(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes
x
No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See
the definitions of “large accelerated filer,” an “accelerated filer,” a
“non-accelerated filer,” or a “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Common
stock, $0.0001 par value, 250,000,000 shares authorized, 55,854,726
and
51,659,488 shares issued and outstanding at June 30, 2008 and
December 31, 2007, respectively
5,586
5,166
Common
stock to be issued
1,062,473
2,249,997
Additional
paid-in-capital
59,977,936
49,404,897
Accumulated
other comprehensive income (expense)
31,215
(86,793
)
Accumulated
deficit
(55,767,633
)
(31,377,397
)
Total
shareholders’ equity
5,309,577
20,195,870
Total
liabilities and shareholders’ equity
$
15,025,349
$
26,220,317
See
Notes
to Condensed Consolidated Financial Statements
Adjustments
to reconcile net loss to net cash used in operating
activities
Stock
and warrant based compensation
2,918,977
3,379,801
Stock
issued for services
17,831
-
Impairment
and other charges
10,292,139
-
Depreciation
and amortization
3,526,660
419,580
Loss
in equity interest in Entlian Corp.
193,109
-
Provision
for uncollectible accounts
71,758
13,000
Abandonment
of equipment
-
212,300
Amortization
of deferred financing costs
29,544
-
Change
in operating assets and liabilities:
(Increase)
in accounts receivable
(503,751
)
(1,386,875
)
(Increase)
decrease in prepaid expense and other assets
(412,897
)
(33,358
)
Increase
(decrease) in accounts payable, accrued expenses and other
liabilities
689,240
2,322,816
Increase
in deferred revenue
(21,754
)
-
Net
cash used in operating activities
(7,589,380
)
(7,018,884
)
Cash
flows from investing activities
Purchase
of fixed assets
(128,211
)
(1,083,163
)
Net
cash used in investing activities
(128,211
)
(1,083,163
)
Cash
flows from financing activities
Proceeds
from issuance of note payable - Showtime, net of issuance
costs
2,985,000
-
Issuance
of common stock and warrants for cash - Showtime
-
5,000,000
Proceeds
from exercise of options and warrants - Showtime
4,000,000
Cash
pledged as collateral for credit card facility
(128,317
)
(240,000
)
Payments
related to acquisitions
(224,164
)
-
Net
cash provided by financing activities
6,632,519
4,760,000
Effect
of exchange rates
118,008
-
Net
decrease in cash and cash equivalents
(967,064
)
(3,342,047
)
Cash
and cash equivalents at beginning of period
4,427,303
7,295,825
Cash
and cash equivalents at end of period
$
3,460,239
$
3,953,778
Supplemental
disclosures of non-cash investing and financing activities:
In
connection with the warrant issued to Showtime on January 5, 2007, the Company
recorded the $608,000 value of the warrant as prepaid distribution
costs.
6
At
March31, 2007, the Company reduced its registration rights liability related to
the
shares issued in a October 2006 private placement by $100,000, with a
corresponding increase to paid-in capital.
In
January 2008, the Company recorded 35,714 issuable shares of restricted common
stock for an acquisition of website-related assets. These shares were valued
at
$44,643, and this amount was recorded in goodwill.
On
February 21, 2008, the Company issued 4,000,000 warrants to purchase common
stock at $2.00 per share to Showtime in connection with a television
distribution agreement with CBS Entertainment. At the grant date, 2,000,000
of
these warrants were vested, and the $2.3 million value of the vested warrants
was recorded as prepaid distribution costs.
On
March15, 2008, the Company’s placement agent exercised 2,750,000 warrants with a
strike price of $2.00 per share on a cashless basis and received 2,016,667
shares of common stock.
On
June18, 2008, the Company issued to Showtime for proceeds of $3.0 million a note
payable with a face value of $3.5 million and a warrant to purchase 100,000
shares of common stock at $0.01 per share. The $0.5 million discount from the
face value of the note payable and the $149,040 value of the warrants issued
will be accreted into the note liability balance over the term of the
note.
During
the six months ended June 30, 2008, the Company accrued a liability of $325,000
for contingent consideration related to the KOTC acquisition.
During
the six months ended June 30, 2008, the Company issued 178,571 shares of
common
stock, previously recorded as common stock issuable, related to the KOTC
acquisition.
In
June
2008, the Company recorded in deferred financing costs $45,000 of accrued
legal
fees.
See
Notes
to Condensed Consolidated Financial Statements
Note
1 Basis of Presentation and Summary of Significant
Accounting Policies
Financial
Statement Presentation
The
accompanying unaudited condensed consolidated financial statements of ProElite,
Inc., a New Jersey company and its subsidiaries (“ProElite” or the “Company”),
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission for Form 10-Q. Accordingly, certain
information and footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting principles, have
been
condensed or omitted pursuant to such rules and regulations.
In
the
opinion of management, these financial statements reflect all adjustments,
consisting of normal recurring accruals, which are considered necessary for
a
fair presentation. These financial statements should be read in conjunction
with
the audited consolidated financial statements included in our annual report
on
Form 10-KSB for the year ended December 31, 2007. Operating results for interim
periods are not necessarily indicative of operating results for an entire fiscal
year or any other future periods.
Principles
of Consolidation
The
Company’s consolidated financial statements include the assets, liabilities and
operating results of ProElite and its wholly-owned subsidiaries since formation
or acquisition of these entities. All significant intercompany accounts and
transactions have been eliminated in consolidation. The equity method of
accounting is used for its investment in Entlian Corp. in which ProElite has
significant influence; this represents common stock ownership of at least 20%
and not more than 50% (see Note 4).
Revenue
Recognition
In
general, the Company recognizes revenue in accordance with Securities and
Exchange Commission Staff Accounting Bulletin ("SAB") No. 101, Revenue
Recognition in Financial Statements modified by Emerging Issues Task Force
("EITF") No. 00-21 and SAB No. 104 which requires that four basic criteria
must
be met before revenue can be recognized: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or services rendered; (3) the
fee
is fixed and determinable; and (4) collectibility is reasonably assured.
The
Company earns revenue primarily from live event ticket sales, site fees,
sponsorship, television license fees and pay per view fees. The Company also
earns incidental revenue from merchandise and video sales and from online
advertising, subscriptions and online store sales. Ticket sales are managed
by
third parties, ticket agencies and live event venues. Revenue from ticket sales
is recognized at the time of the event when the venue provides estimated or
final attendance reporting to the Company. Revenue from merchandise and video
sales is recognized at the point of sale at live event concession stands.
Revenue from sponsorship and television distribution agreements is recognized
in
accordance with the contract terms, which are generally at the time events
occur. Website revenue is recognized as advertisements are shown, as
subscription terms are fulfilled, and as products are shipped.
Cost
of Revenue
Costs
related to live events are recognized when the event occurs. Event costs
incurred prior to an event are capitalized to prepaid costs and then charged
to
expense at the time of the event. Costs primarily include: fighter purses,
travel, arena costs, television production and amortization of capitalized
value
of warrants issued to Showtime. Cost of other revenue streams are recognized
at
the time the related revenues are realized.
8
Significant
Estimates for Events
The
Company is required to estimate significant components of live event revenues
and costs because actual amounts may not become available until one or more
months after an event date. Pay-per-view revenue is estimated based upon
projected sales of pay-per-view presentations. These projections are based
upon
information provided from distribution partners. The amount of final
pay-per-view sales is determined after intermediary pay-per-view distributors
have completed their billing cycles. The television production costs of live
events are based upon the television distribution agreements with Showtime
and
CBS, event-specific production and marketing budgets and historical experience.
Should actual results differ from estimated amounts, a charge or benefit to
the
statement of operations would be recorded in a future period.
Advertising
Expenses
Advertising
is expensed as incurred. Total advertising expense was $764,827 and $464,825
during the six months ended June 30, 2008 and 2007, respectively.
Accounts
Receivable
Accounts
receivable relate principally to amounts due from television networks for
license fees and pay-per-view presentations and from live event venues for
ticket sales. Amounts due for pay-per-view programming are based primarily
upon
estimated sales of pay-per-view presentations and are adjusted to actual after
intermediary pay-per-view distributors have completed their billing cycles.
If
actual sales differ significantly from the estimated sales, the Company records
an adjustment to sales. Accounts receivable from foreign television distribution
is generally based upon contracted fees per event or showing. Accounts
receivable from venues for ticket sales to live events are generally received
within 30 days of an event date.
An
allowance for uncollectible receivables is estimated each period. This estimate
is based upon historical collection experience, the length of time receivables
are outstanding and the financial condition of individual
customers.
Fixed
Assets
Fixed
assets primarily consist of computer, office, and video production equipment;
furniture and fixtures; leasehold improvements; computer software; Internet
domain names purchased from others; and website development costs. Fixed assets
are stated at historical cost less accumulated depreciation and amortization.
Depreciation and amortization are computed on a straight-line basis over the
estimated useful lives of the assets or, when applicable, the life of the lease,
whichever is shorter. Equipment is depreciated over estimated useful lives
ranging from three to five years. Furniture, fixtures and leasehold improvements
are depreciated over estimated useful lives ranging from five to seven years.
Computer software is amortized over estimated useful lives ranging from one
to
five years. Internet domain names are amortized over ten years. Website
development costs are amortized over three years.
Goodwill
and Intangible Assets
Statement
of Financial Accounting Standards No. 142, “Goodwill and Other Intangible
Assets” (“SFAS No. 142”), requires purchased intangible assets other than
goodwill to be amortized over their useful lives unless these lives are
determined to be indefinite. During 2007, the Company acquired amortizable
intangible assets consisting of non-compete agreements, fighter contracts,
merchandising rights and distribution agreements and indefinite-lived intangible
assets consisting of brands and trademarks. The Company amortizes the cost
of
acquired intangible assets over their estimated useful lives, which range from
one to five years.
SFAS
No.
142 requires goodwill and other indefinite-lived intangible assets to be tested
for impairment at least on an annual basis and more often under certain
circumstances, and written down by a charge to operations when impaired. An
interim impairment test is required if an event occurs or conditions change
that
would more likely than not reduce the fair value of the reporting unit below
the
carrying value. At June 30, 2008, the Company modified its operating plan for
its Cage Rage subsidiary, due to its recent operating performance, and as a
result recorded a charge of approximately $5.2 million to reduce the carrying
value of goodwill and acquired intangible assets to their estimated fair values.
Additionally, as of June 30, 2008, management assessed the financial performance
of and market conditions affecting its ICON and King of the Cage acquisitions.
Management evaluated recent adverse economic trends in the Hawaii market and
as
a result recorded an impairment of approximately $1.8 million to reduce goodwill
and acquired intangible assets from the ICON acquisition to estimated realizable
value. Management also evaluated industry trends, including increasing fighter
purses and higher than anticipated promotion expenses in the Company’s King of
the Cage subsidiary. Based upon this analysis, the Company recorded an
impairment charge of approximately $2.4 million to reduce goodwill related
to
the King of the Cage to estimated fair value.
9
Maintaining
the goodwill and indefinite-lived intangible assets is predicated upon the
Company executing the revised operating plan for Cage Rage and improving
profitability of the other acquisitions. If the Company does not execute
successfully against these plans, it may record non-cash charges to operations
in future periods to reduce the amount of goodwill and indefinite-lived
intangible assets.
Prepaid
Distribution Costs
Prepaid
distribution costs represent the value of warrants issued to Showtime Networks,
Inc. (“Showtime”) in November 2006, January 2007 and February 2008 in connection
with television and pay-per-view distribution agreements with Showtime and
CBS
Corp. (“CBS”). Showtime and CBS are related parties. The value of the warrants
issued in 2006 and 2007 is being amortized to cost of revenue over the
three-year term of the distribution agreement with Showtime.
As
of
June 30, 2008, management determined the warrants issued in 2008 in connection
with the CBS distribution agreement had no future value as the likelihood of
realizing gross profit on the CBS events was remote. Therefore, the entire
$2.3
million value of these warrants was charged to cost of revenue during the three
months ended June 30, 2008.
Prepaid
Services
Prepaid
services included in other assets represent the value of shares issued to MMA
Live Entertainment, Inc. for fighter services. The value of the shares is being
amortized to expense over the three-year term of the related
agreement.
Valuation
of Long-Lived Assets
The
carrying amounts of long-lived assets are periodically evaluated for impairment
when events and circumstances warrant such a review.
Fair
Value of Financial Instruments
The
Company measures its financial assets and liabilities in accordance with the
requirements of Statement of Financial Accounting Standards (“SFAS”) No. 107,
“Disclosures about Fair Value of Financial Instruments.” The carrying values of
cash equivalents, accounts receivable, accounts payable, and payments due for
acquired companies approximate fair value due to the short-term maturities
of
these instruments.
Foreign
Currency
The
functional currencies of the Company’s international subsidiary and investee are
the local currency. The financial statements of the foreign subsidiary are
translated into United States dollars using period-end rates of exchange for
assets and liabilities and average rates of exchange for the period for revenues
and expenses. Foreign currency transaction gains and losses were insignificant
during the period. Foreign currency translation adjustments are shown as other
comprehensive income (expense) in the accompanying consolidated balance
sheet.
10
Loss
per Share
The
Company utilizes Statement of Financial Accounting Standards No. 128, “Earnings
per Share.” Basic earnings (loss) per share are computed by dividing earnings
(loss) available to common shareholders by the weighted-average number of common
shares outstanding. Diluted earnings (loss) per share is computed similar to
basic earnings (loss) per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the potential common shares had been issued and if the additional common
shares were dilutive. Potential common shares include stock that would be issued
on exercise of outstanding options and warrants reduced by the number of shares
which could be purchased from the related exercise proceeds.
Recent
Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes
a framework for measuring fair value in generally accepted accounting
principles, and expands disclosures about fair value measurements. It applies
under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, this statement does not require any new fair value measurements.
This statement is effective for all financial instruments issued for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal
years. The Company adopted SFAS No. 157 as of January 1, 2008 and it had no
effect on the Company’s financial position, operations or cash
flows.
In
December 2007, the FASB issued SFAS 141(R), “Business Combinations”, replacing
SFAS 141, “Business Combinations”. This statement retains the fundamental
requirements in SFAS 141 that the acquisition method of accounting (which SFAS
141 termed the purchase method) be used for all business combinations and for
an
acquirer to be identified for each business combination. This Statement also
establishes principles and requirements for how the acquirer: a) recognizes
and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; b)
recognizes and measures the goodwill acquired in the business combination or
a
gain from a bargain purchase; and c) determines what information to disclose
to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination. This Statement clarifies that acquirers
are
required to expense costs related to any acquisitions. SFAS 141R will apply
prospectively to business combinations for which the acquisition date is on
or
after fiscal years beginning December 15, 2008. Early adoption is prohibited.
Determination of the ultimate effect of this statement will depend on the
Company’s acquisitions, if any, subsequent to December 31, 2008.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51”. SFAS 160
establishes new accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary.
Specifically, this statement requires the recognition of a noncontrolling
interest (minority interest) as equity in the consolidated financial statements
and separate from the parent’s equity. The amount of net income attributable to
the noncontrolling interest will be included in consolidated net income on
the
face of the income statement. SFAS 160 clarifies that changes in a parent’s
ownership interest in a subsidiary that do not result in deconsolidation are
equity transactions if the parent retains its controlling financial interest.
In
addition, this statement requires that a parent recognize a gain or loss in
net
income when a subsidiary is deconsolidated. Such gain or loss will be measured
using the fair value of the noncontrolling equity investment on the
deconsolidation date. SFAS 160 also includes expanded disclosure requirements
regarding the interests of the parent and its noncontrolling interest. SFAS
160
is effective for fiscal years beginning on or after December 15, 2008, with
retrospective presentation and disclosure for all periods presented. Early
adoption is prohibited. The Company does not expect it will be affected
by the adoption of SFAS 160.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year
presentation.
11
Note
2 Going Concern
The
Company has incurred losses from operations and negative cash flows from
operations since its inception. These factors raise substantial doubt about
the
Company’s ability to continue as a going concern. The Company’s business plan
calls for expanding the scale of live events, including pay per view, and
Internet operations. As a result, the need for cash has correspondingly
increased. Although the Company had approximately $3.5 million of cash at June30, 2008, the Company continues to expend more cash than it brings in through
operations.
The
Company is actively negotiating to consummate a financing of approximately
$3.5
million in secured debt (with a funded amount of $3.0 million after an original
issue discount of $0.5 million) and believes a successful closing is reasonably
likely, but there is no assurance that it will be successful in doing so at
all
or on a timely basis. Any such failure to obtain financing in the immediate
future would have a material adverse effect on the Company’s liquidity and
capital resources and ability to continue as a going concern.
Even
if
the Company successfully closes on the debt financing referred to above, it
expects that its capital resources would be sufficient only until the end of
the
year, and only if the Company makes significant reductions in or cessation
of
operations and expenditures before the end of the year, including dramatically
reducing costs by reducing administrative expenses and some lines of business.
Such actions would limit our potential for growth and could materially adversely
affect the Company’s business and prospects.
To
address its liquidity needs beyond the immediate period, the Company is actively
seeking additional financing beyond the $3.0 million referred to above to enable
the Company to execute its operating plans without significant reductions in
operations, but there is no assurance as to whether any such financing will
be
available on reasonable terms or at all.
The
auditor's opinion contained in our Annual Report on Form 10-KSB for the year
ended December 31, 2007 states substantial doubt exists about our ability to
continue as a going concern. The financial statements in this Quarterly Report
on Form 10-Q do not contain any adjustments that may be required should we
be
unable to continue as a going concern.
Note
3 Net Loss Per Share
Net
loss
per share was calculated by dividing the net loss by the weighted average number
of shares outstanding during the period. The following table summarizes the
shares of stock included in calculating earnings per share for the three months
ended March 31, 2008 and 2007:
On
September 11, 2007, the Company acquired the outstanding capital stock of King
of the Cage, Inc. (“KOTC”), a promoter of MMA events primarily in the United
States. The acquisition was made in order to increase the Company’s event
activity. The total purchase price, not including contingent consideration,
was
$5.0 million consisting of: $3,250,000 cash paid at closing, $500,000 cash
paid
in November 2007, 178,571 restricted shares of common stock valued at
$1,249,997, or $7 per share that were issued in April 2008, plus nominal direct,
capitalizable transaction costs. Under the stock purchase agreement, the
calculation of the number of common shares to be issued is based upon the quoted
market price of the Company’s common stock subject to a maximum per share price
of $7.00 and a minimum price of $2.00. Additionally, the Company entered into
a
five year employment contract with one of the selling shareholders. (See Note
9.)
The
stock
purchase agreement also calls for contingent consideration to be paid annually
if certain operating results are achieved by KOTC over five years. Contingent
consideration performance thresholds and payment amounts are as follows:
Performance
Thresholds
Annual
Contingent
Consideration
Payable
Years
Ending September 11,
Number
of
Live
Events
Produced
per
Year
Annual
EBITDA
(as
defined in
Stock
Purchase
Agreement)
Cash
Common
Stock
2008
to 2012
15
n/a
$
500,000
$
-
2008
to 2012
22
n/a
$
75,000
$
75,000
2008
to 2012
22
Increasing
from
$700,000
to
$1,500,000
$
175,000
$
175,000
The
maximum additional contingent consideration is $3.75 million in cash and $1.25
million in common stock. At June 30, 2008, the Company had accrued a liability
of $325,000 for estimated contingent consideration payable, which is due in
September 2008.
As
security for the contingent consideration, the Company granted the former KOTC
shareholders a first priority security interest in the shares of
KOTC.
The
purchase price was allocated approximately $0.1 million to tangible assets,
$1.1
million to amortizable intangible assets, $1.7 million to non-amortizable
intangible assets, $0.1 million to liabilities and $2.4 million to
goodwill.
In
the
quarter ended June 30, 2008, the Company recorded a goodwill impairment charge
of approximately $2.4 million to reduce the carrying value of goodwill from
the
KOTC acquisition to their estimated fair value. Management determined the
impairment charge was needed as a result of industry trends, particularly
increasing fighter purses, that caused KOTC’s financial performance to be less
than projected when KOTC was acquired in September 2007. The maintenance of
the
remaining goodwill and acquired intangible assets is predicated upon improving
the profitability of KOTC. If future financial results are less than
anticipated, the Company may record additional impairment charges.
13
For
the
three and six months ended June 30, 2008, respectively, KOTC recognized
revenue of approximately $527,000 and $1,027,000 and after expenses, including
amortization of approximately $105,000 and $209,000 related to acquired
intangible assets and a goodwill impairment charge of approximately $2.4 million
in the quarter ended June 30, 2008 as discussed above, a net loss of
approximately $2.5 million and $2.6 million.
Cage
Rage
On
September 12, 2007, the Company acquired the outstanding capital stock of two
entities that promote MMA events: Mixed Martial Arts Promotions Limited, a
British domiciled company (“MMAP”), and Mixed Martial Arts Productions Limited,
a British domiciled company (“MMAD”) (collectively “Cage Rage”). The acquisition
gives the Company an event promotion business in the United Kingdom. The total
purchase price was $8.6 million consisting of: $4,000,000 cash paid at closing,
500,000 shares of restricted common stock issued in October 2007, $1,000,000
cash to be paid in September 2008 plus $100,398 of direct transaction costs.
The
Company valued the common stock to be issued at $3.5 million, or $7.00 per
share.
The
purchase price was allocated approximately $0.9 million to accounts receivable,
$0.1 million to tangible assets, $1.7 million to amortizable intangible assets,
$3.8 million to non-amortizable intangible assets, $0.5 million to accounts
payable and $2.6 million to goodwill.
In
the
quarter ended June 30, 2008, the Company recorded an impairment charge of
approximately $5.2 million to reduce the carrying value of goodwill and acquired
intangible assets from the Cage Rage acquisition to their estimated fair value.
During July 2008, the Company’s management revised the operating plan for Cage
Rage in an attempt to achieve profitable live events and reduce operating losses
sooner than originally planned in September 2007, when Cage Rage was acquired.
Key aspects of the revised operating plan are to use smaller venues for live
event production and secure a long-term television licensing agreement. If
management is unable to successfully execute the revised operating plan, the
Company may record further impairment charges. Also with respect to assets
acquired, the Company recorded a charge of approximately $0.9 million during
the
quarter ended June 30, 2008 because the likelihood of future recoverability
of
these assets was uncertain.
For
the
three and six months ended June 30, 2008, respectively, Cage Rage
recognized revenue of approximately $505,000 and $971,000 and after expenses
-
including amortization of approximately $216,000 and $432,000 related to
acquired intangible assets and the asset impairment and other charges of
approximately $6.1 million in the quarter ended June 30, 2008 discussed above
-
a net loss of approximately $7.0 million and $7.8 million.
Future
Fight Productions, Inc.
On
December 7, 2007, the Company acquired substantially all the assets of Future
Fight Productions, Inc., (“ICON”) a promoter of MMA events primarily in Hawaii.
The acquisition gives the Company additional promotion talent and access to
fighters and venues. The assets acquired consisted primarily of a brand name.
Additionally the owner of ICON signed a consulting contract with the Company
to
continue promoting ICON and other Company-run events. The total purchase price
was $2.35 million consisting of: $350,000 cash paid at closing and 200,000
shares of restricted common stock, 100,000 of which were issued at closing
and
the remaining 100,000 are issuable over 3 years. Additionally, the Company
will
issue, in three equal installments, 50,000 shares of restricted common stock
in
connection with the consulting agreement with the seller. The shares were valued
at $10 per share. The purchase price was allocated approximately $0.4 million
to
amortizable intangible assets, $0.6 million to non-amortizable assets and $1.3
million to goodwill. The value of the shares to be issued for the consulting
agreement, $500,000, will be recorded into expense ratably over the service
period.
In
the
quarter ended June 30, 2008, the Company recorded an impairment charge of
approximately $1.8 million to reduce the carrying value of goodwill and acquired
intangible assets from the ICON acquisition to their estimated fair value.
A
recessionary economic environment in Hawaii has adversely impacted the Company’s
ability to sell tickets in that market during the first six months of 2008.
Therefore, the Company revised its operating plan for ICON and recorded an
impairment charge to reduce goodwill and acquired intangible assets to their
estimated fair value.
14
For
the
three and six months ended June 30, 2008, under the ICON brand name the
Company recognized revenue of approximately $205,000 for both periods and after
expenses, including amortization of approximately $20,500 and $41,000 related
to
acquired intangible assets and an impairment charge of $1.8 million in the
quarter ended June 30, 2008 as discussed above, a net loss of approximately
$1.8
million and $1.9 million.
Detail
of Acquisitions
The
following table details the fair value of assets and liabilities acquired at
the
date of acquisition:
KOTC
Cage Rage
ICON
Total
Current
assets, exclusive of cash
$
-
$
904,000
$
-
$
904,000
Fixed
assets
30,000
61,000
-
91,000
Intangible
assets with indefinite lives
1,700,000
3,800,000
628,000
6,128,000
Other
intangible assets
1,110,000
1,723,000
410,000
3,243,000
Goodwill
2,356,000
2,571,000
1,312,000
6,239,000
Current
liabilities
(34,000
)
(459,000
)
-
(493,000
)
Consideration
$
5,162,000
$
8,600,000
$
2,350,000
$
16,112,000
The
Company allocated purchase prices to amortizable intangible assets of $1.9
million to noncompete agreements (with a weighted average amortization period
of
3.9 years), fighter contracts of $1.2 million (with a weighted average
amortization period of 2 years), and $0.1 million to distribution contracts
(with a weighted average amortization period of 2.4 years). The Company recorded
amortization expense of approximately $341,000 and $681,000 related to these
intangible assets during the three and six months ended June 30, 2008.
Additionally,
as discussed above, the Company recorded asset impairment and other charges
totaling approximately $10.3 million during the quarter and six months ended
June 30, 2008.
Purchase
Price Allocations
The
purchase price allocations for the acquisitions were based upon discounted
expected cash flow models. Valuation methods including relief from royalty,
excess earnings/contributory asset charges, lost profits, and with and without
competition, were applied to the discounted expected cash flow models to
determine the value of the intangible assets acquired. The purchase prices
of
the acquisitions were then allocated based upon the values of intangible assets
calculated and the carrying values of assets and liabilities acquired.
Additionally,
the maintenance of goodwill and indefinite-lived intangible assets on the
Company’s balance sheet requires management to achieve improvements in and
expansion of the acquired entities’ operations. Should operations not improve to
desired levels, the Company may be required to record an additional charge
to operations for impairment of these assets.
SpiritMC
On
September 18, 2007, the Company made an investment in Entlian Corporation
(“SpiritMC”), a South Korean company promoting MMA events in South Korea. The
investment gives the Company access to event promotion in South Korea and to
fighters and venues under contract with SpiritMC. The cost of the investment
was
$2 million consisting of $1 million cash and $1 million in restricted common
shares (100,000 common shares valued at $10.00 per share). The $10.00 per share
valuation resulted from the Company’s guarantee of a minimum per share value of
$10.00 to Entlian. If the Company’s quoted market price is below $10 per share
on the date the lock up period expires in March 2009, the Company is required
to
issue up to 100,000 additional common shares.
15
The
Company acquired approximately 54% of SpiritMC’s common stock. This ownership
percentage will dilute down to approximately 32% when SpiritMC’s existing debt
facility with a third party mandatorily converts to common stock at any time
but
no later than January 2010. The Company has one third of the seats on SpiritMC’s
Board of Directors, and therefore will not exercise control over SpiritMC.
The
Company has also determined that it is not the primary beneficiary. As such,
the
Company accounts for the investment in SpiritMC using the equity method. The
Company recorded a charge of approximately $78,000 and $193,000, representing
the Company’s share of SpiritMC’s loss for the three and six months ended June30, 2008.
Note
5 Other Current Assets
Other
current assets included a balance due of approximately $940,000 from a business
owned by a former shareholder of Cage Rage. This amount was due primarily for
event sponsorship prior to the Company’s acquisition of Cage Rage. During
the quarter ended June 30, 2008, the Company wrote off this asset into
impairment and other charges due to the uncertainty of future
recoverability.
Original
issue discount and warrant value, unaccreted portion
(621,996
)
-
Accrued
interest
69,213
-
Total
$
4,769,303
$
1,822,086
16
The
$1.8
million note payable dated December 17, 2007 to Showtime was issued to extend
payment of the net amount due to Showtime for television production costs
incurred in 2007. In June 2008, Showtime and the Company extended the note
due
date from December 17, 2008 to March 31, 2009, and the note was given a first
priority security interest in the unpledged assets of the Company. The note
bears interest at the daily prime rate as published by JPMorganChase bank with
interest payable at maturity.
On
June18, 2008, the Company entered into a Senior Secured Note Purchase Agreement
and
related documents with Showtime. Under the agreements, Showtime funded a note
payable by the Company and the Company issued warrants to Showtime. The note
has
a face value of $3,500,000, of which the Company received $3,000,000 after
an
original issue discount of $500,000, and a first priority security interest
in
the unpledged assets of the Company. The note accrues interest at 10% per annum
payable at maturity. The note matures on June 17, 2009. The note agreement
includes a covenant that the Company maintain a minimum unrestricted cash
balance of $550,000. The face value of the note together with accrued, unpaid
interest may be prepaid without penalty prior to maturity. The $0.5 million
discount from the face value of the note payable will be accreted into the
note
liability balance over 12 months, the term of the note.
In
connection with the financing, the Company issued a warrant to purchase 100,000
shares of common stock. The warrant has an exercise price of $0.01 per share,
a
term of 36 months and an estimated fair value of $149,040. The warrant value
is
being amortized to interest expense over 12 months, the term of the note.
The
Senior Secured Note Purchase Agreement allows the Company to raise additional
indebtedness up to $3,500,000 (“Additional Indebtedness”) with collateral pari
pasu with the Showtime notes, provided that Showtime has approval rights over
any new holder of Additional Indebtedness, the right to purchase any Additional
Indebtedness from new holders of debt, and sole power to exercise remedies
upon
a default of any Additional Indebtedness.
Other
Accrued Liabilities
In
connection with the reverse merger of the Company and the predecessor
registrant, the Company assumed accounts payable of approximately $210,000
and
notes payable of approximately $137,000, which existed at the time the
predecessor registrant ceased operations. These liability balances remained
unchanged from the date of the reverse merger.
Note
8 Income Taxes
As
a
result of the Company’s losses, no income taxes were due for the six and three
months ended June 30, 2008 and 2007. The provision for income taxes was offset
by an increase in the deferred tax asset valuation allowance.
As
of
January 1, 2007, the Company implemented FASB Interpretation No. 48,
Accounting
for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109 (“FIN
48”),
which
clarifies the accounting for uncertainty in tax positions. This Interpretation
provides that the tax effects from an uncertain tax position can be recognized
in the financial statements, only if the position is more likely than not of
being sustained on audit, based on the technical merits of the position. The
adoption on FIN 48 did not have an effect on the Company’s consolidated
financial statements. The total amount of unrecognized tax benefits that if
recognized would affect the Company’s effective tax rate is zero based on the
fact that the Company currently has a full reserve against its unrecognized
tax
benefits.
Current
income taxes (benefits) are based upon the year’s income taxable for federal,
state and foreign tax reporting purposes. Deferred income taxes (benefits)
are
provided for certain income and expenses, which are recognized in different
periods for tax and financial reporting purposes. Deferred tax assets and
liabilities are computed for differences between the financial statements and
tax bases of assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted tax laws and rates applicable to the
period in which the differences are expected to affect taxable income. The
Company had a full valuation allowance against deferred tax assets at June30,2008.
17
At
June30, 2008, the Company had net operating loss carryforwards of approximately
$24.4 million for federal tax purposes, expiring through 2028. In addition,
the
Company had net operating loss carryforwards of approximately $24.4 million
for
state tax purposes, which expire through 2018. However, a change in ownership
could result in an “ownership change” under Internal Revenue Code Section 382
which restricts the ability of a corporation to utilize existing net operating
losses. The Company also had net operating loss carryforwards of approximately
$4.1 million for UK tax purposes that had been accumulated since acquisition
of
Cage Rage.
The
Company is subject to Federal and state tax in the United States and tax in
the
United Kingdom. The tax years 2006 and 2007 of the parent company remain open
to
examination by the major taxing jurisdictions to which the Company is subject.
The acquired subsidiaries may have earlier years subject to examination. The
Company is not currently under examination by any tax authorities.
Note
9 Commitments
The
Company’s lease agreement for its corporate office space specifies monthly
payments starting at $25,176 and increasing to $36,472, and the lease expires
on
July 31, 2012. The Company also leases additional office space requiring monthly
payments of approximately $2,600 through 2017. Future minimum annual payments
remaining under these leases are as follows:
Year
ending December 31,
Amount
2008
$
226,000
2009
429,000
2010
445,000
2011
462,000
2012
286,000
Thereafter
142,000
$
1,990,000
The
Company incurred rent expense of approximately $222,000 and $92,000,
respectively, for the six months ended June 30, 2008 and 2007,
respectively.
The
Company has contracts with vendors, including a live events venue. The minimum
annual payments under these contracts are approximately $716,000 and $54,000
in
the years ending December 31, 2008 and 2009, respectively.
The
Company entered into contracts with executives, key employees and consultants.
These contracts call for following minimum annual payments:
Year
ending December 31,
Amount
2008
$
2,357,000
2009
2,135,000
2010
740,000
2011
438,000
2012
229,000
$
5,899,000
18
Additionally,
some employment contracts include performance bonuses related to the operations
of recently acquired businesses. In regards to the KOTC subsidiary, the Company
pays a bonus equal to 20% of the subsidiary’s earnings before interest, taxes,
depreciation and, amortization (“EBITDA”) in excess of specified amounts,
escalating from $850,000 to $1.6 million for each of the twelve-month periods
ending September 30, 2008 through 2012. In regards to the ICON asset purchase,
the Company pays a bonus of $100,000 if the subsidiary’s EBITDA exceeds $196,000
for the twelve-month period ending November 30, 2008. No bonuses have been
accrued for the three and six months ended June 30, 2008.
Note
10 Litigation and Potential Claims
On
December 14, 2006, the Company received a demand letter (the “Demand Letter”)
from counsel for Wallid Ismail Promocoes E Eventos LTDA EPP and Wallid Ismail
(collectively “Wallid”). The Demand Letter alleges that the Company entered into
a “fully enforceable agreement” to compensate Wallid for allegedly assisting the
Company in raising financing, and that the Company or its directors committed
unspecified fraudulent acts, misappropriated Wallid’s “confidential and
proprietary information,” and engaged in an “intentional and well-orchestrated
scheme to wrongfully remove Wallid” as a principal of the Company. Wallid did
not specify the amount of damages he claims to have sustained as a result of
these acts.
The
Company denies Wallid’s allegations, and denies that it has, or has breached,
any obligations to Wallid. On January 2, 2007, the Company filed a lawsuit
against Wallid in the Superior Court for the State of California, County of
Los
Angeles, LASC Case No. BC 364204 (the “California Lawsuit”). In the California
Lawsuit, the Company seeks a judicial declaration that the allegations in the
Demand Letter are false. In addition, the California Lawsuit alleges that Wallid
has misappropriated the Company’s business plan and other confidential and
proprietary information, that Wallid has been unjustly enriched at the Company’s
expense, that Wallid is engaging in unfair competition with the Company , and
that Wallid’s actions violate California Business and Professions Code sections
17200, et
seq.
Wallid
answered the complaint on March 22, 2007, and then transferred the case to
federal court. The case will be litigated in federal court, discovery is
underway and the case is set for trial on September 16, 2008. However, it is
anticipated that the court will vacate this trial date to accommodate pending
defense motions for summary adjudication of issues.
On
January 10, 2007, Wallid filed suit against the Company, among others, in
federal court in New Jersey (the “New Jersey Lawsuit”). He amended his complaint
on February 1, 2007. On April 18, 2007, the Company filed a motion to dismiss
or
stay the New Jersey Lawsuit because the California Lawsuit was filed first,
or
in the alternative to transfer the case to the federal court in California
where
the California Lawsuit is pending. On June 26, 2007, the court granted the
Company’s motion and ordered the New Jersey Lawsuit transferred to the federal
court in California.
On
November 5, 2007, the federal court in the California lawsuit approved a
stipulation by Wallid and the Company granting Wallid leave to file a
Counterclaim and Third Party Complaint in the California Lawsuit, and providing
for dismissal of the New Jersey Lawsuit without prejudice upon completion of
the
transfer of that action to California. The Counterclaim and Third Party
Complaint asserts substantially the same claims Wallid asserted in the New
Jersey Lawsuit. Wallid seeks: a 23.25% to 26.67% equity interest in the Company;
damages for his losses in an amount to be determined at trial, but no less
than
$75,000; punitive damages of no less than $10,000,000; an imposition of a
receiver to oversee the assets of the Company; an accounting on all income
earned by the Company; and attorneys’ fees and costs of suit. The Company denies
Wallid’s allegations and intends to assert a vigorous defense.
West
Coast Productions, Inc. (“West Coast”) filed a civil action against Frank
“Shamrock” Juarez (“Shamrock”) on January 23, 2007, and sought and obtained a
temporary restraining order which prohibited Shamrock from fighting in the
Company’s February 10, 2007 event. The Company subsequently entered into a
settlement agreement on February 5, 2007, pursuant to which West Coast dismissed
its civil action and agreed to permit Shamrock to fight in the February 10,2007
event. The Company agreed to pay an aggregate of $250,000 to West Coast, out
of
future compensation due to Shamrock from the Company under the personal services
agreement. The Company also entered into a co-promotion agreement with West
Coast, pursuant to which it agreed to co-promote up to three live MMA events
that feature Shamrock. To date the Company has paid West Coast $100,000 of
the
$250,000 owed. The remaining portion totaling $150,000 will be paid to West
Coast from future co-produced events. A liability of $150,000 has been
accrued.
19
On
March22, 2007, Zuffa, LLC filed a complaint against Showtime, the Company and Cage
Rage in which it alleges that the defendants infringed Zuffa’s copyrights by
airing footage from certain Ultimate Fighting Championship events and alleges
that the defendants utilized portions of Zuffa’s copyrights in the televised
broadcast of the February 10, 2007 MMA event that was held at the Desoto Civic
Center in Southaven, Mississippi. Zuffa has alleged causes of action for
copyright infringement and unfair competition, and seeks injunctive relief,
compensatory damages or statutory damages, and litigation expenses. Zuffa has
not specified the amount of monetary damages it seeks. ProElite filed a motion
to dismiss the case. The court dismissed ProElite for lack of personal
jurisdiction, and deferred judgment concerning Showtime until further discovery
is conducted. The parties met for mediation on February 11, 2008 and agreed
to
the terms of a settlement agreement, which did not have an adverse financial
impact on the Company. The settlement was entered into the US District Court,
District of Nevada on February 11, 2008. The parties agreed to dismiss the
actions with prejudice upon closing a long-form settlement agreement, which
is
pending.
Note
11 Shareholders’ Equity
CBS
and Showtime
In
connection with a television distribution agreement, the Company and Showtime,
an affiliate of CBS, entered into a Subscription Agreement dated as of February22, 2008 pursuant to which the Company agreed to issue two warrants to Showtime
(the "New Warrants") each for the purchase of 2,000,000 shares of the Company's
Common Stock at an exercise price of $2.00 per share. The first New Warrant
vests immediately and is for a term of five years from February 22, 2008. The
second New Warrant vests in four equal tranches of 500,000 shares with each
respective tranche to vest if an Event is broadcast pursuant to the Broadcast
Agreement. The term of each tranche is five years from the date that such
tranche vests. Pursuant to an Investor Rights Agreement between the Company
and
Showtime dated as of February 22, 2008, the Company granted to Showtime certain
registration rights with respect to the shares issuable upon exercise of the
New
Warrants, and Showtime agreed that such shares and the New Warrants are subject
to certain transfers restrictions until March 5, 2009. The value of the first
New Warrant computed using a Black-Scholes model was approximately $2.3
million. As
of
June 30, 2008, management determined the warrants issued in 2008 in connection
with the CBS distribution agreement had no future value as the likelihood of
realizing gross profit on the CBS events was remote. Therefore, the entire
$2.3
million value of these warrants was charged to cost of revenue during the three
months ended June 30, 2008. The
value of the second New Warrant computed using a Black-Scholes model was
approximately $2.5 million and will be charged to operations on the dates of
the
first four broadcasts under the television distribution agreement.
Additionally,
Showtime exercised part of the warrants previously issued to Showtime in January
2007. The exercise was for an aggregate of 2,000,000 shares of the Company's
Common Stock (the "Warrant Shares") resulting in proceeds to the Company of
$4,000,000.
On
June18, 2008 in connection with the $3.5 million face value note payable, the
Company issued to Showtime a three-year warrant to purchase 100,000 shares
of
common stock at $0.01 per share. The value of this warrant calculated using
a
Black-Scholes model was $149,040 and will be charged to interest expense over
the term of the note using the effective interest method.
Stock-Based
Compensation
The
Company adopted its 2006 Stock Option Plan and amended the plan in 2007,
reserving a total of 8,000,000 shares. The plan provides for the issuance of
statutory and non-statutory stock options to employees, directors and
consultants, with an exercise price equal to the fair market value of the
Company’s common stock on the date of grant. Options granted under the plan
generally vest quarterly over four years and have a life of 10 years. As of
June30, 2008, options to purchase 5,281,797 shares of common stock had been granted
under the plan.
20
The
Company accounts for stock-based compensation arrangements with its employees,
consultants and directors in accordance with SFAS No. 123 (revised),
“Share-Based Payment” (SFAS No. 123R). Under the fair value recognition
provisions of SFAS No. 123R, the Company measures stock-based compensation
cost
at the grant date based on the fair value of the award and recognizes
compensation expense over the requisite service period, which is generally
the
vesting period. For the quarters ended June 30, 2008 and 2007, the Company
incurred approximately $0.7 million and $0.2 million, respectively, of expense
related to stock based compensation under this plan and approximately $1.1
million and $2.8 million, respectively, of expense related to warrants. For
the
six months ended June 30, 2008 and 2007, the Company incurred approximately
$1.2
million and $0.6 million, respectively, of expense related to stock based
compensation under this plan and approximately $1.7 million and $2.9 million
respectively, of expense related to warrants.
Stock
Options
The
Company uses a Black-Scholes option pricing model to estimate the fair value
of
stock-based awards with the weighted average assumptions noted in the following
table.
Six
Months
Ended
June 31,
2008
Six
Months
Ended
June 31,
2007
Black-Scholes
Model:
Risk-free
interest rate
1.84%
- 3.41
%
4.50
- 4.84
%
Expected
life, in years
5.8
- 6.0
5.8
- 6.5
Expected
volatility
96.0
%
60.0
%
Dividend
yield
0.0
%
0.0
%
Expected
volatility is based on the historical volatility of the share price of companies
operating in similar industries. The volatility of industry peers is considered
more representative of expected volatility because there is currently minimal
daily trading volume in the Company’s stock. The expected term is based on
management’s estimate of when the option will be exercised which is generally
consistent with the vesting period. The risk-free interest rate for periods
within the contractual life of the option is based on the U.S. Treasury yield
curve in effect at the time of grant.
The
following table represents stock option activity for the six months ended June30, 2008:
At
June30, 2008 the aggregate intrinsic value of options outstanding and the aggregate
intrinsic value of options exercisable was approximately zero and zero,
respectively. The weighted-average grant-date fair value of options granted
during the six months ended June 30, 2008 and 2007 was $1.53 and $0.64,
respectively. The weighted-average remaining life of outstanding and exercisable
options at June 30, 2008 and 2007 was 6.0 years and 4.4 years,
respectively.
At
June30, 2008 there was approximately $4.8 million of unrecognized compensation
cost
related to non-vested options, which is being expensed through 2012.
During
the quarter ended March 31, 2008, the Company granted 1,260,000 options to
employees in individual grants ranging from 10,000 to 1,000,000 options. The
options have exercise prices ranging from $2.00 to $7.01, vest over two or
four
years and have terms of 10 years. The aggregate fair value of these options
at
the dates of grant was approximately $1.8 million and is being amortized on
a
straight-line basis over the respective vesting periods.
During
the quarter ended June 30, 2008, the Company granted 295,000 options to
employees and a director in individual grants ranging from 20,000 to 100,000
options. The options have exercise prices of $2.00, vest over three to four
years and have terms of 10 years. The aggregate fair value of these options
at
the dates of grant was approximately $0.6 million and is being amortized on
a
straight-line basis over the respective vesting periods.
Warrants
The
Company uses a Black-Scholes option pricing model to estimate the fair value
of
warrants with the assumptions noted in the following table.
At
June30, 2008 the aggregate intrinsic value of warrants outstanding and the aggregate
intrinsic value of warrants exercisable was approximately $0.7 million and
$0.8
million, respectively. The weighted-average remaining life of outstanding and
exercisable warrants at June 30, 2008 and 2007 was 4.6 years and 4.4 years,
respectively.
At
June30, 2008 there was approximately $25.6 million of unrecognized cost related
to
non-vested warrants (including approximately $23.4 million of unrecognized
cost
related to Burnett warrant tranches three through nine, which is discussed
below), which is being expensed through 2012.
During
the quarter ended March 31, 2008, the Company issued 4,000,000 warrants with
exercise prices of $2.00 to Showtime, as discussed above. Also during the
quarter ended March 31, 2008, the Company’s placement agent for prior financings
exercised on a cashless basis 2.75 million warrants at $2.00 per share for
2,016,667 shares of common stock.
During
the quarter ended June 30, 2008, the Company issued 100,000 warrants with
exercise prices of $0.01 per share to Showtime, as discussed above and also
issued 100,000 warrants with an exercise price of $8.00 per share.
Burnett
Warrants
Effective
June 15, 2007 (and as amended on June 28, 2007 and June 1, 2008), the Company
entered into an agreement (the "Series Agreement") with JMBP, Inc. ("MBP"),
wholly-owned by Mark Burnett ("Burnett") in connection with a possible
television series involving mixed martial arts ("Series") for initial exhibition
during prime time on one of specified networks or cable broadcasters. MBP (or
a
separate production services entity owned or controlled by MBP) will render
production services in connection with the Series and will be solely responsible
for and have final approval regarding all production matters, including budget,
schedule and production location. It is anticipated that, as a condition to
involvement in the Series, each of the Series contestants will sign a separate
agreement with the Company or an affiliate of the Company for services rendered
outside of the Series. MBP will own all rights to the Series. The Company and
MBP will jointly exploit the Internet rights in connection with the Series
on
ProElite.com and other websites controlled by ProElite.com. The Company will
be
entitled to a share of MBP's Modified Adjusted Gross Proceeds, as defined.
Subject to specified exceptions, MBP and Burnett have agreed to exclusivity
with
respect to mixed martial arts programming. The term of the Agreement, as amended
effective June 1, 2008, extends until the earlier of the end of the term of
the
license agreement with the broadcaster of the Series (the “License Agreement”)
or the failure of MBP to enter into a License Agreement by November 17, 2008.
Pursuant
to the Series Agreement, the Company and Burnett entered into a Subscription
Agreement (the “Subscription Agreement”) relating to the issuance to Burnett of
warrants to purchase up to 17,000,000 shares of the Company's common stock.
As
amended effective June 1, 2008, the warrants are divided into nine tranches
as
follows:
The
date that the pilot or first episode of a Series is broadcast on
a Network
or Cable Broadcaster.
Four
1,000,000
The
date that the second episode of a Series is broadcast on a network
or
cable broadcaster.
Five
2,000,000
The
date that the pilot or first episode of an additional Series is broadcast
on a specified network or cable broadcaster.
Six
1,000,000
The
last day of the first completed season of any Series.
Seven
2,000,000
The
last day of any additional completed season of any series (or the
last day
of the first completed season of any additional
series).
Eight
4,000,000
1,333,333
shares to be vested on the last day of each additional completed
season of
any series.
Nine
2,000,000
1,000,000
shraes to be vested on the date of broadcast of each of the first
two
derivative pay-per-view events.
23
The
vesting date of each tranche is subject to acceleration under certain
circumstances. However, the warrants are not exercisable if a License Agreement
is not entered into by June 15, 2008, except for 1,000,000 warrants from tranche
one. Additionally, the warrants and any shares purchased through exercise of
the
warrants are subject to forfeiture, except for 1,000,000 warrants from tranche
one, if a License Agreement is not entered into by November 17,2008.
The
warrants have an exercise price of $3.00 per share. The exercise price is
reduced if the Company issues or sells shares of its common stock, excluding
shares issued as compensation for services or in connection with acquisitions,
for less than $3.00 per share. The expiration date for a particular tranche
of
warrants is the latest to occur of (i) June 15, 2013; (ii) the date which is
one
year after the vesting date of any such tranche, and (iii) one year after the
expiration of the term of the License Agreement.
The
value
of the warrants under the June 1, 2008 amendment was less than the previously
calculated value. Therefore, the previous warrant values will be used for any
expense to be recognized. The value of the warrants was calculated as
approximately $2.6 million for tranche one and $2.9 million for tranche two
using a Black-Scholes option pricing model with the following assumptions:
expected term of 3 years (for tranche one) and from 3 to 4 years (for separate
500,000 vesting blocks of tranche two), expected volatility of 60%, risk-free
interest rate of 5.07% to 5.09% and dividend yield of 0%. The value of the
tranche one warrants was charged to expense in June 2007. The value of the
tranche two warrants is being amortized to expense over the vesting period
of
each 500,000 warrant vesting block (i.e., from 1 to 4 years).
The
current value of warrants in tranches three through nine was calculated as
approximately: $1.8 million (tranche three), $1.8 million (tranche four), $3.6
million (tranche five), $1.8 million (tranche six), $3.6 million (tranche
seven), $7.3 million (tranche eight), and $3.6 million (tranche nine) or
approximately $23.7 million in aggregate. The values were calculated using
a
Black-Scholes option pricing model with an expected term of 6 years, expected
volatility of 60%, risk-free interest rate of 5.1% and dividend yield of 0%.
The
Company will begin expensing the value of these tranches once there is a
reasonable likelihood of achieving the performance criteria of each tranche
(as
described above) and would be based on the current values at that time. During
the quarter ended June 30, 2008, the Company recognized approximately $0.3
million expense related to tranche three based upon the status of production
of
a series pilot. No expense has been recognized related to tranches four through
nine.
The
Company, Burnett and Santa Monica Capital Partners II LLC, ("SMCP"), one of
the
Company's shareholders, entered into an Investor Rights Agreement providing
certain registration rights with respect to the shares purchasable under the
warrants, co-sale rights with SMCP, restrictions on resale and board observation
rights.
Note
12 Related Party Transactions
The
Company earns revenue from and incurs expenses to Showtime and CBS in connection
with a television production and distribution agreement. The Company recorded
revenue for television license fees of $0.9 million and $0.4 million during
the
three months ended June 30, 2008 and 2007, respectively and $2.1 million and
$0.4 million during the six months ended June 30, 2008 and 2007, respectively.
The Company incurred television production expenses charged by Showtime of
approximately $0.5 million and $1.1 million during the three months ended June30, 2008 and 2007, respectively, and approximately $0.5 million and $2.5 million
during the six months ended June 30, 2008 and 2007, respectively. The Company
also incurred non-cash expenses of $2.9 million and $0.1 million for warrant
vesting and amortization of prepaid distribution costs for the three months
ended June 30, 2008 and 2007, respectively, and $3.0 million and $0.2 million
during the six months ended June 30, 2008 and 2007, respectively.
24
In
October 2006, the Company entered into a three-year term consulting agreement
and pays a monthly fee of $30,000 to Santa Monica Capital Partners II (“SMCP”)
for services relating to strategic planning, investor relations, acquisitions,
corporate governance and financing. The Company paid $90,000 to SMCP for this
monthly fee during the three months ended June 30, 2008 and 2007, respectively,
and $180,000 during the six months ended June 30, 2008 and 2007, respectively.
Additionally, the Company incurred costs for services to provided to SMCP of
approximately $28,000 and $43,000 during the three months ended June 30, 2008
and 2007, respectively, and $55,000 and $52,000 during the six months ended
June30, 2008 and 2007, respectively
On
June18, 2008, the Company issued to Showtime a note payable with $3.5 million
principal and warrants to purchase 100,000 shares of common stock. This
transaction is more fully described in Note 7 above.
25
Item 2.
Management’s Discussion and Analysis of Operations.
Forward
Looking and Cautionary Statements
This
Form 10-Q contains certain forward-looking statements. For example, statements
regarding our financial position, business strategy and other plans and
objectives for future operations, and assumptions and predictions about future
product demand, supply, manufacturing, costs, marketing and pricing factors
are
all forward-looking statements. These statements are generally accompanied
by
words such as “intend,”“anticipate,”“believe,”“estimate,”“potential(ly),”“continue,”“forecast,”“predict,”“plan,”“may,”“will,”“could,”“would,”“should,”“expect” or the negative of such terms or other comparable
terminology. We believe that the assumptions and expectations reflected in
such
forward-looking statements are reasonable, based on information available to
us
on the date hereof, but we cannot assure you that these assumptions and
expectations will prove to have been correct or that we will take any action
that we may presently be planning. However, these forward-looking statements
are
inherently subject to known and unknown risks and uncertainties. Actual results
or experience may differ materially from those expected or anticipated in the
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, regulatory policies, competition
from other similar businesses, and market and general policies, competition
from
other similar businesses, and market and general economic factors. This
discussion should be read in conjunction with the financial statements and
notes
thereto included in our annual report on Form 10-K.
If
one or more of these or other risks or uncertainties materialize, or if our
underlying assumptions prove to be incorrect, actual results may vary materially
from what we project. Any forward-looking statement you read in this report
reflects our current views with respect to future events and is subject to
these
and other risks, uncertainties and assumptions relating to our operations,
results of operations, growth strategy, and liquidity. All subsequent
forward-looking statements attributable to us or individuals acting on our
behalf are expressly qualified in their entirety by this paragraph. You should
specifically consider the factors identified in this report, which would cause
actual results to differ before making an investment decision. We are under
no
duty to update any of these forward-looking statements after the date of this
report or to conform these statements to actual results.
Overview
Mixed
Martial Arts, commonly referred to as MMA, is a sport growing in popularity
around the world. In MMA matches, athletes use a combination of a variety of
fighting styles, including boxing, judo, jiu jitsu, karate, kickboxing, muay
thai, tae kwon do, and wrestling. Typically, MMA sporting events are promoted
either as championship matches or as vehicles for well-known individual
athletes. Professional MMA competition conduct is regulated primarily by rules
implemented by state athletic commissions and is currently permitted in
twenty-one states. Athletes win individual matches by knockout, technical
knockout (referee or doctor stoppage), submission, or judges’ decision.
Since
the
Company’s formation in August 2006, we have established ourselves as a leading,
global promoter of live MMA events and provider of a social-networking website
focused exclusively on MMA. We have agreements to distribute content by
television and DVD throughout the world. To date, we have focused our efforts
primarily on events in the United States and United Kingdom and on our website.
In
2007,
we accomplished the following strategic objectives:
·
Acquired
well-regarded MMA live event brands throughout the
world:
·
King
of the Cage, Inc. (“KOTC”), a promoter of live MMA events, that has
historically produced in excess of 20 events per
year.
·
Mixed
Martial Arts Promotions, Ltd. and Mixed Martial Arts Productions,
Ltd.
(together “Cage Rage”), a United Kingdom-based promoter of live MMA
events.
26
·
The
assets of Future Fight Promotions, Inc. (“ICON”), a Hawaii-based promoter
of live MMA events.
·
Invested
in Entlian Corp., a South Korea-based promoter of live MMA
events.
During
2008, the Company increased the number of live events that it promoted. In
February 2008, the Company signed a television distribution agreement with
CBS,
which led to the first MMA event broadcast on network television on May 31,2008. In
June
2008, the Company amended its Series Agreement with JMBP, Inc. and Mark Burnett,
extending the time to secure an agreement to run a MMA reality television pilot
episode, which has been filmed. The
Company also began a series of reductions costs designed to reduce monthly
expenditures and improve the profitability of live events. There is no guarantee
that the Company will be successful in its efforts to reduce
expenses.
In
2008,
the Company encountered liquidity issues. The Company’s auditors have issued a
going concern opinion in their report for the year ended December 31, 2007
that
states substantial doubt exists about the Company’s ability to continue as a
going concern. In June 2008, the Company secured $3.0 million proceeds from
a
note payable from Showtime. Additionally, the Company is actively negotiating
to
consummate a financing of approximately $3.5 million in secured debt (with
a
funded amount of $3.0 million after an original issue discount of $0.5 million)
and believes a successful closing is reasonably likely, but there is no
assurance that it will be successful in doing so at all or on a timely basis.
Any such failure to obtain financing in the immediate future would have a
material adverse effect on the Company’s liquidity and capital resources and
ability to continue as a going concern.
Even
if
the Company successfully closes on such financing, it expects that its capital
resources are sufficient only until the end of the year, and only if the Company
makes significant reductions in or cessation of operations and
expenditures. The Company is also actively seeking additional financing beyond
the $3.0 million to enable the Company to execute its operating plans without
significant reductions in operations, but there is no assurance as to whether
any such financing will be available on reasonable terms or at all. Liquidity
matters are discussed in more detail below.
Revenue
from live events, consisting primarily of ticket sales, site fees and
sponsorship, was $2,027,351 for the three months ended June 30, 2008
compared to $1,488,558 for the three months ended June 30, 2007. The
increase was due to higher operating activity in the second quarter of 2008
compared to the second quarter of 2007 when the Company commenced operations
and
to newly acquired subsidiaries. The Company’s EliteXC subsidiary earned revenue
of approximately $1.3 million from promoting three events in the second quarter
of 2008 compared to $1.5 million from promoting two events in the second quarter
of 2007. Also, the Company’s KOTC and Cage Rage subsidiaries, which were
acquired in September 2007, earned live event revenues of $0.5 million and
$0.5
million, respectively, during the second quarter of 2008.
Revenue
from pay-per-view programming (PPV) and television licensing was $178,866 for
the three months ended June 30, 2008 compared to $10,858 for the three months
ended June 30, 2007. The increase was primarily due to acquisitions in late
2007.
The
Company began earning television license fees in 2008 under the distribution
agreement with Showtime and under the distribution agreement with CBS signed
in
2008. In 2007, the Company earned no television license fees from Showtime
or
CBS. In the second quarter of 2008, the Company received television license
fees
of $925,000 from Showtime and CBS.
27
Revenue
from our website was $208,990 for the three months ended June 30, 2008 compared
to $16,963 for the three months ended June 30, 2007. This increase was primarily
due to licensing the Company’s social networking technology.
Other
revenues, which includes DVD sales and fees for licensing fighters under
contract, was $346,442 for the three months ended June 30, 2008 compared to
$0
for the three months ended June 30, 2007. The increase was due to the Company
releasing DVD titles of its live events for sale during the quarter ended June30, 2008 and to the acquisition of KOTC, which had DVD distribution agreements
in place at acquisition.
Cost
of revenue
Cost
of
revenue for live event production (excluding expenses payable to Showtime and
CBS) was $2,865,002 for the three months ended June 30, 2008 compared to
$2,495,618 for the three months ended June 30, 2007. Live event production
costs
consist principally of fighters purses, arena rental and related expenses (e.g.,
staffing, staging, and video equipment rental), event-specific marketing
expenses (e.g., Internet, radio and television advertising, posters and street
teams), and travel. Live event production costs increased primarily due to
inclusion of the KOTC and Cage Rage subsidiaries (acquired in September 2007).
Cost of revenue for KOTC and Cage Rage were approximately $0.3 million and
$0.8
million, respectively, for the quarter ended June 30, 2008. Our EliteXC
subsidiary incurred costs of approximately $1.7 million to promote three events
in the second quarter of 2008 compared to approximately $2.2 million to promote
two events in the second quarter of 2007. The decrease in these expenses for
the
EliteXC subsidiary was primarily the result of “Barker shows” (i.e.,
event-specific promotional videos) produced in 2007 (for approximately $0.6
million) but not in 2008 and to a charge of $0.3 million for set equipment
abandoned in 2007. These decreases were partially offset by higher purses,
marketing and travel.
Also
included in non-cash cost of revenue was a non-cash expense of $2.3 million
related to expensing prepaid distribution costs. As of June 30, 2008, management
determined the likelihood of realizing gross profit on the CBS events was
remote. Therefore, the entire $2.3 million prepaid distribution costs were
charged to cost of revenue during the three months ended June 30,2008.
Additionally,
we incurred related-party production costs for television production by Showtime
of $500,000 for the three months ended June 30, 2008 compared to $1,127,060
for
the three months ended June 30, 2007. The decrease was as a result of the terms
of the distribution agreement with Showtime. This agreement called for the
Company to pay production expenses in 2007 but not in 2008 for events
distributed on Showtime. In 2008, the Company used Showtime’s production staff
to produce the event broadcast on CBS in May 2008 and incurred expenses of
approximately $0.5 million. We expect cost of revenue for live events will
increase in 2008 as we promote more events. However, we expect television
production costs payable to Showtime to decrease in 2008 in accordance with
the
terms of the distribution agreement.
Cost
of
revenue for our website was $34,237 for three months ended June 30, 2008
compared to $53,259 for the three months ended June 30, 2007 and consisted
primarily of merchandise sold through our online store and Internet streaming
expenses.
Marketing
expenses
Marketing
expenses primarily consist of marketing, advertising and promotion expenses
not
directly related to MMA events. Marketing, advertising and promotion expenses
related directly to MMA events are charged to cost of revenue. Marketing
expenses were $107,713 for the quarter ended June 30, 2008 compared to $165,544
for the quarter ended June 30, 2007 and primarily consisted of Internet and
print advertising, public relations and marketing consultants. We anticipate
marketing expenses will decrease as we shift marketing efforts towards specific
events (which are recorded in cost of revenue) and away from brand awareness
campaigns.
Website
operations expenses were $666,201 for the three months ended June 30, 2008
compared to $772,008 for the three months ended June 30, 2007. The decrease
was
due primarily to staffing reductions initiated in January 2008.
Live
events operations
Live
events operations expenses were $1,381,590 for the three months ended June30,2008 compared to $395,609 for the three months ended June 30, 2007. Live events
operations expenses consist primarily of wages and consultants’ fees related to
day-to-day administration of the Company’s live events. The increase was
primarily the result of acquiring KOTC and Cage Rage in September 2007. KOTC
and
Cage Rage incurred operating expenses of approximately $0.3 million and $0.6
million, respectively, during the quarter ended June 30, 2008.
In
2008,
we expect expenses related to our fight operations to increase due to higher
average staffing levels than 2007 and inclusion of a full year of
operations of companies acquired in late 2007.
General
and administrative expenses
General
and administrative expenses were $3,247,118 for the three months ended June30,2008 compared to $4,394,153 for the three months ended June 30, 2007. A
significant component of general and administrative expenses was non-cash
expense related to option and warrant grants of approximately $0.9 million
in
the second quarter of 2008 versus approximately $3.1 million in the second
quarter of 2007. The decrease in option and warrant expense was primarily due
to
exercisable warrants issued to JMBP, Inc. in June 2007. The increase in general
and administrative expenses was also due to higher employee head count resulting
in wages of approximately $0.9 million in the second quarter of 2008 versus
$0.4
million in the second quarter of 2007 and consulting fees of $0.4 million in
the
second quarter of 2008 versus $0.3 million in the second quarter of 2007. Also,
legal expenses increased to $0.3 million in the second quarter of 2008 from
$0.1
million in the second quarter of 2007.
In
the
first and second quarters of 2008, the Company reduced staffing and did not
rehire for open positions resulting from employee turnover in an effort to
cut
costs. However, we expect 2008 general and administrative expenses will increase
over 2007 primarily due to higher average staffing levels.
During
the three months ended June 30, 2008, the Company recognized impairment charges
totaling approximately $10.3 million related to goodwill and non-amortizable
intangible assets and other assets resulting from the acquisitions of Cage
Rage,
KOTC and ICON. The impairment charges were recorded to reduce the carrying
value
of goodwill and acquired intangible assets to estimated fair value. The Company
recorded an impairment charge of approximately $5.2 million related to a change
in the operating plan of Cage Rage and a charge of approximately $0.9 million
related to future realization of assets acquired. The Company recorded an
impairment charge of approximately $2.4 million related to unfavorable industry
trends (i.e., increasing fighter purses) affecting KOTC. The Company recorded
an
impairment charge of approximately $1.8 million due to a recessionary economy
affecting ICON’s market.
Revenue
from live events, consisting primarily of ticket sales, site fees and
sponsorship, was $5,084,790 for the six months ended June 30, 2008 compared
to $1,799,661 for the six months ended June 30, 2007. The increase was due
to higher operating activity in 2008 compared to 2007 when the Company commenced
operations and to newly acquired subsidiaries. The Company’s EliteXC subsidiary
earned revenue of approximately $3.7 million from promoting eight events in
2008
compared to $1.9 million from three events in 2007. Also, the Company’s KOTC and
Cage Rage subsidiaries, which were acquired in September 2007, earned live
event
revenues of $0.9 million and $1.0 million, respectively, during
2008.
Revenue
from pay-per-view programming (PPV) and television licensing was $314,141 for
2008 compared to $10,858 for 2007. The increase was primarily due to
acquisitions in late 2007.
29
The
Company began earning television license fees in 2008 under the distribution
agreement with Showtime and under the distribution agreement with CBS signed
in
2008. In 2007, the Company earned no television license fees from Showtime
or
CBS. In 2008, the Company received television license fees of $2,125,000 from
Showtime and CBS.
Revenue
from our website was $235,454 for the six months ended June 30, 2008 compared
to
$20,463 for the six months ended June 30, 2007. This increase was primarily
due
to licensing the Company’s social networking technology.
Other
revenues, which includes DVD sales and fees for licensing fighters under
contract, was $465,912 for the six months ended June 30, 2008 compared to $0
for
the six months ended June 30, 2007. The increase was due to the Company
releasing DVD titles of its live events for sale during the quarter ended June30, 2008 and to the acquisition of KOTC, which had DVD distribution agreements
in place at acquisition.
Cost
of revenue
Cost
of
revenue for live event production (excluding expenses payable to Showtime and
CBS) was $7,013,024 for the six months ended June 30, 2008 compared to
$3,402,308 for the six months ended June 30, 2007. Live event production costs
consist principally of fighters purses, arena rental and related expenses (e.g.,
staffing, staging, and video equipment rental), event-specific marketing
expenses (e.g., Internet, radio and television advertising, posters and street
teams), and travel. Live event production costs increased primarily due to
inclusion of the KOTC and Cage Rage subsidiaries (acquired in September 2007).
Cost of revenue for KOTC and Cage Rage were approximately $0.7 million and
$1.5
million, respectively, for the six months ended June 30, 2008. Our EliteXC
subsidiary incurred costs of approximately $5.0 million to promote eight events
in 2008 compared to approximately $3.4 million to promote three events in 2007.
The increase in EliteXC’s expenses was primarily due to producing more events
resulting in increases in fight purses to $2.4 million in 2008 from $1.2 million
in 2007, arena and related expenses to $1.2 million in 2008 from $0.4 million
in
2007, and event-specific marketing to $0.5 million from $0.3 million in 2007.
These increases were partially offset by reduced production spending of $0.2
million in 2008 versus $1.0 million in 2007 primarily due to no Barker shows
produced in 2008 (i.e., event-specific promotional videos produced in 2007
for
approximately $0.6 million) and a charge of $0.3 million for set equipment
abandoned in 2007.
Also
included in non-cash cost of revenue was a non-cash expense of $2.3 million
related to expensing prepaid distribution costs. As of June 30, 2008, management
determined the likelihood of realizing gross profit on the CBS events was
remote. Therefore, the entire $2.3 million prepaid distribution costs were
charged to cost of revenue during the six months ended June 30,2008.
Additionally,
we incurred related-party production costs for television production by Showtime
of $500,000 for the six months ended June 30, 2008 compared to $2,460,835 for
the six months ended June 30, 2007. The decrease was as a result of the terms
of
the distribution agreement with Showtime. This agreement called for the Company
to pay production expenses in 2007 but not in 2008 for events distributed on
Showtime. In 2008, the Company used Showtime’s production staff to produce the
event broadcast on CBS in May 2008 and incurred expenses of approximately $0.5
million. We expect cost of revenue for live events will increase in 2008 as
we
promote more events. However, we expect television production costs payable
to
Showtime to decrease in 2008 in accordance with the terms of the distribution
agreement.
Cost
of
revenue for our website was $63,138 for six months ended June 30, 2008 compared
to $111,814 for the six months ended June 30, 2007 and consisted primarily
of
merchandise sold through our online store and Internet streaming
expenses.
Marketing
expenses
Marketing
expenses primarily consist of marketing, advertising and promotion expenses
not
directly related to MMA events. Marketing, advertising and promotion expenses
related directly to MMA events are charged to cost of revenue. Marketing
expenses were $206,878 for the six months ended June 30, 2008 compared to
$269,438 for the six months ended June 30, 2007 and primarily consisted of
Internet and print advertising, public relations and marketing consultants.
We
anticipate marketing expenses will decrease as we shift marketing efforts
towards specific events (which are recorded in cost of revenue) and away from
brand awareness campaigns.
Website
operations expenses were $1,390,464 for the six months ended June 30, 2008
compared to $1,187,167 for the six months ended June 30, 2007. The increase
was
due primarily to higher average staffing levels in 2008 than in 2007.
In
the
first and third quarters of 2008, the Company reduced staffing and did not
rehire for open positions resulting from employee turnover in an effort to
cut
costs. Therefore, we expect website operations expenses will decrease in
2008.
Live
events operations
Live
events operations expenses were $2,722,882 for the six months ended June 30,2008 compared to $731,558 for the six months ended June 30, 2007. Live events
operations expenses consist primarily of wages and consultants’ fees related to
day-to-day administration of the Company’s live events. The increase was
primarily the result of acquiring KOTC and Cage Rage in September 2007. KOTC
and
Cage Rage incurred operating expenses of approximately $0.7 million and $1.5
million, respectively, during 2008.
In
2008,
we expect expenses related to our fight operations to increase due to higher
average staffing levels than 2007 and inclusion of a full year of
operations of companies acquired in late 2007.
General
and administrative expenses
General
and administrative expenses were $6,945,746 for the six months ended June 30,2008 compared to $6,223,907 for the six months ended June 30, 2007. A
significant component of general and administrative expenses was non-cash
expense related to option and warrant grants of approximately $2.3 million
in
2008 versus approximately $3.2 million in 2007. The decrease in option and
warrant expense was primarily due to exercisable warrants issued to Burnett
in
June 2007 offset by additional option and warrant grants in 2008. Contributing
to the increase in general and administrative expenses were higher employee
head
count resulting in wages and consulting fees of approximately $1.8 million
in
2008 versus $0.6 million in 2007 and consulting fees of $0.7 million in 2008
versus $0.6 million in 2007. Legal expenses increased to $0.6 million in 2008
from $0.3 million in 2007 related primarily to ongoing litigation. Insurance
expense increased to $0.4 million in 2008 from $0.1 million in 2007 as the
Company expanded its policy coverage, and rent expense increased to $0.2 million
in 2008 from $0.1 million in 2007 due to moving to new office
space.
In
the
first and second quarters of 2008, the Company reduced staffing and did not
rehire for open positions resulting from employee turnover in an effort to
cut
costs. However, we expect 2008 general and administrative expenses will increase
over 2007 primarily due to higher average staffing levels.
During
the quarter ended June 30, 2008, the Company recognized impairment charges
totaling approximately $10.3 million related to goodwill and non-amortizable
intangible assets resulting from the acquisitions of Cage Rage, KOTC and ICON.
The impairment charges were recorded to reduce the carrying value of goodwill
and acquired intangible assets to estimated fair value. The Company recorded
an
impairment charge of approximately $5.2 million related to a change in the
operating plan of Cage Rage and a charge of approximately $0.9 million related
to future realization of assets acquired. The Company recorded an impairment
charge of approximately $2.4 million related to unfavorable industry trends
(i.e., increasing fighter purses) affecting KOTC. The Company recorded an
impairment charge of approximately $1.8 million due to a recessionary economy
affecting ICON’s market.
31
Liquidity
and Capital Resources
Net
cash
used in operating activities was $7.6 million during the six months ended
June 30, 2008 compared to $7.0 million during the six months ended
June 30, 2007. The use of cash was primarily the result of net losses for
the periods. The Company is currently working to achieve event profitability
and
decrease overhead, although there is no assurance it will be successfully able
to do so.
Net
cash
used in investing activities was $0.1 million during the six months ended
June 30, 2008 compared to $1.1 million during the six months ended
June 30, 2007. The decrease was due to less need for capital expenditures
in the current year compared to the prior year when the Company was developing
its social networking website.
Net
cash
provided by financing activities was $6.6 million during the six months ended
June 30, 2008 compared to $4.8 million during the six months ended
June 30, 2007. In the six months ended June 30, 2008, the Company received
$4.0 million from Showtime from the exercise of 2.0 million warrants at $2.00
per share in February 2008 and $3.0 million from the proceeds of the note
payable issued June 2008. In the six months ended June 30, 2007, the Company
received $5.0 million from Showtime for the issuance of 5 million shares of
common stock and 6.7 million warrants exercisable at $2.00 per share.
In
September and December 2007, the Company acquired the stock of two fight
promotion companies, purchased the assets of a fight-promotion company, and
made
a significant investment in a fourth. Additionally, the Company’s business plan
calls for expanding the scale of live events, including pay-per-view, and
Internet operations. As a result, the need for cash has correspondingly
increased. Although the Company had approximately $3.5 million of cash at June30, 2008, the Company continues to expend more cash than it brings in through
operations.
The
Company is actively negotiating to consummate a financing of approximately
$3.5
million in secured debt (with a funded amount of $3.0 million after an original
issue discount of $0.5 million) and believes a successful closing is reasonably
likely, but there is no assurance that it will be successful in doing so at
all
or on a timely basis. Any such failure to obtain financing in the immediate
future would have a material adverse effect on the Company’s liquidity and
capital resources and ability to continue as a going concern.
Even
if
the Company successfully closes on the debt financing referred to above, it
expects that its capital resources would be sufficient only until the end of
the
year, and only if the Company makes significant reductions in or cessation
of
operations and expenditures before year end, including dramatically reducing
costs by reducing administrative expenses and some lines of business. Such
actions would limit our potential for growth and could materially adversely
affect the Company’s business and prospects.
To
address its liquidity needs beyond the immediate period, the Company is also
actively seeking additional financing beyond the $3.0 million referred to above
to enable the Company to execute its operating plans without significant
reductions in operations, but there is no assurance as to whether any such
financing will be available on reasonable terms or at all.
The
auditor's opinion contained in our Annual Report on Form 10-KSB for the year
ended December 31, 2007 states substantial doubt exists about our ability to
continue as a going concern. The financial statements in this Quarterly Report
on Form 10-Q do not contain any adjustments that may be required should we
be
unable to continue as a going concern.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk.
Not
applicable.
32
Item 4.
Controls and Procedures.
(a)
Evaluation
of disclosure controls and procedures.
The
Company’s Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company’s disclosure controls and procedures as of
June 30, 2008. Based on such evaluation, such officers have concluded that,
as of June 30, 2008, the Company’s disclosure controls and procedures were
not effective in ensuring that (i) information required to be disclosed by
the
Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the SEC’s rules and forms and (ii) information required to be disclosed by
the Company in the reports that it files and submits under the Exchange Act
is
accumulated and communicated to the Company’s management, including its
principal executive and principal financial officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure. The deficiencies in disclosure controls and procedures were related
to the deficiencies in our internal control over financial reporting. In
evaluating our internal controls as of December 31, 2007, our auditors noted
several material weaknesses and a significant deficiency which we are working
to
address. The material weaknesses noted were: (1) The Company’s accounting
records, policies and procedures were not adequately maintained or documented,
and the accounting department did not have sufficient technical accounting
knowledge. (2) Due to a lack of resources, the Company did not analyze financial
and operating results in a timely manner, including spending by management
and
other officers. Additionally, the Company did not proactively review the legal
contracts entered into for financial implications. (3) Departments did not
always work in a cohesive manner, particularly in regards to required
disclosures, due diligence and acquisitions, and grants of options and warrants.
(4) A portion of the Company’s expenditures for live events are paid by and
reimbursed to an executive/director in advance of review and approval of the
charges. (5) The Company’s executives, directors and shareholders have business
relationships requiring them to advise, manage and/or provide services to other
businesses. The Company has engaged in transactions with some of these
businesses. Due to the wide-ranging network of contacts and business
relationships of our executives, directors and shareholders, the Company was
not
always able to devote sufficient resources to identify, monitor and report
all
transactions with such businesses in a timely manner. (6) The Company did not
have an active audit committee.
(b)
Changes
in internal controls.
The
Company is in the early stages of taking remediation steps to enhance its
internal control over financial reporting and reduce control deficiencies.
We
have been and are actively working to eliminate the internal control weaknesses
noted by taking the following measures: We are working to bring all accounting
and record maintenance in-house and creating centralized, on-site document
repositories; We hired personnel in the accounting department with technical
accounting and financial reporting experience suitable for a public company.
Additionally, We also hired personnel in our legal department; We have
implemented Microsoft Dynamics/Great Plains accounting software; We are formally
documenting Company policies and procedures; We are implementing a purchase
order and approval system and system of managerial approval prior to
disbursement of funds; We have implemented periodic reviews of budget and actual
results by department managers; In order to improve communication throughout
the
Company and to identify transactions that may require disclosure, we implemented
twice weekly meetings of department heads to communicate financial results
and
operational activities; We have added three new independent Directors to our
Board and key committees.
As
noted
above, there were changes in our internal controls over financial reporting
that
occurred during the period covered by this report that have materially affected
our internal controls over financial reporting. It is expected that
implementation of the above described remediation steps will have a significant
impact on enhancing our internal control over financial reporting during
2008.
See
Note
10 to the Condensed Consolidated Financial Statements contained in this
Quarterly Report on Form 10-Q.
Item
1A. Risk Factors.
Not
applicable.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
On
June18, 2008, in connection with the issuance of a Senior Secured Note Purchase
Agreement and related documents with Showtime Networks, Inc. (“Showtime”), the
Company issued to Showtime a warrant (“Warrant”) to purchase 100,000 shares of
common stock. The warrant has an exercise price of $0.01 per share and a term
of
36 months.
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
