f10qsb0607_redmile.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
-----------------------------------------
FORM
10-QSB
-----------------------------------------
|
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
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|
FOR
THE QUARTERLY PERIOD ENDED June 30,
2007
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|
o
TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR
THE
QUARTERLY PERIOD FROM _____ TO _________ .
Commission
File # 000-51055
RED
MILE ENTERTAINMENT, INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
20-4441647
|
(State
or other jurisdiction of incorporation or organization)
|
(IRS
Employer Identification Number)
|
4000
Bridgeway, Suite 101
Sausalito,
CA 94965
(ADDRESS
OF PRINCIPAL EXECUTIVE OFFICES)
(415)
339-4240
(ISSUER
TELEPHONE NUMBER)
Securities
registered pursuant to Section 12(b) of the Act: None
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 of 1934 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 shell company as defined in Rule
12b-2
of the Exchange Act. Yes o No
[ X
]
Number
of
shares of the registrant's common stock outstanding as of August 10, 2007 is:
15,854,123.
Transitional
Small Business Disclosure Format (check one) Yes o No
[ X
]
Table
of Contents
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Page
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PART
I
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FINANCIAL
INFORMATION
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ITEM
1.
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FINANCIAL
STATEMENTS
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3
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
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17
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CONTROLS AND PROCEDURES
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22
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OTHER
INFORMATION
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ITEM
1A.
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RISK
FACTORS
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23
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ITEM
2.
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CREATION
OF A DIRECT FINANCIAL OBLIGATION OR AN OBLIGATION UNDER AN OFF-BALANCE
SHEET ARRANGEMENT OF REGISTRANT
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28
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EXHIBITS
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29
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SIGNATURE
PAGE
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30
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2
ITEM
1.
Financial Statements
RED
MILE ENTERTAINMENT, INC. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
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Assets
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(Unaudited)
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Current
assets:
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Cash
and cash equivalents
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$ |
2,245,906
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$ |
1,912,992
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Accounts
receivable, net of reserves of $238,168 and $265,765
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413,034
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245,843
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Inventory,
net
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50,003
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77,232
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Prepaid
expenses and other assets
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300,177
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302,431
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Current
portion of issuance costs on senior secured convertible debentures
and
convertible promissory notes
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528,240
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305,226
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Software
development costs and advanced royalties
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Total
current assets
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Property
and equipment, net
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197,275
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241,171
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Long
term portion of issuance costs on senior secured convertible
debentures, net
Intangible assets, net
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-
103,479
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176,321
114,240
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Other
assets
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Total
assets
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$ |
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$ |
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Liabilities,
and stockholders’ deficit
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Current
liabilities:
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Accounts
payable:
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$ |
903,617
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$ |
994,675
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Accrued
liabilities
Convertible
promissory notes
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1,476,782
2,400,000
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1,124,398
-
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Deferred
revenue
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Total
current liabilities
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Senior
secured convertible debentures
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Total
liabilities
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Common
stock, $0.01 par value, authorized 100,000,000 shares; 9,661,740
and
9,661,740 shares outstanding, respectively
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96,617
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96,617
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Additional
paid-in capital
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16,635,915
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16,518,164
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Accumulated
other comprehensive income
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2,614
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1,885
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Accumulated
deficit
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(18,595,034 |
) |
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(17,218,190 |
) |
Total
stockholders’ deficit
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(1,859,888 |
) |
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(601,524 |
) |
Total
liabilities, and stockholders’ deficit
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$ |
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$ |
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The
accompanying notes are an integral part of these unaudited condensed financial
statements.
3
RED
MILE ENTERTAINMENT, INC. AND SUBSIDIARIES
Condensed
Consolidated statements of operations
(Unaudited)
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Three
months ended June 30,
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2007
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2006
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Revenues,
net
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$ |
274,422
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$ |
41,848
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Cost
of sales
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Gross
margin
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Operating expenses
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Research and
development costs
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154,027
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85,830
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General
and administrative costs
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898,066
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683,084
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Sales,
marketing and business development costs
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235,431
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Total
operating expenses
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1,287,524
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1,000,858
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Net
loss before interest and provision for income taxes
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(1,265,610 |
) |
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(996,470 |
) |
Interest
income (expense), net
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(111,234 |
) |
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Net
loss before income tax expense
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(1,376,844
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(990,925 |
) |
Income
tax expense
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-
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-
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Net
loss
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(1,376,844 |
) |
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(990,925 |
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Accretion
on redeemable convertible preferred stock
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(30,888 |
) |
Net
loss attributable to common shareholders
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$ |
(1,376,844 |
) |
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$ |
(1,021,813 |
) |
Net
loss per common share, basic and diluted
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$ |
(0.14 |
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$ |
(0.16 |
) |
Shares
used in computing basic and diluted loss per share
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The
accompanying notes are an integral part of these unaudited condensed financial
statements.
4
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
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Three
months ended June 30,
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2007
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2006
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Cash
flows from operating activities:
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Net
loss
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$ |
(1,376,844 |
) |
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$ |
(990,925 |
) |
Adjustments
to reconcile net loss to net cash used in operating
activities
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Depreciation
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46,200
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18,704
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Amortization
of software development costs
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74,017
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32,998
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Amortization
of senior secured convertible debenture issuance costs
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76,307
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-
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Amortization
of intangibles`
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10,761
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-
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Loss
on disposal of asset
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1,970
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-
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Impairment
of inventory
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12,836
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-
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Impairment
of software development and licensing costs
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14,772
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37,575
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Stock
based compensation
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117,751
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69,107
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Reserve
for price protection and bad debt expense
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(27,597 |
) |
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-
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Changes
in current assets and liabilities
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Accounts
receivable
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(139,594 |
) |
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92,044
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Inventory
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14,393
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-
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Prepaid
expenses and other current assets
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(120,746 |
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(29,320 |
) |
Software
development costs
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(1,229,743 |
) |
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(803,225 |
) |
Other
assets
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-
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(41,727 |
) |
Accounts
payable
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(91,058 |
) |
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(298,185 |
) |
Accrued
liabilities
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352,384
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(141,721 |
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Deferred
revenue
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Net
cash used in operating activities
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(2,016,173 |
) |
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(1,992,175 |
) |
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Cash
flows from investing activities:
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Sales
of marketable securities
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-
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10,313
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Acquisition
of property and equipment
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(4,182 |
) |
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(85,679 |
) |
Cash
paid for other investment
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(47,366 |
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Net
Cash flows used in investing activities
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(51,548 |
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(75,366 |
) |
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Cash
flows from financing activities:
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Proceeds
from sales of preferred stock and warrants
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-
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2,645,000
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Cost
of redeemable convertible preferred stock issuances
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-
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(165,624 |
) |
Proceeds
from issuance of convertible promissory notes
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Net
cash provided by financing activities
|
|
|
|
|
|
|
|
|
|
|
|
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Effect
of exchange rate changes on cash
|
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|
635
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(977 |
) |
Net
increase in cash
|
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|
332,914
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|
410,858
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Cash
and cash equivalents, beginning of period
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Cash
and cash equivalents, ending of period
|
|
$ |
|
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|
$ |
|
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|
|
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Supplemental
Disclosure of Non-Cash Financing Transactions
|
|
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|
|
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Agent
commissions accrued on issuance of convertible promissory
notes
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|
$ |
123,000
|
|
|
|
-
|
|
Accretion
of redeemable convertible preferred stock
|
|
|
-
|
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|
$ |
30,888
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|
Relative
fair value of warrants issued for preferred stock
|
|
|
-
|
|
|
$ |
423,788
|
|
Conversion
of Series A Redeemable Convertible Preferred Stock, net of offering
costs
|
|
|
-
|
|
|
$ |
10,344,446
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|
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|
6
RED
MILE ENTERTAINMENT, INC.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
NOTE
1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Business—
Red Mile Entertainment, Inc. (“Red Mile” or “the Company”) was incorporated in
Delaware in August of 2004. The Company is a developer and publisher of
interactive entertainment software across multiple hardware platforms, with
a
focus on creating or licensing intellectual properties. The Company
sells its games directly to distributors and retailers in North America. In
Europe and Australia, the Company either sells its games directly to
distributors or licenses its games with major international game co-publishers
in exchange for payment to the Company of either development fees or guaranteed
minimum payments. The guaranteed minimum payments are recoupable by the partner
against amounts owed computed under the various agreements. Once the partner
recoups the guaranteed minimum payments, the Company is entitled to additional
payments as computed under the agreements. The Company operates in one business
segment, interactive software publishing.
Going
Concern— The accompanying financial statements have been prepared in
conformity with accounting principles generally accepted in the United States
of
America, which contemplates continuation of the Company as a going concern.
However, the Company has sustained substantial operating losses since inception
of $18,595,034 at June 30, 2007, and has incurred negative cash flows from
operations.
The
Company shipped its first products in August and September of 2005 generating
its initial revenue. The Company expects that sales growth from existing as
well
as new products will continue. The continuation of the Company as a going
concern is dependent upon the continued financial support of current
shareholders, current debenture holders, and new investors, of which management
cannot make any assurances.
The
accompanying financial statements do not include any adjustments relating to
the
recoverability and classification of recorded asset amounts or the amounts
and
classifications of liabilities or any other adjustment that might result from
these uncertainties.
Basis
of Presentation — The unaudited condensed consolidated financial
statements of the Company have been prepared in accordance with the instructions
for Form 10-QSB and Article 10 of Regulation SX. Accordingly, the financial
statements do not include all the information and disclosures necessary for
a
presentation of the Company’s financial position, results of operations and cash
flows in conformity with generally accepted accounting principals in the United
States of America. In the opinion of management, the financial statements
reflect all adjustments (consisting only of normal recurring accruals) necessary
for a fair statement of the Company’s financial position, results of operations
and cash flows. The results of operations for an interim period are not
necessarily indicative of the results for the full year. The financial
statements should be read in conjunction with the audited financial statements
and notes thereto contained in the Company’s Annual Report on Form 10-KSB for
the fiscal year ended March 31, 2007.
On
January 30, 2007 the company amended its Certificate of Incorporation to affect
a 1 for 3 reverse stock split of the company’s common stock. The unaudited
condensed consolidated financial statements for the current and prior periods
have been adjusted to reflect the change in the number of shares.
Principals
of Consolidation— The consolidated financial statements of Red Mile
include the accounts of the Company, and its wholly-owned subsidiaries, 2WG
Media, Inc., Roveractive, Ltd. and Red Mile Australia Pty Ltd. All
intercompany accounts and transactions have been eliminated in
consolidation.
Use
of Estimates– The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures
of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Such
estimates include sales returns and allowances, price protection estimates,
provisions for doubtful accounts, accrued liabilities, estimates regarding
the
recoverability of prepaid royalties, inventories, software development costs,
long lived assets, and deferred tax assets. These estimates generally involve
complex issues and require us to make judgments, involve analysis of historical
and future trends, can require extended periods of time to resolve, and or
subject to change from period to period. Actual results could differ materially
from our estimates.
Concentration
of Credit
Risk— Financial
instruments which potentially subject us to concentration of credit risk consist
of temporary cash investments and accounts receivable. During the periods ended
June 30, 2007 and March 31, 2007, we had deposits in excess of the Federal
Deposit Insurance Corporation (“FDIC”) limit at one U.S. based financial
institution. At June 30, 2007 and March 31, 2007, Red Mile had uninsured bank
balances and certificates of deposit totaling approximately $2,159,000 and
$1,731,000, respectively.
7
Receivable
Allowances – Receivables are stated net of allowances for price
protection, returns, discounts and doubtful accounts.
We
grant
price protection to, and sometimes allow product returns from our customers
under certain conditions. Therefore, we record an allowance for price
protection and returns at each balance sheet date. The provision
related to this allowance is reported in net revenues. Price
protection means credits relating to retail price markdowns on our products
previously sold by us to customers. We base these allowances on
expected trends and estimates of potential future price protection and product
returns related to current period product revenue. Actual price
protection and product returns may materially differ from our estimates as
our
products are subject to changes in consumer preferences, technological
obsolescence due to new platforms or competing products. Changes in
these factors could change our judgments and estimates and result in variances
in the amount of allowance required. If customers request price
protection in amounts exceeding the rate expected and if management agrees
to
grant it, then we may incur additional charges against our net
revenues.
Intangible
Assets — Intangible assets primarily consist of a website and customer
list in conjunction with the acquisition of the assets of Rover
Interactive. These intangible assets are being amortized by the
straight-line method over their useful lives, ranging from 12 to 120
months. Amortization of these intangible assets totaled $10,760 and
$0 for the three months ended June 30, 2007 and 2006, respectively.
Other
Assets – Other assets consist primarily of our 18% equity investment in
the outstanding shares of IR Gurus Pty Ltd, a developer of interactive video
games headquartered in Melbourne, Australia.
Inventories—
Inventories consist of materials (including manufacturing royalties paid to
console manufacturers), labor charges from third parties, and freight-in.
Inventories are stated at the lower of cost or market, using the first-in,
first-out method. The Company performs periodic assessments to
determine the existence of obsolete, slow moving and non-saleable inventories,
and records necessary provisions to reduce such inventories to net realizable
value. We recognize all inventory reserves as a component of cost of
goods sold. All inventories are produced by third party
manufacturers, and substantially all inventories are located at third party
warehouses on consignment.
Software
Development Costs and Prepaid Royalties— Software development costs
include milestone payments to independent software developers and other third
parties under development contracts and direct labor costs. Software
development costs also include license payments made to licensors of
intellectual property we license.
Software
development costs are accounted for in accordance with Statement of Financial
Standards No. 86, “Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed”.
Commencing
upon product release, capitalized software development costs are amortized
to
cost of sales using the greater of the ratio of actual cumulative revenues
to
the total of actual cumulative revenues plus projected future revenues for
each
game or straight-line over the estimated life of the product. For
products that have been released in prior periods, we evaluate the future
recoverability of capitalized amounts on a quarterly basis or when events or
circumstances indicate the capitalized costs may not be recoverable. The primary
evaluation criterion is actual title performance.
Significant
management judgments and estimates are utilized in the assessment of when
technological feasibility is established, as well as in the ongoing assessment
of the recoverability of capitalized costs. In evaluating the
recoverability of capitalized software development costs, the assessment of
expected product performance utilizes forecasted sales amounts and estimates
of
additional costs to be incurred. If revised forecasted or actual
product sales are less than and/or revised forecasted or actual costs are
greater than the original forecasted amounts utilized in the initial
recoverability analysis, the net realizable value may be lower than originally
estimated in any given quarter, which could result in an impairment charge
to
cost of sales.
Revenue
Recognition — The Company’s revenue
recognition policies are in accordance with the American Institute Of Certified
Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2 “Software
Revenue Recognition” as amended by SOP 98-9 “Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions” and SOP 81-1
“Accounting for Performance of Construction Type and Certain Production-Type
Contracts”, and Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition
in Financial Statements”, as revised by SAB No. 104, “Revenue Recognition”. We
evaluate revenue recognition using the following basic criteria and recognize
revenue when all four criteria are met:
(i)
Evidence of an arrangement: Evidence of an arrangement with the customer that
reflects the terms and conditions to deliver products must be present in order
to recognize revenue.
8
(ii)
Delivery: Delivery is considered to occur when the products are shipped and
the
risk of loss and reward has been transferred to the customer. At times for
us,
this means when the product has shipped to the retailer from the distributor
that we sold to.
(iii)
Fixed or determinable fee: If a portion of the arrangement fee is not fixed
or
determinable, we recognize that amount as revenue when the amount becomes fixed
or determinable.
(iv)
Collection is deemed probable: We conduct a credit review of each customer
involved in a significant transaction to determine the creditworthiness of
the
customer. Collection is deemed probable if we expect the customer to be able
to
pay amounts under the arrangement as those amounts become due. If we determine
that collection is not probable, we recognize revenue when collection becomes
probable (generally upon cash collection).
Product
revenue, including sales to distributors, retailers, and co-publishers is
recognized when the above criteria are met. We reduce product revenue for
estimated future returns and price protection, which may occur with our
distributors, retailers, and co-publishers. In the future, we may decide to
issue price protection credits for either our PC or console products. When
evaluating the adequacy of sales returns and price protection allowances, we
analyze our historical returns, current sell-through of distributor and retailer
inventory, historical returns on similar products, current trends in the video
game market and the overall economy, changes in customer demand and acceptance
of our products, and other factors.
In
many cases, Red Mile receives minimum guaranteed royalties from the co-publisher
or distributor prior to delivery of the products. Pursuant to SOP 81-1, the
completed contract method of accounting is used as these minimum guarantee
royalties usually do not become non-refundable until the co-publisher or
distributor accepts the completed product. These receipts are credited to
deferred revenue when received. Revenues are recognized as the product is
shipped and actual royalties are earned. Periodically, we review the deferred
revenue and, when the product is no longer being actively sold by the
co-publisher or distributor or when our forecasts show that a portion of the
revenue will not be earned out, this excess is taken into revenue. For the
three
month ended June 30, 2007, no unearned fees were included in revenue.
Our
co-publishers will reserve a portion of their estimated sales for returns.
Red
Mile’s royalty revenue bears a direct relationship to the revenue of our
co-publishers and our co-publishers have extensive history on which to estimate
future returns. Therefore, Red Mile will often book its returns and price
protection reserves using the same reserve factors as its co-publisher in
determining net royalty revenues. Our returns and price protection
reserves for the three months ended June 30, 2007 and June 30, 2006 was $144,244
and $0, respectively.
Reclassification
– Certain prior period items have been reclassified to conform to the
current period’s presentation.
Foreign
Currency Translation— The functional currency of our foreign subsidiary
is its local currency. All assets and liabilities of our foreign subsidiary
are
translated into U.S. dollars at the exchange rate in effect at the end of the
period, and revenue and expenses are translated at weighted average exchange
rates during the period. The resulting translation adjustments are reflected
as
a component of accumulated other comprehensive income (loss) in shareholders’
equity. The functional currency of the Company’s assets and liabilities
denominated in foreign currencies is the US dollar.
Stock-Based
Compensation Plans— On April 1, 2006, we adopted the provisions of
Statement of Financial Accounting Standards (“SFAS”) 123(revised 2004),
“Share-Based Payment” (the “Statement or “SFAS 123(R)”), requiring us
to recognize expense related to the fair value of our stock-based compensation
awards. Prior to April 1, 2006, the Company used the minimum value method in
estimating the value of employee option grants as allowed by SFAS 123, amended
by SFAS 148 “ Accounting for stock based compensation - transition and
disclosure”. Accordingly, we have elected to use the prospective transition
method as permitted by SFAS 123(R) and therefore have not restated our financial
results for prior periods. Under this transition method, stock-based
compensation expense for the three months ended June 30, 2007 includes
compensation expense for all stock option awards granted subsequent to March
31,
2006 based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R). We recognize compensation expense for stock option
awards on a straight-line basis over the requisite service period of the
award.
In
March
2005, the SEC issued SAB No. 107, which offers guidance on SFAS 123(R). SAB
107
was issued to assist preparers by simplifying some of the implementation
challenges of SFAS 123(R) while enhancing the information that investors
receive. SAB 107 creates a framework that is premised on two overarching themes:
(a) considerable judgment will be required by preparers to successfully
implement SFAS 123(R), specifically when valuing employee stock options; and
(b)
reasonable individuals, acting in good faith, may conclude differently on the
fair value of employee stock options. Key topics covered by SAB 107 include
valuation models, expected volatility and expected term. The Company is applying
the principles of SAB 107 in conjunction with its adoption of SFAS
123(R).
Prior
to
the adoption of SFAS 123(R), we applied SFAS 123, amended by SFAS 148,
“Accounting for Stock-Based Compensation, Transition and Disclosure”
(“SFAS 148”), which allowed companies to apply the existing accounting rules
under Accounting Principles Board No. 25, “ Accounting for Stock Issued to
Employees ,” (APB 25) and related Interpretations. In general, as the
exercise price of options granted under these plans was equal to the market
price of the underlying common stock on the grant date, no stock-based employee
compensation cost was recognized in our statements of operations for periods
prior to the adoption of SFAS 123(R).
9
As
required by SFAS 148, prior to the adoption of SFAS 123(R), we disclosed
reported net loss which included stock-based compensation expense of $0,
calculated in accordance with APB 25, and then pro forma net loss as if the
fair-value-based compensation expense calculated in accordance with SFAS 123
using the minimum value method had been recorded in the financial
statements.
The
following table summarizes the weighted average shares outstanding:
|
|
Three
Months Ended June 30,
|
|
|
|
2007
|
|
|
2006
|
|
Basic
weighted average shares outstanding
|
|
|
9,661,740
|
|
|
|
6,552,092
|
|
Total
stock options outstanding
|
|
|
1,988,745
|
|
|
|
1,037,633
|
|
Less:
anti-dilutive stock options due to loss
|
|
|
(1,988,745 |
) |
|
|
(1,037,633 |
) |
Total
redeemable convertible preferred stock outstanding
|
|
|
-
|
|
|
|
1,278,287
|
|
Less:
anti-dilutive redeemable convertible preferred stock due to
loss
|
|
|
-
|
|
|
|
(1,278,287 |
) |
Total
senior secured convertible debenture
|
|
|
1,570,286
|
|
|
|
-
|
|
Less:
anti-dilutive seniot secured convertible debenture due to
loss
|
|
|
(1,570,286 |
) |
|
|
-
|
|
Total
warrants outstanding
|
|
|
2,794,176
|
|
|
|
4,099,620
|
|
Less:
anti-dilutive warrants due to loss
|
|
|
(2,794,176 |
) |
|
|
(4,099,620 |
) |
Total
convertible promissory notes outstanding
|
|
|
960,000
|
|
|
|
-
|
|
Less:
anti-dilutive convertible promissory notes due to loss
|
|
|
(960,000 |
) |
|
|
-
|
|
Diluted
weighted average shares outstanding
|
|
|
9,661,740
|
|
|
|
6,552,092
|
|
|
|
June
30, 2007
|
|
|
March
31, 2007
|
|
Accrued
professional fees
|
|
$ |
159,771
|
|
|
$ |
217,370
|
|
Accrued
royalties payable
|
|
|
55,851
|
|
|
|
50,676
|
|
Accrued
bonuses
|
|
|
127,530
|
|
|
|
87,314
|
|
Accrued
interest on senior secured convertible debentures
|
|
|
137,194
|
|
|
|
—
|
|
Accrued
milestone payments to developers
|
|
|
510,000
|
|
|
|
420,000
|
|
Accrued
paid time off
|
|
|
54,017
|
|
|
|
38,741
|
|
Other
miscellaneous
|
|
|
26,208
|
|
|
|
93,203
|
|
Accrued
marketing costs
|
|
|
235,000
|
|
|
|
175,000
|
|
Accrued
commissions
|
|
|
171,211
|
|
|
|
42,094
|
|
Total
|
|
$ |
1,476,782
|
|
|
$ |
1,124,398
|
|
NOTE
3 — DEFERRED REVENUE
|
|
June
30, 2007
|
|
|
March
31, 2007
|
|
Lucinda
Green’s Equestrian Challenge
|
|
$ |
248,018
|
|
|
$ |
—
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
248,018
|
|
|
$ |
—
|
|
10
NOTE
4 — COMMITMENTS
In
the
normal course of business, we enter into contractual arrangements with
third-parties for the development of products, as well as for the rights to
intellectual property. Under these agreements, we commit to provide specified
payments to a developer, or intellectual property holder, based upon contractual
arrangements. Typically, the payments to third-party developers are conditioned
upon the achievement by the developers of contractually specified development
milestones. These payments to third-party developers and intellectual property
holders may be deemed to be advances and are recoupable against future royalties
earned by the developer or intellectual property holder based on the sale of
the
related game. Assuming all contractual provisions are met, the total future
minimum contract commitments for development contracts and intellectual property
holders in place as of June 30, 2007 are approximately $14,734,929. which is
scheduled to be paid as follows:
|
Year
ended March 31,
|
|
|
2008
|
|
$ |
8,717,796
|
|
|
2009
|
|
|
6,017,134
|
|
Total
|
|
|
$ |
14,734,929
|
|
Lease
Commitments
Operating
Leases — Red Mile leases its office space under a twelve month operating lease
expiring March 2008 with a monthly base rental of $6,240 per month. Rent expense
for the three months ended June 30, 2007 and 2006 was $18,720 and $24,150,
respectively.
The
minimum future lease payments for the above lease as of June 30, 2007 is $49,920
for the fiscal year ended March 31, 2008. No payments are due in future fiscal
years beyond 2008.
Convertible
Promissory Notes
On
June
25 through June 27, 2007, the Company issued an aggregate of $2,050,000 of
Convertible Promissory Notes (the “Notes”) to a total of 19 note holders with
J.F. Mackie & Company, Ltd. acting as the placement agent (the “Agent”). All
the note holders are residents of Canada. The Notes mature on the earlier to
occur of a Sale Event, as defined below, or the one year anniversary of the
date
of issuance. A Sale Event constitutes a bona fide, negotiated
transaction or integrated series of transaction pursuant to which either: (i)
the Company merges or consolidates with any other non-affiliated entity or
sells, exchanges, or otherwise disposes of all or substantially all of its
assets to a non-affiliated third party; or (ii) in which more than 50% of the
Company’s voting power is transferred in a private placement to one
person.
In
addition, on June 25, 2007, the Company, without the assistance of the Agent,
issued a $350,000 Convertible Promissory Note to one note holder. This note
holder is also a resident of Canada. This note matures on the same terms as
the
Notes (the Notes and this additional note, the “Combined Notes”).
The
Combined Notes will automatically convert concurrent with the consummation
of a
Next Financing prior to the Maturity Date. In the case of such a conversion,
the
Combined Notes will convert into the form of equity issued by the Company in
that equity financing at a price per share equal to the lowest price in that
financing. Immediately upon such conversion, the Note Holder will also receive
one half of one warrant for every share received upon conversion of the note
held by such Note Holder, exercisable at $2.75 per share for a period of 2
years
from the closing date of such equity financing.
The
Combined Notes bear interest at the rate of 10% per annum, non-compounded,
and
the interest is payable in cash by the Company on the maturity date. The
Agent is to be paid a commission equal to 6% of the principal amount of the
Notes.
The
Company issued the Agent and its nominees broker’s warrants entitling it to
purchase up to 215,408 shares of the Common Stock at $3.00 until July 18,
2009.
The
Combined Notes are subordinated obligations of the Company secured against
all
present and after acquired assets of the Company.
The
Combined Notes were issued in private placement transactions to investors who
are not "U.S. persons" pursuant to the exemption from registration provided
by
Rules 901 and 903 of Regulation S under the Securities Act of 1933, as
amended.
On
July
18, 2007, the convertible promissory notes automatically converted upon the
completion of a private placement financing as described in
our
subsequent events note (Note 10) into 960,000 shares of the Company’s common
stock and 192,000 warrants. One whole warrant entitles the holder to
acquire, for no additional consideration, one common share of the Company in
the
event that the Company does not complete a liquidity transaction by March 18,
2008. The warrants will automatically be cancelled if the Company
completes such a liquidity transaction by March 18, 2008.
11
In
addition, the Company issued to the note holders warrants to purchase 480,000
shares of the Common Stock at $2.75 per share until July 18, 2009.
Senior
Secured Convertible Debentures
On
October 19, 2006, the Company issued $5,824,000 of Senior Secured Convertible
Debentures. Pursuant to the terms of the Agency Agreement, the Agent
facilitated the purchase of 5,824 convertible debentures to 74 Debenture Holders
for an aggregate principal face amount of $5,824,000. The Debentures mature
on
October 19, 2008 and are convertible into shares of the Common Stock of the
Company at a ratio of $5.25 per Common Share (the “Conversion
Price).
On
November 20, 2006, the Company, issued $2,420,000 of Senior Secured Convertible
Debentures. Pursuant to the terms of the Agency Agreement, the Agent
facilitated the purchase of 2,420 convertible debentures to 7 Debenture Holders
for an aggregate principal face amount of $2,420,000. These Debentures mature
on
November 20, 2008 and are convertible into shares of the Common Stock of the
Company at a ratio of $5.25 per Common Share (the “Conversion
Price).
The
conversions on the above mentioned Debentures may be exercised at the election
of the holders of the Debentures at any time after a minimum non-conversion
period of 12 months from the issue date. The conversions can also be exercised
by the Company after a minimum non-conversion period of 12 months from the
issue
date so long as the Company’s Common Shares have begun trading on a recognized
exchange and have traded at a minimum volume weighted average price of
$9.00/share for 20 consecutive trading days, subject to certain
limitations.
On
the
maturity dates of the two sets of Debentures, the Company retains the right
to redeem the Debentures in cash, in kind, or in cash and in kind with Common
Shares of the Company. The Company also has the right to redeem the Debentures
at a redemption price equal to 115% of the principal face value at any time
after a period of 12 months so long as the Company’s Common Shares have begun
trading on a recognized exchange and have traded at a minimum volume weighted
average price of $9.00/share for 20 consecutive trading days, subject to certain
limitations.
The
total
capitalized fees were $610,453, with the $494,640 in agent’s commissions
comprising the majority of the capitalized fees. The remaining $115,813 in
fees
was primarily legal fees.
The
Debentures carry a coupon rate of 5.5% per annum, non-compounded, and the
interest is payable semi-annually on March 15 and September 15 in cash, or
in
kind. The accrued interest at June 30, 2007 is $132,920. This is included
within the Accrued Liabilities account. For the three month ended
June 30, 2007, interest expense was $113,044, of which $16,347 was capitalized
to software development costs, in accordance with SFAS 34, “Capitalization of
Interest Cost.” .
The
Debentures are secured direct senior obligations of the Company secured against
all present and after acquired property of the Company except for accounts
receivable in which case the Debenture holders rank less senior to other
creditors for the security interest in accounts receivable. The Debentures
have
full rights to piggyback registration after a period of 12 months.
On
July
18, 2007, holders of more than 66 2/3% of the $8,244,000 principal amount of
senior secured convertible debentures and the accrued interest on the
debentures, after a proposal brought forth by the Company, voted by way of
extraordinary resolution to cancel such debentures and convert the principal
and
accrued interest amounts of their debentures into shares of the Company’s stock
at $2.50 per share, thereby resulting in the conversion of the full principal
and interest amounts associated with such debentures into 3,359,713 shares
of
the Company’s common stock (see Note 10).
NOTE
6 — STOCK OPTIONS AND STOCK COMPENSATION
The
fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
|
|
Period
Ended June 30, 2007
|
Expected
life (in years)
|
|
4.2
– 6.5
|
Risk
free rate of return
|
|
4.5%
- 5.13%
|
Volatility
|
|
50%
- 80%
|
Dividend
yield
|
|
-
|
Forfeiture
rate
|
|
9%
- 15%
|
12
The
following table sets forth the total stock-based compensation expense for the
three months ended June 30, 2007 and June 30, 2006. All research and
development costs, and sales, marketing, and business development costs in
this
table are related to employees. General and administrative costs are broken
out
between those related to consultants and those related to
employees.
|
|
Three
Months Ended June 30, 2007
|
|
|
June
30, 2006
|
|
Research
and development costs
|
|
$ |
5,597
|
|
|
$ |
$ 1,736
|
|
Sales,
marketing, and business development costs
|
|
|
7,284
|
|
|
|
4,850
|
|
General
and administrative costs—consultants
|
|
|
-
|
|
|
|
62,521
|
|
General
and administrative costs—employees
|
|
|
104,870
|
|
|
|
-
|
|
Stock-based
compensation before income taxes
|
|
|
117,751
|
|
|
|
69,107
|
|
Income
tax benefit
|
|
|
-
|
|
|
|
-
|
|
Total
stock-based employee compensation expense after income
taxes
|
|
$ |
117,751
|
|
|
$ |
$69,107
|
|
The
following table sets forth the total stock-based compensation expense for the
three months ended June 30, 2007 and 2006:
|
|
Three
Months Ended June 30, 2007
|
|
|
June
30, 2006
|
|
Stock-based
employee compensation expense before income taxes
|
|
$ |
117,751
|
|
|
$ |
6,586
|
|
Stock-based
consultant compensation expense before income taxes
|
|
|
-
|
|
|
|
62,521
|
|
Stock-based
compensation before income taxes
|
|
|
117,751
|
|
|
|
69,107
|
|
Income
tax benefit
|
|
|
-
|
|
|
|
-
|
|
Total
stock-based employee compensation expense after income
taxes
|
|
$ |
117,751
|
|
|
$ |
69,107
|
|
During
the three months ended June 30, 2007, no common stock options were granted
to
non-employees.
On
April
8, 2005, the Board of Directors approved the Red Mile Entertainment 2005 Stock
Option Plan which permits the Board of Directors to grant to officers,
directors, employees and third parties incentive stock options (“ISOs”),
non-qualified stock options, restricted stock and stock appreciation rights
(“SARs”). At March 15, 2007, the Board of Directors and stockholders holding a
majority of voting power voted to authorize the board of directors, at its
discretion, to amend the 2005 Stock Option Plan. This amendment would take
effect no sooner than May 14, 2007. Under the Amended Plan, options for
2,500,000 shares of common stock are reserved for issuance. At June
30, 2007, 511,255 options are available for grant. Options have been
issued with exercise prices of between $0.66 and $4.00 per share as
follows:
Options
Outstanding
|
|
|
Options
Exercisable
|
|
|
|
|
Number
|
|
|
Weighted
Avg.
|
|
|
Weighted
Avg.
|
|
|
Number
|
|
|
Weighted
Avg.
|
|
Range
of Exercise Prices
|
|
|
Outstanding
|
|
|
Remaining
Life
|
|
|
Exercise
Price
|
|
|
Exercisable
|
|
|
Exercise
Price
|
|
$ |
0.66
- $1.49
|
|
|
|
902,910
|
|
|
|
8.50
|
|
|
|
0.71
|
|
|
|
562,854
|
|
|
|
0.74
|
|
$ |
1.50
- $2.37
|
|
|
|
96,667
|
|
|
|
8.65
|
|
|
|
2.89
|
|
|
|
63,333
|
|
|
|
1.91
|
|
$ |
2.38
- $4.00
|
|
|
|
989,168
|
|
|
|
9.72
|
|
|
|
4.03
|
|
|
|
18,542
|
|
|
|
3.30
|
|
|
|
|
|
|
1,988,745
|
|
|
|
|
|
|
$ |
3.02
|
|
|
|
644,729
|
|
|
$ |
0.83
|
|
13
Option
activity under the Amended Plan is as follows:
Options
|
|
Shares
|
|
Weighted
Average Exercise Price
|
|
Weighted
Average Remaining Contractual Term
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2006
|
|
|
940,966
|
|
$
|
0.75
|
|
|
|
|
|
|
|
Exercisable at March 31, 2006
|
|
|
177,620
|
|
$
|
0.90
|
|
|
|
|
|
|
|
Granted
|
|
|
1,124,167
|
|
|
3.75
|
|
|
|
|
|
|
|
Forfeited or expired
|
|
|
(76,388)
|
|
|
2.73
|
|
|
|
|
|
|
|
Outstanding at March 31, 2007
|
|
|
1,988,745
|
|
$
|
2.28
|
|
|
|
|
|
|
|
Exercisable at March 31, 2007
|
|
|
607,000
|
|
$
|
0.83
|
|
|
|
|
|
|
|
Granted
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
Forfeited
or expired
|
|
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2007
|
|
|
1,988,745
|
|
$
|
2.28
|
|
|
9.45
|
|
$
|
2,425,794
|
|
Exercisable
at June 30, 2007
|
|
|
644,729
|
|
$
|
0.85
|
|
|
8.41
|
|
$
|
1,706,565
|
|
In
the
case where shares have been granted to third parties, the fair value of such
shares is recognized as an expense in the period issued using the Black-Scholes
option pricing model,. There were no grants made to third parties
during the three months ended June 30, 2007.
In
the
case of shares granted to employees, the fair value of such shares is recognized
as an expense over the service period. There were no option grants issued to
employees during the three months ended June 30, 2007. As of June 30,
2007, the fair value of options issued by the Company was $1,837,618. Expense
recognized for the three months ended June 30, 2007 was $117,751. The
unamortized cost remaining at June 30, 2007 was $1,352,988 with a weighted
average expected term for recognition of 4.49 years. At the time of grant,
the
estimated fair values per option were from $0.33 to $2.94.
NOTE
7 — WARRANTS
The
following table lists the total number of warrants outstanding as of June 30,
2007.
|
Expiring
|
|
Strike
Price
|
|
Number
of
Common
shares
|
|
December
31, 2007
|
|
4.50
|
|
681,778
|
|
May
1, 2008
|
|
4.50
|
|
585,287
|
|
May
2, 2008
|
|
4.50
|
|
845,333
|
|
December
31, 2008
|
|
5.25
|
|
681,778
|
|
Total
|
|
|
|
2,794,176
|
|
|
|
|
|
|
During
the three months ended June 30, 2007, there were no warrants exercised, and
no
warrants that expired.
NOTE
8 — CONCENTRATIONS
Customer
base
Our
customer base includes distributors, co-publishers, and retailers of video
games
in the United States, Europe, and Australia. We review the credit worthiness
of
our customers on an ongoing basis, and believe that we need an allowance for
potential credit losses at June 30, 2007 of $93,924. Also netted against
accounts receivable are returns and price protection reserves on existing
receivables of $144,244. Account balances are charged off against the
allowance when the Company believes it is probable that accounts receivable
will
not be recovered. As of June 30, 2007, we had two customers who accounted for
63.6% and 32.0% of gross accounts receivable. These customers were Navarre
Corporation and GameStop, respectively. Navarre Corporation, Funtastic, Ltd.
and
GameStop accounted for 42.4%, 32.7% and 15.1%, respectively, of consolidated
revenue during the three months ended June 30, 2007. As of March 31, 2007,
we
had two customers who accounted for 49.1% and 28.1% of gross accounts
receivable.
14
Operations
by Geographic Area
Our
products are sold in North America, Europe, and Australia through third-party
licensing arrangements, through distributors, and through
retailers.
The
following table displays consolidated net revenue by location:
Location
|
|
Revenue
|
|
|
|
|
|
United
States
|
|
$ |
161,960
|
|
Australia
|
|
|
112,462
|
|
|
|
$ |
274,422
|
|
Location
of assets
The
Company’s tangible assets excluding inventory are located at its corporate
offices in Northern California and on loan to a third party developer in
Melbourne, Australia, for which the Company owns an 18% interest in. Inventory
is located at several third party warehouse facilities, primarily in
Minnesota.
NOTE
9 — NEW ACCOUNTING PRONOUNCEMENT
EITF
06-03
In
June
2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue
No. 06-03 (“EITF 06-03”), “How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That
Is,
Gross versus Net Presentation).” EITF 06-03 provides that the presentation of
taxes assessed by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer on either a gross
basis (included in revenues and costs) or on a net basis (excluded from
revenues) is an accounting policy decision that should be disclosed. The
provisions of EITF 06-03 became effective as of December 31, 2006. Our adoption
of ETIF 06-03 has not and is not expected to have a material effect on our
consolidated financial position or results of operations.
SFAS
157
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157), which provides guidance on how to measure assets and
liabilities that use fair value. SFAS 157 will apply whenever another
US GAAP standard requires (or permits) assets or liabilities to be measured
at
fair value but does not expand the use of fair value to any new
circumstances. This standard also will require additional disclosures
in both annual and quarterly reports. SFAS 157 will be effective for
fiscal 2009. We are currently evaluating the potential impact this standard
may
have on its financial position and results of operations.
SFAS
159
On
February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159). Under this
Standard, we may elect to report financial instruments and certain other items
at fair value on a contract-by-contract basis with changes in value reported
in
earnings. This election is irrevocable. SFAS No. 159 provides an opportunity
to
mitigate volatility in reported earnings that is caused by measuring hedged
assets and liabilities that were previously required to use a different
accounting method than the related hedging contracts when the complex provisions
of SFAS No. 133 hedge accounting are not met. SFAS No. 159 is effective for
years beginning after November 15, 2007. Early adoption within 120 days of
the
beginning of the company’s 2008 fiscal year is permissible, provided the company
has not yet issued interim financial statement for 2008 and has adopted SFAS
No.
157. Management is currently evaluating the potential impact of adopting this
Standard.
FIN
48
Effective
April 1, 2007, we adopted the provisions of FASB Interpretation
No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation
of FASB Statement No. 109, or FIN 48. FIN 48 provides
detailed guidance for the financial statement recognition, measurement and
disclosure of uncertain income tax positions recognized in the financial
statements in accordance with SFAS No. 109. Income tax positions must meet
a “more-likely-than-not” recognition threshold at the effective date to be
recognized upon the adoption of FIN 48 and in subsequent
periods.
Upon
review and analysis by the Company, we have concluded that no FIN 48 effects
are
present as of June 30, 2007 and our tax position has not materially changed
since March 31, 2007. For the three months ended June 30, 2007, we
did not identify and record any liabilities related to unrecognized income
tax
benefits. Therefore the adoption of FIN 48 does not impact our
financial statements for the three months ended June 30, 2007.
15
We
recognize interest and penalties related to uncertain income tax positions
in
income tax expense. No interest and penalties related to uncertain income tax
positions were accrued at June 30, 2007. Income tax returns for
the fiscal tax year ended June 30, 2004 to the present are subject to
examination by major tax jurisdictions.
NOTE
10 — SUBSEQUENT EVENTS
On
July
18, 2007, Red Mile Entertainment, Inc., a Delaware corporation (the
“Registrant”), issued 1,872,600 units (the “Units”) at $2.50 per Unit with each
Unit consisting of one share of the Registrant’s common stock, par value $.01
(the “Common Stock”), and 0.2 of one warrant, pursuant to an agency agreement
with J.F. Mackie & Company, Ltd. (the “Agent”).
Pursuant
to the terms of the agency agreement, the Agent facilitated the purchase of
the
Units to a total of 69 accredited investors for an aggregate amount of
$4,681,500. Of the 69 investors, 67 are residents of Canada, one is a resident
of the Bahamas and one is a resident of Argentina.
Each
whole warrant entitles the holder of the warrant to acquire, for no additional
consideration, one share of the Common Stock in the event that the Registrant
does not complete by March 18, 2008 a liquidity transaction, as defined in
the
agency agreement with the Agent. The warrants will automatically be cancelled
if
the Registrant completes a liquidity transaction by March 18,
2008. It is Management’s best estimation that a liquidity transaction
is highly probable to be completed by March 18, 2008 with the warrants thereto
being cancelled.
Additionally,
upon the closing of the purchase of the Units, the convertible promissory notes
issued by the Registrant on June 25 through June 27, 2007 with an aggregate
principal amount of $2,400,000 automatically converted into 960,000 Units.
In
addition, the Registrant issued to the former note holders warrants
to purchase 480,000 shares of the Common Stock at $2.75 per share until July
18,
2009. Using the Black-Scholes option pricing model, the fair value of
such warrants issued was $662,902, which will be recorded as a beneficial
conversion feature.
The
Agent
is an independent equity investment firm located in Calgary, Canada. Upon the
closing of the transaction, the Registrant paid the Agent commissions of
$403,890 and issued the Agent and its nominees broker’s warrants entitling it to
purchase up to 215,408 shares of the Common Stock at $3.00 until July 18,
2009.
The
Registrant intends to use the proceeds of the offering for development and
marketing of its interactive game franchises and ongoing working capital
requirements.
Separately,
holders of more than 66 2/3% of the $8,244,000 principal amount of senior
secured convertible debentures and $155,281 in accrued interest on the
debentures issued by Red Mile in October and November 2006 voted, pursuant
to
the Company’s offer, by way of extraordinary resolution to cancel such
debentures and to convert the principal and accrued interest amounts of their
debentures into shares of the Common Stock at $2.50 per share, thereby resulting
in the conversion of the full principal and interest amounts associated with
all
such debentures into 3,359,713 shares of the Common Stock. With the
conversion, the Company will record a non-cash debt inducement conversion charge
of $4,318,286.
All
of the securities were issued in
private placement transactions outside the United States to investors who are
not “U.S. persons” pursuant to the exemption from registration provided by
Regulation S under the Securities Act of 1933.
16
RED
MILE ENTERTAINMENT, INC.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATIONS
This
report on Form 10-QSB includes forward-looking statements, within the meaning
of
Section 21E of the Securities Exchange Act of 1934, that reflect Red Mile
Entertainment, Inc.’s current expectations about its future results,
performance, prospects and opportunities, including statements regarding the
development and publishing of interactive entertainment software for console
video game systems, personal computers and other interactive entertainment
platforms. Where possible, we have tried to identify these
forward-looking statements by using words such as "anticipates," "believes,"
"intends," or similar expressions. We cannot assure you that we will be able
to
successfully develop or publish any of these products. All forward-looking
statements made in this report are made as of the date hereof, and we assume
no
obligation to update the forward-looking statements whether as a result of
new
information, future events, or otherwise, other than as required by law. The
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially, including risks that our proposed
games will not be popular with consumers, that we may lose one or more of our
key customers and other risks detailed in our SEC reports, including our Form
10-KSB. Copies of these filings are available at
www.sec.gov.
Liquidity
and Capital resources
During
the quarter ended June 30, 2007, we raised $2.4 million before agent’s
commissions in cash through private offerings. On July 18, 2007, we
raised an additional $4,681,500 before agent’s commissions through private
offerings. We plan to use the proceeds from the offerings for
development and marketing of our interactive game franchises and ongoing working
capital requirements.
We
anticipate needing an additional $15,000,000 to finance our planned expansion
OVER the next 12 months. We will be unable to complete development of new games
or publish additional games other than those currently under development, or
consummate any acquisitions, if we are unable to raise THIS additional
financing. We believe our current cash on hand of approximately $4.8 million
as
of July 27, 2007, in addition to anticipated cash flow from operations, will
enable the company to continue operating into our third fiscal quarter of
2008.
In
addition to money needed to develop new games, we will also need money to fund
the expansion of our staff. It is currently anticipated we will hire an
additional two employees in the next six months to support our expansion
plans.
Recent
Developments
On
May
18, 2007, the Company entered into a multi-year world-wide license agreement
with Frank Miller, Inc., a New York Corporation (“FMI”). The license
grants the Company the exclusive rights for the development, manufacturing,
and
publishing of games on multi-platforms based on all current and future Sin
City
comic books and collections, graphic novels, and other books owned or controlled
by FMI, including all storylines of those comic books and graphic
novels.
17
RED
MILE ENTERTAINMENT, INC.
Results
of Operations
The
unaudited results of operations for the three months ending June 30, 2007 and
June 30, 2006 are as follows:
Three
Months Ended June 30, 2007 and 2006
Summary
of Statements of Operations
|
|
2007
|
|
|
2006
|
|
|
%
change
|
|
Revenue
|
|
$ |
274,422
|
|
|
$ |
41,848
|
|
|
|
555.8 |
% |
Cost
of sales
|
|
|
252,508
|
|
|
|
37,460
|
|
|
|
574.1 |
% |
Gross
margin
|
|
|
21,914
|
|
|
|
4,388
|
|
|
|
|
|
Operating
expenses
|
|
|
1,287,524
|
|
|
|
1,000,858
|
|
|
|
28.6 |
% |
Net
loss before interest and provision for income taxes
|
|
|
(1,265,610 |
) |
|
|
(996,470 |
) |
|
|
|
|
Interest
income (expense), net
|
|
|
(111,234 |
) |
|
|
5,545
|
|
|
|
|
|
Income
tax expense
|
|
|
---
|
|
|
|
---
|
|
|
|
|
|
Net
loss
|
|
|
(1,376,844 |
) |
|
|
(990,925 |
) |
|
|
38 |
% |
Accretion
on redeemable convertible preferred stock
|
|
|
(--- |
) |
|
|
30,888
|
|
|
|
|
|
Net
loss attributable to common shareholders
|
|
$ |
(1,376,844 |
) |
|
$ |
(1,021,813 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per common share
- Basic and
diluted
|
|
$ |
(.14 |
) |
|
$ |
(.16 |
) |
|
|
|
|
Shares
used in computing basic and diluted net loss per share (in
000’s)
|
|
|
9,662
|
|
|
|
6,552
|
|
|
|
|
|
Revenues
Revenues
were approximately $274,000 during the three months ended June 30, 2007 as
compared to approximately $42,000 during the three months ended June 30, 2006,
an increase of approximately $232,000 or 556%. The increase is
primarily due to sales of Crusty Demons in Australia and sales of Aircraft
Power
Pack in North America. During this period, our revenues consisted of
sales from three new PC games (10 Talismans, Ouba, and Pantheon) licensed under
our Roveractive, ltd. casual games division.
We
have
three games under development which we anticipate will be ready for shipment
in
fiscal years 2008 through 2010. We expect Jackass: The Game (for console and
handheld platforms) to be ready for shipment in September 2007 for Sony
platforms and in November 2008 for Nintendo platforms. We are also developing
a
sequel to Heroes of the Pacific that is set in the European theatre (next
generation console and PC) that we expect to ship in fiscal 2009. We
have also commenced pre-production oF Sin City: The Game and expect development
to commence in September 2007.
For
the
quarter ended June 30, 2006, our revenue consisted of royalties from three
products (Crusty Demons, GripShift, and Disney’s Aladin Chess
Adventure).
At
June
30, 2007, Navarre Corporation and GameStop accounted for approximately 95%
of
the gross consolidated accounts receivable and represented approximately 58%
of
our consolidated revenues for the three months ended June 30,
2007. As a result, we were materially dependent upon these customers
for our revenues. The loss of any single significant customer,
especially Navarre Corporation and GameStop, would have a material adverse
effect on our results.
In
fiscal
2008, we expect to self-publish our video games under development for release
in
North America, Europe, and Australia through third party distributors. Video
games are significantly more capital intensive to self-publish due to the high
cost of goods, which includes the hardware manufacturer royalties and the
extensive marketing which is necessary to generate high consumer
awareness. Self publishing in North America would enable us to retain
a greater portion of the wholesale revenue from these games. We would also
take
responsibility for consumer and trade advertising for these games under the
self
publishing model.
18
Cost
of sales
Cost
of
goods sold were approximately $253,000 during the three months ended June 30,
2007 as compared to approximately $37,000 during the three months ended June
30,
2006, an increase of approximately $215,000 or 574%. The increase in
cost of goods sold during the three months ended June 30, 2007 as compared
to
the prior year is primarily the result of the increase in sales as described
in
the above section.
For
the
three months ended June 30, 2007, cost of sales includes the amortization of
software development costs for Equestrian Challenge. Cost of sales
also includes the amortization of prepaid royalties paid to the licensors
of 10 Talismans, Ouba, and Pantheon. In addition, cost of sales
includes the cost of manufacturing all of our products sold in the period as
well as actual royalties paid to the developers of Power Pack. Also
included in cost of sales for the three months ended June 30, 2007 is a $29,766
charge for the impairment of development costs and inventory for several games
for which we now do not project we will be able to realize the carrying
value.
Cost
of
sales for the three months ended June 30, 2007 consisted of:
Amortization
of capitalized software development costs and manufacturing and
distribution costs
|
|
$ |
193,476
|
|
Royalties
to third party game developers
|
|
|
29,267
|
|
Write
down of inventory costs to net realizable value
Write
down of software development costs and advanced royalties to net
realizable value
|
|
|
12,836
16,929
|
|
Total
|
|
$ |
252,508
|
|
Operating
Expenses
Operating
expenses for the quarters ended June 30, 2007 and 2006, respectively, were
as
follows:
|
|
Quarter
ended
June
30, 2007
|
|
|
Percent
of
total
|
|
|
Quarter
ended
June
30, 2006
|
|
|
Percent
Of
total
|
|
|
Percent
Increase
|
|
Research
and development costs
|
|
$ |
154,027
|
|
|
|
12.0%
|
|
|
$ |
85,830
|
|
|
|
8.6%
|
|
|
|
79.5%
|
|
General
and administrative costs
|
|
|
898,066
|
|
|
|
70.0%
|
|
|
|
683,084
|
|
|
|
68.2%
|
|
|
|
31.5%
|
|
Marketing,
sales and business development costs
|
|
|
235,431
|
|
|
|
18.0%
|
|
|
|
231,944
|
|
|
|
23.2%
|
|
|
|
1.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
$ |
1,287,524
|
|
|
|
100.0%
|
|
|
$ |
1,000,858
|
|
|
|
100.0%
|
|
|
|
28.6%
|
|
Research
and Development Costs
Our
research and development (R&D) expenses consist of the costs incurred in our
internal development group which are not capitalized into our games under
development as well as costs incurred prior to a game reaching technological
feasibility as described in FAS 86. All direct game development during the
year
was performed by third party developers under fixed fee contracts. These
external costs are capitalized upon the company determining that the game has
passed the technological feasibility standard of FAS 86 and Commencing upon
product release, capitalized software development costs are amortized to cost
of
sales using the greater of the ratio of actual cumulative revenues to the total
of actual cumulative revenues plus projected future revenues for each game
or
straight-line over the estimated life of the product. Certain
internal costs are capitalized as part of the development costs of a game.
During the three months ended June 30, 2007 approximately $118,000 of internal
costs were capitalized and approximately $145,000 of external costs were
expensed as incurred as costs prior to the related game reaching technological
feasibility.
Research
and development expenses were approximately $154,000 during the three months
ended June 30, 2007 as compared to approximately $86,000 during the three months
ended June 30, 2006, an increase of approximately $68,000 or
80%. Virtually all of the costs for R&D during the three months
ended June 30, 2007 related to costs incurred in development prior to the
related game reaching technological feasibility.
In
general, a product goes through multiple levels of design, production, approvals
and authorizations before it may be shipped. These approvals and authorizations
include concept approvals from the platform licensors of the game concept and
product content, approvals from the licensor of the intellectual property of
the
game design and game play, and approvals from the platform licensors that the
game is free of all material bugs and defects. In addition, all games are
required to be rated by the Entertainment Software Rating Board (ESRB) for
their
content.
19
Once
the
aforementioned approvals have been satisfied, the game can be placed into
manufacturing at a manufacturer that must also be approved by the platform
licensor. Once a product is manufactured and inspected, it is ready to be
shipped.
One
multi-platform product, Lucinda Green’s Equestrian Challenge, shipped in late
November 2006 for the PS2 in North America, and shipped in early January 2007
for the PC. This product shipped in July 2007 in Europe and is expected to
ship
in August 2007 in Australia.
Jackass:
The Game, currently in the late stages of development, is expected to be
available for shipment worldwide in September 2007 for the PSP and PS2 platforms
and in the third fiscal quarter of 2008 for the DS Platform. In
August of 2006, we also began the production stage of a sequel of Heroes of
the
Pacific set in the European theatre on the next generation console and PC.
It is
targeted for shipment in fiscal 2009. This game moved in August of 2006 from
the
pre-production phase to the production phase.
On
May
18, 2007 we entered into a multi-year world-wide license agreement with Frank
Miller, Inc., a New York Corporation (“FMI”). This license grants us the
exclusive rights for the development, manufacturing, and publishing of games
on
multi-platforms based on all current and future Sin City comic books and
collections, graphic novels, and other books owned or controlled by FMI,
including all storylines of those comic books and graphic novels. We
have currently commenced pre production on this game and expect development
to
begin in September 2007.
The
funds
required to develop a new game depend on several factors, including: the target
release platform, the scope and genre of the game design, the cost of any
underlying intellectual property licenses, the length of the development
schedule, the size of the development team, the complexity of the game, the
skill and experience of the development team, the location of the development
studio, and any specialized software or hardware necessary to develop a
game.
General
and Administrative Costs
General
and administrative costs were approximately $898,000 during the three months
ended June 30, 2007 as compared to approximately $683,000 during the three
months ended June 30, 2006, an increase of $215,000 or 32%. General
and administrative (G&A) costs are comprised primarily of the costs of stock
options issued to employees and consultants, employee salaries and benefits,
professional fees (legal, accounting, investor relations, and consulting),
facilities expenses, amortization and depreciation expenses, and insurance
costs. The majority of the increase relates to employee salaries and
related costs and amortization on the convertible
debentures. Employee salaries and related costs had a year over year
increase of approximately $107,000 or 41%. The increase is due to the
recognition of expense related to the fair value of employee option
grants. Amortization expense had a year over year increase of
approximately $77,000. The increase is primarily due to agent’s
commission, associated with the issuance of senior secured
convertible debentures during the third quarter of fiscal 2007.
We
expect
that G&A cost will increase substantially throughout the remainder of fiscal
2008 with our eventual implementation of Sarbanes-Oxley Section 404 and our
expectation to become a reporting issuer in Canada as well as expanding the
scope of our operations.
Sales,
Marketing and Business Development Costs
Sales,
marketing and business development costs were approximately $235,000 during
the
three months ended June 30, 2007 as compared to approximately $232,000 during
the three months ended June 30, 2006, an increase of $3,000 or
2%. Sales, marketing, and business development costs consist
primarily of employee salaries, stock option expenses, and employee benefits,
consulting costs, public relations costs, marketing research, and sales support
materials costs. Sales costs year over year increased approximately
$89,000 mainly due to the hiring of two full time employees. We did
not incur any sales related costs during the three months ended June 30,
2006. Business development costs year over year decreased
approximately $73,000 mainly due to the refocus only on franchise
products. Overal marketing costs year over year decreased
approximately $12,000 mainly due to the loss of one full time
employee. The net decrease in overall marketing costs was offset by
an approximately $48,000 increase in public relations/promotional costs
primarily due to the upcoming release of Jackass: The
Game. In addition, a net decrease of $27,000 in marketing costs were
realized from trade show costs that were incurred in the three months ended
June
30, 2006 but not incurred during the three months ended June 30,
2007.
With
the
expected release of Jackass: The Game in September 2007, we expect marketing
costs during fiscal 2008 to increase substantially. We plan a major
television and print advertising campaign behind this new game.
Critical
Accounting Policies and Estimates
Red
Mile's financial statements and related public financial information are based
on the application of accounting principles generally accepted in the United
States ("GAAP"). GAAP requires the use of estimates; assumptions, judgments
and
subjective interpretations of accounting principles that have an impact on
the
assets, liabilities, revenue and expense amounts reported. These estimates
can
also affect supplemental information contained in our external disclosures
including information regarding contingencies, risk and financial condition.
20
We
believe our use of estimates and underlying accounting assumptions adhere to
GAAP and are consistently applied. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances. Actual results may differ materially from these
estimates under different assumptions or conditions. We continue to monitor
significant estimates made during the preparation of our financial
statements.
Our
significant accounting policies are
summarized in Note 1 of our consolidated financial statements. While all these
significant accounting policies impact its financial condition andresults of operations,
Red Mile views
certain of these policies as critical. Policies determined to be critical are
those policies that have the most significant impact on Red Mile's consolidated
financial statements and require management to use a greater degree of judgment
and estimates. Actual results may differ from those estimates. Our management
believes that given current facts and circumstances, it is unlikely that
applying any other reasonable judgments or estimate methodologies would cause
a
material effect on our consolidated results of operations, financial position
or
liquidity for the periods presented in this report.
Revenue
recognition
Red
Mile’s revenue recognition policies are in accordance with the American
Institute Of Certified Public Accountants (“AICPA”) Statement of Position
(“SOP”) 97-2 “Software Revenue Recognition” as amended by SOP 98-9 ”Modification
of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”
and SOP 81-1 “Accounting for Performance of Construction Type and Certain
Production-Type Contracts”.
In
most
cases, Red Mile ships finished products to major third party game distributors
who will then sell these products to retailers. In North America, shipments
made
to an exclusive distributor are sold under consignment, and accordingly we
do
not record any revenue on these shipments until the distributor ships the games
to its customers. Revenue is recorded at the net amount the
distributor is obligated to pay us.
Red
Mile
may receive minimum guaranteed royalties or development advances from its
co-publisher(s) or distributor(s) prior to and upon final delivery and
acceptance of a completed game. Under these agreements, such payments do not
become non-refundable until such time as the game is completed and accepted
by
the co-publisher(s). Pursuant to SOP 81-1, the completed contract method of
accounting is used and these cash receipts are credited to deferred revenue
when
received.
In
cases
where the contract with the co-publisher(s) is a development contract, revenue
is recognized once the product is completed and accepted by the co-publisher(s).
This acceptance by the co-publisher(s) is typically concurrent with approval
from the third party hardware manufacturer for those products where approval
is
required from the third party hardware manufacturer.
In
cases
where the agreement with the co-publisher(s) or distributor(s) calls for these
payments to be recouped from royalties earned by Red Mile from sales of the
games, we do not recognize revenue from these payments until the game begins
selling. Accordingly, we recognize revenue as the games are sold by the
co-publisher(s) or distributor(s) using the stated royalty rates and definitions
in the respective contract(s). Periodically, we review our deferred revenue
balances and if the product is no longer being sold or when our current
forecasts show that a portion of the revenue will not be earned out through
forecasted sales of the games, the excess balance in deferred revenue is
recognized as revenue.
Determining
when and the amount of
revenue to be recognized often involves assumptions and judgments that can
have
a significant impact on the timing and amount of revenue we report. For example,
in recognizing royalty revenue, we must make assumptions as to the total number
of units a product will sell, the average selling price of these units,
potential returns and potential price protection of the product which could
result incredits to
retailers for their unsold inventory. Changes in any of these assumptions or
judgments could cause a material increase or decrease in the amount of net
revenue we report in a particular period.
Software
Development Costs
Software
development costs include the costs of milestone payments made to software
developers and other third parties under development contracts. Such costs
are
accounted for in accordance with Statement of Financial Standards No. 86
“Accounting For The Costs Of Computer Software To Be Sold, Leased or Otherwise
Marketed”.
Software
development costs are capitalized once technological feasibility is established
and such costs are determined to be recoverable from future sales of the game.
For products where
proven technology exists, this may occur very early in the development cycle.
Technological feasibility is determined on a game by game basis.
Capitalized
costs for such games that are cancelled or abandoned are charged immediately
to
cost of sales. Recoverability of capitalized software is evaluated on the
expected performance of the specific games for which the costs relate. Once
the
product is completed and released, capitalized software development
costs are amortized to cost of sales using the greater of the ratio of actual
cumulative revenues to the total of actual cumulative revenues plus projected
future revenues for each game or straight-line over the estimated life of the
product.
21
For
products released in prior periods, we evaluate the future recoverability of
capitalized amounts on a quarterly basis or when events or circumstances
indicate the capitalized costs may mot be recoverable.
Determining
the amount to be expensed in a period and the ultimate recoverability requires
judgments and assumptions that can have a significant impact on the timing
and
amount of the cost of sales that we report. For example, because the computation
of cost of sales requires us to periodically forecast the worldwide lifetime
unit shipments of a game, an increase or decrease in this assumption of total
lifetime shipments could cause a material increase or decrease in the amount
of
cost of sales we report in a particular period.
Receivable
Allowances
Receivables
are stated net of allowances for price protection, returns, discounts and
doubtful accounts.
We
grant
price protection or discounts to, and sometimes allow product returns from,
our
customers under certain conditions. Therefore, we record an allowance
for price protection, returns and discounts at each balance sheet
date. The provision related to this allowance is reported in net
revenues. Price protection means credits relating to retail price
markdowns on our products previously sold by us to customers. We base
these allowances on expected trends and estimates of potential future price
protection, product returns and discounts related to current period product
revenue. Actual price protection, product returns and discounts may
materially differ from our estimates as our products are subject to changes
in
consumer preferences, technological obsolescence due to new platforms or
competing products. Changes in these factors could change our
judgments and estimates and result in variances in the amount of allowance
required. If customers request price protection in amounts exceeding
the rate expected and if management agrees to grant it, then we may incur
additional charges.
Inventories
Inventories
consist of materials (including manufacturing royalties paid to console
manufacturers), labor charges from third parties, and freight-in. Inventories
are stated at the lower of cost or market, using the first-in, first-out
method. The Company performs periodic assessments to determine the
existence of obsolete, slow moving and non-saleable inventories, and records
necessary provisions to reduce such inventories to net realizable
value. We recognize all inventory reserves as a component of cost of
goods sold. All inventories are produced by third party
manufacturers, and substantially all inventories are located at third party
warehouses on consignment.
ITEM
3. CONTROLS AND PROCEDURES
The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s reports under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Commission’s rules and forms and that such information
is accumulated and communicated to the Company’s management, including its chief
executive officer and its chief financial officer, to allow for timely decisions
regarding required disclosure.
As
required by Commission Rule 13a-15(b), the Company carried out an evaluation,
under the supervision and with the participation of the Company’s management,
including the Company’s chief executive officer and chief financial officer, of
the effectiveness of the design and operation of the Company’s disclosure
controls and procedures as of the end of the quarter covered by this report.
Based on the foregoing evaluation, the Company’s chief executive officer and
chief financial officer concluded that these disclosure controls and procedures
were effective as of June 30, 2007.
There
has
been no change in the Company’s internal control over financial reporting during
the Company’s most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.
22
PART
II. OTHER INFORMATION
Item
1A
(“Risk Factors”) of the Company’s Form 10-KSB for the year ended March 31, 2007
sets forth information relating to important risks and uncertainties that could
materially adversely affect the Company’s business, financial condition or
operating results. Those risks factors continue to be relevant to an
understanding of the Company’s business, financial condition and operating
results. Certain of those risk factors have been revised below to provide
updated information. References to “we,” “our” and “us” in these risks factors
refer to the Company.
An
investment in our securities is highly speculative and involves a high degree
of
risk. Therefore, in evaluating us and our business you should carefully consider
the risks set forth below. You should be in a position to risk the loss of
your
entire investment.
Risks
Relating to Our Company
Because
we have only recently commenced business operations, it is difficult to evaluate
our prospects and we face a high risk of business
failure.
We
were
incorporated in August 2004 and shipped our first two games in our second fiscal
quarter of 2006 and an additional six games in fiscal 2007. During the three
months ended June 30, 2007, we shipped an additional three PC games from our
Roveractive, Ltd. casual games division. We therefore face the risks
and problems associated with businesses in their early stages in a competitive
environment and have a limited operating history on which an evaluation of
our
prospects can be made. Until we develop our business further by publishing
and
developing more games, it will be difficult for an investor to evaluate our
chances for success. Our prospects should be considered in light of the risks,
expenses and difficulties frequently encountered in the establishment of any
business in a competitive environment.
We
have not yet generated any income and may never become
profitable.
During
the years ended March 31, 2007 and 2006, and the three months ended June 30,
2007, we incurred net losses of $8,038,894, $4,849,678, and $1,376,844
respectively. Our ability to generate revenues and to become profitable depends
on many factors, including the market acceptance of our products and services,
our ability to control costs and our ability to implement our business strategy.
There can be no assurance that we will become or remain profitable.
If
we are unable to raise additional financing, we will be unable to fund our
planned expansion.
We
have
never achieved positive cash flow from operations and there can be no assurance
that we will do so in the future. We need additional financing to fund our
product development costs and the operating losses we anticipate incurring
over
the next several quarters. Our current cash on hand with our expected cash
flows
from operating activities will enable us to continue operating until the end
of
our third fiscal quarter of 2008. We anticipate needing an additional
$15,000,000 in addition to our cash flow from operations to bring our existing
products under development to market and finance our day to day
operations.
Because
we have significant accumulated deficit and negative cash flows from operations,
our independent registered accounting firm has qualified its opinion regarding
our ability to continue as a going concern.
We
have a
significant accumulated deficit and have sustained negative cash flows from
operations since our inception. The opinion of our independent registered
accounting firm for the years ended March 31, 2007 and 2006 contained an
explanatory paragraph regarding our ability to continue as a going concern.
In
fact, the opinion states that these factors raise substantial doubt as to our
ability to continue as a going concern. In order for us to operate and not
go
out of business, we must generate and/or raise capital to stay operational.
The
continuity as a going concern is dependent upon the continued financial support
of our current shareholders, current debenture holders and new investors. There
can be no assurance that we will be able to generate income or raise additional
capital.
If
we are unable to hire and retain key personnel, then we may not be able to
implement our business plan.
The
success and growth of our business will depend on the contributions of our
Chairman and Chief Executive Officer, Chester Aldridge and our President and
Chief Operating Officer, Glenn Wong, as well as our ability to attract, motivate
and retain other highly qualified personnel. Competition for such personnel
in
the publishing industry is intense. We do not have employment agreements with
Mr. Aldridge, Mr. Wong or any of our other employees. The loss of the services
of any of our key personnel, or our inability to hire or retain qualified
personnel, could have a material adverse effect on our business.
If
our business plan fails, our company will dissolve and investors may not receive
any portion of their investment back.
If
we are
unable to realize profitable operations, or raise sufficient capital, we will
be
unable to implement our business strategy. If we cannot continue to self publish
in North America, we will have to license our games to co-publishers, and our
profit and operating margins will be lower, making it more difficult to achieve
profitability, and our business will eventually fail.
23
In
such
circumstances, it is likely that we will dissolve and, depending on our
remaining assets at the time of dissolution, we may not be able to return any
funds back to investors.
Our
business depends on the availability and installed base of current and next
generation video game platforms and will suffer if an insufficient quantity
of
these platforms is sold.
Most
of
our anticipated revenues will be generated from the development and publishing
of games for play on video game platforms produced by third parties. Our
business will suffer if the third parties do not manufacture and sell an
adequate number of platforms to meet consumer demand or if the installed base
of
the platforms is insufficient.
If
we do not continually develop and publish popular games, our business will
suffer.
The
lifespan of any of our games is relatively short, in many cases less than one
year. It is therefore important for us to be able to continually develop games
that are popular with the consumers. During the last two fiscal years, we have
sold four Console or Handheld games and six PC only games. We are currently
involved in the development of three games, one of which is expected to ship
during fiscal 2008. If we are unable to continually identify, develop and
publish games that are popular with the consumers on a regular basis, our
business will suffer. Our business will also suffer if we do not receive
additional financing to be used for research and development of new
games.
We
have
shipped the following Console or Handheld games: (i) Heroes of the Pacific
for
the PS2, Xbox and PC platforms which first began shipping in September, 2005;
(ii) GripShift for the PSP platform which first began shipping in September
2005; (iii) Crusty Demons for the PS2 and Xbox platforms which first began
shipping in July 2006; (iv) Lucinda Green’s Equestrian Challenge for the PS2 and
PC which first began shipping in November 2006. On the PC, we have
shipped: (i) Disney’s Aladdin Chess Adventures which first began shipping in
February 2006; (ii) El Matador, which first began shipping in October 2006;
(iii) Dual Sudoku, which first began shipping in September 2006; (iv) Timothy
and Titus, which first began shipping in November 2006; (v) Aircraft Power
Pack,
which first began shipping in December 2006; and (vi) Lucinda Green’s
Equestrian Challenge, which we first began shipping in November 2006. We are
currently involved in the development of two games: (i) Jackass for the PS2,
PSP, and DS; and (ii) a sequel to Heroes of the Pacific based in the
European theatre for the Xbox 360, PS3, and PC. We have commenced pre
production of Sin city: The Game for the PS3 and Xbox 360 and expect to begin
development in September 2007.
The
cyclical nature of video game platforms and the video game market may cause
our
operating results to suffer, and make them more difficult to predict. We may
not
be able to adapt our games to the next generation
platforms.
Video
game platforms generally have a life cycle of approximately six to ten years,
which has caused the market for video games to also be cyclical. Sony’s
PlayStation 2 was introduced in 2000 and Microsoft’s Xbox and the Nintendo
GameCube were introduced in 2001. Microsoft introduced the Xbox 360, Sony the
PlayStation3 and Nintendo the Wii in 2006. These introductions have created
a
new cycle for the video game industry which will require us to make significant
financial and time investments in order to adapt our current games and develop
and publish new games for these new consoles. We cannot assure you that we
will
be able to accomplish this or that we will have the funds or personnel to do
this. Furthermore, we expect development costs for each game on the new consoles
to be significantly greater than in the past. If the increased costs we incur
due to next generation consoles are not offset by greater sales, we will
continue to incur losses.
We
are
dependent on our platform licensors for the license to the specifications needed
to develop software for their platforms. These platform licensors set the
royalty rates that we must pay in order to publish games for their platforms.
These royalty rates will vary based on the expected wholesale price point of
the
game. Certain of our platform licensors have retained the ability to change
their royalty rates. It is possible that a platform licensor may terminate
or
not renew our license. Our gross margins and operating margins will
suffer if our platform licensors increase the royalty rates that we must pay,
terminate their licenses with us, do not renew their licenses with us, or do
not
grant us a license to publish on the next generation consoles.
24
We
have
the following platform licenses:
Platform
|
|
Term
|
Microsoft
Xbox 360
|
|
Three
years from first commercial release of platform. Then automatic renewal
unless noticed 60 days prior to expiration of non-renewal. Royalty
rates
are fixed during the term.
|
Microsoft
Xbox
|
|
Initial
term expires on November 15, 2007. Then automatic renewal unless
noticed
60 days prior to expiration of non-renewal. Royalty may change on
July 1st
of any year.
|
|
|
Initial
term expired on March 31, 2007. Then automatic renewal unless noticed
60
days prior to expiration of non-renewal. Royalty rates are subject
to
change with 60 days notice.
|
Sony
PS3
|
|
Initial
term expired on March 31, 2012. Automatic renewal for one-year terms,
unless noticed on or before January 31 of the year in which the term
would
renew. Royalty rates are subject to change with 60 days
notice.
|
Nintendo
Gamecube
|
|
Expires
on August 17, 2007. Royalty rates are subject to change with 60 days
notice. Cost of manufacture is subject to change at any
time.
|
Nintendo
Wii and DS
|
|
Expires
June 12, 2010
|
PCs
|
|
There
are no platform licenses required for the
PCs
|
In
addition, each platform licensor has its own criteria for approving games for
its hardware platform. In addition, each platform licensor has different
criteria depending on the geographical territory of the game release. These
criteria are highly subjective. Without such approval, we would not be able
to
publish our games nor have the games manufactured. Failure to obtain these
approvals on the games we are currently developing and any games that we develop
in the future will preclude any sales of such products and, as such, negatively
affect our margins and profits.
Our
financial performance will suffer if we do not meet our game development
schedules.
We
expect
that many of our future games will be developed and published in connection
with
the releases of related movie titles and other significant marketing events,
or
more generally in connection with higher sales periods, including our third
quarter ending December 31. As such, we will establish game development
schedules tied to these periods. If we miss these schedules, we will incur
the
costs of procuring licenses without obtaining the revenue from sales of the
related games.
It
may become more difficult or expensive for us to license intellectual property,
thereby causing us to publish fewer games.
Our
ability to compete and operate successfully depends in part on our acquiring
and
controlling proprietary intellectual property. Our games embody trademarks,
trade names, logos, or copyrights licensed from third parties. An example is
MTVN’s JackassTM, which
utilizes
rights licensed from MTVN and Frank Miller’s, Sin City. If we cannot maintain
the licenses that we currently have, or obtain additional licenses for the
games
that we plan to publish, we will produce fewer games and our business will
suffer. Furthermore, some of our competitors have significantly greater
resources than we do, and are therefore better positioned to secure intellectual
property licenses. We cannot assure you that our licenses will be extended
on
reasonable terms or at all, or that we will be successful in acquiring or
renewing licenses to property rights with significant commercial
value.
Infringement
claims regarding our intellectual property may harm our
business.
Our
business may be harmed by the costs involved in defending product infringement
claims. We can give no assurances that infringement or invalidity claims (or
claims for indemnification resulting from infringement claims) will not be
asserted or prosecuted against us or that any such assertions or prosecutions
will not materially adversely affect our business. The images and other content
in our games may unintentionally infringe upon the intellectual property rights
of others despite our best efforts to ensure that this does not occur.
25
It
is
therefore possible that others will bring lawsuits against us claiming that
we
have infringed on their rights. Regardless of whether any such claims are valid
or can be successfully asserted, defending against such lawsuits could be
expensive and cause us to stop publishing certain games or require us to license
the proprietary rights of third parties. Such licenses may not be available
upon
reasonable terms, or at all.
The
content of our games may become subject to increasing regulation and such
regulation may limit the markets for our games.
Legislation
is periodically introduced at the local, state and federal levels in the United
States and in foreign countries that is intended to restrict the content and
distribution of games similar to the ones that we develop and produce, and
could
prohibit certain games similar to ours from being sold to minors. Additionally,
many foreign countries have laws that permit governmental entities to censor
the
content and advertising of interactive entertainment software. We believe that
similar legislation will be proposed in many countries that are significant
markets for our games, including the United States. If any of this proposed
legislation is passed, it could have the effect of limiting the market for
our
games and/or require us to modify our games at an additional cost to
us.
If
we or others are not successful in combating the piracy of our games, our
business could suffer.
The
games
that we develop and publish are often the subject of unauthorized copying and
distribution, which is referred to as pirating. The measures taken by the
manufacturers of the platforms on which our games are played to limit the
ability of others to pirate our games may not prove successful. Increased
pirating of our games throughout the world negatively impacts the sales of
our
games.
If
any of our games are found to contain hidden, objectionable content, our
business may be subject to fines or otherwise be
harmed.
Some
game
developers and publishers include hidden content in their games that are
intended to improve the experience of customers that play their games.
Additionally, some games contain hidden content introduced into the game without
authorization by an employee or a non-employee developer. Some of this hidden
content has in the past included graphic violence or sexually explicit material.
In such instances, fines have been imposed on the publisher of the game and
the
games have been pulled off the shelves by retailers. The measures we have taken
to reduce the possibility of hidden content in the games that we publish may
not
be effective, and if not effective our future income will be negatively impacted
by increased costs associated with fines or decreased revenue resulting from
decreased sales volume because of ownership of games that cannot be
sold.
Our
business is subject to economic, political, and other risks associated with
international operations.
Because
we have distribution agreements with entities located in foreign countries,
our
business is subject to risks associated with doing business internationally.
Accordingly, our future results could be harmed by a variety of factors,
including less effective protection of intellectual property, changes in foreign
currency exchange rates, changes in political or economic conditions,
trade-protection measures and import or export licensing requirements. Effective
protection of intellectual property rights is unavailable or limited in certain
foreign countries. There can be no assurance that the protection afforded our
proprietary rights in the United States will be adequate in foreign countries.
Furthermore, there can be no assurance that our business will not suffer from
any of these other risks associated with doing business in a foreign
country.
We
are currently dependent on a small number of customers, the loss of any of
which
could cause a significant decrease in our revenue.
As
of
June 30, 2007, we had two customers who accounted for 63.6% (Navarre
Corporation) and 32.0% (GameStop) of our consolidated accounts receivable and
three customers who accounted for 42.4% (Navarre Corporation), 32.7% (Funtastic,
Ltd.) and 15.1% (GameStop) of consolidated revenue. As of March 31, 2007, we
had
two customers who accounted for 49.1% (Navarre Corporation) and 28.1% (GameStop)
of our consolidated accounts receivable and three customers who accounted for
48.1% (Navarre Corporation), 18.1% (GameStop) and 14.7% (Koch Media) of
consolidated revenue. If Navarre Corporation or GameStop were to decrease their
purchase volume or discontinue their relationship with us, our revenue would
decrease significantly unless we were able to find new customers to replace
the
lost volume. There can be no assurance that such new customers could be found,
or if found, that they would purchase the same quantity as the current
customers.
We
have not yet internally developed any games that we sell and our business has
been derived from the sale of games developed by external development studios.
If the external developers of our games were to discontinue their relationship
with us, we may not be able to find a replacement. If our external developers
were to increase the fees that we pay for development, our costs would increase,
making it more difficult to achieve positive margins and profitability and
we
would be forced to find alternative developers. There can be no assurance that
we would be able to find alternative developers, or even if such developers
are
available, that they will be available on terms acceptable to us.
26
We
will incur increased costs as a result of being a public company, which could
adversely affect our operating results.
As
a
public company, we will incur significant legal, accounting and other expenses
that we did not incur as a private company. In addition, the Sarbanes-Oxley
Act
of 2002 and the new rules subsequently implemented by the Securities and
Exchange Commissions, the National Association of Securities Dealers, Inc.,
and
the Public Company Accounting Oversight Board have imposed various new
requirements on public companies, including requiring changes in corporate
governance practices. We expect these rules and regulations to increase our
legal and financial compliance costs and to make some activities more
time-consuming and costly. We also expect these new rules will require us to
incur substantial costs to obtain the same or similar insurance coverage. We
also expect to become a reporting issuer in Canada over the next 2 fiscal
quarters. These additional costs will have a negative impact on our
income and make it more difficult for us to achieve
profitability.
Effect
of Recent Accounting Pronouncements
EITF
06-03
In
June
2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue
No. 06-03 (“EITF 06-03”), “How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That
Is,
Gross versus Net Presentation).” EITF 06-03 provides that the presentation of
taxes assessed by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer on either a gross
basis (included in revenues and costs) or on a net basis (excluded from
revenues) is an accounting policy decision that should be disclosed. The
provisions of EITF 06-03 became effective as of December 31, 2006. Our adoption
of ETIF 06-03 has not and is not expected to have a material effect on our
consolidated financial position or results of operations.
SFAS
157
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157), which provides guidance on how to measure assets and
liabilities that use fair value. SFAS 157 will apply whenever another
US GAAP standard requires (or permits) assets or liabilities to be measured
at
fair value but does not expand the use of fair value to any new
circumstances. This standard also will require additional disclosures
in both annual and quarterly reports. SFAS 157 will be effective for
fiscal 2009. We are currently evaluating the potential impact this standard
may
have on its financial position and results of operations.
SFAS
159
On
February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159). Under this
Standard, we may elect to report financial instruments and certain other items
at fair value on a contract-by-contract basis with changes in value reported
in
earnings. This election is irrevocable. SFAS No. 159 provides an opportunity
to
mitigate volatility in reported earnings that is caused by measuring hedged
assets and liabilities that were previously required to use a different
accounting method than the related hedging contracts when the complex provisions
of SFAS No. 133 hedge accounting are not met. SFAS No. 159 is effective for
years beginning after November 15, 2007. Early adoption within 120 days of
the
beginning of the company’s 2008 fiscal year is permissible, provided the company
has not yet issued interim financial statement for 2008 and has adopted SFAS
No.
157. Management is currently evaluating the potential impact of adopting this
Standard.
Effective
April 1, 2007, we adopted the provisions of FASB Interpretation
No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation
of FASB Statement No. 109, or FIN 48. FIN 48 provides
detailed guidance for the financial statement recognition, measurement and
disclosure of uncertain income tax positions recognized in the financial
statements in accordance with SFAS No. 109. Income tax positions must meet
a “more-likely-than-not” recognition threshold at the effective date to be
recognized upon the adoption of FIN 48 and in subsequent
periods. For the three months ended June 30, 2007, we did not
identify and record any liabilities related to unrecognized income
tax benefits. Therefore the adoption of FIN 48 does not impact our
financial statements for the three months ended June 30, 2007.
27
ITEM
2. Creation of a Direct
Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement
of
Registrant.
On
June
25 through June 27, 2007, the Company issued an aggregate of $2,050,000 of
Convertible Promissory Notes (the “Notes”) to a total of 19 note holders with
J.F. Mackie & Company, Ltd. acting as the placement agent (the “Agent”). All
the note holders are residents of Canada. The Notes mature on the earlier to
occur of a Sale Event, as defined below, or the one year anniversary of the
date
of issuance. A Sale Event constitutes a bona fide, negotiated
transaction or integrated series of transaction pursuant to which either: (i)
the Company merges or consolidates with any other non-affiliated entity or
sells, exchanges, or otherwise disposes of all or substantially all of its
assets to a non-affiliated third party; or (ii) in which more than 50% of the
Company’s voting power is transferred in a private placement to one
person.
In
addition, on June 25, 2007, the Company, without the assistance of the Agent,
issued a $350,000 Convertible Promissory Note to one note holder. This note
holder is also a resident of Canada. This note matures on the same terms as
the
Notes (the Notes and this additional note, the “Combined Notes”).
The
Combined Notes will automatically convert if the Company completes prior to
maturity an equity financing in an amount of approximately $10 million on
certain terms. In the case of such a conversion, the Combined Notes
will convert into the form of equity issued by the Company in that equity
financing at a price per share equal to the lowest price in that financing.
Immediately upon such conversion, the Note Holder will also receive one half
of
one warrant for every share received upon conversion of the note held by such
Note Holder, exercisable at $2.75 per share for a period of 2 years from the
closing date of such equity financing.
The
Combined Notes bear interest at the rate of 10% per annum, non-compounded,
and
the interest is payable in cash by the Company on the maturity date. The
Agent is to be paid a commission equal to 6% of the principal amount of the
Notes.
The
Combined Notes are subordinated obligations of the Company secured against
all
present and after acquired assets of the Company.
The
Combined Notes were issued in private placement transactions to investors who
are not "U.S. persons" pursuant to the exemption from registration provided
by
Rules 901 and 903 of Regulation S under the Securities Act of 1933, as
amended.
On
July
18, 2007, the convertible promissory notes automatically converted upon the
completion of a private placement financing as described inour subsequent events
note (Note 10) into 960,000 shares of the Company's common stock and 192,000
warrants. One whole warrant entitles the holder to acquire, for no
additional consideration, one common share of the Company in the event that
the
Company does not complete a liquidity transaction by March 18, 2008. The
warrants will automatically be cancelled if the Company completes such a
liquidity.
28
ITEM
6. EXHIBITS
31.1
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Certification
of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
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31.2
|
Certification
of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
|
32.1
|
Certification
of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
|
Certification
of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|
SIGNATURES
Pursuant
to the requirements of the Securities and Exchange Act of 1934, the Registrant
had duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
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RED
MILE ENTERTAINMENT, INC.
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|
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(Registrant)
|
Date: August
10, 2007
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By:
/s/ Chester Aldridge
|
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Chester
Aldridge
|
|
|
Chief
Executive Officer
|
|
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(Principal
Executive Officer)
|
Date: August
10, 2007
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By:
/s/ Ben Zadik
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Ben
Zadik
|
|
|
Chief
Financial Officer
|
|
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(Principal
Financial Officer)
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30