ProElite financial results for 2007
http://biz.yahoo.com/e/080415/pele.pk10ksb.html
15-Apr-2008
Annual Report
Item 6. Management's Discussion and Analysis of Operations
Overview
Since the Company's formation in August 2006, we have established ourselves as a leading, global promoter of live MMA events and provider of a social-networking website focused exclusively on MMA. We have agreements to distribute content by television and DVD throughout the world. To date, we have focused our efforts primarily on events in the United States and United Kingdom and on our website.
In 2007, we accomplished the following strategic objectives:
· Acquired well-regarded MMA live event brands throughout the world:
--------------------------------------------------------------------------------
· King of the Cage, Inc., a promoter of live MMA events, that has historically produced in excess of 20 events per year.
· Acquired Mixed Martial Arts Promotions, Ltd. and Mixed Martial Arts Productions, Ltd. (together "CageRage"), a UK-based promoter of live MMA events.
· Acquired the assets of Future Fight Promotions, Inc., a Hawaii-based promoter of live MMA events.
· Invested in Entlian Co., a Korea-based promoter of live MMA events.
· Launched our social-networking MMA community website,
www.proelite.com, for use.
Results of Operations for the Year Ended December 31, 2007, Compared to the Period from August 10, 2006 to December 31, 2006
The Company was formed in 1992 and began operations after a reverse merger in August 2006. Therefore, the Company has only insignificant financial results, consisting of nominal general and administrative expenses and a non-cash interest charge, for the period from August 10, 2006 (inception) to December 31, 2006. The Company was considered in the development stage until February 2007 when we first earned revenue.
Revenue
Revenue from live events, consisting primarily of ticket sales, site fees and sponsorship, was $4,560,917 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006. The increase was the result of the Company commencing operations in February 2007.
Revenue from pay-per-view programming (PPV) and television licensing was $477,679 (including $240,133 earned from Showtime) for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006. The PPV revenue was earned from Showtime and from our recently-acquired King of the Cage subsidiary.
Revenue from our website was $68,782 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006. This revenue consisted primarily of online advertising, online store sales and video subscriptions.
Other revenues, which includes merchandise and DVD sales and fees for licensing fighters under contract, was $184,192 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006 as these were new activities in 2007.
Cost of revenue
Cost of revenue for live event production was $9,619,606 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006. Live event production costs consist principally of fighters purses, production of "Barker shows" (i.e., event-specific promotional videos), arena rental and related expenses, event-specific marketing expenses (e.g., Internet, radio and television advertising, posters and street teams), and travel. Additionally, we incurred related-party production costs from Showtime of $2,855,723 in 2007 for television production. We expect cost of revenue for live events will increase in 2008 as we promote more events. However, we expect television production costs from Showtime to decrease in 2008 in accordance with the terms of the distribution agreement.
Cost of revenue for our website was $234,295 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006 and consists principally of video production costs related to live event streaming.
Gross margin
The Company incurred a negative gross margin of $7,435,118 for the year ended December 31, 2007 compared to $0 for the period from August 10, 2006 (inception) to December 31, 2006. The gross loss was primarily attributable to our Fight operations' live events. Management expects gross margins to improve in 2008 primarily due to (1) the nature of the distribution agreement with Showtime and
(2) plans to improve our operations in the UK. In 2007, Showtime paid no television license fee to the Company, and the Company was obligated to pay Showtime's production expenses (ranging from approximately $30,000 to approximately $400,000 per event). In 2008, Showtime began paying the Company a television license fee (ranging from $50,000 to $500,000 per event), and the Company no longer pays Showtime's production costs. Additionally in 2008, management began to reduce costs associated with US live event operations by better matching fight purses and expected event revenues and by reducing the number of staff and guests traveling to events. In 2008, management has more actively monitored the planning and preparations for our March 2008 UK event. Additionally, management is seeking to reduce venue costs and increase ticket sales, television licensing and sponsorship for UK events.
--------------------------------------------------------------------------------
Marketing expenses
Marketing expenses primarily consist of marketing, advertising and promotion expenses not directly related to MMA events. Marketing, advertising and promotion expenses related directly to MMA events are charged to cost of revenue. Marketing expenses were $952,520 for the year ended December 31, 2007 compared to $101,156 for the period from August 10, 2006 (inception) to December 31, 2006 and primarily consisted of Internet and print advertising, public relations and marketing consultants. We expect marketing expenses, particularly for advertising, will increase in 2008 as we promote more events and expand Internet advertising campaigns related to new revenue streams.
Website operations
Website operations expenses were $3,341,291 for the year ended December 31, 2007 compared to $171,329 for the period from August 10, 2006 (inception) to December 31, 2006. The increase was due primarily to hiring employees and consultants to develop and maintain our website and conduct business development activities.
Fight Operations
Fight operations expenses for promotion of our live events were $2,379,891 for the year ended December 31, 2007 compared to $205,825 for the period from August 10, 2006 (inception) to December 31, 2006. Fight operations expenses consist primarily of wages and consultants' fees related to day-to-day administration of the Company's live events, travel and fighter recruiting and signing bonuses. The increase was primarily the result of higher staffing levels in 2007 due to operations starting and to acquisitions in 2007.
In 2008, we expect expenses related to our fight operations to increase for higher average staffing levels in 2008 than 2007, increased fighter signing bonuses and recruiting and inclusion of a full year of operations of companies acquired in late 2007.
General and administrative expenses
General and administrative expenses were $13,475,680 for the year ended December 31, 2007 compared to $3,466,278 for the period from August 10, 2006 (inception) to December 31, 2006. The increase was primarily related to increased option and warrant grants resulting in non-cash, stock-based compensation expense of approximately $5.2 million in 2007 versus approximately $0.2 million in 2006. We also incurred higher non-cash depreciation and amortization expenses of approximately $1.4 million in 2007 versus $0.1 million in 2006 due to capital expenditures and to amortization of capitalized values of warrants and common stock issued for prepaid services. The increase in general and administrative expenses was also due to higher employee head count resulting in wages of approximately $2.3 million in 2007 versus $0.1 million in 2006, increased use of consultants resulting in expenses of approximately $1.1 million in 2007 versus $0.1 million in 2006; higher fees for professional services due primarily to our financing and acquisition activities of approximately $1.2 million in 2007 versus $0.3 million in 2006; and higher travel expenses related to increased operations of approximately $0.8 million in 2007 versus $0.1 million in 2006
--------------------------------------------------------------------------------
In January 2008, Management began cost reductions through a lay off. We expect annualized savings from this layoff of approximately $1 million. However, we expect 2008 general and administrative expenses will increase over 2007 primarily due to higher average staffing levels.
Loss from operations
Loss from operations was $27,584,500 for the year ended December 31, 2007 compared to $4,249,855 for the period from August 10, 2006 (inception) to December 31, 2006 as the Company incurred expenses in advance of revenues expected once brands and operations are established.
Liquidity and Capital Resources
Net cash used in operating activities was $17,173,363 during the year ended December 31, 2007 compared to $1,441,658 for the period from August 10, 2006 (inception) to December 31, 2006. The use of cash was primarily the result of the Company being in the early phases of executing its business plan and incurring expenses in advance of establishing its brand and operations.
Net cash used in investing activities was $10,626,880 during the year ended December 31, 2007 compared to $212,517 for the period from August 10, 2006 (inception) to December 31, 2006 due primarily to the cash consideration of $3.25 million paid for the acquisition of King of the Cage, Inc., $4.1 million paid for the acquisition of Mixed Martial Arts Productions, Ltd., $0.4 million paid for the purchase of assets from Future Fight Promotions, Inc. (ICON), and $1 million paid to purchase a partial ownership interest in Entlian Corp. (SpiritMC) and to the purchase of equipment, furniture and leasehold improvements.
Net cash provided by financing activities was $25,018,514 during the year ended December 31, 2007 compared to $8,950,000 for the period from August 10, 2006 (inception) to December 31, 2006 due primarily to the issuance of common stock and warrants for $20.2 million in a private placement and to the issuance of common stock and warrants to Showtime for $5 million. The proceeds from the Showtime stock was used primarily for general operations, and the proceeds from the private placement were used to fund acquisitions, an investment and general operations.
In September and December 2007, the Company acquired the stock of two fight promotion companies, purchased the assets of a fight-promotion company, and made a significant investment in a fourth. Additionally, the Company's business plan calls for expanding the scale of live events and Internet operations. As a result, the need for cash has correspondingly increased. Although the Company had approximately $4 million of cash at December 31, 2007 and received $4 million from warrant exercises in February 2008, additional financing is needed to continue to grow the operations to their desired levels over the next 12 months. We are currently seeking additional financing. However, there can be no assurances that we will be able to raise sufficient financings on favorable terms and conditions.
If we are unable to raise sufficient financing, we will be required to reduce our expansion programs, dramatically reduce costs and growth may be limited. If sufficient additional financing cannot be obtained, the Company may have to curtail or reduce operations. There is no guarantee that we will succeed in accomplishing our objectives. The auditor's opinion states there is substantial doubt exists about our ability to continue as a going concern. These financial statements do not contain any adjustments that may be required should we be unable to continue as an on-going concern.
Capital Expenditure Commitments
As of December 31, 2007, we had commitments for capital expenditures of approximately $600,000 for software development. In early 2008, our vendor agreed to cancel the commitment.
Off Balance Sheet Arrangements
None.
--------------------------------------------------------------------------------
Contractual Obligations, Contingent Liabilities and Commitments
We have contractual obligations and commitments primarily with regard to facilities leases, employment contracts and deferred consideration payable for acquisitions. A non-cancelable office leases in the United States requires monthly payments of $31,176 in January 2008 escalating to $36,472 through July 2012. Our United Kingdom office lease requires monthly payments of approximately $2,580 through July 2017. Employment contracts with officers and key employees require annual payments of approximately $2.4 million in 2008, $2.1 million in 2009, $0.7 million in 2010, $0.4 million in 2011 and $0.2 million in 2012. Under the terms of the King of the Cage purchase agreement, we are obligated to issue a minimum of 178,571 shares of common stock in 2008. Additionally, if King of the Cage achieves specified performance goals, we could be required to make contingent payments over five years of as much as $3.8 million in cash and $1.3 million in stock (assuming a $7 per share value). Additionally, we are required to pay 20% of earnings before interest, taxes, depreciation and amortization ("EBITDA") in excess of $850,000, and increasing to $1,650,000 over five years to the former owners of King of the Cage. Under the terms of the CageRage acquisition, we have a liability to pay $1 million in October 2008. Under the terms of the asset purchase agreement with Future Fight Productions, we are required to issue 100,000 shares of common stock and could be required to pay an additional $100,000 if the Future Fight Productions achieves EBITDA in excess of $195,000 for the twelve months ended November 30, 2008. Additionally, we have contracts with venues and other vendors requiring payments of approximately $0.7 million in 2008 and $0.1 million in 2009.
Critical Accounting Estimates and Policies
Critical accounting policies are those that are important to the portrayal of our financial condition and results, and which require management to make difficult, subjective or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We have made critical estimates in the following areas. We also believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue
We earn revenue primarily from ticket sales, events broadcast on pay-per-view television and sponsorship at live events. We also earn incidental revenue from event merchandise and video sales. Ticket sales are managed by third-parties, ticket agencies and live event venues. Revenue from ticket sales is recognized at the time of the event when the venue provides estimated or final attendance reporting to the Company. Revenue from merchandise and video sales is recognized at the point of sale at live event concession stands. Revenue from sponsorship and distribution agreements is recognized in accordance with the contract terms, which are generally at the time events occur.
--------------------------------------------------------------------------------
On our websites, we earn revenue from online advertising and subscription services. Revenue is recognized at the time advertising is run or subscription terms are met.
Significant estimates for events
The Company is required to estimate significant components of live event revenues and costs because actual amounts may not become available until one or more months after an event date. Pay-per-view revenue for live events is estimated based upon projected sales of pay-per-view presentations. These projections are based upon information provided from distribution partners. The amount of final pay-per-view sales is determined after intermediary pay-per-view distributors have completed their billing cycles. The television production costs of live events are based upon the television distribution agreement with Showtime, event-specific production and marketing budgets and historical experience. Should actual results differ from estimated amounts, a charge or benefit to the statement of operations would be recorded in a future period.
Valuation of long-lived and intangible assets
Long-lived assets consist primarily of property, plant and equipment, goodwill and intangibles.
Long-lived assets, including goodwill and indefinite-lived intangible assets, are reviewed for impairment annually or whenever events or changes in circumstances have indicated that their carrying amounts may not be recoverable, but no more than 12 months following the acquisition date. Recoverability of these assets is measured by comparing the carrying amount of an asset to its fair value in a current transaction between willing parties, other than in a forced liquidation sale. Recorded fair value was estimated by independent appraisals and other valuation techniques.
Factors we consider important which could trigger an impairment review include the following:
· Significant underperformance relative to expected historical or projected future operating results;
· Significant changes in the manner of our use of the acquired assets or the strategy of our overall business;
· Significant negative industry or economic trends;
· Significant decline in our stock price for a sustained period; and
· Our market capitalization relative to net book value.
If we determine that the carrying value of long-lived assets and related goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would measure any impairment based on comparing the carrying amount of the asset to its fair value in a current transaction between willing parties or, in the absence of such measurement, on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Any amount of impairment so determined would be written off as a non-cash charge to the income statement, together with an equal reduction of the related asset.
Our acquisitions in 2007 resulted in us recording goodwill and intangible assets with indefinite lives of approximately $2.6 million and $3.8 million, respectively, for CageRage, approximately $2.4 million and $1.7 million, respectively, for King of the Cage and approximately $1.8 million and $0.6 million, respectively, for the purchase of assets from Future Fight Productions (ICON). Maintaining these amounts is predicated upon us substantially improving the operations of CageRage and maintaining profitable operations of the other acquisitions. We have developed plans to increase the revenue and profitability of CageRage. Similarly, maintaining the goodwill and indefinite-lived intangible assets related to the ICON purchase requires us to improve the profitability and/or increase the number of ICON events. If we do not execute successfully against these plans, we will be required to record a non-cash charge to operations to reduce the amount of these assets.
--------------------------------------------------------------------------------
Stock-based compensation and warrant valuation
We record stock-based compensation expense for options and warrants issued to employees and consultants in accordance with Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" using a Black-Scholes option pricing model. Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility and fair value of our stock. Due to our short history, we do not have reliable information about employee exercise behavior. Therefore, we estimate the expected life of options and warrants granted based on an average of the vesting terms and the term of the grant in accordance with guidance in the SEC's Staff Accounting Bulletins No. 107 and 110. We estimate the volatility of our common stock on the date of grant based on the historical volatility of the stock of other publicly traded companies in the general entertainment industry. We believe the industry historical volatility is currently a better indicator of expected volatility and future stock price trends than the historical volatility of our stock because our stock has had limited or no trading volume. Additionally, due to the lack of trading in our stock, we estimate fair value using consummated transactions such as private placements of common stock and significant warrant grants where terms were negotiated.
The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 157, "Fair Value Measurements". SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. It applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. This statement is effective for all financial instruments issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not yet determined the effect of SFAS No. 157 on its financial position, operations or cash flows.
In December 2007, the FASB issued SFAS 141(R), "Business Combinations", replacing SFAS 141, "Business Combinations". This statement retains the fundamental requirements in SFAS 141 that the acquisition method of accounting (which SFAS 141 termed the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement also establishes principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement clarifies that acquirers are required to expense costs related to any acquisitions. SFAS 141R will apply prospectively to business combinations for which the acquisition date is on or after fiscal years beginning December 15, 2008. Early adoption is prohibited. The Company believes that SFAS 141R could have a significant impact on the Company's future operations. Determination of the ultimate effect of this statement will depend on the Company's acquisition plans at the date of adoption.
