Form 10QSB for GAMEZNFLIX INC
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13-Aug-2004
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, its 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.
The Registrant, through its website www.gameznflix.com is an on- line console video game and DVD movie rental business dedicated to providing customers a quality rental experience. The company offers customers a reliable, web-based, high-quality alternative to traditional store based gaming rentals on a national scale. The Registrant's service is an alternative to store based gaming rentals that offer a high level of customer service, quality titles, and superior product availability.
In March 2004, the Registrant launched its website, http://www.gameznflix.com, and began operating in the online DVD and video game rental industry. In conjunction with the website launch, the company also launched a national television ad campaign designed to create awareness among the company's target consumers and to generate traffic to the website. In June 2004, the Registrant launched the second phase of the television ad campaign, and launched its redesigned website on its new IBM server. This second phase is more narrowly designed to attract the core consumer to the products of the Registrant and smooth out the initial operations of the company.
The Registrant believes that its planned growth and profitability will depend in large part on the ability to promote its services, gain clients and expand its relationship with current clients. Accordingly, the Registrant intends to focus its attentions and investment of resources in marketing, strategic partnerships, and development of its client base. If the Registrant is not successful in promoting its services and expanding its client base, this may have a material adverse effect on its financial condition and the ability to continue to operate the business.
Results of Operations.
(a) Revenues.
The Registrant reported approximately $27,000 and $58,000 of gross income for the three and six months ended June 30, 2004, compared to $37,000 and $79,000 for the three and six months ended June 30, 2003. This represents an approximate 27% decrease for the three and six months ended June 30, 2004 compared to the prior periods. The decreased revenue was due to the change in business focus from consulting services to DVD and video game rentals. Overall, the Registrant reported approximately $(17,000) and $9,000 gross profit (loss) for the three and six months ended June 30, 2004 compared to $37,000 and $79,000 of gross profit in the prior periods. For the three and six months ended June 30, 2004, the Registrant primarily spent its efforts on redesigning its website and developing its marketing campaign which in effect resulted in an overall decrease in gross income as compared to the prior periods.
(b) Advertising.
The Registrant reported approximately $1,571,000 and $1,675,000 in advertising expenses for the three and six months ended June 30, 2004 compared $-0- in the prior periods. Advertising expenses increased as result of the marketing campaign through television advertising and is anticipated to continue at similar levels in next six to twelve months.
(c) Selling, General and Administrative Expenses.
Selling, general and administrative expenses for the three and six months ended June 30, 2004 approximated $215,000 and $488,000, compared to $280 and $6,300 for the prior periods. The increase compared to the prior periods was primarily due to salaries. The Registrant believes selling, general and administrative expenses will continue at such levels due to anticipated growth in the next six to twelve months.
(d) Consulting Fees Expenses.
For the three and six months ended June 30, 2004, consulting fees approximated $1,061,000 and $2,381,000 compared to $33,000 and $68,000 for the three and six months ended June 30, 2003. This increase in these expenses is due primarily to hiring of business consultants to develop the Registrant's business model for the launching of the DVD movie and video game on-line rental service. The Registrant believes that such expenses will continue for the next six months since as of June 30, 2004, prepaid consulting expenses approximated $2,699,000 that will be significantly expensed within the next six months.
(e) Professional Fees Expense.
The Registrant incurred professional fees expenses of $81,000 and $159,000 for the three and six months ended June 30, 2004, compared with $1,500 in the same period ended for both the three and six months ended June 30, 2003. This increase is primarily due to the retaining of attorneys and accountants for purpose of beginning operations of the DVD and video game rental online service.
(f) Net Loss.
The Registrant reported a net operating loss of $2,968,000 and $4,722,000 for the three and six months ended June 30, 2004, compared to a net operating profit of $9,500 and $294,000 for the three and six months ended June 30, 2003, which was due to the foregoing factors described above. The Registrant believes that such losses will continue for at least the next six to twelve months as it continues the marketing campaign and brand recognition of "GameZnFlix" to the general public and targeted consumers.
Factors That May Affect Operating Results.
The operating results of the Registrant can vary significantly depending upon a number of factors, many of which are outside its control. General factors that may affect the Registrant's 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 the Registrant's 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 the Registrant or by its 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.
The Registrant believes that its planned growth and profitability will depend in large part on the ability to promote its services, gain clients and expand its relationship with current clients. Accordingly, the Registrant intends to invest in marketing, strategic partnerships, and development of its customer base. If the Registrant is not successful in promoting its services and expanding its customer base, this may have a material adverse effect on its financial condition and its ability to continue to operate its business.
The Registrant is also subject to the following specific factors that may affect its operating results:
(a) Competition.
The market for on-line rental of DVD's and games is competitive and the Registrant expects competition to continue to increase. In addition, the companies with whom the Registrant has relationships could develop services that compete with the Registrant's services. Also, some competitors in the Registrant's market have longer operating histories, significantly greater financial, technical, marketing and other resources, and greater brand recognition than the Registrant does. The Registrant also expects to face additional competition as other established and emerging companies enter the market for on-line rentals. To be competitive, the Registrant believes that it must, among other things, invest resources in developing new services, improving its current services, and maintaining customer satisfaction. Such investment will increase the Registrant's expenses and affect its profitability. In addition, if it fails to make this investment, the Registrant may not be able to compete successfully with its competitors, which could have a material adverse effect on its revenue and future profitability.
(b) Technological and Market Changes.
The markets in which the Registrant competes are characterized by new service introductions, evolving industry standards, and changing needs of customers. There can be no assurance that the Registrant's existing services will continue to be properly positioned in the market or that it will be able to introduce new or enhanced products into the market on a timely basis, or at all. Currently, the Registrant is focusing on upgrading and introducing new services. There can be no assurance that enhancements to existing products or new products will receive customer acceptance.
There is a risk to the Registrant that there may be delays in initial implementation of new services. Further risks inherent in new service introductions include the uncertainty of price-performance relative to services of competitors, competitors' responses to its new service introductions, and the desire by customers to evaluate new services for longer periods of time.
(c) Key Personnel.
The Registrant's success is largely dependent on the personal efforts and abilities of its senior management. The loss of certain members of the Registrant's senior management, including the company's chief executive officer, chief financial officer and chief technical officer, could have a material adverse effect on the company's business and prospects.
The Registrant intends to recruit in fiscal year 2004 employees who are skilled in its industry. The failure to recruit these key personnel could have a material adverse effect on the Registrant's business. As a result, the Registrant may experience increased compensation costs that may not be offset through either improved productivity or higher revenue. There can be no assurances that the Registrant will be successful in retaining existing personnel or in attracting and recruiting experienced qualified personnel.
Operating Activities.
The net cash used by operating activities for the six months ended June 30, 2004 was $2,293,000, as compared to $17,000 for the six months ended June 30, 2003. A significant portion of cash used was attributed to marketing and professional expenses related to developing, launching and marketing the on-line rental of DVD's and games.
Liquidity and Capital Resources.
As of June 30, 2004, the Registrant had total current assets of approximately $790,000 and total current liabilities of $1,438,000, resulting in a working capital deficit of $648,000.
The Registrant commenced a private placement on November 29, 2003 and sold approximately 12,722,000 shares of common stock from that date to June 8, 2004 to 116 investors (93 of which are accredited) for a total consideration of approximately $642,000. In addition, from February 18, 2004 to June 23, 2004, options covering approximately 26,795,000 shares of common stock were exercised (average of $0.064 per share) into free trading stock under the Registrant's Stock Incentive Plan, resulting in proceeds to the company of approximately $1,713,000.
The Registrant's continued operations, as well as the implementation of its business plan, will depend upon its ability to raise additional funds through bank borrowings and equity or debt financing. The Registrant estimates that it will need to raise up to $10,000,000 over the next twelve months for such purposes. However, adequate funds may not be available when needed or may not be available on terms favorable to the Registrant. The ability of the Registrant to continue as a going concern is dependent on additional sources of capital and the success of the Registrant's business plan. The Registrant's independent accountants audit reports included in the Form 10-KSB for the fiscal year ended December 31, 2003 includes a substantial doubt paragraph regarding the Registrant's ability to continue as a going concern.
If funding is insufficient at any time in the future, the Registrant may not be able to take advantage of business opportunities or respond to competitive pressures, or may be required to reduce the scope of its planned product development and marketing efforts, any of which could have a negative impact on its business and operating results. In addition, insufficient funding may have a material adverse effect on the company's financial condition, which could require the company to:
- curtail operations significantly;
- sell significant assets;
- seek arrangements with strategic partners or other parties that may require the company to relinquish significant rights to products, technologies or markets; or
- explore other strategic alternatives including a merger or sale of the company.
To the extent that the Registrant raises additional capital through the sale of equity or convertible debt securities, the issuance of such securities will result in dilution to existing stockholders. If additional funds are raised through the issuance of debt securities, these securities may have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on the Registrant's operations. Regardless of whether the Registrant's cash assets prove to be inadequate to meet the company's operational needs, the Registrant may seek to compensate providers of services by issuance of stock in lieu of cash, which will also result in dilution to existing shareholders.
Inflation.
The impact of inflation on the costs of the Registrant, and the ability to pass on cost increases to its customers over time is dependent upon market conditions. The Registrant is not aware of any inflationary pressures that have had any significant impact on the Registrant's operations over the past quarter, and the company does not anticipate that inflationary factors will have a significant impact on future operations.
Other.
The Registrant does not provide post-retirement or post- employment benefits requiring charges under Statements of Financial Accounting Standards No. 106 and No. 112.
Critical Accounting Policies.
The Securities and Exchange Commission ("SEC") has issued Financial Reporting Release No. 60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC has defined the most critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Registrant's most critical accounting policies include: (a) use of estimates in the preparation of financial statements; (b) valuation of stock-based compensation; (c) revenue recognition; and (d) impairment of long-lived assets. The methods, estimates and judgments the Registrant uses in applying these most critical accounting policies have a significant impact on the results the Registrant reports in its financial statements.
(a) Use of Estimates in the Preparation of Financial Statements.
The preparation of these financial statements requires the Registrant to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Registrant evaluates these estimates, including those related to revenue recognition and concentration of credit risk. The Registrant bases its estimates on historical experience and on various other 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 apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
(b) Valuation of Stock-Based Compensation Arrangements.
The Registrant intends to issue shares of common stock to various individuals and entities for management, legal, consulting and marketing services. These issuances will be valued at the fair market value of the services provided and the number of shares issued is determined, based upon the open market closing price of common stock as of the date of each respective transaction. These transactions will be reflected as a component of selling, general and administrative expenses in the Registrant's statement of operations.
(c) Revenue Recognition.
Revenue from proprietary software sales that does not require further commitment from the Registrant is recognized upon shipment. Consulting revenue is recognized when the services are rendered. License revenue is recognized ratably over the term of the license. Video game subscription revenues are recognized when billed. Customers are required to authorize a monthly automatic charge to a major credit card. Because of this, the billing and receipt of revenue occur simultaneously. Subscribers pay on a monthly basis and may cancel service at anytime. The cost of services, consisting of staff payroll, outside services, equipment rental, communication costs and supplies, is expensed as incurred.
(d) Impairment of Long-Lived Assets.
The Registrant reviews its long-lived assets and intangibles periodically to determine potential impairment by comparing the carrying value of the long-lived assets with the estimated future cash flows expected to result from the use of the assets, including cash flows from disposition. Should the sum of the expected future cash flows be less than the carrying value, the Registrant would recognize an impairment loss. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the long-lived assets and intangibles.
Forward Looking Statements.
The foregoing management's discussion and analysis of financial condition and results of operations contains "forward looking statements" within the meaning of Rule 175 of the Securities Act of 1933, as amended, and Rule 3b-6 of the Securities Act of 1934, as amended. The words "believe," "expect," "anticipate," "intends," "forecast," "project," and similar expressions identify forward- looking statements. These are statements that relate to future periods and include, but are not limited to, statements as to the Registrant's estimates as to the adequacy of its capital resources, its need and ability to obtain additional financing, the features and benefits of its services, its growth strategy, the need for additional sales and support staff, its operating losses and negative cash flow, its critical accounting policies, and factors contributing to its future growth. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those discussed above, as well as risks related to the Registrant's ability to develop and introduce new services. These forward-looking statements speak only as of the date hereof. The Registrant expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
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