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EX-10 - T.O ENTERTAINMENT, INC.exhibit1012creditagreementam.htm


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


[   ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended September 30, 2012

or


[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from _____________ to __________________


Commission File Number: 000-53213


T.O ENTERTAINMENT, INC

 (Exact name of registrant as specified in its charter)


Colorado

 

26-2666328

(State or other jurisdiction of incorporation)

 

(IRS Employer Identification Number)


90 Madison Street

Suite 701

Denver, CO 80206

(Address of principal executive offices)

303-329-3008

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [ X ] Yes   [ ] No


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  [ ] Yes    [X] No


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer [ ]

Accelerated filer [ ]

Non-accelerated filer [ ]  (Do not check if a smaller reporting company)

Smaller reporting company [ X ]


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

          [  ] Yes   [X] No


As of January 31, 2013, the Registrant had 33,000,000 shares of common stock issued and outstanding.











 

TABLE OF CONTENTS

 

 

 

 

 

 

Page

Number

 

 

 

PART I.

FINANCIAL INFORMATION

1

 

 

 

Item 1.

Financial Statements

1

 

 

 

 

Consolidated Balance Sheets as of September 30, 2012 (unaudited) and March 31, 2012

1

 

 

 

 

Consolidated Statements of Operations for the three and six months ended September 30, 2012 and 2011 (unaudited)

3

 

 

 

 

Consolidated Statements of Cash Flows for the six months ended September 30, 2012 and 2011 (unaudited)

5

 

 

 

 

Notes to Condensed Financial Statements (unaudited)

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

27

 

 

 

Item 4.

Controls and Procedures

27

 

 

 

PART II.

OTHER INFORMATION

28

 

 

 

Item 1.

Legal Proceedings

28

 

 

 

Item 1A.

Risk Factors

28

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

28

 

 

 

Item 3.

Defaults Upon Senior Securities

28

 

 

 

Item 4.

Mine Safety Disclosures

28

 

 

 

Item 5.

Other Information

28

 

 

 

Item 6.

Exhibits

29

 

 

 

SIGNATURES

30




ii







PART I-FINANCIAL INFORMATION


ITEM 1.  FINANCIAL STATEMENTS.


T.O Entertainment, Inc.

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

September 30, 2012

 

March 31, 2012

 

 

(Unaudited)

 

(Audited)

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

183,678

 

$

679,541

Accounts receivable, less allowance for doubtful accounts and provision for sales returns

 

 

3,226,914

 

 

4,893,283

Other receivables

 

 

126,747

 

 

20,519

Inventories

 

 

1,052,658

 

 

850,210

Prepaid expenses and other current assets

 

 

453,608

 

 

83,482

Deferred tax assets

 

 

-

 

 

683,968

Total Current Assets

 

 

5,043,605

 

 

7,211,003

Non-current assets:

 

 

 

 

 

 

Film costs

 

 

4,264,962

 

 

5,387,482

Investment in animation film

 

 

2,048,800

 

 

2,117,904

Property, plant and equipment

 

 

46,052

 

 

64,620

Other assets

 

 

364,238

 

 

573,595

Total non-current assets

 

 

6,724,052

 

 

8,143,601

Total assets

 

$

11,767,657

 

$

15,354,604

 

 

 

 

 

 

 

Liabilities and stockholders’ deficit

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

6,684,198

 

$

5,072,609

Other payables and accrued expenses

 

 

640,831

 

 

191,858

Bank loans – current portion

 

 

242,158

 

 

858,953

Deferred revenue

 

 

3,821,529

 

 

7,861,505

Bond payable (previously convertible)

 

 

466,560

 

 

-

Total Current Liabilities

 

 

11,855,276

 

 

13,984,925

Non-current liabilities:

 

 

 

 

 

 

Bank loans – non-current portion

 

 

4,050,583

 

 

3,037,898

Convertible bonds

 

 

-

 

 

421,464

Option liability

 

 

-

 

 

2,988

Total non-current Liabilities

 

 

4,050,583

 

 

3,462,350

Total liabilities

 

 

15,905,859

 

 

17,447,275

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ deficit:

 

 

 

 

 

 

Common stock, no par value; 100,000,000 shares authorized; 33,000,000 shares issued and outstanding at September 30, 2012 and March 31, 2012

 

 

396,000

 

 

396,000

Additional paid in capital

 

 

2,790,998

 

 

2,790,998

Accumulated deficit

 

 

(6,617,036)

 

 

(4,724,986)



1









Accumulated other comprehensive loss

 

 

(708,164)

 

 

(554,683)

Total stockholders’ deficit

 

 

(4,138,202)

 

 

(2,092,671)

Total liabilities and stockholders’ deficit

 

$

11,767,657

 

$

15,354,604

See notes to consolidated financial statements



2







T.O Entertainment, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

 

 

For the six months ended September 30,

 

For the three months ended September 30,

 

 

2012

 

2011

 

2012

 

2011

Revenues

 

$

10,110,803

 

$

10,763,832

 

$

3,258,969

 

$

6,996,674

Cost of revenue

 

 

9,219,487

 

 

8,287,350

 

 

3,252,164

 

 

4,734,638

Gross profit

 

 

891,316

 

 

2,476,482

 

 

6,805

 

 

2,262,036

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

 

1,502,989

 

 

1,284,306

 

 

631,978

 

 

657,594

Depreciation and amortization

 

 

21,873

 

 

23,288

 

 

10,855

 

 

12,390

 

 

 

1,524,862

 

 

1,307,594

 

 

642,833

 

 

669,984

 

 

 

 

 

 

 

 

 

 

 

 

 

Income/(Loss) from operations

 

 

(633,546)

 

 

1,168,888

 

 

(636,028)

 

 

1,592,052

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expenses)

 

 

 

 

 

 

 

 

 

 

 

 

(Loss) /Income from unconsolidated entities

 

 

(455,478)

 

 

-

 

 

(465,064)

 

 

-

Interest expenses

 

 

(86,249)

 

 

(87,942)

 

 

(49,038)

 

 

(48,507)

Gain on derivative

 

 

3,086

 

 

-

 

 

3,086

 

 

-

Other income

 

 

6,713

 

 

13,096

 

 

3,301

 

 

13,376

 

 

 

(531,928)

 

 

(74,846)

 

 

(507,715)

 

 

(35,131)

 

 

 

 

 

 

 

 

 

 

 

 

 

Income/(Loss) from operations before income taxes

 

 

(1,165,474)

 

 

-

 

 

(1,143,743)

 

 

1,556,921

 

 

 

 

 

 

 

 

 

 

 

 

 

Income taxes

 

 

726,576

 

 

-

 

 

726,576

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income /(loss)

 

 

(1,892,050)

 

 

1,094,042

 

 

(1,870,319)

 

 

1,556,921

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation loss

 

 

(153,481)

 

 

(277,135)

 

 

(54,228)

 

 

(210,817)

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive gain/(loss)

 

$

(2,045,531)

 

$

816,907

 

$

(1,924,547)

 

 

1,346,104

 

 

 

 

 

 

 

 

 

 

 

 

 



3









Per share information – basic:

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

 

33,000,000

 

 

31,680,000

 

 

33,000,000

 

 

31,680,000

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings/(loss) per share – basic

 

$

(0.06)

 

$

0.03

 

$

(0.06)

 

 

0.05

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to consolidated financial statements





4







T.O Entertainment, Inc.

Condensed Consolidated Statements of Cash Flows

For the Six Months Ended September 30, 2012 and 2011

(Unaudited)

 

 

 

 

 

 

 

 

 

2012

 

2,011

Net cash (used in) operating activities

 

$

(325,682)

 

$

2,056,982

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Purchase of plant and equipment

 

 

23,187

 

 

-

Investments and acquisitions, net of cash acquired

 

 

(320,712)

 

 

(3,127,444)

Net cash (used in) investing activities

 

 

(297,525)

 

 

(3,127,444)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from long-term bank loans

 

 

823,440

 

 

1,634,989

Repayments of long-term bank loans

 

 

-

 

 

(1,060,920)

Proceeds from short-term bank loans

 

 

324,000

 

 

-

Repayment of short-term bank loans

 

 

(994,305)

 

 

-

Proceeds from issuance of common stock

 

 

 

 

 

262,873

Net cash provided by financing activities

 

 

153,135

 

 

836,942

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

 

(25,791)

 

 

24,430

 

 

 

 

 

 

 

Net (decrease) in cash and cash equivalents

 

 

(495,863)

 

 

(209,090)

Cash and cash equivalents at beginning of year

 

 

679,541

 

 

636,744

Cash and cash equivalents at end of year

 

$

183,678

 

$

427,654

 

 

 

 

 

 

 

Supplementary cash flow information

 

 

 

 

 

 

   Income taxes paid

 

$

-

 

$

-

   Interest paid

 

$

86,249

 

$

69,915

 

 

 

 

 

 

 





5






NOTE 1.  ORGANIZATION AND PRINCIPAL ACTIVITY


Throughout this report, the terms “our,” “we,” “us,” and “Company” refer to T.O Entertainment, Inc., including its subsidiaries.  The accompanying unaudited financial statements of T.O Entertainment, Inc. at September 30, 2012 and 2011 have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial statements, instructions to Form 10-Q, and Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted.  These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in our annual report on Form 10-K for the year ended March 31, 2012.  In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation to make our financial statements not misleading have been included.  The results of operations for the periods ended September 30, 2012 and 2011 presented are not necessarily indicative of the results to be expected for the full year. The March 31, 2012 balance sheet has been derived from our audited financial statements included in our annual report on Form 10-K for the year ended March 31, 2012.


T.O Entertainment, Inc. (formerly IBI Acquisitions, Inc. or “IBI”) was incorporated in the State of Colorado on May 22, 2008.  The Company was formed to explore merger and acquisitions opportunities with other companies.  


On January 3, 2012, pursuant to the terms of a Agreements between IBI and T.O Entertainment, Inc., Japan (“TOE Japan”) the shareholders invested 100% of the then outstanding stock in IBI by transferring ownership of such shares to IBI. IBI issued a total of 31,680,000 common shares of its common stock to the TOE Japan’s shareholders in exchange for their TOE Japan common shares.


On March 5, 2012, the Company changed the name from IBI Acquisitions, Inc. to T.O Entertainment, Inc.


The transaction was accounted for as a “reverse merger,” since the original stockholders of the TOE Japan own a majority of the outstanding shares of our common stock immediately following the completion of the transaction.  TOE Japan was the legal acquiree but deemed to be the accounting acquirer, IBI was the legal acquirer but deemed to be the accounting acquiree in the reverse merger.  The historical financial statements prior to the acquisition are those of the accounting acquirer (TOE Japan).  Historical stockholders' equity of the acquirer prior to the merger are retroactively restated (a recapitalization) for the equivalent number of shares received in the merger.  Operations prior to the merger are those of the acquirer.  After completion of the transaction, the Company’s consolidated financial statements include the assets and liabilities of the Company and its subsidiaries, the operations and cash flow of the Company and its subsidiaries


We are an entertainment company incorporated in Tokyo, Japan on April 1, 2003, whose businesses include filmed entertainment and book publishing and production which consists principally of production and distribution of animated and live feature films, including distribution of such films on DVD’s and Blue Ray Discs, and.  Book publishing consisting principally of the sale of books to which TOE has the rights to print and distribute. TOE operations are currently in Japan, Singapore, the United Kingdom and the Russia Federation.  


After the reverse merger, TOE has been operating in the United States of America, Japan, Republic of Singapore, and the Russian Federation while the operations in the United Kingdom are in dormant.



NOTE 2.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Basis of presentation

The condensed consolidated financial statements have been prepared in accordance with GAAP and are expressed in United States dollars ($).  Financial statements prepared in accordance with GAAP contemplate the realization of assets and the satisfaction of liabilities in the normal course of business.


As of September30, 2012 the Company has an accumulated deficit of $6,617,036 and its current liabilities exceed its current assets by $6,811,671.  Included in non-current assets at September 30, 2012 is $4,264,962 of film costs which will be expensed against future revenues and will not require the use of cash.  Included in current liabilities at September 30, 2012 is $3,821,529 of deferred revenue, which accounted for approximately 32% of the current liabilities, and represents projects in production. The deferred revenue does not represent a cash liability.  Excluding



6






the deferred revenue, at September 30, 2012 we would have had a working capital deficit of $2,990,142.  In view of the matters described above, recoverability of a major portion of the recorded asset amounts and realization of the portion of current liabilities into revenue shown in the accompanying balance sheets are dependent upon continued operations of the Company, which in turn are dependent upon the Company's ability to raise additional financing and to succeed in its future operations.  These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.


Management has taken the following steps to revise its operating and financial requirements, which it believes are sufficient to provide the Company with the ability to continue as a going concern. The Company is actively pursuing additional funding which would enhance capital employed and strategic partners which would increase revenue bases or reduce production costs.  Subsequent to September 30, 2012 the Company entered in a Credit Agreement with an unrelated third party (see Note 15 for additional details).  Management believes that the above actions will allow the Company to continue its operations throughout the next fiscal year.


Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results could differ from those estimates.


Significant estimates and judgments inherent in the preparation of these consolidated financial statements include, among other things, accounting for asset impairments, allowances for doubtful accounts, depreciation and amortization, the determination of ultimate revenues as it relates to amortization of capitalized film costs from participations and residuals, books and DVD sales returns, equity-based compensation, income taxes, and contingencies.


Foreign Currency Translation

The Company’s reporting currency is the United States dollar (“$”) and the accompanying consolidated financial statements have been expressed in United States dollars. The Company’s functional currency is the Japanese Yen (“¥”).  In addition, its operating subsidiaries in the United Kingdom and Singapore maintain their books and record in their respective local currencies, the British Pound (“£”), the Singapore dollar (“SG$”), and the Russian ruble (“Rup”) which is a functional currency as being the primary currency of the economic environment in which their operations are conducted.


In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 830 “Translation of Financial Statements” (“ASC 830”), capital accounts of the consolidated financial statements are translated into United States dollars from Japanese yen at their historical exchange rates when the capital transactions occurred.  Assets and liabilities are translated at the exchange rates as of balance sheet date. Income and expenditures are translated at the average exchange rate of the respective year.  The resulting exchange differences are recorded in the consolidated statement of operations.


Translation of amounts from the local currency of our subsidiaries into United States dollars has been made at the following exchange rates for the six month periods ended September 30, 2012 and 2011:

 

 

 

 

 

 

 

2012

 

2011

Period-end ¥: $1 exchange rate

 

77.17

 

76.33

Average period ¥ : $1 exchange rate

 

79.37

 

79.36

Period-end £: $1 exchange rate

 

0.63

 

0.64

Average period £: $1 exchange rate

 

0.61

 

0.61

Period-end SG$: $1 exchange rate

 

1.23

 

1.30

Average period SG$: $1 exchange rate

 

1.25

 

1.23

Period-end Rub: $1 exchange rate

 

34.45

 

31.94

Average period Rub: $1 exchange rate

 

31.49

 

28.49


Fair Value

ASC Topic 820 “Fair Value Measurement and Disclosures” establishes a three-tier fair value hierarchy, which



7






prioritizes the inputs used in measuring fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market.


These tiers include:

·Level 1defined as observable inputs such as quoted prices in active markets;

·Level 2defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

·Level 3defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.


The Company’s financial instruments consist of cash and cash equivalents, trade receivables, other receivables, payables, and long term debt. The carrying values of cash and cash equivalents, trade receivables, other receivables, and payables approximate their fair value due to their short maturities. The carrying value of long term debt approximates the fair value of debt of similar terms and remaining maturities available to the company.


The Company’s non-financial assets are measured on a recurring basis. These non-financial assets are measured for impairment annually on the Company’s measurement date at the reporting unit level using Level 3 inputs. For most assets, ASC 820 requires that the impact of changes resulting from its application be applied prospectively in the year in which the statement is initially applied.


The Company’s non-financial assets measured on a non-recurring basis include the Company’s property, plant and equipment and finite-use intangible assets which are measured for recoverability when indicators for impairment are present.  ASC 820 requires companies to disclose assets and liabilities measured on a non-recurring basis in the period in which the re-measurement at fair value is performed.


The Company valued the convertible bonds using Level 3 criterion. As of September 30, 2012, the valuations resulted in a gain on derivatives of $3,086.


Fair Value of Financial Instruments with Conversion Features

In accordance with ASC Topic 815 “Derivatives and Hedging”, the conversion feature of convertible bonds are separated from the debt instrument and accounted for separately as a derivative instrument. On the date the Company’s convertible bonds are issued, the conversion feature was recorded as a liability at its fair value, and future decreases in fair value recognized in earnings while increases in fair values recognized in expenses as interest expense.


The Company used the Black-Scholes-Merton (“Black-Scholes”) model to obtain the fair value of the conversion feature. The Company’s expected volatility assumption is based on the historical volatility of stock prices of entertainment industry average in Japan.  The expected life assumption is primarily based on the expiration date of the conversion features. The risk-free interest rate for the expected term of the conversion features is based on the U.S. Treasury yield curve in effect at the time of measurement.


The convertible bonds reached maturity and were not converted.  The conversion feature has expired and is no longer available.


Investments in Animations Films

Investments in animation films includes the Company’s investments in co-production animation films which are generally less than 50% owned by the Company and are produced by the other investors of the ventures. Prior to August 1, 2012, the Company accounted for investments in animated films for which it had an interest greater than 20% and exercised influence over the investment using the equity .  Under the equity method, the initial investment is recorded at cost and adjusted annually to recognize the Company’s share of earnings and losses of the entity.  As a result of the Company’s inability to fund certain requirements of its investment it no longer exercises any influence over the co-productions.  On August 1, 2012, the Company ceased accounting for its investment in animated films under the equity method, and began accounting for the investment utilizing the cost method.


Film Costs and Revenues

Feature films typically are produced for initial exhibition in theaters, followed by distribution in the home video, electronic sell-through, video-on-demand, pay cable, basic cable and broadcast network sectors. Generally,



8






distribution to the home video, video-on-demand, pay cable, basic cable and broadcast network sectors each commence within a range of approximately one to five years of initial theatrical release. Theatrical revenues are recognized as the films are exhibited. Revenues from home video sales are recognized at the later of the delivery date or the date that video units are made widely available for sale or rental by retailers based on gross sales less a provision for estimated returns.  A warranty period for six months are usually provided by the Company on the film produced or arranged by the Company.  Based on management’s past experience, no report of defects or claim for compensation


Upfront or guaranteed payments for the licensing of intellectual property are recognized as revenue when (i) an arrangement has been signed with a customer, (ii) the customer’s right to use or otherwise exploit the intellectual property has commenced and there is no requirement for significant continued performance by the Company, (iii) licensing fees are either fixed or determinable and (iv) collectability of the fees is reasonably assured. In the event any significant continued performance is required in these arrangements, revenue is recognized when the related services are performed.


Film costs include the unamortized cost of completed films, films in production and film rights in preparation of development. Film costs are stated at the lower of cost, less accumulated amortization, or fair value. The amount of capitalized film costs recognized as cost of revenues for a given film as it is exhibited in various sectors, throughout its life cycle, is determined using the film forecast computation method. Under this method, the amortization of capitalized costs and the accrual of participations and residuals are based on the proportion of the film’s revenues recognized for such period to the film’s estimated remaining ultimate revenues. The process of estimating a film’s ultimate revenues (i.e., the total revenue to be received throughout a film’s life cycle) is discussed further under “Film Cost Recognition and Impairments.”


Film Cost Recognition and Impairments

Film costs include direct production costs, production overhead and acquisition costs for films are stated at the lower of unamortized cost or estimated fair value and classified as noncurrent assets. Accounting for film costs, as well as related revenues requires the exercise of judgment relates to the process of estimating a film’s ultimate revenues and is important for two reasons. First, while a film is being produced and the related costs are being capitalized, as well as at the time the film is released, it is necessary for management to estimate the ultimate revenues, less additional costs to be incurred (including exploitation and participation costs), in order to determine whether the value of a film has been impaired and, thus, requires an immediate write-off of unrecoverable film costs. Second, it is necessary for management to determine, using the film forecast computation method, the amount of capitalized film costs and the amount of participations and residuals to be recognized as costs of revenues for a given film in a particular period. To the extent that the film’s ultimate revenues are adjusted, the resulting gross margin reported on the exploitation of that film in a period is also adjusted.


Prior to the theatrical release of a film, management bases its estimates of ultimate revenues for each film on factors such as the historical performance of similar films, the rating and genre of the film, pre-release market research (including test market screenings) and the expected number of theaters in which the film will be released. Management updates such estimates based on information available during the film’s production and, upon release, the actual results of each film. Changes in estimates of ultimate revenues from period to period affect the amount of film costs amortized in a given period and, therefore, could have an impact on the Company’s financial results for that period. For example, prior to a film’s release, the Company often will test market the film to the film’s targeted demographic. If the film is not received favorably, the Company may (i) reduce the film’s estimated ultimate revenues, (ii) revise the film, which could cause the production costs to increase or (iii) perform a combination of both. Similarly, a film that generates lower-than-expected theatrical revenues in its initial weeks of release would have its theatrical and home video ultimate revenues adjusted downward.


Collaborative Arrangements

The Company has entered into collaborative arrangements in the film business, with one or more active participants to jointly finance produce and/or distribute motion picture or television product under which both the Company and the other active participants share in the risks and rewards of ownership. These arrangements are referred to as co-production and distribution arrangements.


The Company typically records an asset for only the portion of the film it owns and finances. The Company and the other participants typically distribute the product in different media or markets. Revenues earned and expenses



9






incurred for the media or markets in which the Company distributes the product are typically recorded on a gross basis. The Company typically does not record revenues earned and expenses incurred when the other participants distribute the product. The Company and the other participants typically share in the profits from the distribution of the product in all media or markets. For films product, if the Company is a net receiver of (1) the Company’s share of the profits from the media or markets distributed by the other participants less (2) the other participants’ share of the profits from the media or markets distributed by the Company then the net amount is recorded as net sales. If the Company is a net payer then the net amount is recorded in cost of sales.


Comprehensive Income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under  current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Comprehensive income includes net income and the foreign currency translation changes.


Recent Pronouncements

We have reviewed all recently issued, but not yet effective, accounting pronouncements and do not believe the future adoptions of any such pronouncements may be expected to cause a material impact on our financial condition or the results of operations.



NOTE 3 - INVENTORIES


Inventories are valued at cost, not in excess of market, cost being determined on the “First-in-first-out” basis and consist of finished goods of books and DVDs. Inventories are at September 30, 2012 and March 31, 2012are summarized as follows:


 

September 30

 

March 31

Inventories

$

1,052,658

 

$

859,478

Less: provision for inventory written off

 

 

 

(9,268)

Inventories

$

1,052,658

 

$

850,210


The inventories represent the ending balance of finished goods of books and DVDs as at September 30, 2012 and March 31, 2012.



NOTE 4 – FILM COSTS


Film costs at September 30, 2012 and March 31, 2012 are summarized as follows:

 

 

 

 

 

 

 

 

 

 

September 30

 

March 31

Film costs — Theatrical film and animation:

 

 

 

 

 

 

Released, less amortization

 

$

1,142,396

 

886,069

Completed and not released

 

 

1,252,050

 

 

-

In production and development

 

 

1,185,926

 

 

568,301

Television production:

 

 

 

 

 

 

Released, less amortization

 

 

684,500

 

 

1,079,684

In production and development

 

 

-

 

 

2,853,428

 

 

$

$4,264,962

 

5,387,482


The cost of completed films amounting to $1,929,896 and $1,965,753, respectively, are expected to be amortized in the next operating cycle (i.e. 12 months from the date of September 30, 2012 and March 31, 2012).




10






All unamortized film cost as of September 30, 2012 and March 31, 2012 are expected to be amortized within three years from September 30, 2012 and March 31, 2012.



NOTE 5 – PROPERTY, PLANT AND EQUIPMENT


Property and equipment at September 30, 2012 and March 31, 2012 is summarized as follows:


 

 

September 30

 

March 31

Leasehold improvement

 

$

104,603

 

$

98,469

Office equipment

 

 

147,117

 

 

138,655

 

 

 

251,720

 

 

237,124

Accumulated depreciation

 

 

(205,668)

 

 

(172,504)

 

 

$

46,052

 

$

64,620


The depreciation of leasehold improvement and office equipment charged was $21,873, $23,288, $10,691 and $12,390 for the six and three months periods ended September 30, 2012 and 2011, respectively.


NOTE 6 – DEFERRED REVENUE


The deferred revenue represents the amount of money received from other participants of the films and animation in production stage. This deferred revenue will be realized when the Company fulfills its performance obligation stated in the production contracts entered into with other participant. As of September 30, 2012 and March 31, 2012, the Company had a balance of $ 3,821,529 and $7,861,505 respectively as deferred revenue.



NOTE 7 –BANK LOANS


Bank loans are summarized as follows:

 

Interest rate

 

Due date

 

September 30, 2012

 

March 31, 2012

Financial institution in Japan 1

2.000%

 

10/31/2012

 

2,411

 

8,345

Financial institution in Japan 1

1.975%

 

7/15/2013

 

 

84,240

 

 

97,600

Financial institution in Japan 1

2.200%

 

3/25/2014

 

 

270,151

 

 

117,120

Financial institution in Japan 1

1.975%

 

7/15/2014

 

 

907,135

 

 

284,797

Financial institution in Japan 1

2.250%

 

10/10/2015

 

 

56,635

 

 

268,400

Financial institution in Japan 1

2.150%

 

6/30/2015

 

 

647,870

 

 

271,206

Financial institution in Japan 1

2.200%

 

2/29/2016

 

 

103,680

 

 

220,820

Financial institution in Japan 2

1.200%

 

7/31/2015

 

 

259,200

 

 

139,068

Financial institution in Japan 2

2.300%

 

3/31/2021

 

 

252,137

 

 

886,489

Financial institution in Japan 2

2.300%

 

3/31/2021

 

 

209,952

 

 

55,364

Financial institution in Japan 2

2.300%

 

4/28/2018

 

 

129,782

 

 

644,770

Financial institution in Japan 2

2.000%

 

5/25/2021

 

 

915,961

 

 

902,872

Financial institution in Japan 2

4.175%

 

11/30/2012

 

 

64,787

 

 

 

Financial institution in Japan 2

5.900%

 

9/30/2013

 

 

388,800

 

 

 

Notes payable to banks

 

 

 

 

 

4,292,741

 

 

3,896,851

Less current portion

 

 

 

 

 

(242,158)

 

 

(858,953)



11









Long term loan payable

 

 

 

 

$

4,050,583

 

3,037,898


1. Bank loans guaranteed by the Company’s Chief Executive Officer

2. Bank loans guaranteed by the Company’s Chief Executive Officer and Tokyo Credit Guarantee Association, an independent commercialized credit guarantee company.


The scheduled maturities of the Company’s bank loans are as follows:

 

 

 

12 Months ending September 30,

 

 

2013

$

242,158

2014

 

898,867

2015

 

845,977

2016

 

762,462

2017

 

373,365

Thereafter

 

1,169,912

Total

$

4,292,741



NOTE 8 - CONVERTIBLE BONDS


The Company previously issued an unsecured convertible bond aggregating $466,560 (amount in original currency: ¥42,000,000) with an undetectable conversion feature in the form of a warrant due September 30, 2012 to stockholders of the company. The convertible bond bears interest at 3% per annum.  The convertible bond reached maturity and was not converted.  The conversion feature has expired and no longer is available.


The convertible bond holder agreed to extend the payment date of bond until March31, 2013.



NOTE 9 - SHARE BASED COMPENSATION


All shares amounts have been restated retroactively to reflect the reverse merger.


On August 29, 2005, Board of Directors passed a resolution which was approved by the Company’s stockholders to permit the grant of incentive stock options to its officers, employees, consultants and non-employee directors.  In November, 2005, 599,691 stock options were granted pursuant to the resolution. Option awards could be exercised two years after the day of allocation of the share option to eight years after that. The exercise price for this option is ¥7.25 per share ($0.09 per share at September 30, 2012). On October 25, 2006, the Company exercised a stock split of ratio 1:3 and accordingly, the number of option granted and the price was adjusted accordingly.


On October 22, 2007 the Board of Directors passed a resolution which was approved by the Company’s stockholders to grant incentive options to its officers, employees, consultants and non-employee directors. In October, 2007, 16,543,200 stock options were granted pursuant to the resolution. Option awards could be exercised two years after the day of allocation of the share option to eight years after that. The exercise price for this option is ¥8.70 per share ($0.11 per share at September 30, 2012).


During 2008, 516,975 of 16,543,200 stock options were automatically cancelled upon the departure of two employees who were granted with such stock options according to the stock option agreement.


On January 20, 2010 the Board of Directors passed a resolution which was approved by the Company’s shareholders in a special shareholder meeting held at the same date to grant incentive options to a business partner. In January 26, 2011, 689,300 stock options were granted pursuant to the resolution. Option awards could be exercised the following day after the date of allocation of the share option to ten years after that. The exercise price for this option is ¥8.70 per share ($0.11 per share at September 30, 2012).




12






On July 6, 2010, 137,860 of 16,543,200 stock options were automatically cancelled upon the departure of an employee who was granted with such stock options according to the stock option agreement.


On September 22, 2011, 1,488,888 stock options granted during the year of 2005 were exercised at price of ¥2.42 per share ($0.03 per share at September 22, 2011), On same date, 1,723,250 share options granted during the year of 2011 were exercised at price of ¥8.70 ($0.11 per share at September 22, 2011).


The fair value of stock acquisition rights granted to employees on the date of grant and used to recognize compensation were estimated using the Black-Scholes model with the following weighted-average assumptions:

 

 

 

Dividend yield

 

0.00%

Volatility

 

38.4-43.14%

Risk free rate

 

4.42-4.75%

Expected option life

 

8-10 years


There was no expense recorded for the three month periods ended September 30, 2012 and 2011.


The following table summarizes options outstanding issued to employees at September 30, 2012.  There were no options granted exercised or cancelled during the three months ended September 30, 2012.

 

 

 

 

 

 

 

 

 

 

 

 

Options

 

Weighted Average Exercise Price

 

Weighted Average remaining contractual life (in years)

 

Average Intrinsic Value

 

Outstanding as at September 30, 2012

13,786,000

 

$

0.11

4.8

 

16,833 

(*)


(#): Weighted average exercise prices in original currency are ¥8.61 as at September 30, 2012.

(*): Average intrinsic values in original currency are ¥1,299,000 as at September 30, 2012.


The stock option granted to non-employees is for the services rendered or sign-up bonus to strengthen the relationship with business partners or service providers. The fair values of the vesting non-employee options were determined using the Black Scholes option pricing model with the following assumptions:

 

 

 

Dividend yield

 

0.00%

Volatility

 

38.4-43.14%

Risk free rate

 

4.42-4.75%

Expected option life

 

8-10 years


The following table summarizes options outstanding issued to non-employees at September 30, 2012. There were no options granted exercised or cancelled during the three months ended September 30, 2012.

 

 

 

 

 

 

 

 

 

 

 

Options

 

Weighted Average Exercise Price

 

Weighted Average remaining contractual life (in years)

 

Average Intrinsic Value

Outstanding September 30, 2012

1,378,600

 

0.10

(#)

5.2 

 

25,010

(#): Weighted average exercise price in original currency is ¥7.90 as at September 30, 2012.



13







There was no stock option expense of non-employee options for the six and three months periods ended September 30, 2012 and 2011, respectively.


The following table summarizes all options outstanding issued to both employee and non-employees at September 30, 2012:

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding

 

 

Options Exercisable

 

 

 

 

Weighted

 

 

Weighted

 

 

 

 

Average

Weighted

 

Average

Weighted

Range of

 

 

Remaining

Average

 

Remaining

Average

Exercise Price

 

Number Outstanding

Contractual Life

Exercise Price

Number Exercisable

Contractual Life

Exercise Price

$0.03

(*)

310,185

2.45

$0.03

310,185

2.45

$0.03

$0.11

(#)

14,165,115

5.45

$0.11

14,165,115

5.45

$0.11

$0.11

(#)

689,300

7.75

$0.11

689,300

7.75

$0.11

Total

 

15,164,600

 

 

15,164,600

 

 


(*): Weighted average exercise price in original currency is ¥2.37 as at September 30, 2012.

(#): Weighted average exercise price in original currency is ¥8.69 as at September30, 2012.


Although the fair value of stock options is determined in accordance with ASC 718 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.



NOTE 10–INCOME TAXES


We account for income taxes in interim periods in accordance with ASC Topic 740, Income Taxes (“ASC 740”).  We have determined an estimated annual effective tax rate.  The rate will be revised, if necessary, as of the end of each successive interim period during our fiscal year to our best current estimate.  As of September 30, 2012, the estimated effective tax rate for the year will be 0%


In accordance with ASC 740, at September 30, 2012 we determined that a valuation allowance should be recognized against deferred tax assets because, based on the weight of available evidence, it is more likely than not (i.e., greater than 50% probability) that some portion or all of the deferred tax asset will not be realized in the future.  We recognized a reserve of 100% of the amounts of the deferred tax benefit in the amount of $726,576


There are open statutes of limitations for taxing authorities in federal and state jurisdictions to audit our tax returns from 2008 through the current period.  Our policy is to account for income tax related interest and penalties in income tax expense in the statement of operations.  There have been no income tax related interest or penalties assessed or recorded.


ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  This pronouncement also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.



NOTE 11- INVESTMENT IN ANIMATED FILMS


The Company invests in co-production of animated films through co-production agreements in which it generally has less than a 50% ownership interest, and records its investment in the co-productions using the equity method of accounting for projects in which it has a 20% to 50% ownership interest, and the cost method of accounting for projects in which it has an ownership interest of less than 20%, prescribed by ASC Topic 323 “Investments – Equity Method and Joint Ventures”.  



14







Co-production animated films that we account for using the equity method have a committee set-up which is used to co-ordinate the relationship between all participating parties.  The co-production committee agreement allocates production duties and ownership percentages among the parties. The ownership ratio of the participants in the co-production committee is also adopted as the profit or loss sharing ratio of the participants.


Costs incurred by the participants upon performance of their duties under the co-production agreement are capitalized.  The maximum cost capitalized is limited to the estimated total cost of production developed by the committee in the planning stage.  Spending by any participant in excess of its portion of the total estimated cost of production specified in the co-production agreement, is recorded as an expense and is not capitalized.


There are no liabilities incurred by the co-production because each participant bears responsibility for its portion of the cost of production.  


None of the investments have any liquidity because transfer of ownership is restricted by the co-production agreement.


As a result of the Company’s inability to fund certain requirements of its investments, the cost contribution and profit sharing ratio decrease led to an equity interest reduction.  Consequently  it no longer exercises any influence over the co-productions.  As of August 1, 2012, the Company ceased accounting for its investment in animated films under the equity method, and began accounting for the investment utilizing the cost method.


(Loss)/Income from unconsolidated entities for the three and six months ended September 30, 2012,  includes $465,505 which represents the write off of investments from which the Company is no longer entitled to receive any distributions.



NOTE 12 – EARNING PER SHARE


The Company calculates earnings per share in accordance with ASC Topic 260 “Earnings Per Share”, which requires a dual presentation of basic and diluted earnings per share. Basic earnings per share are computed using the weighted average number of shares outstanding during the fiscal year. Diluted earnings per share represents basic earnings per share adjusted to include the potentially dilutive effect of outstanding stock options, warrants and convertible note (using the if-converted method). The dilutive earnings per share was not calculated because the exercise price of the outstanding stock options in 2012 and the conversion price of convertible bonds and the exercise price outstanding stock options in 2011 were higher than the average trading price of shares in those periods.



NOTE 13 - RELATED PARTY TRANSACTIONS


There was no related transaction reported for the six and three months ended September 30, 2012 and 2011.



NOTE 14 – SEGMENT REPORTING


The Company has two reportable business segments; (i) film entertainment, which consists principally of production and distribution of animated and live feature films, including distribution of such films on DVD and Blu-ray Disc, and (ii) book publishing and distribution.  The accounting policies of the segments are the same as those described in the summary of significant t accounting policies.


Operating profits for these segments excludes unallocated corporate items.  Administrative and staff and costs were commonly used by all business segments and was indistinguishable.  


The following sets forth information about the operations of the business segments:

Assets of the Company are used for all business segments and a segment differentiation cannot be made.



15








 

Six months ended September 30,

 

Three months ended September 30,

Revenue

2012

 

2011

 

2012

 

2011

   Film entertainment

$

7,820,352 

 

$

9,616,117 

 

$

2,130,825 

 

$

6,044,957 

   Book publishing and distribution

 

2,290,451 

 

 

1,147,715 

 

 

1,128,144 

 

 

951,717 

Total revenue

$

10,110,803 

 

$

10,763,832 

 

$

3,258,969 

 

$

6,996,674 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

 

 

 

 

 

 

 

 

 

   Film entertainment

$

327,632 

 

$

1,662,721 

 

$

70,848 

 

$

1,511,356 

   Book publishing

 

563,684 

 

 

813,761 

 

 

(64,043)

 

 

750,680 

Total gross profit

$

891,316 

 

$

2,476,482 

 

$

6,805 

 

$

2,262,036 

 

 

 

 

 

 

 

 

 

 

 

 

Other items

 

 

 

 

 

 

 

 

 

 

 

 General and administrative expenses

 

 

 

 

 

 

 

 

 

 

 

   Unallocated

$

(1,524,862)

 

$

(1,307,594)

 

$

(642,833)

 

$

(669,984)

 (Loss)/income from unconsolidated entities

 

 

 

 

 

 

 

 

 

 

 

   Film entertainment

$

(455,478)

 

$

 

 

$

(465,064)

 

$

 

 Interest (expense)

 

 

 

 

 

 

 

 

 

 

 

 Unallocated amounts

$

(86,249)

 

$

(87,942)

 

$

(49,038)

 

$

(48,507)

 Other income/(expense)

 

 

 

 

 

 

 

 

 

 

 

   Unallocated

$

9,799 

 

$

13,096 

 

$

6,387 

 

$

13,376 

 

 

 

 

 

 

 

 

 

 

 

 

 (film entertainment)

 

 

 

 

 

 

 

 

 

 

 

Operating Income (loss)

 

 

 

 

 

 

 

 

 

 

 

   Film entertainment

$

(127,846)

 

$

1,662,721 

 

$

(394,216)

 

$

1,511,356 

   Book publishing

 

563,684 

 

 

813,761 

 

 

(64,043)

 

 

750,680 

   Unallocated amounts

 

(1,601,312)

 

 

(1,382,440)

 

 

(685,484)

 

 

(705,115)

Total loss from operations before income taxes

$

(1,165,474)

 

$

1,094,042 

 

$

(1,143,743)

 

$

1,556,921 


Assets of the Company are used for all business segments and a segment differentiation cannot be made.


More than 90% of the Company’s total revenue is derived from Japan and accordingly no geographic segment reporting is included.


No single customer accounts for more than ten percent (10%) of the Company’s revenues in the six months and three month periods ended September 30, 2012 or 2011.



NOTE 15 - SUBSEQUENT EVENT


Management has evaluated all activity and concluded that no subsequent events have occurred that would require recognition in the financial statements or disclosure in the notes to the financial statements other than as follows:


On November 12, 2012 the Company borrowed $1,200,000 from an unrelated third party.  


The loan was made pursuant to the terms of a Credit Agreement dated as of October 31, 2012 (the "Credit Agreement"), and made effective as of November 12, 2012, by and is evidenced by a Revolving Note.  Under the



16






Credit Agreement, the Company may borrow up to an amount equal to the lesser of 80% of its Eligible Accounts (as defined in the Credit Agreement) and the revolving loan commitment, which initially is $1,200,000.  Upon satisfaction of certain conditions, The Company may, from time to time, request that the revolving loan commitment be raised up to a maximum of $5,000,000.  The decision to grant any such increase in the revolving loan commitment is in the Lender's sole discretion. 

The loan matures on the earlier of May 12, 2013, which is six (6) months from the closing date, subject to a six-month extension upon written request of the Company made prior to the initial closing date. The maturity date may also be extended in the Lender's sole discretion, in connection with execution of any modification, extension or renewal of the Revolving Note evidencing the loan.  

The loan bears interest at the rate of 10% per annum.  In addition, the Company is required to pay certain fees specified in the Credit Agreement.  The fees include due diligence fees, document review and legal fees, an asset monitoring fee, and a transaction advisory fee, all of which are payable in cash, and an additional advisory fee payable through issuance to the Lender of three (3) redeemable warrants to purchase shares of common stock of the Company.  Each of the warrants has a term of 10 years, and each of them grants the Lender the right to purchase a number of shares equal to up to one percent (1%) of the Company’s issued and outstanding common stock at a price of $0.001 per share.  Each of the warrants includes a mandatory redemption provision pursuant to which the Company is required to redeem the warrant for a redemption price of $45,000 if the Lender has not previously elected to exercise the warrant.  The mandatory redemption dates of the three warrants are May 12, 2013, August 12, 2013 and November 12, 2013, respectively, which dates are 6 months, 9 months and 12 months after the initial closing date.  

Under the terms of the Credit Agreement, the Company is required to direct all payments received on account to a lock box account under the control of the Lender.  The Lender is authorized, on a weekly basis, to apply funds in the lock box account toward payment of fees and interest due and owing by the Company, to the establishment of a reserve in the amount of twenty percent (20%) of the amount of the revolving loan commitment, and, in its sole discretion, to prepayments of the outstanding principal due on the loan.  Any funds remaining on deposit in the lock box account after payment of the foregoing items, are required to be disbursed on a weekly basis to the Company.


In addition to the lock box, the loan is secured by a pledge of substantially all of the assets of the Company, by a pledge of all of the shares of T.O Entertainment, Inc., a Japan corporation, owned by the Company, and by the pledge by the officers and directors of the Company of a total of 8,581,725 shares of common stock of the Company currently owned by such officers and directors, and representing approximately 26% of the Company’s currently issued and outstanding common stock.  


The Credit Agreement imposes certain restrictions on the Company, including restrictions on its ability to (i) incur any Funded Indebtedness (as defined in the Credit Agreement), (ii) incur liens, (iii) make investments, (iv) permit a Change in Control (as defined in the Credit Agreement) or dispose of all or substantially all of its assets, (v) make capital expenditures not in the ordinary course of its business, (vi) issue or distribute capital stock, (vii) make distributions to its shareholders, (viii) engage in any line of business other than the business engaged in on the date of the Credit Agreement and businesses reasonably related thereto, and (ix) enter into transactions with any affiliates except in the ordinary course of business and upon fair and reasonable terms that are no less favorable to Company than it would obtain in an arm-length's basis with a non-affiliate.  Each of these restrictions is subject to certain exceptions, as specified in the Credit Agreement.


The loan may be accelerated upon the occurrence and during the continuation of an Event of Default (as defined in the Credit Agreement), including nonpayment of amounts owed, misrepresentation, failure to perform under the Credit Agreement or related documents, default under certain other obligations, events of bankruptcy, the entry of a judgment in excess of certain specified amounts, the occurrence of a Material Adverse Effect (as  defined in the Credit Agreement), the occurrence of a Change in Control (as defined in the Credit Agreement), certain impairments of collateral, and the determination in good faith by the Lender that the prospect for payment or performance of the Obligations (as defined in the Credit Agreement) is impaired for any reason.


On January 31, 2013 the Credit Agreement was modified.  The Lender agreed to waive its right to retain any portion of   payments received in the lock box between January 31, 2013 and March 31, 2013 for purposes of establishing a



17






reserve account equal to 20% of the initial Revolving Loan Commitment of $1,200,000.   All funds held in reserve by Lender prior to January 31, 2013, will continue to be held in reserve in the lock box account. In consideration for agreeing to enter into this Amendment, the Company agreed to pay Lender an additional advisory fee in the form of a  redeemable warrant, giving the Lender the right to purchase, for no additional consideration, one percent (1.0%) of the issued and outstanding common stock of the Issuing Borrower, which warrant is  in substantially the same form as the Warrants issued under the Credit Agreement (the “Additional Warrant”).  The Additional Warrant includes a mandatory redemption feature pursuant to which the Company is required to redeem the warrant for a redemption price of $135,000 if the Lender has not previously elected to exercise the warrant.  The mandatory redemption price is payable in twelve (12) equal monthly installments of $11,250.00 each, commencing on April 1, 2013, and continuing on the first day of each consecutive calendar month thereafter until the Additional Warrant is redeemed in full.

 

There are no material relationships between the Company or any of its affiliates and the Lender, other than with respect to the Credit Agreement.




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ITEM 2.

MANAGEMENT’S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:


SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS


CERTAIN STATEMENTS IN THIS REPORT, INCLUDING STATEMENTS IN THE FOLLOWING DISCUSSION, ARE WHAT ARE KNOWN AS "FORWARD LOOKING STATEMENTS", WHICH ARE BASICALLY STATEMENTS ABOUT THE FUTURE. FOR THAT REASON, THESE STATEMENTS INVOLVE RISK AND UNCERTAINTY SINCE NO ONE CAN ACCURATELY PREDICT THE FUTURE. WORDS SUCH AS "PLANS," "INTENDS," "WILL," "HOPES," "SEEKS," "ANTICIPATES," "EXPECTS "AND THE LIKE OFTEN IDENTIFY SUCH FORWARD LOOKING STATEMENTS, BUT ARE NOT THE ONLY INDICATION THAT A STATEMENT IS A FORWARD LOOKING STATEMENT. SUCH FORWARD LOOKING STATEMENTS INCLUDE STATEMENTS CONCERNING OUR PLANS AND OBJECTIVES WITH RESPECT TO THE PRESENT AND FUTURE OPERATIONS OF THE COMPANY, AND STATEMENTS WHICH EXPRESS OR IMPLY THAT SUCH PRESENT AND FUTURE OPERATIONS WILL OR MAY PRODUCE REVENUES, INCOME OR PROFITS. NUMEROUS FACTORS AND FUTURE EVENTS COULD CAUSE THE COMPANY TO CHANGE SUCH PLANS AND OBJECTIVES OR FAIL TO SUCCESSFULLY IMPLEMENT SUCH PLANS OR ACHIEVE SUCH OBJECTIVES, OR CAUSE SUCH PRESENT AND FUTURE OPERATIONS TO FAIL TO PRODUCE REVENUES, INCOME OR PROFITS. THEREFORE, THE READER IS ADVISED THAT THE FOLLOWING DISCUSSION SHOULD BE CONSIDERED IN LIGHT OF THE DISCUSSION OF RISKS AND OTHER FACTORS CONTAINED IN THIS REPORT ON FORM 10-Q AND IN THE COMPANY'S OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. NO STATEMENTS CONTAINED IN THE FOLLOWING DISCUSSION SHOULD BE CONSTRUED AS A GUARANTEE OR ASSURANCE OF FUTURE PERFORMANCE OR FUTURE RESULTS.



Background


We were incorporated in the State of Colorado on May 22, 2008.  Since inception, we have been engaged in organizational efforts and obtaining initial financing. The Company was formed as a vehicle to pursue a possible business combination.


On January 3, 2012, we entered into Investment Agreements with all shareholders of TOE Japan (the “Investors”).   Pursuant to the Investment Agreements, each of the Investors agreed to make a direct investment in the Registrant in the form of a contribution to the Registrant of all shares of common stock of TOE Japan owned by the Investor (“TOE Japan Shares”).  In consideration for the investment in the Registrant of the TOE Japan Shares by each Investor, the Registrant agreed to issue to each of the Investors approximately 6,893 shares of common stock of the Registrant for each TOE Japan Share invested in the Registrant.  Twenty Investors, who were the holders of one hundred percent (100%) of the outstanding shares of TOE Japan, invested in the Registrant.  At the time of closing under the Investment Agreements, the Investors invested a total of 4,596 TOE Japan Shares in the Registrant, representing 100% of the outstanding stock of TOE Japan, and the Registrant issued a total of 31,680,000 shares of common stock to the Investors.  The effect of the transaction was to make TOE Japan and its subsidiaries (“TOE Group”) wholly-owned subsidiaries of the Registrant, and to cause a change of control of the Registrant.  


TOE Japan was formed in 2003. It initially acted as an agent for authors and cartoonists and was mainly involved in the publishing of books.  In 2007 TOE Japan entered into the production segment of the entertainment industry with the production of animated films such as Straight Jacket, a co-production with Manga Entertainment (Starz Entertainment Group)


In 2007, as TOE Japan’s growth continued in Japan, it formed its first subsidiary outside of Japan (“overseas”) in the United Kingdom and opened an office in London.  In 2008, TOE set up a branch office in Korea and in 2009, TOE Japan set up a subsidiary in Singapore and a branch office in Russia (incorporated in 2011).  In 2010 TOE Group set up a sales office in Los Angeles.  These offices were set up in order to facilitate business expansion in those markets.  These offices have limited staff and mainly operate with the assistance of the main office in Ebisu,



19






Japan.  Our representative in the London office has recently resigned leaving the office dormant until we can find a replacement.


Currently we are engaged in two industry segments (i) film entertainment, which consists principally of production and distribution of animated and live action feature films, including distribution of such films on DVD’s and Blu-ray Discs (jointly referred to as “DVD”), and (ii) publishing and distribution of books


In addition TOE Group possesses the intellectual property rights of 24 films, including both animated and live action.  TOE Group derives its revenue from these rights through the receipts of royalties.  Depending on the nature of the intellectual property, royalty revenues can be derived from various distribution channels as stated below.


We derive our revenue from the production and distribution of animated and live action films and television programs. We receive a percentage of the ticket revenue generated by the theatrical release of our films.  In addition we receive revenue from post theatrical release which includes the sale and/or license of DVD’s and Blu-ray Discs.  The sale or rental of these products generally occurs in a variety of retail outlets such as video specialty stores, mass merchants, and convenience stores, and recently, films have become available for rental by mail from various companies and by downloading from the internet.


Normally the post theatrical release occurs 3 to 6 months after the theatrical release and broadcasting on television.


Additional revenue is generated from pay-per-view television which allows cable and satellite television subscribers to purchase individual programs, including recently released films, on a “per use” basis.  The subscriber fees are typically divided among the program distributor, the pay-per-view operator and the cable system operator; pay television which allows subscribers to view premium channels that are offered by cable and satellite system operators for a monthly subscription fee; broadcast television which provides programming over the air; and basic cable which is a fee based service that provides programming via cable or satellite transmission.  Broadcasters, cable and satellite systems pay fees to us for the right to air programming a specified number of times. However, revenue generated from this source is currently rather insignificant for TOE.


In addition to content produced by us, we may on occasion purchase the license right to create and distribute DVD and Blu-ray Discs of products produced by other companies.  Distribution is divided between outsources and internal distribution.


Our profitability is based on our ability to control the cost of production through careful selection of the production houses and other subcontractors, monitoring of ongoing projects as to cost and budget, and selection of the most appropriate distribution channel for our products.


Our initial business was that of representing authors and creative talent.  As a result of the relationships we established, we also began to engage in publishing their works.  In addition to the works that are created by authors we represent, we also acquire the rights to translate foreign (non-Japanese) titles to be published in Japan.


In the book publishing sector, our revenues are derived from the sale of books we publish to publication wholesalers and in some instances also from sales directly to retailers when such sales will not compete with the distributor.  Our profitability in this portion of our business is based on our ability to control the cost of production through careful selection of the printers and publication wholesalers for each book published.


Critical Accounting Policies


Basis of presentation

The condensed consolidated financial statements have been prepared in accordance with GAAP and are expressed in United States dollars ($).  Financial statements prepared in accordance with GAAP contemplate the realization of assets and the satisfaction of liabilities in the normal course of business.


As of September 30, 2012 we have an accumulated deficit of $6,617,036, and our current liabilities exceed our current assets by $6,811,671.  Included in non-current assets at September 30, 2012 is $4,264,962 of film costs which will be expensed against future revenues and will not require the use of cash.  Included in current liabilities at



20






September 30, 2012 is $3,821,529 of deferred revenue, which accounted for approximately32% of the current liabilities, and represents projects in production. The deferred revenue does not represent a cash liability.  Excluding the deferred revenue, at September 30, 2012 we would have had working capital deficit of $2,990,142.


In view of the matters described above, recoverability of a major portion of the recorded asset amounts and realization of the portion of current liabilities into revenue shown in the accompanying balance sheets are dependent upon continued operations of the Company, which in turn are dependent upon the Company's ability to raise additional financing and to succeed in its future operations.  These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.


Management has taken the steps which it believes are sufficient to revise our operating and financial requirements and provide us with the ability to continue as a going concern.  We are actively pursuing additional funding which would enhance capital employed and strategic partners which would increase revenue bases or reduce production costs. Management believes that the above actions will allow us to continue our operations throughout the remainder of the current fiscal year.


Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”) requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results could differ from those estimates.


Significant estimates and judgments inherent in the preparation of these consolidated financial statements include, among other things, accounting for asset impairments, allowances for doubtful accounts, depreciation and amortization, the determination of ultimate revenues as it relates to amortization of capitalized film costs from participations and residuals, books and DVD sales returns, equity-based compensation, income taxes, and contingencies.


Foreign Currency Translation

The Company’s reporting currency is the United States dollar (“$”) and the accompanying consolidated financial statements have been expressed in United States dollars. The Company’s functional currency is the Japanese Yen (“¥”).  In addition, its operating subsidiaries in the United Kingdom and Singapore maintain their books and record in their respective local currencies, the British Pound (“£”) and the Singapore dollar (“SG$”), which is a functional currency as being the primary currency of the economic environment in which their operations are conducted.


In accordance with ASC Topic 830 “Translation of Financial Statements”, capital accounts of the consolidated financial statements are translated into United States dollars from JPY at their historical exchange rates when the capital transactions occurred.  Assets and liabilities are translated at the exchange rates as of balance sheet date. Income and expenditures are translated at the average exchange rate of the respective year.  The resulting exchange differences are recorded in the consolidated statement of operations.


Translation of amounts from the local currency of our subsidiaries into United States dollars has been made at the following exchange rates for the six month periods ended September 30, 2012 and 2011:


 

 

2012

 

2011

Period-end ¥ : $1 exchange rate

 

77.17

 

76.33

Average period ¥ : $1 exchange rate

 

79.37

 

79.36

Period-end £ : $1 exchange rate

 

0.63

 

0.64

Average period £ : $1 exchange rate

 

0.61

 

0.61

Period-end SG$ : $1 exchange rate

 

1.23

 

1.30

Average period SG$ : $1 exchange rate

 

1.25

 

1.23

Period-end Rub:$1 exchange rate

 

34.45

 

31.94

Average period Rub : $1 exchange rate

 

31.49

 

28.49




21







Fair Value

ASC Topic 820 “Fair Value Measurement and Disclosures” establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market.


These tiers include:

·

Level 1—defined as observable inputs such as quoted prices in active markets;

·

Level 2—defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

·

Level 3—defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.


The Company’s financial instruments consist of cash and cash equivalents, trade receivables, other receivables, payables, and long term debt. The carrying values of cash and cash equivalents, trade receivables, other receivables, and payables approximate their fair value due to their short maturities. The carrying value of long term debt approximates the fair value of debt of similar terms and remaining maturities available to the company.


The Company’s non-financial assets are measured on a recurring basis. These non-financial assets are measured for impairment annually on the Company’s measurement date at the reporting unit level using Level 3 inputs. For most assets, ASC 820 requires that the impact of changes resulting from its application be applied prospectively in the year in which the statement is initially applied.


The Company’s non-financial assets measured on a non-recurring basis include the Company’s property, plant and equipment and finite-use intangible assets which are measured for recoverability when indicators for impairment are present.  ASC 820 requires companies to disclose assets and liabilities measured on a non-recurring basis in the period in which the re-measurement at fair value is performed.


The Company valued the convertible bonds using Level 3 criterion. As of September 30, 2012, the valuations resulted in a gain on derivatives of $3,086.


Fair Value of Financial Instruments with Conversion Features

In accordance with ASC Topic 815 “Derivatives and Hedging”, the conversion feature of convertible bonds are separated from the debt instrument and accounted for separately as a derivative instrument. On the date the Company’s convertible bonds are issued, the conversion feature was recorded as a liability at its fair value, and future decreases in fair value recognized in earnings while increases in fair values recognized in expenses as interest expense.


The Company used the Black-Scholes-Merton (“Black-Scholes”) model to obtain the fair value of the conversion feature. The Company’s expected volatility assumption is based on the historical volatility of stock prices of entertainment industry average in Japan.  The expected life assumption is primarily based on the expiration date of the conversion features. The risk-free interest rate for the expected term of the conversion features is based on the U.S. Treasury yield curve in effect at the time of measurement.


The convertible bonds reached maturity and were not converted.  The conversion feature has expired and is no longer available.


Investments in Animations Films

Investments in animation films includes the Company’s investments in co-production animation films which are generally less than 50% owned by the Company and are produced by the other investors of the ventures. Prior to August 1, 2012, the Company accounted for investments in animated films for which it had an interest greater than 20% and exercised influence over the investment using the equity .  Under the equity method, the initial investment is recorded at cost and adjusted annually to recognize the Company’s share of earnings and losses of the entity.  As a result of the Company’s inability to fund certain requirements of its investment it no longer exercises any influence over the co-productions.  On August 1, 2012, the Company ceased accounting for its investment in animated films under the equity method, and began accounting for the investment utilizing the cost method.



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Film Costs and Revenues

Feature films typically are produced for initial exhibition in theaters, followed by distribution in the home video, electronic sell-through, video-on-demand, pay cable, basic cable and broadcast network sectors. Generally, distribution to the home video, video-on-demand, pay cable, basic cable and broadcast network sectors each commence within a range of approximately one to five years of initial theatrical release. Theatrical revenues are recognized as the films are exhibited. Revenues from home video sales are recognized at the later of the delivery date or the date that video units are made widely available for sale or rental by retailers based on gross sales less a provision for estimated returns.  A warranty period for six months are usually provided by the Company on the film produced or arranged by the Company.  Based on management’s past experience, no report of defects or claim for compensation


Upfront or guaranteed payments for the licensing of intellectual property are recognized as revenue when (i) an arrangement has been signed with a customer, (ii) the customer’s right to use or otherwise exploit the intellectual property has commenced and there is no requirement for significant continued performance by the Company, (iii) licensing fees are either fixed or determinable and (iv) collectability of the fees is reasonably assured. In the event any significant continued performance is required in these arrangements, revenue is recognized when the related services are performed.


Film costs include the unamortized cost of completed films, films in production and film rights in preparation of development. Film costs are stated at the lower of cost, less accumulated amortization, or fair value. The amount of capitalized film costs recognized as cost of revenues for a given film as it is exhibited in various sectors, throughout its life cycle, is determined using the film forecast computation method. Under this method, the amortization of capitalized costs and the accrual of participations and residuals are based on the proportion of the film’s revenues recognized for such period to the film’s estimated remaining ultimate revenues. The process of estimating a film’s ultimate revenues (i.e., the total revenue to be received throughout a film’s life cycle) is discussed further under “Film Cost Recognition and Impairments.”


Film Cost Recognition and Impairments

Film costs include direct production costs, production overhead and acquisition costs for films are stated at the lower of unamortized cost or estimated fair value and classified as noncurrent assets. Accounting for film costs, as well as related revenues requires the exercise of judgment relates to the process of estimating a film’s ultimate revenues and is important for two reasons. First, while a film is being produced and the related costs are being capitalized, as well as at the time the film is released, it is necessary for management to estimate the ultimate revenues, less additional costs to be incurred (including exploitation and participation costs), in order to determine whether the value of a film has been impaired and, thus, requires an immediate write-off of unrecoverable film costs. Second, it is necessary for management to determine, using the film forecast computation method, the amount of capitalized film costs and the amount of participations and residuals to be recognized as costs of revenues for a given film in a particular period. To the extent that the film’s ultimate revenues are adjusted, the resulting gross margin reported on the exploitation of that film in a period is also adjusted.


Prior to the theatrical release of a film, management bases its estimates of ultimate revenues for each film on factors such as the historical performance of similar films, the rating and genre of the film, pre-release market research (including test market screenings) and the expected number of theaters in which the film will be released. Management updates such estimates based on information available during the film’s production and, upon release, the actual results of each film. Changes in estimates of ultimate revenues from period to period affect the amount of film costs amortized in a given period and, therefore, could have an impact on the Company’s financial results for that period. For example, prior to a film’s release, the Company often will test market the film to the film’s targeted demographic. If the film is not received favorably, the Company may (i) reduce the film’s estimated ultimate revenues, (ii) revise the film, which could cause the production costs to increase or (iii) perform a combination of both. Similarly, a film that generates lower-than-expected theatrical revenues in its initial weeks of release would have its theatrical and home video ultimate revenues adjusted downward.


Collaborative Arrangements

The Company has entered into collaborative arrangements in the film business, with one or more active participants to jointly finance produce and/or distribute motion picture or television product under which both the Company and



23






the other active participants share in the risks and rewards of ownership. These arrangements are referred to as co-production and distribution arrangements.


The Company typically records an asset for only the portion of the film it owns and finances. The Company and the other participants typically distribute the product in different media or markets. Revenues earned and expenses incurred for the media or markets in which the Company distributes the product are typically recorded on a gross basis. The Company typically does not record revenues earned and expenses incurred when the other participants distribute the product. The Company and the other participants typically share in the profits from the distribution of the product in all media or markets. For films product, if the Company is a net receiver of (1) the Company’s share of the profits from the media or markets distributed by the other participants less (2) the other participants’ share of the profits from the media or markets distributed by the Company then the net amount is recorded as net sales. If the Company is a net payer then the net amount is recorded in cost of sales.


Comprehensive Income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Comprehensive income includes net income and the foreign currency translation changes.


Recent Pronouncements

We have reviewed all recently issued, but not yet effective, accounting pronouncements and do not believe the future adoptions of any such pronouncements may be expected to cause a material impact on our financial condition or the results of operations.


Results of Operations


Our revenue for the six and three month periods ended September 30, 2012 and 2011 was $10,110,803, $10,763,932, $3,258,969, and$6,996,674, respectively.  Our net income/(loss) for the six and three month periods ended September 30, 2012 and 2011 was $(1,892,050), $1,094,042, $(1,870,319), and $1,556,921, respectively.  Our comprehensive income/(loss) for the six and three month periods ended September 30, 2012 and 2011 was $(2,045,531), $816,907, $(1,924,547), and $1,346,104, respectively.  Through September 30, 2012 our cumulative net losses and cumulative comprehensive loss were $(6,617,036) and $(708,164), respectively.


RESULTS OF OPERATION FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30, 2011

(References to 2012 and 2011 are to the six months ended September 30, 2012 and 2011 respectively, unless otherwise specified.)


Total Revenue decreased $653,029 (6%) from $10,763,832 for 2011 to $10,110,803 for 2012.  Revenue from film entertainment decreased $1,795,765 (19%) from $9,616,117 for 2011 to $7,820,352 for 2012.  Revenue from book publishing and distribution increased $1,142,736 (99%) from $1,147,715 for 2011 to $2,290,451 for 2012.


The decrease in revenue from film entertainment is due to a reduction in the number of new producing film contracts in 2012 compared to 2011.  As a result of cash flow constraints we were involved in fewer productions.



During 2012 our book division released a total of 26 new books which generated $1,420,552 of the total book revenue of $2,290,451 as compared to 11 new books which generated $973,915 of the total book revenue of $1,147,715 in 2011.


We anticipate that our growth in the book publishing segment will continue as we release more new titles.


Cost of revenue increased $932,137(11%) from $8,287,350 in 2011 to $9,219,487 in 2012.  In terms of percentage of revenue, cost of revenue was 91% in 2012 as compared to 77% in 2011.  




24






Cost of revenue for our film entertainment segment was approximately 95% for 2012 as compared to 82% in 2011.

 

Cost of revenue is calculated using a fraction in which the denominator is an estimate of the ultimate revenue that a production will produce and the numerator is the revenue achieved for the accounting period.  The unamortized film cost for the project is then multiplied by the percentage calculated.  To the extent that the film’s ultimate revenues are adjusted, the resulting gross margin reported on the exploitation of that film in a period is also adjusted.


Changes in estimates of ultimate revenues from period to period affect the amount of film costs amortized in a given period and, therefore, have an impact on our financial results for that period. For example, prior to a film’s release, we often will test market the film to the film’s targeted demographic. If the film is not received favorably, we may then (i) reduce the film’s estimated ultimate revenues, (ii) revise the film, which could cause the production costs to increase or (iii) perform a combination of both. Similarly, a film that generates lower-than-expected theatrical revenues in its initial weeks of release would have its theatrical and home video ultimate revenues adjusted downward.  (See Film Costs and Revenues included in Critical Accounting Policies and Estimates above for a more detailed explanation of the accounting).


Our estimates of ultimate revenue were lower in 2012 than in 2011.  This resulted in a higher cost of revenue.


Cost of revenue for our book publishing segment was approximately 75% in 2012 as compared to29% in 2011.  The increase/ in cost of revenue is attributable to our disposal during 2012 of unsold inventories which had been  held without sales for a long period.  


Total gross profit decreased $1,585,166 (36%) from $2,476,482 in 2011 to $891,316 in 2012.  In terms of percentage of revenue, the gross profit percentage decreased to 9% for 2012 as compared to 23% for 2011.Gross profit decreased in 2012 as compared to 2011 because of the fact that we had both a decrease in total revenues and an increase in cost of revenue in 2012 as compared to 2011.


Selling, general and administrative expenses increased $218,683 (17%) from $1,284,306 for 2011 to $1,502,989 for 2012.


The following is a summary of selling general and administrative expenses for the six months ended September 30, 2012 and 2011.


 

 

2012

 

2011

 

Difference

Personnel costs

 

$

909,719

 

$

791,464

 

$

118,255

Rental

 

 

212,573

 

 

193,464

 

 

19,109

Professional fees

 

 

100,665

 

 

6,175

 

 

94,490

Travel and entertainment

 

 

73,265

 

 

99,477

 

 

(26,212)

Other

 

 

206,767

 

 

193,726

 

 

13,041

 

 

$

1,502,989

 

$

1,284,306

 

$

218,683


Our most significant cost is personnel costs which include salaries, benefits and payroll taxes.  These costs increased $118,255 (15%) from $791,464 in 2011 to $909,719 in 2012, primarily as a result of an increase in the number of employees in the first quarter of our fiscal year.  We had an average of 28 employees for the six months ended September 30, 2011 and an average of 35 for the six months ended September 30, 2012.  The increase was minimized by a decrease in officer compensation.  Officer salaries decreased by $46,000.  In future periods our personnel cost should go down as a result of shifting some of our work to our Okinawa office where salaries are lower.


Rental expenses remained fairly consistent for 2011 and 2102.   We are planning to downsize our office space, thus reducing our rental expense in future periods.


Legal and professional fees increased $94,490(1530%) from $6,175 in 2011 to $100,665 in 2012 as a result of the merger which took place in 2012

.



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Travel and entertainment decreased $26,212 (26%) from $99,477 in 2011 to $73,265 in 2012. The decrease directly relates to our efforts to minimize operating expenses which will be continued through the remainder of the current fiscal year.


Other selling, general and administrative expenses include items such as office expenses, software related costs, telephone and a variety of other miscellaneous costs.  Included in other cost were the costs of opening an office in Okinawa, Japan.  Other than the cost of opening the office in Okinawa, which was approximately $20,000, none of these costs individually increased or decreased significantly.  We opened the office in Okinawa to reduce personnel cost as salaries are lower than in Tokyo where our main office is located.


We anticipate that we will incur higher general and administrative expenses as a public company than we incurred in the past as a private company.  We expect that our professional fees, cost of transfer agent, investor relations costs and other stock related costs will increase.  We are currently reviewing all of our costs in order to reduce overhead expenses.


Our income (loss) from operations decreased $1,802,434 from an income of $1,168,888 in 2011 to a loss of $(633,546) in 2012.  The increase in income from operations was the result of the fact that we had both a decrease in revenue and an increase in general and administrative expenses in 2012 as compared to 2011.


Other expense increased $457,082 (612%) from $74,846 in 2011 to $532,928 in 2012.  During 2012 we wrote off investments in animated films in the amount of $465,505 and recorded income from investments of $10,029. There was no income from this source in 2011.


In light of continued losses, at September 30, 2012 we could no longer be more than 50% assured that we would receive the benefit from deferred tax assets carried on our balance sheet.  Accordingly, we reserved for 100% of the deferred tax asset and recorded tax expense of $726,576.


The net (loss) increased $2,986,092 from $1,094,042 in 2011 to $(1,892,050) in 2012.



RESULTS OF OPERATION FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2011

(References to 2012 and 2011 are to the three months ended September 30, 2012 and 2011 respectively, unless otherwise specified.)


Total Revenue decreased $3,737,705(53%) from $6,996,674 for 2011 to $3,258,969 for 2012 as a result of a decrease in revenue from film entertainment.  Revenue from film entertainment decreased $3,914,132(64%) from $6,044,957for 2011 to $2,130,825for 2012, while revenue from book publishing and distribution increased $176,427 (18%) from $951,717for 2011 to $1,128,144 for 2012.


The decrease in revenue in film entertainment is due to a reduction in the number of  new producing film contracts in 2012 as compared to 2011.  Our cash constraints required us to cut back in the number of new film productions.


During the three months ended September 30, 2012, our book division released a total of 11books.   Sales from new releases totaled $843,736 during the period, and total revenue from book sales was $929,728 for the period.  



We do not anticipate significant growth until such time as our cash flow improves.  We estimate  that our growth will resume by the end of this fiscal year.


Cost of revenue decreased $1,482,474(31%) from $4,734,638 in 2011 to $3,252,164 in 2012.  In terms of percentage of revenue, cost of revenue was 99% in 2012 as compared to 33% in 2011.  


Cost of revenue for our film entertainment segment was approximately96% for 2012 as compared to75% in 2011.

 

Cost of revenue is calculated using a fraction in which the denominator is an estimate of the ultimate revenue that a



26






production will produce and the numerator is the revenue achieved for the accounting period.  The unamortized film cost for the project is then multiplied by the percentage calculated.  To the extent that the film’s ultimate revenues are adjusted, the resulting gross margin reported on the exploitation of that film in a period is also adjusted.


Changes in estimates of ultimate revenues from period to period affect the amount of film costs amortized in a given period and, therefore, have an impact on our financial results for that period. For example, prior to a film’s release, we often will test market the film to the film’s targeted demographic. If the film is not received favorably, we may then (i) reduce the film’s estimated ultimate revenues, (ii) revise the film, which could cause the production costs to increase or (iii) perform a combination of both. Similarly, a film that generates lower-than-expected theatrical revenues in its initial weeks of release would have its theatrical and home video ultimate revenues adjusted downward.  (See Film Costs and Revenues included in Critical Accounting Policies and Estimates above for a more detailed explanation of the accounting).


Our estimates of ultimate revenue were lower in 2012 than in 2011.  This resulted in a higher cost of revenue.


Cost of revenue for our book publishing segment was approximately105% in 2012 as compared to21% in 2011.  The increase in cost of revenue is attributable to our disposal during 2012 of unsold inventories which had been held without sales for a long period.


Total gross profit decreased $2,255,231from $2,262,036 in 2011 to $6,805 in 2012.  In terms of percentage of revenue, the gross profit percentage decreased to 0.2% for 2012 as compared to 32% for 2011.


Selling, general and administrative expenses decreased $25,645 (4%) from $657,594 for 2011 to $631,948 for 2012.


The following is a summary of selling general and administrative expenses for the three months ended September 30, 2012 and 2011.


 

 

2012

 

2011

 

Difference

Personnel costs

 

$

352,325

 

 

387,475

 

$

35,150

Rental

 

 

107,555

 

 

88,611

 

 

18,944

Professional fees

 

 

53,665

 

 

3,663

 

 

50,002

Travel and entertainment

 

 

29,286

 

 

61,237

 

 

(31,951)

Other

 

 

89,117

 

 

116,608

 

 

(27,491)

 

 

$

631,948

 

 

657,594

 

$

(25,645)



Our most significant cost is personnel costs which include salaries, benefits and payroll taxes.  These costs decreased $17,116 (6%) from $268,275 in 2011 to $285,391 in 2012.  We had an average of34 employees for the three months ended September 30, 2011 and an average of 29for the three months ended September 30, 2012.   In addition to the decrease in number of staff we also had salary cuts during the period in 2012.  The most significant reduction was in officer salaries.


Rental expenses remained fairly consistent for 2011 and 2102.  We are planning to downsize the office to cut the expenses.  This should effect all future periods.


Professional fees increased $50,002(1365%) from $3,663 in 2011 to $53665 in 2012 as a result of the merger which took place in 2012 and the cost of being a public company.


Travel and entertainment decreased $31,951 (52%) from $61,237 in 2011 to $29,286 in 2012. The decrease directly relates to our efforts to minimize operating expenses which will be continued through the remainder of the current fiscal year.


Other selling, general and administrative expenses include items such as office expenses, software related costs, telephone and a variety of other miscellaneous costs.  Included in other cost were the costs of opening an office in Okinawa, Japan.  Other than opening the office which was approximately $20,000, none of these cost individually



27






increased or decreased significantly.


We anticipate that we will incur higher general and administrative expenses as a public company than we incurred in the past as a private company.  We expect that our professional fees, cost of transfer agent, investor relations costs and other stock related costs will increase.


We also anticipate that selling, general and administrative expenses will concurrently increase with any  increased activity in the future but will not increase in the same proportion to that of revenue.  We are currently reviewing all of our costs in order to reduce overhead expenses.


Our income (loss) from operations decreased $2,228,080 from income of $1,591,052 in 2011 to a loss of $(636,028) in 2012.  


Other expense increased $542,846 (1545%) from $35,131 in 2011 to $507,715 in 2012.  During 2012 we wrote off investments in animated films in the amount of $465,505 and recorded income from investments of $10,029. There was no income from this source in 2011.


In light of continued losses, at September 30, 2012 we could no longer be more than 50% assured that we would receive the benefit from deferred tax assets carried on our balance sheet.  Accordingly, we reserved for 100% of the deferred tax asset and recorded tax expense of $726,576.


The net (loss) increased $3,427,240 from $1,556,921 in 2011 to $(1,870,319) in 2012.



Liquidity and Capital Resources


At September 30, 2012, we had a working capital deficit of $6,811,671, as compared to a working capital deficit of $6,773,922 at March 31, 2012. Of the working capital deficit at September 30, 2012, $3,821,529 was in deferred revenue and does not represent a cash liability.  This amount will be included in future revenue.  In addition, $4,264,962 was in film costs and this asset will not result in our receipt of cash.  This amount will be used as a cost of revenue in the future.  Excluding the amounts for deferred revenue, we would have had working capital deficit of $2,990,142 at September 30, 2012.


During the six months ended September 30, 2012, operating activities used cash of $325,682 and for the six months ended September 30, 2011, we provided cash from operations of $2,056,982.  This was primarily due to the loss in 2012.


During the six months ended September 30, 2012, investing activities used $297,525 of cash and for the six months ended September 30, 2011, investing activities used $3,127,444 of cash.  In 2011, we invested in excess of $3,000,000 in animated film projects and in 2012 we only invested approximately $320,000.


During the six months ended September 30, 2012, financing activities provided $153,135of cash and for the six months ended September 30, 2011, financing activities provided $836,942 of cash.  For the six months ended September 30, 2012 new bank borrowings, both short and long term, of $1,147,440 were offset by repayments of $994,305 as compared to borrowings of $1,634,989 and repayments of $1,060,920 for the six months ended September 30, 2011.


We are dependent on third party financing to provide the liquidity to fund future projects.  In the past this funding has been provided by bank loans which have been guaranteed by our Chief Executive Officer and some of which have had an additional guarantee of a third party commercialized credit guarantee company.  There can be no assurances that we will be able to continue financing projects in this manner.  We are currently exploring other alternatives which might include equity financing.


In addition to the bank financing, in prior years we issued convertible bonds, to a shareholder of ours, in the original amount of ¥84,000,000 (approximately US$1,103,758).  The bonds bear interest at a fluctuating rate of interest equal to the prime lending rate for long-term credit established by Mizuho Corp bank as of the first day of each



28






interest payment period plus 0.3%, based on prime rate.   The convertible bonds matured on September 30, 2012 and the holder agreed to extend the due date until March 31, 2013.  The bonds are no longer convertible.


Subsequent Event


On November 12, 2012 we borrowed $1,200,000 from an unrelated third party.  


The loan was made pursuant to the terms of a Credit Agreement dated as of October 31, 2012 (the "Credit Agreement"), and made effective as of November 12, 2012, by and is evidenced by a Revolving Note.  Under the Credit Agreement, We may borrow up to an amount equal to the lesser of 80% of its Eligible Accounts (as defined in the Credit Agreement) and the revolving loan commitment, which initially is $1,200,000.  Upon satisfaction of certain conditions, we may from time to time, request that the revolving loan commitment be raised up to a maximum of $5,000,000.  The decision to grant any such increase in the revolving loan commitment is in the Lender's sole discretion. 

The loan matures on the earlier of May 12, 2013, which is six (6) months from the closing date, subject to a six-month extension upon written request of we made prior to the initial closing date. The maturity date may also be extended in the Lender's sole discretion, in connection with execution of any modification, extension or renewal of the Revolving Note evidencing the loan.  

The loan bears interest at the rate of 10% per annum.  In addition, we are required to pay certain fees specified in the Credit Agreement.  The fees include due diligence fees, document review and legal fees, an asset monitoring fee, and a transaction advisory fee, all of which are payable in cash, and an additional advisory fee payable through issuance to the Lender of three (3) redeemable warrants to purchase shares of our common stock.  Each of the warrants has a term of 10 years and each of them grants the Lender the right to purchase a number of shares equal to up to one percent (1%) of our issued and outstanding common stock at a price of $0.001 per share.  Each of the warrants includes a mandatory redemption provision pursuant to which we are required to redeem the warrant for a redemption price of $45,000 if the Lender has not previously elected to exercise the warrant.  The mandatory redemption dates of the three warrants are May 12, 2013, August 12, 2013 and November 12, 2013, respectively, which dates are 6 months, 9 months and 12 months after the initial closing date.  

Under the terms of the Credit Agreement, we are required to direct all payments received on account to a lock box account under the control of the Lender.  The Lender is authorized, on a weekly basis, to apply funds in the lock box account toward payment of fees and interest due and owing by us, to the establishment of a reserve in the amount of twenty percent (20%) of the amount of the revolving loan commitment, and, in its sole discretion, to prepayments of the outstanding principal due on the loan.  Any funds remaining on deposit in the lock box account after payment of the foregoing items are required to be disbursed on a weekly basis to us.


In addition to the lock box, the loan is secured by a pledge of substantially all of the our assets, by a pledge of all of the shares of T.O Entertainment, Inc., a Japan corporation, owned by us, and by the pledge by the officers and directors of the Company of a total of 8,581,725 shares of our common stock currently owned by such officers and directors, and representing approximately 26% of our currently issued and outstanding common stock.  


The Credit Agreement imposes certain restrictions on us, including restrictions on its ability to (i) incur any Funded Indebtedness (as defined in the Credit Agreement), (ii) incur liens, (iii) make investments, (iv) permit a Change in Control (as defined in the Credit Agreement) or dispose of all or substantially all of its assets, (v) make capital expenditures not in the ordinary course of its business, (vi) issue or distribute capital stock, (vii) make distributions to its shareholders, (viii) engage in any line of business other than the business engaged in on the date of the Credit Agreement and businesses reasonably related thereto, and (ix) enter into transactions with any affiliates except in the ordinary course of business and upon fair and reasonable terms that are no less favorable to us than we would obtain in an arm-length's basis with a non-affiliate.  Each of these restrictions is subject to certain exceptions, as specified in the Credit Agreement.


The loan may be accelerated upon the occurrence and during the continuation of an Event of Default (as defined in the Credit Agreement), including nonpayment of amounts owed, misrepresentation, failure to perform under the Credit Agreement or related documents, default under certain other obligations, events of bankruptcy, the entry of a



29






judgment in excess of certain specified amounts, the occurrence of a Material Adverse Effect (as  defined in the Credit Agreement), the occurrence of a Change in Control (as defined in the Credit Agreement), certain impairments of collateral, and the determination in good faith by the Lender that the prospect for payment or performance of the Obligations (as defined in the Credit Agreement) is impaired for any reason.


On January 31, 2013 the Credit Agreement was modified.  The Lender agreed to waive its right to retain any portion of payments received in the lock box between January 31, 2013 and March 31, 2013 for purposes of establishing a reserve account equal to 20% of the initial Revolving Loan Commitment of $1,200,000.   All funds held in reserve by Lender prior to January 31, 2013, will continue to be held in reserve in the lock box account. In consideration for agreeing to enter into this Amendment, the Company agreed to pay Lender an additional advisory fee in the form of a  redeemable warrant, giving the Lender the right to purchase, for no additional consideration, one percent (1.0%) of the issued and outstanding common stock of the Issuing Borrower, which warrant is  in substantially the same form as the Warrants issued under the Credit Agreement (the “Additional Warrant”).  The Additional Warrant includes a mandatory redemption feature pursuant to which the Company is required to redeem the warrant for a redemption price of $135,000 if the Lender has not previously elected to exercise the warrant.  The mandatory redemption price is payable in twelve (12) equal monthly installments of $11,250.00 each, commencing on April 1, 2013, and continuing on the first day of each consecutive calendar month thereafter until the Additional Warrant is redeemed in full.  


There are no material relationships between us or any of our affiliates and the Lender, other than with respect to the Credit Agreement.


Summary


Generally speaking, the production of video footage such as animation and movies takes approximately 2 years from planning to being screened to the public.  As a result of our cash flow problems we are currently involved in smaller size animation productions.   We started a number of projects in the six months ended September 30, 2012 and will continue to see the results in future periods.  As of September 30, 2012 a total of $4,264,962 in costs has been capitalized as film costs which will be offset against future revenue. We also have deferred revenue of $3,821,529 which will result in revenue in future periods.


In addition, we do not anticipate increasing the number of DVD’s produced nor the number of books produced.  We will begin to increase our activity as our cash flow improves.


In the entertainment industry, financial success is based upon audience acceptance of the products produced.  Although we are selective in our choice of projects, there can be no guarantee that our productions will be widely received.   


In order to minimize our risk of acceptance by audiences, we plan to do sequels of titles that have previously done well and also to prepare new titles with the same production team that produced the hits. Our main target group, the “Otaku”, are known for their tendency in purchasing of related products.


As a result of our weakened cash flow position caused by delays in closing the loan discussed above as a subsequent event, we were unable to fund certain projects that we had planned.  Until such time as we can fund additional projects our growth will be slowed.  There is no assurance that we can obtain additional financing for those projects and we will have to fund them form cash flow.



Off-Balance Sheet Arrangements


At September 30, 2012, we had no obligations that would qualify to be disclosed as off-balance sheet arrangements.


ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:


Not Applicable



30








ITEM 4.

CONTROLS AND PROCEDURES:


Disclosure Controls and Procedures


The Securities and Exchange Commission defines the term “disclosure controls and procedures” to mean a company's controls and other procedures of an issuer that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.  The Company maintains such a system of controls and procedures in an effort to ensure that all information which it is required to disclose in the reports it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified under the SEC's rules and forms and that information required to be disclosed is accumulated and communicated to principal executive and principal financial officers to allow timely decisions regarding disclosure.


As of the end of the period covered by this report, The Company's management, with the participation of the chief executive officer and the chief financial officer, carried out an evaluation of the effectiveness of the design and operation of the Company's "disclosure, controls and procedures" (as defined in the Exchange Act Rules 13a-15(3) and 15-d-15(3) as of the end of the period covered by this annual report (the "Evaluation Date").  As a result of the evaluation, the chief executive officer and the chief financial officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures although designed to provide reasonable assurance of achieving the objectives of timely alerting them to material information required to be included in our periodic SEC reports and of ensuring that such information is recorded, processed, summarized and reported with the time periods specified were not effective.  During the period covered by this report the Company lost personnel in the accounting department which caused the Company to not have timely financial information.  


The Company will remedy the inadequacy by hiring additional accounting personnel.


Changes in Internal Controls Over Financial Reporting


There have not been any changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) or any other factors during the three months ended September 30, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



PART II-OTHER INFORMATION


ITEM 1.

LEGAL PROCEEDINGS.


The Company is not a party to any pending legal proceedings, and no such proceedings are known to be contemplated. No director, officer or affiliate of the Company, and no owner of record or beneficial owner of more than 5.0% of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.


ITEM 1A. RISK FACTORS.


Not Applicable.





31






ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.


None


ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.


None.


ITEM 4.

MINE SAFETY DISCLOSURES


Not Applicable


ITEM 5.    

OTHER INFORMATION.


None.




32







ITEM 6.

EXHIBITS.


(a)

The following exhibits are filed herewith:

 

 

 

 

Regulation S-K Number


Exhibit

 

 

10.12

Credit Agreement Amendment No. 1, dated January 31, 2013, by and among T.O Entertainment, Inc., a Colorado corporation, T.O Entertainment, Inc., a Japan corporation, T.O Entertainment United Kingdom, a United Kingdom corporation, T.O Entertainment Rus, LLC., a Russia limited liability company, and T.O Entertainment Singapore PTE Ltd., a Singapore corporation, collectively as Borrower and TCA Global Credit Master Fund LP, as Lender*

 

 

31.1

Certifications pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

31.2

Certifications pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

32.1

Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

 

 

32.2

Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

 

 

101

INS XBRL Instance Document*

 

 

101

SCH XBRL Schema Document*

 

 

101

CAL XBRL Taxonomy Extension Calculation Linkbase Document*

 

 

101

LAB XBRL Taxonomy Extension Label Linkbase Document*

 

 

101

PRE XBRL Taxonomy Extension Presentation Linkbase Document*

 

 

101

DEF XBRL Taxonomy Extension Definition Linkbase Document*

 

 


 

 

*

filed herewith

 

 





33







SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


T.O ENTERTAINMENT, INC



By:  /S/ Takeichi Honda

Takeichi Honda, Chief Executive Officer


Date:  February 6, 2013



By: /S/ Arnold Tinter

Arnold Tinter, Principal Financial Officer


Date:  February 6, 2013





34