circumstances indicate that we will not be able to recover the asset's carrying amount in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or asset, a significant decrease in the benefits realized from the software products, difficulty and delays in sales or a significant change in the operations of the use of an asset.
Recoverability of long-lived assets by comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds its fair value.
Capitalized development costs and licenses, net of accumulated amortization, totaled approximately $3,525,221 at September 30, 2008. Factors we consider . . .
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Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The information in this report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact made in this report are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. Our actual results may differ significantly from management's expectations.
The following discussion and analysis should be read in conjunction with the financial statements and notes thereto included elsewhere in this report and with our annual report on Form 10-KSB for the fiscal year ended December 31, 2007. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.
Results of Operations
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Revenues for the three months ended September 30, 2008 were $3,024,146, compared to $1,700,000 for the three months ended September 30, 2007. This represents an increase of $1,324,146. This increase was primarily attributable to the releases of Summer Athletics and Crashtime over flat fee releases for the same period in 2007.
There was a -23.8% change in gross profit for the three months ended September 30, 2008 which was $604,040, compared to $792,357 for the three months ended September 30, 2007. This decrease in gross profit was primarily the result of our releases of Summer Athletics and Crashtime being conventional type releases where production is part of the cost of goods, whereas our flat fee releases over the same period in 2007 had no productions costs associated with revenue.
For the three months ended September 30, 2008, operating expenses totaled $476,756 as compared to $570,397 for the three months ended September 30, 2007. This was a decrease of $93,641 or 16.4%. The decrease in operating expenses resulted from an decrease in marketing expenses of $106,937 or 59.0% from $181,166 for the three months ended September 30, 2007 to $74,229 for the three months ended September 30, 2008, a releasing two titles in the quarter as compared to 5 over the same period one year ago. In addition outside service decreased $31,117 or 100% from $31,117 for the three months ended September 30, 2007 to $0 for the three months ended September 30, 2008 which was a result of the additional employees hired earlier in the year being able to limit the need for temporary assistance during the quarter. Professional fees decreased from $173,115 for the three months ended September 30, 2007 to $78,740 for the three months ended September 30, 2008, a decrease of 54.5% or $94,375 due to our agreement with consultants to reduce their fees during the year from a percentage base to a fixed fee. However, Auto Expense increased $18,368 or 616.0% from $2,982 for the three months ended September 30, 2007 to $21,350 for the three months ended September 30, 2008 a result of the increased travel activity, and our agreement with consultants to reimburse auto expenses. Entertainment also increased during the quarter from $9,329 for the three months ended September 30, 2007 to $27,096 for the three months ended September 30, 2008 which was an 190.5% increase or $17,768 increase over the same period last year due to our efforts to secure alternate distribution for upcoming titles as well as entertaining several new developers and publishers. Payroll increased 35.6% or $40,787 from $114,630 for the three months ended September 30, 2007 to $155,417 due to additional employees being added to payroll. Office Rent also increased $21,735 or 159.4% from $13,632 for the three months ended September 30, 2007 to $35,367 for the three months ended September 30, 2008 to to our expansion of office space to accommodate additional employees and consultants necessary to assist the company in its growth. Finally, Penalty increased $33,000 or 100% from $0 over the three months ended September 30, 2007 due to fees associated with our tax debt to the Internal Revenue Service.
Interest expense was $62,313 and $40,893 for the three months ended September 30, 2008 and 2007, respectively. This was an increase of $21,420, or 52.4%^%.
We received $4,748,538 in other income for the three months ended September 30, 2008 compared to Other Expense of $6,595,327 for the three months ended September 30, 2007. The difference of $11,343,865 which was a result of adjustments on the valuation of our derivative liablities.
Our net income was $4,875,822 for the three months ended September 30, 2008 compared to a net loss of $6,373,367 for the three months ended September, 2007. The increase in net income for the three months ended September 30, 2008 was due to the adjustments made to the valuation of derivative liability over the three months ended September 30, 2008.
Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Revenues for the nine months ended September 30, 2008 were $7,784,004 compared to $2,519,330 for the nine months ended September 30, 2007. This represents an increase of $5,264,674.
There was a 69.8]% change in gross profit for the nine months ended September 30, 2008 which was $2,096,847, compared to $1,234,857 for the nine months ended September 30, 2007. This increase resulted primarily from the release of conventional titles over flat fee titles and the continued success of Winter Sports: The Ultimate Challenge.
For the nine months ended September 30, 2008, operating expenses totaled $1,722,066 as compared to $1,098,357 for the nine months ended September 30, 2007. This was an increase of $623,709 or 56.8%. The increase in operating expenses resulted from an increase in marketing expenses of $144,361 or 51.0% from $282,986 for the nine months ended September 30, 2007 to $427,348 for the nine months ended September 30, 2008, a result of our IR campaign and efforts to bring more information to current and potential shareholders. In addition, entertainment expenses increased $44,057 or 140.9% from $31,278 for the nine months ended September 30, 2007 to $75,335 for the nine months ended September 30, 2008. Automobile Expense increased from $9,085 for the nine months ended September 30, 2007 to $42,638 for the nine months ended September 30, 2008 due to our agreement to reimburse consultant auto expenses and an increased amount of travel. Payroll Expenses increased from $287,110 for the nine months ended September 30, 2007 to $462,139 for the nine months ended September 30, 2008, an increase of 61.0% or $175,029 due to additional employees hired to help offset the need for temporary services. Penalty increased $98,972 or 100% from $0 for the nine months ended September 30, 2007 a result of the increased fees incurred in relation our to our tax debts. Professional fees increased $99,747 or 39.2% from $254,365 for the nine months ended September 30, 2007 to $354,112 for the nine month due to the fees paid to Consultants and attorneys. Finally Travel increased $41,146 or 129.8% from 31,704 for the nine months ended September 30, 2007 to $72,850 for the nine months ended September 30, 2008 due to Travel fees incurred by consultants as well as our efforts to expand or distribution network and our attempt to acquire future titles from developers and publishers. These increases were offset by decreases in Outside Service of $66,687 or 93.1% from $71,667 for the nine months ended September 30, 2007 to $4,980 for the nine months ended September30, 2008 due to the hiring of additional employees to reduce the need for temporary assistance.
Interest expense was $159,818 and $106,489 for the nine months ended September 30, 2008 and 2007, respectively. This was an increase of $53,329 or 50.1%.
We had $138,073 net gain on the valuation of derivative liabilities for the nine months ended September 30, 2008 compared to a net loss of $3,682,722 for the nine months ended September 30, 2007.
Our net income was $353,701 for the nine months ended September 30, 2008 compared to a net loss of $3,821,614 for the nine months ended September 30, 2007. The increase in net income for the nine months ended September 30, 2008 was due to the gain on valuation of our derivative liabilities of $138,073 as compared to a loss on valuation of our derivative liabilities of $3,682,722 for the nine months ended September 30, 20076.
Liquidity and Capital Resources
As of September 30, 2008 our cash balance was $211,277 compared to $539,990 at December 31, 2007. Total current assets at September 30, 2008 were $370,277 compared to $927,385 at December 31, 2007. We currently plan to use the cash balance and cash generated from operations for increasing our working capital reserves and, along with additional debt financing, for new product development, securing new licenses, building up inventory, hiring more sales staff and funding advertising and marketing. Management believes that the current cash on hand and additional cash expected from operations in fiscal 2008 will be sufficient to cover our working capital requirements for the remainder of fiscal 2008. The Company reached this conclusion by recognizing that a major portion ($2,217,400) of our debt is attributed to convertible notes payable, which we expect to be converted into shares, Deferred Revenue ($2,373,441) will be reclassified as revenue upon the completion of the current projects in development, and Derivative Liability ($3,444,428) would be the amount of cash required should our investors call in our outstanding loans. Although we do not believe that our investors will call in our outstanding loans anytime in the near future. We can provide no assurance that this will not occur. We have informally negotiated with the IRS to pay down our Payroll Taxes liability in the amount of $10,000 per month. The Company is negotiating with several other parties to waive portions of our debt, or to pay the debt with the issuance of company stock including Deferred Compensation ($394,544). In addition, based on our schedule of development for the remainder of the year, we anticipate an increase in sales, profitability and cash receipts in 2008 which will allow the Company to continue to pay down our working capital requirements and help avoid additional need for working capital.
For the nine months ended September 30, 2008, net cash provided in operating activities was $2,024,956 as compared to $3,071,551 used by operating activities for the nine months ended September 30, 2007. The increase in cash provided in operating activities can be attributed to an increase in net profit of $4,175,315 from a loss of $3,821,614 for the nine months ended September 30, 2007 to net income of $353,701 for the nine months ended September 30, 2008. In addition, we had a net gain in the valuation of our derivative liability of $138,073 as compared to a net loss in the valuation of our derivative liability of $3,682,722. Finally we a change in Prepaids of $ 3,085,808 from $2,808,608 reduction for the nine months ended September 30, 2007 as compared to an increase of $277,200 for the nine months ended September 30, 2008.
For the nine months ended September 30, 2008, net cash used in investing activities was $2,598,669, compared to net cash used in investing activities of $944,922 for the nine months ended September 30, 2007. The increase in cash used in investing activities of $1,653,747 for the nine months ending September 30, 2008, was due to the increase in payments for development costs and licenses.
For the nine months ended September 30, 2008, net cash provided by Financing Activities was $245,000 compared to $4,358,992 for the nine months ended September 30, 2007. This decrease in cash provided by financing activities resulted primarily from less proceeds from advances.
Our accounts receivable at September 30, 2008 was $159,000, compared to $110,195 at December 31, 2007. The increase in accounts receivable is primarily attributable to receiving larger orders at the end of the quarter prior as compared to December 31, 2007.
As of September 30, 2008 we had a working capital deficiency of $12,167,676. A major portion of our debt is attributed to consulting fees, attorney fees, and payroll taxes payable. We plan to reduce these debts with proceeds generated from normal operational cash flow as well as the issuance of company stock.
At September 30, 2008 we had no bank debt.
Financings
On January 16, 2004, we received $50,000 from Calluna Capital Corporation under the terms of a February 25, 2003 convertible notes payable agreement bringing the total amount borrowed from Calluna Capital Corporation to $500,000.
On May 17, 2004, we sold 2,792,200 shares of common stock to accredited investors for $.10 per share, or an aggregate of $279,220.
On August 31, 2004, we sold an aggregate of $1,050,000 principal amount of 5% Secured Convertible Debentures, Class A Common Stock Purchase Warrants to purchase 21,000,000 shares of our common stock, and Class B Common Stock Purchase Warrants to purchase 21,000,000 shares of our common stock, to four institutional investors. We received gross proceeds totaling $1,050,000 from the sale of the Debentures and the Warrants.
On September 28, 2004, we sold a $50,000 principal amount 5% Secured Convertible Debenture, Class A Common Stock Purchase Warrants to purchase 1,000,000 shares of our common stock, and Class B Common Stock Purchase Warrants to purchase 1,000,000 shares of our common stock, to one institutional investor. We received gross proceeds totaling $50,000 from the sale of the Debentures and the Warrants.
On February 9, 2005, we sold an aggregate of $650,000 principal amount of 5% Secured Convertible Debentures, 13,000,000 Class A Common Stock Purchase Warrants, and 13,000,000 Class B Common Stock Purchase Warrants, to four accredited institutional investors for gross proceeds totaling $650,000.
On August 11, 2006, we sold an aggregate of $247,000 principal amount of 15% secured convertible notes to two accredited institutional investors for gross proceeds totaling $247,000 less expenses of $4,000.
On March 30, 2007, we sold an aggregate of $80,000 principal amount of 15% secured convertible notes to two accredited institutional investors for gross proceeds of $80,000 less expenses of $12,500.
We do not have any current plans to obtain additional debt or equity financing. We plan to satisfy our capital expenditure commitments and other capital requirements through cash generated from operations and through funds received upon exercise of outstanding warrants. We believe the proceeds from exercise of our outstanding warrants will be sufficient to fund any need for additional capital. We currently have outstanding 35,000,000 Class A Warrants with exercise prices of $0.05 and 35,000,000 Class B Warrants with exercise prices of $0.20. Exercise of all of these warrants would provide gross proceeds of $8,750,000. However, at recent market prices of our common stock, none of these warrants are in the money. Thus, if the market price of our common stock does not increase and warrant holders do not exercise their warrants, we may be required to seek additional debt or equity financing. If additional financing is required and we cannot obtain additional financing in sufficient amounts or on acceptable terms when needed, our financial condition and operating results will be materially adversely affected.
Contractual Obligations
The following table summarizes our contractual obligations as of September 30,
2008:
Payments due by period
Less than More
Contractual Obligations Total One Year Years 1-2 than 2 years
Notes Payable $ 2,630,347 $ 2,630,347
Operating Lease Obligations $ 99,929 $ 99,929 $
License Fee Obligations $ 60,000 $ 60,000
Total $ 2,790,276 $ 2,790,276 $
In March 2007, we entered into a convertible notes agreement totaling $80,000. The notes if called would be payable August 2007.
In August 2006, we entered into a convertible notes agreement totaling $247,000. The notes if called would be payable February 2007.
On August 5, 2005 and August 8, 2005, two accredited investors loaned us an aggregate of $223,600 in gross proceeds in exchange for two notes payable. The notes bear no interest and were due February 1, 2006.
On February 9, 2005, we entered into three convertible notes payable agreements totaling $650,000. To date, these notes are past due and have not been called.
In September and October 2004, we entered into two convertible notes payable agreements totaling $1.1 million. To date, these notes are past due and have not been called.
In August 2003, we obtained an unsecured loan from an individual in the amount of $355,000 including interest. We have repaid approximately $184,872 with the remaining balance to be paid in the year 2007.
We currently lease office space at 612 Santa Monica Boulevard in Santa Monica, California. Through the remainder of the lease term, our minimum lease payments are as follows:
2007 $ 28,331
2008 $ 69,598
Our license agreement with Discovery for "The Jeff Corwin Experience" requires payments of the remaining $80,000 to be paid in full during the year 2005. Although we have only made $20,000 in payments during 2006, we are looking into our options on how to best handle this matter and plan to pay the balance in full by the end of 2007.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
Summary of Significant Accounting Policies
Assignment of Accounts Receivable. We regularly assign our receivables to vendors with recourse. Assigned accounts receivable are shown on the accounts receivable section of the balance sheet until collected by the beneficiary. Should the accounts receivable become uncollectible, we are ultimately responsible for paying the vendor and recording an allowance for potential credit losses as deemed necessary. The assigned accounts receivable are generally collected within 90 days; therefore, the balance shown approximates its fair value.
Capitalized Development Costs and Licenses. Capitalized development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products. Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation.
Capitalized Development Costs. For products where proven technology exits, this may occur early in the development cycle. Technological feasibility is evaluated on a product-by-product basis. Prior to a product's release, we expense, as part of cost of sales, development costs when we believe such amounts are not recoverable. Amounts related to capitalized development costs that are not capitalized are charged immediately to cost of sales. We evaluate the future recoverability of capitalized amounts on a quarterly basis. The recoverablility of capitalized development costs is evaluated based on the expected performance of the specific products for which the costs relate. The following criteria are used to evaluate expected product performance: historical performance of comparable products using comparable technology and orders of the product prior to its release. Commencing upon product release, capitalized development costs are amortized to cost of sales - software royalties and amortization is based on the ratio of current revenues to total projected revenues, generally resulting in an amortization period of one year or less. For products that have been released in prior periods, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Capitalized Licenses. Capitalized license costs represent license fees paid to intellectual property rights holders for use of their trademarks or copyrights in the development of the products. Depending on the agreement with the rights holder, we may obtain the rights to use acquired intellectual property in multiple products over multiple years, or alternatively, for a single product over a shorter period of time.
We evaluate the future recoverability of capitalized licenses on a quarterly basis. The recoverability of capitalized license costs is evaluated based on the expected performance of the specific products in which the licensed trademark or copyright is to be used. Prior to the related product's release, we expense, as part of cost of sales, licenses when we believe such amounts are not recoverable. Capitalized development cost for those products that are cancelled or abandoned are charged to cost of sales. The following criteria are used to evaluate expected product performance: historical performance of comparable products using comparable technology and orders for the product prior to its release.
Commencing upon the related products release, capitalized license costs are amortized to cost of sales - licenses based on the ratio of current revenues for the specific product to total projected revenues for all products in which the licensed trademark or copyright will be utilized. As license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year. For intellectual property included in products that have been released, we evaluate the future recoverability of capitalized amounts on a quarterly basis. The primary evaluation criterion is actual title performance.
Revenue Recognition. Revenue from video game distribution contracts, which provide for the receipt of non-refundable guaranteed advances, is recognized when the games are delivered to the distributor by the manufacturer under the completed contract method, provided the other conditions of sale are satisfied.
Until all of the conditions of the sale have been met, amounts received on such distribution contracts are recorded as deferred income. Although we regularly enter into the assignment of accounts receivable to vendors, we do not record revenues net versus gross since we:
i. Act as the principal in the transaction.
ii. Take title to the products.
iii. Have risks and rewards of ownership, such as the risk of loss for collection, delivery, or returns.
iv. Do not act as an agent or broker.
At all times, we maintain control of the development process and is responsible for directing the vendor. Other than for payment, the customer does not communicate with the vendor.
We utilize the completed contract method of revenue recognition as opposed to the percentage-of-completion method of revenue recognition for substantially all of its products since the majority of its products are completed within six to eight months. We complete the products in a short period of time since we obtain video games that are partially complete or obtain foreign language video games published by foreign manufacturers that are completed.
Allowance For Doubtful Accounts. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments where applicable. The majority of the Company's sales are done through exclusive distribution which requires advance payments from the distributor. If payments are not received, product will not be published. This eliminates the need for allowance for doubtful accounts for the majority of the Company's receivables. However the Company regularly reviews the adequacy of its accounts receivable allowance for all sales not made under the explained scenario, and after considering the size of the accounts receivable balance, each customer's expected ability to pay and our collection history with each customer an allowance is established if deemed necessary by the Company's findings. The Company reviews significant invoices that are past due to determine if an allowance is appropriate based on the risk category using the factors described above. In addition, the Company maintains a general reserve for certain invoices by applying a percentage based on the age category. The Company also monitors its accounts receivable for concentration to any one customer, industry or geographic region. The allowance for doubtful accounts represents the Company's best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. The balance of the allowance for doubtful accounts as of September 30, 2008 and December 31, 2007 was $0 and $62,500, respectively.
Valuation of Long-Lived Intangible Assets Including Capitalized Development Costs and Licenses. Capitalized development costs include payments made to independent software developers under development agreements, as well as direct costs incurred for internally developed products.
We account for software development costs in accordance with SFAS No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Software development costs are capitalized once technological feasibility of a product is established and such costs are determined to be recoverable. Technological feasibility of a product encompasses both technical design documentation and game design documentation. The accumulation of appropriate costs as a capitalized, long-term asset involves significant judgment and estimates of employee time spent on individual software projects. The accumulation and timing of costs recorded and amortized may differ from actual results.
Our long-lived assets consist primarily of capitalized development costs and licenses. We review such long-lived assets, including certain identifiable intangibles, for impairment whenever events or changes in circumstances indicate that we will not be able to recover the asset's carrying amount in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or asset, a significant decrease in the benefits realized from the software products, difficulty and delays in sales or a significant change in the operations of the use of an asset.
Recoverability of long-lived assets by comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds its fair value.
Capitalized development costs and licenses, net of accumulated amortization, totaled approximately $3,525,221 at September 30, 2008. Factors we consider . . .
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