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SAPX > SEC Filings for SAPX > Form 10-K/A on 9-Nov-2012All Recent SEC Filings

Show all filings for SEVEN ARTS ENTERTAINMENT INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K/A for SEVEN ARTS ENTERTAINMENT INC.


9-Nov-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the preceding financial statements and footnotes thereto contained in this report. This discussion contains forward-looking statements, which are based on our assumptions about the future of our business. Our actual results may differ materially from those contained in the forward-looking statements.

Company Overview

We are an independent motion picture production company engaged in developing, financing, producing and licensing theatrical motion pictures with budgets in the range of $2 million to $15 million for exhibition in domestic (i.e. the United States and Canada) and foreign theatrical markets and for subsequent post-theatrical worldwide release in other forms of media, including DVD, home video, pay-per-view, and free television. Our pictures generally receive either a wide theatrical release (1,000 to 3,000 theaters in the United States) or only a limited theatrical release (50-300 theaters in the United States), or may even be released directly to post-theatrical markets, primarily DVD. Our pictures that receive limited theatrical release or post-theatrical release typically benefit from lower prints and advertising ("P & A") cost and, in turn, improved gross profit margins. We determine the size of a theatrical release in the United States based on distributor and our estimates of the commercial prospects of theatrical box office and our own evaluation of the level of expected theatrical release costs as opposed to our estimation of potential theatrical box office in the United States.

No one picture had a principal or controlling share of gross revenues or operating profits in these periods.

Film Company

We license distribution rights in our motion pictures in the United States and in most foreign territories prior to and during the production or upon the acquisition of rights to distribute a picture. We share in the commissions generated by the sales of the pictures. Sale of a license to distribute a motion picture prior to its delivery is termed a "pre-sale" and may occur at any time during the development and production process. In a typical license agreement, we license a picture to a distributor before it is produced or completed for an advance from the licensee, which advance is recoverable by the distributor from our share of the revenues generated by the distribution of the picture in the licensee's territory, after deduction of the distributor's expenses and distributor fee. The advance usually is in the form of a cash deposit plus a letter of credit or "bank letter" for the balance payable 10-20% on execution (i.e., the cash deposit) and the balance on delivery (i.e., the letter of credit or "bank letter"). The license grants the distributor the right to the post-theatrical release of the picture in all or certain media in their territory for a predetermined time period. After this time, the distribution rights revert back to us and we are then free to re-license the picture. The license specifies that the distributor is entitled to recoup its advance from the revenue generated by the release of the picture in all markets in its territory, as well as its release costs and distribution fees.

After the distributor has recouped its advance, costs, and fees, any remaining revenue is shared with us according to a predetermined formula. This is known as an "overage" and can be a significant source of revenue for us from successful films. However, a film's poor reception in one market does not preclude it from achieving success in another market and generating significant additional revenue for us in the form of an "overage" in that territory. In all of our licensing arrangements, we retain ownership of our films and maintain our control of each copyright. We intend to continue the practice of retaining underlying rights to our film projects in order to continue to build our motion picture library to license or sell in the future.


We create a separate finance plan for each motion picture we produce. Accordingly, the sources of the funds for production of each motion picture vary according to each finance plan. We utilize financing based on state and foreign country tax credits (e.g. Louisiana, United Kingdom and Hungary) and direct subsidies, "mezzanine" or "gap" funds, which are senior to our equity, and senior secured financing with commercial banks or private lenders, together in certain cases with a limited investment from us, which is customarily less than 10% of the production budget. Since each finance plan is unique to each motion picture, we cannot generalize as to the amount we will utilize any of these sources of funds for a particular motion picture. We generally obtain some advances or guarantees prior to commitment to production of a motion picture project, but those amounts may not be substantial on smaller budgeted motion picture (e.g., under $10,000,000), and in certain cases we have committed to production with an insubstantial amount of advances and guarantees. Unless we can manage the risks of production through the use of these financing techniques, we will not likely commit to production of larger budget motion pictures (e.g., over $15,000,000), and we have never in the past committed to such productions, without substantial advances or guarantees from third-party distributors, or the equivalent in "non-recourse" financings.

Music Company

Seven Arts Music Inc ("SAM") became a wholly owned subsidiary of the Company on February 23, 2012, although set-up costs had been incurred as early as September 2011. The delivery of the first of the DMX albums acquired from David Michery was released on September 11, 2012 and initial costs in creating the first album for Bone Thugs-N-Harmony are being incurred for delivery in November 2012. Several other new artists are being considered by SAM.

Post-Production Facility

As of June 30, 2012 SAFELA was transferred to the Company. SAFELA, which is 60% owned by the Company, has a 30 year lease to run a production and post-production facility at 807 Esplanade Avenue in New Orleans, Louisiana ("807 Esplanade"). The facility commenced operations on August 12, 2012.

Company Outlook

The principal factors that affected our results of operations have been the number of motion pictures delivered in a fiscal period, the distribution rights of motion pictures produced by others acquired in a fiscal period, the choice of motion pictures produced or acquired by us, management's and talents' execution of the screenplay and production plan for each picture, the distribution and market reactions to the motion pictures once completed, management's ability to obtain financing and to re-negotiate financing on beneficial terms, the performance of our third-party distributors and our ability to take advantage of tax-incentivized financing. These factors will continue to be, in our opinion, the principal factors affecting future results of operation and our future financial condition. No particular factor has had a primary or principal effect on our operations and financial condition in the periods discussed below.

Our revenues principally consist of amounts we earned from third-party distributors of its motion pictures. We recognize revenue from license fees as and when a motion picture is delivered to the territory to which the license relates if we have a contractual commitment and the term of license has begun or upon receipt of a royalty statement or other reliable information from a distributor of the amounts due to us from distribution of that picture. A motion picture is "delivered" when we have completed all aspects of production and may make playable copies of the motion picture for exhibition in a medium of exhibition such as theatrical, video, or television distribution.

We also recognize revenue beyond an initial license fee from our share of gross receipts on motion pictures which we recognize as revenue when we are notified of the amounts that are due to us. In some fiscal periods, a significant portion of our revenue is derived from sources other than motion picture distribution, including the cancellation of debt and interest income on a financing transaction.

We have also benefited significantly from our ability to raise third party film equity investments such as in tax advantaged transactions under which we transfer to third party investor's tax benefits for motion picture production and distribution. These types of investments have enabled us to substantially reduce the cost basis of our motion pictures and even to record significant fee-related revenues.

RESULTS OF OPERATIONS
for the Year Ended June 30, 2012 Compared To Year Ended June 30, 2011

Our total revenues increased from $3,328,388 for the fiscal year ended June 30, 2011 to $8,363,904 in the fiscal year ended June 30, 2012. This increase principally relates to the fee income earned from SAPLA related to the production/post-production facility located at 807 Esplanade in New Orleans, Louisiana. The gross fee recorded of $9,447,544 represents the proceeds from disposition of the tax credits to be received by SAPLA for Louisiana and Federal historic rehabilitation expenses and Louisiana film infrastructure expenses, less a provision of $1,906,646 for the costs of deposing of these tax credits and any reductions resulting from Louisiana or Federal revenue authority adjusting the audited expenses submitted by the Company on which the tax credits are based.


Revenues derived from the licensing and distribution of motion pictures decreased from $2,758,359 in the previous fiscal year to $823,006 in this fiscal year, due to a decrease in sales on the motion pictures Deal and American Summer. The digital release of Pool Boys (American Summer) in the Autumn of 2011 was less than management expectation.

Fee-related revenues in the fiscal year ended June 30, 2011 derived from:

a) Producer's fees of $70,029 resulting from excess tax credits received on Night of the Demons.

b) $500,000 of production fees related to the production and preproduction of three films in Louisiana.

There are no such revenues in the fiscal year ended to June 30, 2012.

Costs of revenue increased from $3,447,996 to $4,895,641 including certain distribution costs, producers' costs and other third party payments, and amortization and impairment of film costs of $3,996,576. The amortization charge represents the amortization of the film assets calculated as the portion of the current year revenue compared to management's estimate of the ultimate revenue from the films.

Consequently, the Group recorded a gross profit of $3,468,263 in the year-ended June 30, 2012 compared to a gross loss of ($119,608) in the year-ended June 30, 2011

General and administrative expenses increased to $2,251,139, from $1,852,303. External legal and professional fees were significantly increased by approximately $400,000, as a result of investigations carried out in the year by government authorities, as well as a significant increase in NASDAQ compliance matters. The acquisition of the music assets has increased general and administrative expense although a substantial proportion of such expenses was capitalized into music assets, with the development of the DMX album and videos.

Management's reserve for doubtful accounts increased to $307,481 compared to $234,429 due to the continued consolidation in the international film business.

The Company had an one-time revaluation due to asset transfer of $6,459,248 during the year ended June 30, 2012 of film costs, the most significant of which related to the decreased revenue estimates on the film, The Pool Boys, which was released in September 2011.

We recorded $4,458,621 in other income for the fiscal year ended June 30, 2011 reflecting forgiveness of debt mainly from a Workout Agreement reached with Palm Finance Inc. and Arrowhead Consulting Group, compared to $31,100 in "other income" in the fiscal year ended June 30, 2012.

Net interest expense increased from $758,197 to $2,752,681, reflecting settlement agreements with senior lenders Blue Rider, Cold Fusion and 120db, and accrual of a full year's interest charge on the Pool Boys, Autopsy and Nine Miles Down production loans. Interest of these production loans was forgiven in the prior fiscal year ended June 30, 2011. The Company disputes $957,696 of the interest expense charged to the Pool Boys/Autopsy and Nine Miles Down loans as it has a different interpretation of the contract to that of Palm. Management believe this dispute will be resolved in the near future.

We recorded no tax provision in the fiscal year ended June 30, 2012, because we had no taxable income.

As result of the aforementioned results, we recorded a net loss of ($8,271,186) in the fiscal year ended June 30, 2012 compared to a net profit of $1,461,554 for the fiscal year ended June 30, 2011.


Foreign Currency Transactions and Comprehensive Income

The Company's functional currency, as well as the Company's subsidiaries, is the US Dollar. The functional currency of PLC, was the Pound Sterling ("GBP"), and some transactions which are generated in the United Kingdom are denominated in GBP.

Assets and liabilities generated in a currency other than the functional currency are translated at exchange rates as of the balance sheet date. Revenues and expenses are translated at average rates in effect for the periods presented. The cumulative translation adjustment is included in the accumulated other comprehensive gain (loss) within shareholders' equity (deficit). Foreign currency transaction gains and losses arising from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the consolidated results of operations.

Where possible, the Company seeks to match GBP income with GBP expenditures. To date, the Company has not hedged any transactional currency exposure but will keep such exposures under review and where appropriate may enter into such transactions in future.

Segment Reporting

The Company now operates in two business segments as a motion picture producer and distributor and as a music label managing the assets acquired from Mr Michery. The Company believes that its businesses should be reported as two business segments.

In accordance with ASC 280 Segment Reporting, operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions how to allocate resources and assess performance. Our chief decision maker, as defined under the FASB's guidance, is a combination of the Chief Executive Officer and the Chief Financial Officer.

In the quarter ended March 31, 2012, the Company formed a new subsidiary, SAM, and acquired music assets from Mr. Michery and purchased the stock of BJM. This is a new line of business for the Company, and therefore, will now have two reportable operating segments.

The table below presents the financial information for the two reportable segments for the year ended June 30, 2012. Comparable financial information for 2011 is not presented as the Company only had one segment during that time.

                                      Twelve months ended
                                         June 30, 2012
                             Film            Music           Total
Revenues                 $   8,357,927     $    5,977     $  8,363,904
Cost of revenues            (4,856,610 )      (39,031 )     (4,895,641 )
Gross profit/(loss)      $   3,501,317     $  (33,054 )   $  3,468,263
Operating expenses         ( 8,926,363 )      (91,505 )     (9,017,868 )
Profit from operations   $ ( 5,425,046 )   $ (124,559 )   $ (5,549,605 )

As of June 30, 2012, the Company had film and music assets of $14,612,609 and $2,923,474 respectively. As of June 30, 2011, all of the Company's assets were related to film. From July 1, 2012 there will be three segments reported due with the commencement of operations of the post-production facility at 807 Esplanade.

LIQUIDITY AND CAPITAL RESOURCES

Management assesses the Company's liquidity in terms of its ability to generate cash to fund its operating, investing and financing activities and whether it will be sufficient to allow it to continue investing in existing businesses, consummating strategic acquisitions, paying interest and servicing debt and managing its capital structure on a short and long-term basis.


Short Term Liquidity

The Company has a retained deficit of $8,271,186 as of June 30, 2012. Management believes that, as a result of the proceeds derived from the proposed offering (registration statement, Form S-3, filed August 20, 2012) , and based on historical revenues generated from the licensing of the distribution rights on our motion pictures and the new revenues generated from the music division and post-production facility, we will have sufficient working capital to operate for the next twelve months. Fiscal 2012 was a year of development of the music and post-production businesses, as well as work on strengthening the balance sheet through conversion of debt to equity which is anticipated to lead to positive cash flow from operations during fiscal 2013. Less than $6,000 of revenue was recorded in the year ended June 30, 2012 related to the music assets and post-production facility.

We currently borrow funds for the financing of each of our motion pictures from several production lenders. There can be no assurances given that the Group will be able to borrow funds to finance our motion pictures in the future

Long Term Liquidity

The long term liquidity needs of the Company, are projected to be met primarily through the cash flow provided by operations. Cash flow from Operating Activities is expected to become positive in fiscal 2013 due to the impact of the release of the first DMX album, the operation of the post-production facility and on-going film revenues.

Cash Flows

Operating Activities: Net cash used in operating activities in the year ended June 30, 2012 was $4,082,438. An increase in receivables from fee income from related parties was offset by the amortization and impairment of film costs during the year. Additionally, $640,527 of common stock was issued for services during the year.

Investing Activities: Net cash used in investing activities in the year ended June 30, 2012 was $9,409,615 which is attributable to the acquisition of the music assets, leasehold improvements for the post-production facility and additions to film costs for films currently in production.

Financing Activities: Net cash provided by financing activities during the year ended June 30, 2012 was $13,603,926 mainly due to the proceeds from additional debt, the assumption of debt on 807 Esplanade, and issuance of common stock for cash and issuance of preferred stock for the acquisition of the music assets.

Capital Resources

As of June 30, 2012, the Company did not have any outstanding capital commitments. As of the date of this filing the Company had no other commitments than disclosed in the Company's financial statements and notes to the financial statements.

WORKING CAPITAL: Working capital at June 30, 2012 was $(10,298,134). This is a favorable change versus June 30, 2011 of ( $15,199,849). The change is mainly due to:

a) Receivables due from related party fees earned on 807 Esplanade

b) Reduction in accounts payable and VAT

c) Conversion of short-term debt to equity

Working capital is negative due to the fact that all the loans are classified as current even with longer-term workout agreements. The receivables for the fee income from related parties will be paid out over the next four years and, accordingly, are reported long and short-term. The majority of the other loans are convertible to stock so will have little or no cash impact.

Additionally, the mortgage and construction loans on 807 Esplanade are current liabilities with corresponding leasehold improvements being recorded as non-current assets.

SHAREHOLDER'S EQUITY/(DEFICIT): Shareholder's Equity at June 30, 2012 was $13,449,284 increasing from June 30, 2011 by $7,958,253. The change was primarily due to:

a) Acquisition of music assets for preferred stock (Series B)

b) Sales of preferred stock for cash (Series A)

c) Addition of leasehold improvements on 807 Esplanade

d) Net reduction in loans despite taking on the mortgage and construction loans of 807 Esplanade

e) Conversion of debt to equity though issuance of common shares


The Company has the following indebtedness as of June 30, 2012:

Lender                 Date of Loan    Due Date       Balance        Interest Rate        Terms/Status
Film and Production
Loans

                                                                                          Forebearance
Palm Finance *                                      $ 4,324,431                  18 %      agreement
                                                                                          Forebearance
Palm Finance                                        $    82,354                  18 %      agreement

                                                                                          Forebearance
Palm Finance *                                      $ 1,538,218                  18 %      agreement

120db Film Finance
LLC                                                 $     4,425          Non stated      Due on demand

Cold Fusion Media
Group LLC                                           $   175,000                  10 %    Due on demand


Total Film and
Production Loans                                    $ 6,124,428

Other loans
Other
Trafalgar Capital
(in liquidation)                                    $   531,986                   9 %    Due on demand
TCA loan                 03/31/2011    09/30/2011   $    62,149                  10 %    Due on demand
GHP Note                                            $   137,573
JMJ Financial (**)       06/29/2012    10/27/2012   $   500,137                  10 %
                                                    $ 1,231,845
Convertibles
Hanover Holding          10/19/2011    05/18/2012   $   160,479                  10 %    Due on demand
                                                                                           Paying in
Hanover Holding          11/16/2011    02/16/2012   $    65,821                  12 %     instalments
Beauvoir Capital
Ltd                      11/22/2011    03/31/2012   $   110,899                  18 %    Due on demand
FireRocks-East Side
Holdings                 12/12/2011    06/12/2012   $    28,784                  12 %    Due on demand
Aegis - Tripod           12/15/2011    06/30/2012   $    35,504                  12 %    Due on demand
Aegis - CMS              12/15/2011    06/30/2012   $    35,503                  12 %    Due on demand
Aegis - Rachel           12/15/2011    06/30/2012   $    35,503                  12 %    Due on demand


Runway                 01/11/2012    09/30/2012   $    200,682            12 %    Due on demand
Tripod                 01/16/2012    06/30/2012   $     52,729            12 %    Due on demand
Isaac Loan             01/20/2012    06/30/2012   $    263,315            12 %    Due on demand
Sendero                01/24/2012    09/30/2012   $    262,986            12 %
Tripod - $150k         02/01/2012    02/01/2013   $    125,918            12 %
Michael Briskin        02/03/2012    02/03/2013   $    104,866            12 %
                                                                                    Paying in
Hanover                02/23/2012    08/23/2012   $    420,053            10 %     instalments
Briskin - $50k         04/04/2012    10/10/2012   $     52,500            10 %
Briskin - $40k         04/13/2012    10/22/2012   $     41,667            10 %
Briskin - $60k         04/17/2012    10/22/2012   $     62,500            10 %
Briskin - $45k         05/14/2012    10/22/2012   $     46,350            10 %
Firerock - $62,500     06/21/2012    12/21/2012   $     62,654            10 %
Agua Alta (Cold
Fusion)                06/25/2012    06/25/2013   $    100,163            12 %
Beaufort               06/26/2012    06/26/2013   $     50,066            12 %
                                                  $  2,318,942

807 Esplanade
Beaufort - $100k
(807 Esplanade)        04/06/2012    04/05/2013   $    102,794            12 %
Beaufort - $250k
(807 Esplanade)        04/13/2012    04/12/2013   $    256,411            12 %
Old Capital - $250k
(807 Esplanade)        05/31/2012    05/30/2013   $    252,466            12 %
Palm Finance -
mortgage and                                                                       Forebearance
construction loan                                 $  3,001,271            15 %      agreement

SAFELA loans
outstanding                                       $  3,612,942

Total Other Loans                                 $  7,163,731

TOTAL LOANS                                       $ 13,288,159


___________

*The Company does not agree with $957,696 of interest charged by Palm on these two film loans and believes the dispute will be resolved once the loans are repaid from the proceeds from the fee income.

** In connection with this loan of $500,000 with JMJ Financial, and a new loan entered into with Tonaquint Inc. of $435,000, the Company issued to Mr. Hoffman, our CEO, who will in turn pledge 8,000,000 shares to JMJ and has pledged 7,000,000 shares of our common stock to Tonaquint, in exchange for a portion of our existing indebtedness to Mr. Hoffman. Mr. Hoffman has agreed to return these shares to us if not levied on by the pledges.


Contractual Obligations (as of June 30, 2012):

The following table sets forth our obligations and commitments to make future
payments under contracts and other commitments.

                             Payments due by Period

                                                                                                             More than 5
                                     Total          Less than 1 year        1-3 years        3-5 years          years
Film and other production loans
(1)                               $  6,124,428     $        6,124,428
Trafalgar Capital Special
Investment Fund (4)               $    531,987     $          531,987
JMJ Financial (7)                 $    500,137     $          500,137
Convertible Loans (6)             $  2,318,942     $        2,318,942
Loans relating to 807 Esplanade
(2)                               $  3,612,942     $        3,612,942
Other Loans                       $    199,723     $          199,723
Sums due to Producers (5)         $    150,982     $          150,982
Provision for earn-out            $     50,000                                                   50,000
. . .
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