10KSB: CONSPIRACY ENTERTAINMENT HOLDINGS INC
(EDGAR Online via COMTEX) -- ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
FORWARD-LOOKING STATEMENTS
The information in this annual 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 of Conspiracy Entertainment Holdings, Inc., included herewith. 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 - YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED
DECEMBER 31, 2005
In early 2004, we formed Conspiracy Entertainment Europe, Ltd., a United Kingdom corporation. We currently own a 51% interest in Conspiracy Entertainment Europe, Ltd. Conspiracy Entertainment Europe was formed with the purpose of eventually obtaining publishing license agreements for European regions and eventually distributing our products throughout Europe. Conspiracy Entertainment Europe has not entered into any such publishing license agreements and Conspiracy Entertainment Europe has not generated any revenues to date. During 2004, we advanced $60,000 to Conspiracy Entertainment Europe to cover operating expenses. The financial statements of Conspiracy Entertainment Europe are consolidated with our financial statements, with a minority interest adjustment. In late 2005 we sold our interest in Conspiracy Entertainment Europe and have decided it is more economical at this point in time to sell our European products thru distribution as we do here in the United States.
For the fiscal year ended December 31, 2006 we had total revenue of $803,493 compared to revenue of $1,397,891 for the fiscal year ended December 31, 2005. The major components of revenues are product sales and license revenue. Product sales represent revenues for products manufactured and sold to distributors. License revenue represents license fees earned for the sale of certain products under certain licenses to third parties. We occasionally enter into such license agreements if management determines that it is in our best interest to sell rights to a particular product to a third party, rather than publishing the product our self. For the period ended December 31, 2006 we earned $182,500 in license revenue as compared to $283,235 license revenue earned in 2005. License revenue in 2006 consisted of revenues generated for products licensed to EUR while 2005 license revenue was the result of deferred revenues paid to us without the corresponding units being ordered. It was decided that by year end 2005 we would recognize these deferred revenues as license revenue. Product sales for the period ended December 31, 2005 was $620,993 as compared to $1,114,657 for the period ended December 31, 2005. The decrease in product sales revenue of $493,664, or 44.3%, is primarily the result of our decision to postpone the release of Pocket Pool until April 2007. Instead of selling the product in the 4th quarter 2006, we elected to sign a distribution agreement with Eidos, Inc., which we hope will net more profit for the company in the long run.
The below table provides a comparison of the nature and source of our revenue for the periods indicated.
Fiscal Year Ended
December 31, 2006 December 31, 2005
Number of New Titles Released 9 1
Number of Titles Reordered 2 7
Average Price Per Title $ 4.97 $ 7.44
Revenue From Internally Developed Titles $ 290,000 $ 652,126
Partially Complete Sales 0 0
Translated Sales $ 330,993 $ 462,531
License Revenue $ 182,500 $ 283,235
Other Revenue (packaging) $ 0 $ 0
The major components of cost of sales are production costs and license/development costs. Productions costs are the manufacturing costs of the games we sell and are generally proportional to the number of units manufactured. These costs include manufacturing of the software, packaging and assembly fees. License/development costs are the costs of having the product created, translated, or developed. They include, but are not limited to, translations fees for translating foreign game titles that we re-release in the United States. For the period ended December 31, 2006, we had license/development costs of $431,287 as compared to $109,382 for the period ended December 31, 2005. The increase in license/development costs of $321,905, or 294%, is due to the cancellation of the Johnny Rocketfingers (PSP) $23,000 and Sega Classics (PS2) $67,500. These products required license advances and development costs, but they were cancelled; we determined that Johnny Rocketfingers was no longer a profitable project; for the SEGA Classics project, the licensor terminated our agreement to which we received a cash settlement and were required to amortize all costs for the project. In addition, we incurred license fees with our UMD movie releases of $134,500. For the period ended December 31, 2006, we had production costs of $273,167 representing 125,020 units manufactured, compared to $723,746 of production costs for the period ended December 31, 2005 which represented 149,688 units manufactured.
Gross profit totaled $99,038 for the fiscal year ended December 31, 2006 as compared to gross profit of $564.763 for the fiscal year ended December 31, 2005, a decrease of $450,579 or 62%. Gross loss as a percentage of sales for the fiscal year ended December 31, 2006 was 12% as compared to gross profit as a percentage of sales of 40% for the fiscal year ended December 31, 2005. The decrease in our gross profit percentage is a result of the company of the company earning $284,729 in deferred revenue converted to sales as the project agreements expired. We often have agreements where the distributor will prepay royalties in advance of purchasing the project from Conspiracy. In time if the products are never ordered, SVG may select to waive the requirement to purchase additional units with Conspiracy keeping the balance. In addition, manufacturing costs for production were reduced by both Nintendo and Sony during the year 2005. There were no such exceptional adjustments made in 2006. In addition the company cancelled both the Johnny Rocketfingers (PSP) and SEGA Classics (PSP) projects which decreased the gross profit to sales ratios in 2006.
Total operating expenses in each of the fiscal years ended December 31, 2006 and December 31, 2005 were comprised of selling, general and administrative expenses. Operating expenses for the fiscal years ended December 31, 2006 and 2005 were $1,135,667 and $1,277,172 respectively, which constituted a decrease of $141,503, or 11%. The decrease in operating expenses is attributable to efforts to reduce Selling, General and Administrative Fees.
Other income is income not related to the buying or selling of games and or licenses or income obtained for services not generally part of the company's normal operation. For the period ending December 31, 2006 we incurred Other Income of $41,762 compared to Other Income of $476,847 for the period ending December 31, 2005 a decrease in Other Income of $435,084 or 91%. In 2006 we only earned $41,762 for our sale of our European Office, while in 2005, we received Other Income of $476,857 in Forgiveness of Debt from the consulting team responsible for the establishment of the European Office, when the decision was made to close the office, the team waived its consulting fees as agreed, and 4,472,083 as a net financing income, a result of a derivative calculation on our convertible notes payable.
In 2006 we incurred $176,722 in Finance Costs as compared to -$1,670,000 incurred during the period ending December 31, 2005. The costs are related to our financing agreements with our investors and also consist of Derivative Income and Discount Amortization (Expense). We incurred no loss on investment in 2006 or 2005. We also did not incur any Exchange for the period ending December 31, 2006 as compared to $44,890 for the period ending December 31, 2005. We did however incur $266,236 in interest expense for the year ending December 31, 2006 which was $72,20 or 21% lower than for the period ending December 31, 2005 amount of $338,443 which was a result of interest incurred on our existing Convertible Notes.
Our net loss was $1,437,824 in the fiscal year ended December 31, 2006 compared to a net profit of $1,051,105 in the fiscal year ended December 31, 2005 a combined result in lower gross profits but less general and administrative expenses and the substantially lower Finance Income of $2,164,709 which was non related to our operations.
SEASONALITY AND OTHER TRENDS
The interactive entertainment software industry is a seasonal and cyclical industry. The majority of sales are generated in the fourth quarter of each year due to the winter holiday, followed by the first quarter of each year which consists of sales to those who received new video game platforms over the winter holiday. If we miss this key selling period, due to product delays or delayed introduction of a new platform for which we have developed products, our sales will suffer disproportionately. Second and third quarter sales generally drop off considerably unless new products are introduced. Introducing new products during this period however do not do as well as products introduced in either the fourth or first quarters.
The interactive entertainment software industry is also cyclical. Videogame platforms have historically had a life cycle of four to six years. As one group of platforms is reaching the end of its cycle and new platforms are emerging, consumers often defer game software purchases until the new platforms are available, causing sales to decline. This decline may not be offset by increased sales of products for the new platform.
RESEARCH AND DEVELOPMENT
We did not spend any money on research and development during the fiscal years ended December 31, 2006 and 2005.
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of December 31,
2006:
Payments due by period
Less than More
Contractual Obligations Total One Year Years 1-2 than 2 years
Notes Payable $ 2,393,228 $ 2,393,228
Operating Lease Obligations $ 137,160 $ 53,736 $ 83,424
License Fee Obligations $ 60,000 $ 60,000
Total $ 2,590,388 $ 2,506,964 $ 83,424
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 $182,372 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 $53,736
2008 $55,344
2009 $28,080
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.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2006, our cash balance was $24,976, as compared to $4,489 at December 31, 2005. Total current assets at December 31, 2006 were $509,477, as compared to $194,265 at December 31, 2005. 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 2007 will be sufficient to cover our working capital requirements for fiscal 2007.
For the year ended December 31, 2006 net cash used in operating activities was $80,287, compared to net cash used in operating activities of -$1,270,540 for the period ended December 31, 2005. The change in net cash used in operating activities of $1,350,827 was primarily the result of our Net Loss for the fiscal year ended December 31, 2006 of $1,437,824. Although we used more cash in our minority interest or joint venture with Bravado for our mobile fan clubs of $187,500, amortized capitalized license and development of $431,287, Accounts Payable and Accrued Expenses by $ 1,374,436, and Deferred Compensation of $638,043 we realized less change in derivative liability of $3,101,000 as compared to $3,566,000 which negates much of the other increases.
For the year ended December 31, 2006 net cash used in investing activities totaled-$370,627, compared to net cash used in investing activities of $802,6675 for the year ended December 31, 2005. The decrease of $1,173,302 is due to decrease of $ 1,182,091 in cash paid for acquisition of products and licenses in the fiscal year ended December 31, 2006.
For the period ended December 31, 2005 net cash provided by financing activities totaled $315,316, compared to net cash provided by financing activities of $698,582 for the period ended December 31, 2005. The decrease of net cash provided by financing activities of $383,266, or 55%, was primarily the result of us obtaining $403,000 less of proceeds from the sale of convertible notes or $247,000 compared to $650,000 for the period ending December 31, 2005.
Our accounts receivable at December 31, 2006 was $305,002, as compared to $189,776 at December 31, 2005. The change in accounts receivable is due to our license revenue sold to Midas Interactive in Europe along with some late 4th quarter reorders from SVG Distribution as well as UMD movies for PSP sold to Geneon.
As of December 31, 2006 we had a working capital deficiency of $4,128,608. A major portion of our debt is attributed to consulting fees, attorney fees, deferred compensation, notes payable, convertible notes payable and payroll taxes payable. Despite increasing Accounts Receivable in the fiscal year ended December 31, 2006, we also increased our debt by receiving Advances from our customers, accruing additional interest for our recent fundings, and increased the convertible notes payable adjustments. We plan to continue to reduce these debts with proceeds generated from normal operational cash flow as well as the issuance of company stock.
The current portion of long-term debt at December 31, 2006 consisted of $0 as opposed to $0 at December 31 2005. We paid off the entire long term debt balance by year-end 2005 and had no new additional long term agreements in 2006.
As of December 31, 2006, we owed payroll taxes to the IRS in the amount of $245,088 as compared to $175,356 as of December 31, 2005. The increase due to payroll taxes due as of December 31, 2006 to be paid during 2007.
At December 31, 2006 and December 31, 2005 we had no bank debt.
FINANCING NEEDS
We expect our capital requirements to increase over the next several years as we continue to develop new products, increase marketing and administration infrastructure, and embark on in-house business capabilities and facilities. Our future liquidity and capital funding requirements will depend on numerous factors, including, but not limited to, the cost and hiring and training production personnel who will produce our titles, the cost of hiring and training additional sales and marketing personnel to promote our products, and the cost of hiring and training administrative staff to support current management. We anticipate that we may require additional financing to expand our operations over the next twelve months. We cannot guarantee that we will be able to obtain any additional financing or that such additional financing, if available, will be on terms and conditions acceptable to us. The inability to obtain additional financing should it be required will restrict our ability to grow and may reduce our ability to continue to conduct business operations. If we are unable to obtain additional financing, we will likely be required to curtail our marketing and development plans.
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.
Each Class A Warrant is currently exercisable at a price of $0.20 per share until expiration on August 31, 2009. Each Class B Warrant is currently exercisable at a price of $0.05 per share until expiration 18 months after the date on which the resale of the shares of common stock issuable upon exercise of the Class B Warrants are registered under the Securities Act of 1933 (subject to extension under certain circumstances).
In February 2005, we closed a Securities Purchase Agreement for 5% Secured Convertible Debentures, Class A Common Stock Purchase Warrants to purchase 13,000,000 shares of our common stock, and Class B Common Stock Purchase Warrants to purchase 13,000,000 shares of our common stock, to three institutional investors. We received gross proceeds of $650,000 from the sale of the Debentures and the Warrants.
In August 2005, we amended the terms of all existing convertible notes to convert at the lesser of $0.05 or 70% of the average five lowest closing bid prices of our Common Stock for the 30 trading days prior to the conversion date. At the same time we received $223,600 in loans from two institutional investors which require payment in 2006 as well as a percentage of profits from our Ultimate Block Party-PSP title.
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.
We currently have outstanding 35,000,000 Class A Warrants and 35,000,000 Class B Warrants with exercise prices of the lower of $0.02 per share or 70% of the average five lowest closing bid prices of our Common Stock for the 30 trading days prior to the conversion date. 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.
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.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT MANAGEMENT ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, allowance for doubtful accounts, long-lived assets, and deferred taxes. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.
REVENUE RECOGNITION
We recognize revenue in accordance with current generally accepted accounting principles. Revenue recognition requirements require us to make significant judgments and estimates which may be difficult and complex. We make determinations regarding revenue that is recognized in the current period and the revenue that will be deferred. This is performed through judgment and estimates with regard to the software and related services to be provided to our customers. Our assumptions and judgments regarding revenue recognition could differ from actual events.
Funds received in advance of software completion are recorded as a liability and deferred until the products are completed and delivered.
We utilize the completed contract method of revenue recognition as opposed to the percentage-of-completion method of revenue recognition for substantially all of our products since the majority of our products are completed within six to eight months. We complete the products in a short period of time since we obtain video game software code that may be partially complete and/or we obtain foreign language video game software code that is published by foreign manufacturers that are completed and we develop and market them in the United States.
License revenue is generated when we sell an acquired license to another publisher to develop and sell. Revenues are recorded when the royalty payments are received from that publisher subsequent to sale of the product.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customer's expected ability to pay and our collection history with each customer. We review 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, we maintain a general reserve for certain invoices by applying a percentage based on the age category. We also monitor our accounts receivable for concentration to any one customer, industry or geographic region. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. As of December 31, 2006, the allowance for doubtful accounts holds a zero balance as none of our accounts receivable are deemed uncollectible.
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 . . .
Apr 16, 2007
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