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 an accumulated deficit of $28,072,446 at September
30,
2007, and has incurred negative cash flows from operations since
inception.
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, 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. The 3/31/07 balance sheet
was
derived from audited financial statements filed with our 10-KSB as of 3/31/07
and therefore may 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,
retail sell through estimates, provisions for doubtful accounts, accrued
liabilities, estimates regarding the recoverability of advanced royalties,
inventories, software development costs, long lived assets, estimates of when
a
game in development has reached technological feasibility 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 are 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
September 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 September 30, 2007 and March 31, 2007, Red Mile had uninsured
bank balances and certificates of deposit totaling approximately $2,265,000
and
$1,731,000, respectively
.
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 future retail sell through of our
games. 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
$21,521 for the three and six months ended September 30, 2007 and $0 and $0
for
the three and six months ended September 30, 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, consisting primarily of finished goods and components, are made
up
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 Advanced Royalties
— Software development costs
and advanced royalties to developers include milestone payments made to
independent software developers and other third parties under development
contracts and direct labor costs. Software development costs and
advanced royalties 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”.
Software
development costs are capitalized once technological
feasibility of a product is established and such costs are determined to be
recoverable. For products where proven technology exists, this may occur very
early in the development cycle. Factors we consider in determining when
technological feasibility has been established include (i) whether a proven
technology exists; (ii) the quality and experience levels of the development
studio developing the game; (iii) whether the game is a sequel to an already
completed game which has used the same or similar technology; and (iv) whether
the game is being developed with a proven underlying game engine. Technological
feasibility is evaluated on a product-by-product basis. Capitalized costs for
those products that are cancelled or abandoned are charged immediately to cost
of sales. The recoverability of capitalized software development costs is
evaluated based on the expected performance of the specific products for which
the costs relate.
Commencing
upon a product’s release, capitalized software development costs are amortized
to cost of sales using the greater of the ratio of actual cumulative revenues
during the quarter to the total of actual cumulative revenues during the quarter
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 development costs and advanced
royalties. In evaluating the recoverability of capitalized software
development costs and advanced royalties, 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”. SOP 81-1
“Accounting for Performance of Construction Type and Certain Production-Type
Contracts”. Staff Accounting Bulletin (“SAB”) No. 101, “Revenue
Recognition in Financial Statements”, as revised by SAB No. 104, “Revenue
Recognition”. EITF 01-09 “Accounting for Consideration
Given by a Vendor to a Customer”, and FASB Interpretation No. 39 “Offsetting of
amounts related to certain contracts an interpretation of APB No. 10 and FASB
Statement No. 105.
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.
(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 on consignment.
(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. At September 30, 2007 and March
31, 2007, our returns and price protection reserves was $459,148 and $171,841,
respectively.
In
North
America, we primarily sell our games through distributors to retailers that
both
our internal and outsourced sales force and the distributors’ sales force
generate orders from. These distributors will charge us a
distribution fee based on a percentage of the prevailing wholesale price of
the
product. We record revenues net of these distribution fees.
Red
Mile may receive minimum guaranteed amounts from a 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 amounts 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 amounts
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 and six months ended September 30, 2007,
no
unearned fees were included in revenue.
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 and six months ended September 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). 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.
Loss
Per Share
—
We compute basic and diluted loss per share amounts pursuant to the
Statement of
Financial Accounting Standards (“SFAS”) No. 128, “Earnings per Share.” Basic
loss per share are computed using the weighted average number of common shares
outstanding during the period. Diluted loss per share are computed using the
weighted average number of common and potentially dilutive securities
outstanding during the period. Potentially dilutive securities consist of the
incremental common shares issuable upon on exercise of stock options, warrants,
convertible promissory notes, and senior secured convertible debentures (using
the treasury stock method). Potentially dilutive securities are excluded from
the computation if their effect is anti-dilutive.
The
following table summarizes the weighted average shares outstanding for the
six
months ending September 30, 2007 and 2006:
|
|
Six
Months Ended September 30,
|
|
|
|
2007
|
|
|
2006
|
|
Basic
weighted average shares outstanding
|
|
|
12,099,236
|
|
|
|
7,470,341
|
|
Total
stock options outstanding
|
|
|
1,791,009
|
|
|
|
1,037,633
|
|
Less:
anti-dilutive stock options due to loss
|
|
|
(1,791,009
|
)
|
|
|
(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
warrants outstanding
|
|
|
4,056,104
|
|
|
|
3,475,953
|
|
Less:
anti-dilutive warrants due to loss
|
|
|
(4,056,104
|
)
|
|
|
(3,475,953
|
)
|
Diluted
weighted average shares outstanding
|
|
|
12,099,236
|
|
|
|
7,470,341
|
|
The
following table summarizes the weighted average shares outstanding for the
three
months ending September 30, 2007 and 2006:
|
|
Three
Months Ended September 30,
|
|
|
|
2007
|
|
|
2006
|
|
Basic
weighted average shares outstanding
|
|
|
14,510,238
|
|
|
|
8,378,608
|
|
Total
stock options outstanding
|
|
|
1,791,009
|
|
|
|
1,037,633
|
|
Less:
anti-dilutive stock options due to loss
|
|
|
(1,791,009
|
)
|
|
|
(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
warrants outstanding
|
|
|
4,056,104
|
|
|
|
3,475,953
|
|
Less:
anti-dilutive warrants due to loss
|
|
|
(4,056,104
|
)
|
|
|
(3,475,953
|
)
|
Diluted
weighted average shares outstanding
|
|
|
14,510,238
|
|
|
|
8,378,608
|
|
NOTE
2 — ACCRUED
LIABILITIES
|
|
September
30, 2007
|
|
|
March
31, 2007
|
|
Accrued
professional fees
|
|
$
|
156,453
|
|
|
$
|
217,370
|
|
Accrued
royalties payable
|
|
|
44,917
|
|
|
|
50,676
|
|
Accrued
bonuses
|
|
|
87,823
|
|
|
|
87,314
|
|
Accrued
milestone payments to developers
|
|
|
146,085
|
|
|
|
420,000
|
|
Accrued
paid time off
|
|
|
55,698
|
|
|
|
38,741
|
|
Other
miscellaneous
|
|
|
11,505
|
|
|
|
93,203
|
|
Accrued
marketing costs
|
|
|
571,500
|
|
|
|
175,000
|
|
Accrued
commissions
|
|
|
159,113
|
|
|
|
42,094
|
|
Total
|
|
$
|
1,233,094
|
|
|
$
|
1,124,398
|
|
NOTE
3 — DEFERRED REVENUE
|
|
September
30, 2007
|
|
|
March
31, 2007
|
|
Lucinda
Green’s Equestrian Challenge
|
|
$
|
217,188
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
217,188
|
|
|
$
|
—
|
|
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 license 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 September 30, 2007 are approximately $18,430,925, which
is scheduled to be paid as follows:
Year
ended March 31,
|
|
2008
|
|
$
|
5,687,681
|
|
2009
|
|
|
6,017,134
|
|
2010
|
|
|
6,726,110
|
|
Total
|
|
$
|
18,430,925
|
|
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 six months ended September
30, 2007 was $37,440.
The
minimum future lease payment for the above lease as of September 30, 2007 is
$31,200 for the fiscal year ended March 31, 2008. No payments are due in future
fiscal years beyond 2008.
NOTE
5 — 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
September
30, 2007
|
Expected
life (in years)
|
|
4.2
– 6.5
|
Risk
free rate of return
|
|
|
Volatility
|
|
50%
- 80%
|
Dividend
yield
|
|
-
|
Forfeiture
rate
|
|
9%
- 15%
|
The
following table sets forth the total stock-based compensation expense for the
three months ended September 30, 2007 and September 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
September
30, 2007
|
|
|
Three
Months
Ended
September
30, 2006
|
|
Research
and development costs
|
|
$
|
5,659
|
|
|
$
|
5,648
|
|
Sales,
marketing, and business development costs
|
|
|
7,284
|
|
|
|
5,707
|
|
General
and administrative costs—consultants
|
|
|
1,439
|
|
|
|
-
|
|
General
and administrative costs—employees
|
|
|
106,742
|
|
|
|
-
|
|
Stock-based
compensation before income taxes
|
|
|
121,124
|
|
|
|
11,355
|
|
Income
tax benefit
|
|
|
-
|
|
|
|
-
|
|
Total
stock-based employee compensation expense after income
taxes
|
|
$
|
121,124
|
|
|
$
|
11,355
|
|
The
following table sets forth the total stock-based compensation expense for the
six months ended September 30, 2007 and September 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.
|
|
Six
Months
Ended
September
30, 2007
|
|
|
Six
Months
Ended
September
30, 2006
|
|
Research
and development costs
|
|
$
|
11,256
|
|
|
$
|
7,384
|
|
Sales,
marketing, and business development costs
|
|
|
14,568
|
|
|
|
10,557
|
|
General
and administrative costs—consultants
|
|
|
1,439
|
|
|
|
62,522
|
|
General
and administrative costs—employees
|
|
|
211,612
|
|
|
|
-
|
|
Stock-based
compensation before income taxes
|
|
|
238,875
|
|
|
|
80,463
|
|
Income
tax benefit
|
|
|
-
|
|
|
|
-
|
|
Total
stock-based employee compensation expense after income
taxes
|
|
$
|
238,875
|
|
|
$
|
80,463
|
|
During
the six and three months ended September 30, 2007, the Company granted employee
stock options for 15,000 common shares and non-employee stock options for 30,000
common shares exercisable at $2.35 per share expiring in 10 years and vesting
over 3 years. The options were valued at $71,301 or $1.58 per option
using a Black-Scholes option pricing method that uses the assumptions noted
above.
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. Under the Amended
Plan, options for 2,500,000 shares of common stock are reserved for
issuance. At September 30, 2007, 466,255 options are available for
grant. Options have been issued with exercise prices of between $0.66
and $4.00 per share as follows:
Options
Outstanding
|
|
|
Options
Exercisable
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Number
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Weighted
Avg.
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Weighted
Avg.
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Number
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Weighted
Avg.
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Range
of Exercise Prices
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Outstanding
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Remaining
Life
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Exercise
Price
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Exercisable
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Exercise
Price
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$
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0.66
- $1.49
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660,174
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8.29
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0.71
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503,954
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0.73
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$
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1.50
- $2.37
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141,667
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8.88
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2.16
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78,333
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2.00
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$
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2.38
- $4.00
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989,168
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9.46
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3.90
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74,931
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3.77
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1,791,009
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$
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2.59
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657,218
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$
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1.23
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Option
activity under the Amended Plan is as follows:
Options
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Shares
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Weighted
Average Exercise Price
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Weighted
Average Remaining Contractual Term
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Aggregate
Intrinsic Value
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Outstanding
at March 31, 2006
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940,966
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$
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0.75
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Exercisable at March 31, 2006
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177,620
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$
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0.90
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Granted
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1,124,167
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3.75
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Forfeited or expired
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(76,388
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)
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2.73
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Outstanding at March 31, 2007
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1,988,745
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$
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2.28
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Exercisable at March 31, 2007
|
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607,000
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$
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0.83
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Granted
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45,000
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2.35
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Exercised
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(143,067
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)
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.66
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Forfeited
or expired
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(99,669
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)
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$
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.71
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Outstanding
at September 30, 2007
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1,791,009
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$
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2.59
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8.98
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$750,431
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Exercisable
at September 30, 2007
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657,218
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$
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1.23
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8.31
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$638,630
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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.
In
the
case of shares granted to employees, the fair value of such shares is recognized
as an expense over the service period. As of September 30, 2007, the
fair value of options issued by the Company was $1,861,385. Expense recognized
for the six and three months ending September 30, 2007 and 2006 was $238,875
and
$121,124, and $17,941 and $11,355, respectively. The unamortized cost
remaining at September 30, 2007 was $1,255,631 with a weighted average expected
term for recognition of 4.47 years. At the time of grant, the estimated fair
values per option were from $0.33 to $2.94.
During
the six months ended September 30, 2007, 112,243 options with a $0.66 strike
price and 30,825 options with a $0.90 strike price were exercised pursuant
to a
cashless provision. The Company issued 97,952 common shares for the
options exercised.
During
the six months ended September 30, 2007, 98,331 options with a $0.66 strike
price and 1,338 options with a $0.90 strike price expired.
NOTE
6 — COMMON STOCK
On
July
18, 2007, the Company issued 1,872,600 of its common stock to a total of 69
accredited investors for an aggregate amount of $4,681,500. The
shares were issued pursuant to an agency agreement with J.F. Mackie &
Company, Ltd. (the “Agent”). The Agent is an independent equity
investment firm located in Calgary, Canada. Upon the closing of the
transaction, the Company paid the Agent commissions of $320,890 and $64,803
for
related legal fees.
On
July
18, 2007, 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, 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. With the conversion, the Company recorded
a non-cash debt inducement conversion charge of $4,318,286.
On
July
18, 2007, convertible promissory notes with an aggregate principal amount of
$2,400,000 automatically converted into 960,000 of the Company’s common stock
concurrent with the closing of the purchase of 1,872,600 of the Company’s common
stock.
On
September 30, 2007, the Company issued 97,952 of its common stock in connection
with the exercise of cashless options.
NOTE
7 — WARRANTS
On
July
18, 2007, the Company issued 374,520 warrants to 69 accredited investors as
part
of unregistered sales of equity securities. Each whole warrant
entitles the holder of the warrant to acquire, for no additional consideration,
one share of common stock in the event that the Company 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
Company completes a liquidity transaction by March 18, 2008. At this
time, 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.
On
July
18, 2007, concurrent with the conversion of $2,400,000 convertible promissory
notes, the Company issued 480,000 warrants. Each whole warrant
entitles the former note holders to acquire one share of 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. This
value has been recorded as a non-cash beneficial conversion inducement charge
in
other expense.
In
addition, concurrent with the conversion of $2,400,000 convertible promissory
notes, the Company issued 0.2 of one warrant to the former note
holders. Each whole warrant entitles the holder of the warrant to
acquire, for no additional consideration, one share of common stock in the
event
that the Company 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 Company completes a liquidity transaction
by
March 18, 2008. At this time, 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.
On
July
18, 2007, upon the closing of the unregistered sales of equity securities as
described above, the Company issued the Agent and its nominees broker’s warrants
entitling it to purchase up to 215,408 shares of the Company’s common stock at
$3.00 per share until July 18, 2009.
The
following table lists the total number of warrants outstanding as of September
30, 2007.
|
Expiring
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|
Strike
Price
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Number
of
Common
shares
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December
31, 2007
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4.50
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681,778
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May
1, 2008
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4.50
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585,287
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May
2, 2008
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4.50
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845,333
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December
31, 2008
January
18, 2009 (a)
July
17, 2009
July
18, 2009
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5.25
(a)
2.75
3.00
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681,778
566,520
480,000
215,408
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Total
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4,056,104
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(a)
The
warrants expire the earlier of a liquidity transaction or January 18,
2009. The warrants entitle the holder to acquire common stock
for no consideration.
During
the six months ended September 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 September 30, 2007 of $93,924. Also netted against
accounts receivable are returns and price protection reserves on existing
receivables of $459,148. Account balances are charged off against the
allowance when the Company believes it is probable that accounts receivable
will
not be recovered. As of September 30, 2007, we had two customers who accounted
for 64.8% and 20.9% of gross accounts receivable. These customers were Navarre
Corporation and Hollywood Entertainment, respectively. Navarre Corporation,
Hollywood Entertainment and Funtastic Corporation accounted for 75.0%, 10.3%
and
5.4%, respectively, of consolidated revenue during the six months ended
September 30, 2007. As of March 31, 2007, we had two customers who accounted
for
49.1% and 28.1% of gross accounts receivable.
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 during the six
months ended September 30, 2007:
Location
|
|
Revenue
|
|
United
States
|
|
$
|
3,030,276
|
|
Australia
|
|
|
213,714
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Europe
|
|
|
189,325
|
|
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$
|
3,433,315
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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.
NOTE
9 — NEW ACCOUNTING PRONOUNCEMENT
EITF
06-03
In
June
2006, the EITF reached a consensus on 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. 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 September 30, 2007 and our tax position has not materially changed
since March 31, 2007. For the six months ended September 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 and six months ended September 30,
2007.
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 September 30, 2007. Income tax returns
for the fiscal tax year ended September 30, 2004 to the present are subject
to
examination by major tax jurisdictions.
NOTE
10 — SUBSEQUENT EVENTS
None
RED
MILE ENTERTAINMENT, INC.