Development.
GameZnFlix, Inc. ("Company") was formed in Delaware in June 1997 under the name SyCo Comics and Distribution Inc. and is the successor to a limited partnership named SyCo Comics and Distribution formed under the laws of the Commonwealth of Virginia on January 15, 1997, by Sy Robert Picon and William Spears, the co-founders and principal shareholders of the Company. On February 17, 1999, SyCo Comics and Distribution Inc. changed its name to Syconet.com, Inc. With the filing of Articles of Merger with the Nevada Secretary of State on April 12, 2002, the Company was redomiciled from Delaware to Nevada, and its number of authorized common shares was increased to 500,000,000. On November 21, 2002, the Company amended its articles of incorporation changing its name to Point Group Holdings, Incorporated. On March 5, 2003, we again amended our articles of incorporation so that (a) an increase in the authorized capital stock of the Company can be approved by the board of directors without shareholder consent; and (b) a decrease in the issued and outstanding common stock of the Company (a reverse split) can be approved by the board of directors without shareholder consent. On July 11, 2003, the Company amended its articles of incorporation to increase the number of authorized common shares to 900,000,000. On January 26, 2004, the name of the Company was changed to "GameZnFlix, Inc" by the filing of amended articles of incorporation. On December 16, 2004, we amended our articles of incorporation to increase the authorized common stock of the Company to 2,000,000,000 shares. On July 19, 2005, the articles of incorporation were further amended to increase the number of authorized common shares to 4,000,000,000.
During the period of July 2002 to September 2002, we acquired two companies, AmCorp Group, Inc., a Nevada Corporation, and Naturally Safe Technologies, Inc. also a Nevada corporation. Currently, Naturally Safe is current with its incorporation with the State of Nevada, but does not have any business operations. In February 2005, AmCorp amended its articles of incorporation, changing its name to GameZnFlix Racing and Merchandising, Inc. AmCorp provided services to companies that desired to be listed on the OTCBB and Naturally Safe held patents on a product that assisted Christmas trees in retaining water. During the fiscal year ended December 31, 2002, AmCorp generated 26% of our total revenues and Naturally Safe generated approximately 74% of our revenues. During the fiscal year ended December 31, 2003, AmCorp generated 2% of our total revenues and Naturally Safe generated approximately 88% of our revenues. In May 2003, we ceased operation of Prima International, LLC, a wholly owned subsidiary of Naturally Safe. In September 2003, the Company acquired Veegeez.com, LLC, a California limited liability company.
Business of the Company.
Our Company, through our website www.gameznflix.com, is an online DVD movie and video game rental business dedicated to providing subscribers a quality rental experience. We offer subscribers a reliable, web-based alternative to traditional store-based DVD and video game rentals on a national scale with an extensive library of approximately 40,000 DVD and video game titles for Xbox, Xbox 360, Playstation, Playstation 2, and Nintendo Gamecube. We believe our service is an alternative to store based DVD and video game rentals and that we offer a high level of customer service, quality titles and product availability. We offer subscribers several different subscription plans ranging from $8.99 per month to $16.99 per month and $249.00 annual membership. Our more popular subscription plan of $16.99 per month allows subscribers to have up to three DVD and video game titles out at the same time with no due dates, late fees or shipping charges. Subscribers select titles at our website which are then sent via U.S mail with a prepaid return mailer. When a game and DVD has been returned, the subscriber's next available selection is mailed to them.
In March 2004, we launched our website, http://www.gameznflix.com, and became fully operational in September 2004. In conjunction with the website the Company runs ad campaigns designed to create awareness among our target consumers and to generate traffic to the website.
Our management believes that we are in a good position to take advantage of the following market conditions:
- start-up opportunities exist in the on-line video game rental business;
- the need for use of efficient distribution and financial methods;
- under-served market that has growth opportunity;
- existing video game rental companies' uneven track record in providing customer service.
Our internally developed software enables us to customize our website for each of our subscribers. Since our software is internally developed, our web site is easily changed and expanded to meet customer needs and provide vital business information. Our online interface with customers eliminates the need for costly retail outlets and allows us to serve a national customer base with low overhead costs.
We currently provide rental services to our subscribers. In addition, we also sell new titles to our subscribers as well as non- members visiting our web site. Plans are in place to expand and provide sales of used DVD titles at a discounted price and new video gaming accessories. The development of this portion of the website is nearly completed. Management believes by adding these additional services we will be able to complement our rental service by increasing cash flow and capitalizing on impulse sales to our current subscribers.
We seek to provide our customers with a large selection of video game rental and DVD movie choices on a monthly subscription basis. Customers can sign-up via the web page to rent video games of their choice. The titles are then shipped to the customer via first class mail once they have made their selection(s). Active subscribers can retain the games for an indefinite amount of time as long as they are active paying subscribers. Customers can exchange their selections at anytime by returning their game(s) in the pre-addressed package provided.
From November 2004 through October 2005, when we commenced tracking our customer base, we have consistently maintained a monthly customer base of 3,000 customers. As of the end of December 31, 2005, we have increased our customer base to approximately 6,000, which such growth can be attributed to more public awareness of our Company. Part of this public awareness of our Company resulted from a service agreement we had entered into with Circuit City Stores, Inc. in October 2005 that commenced in November 2005 and ends March 2006. The agreement with Circuit City provided for a pilot program to be run in 27 retail stores and on the Circuit City website to promote services offered by us. On December 28, 2005, we entered into an amendment of the service agreement extending the pilot program until March 15, 2006. Although the overall number of subscribers obtained from the Circuit City service agreement was not considered significant in relation to the number of new subscribers added during the last quarter of 2005, we believe that our relationship with Circuit City brought more prominence and recognition to our Company. We will continue to seek similar relationships with nationally known companies or agencies to further brand our Company name.
Product and Service Description.
We offer both DVD movie and video game rental services and the ability to purchase new DVD movie and video game titles to our subscribers. In addition, we also sell new DVD movie and video game titles to our non-members. Members can choose from rental packages of three to six titles outstanding at one time on a monthly subscription basis with unlimited replacement of products as long as they are an active subscriber. For the period of April 2004 through December 2004, the average number of active subscribers per month has been 2,052. For the year ended December 31, 2005, the amount of revenues that have been generated from these subscriptions has totaled approximately $676,000. Plans are priced at $16.99 for a three-title package. Applicable tax is also collected for California residents.
We currently own approximately 40,000 titles and approximately 97,638 copies. In March 2004, we signed a supply agreement with an entertainment distributor. The supply agreement is designed to enable us to access the most current DVD and video game titles for purposes of meeting rental requests as well as all purchases. We own all titles that are rented to our subscribers. We purchase titles based on membership request for a title. We are building the inventory based on membership requests. In the event that a title is purchased through our web site, if we do not already own such title, we then purchase that title to fulfill the request. We purchase our inventory from Ingram Entertainment, Inc. for cash.
Our proprietary queue system and dynamic web server based database system automatically select the next game a customer receives based on factors such as the subscriber's next game preferences, game availability, length of time a subscriber has been with us, and the subscriber's subscription plan level.
All products sold, DVD's and games, are offered to current subscribers at a 10% discount from our retail price. In the future, used DVD's will be sold and will be priced based on the length of time the game has been in service, the current market rate (as determined by on-line sites like Amazon.com, and EBGames.com), and customer demand to maximize profit. For example, most new games are sold for $49.99 at retail stores and for $49.99 plus shipping from on-line stores. The Company offers the games at a price of $46.99 plus shipping charges paid by the customer. We currently charge a flat rate of $3.00 per order for shipping. Most of our online competitors utilize multiple shipping rates, which incorporates a per piece charge as part of their shipping calculations.
Like some of our competitors, we offer a toll free customer service phone number 8 hours per day, five days per week (Monday - Friday). We also take customer inquiries and requests via our e-mail address and maintain a policy to answer each e-mail within 24 - 48 hours.
Competition
(a) Game Rentals.
Our competition for game rentals comes in two main forms:
- Chain rental stores - Our indirect competitors include traditional retail stores that offer video game rentals such as Blockbuster, Hollywood Video, and other national and local video rental stores. These companies are formidable, established competitors for video game rentals. The primary business of these companies is the renting of movies and not video games. Additionally, late returns are assessed stringent daily late fees by some of these chain rental stores for relatively short rental periods.
- Online competitors - Currently there are approximately 12 direct competitors that provide online video game rentals. Some of our competitors include AngelGamer.com, DVDAvenue.com, Gamez2go.com, Govojo.com, Midwest- games.com, RedOctane.com, Rent-a-realm.com, Gamefly.com, and Videogamealley.com. Each of these competitors offers rental packages on a monthly subscription basis with offerings of one to eight games available at varying prices.
We compete on product availability, customer service and product availability information.
(b) DVD Rentals.
Our competition for DVD rentals comes in the following forms:
- Chain rental stores - there are a number of retail stores located across the country that rent DVD's. These retail stores have a national image, high volume, multiple locations and general familiarity.
- Other local video rental stores - the number and size of these competitors varies, but is not substantial. They are competing against the chains in an attempt to offer lower prices and a more customer friendly staff. They offer a certain amount of customer service, as this is their only business as compared to the chain rental stores.
- Online competitors - the number of online competitors is growing. Management is aware of 12 other online services, such as NetFlix.com (the dominant force in this sector). Competitors vary in their service offerings.
In summary, management believes that in order to be successful we must provide our subscribers with the best possible renting experience and a willingness to develop a long-standing relationship. We must offer a high level of customer service, reliable product availability, and a responsive and efficient web site to deliver the service.
(c) Sale of DVD's and Games.
In November 2004, we commenced selling new DVD and video games, and video game system accessories such as controllers, memory cards, and cables. The offering of these products for sale has been integrated with the existing website and has accounted for approximately 42% of our revenue on a monthly basis. Management believes these new offerings will complement the current rental service as many of our subscribers have indicated that they rent games to decide which games they would like to buy in the future.
Chain rental stores and other local rental stores also sell DVD's. In addition, DVD's are sold by large retailers, including Wal Mart, Target, and Best Buy.
Fulfillment.
In February, 2005, we ceased using the services of National Fulfillment, Incorporated to meet our fulfillment needs and internalized the fulfillment with distribution centers located in Franklin, Kentucky, Holtville, California, Sterling, Colorado, and Scranton, Pennsylvania. The California location services the subscriber base west of the Rocky Mountains, the Kentucky location services the subscriber base to the east of the Mississippi River except for the Northeast which is serviced by the Scranton location, and the Colorado location services the middle states. Delivery of the video game discs and DVD's is provided by first class mail. During 2005, we were able to negotiate a new mailer envelope with the United States Postal Office ("USPS") that reduced our overall postage cost and decreased the delivery turnaround time from 7 to 2 days. The average cost, after the new mailer, of delivery for the shipment is $1.20. The delivery of each subsequent game costs $0.60 for shipment to the customer and $0.60 for each return.
Each day at mid-night the computers create a ship file for each center. These files are downloaded Monday through Saturday at each of the centers that then process the titles to be shipped for the day. Each distribution center delivers the outgoing titles to the USPS by a cut-off time established by the local USPS in order to make the mail on that day. After dropping off the outgoing titles, the personnel receive the return titles and then process the returned titles back into our inventory through the use of scanners. Each return title is verified to be the correct title, matches the member who returns it and that the title is in good working condition.
Technology.
All orders are taken by credit card via our web site at www.gameznflix.com and processed through Authorize.Net and our Humboldt Bank merchant account. Data resulting from customer sales transactions is transferred to our proprietary database system. This database system provides the necessary information for accounting, sales, customer service, inventory management, and marketing information needs and is accessible directly through any Internet connection.
Marketing.
Our target market for games is the hard core gamer that purchases and rents games on a regular basis. We will also target the DVD movie rental market similar to NetFlix.com and Blockbuster.com. We are targeting subscribers of other services through our affiliate program, which is a commission based referral program that is administered through our own affiliate tracking software. These affiliates consist of web sites that drive consumers to our web site in consideration for a fee. The participants in this program are not affiliated with our Company outside of their participation in the affiliate program. Participants in the affiliate program through which we obtain subscribers, can receive up to $70 for each new subscriber directed to our Company by that affiliate that elects to use our service. The commission schedule is tied to the type of account the subscriber whom they sent to us signs up for. A $70 commission would be for an annual membership signup. In addition, there are other programs where we will pay a range from $10 to $25 per member based on the volume the affiliate provides our Company.
We also have a special program that we offer to the U.S. military, including active duty, veterans, reservists, National Guardsmen, DOD employees and their dependents. They receive a special rate that is roughly a 10% discount on our standard rates. We also offer them shipping to any base throughout the world.
Since the target market for our game rentals is already renting games from traditional rental stores, the most important market needs are a higher level of support and service, a greater value for the money they spend, and greater product availability. One of the key points of our strategy is the focus on hard-core gamers that know and understand these needs and are looking to pay less, and spend less time to have them filled.
We believe the most obvious and important trend in the market is an increase in the number of people playing video games. A second trend is that, in management's opinion, video game players are becoming more and more unsatisfied with the current video game rental stores due to late fees, short rental times and a general lack of customer service support are all strong reasons why video game players are looking for an alternative.
We believe a third trend is ever-greater connectivity, with more people getting onto the Internet and purchasing more items over the Internet. Items such as computer hardware, apparel, consumer electronics, office supplies, toys, movies and video games are all seeing what we believe is an increasing numbers of online sales. An estimated 15% of our current subscriber base is college students. Advertisement in school newspapers, on college websites, and other advertising media will be placed at college campuses in targeted cities. We will also participate in direct marketing opportunities in conjunction with back-to-school events on these campuses. Our first opportunity will be with the universities in the vicinity of Nashville, Tennessee.
In February 2004, we retained the services of AdSouth Partners, Inc., a national ad agency, to assist in the launch and marketing of our website http://www.gameznflix.com. Through AdSouth Partners, Inc., we commenced a direct television response advertising campaign that covered 13 different national television channels by use of five different commercials, starring Dennis Coleman (a television and movie actor) and Ben Curtis (the former star of Dell television commercials). The television ad campaign covered the period from April 2004 to February 2005 on a monthly basis, and the advertising was prepaid. The last advertisement in this campaign was a commercial aired during the 4th quarter of the 2005 Super Bowl on three local television stations. For the remainder of 2005, we did not have any major television advertising campaigns; the Company ended its relationship with AdSouth Partners, Inc. Due to software issues, we are unable to determine the effect that this advertising has on our subscriptions and revenue.
In 2005, we continued to market online through our affiliate program and expand it to meet the membership growth we will require. Our other advertising and marketing programs will move away from national advertising and focus on areas in the proximity of our distribution centers. We will utilize such media as print, radio, outdoor and others where appropriate. This marketing program was launched in Nashville, Tennessee and then expanded to those other markets throughout the year.
We also utilize "grass-roots" tactics that may include local market sponsorships, direct marketing opportunities via kiosks, corporate gift programs, employee benefits programs, member referral programs and other areas that will help us get in front of our target markets.
In addition, in February 2005 we commenced marketing activities through our wholly owned subsidiary GameZnFlix Racing and Merchandising, Inc. In connection with these activities we sponsored a local drag racing car that covered the local Kentucky and Tennessee areas. In accordance with the drag racing team, we pay entry fees and pre-approved travel expenses to attend races in consideration for the placement of our name on the racecar, trailer and tow vehicle. We also receive half of all winnings and reimbursement of expenses.
In October 2005, we entered into a service agreement with Circuit City that provided a pilot program for the sale of our standard $16.99 monthly subscription on a prepaid card basis. The pilot program expanded to 27 retail stores and on Circuit City's website.
Research and Development.
During the fiscal year ended December 31, 2005, we have engaged in research and development activities, including the development of online games and broadband delivery of our rental inventory. The portion of our operating costs that is allocable to research and development is immaterial.
Strategy and Implementation Summary.
In order to successfully implement our business plan, we must:
- emphasize service and support;
- differentiate our self from the competition;
- establish our service offering as a clear and viable alternative to time period rentals;
- build a relationship-oriented business;
- become subscribers' video game rental site of choice; and
- ensure that all orders are delivered timely and accurately.
Employees.
The Company currently has fourteen employees and one paid consultant. Our employees and consultant operate in the following areas:
- purchasing (1 employee)
- sales and marketing (1 consultant)
- general business operations and management (12 employees)
- website operations (1 employee)
Risks Relating to Our Business.
(a) We Have a History of Losses That May Continue.
We incurred net losses of $4,239,532 for the year ended December 31, 2005 and $9,717,301 for the year ended December 31, 2004. We cannot assure you that we can achieve or sustain profitability on a quarterly or annual basis in the future. If revenues grow more slowly than we anticipate, or if operating expenses exceed our expectations or cannot be adjusted accordingly, we will continue to incur losses. We will continue to incur losses until we are able to establish significant rentals of our DVD's and games over the Internet. Our possible success is dependent upon the successful development and marketing of our web site and products, as to which there is no assurance. Any future success that we might enjoy will depend upon many factors, including factors out of our control or which cannot be predicted at this time. These factors may include changes in or increased levels of competition, including the entry of additional competitors and increased success by existing competitors, changes in general economic conditions, increases in operating costs, including costs of supplies, personnel and equipment, reduced margins caused by competitive pressures and other factors. These conditions may have a materially adverse effect upon us or may force us to reduce or curtail operations.
(b) Ability to Attract and Retain Subscribers Will Affect Our Business.
The Company must continue to attract and retain subscribers. To succeed, we must continue to attract subscribers who have traditionally used video and game retailers, video and game rental outlets, cable channels, such as HBO and Showtime and pay-per-view. The Company's ability to attract and retain subscribers will depend in part on its ability to consistently provide its subscribers a high quality experience for selecting, viewing or playing, receiving and returning titles. If consumers do not perceive the service offering to be of quality, or if the Company introduces new services that are not favorably received by them, we may not be able to attract or retain subscribers. If the efforts to satisfy its existing subscribers are not successful, we may not be able to attract new subscribers, and as a result, revenues will be affected adversely.
The Company must minimize the rate of loss of existing subscribers while adding new subscribers. Subscribers cancel their subscription to our service for many reasons, including a perception that they do not use the service sufficiently, delivery takes too long, the service is a poor value and customer service issues are not satisfactorily resolved. The Company must continually add new subscribers both to replace subscribers who cancel and to grow the business beyond the current subscriber base. If too many of subscribers cancel the Company's service, or if the Company is unable to attract new subscribers in numbers sufficient to grow the business, operating results will be adversely affected. Further, if excessive numbers of subscribers cancel the service, we may be required to incur significantly higher marketing expenditures than currently anticipated to replace these subscribers with new subscribers.
Subscribers to the service can view as many titles and/or play games as they want every month and, depending on the service plan, may have out between three and six titles at a time. With the Company's use of three shipping centers and the associated software and procedural upgrades, we have reduced the transit time of DVD's and games. As a result, our subscribers have been able to exchange more titles each month, which has increased operating costs. As the Company established additional planned shipping centers or further refines its distribution process, it may see a continued increase in usage by subscribers. If subscriber retention does not increase or operating margins do not improve to an extent necessary to offset the effect of increased operating costs, operating results will be adversely affected.
Subscriber demand for titles may increase for a variety of other reasons beyond the Company's control, including promotion by studios and seasonal variations in movie watching. Subscriber growth and retention may be affected adversely if the Company attempts to increase monthly subscription fees to offset any increased costs of acquiring or delivering titles and games.
The GameZnFlix brand is young, and the Company must continue to build strong brand identity. To succeed, we must continue to attract and retain a number of owners of DVD and video game players who have traditionally relied on store-based rental outlets and persuade them to subscribe to its service through its website. The Company may be required to incur significantly higher advertising and promotional expenditures than currently anticipated to attract numbers of new subscribers. The Company believes that the importance of brand loyalty will increase with a proliferation of DVD and game subscription services and other means of distributing titles. If our efforts to promote and maintain its brand are not successful, our operating results and ability to attract and retain subscribers will be affected adversely.
(c) Inability to Use Current Marketing Channels May Affect Ability to Attract New Subscribers.
We may not be able to continue to support the marketing of our service by current means if such activities are no longer available to us or are adverse to our business. In addition, we may be foreclosed from certain channels due to competitive reasons. If companies that currently promote our service decide to enter our business or a similar business, we may no longer be given access to such channels. If the available marketing channels are curtailed, our ability to attract new subscribers may be affected adversely.
(d) Selection of Certain Titles by Subscribers.
Certain titles cost the Company more to acquire depending on the source from whom they are acquired and the terms on which they are acquired. If subscribers select these titles more often on a proportional basis compared to all titles selected, DVD or game acquisition expenses could increase, and gross margins could be adversely affected.
(e) Mix of Acquisition Sources May Affect Subscriber Levels.
The Company utilizes a mix of incentive-based and fixed-cost marketing programs to promote its service to potential new subscribers. We obtain a portion of its new subscribers through online marketing efforts, including third party banner ads, direct links and an active affiliate program. While the Company opportunistically adjusts its mix of incentive-based and fixed-cost marketing programs, it attempts to manage the marketing expenses to come within a prescribed range of acquisition cost per subscriber. To date, the Company has been able to manage its acquisition cost per subscriber; however, if we are unable to maintain or replace sources of subscribers with similarly effective sources, or if the cost of existing sources increases, subscriber levels may be affected adversely and the cost of marketing may increase.
(f) Competition.
The market for on-line rental of DVD's and games is competitive and the Company expects competition to continue to increase. In addition, the companies with whom we have relationships could develop products or services, which compete with the Company's products or services. Also, some competitors in our market have longer operating histories, significantly greater financial, technical, marketing and other resources, and greater brand recognition than we do. The Company also expects to face additional competition as other established and emerging companies enter the market for on-line rentals. To be competitive, we believe that we must, among other things, invest resources in developing new products, improving our current products and maintaining customer satisfaction. Such investment will increase the Company's expenses and affect its profitability. In addition, if it fails to make this investment, the Company may not be able to compete successfully with its competitors, which could have a material adverse effect on its revenue and future profitability.
(g) Any Significant Disruption in Service on Our Website Could Result in Loss of Subscribers.
Subscribers and potential subscribers access our service through our website, where the title selection process is integrated with our delivery processing systems and software. Our reputation and ability to attract, retain and serve our subscribers is dependent upon the reliable performance of our website, network infrastructure and fulfillment processes. Interruptions in these systems could make our website unavailable and hinder our ability to fulfill selections. Service interruptions or the unavailability of our website could diminish the overall attractiveness of our subscription service to existing and potential subscribers.
Our servers utilize a number of techniques to track, deter and thwart attacks from computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions and delays in our service and operations as well as loss, misuse or theft of data. We currently use both hardware and software to secure our systems, network and, most importantly, our data from these attacks. This includes several layers of security in place for our protection and that of our member's data. We also have procedures in place to ensure that the latest security patches and software are running on our servers - thus maintaining another level of security.
Any attempts by hackers to disrupt our website service or our internal systems, if successful, could harm our business, be expensive to remedy and damage our reputation. We do not have an insurance policy that covers expenses related to direct attacks on our website or internal systems. Any significant disruption to our website or internal computer systems could result in a loss of subscribers and adversely affect our business and results of operations.
(h) Potential Delivery Issues Could Result in the Loss of Subscribers.
The Company relies exclusively on the U.S. Postal Service to deliver DVD's and games from its shipping centers and to return DVD's and games from subscribers. We are subject to risks associated with using the public mail system to meet our shipping needs, including delays caused by bioterrorism, potential labor activism and inclement weather. The Company's DVD's and games are also subject to risks of breakage during delivery and handling by the U.S. Postal Service. The risk of breakage is also impacted by the materials and methods used to replicate DVD's and games. If the entities replicating DVD's and games use materials and methods more likely to break during delivery and handling or the Company fails to timely deliver DVD's and games to subscribers, subscribers could become dissatisfied and cancel the service, which could adversely affect operating results. In addition, increased breakage rates for DVD's and games will increase the Company's cost of acquiring titles.
(i) There May be a Change in Government Regulation of the Internet or Consumer Attitudes Toward Use of the Internet.
The adoption or modification of laws or regulations relating to the Internet or other areas of our business could limit or otherwise adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, which may impose additional burdens on us. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model.
The manner in which Internet and other legislation may be interpreted and enforced cannot be precisely determined and may subject either us or our customers to potential liability, which in turn could have an adverse effect on our business, results of operations and financial condition. The adoption of any laws or regulations that adversely affect the popularity or growth in use of the Internet could decrease the demand for our subscription service and increase our cost of doing business.
In addition, if consumer attitudes toward use of the Internet change, consumers may become unwilling to select their entertainment online or otherwise provide us with information necessary for them to become subscribers. Further, we may not be able to effectively market our services online to users of the Internet. If we are unable to interact with consumers because of changes in their attitude toward use of the Internet, our subscriber acquisition and retention may be affected adversely.
(j) Any Required Expenditures as a Result of Indemnification Will Result in a Decrease of Our Net Income.
The Company's bylaws include provisions to the effect that we may indemnify any director, officer, or employee. In addition, provisions of Nevada law provide for such indemnification, as well as for a limitation of liability of our directors and officers for monetary damages arising from a breach of their fiduciary duties. Any limitation on the liability of any director or officer, or indemnification of any director, officer, or employee, could result in substantial expenditures being made by the Company in covering any liability of such persons or in indemnifying them.
Risks Relating to the Financing Arrangements.
(a) There are a Large Number of Shares Underlying our Convertible Debentures and Warrants; Sale of These Shares may Depress the Market Price of our Common Stock.
As of December 31, 2005, we had 3,291,733,490 shares of common stock issued and outstanding and convertible debentures outstanding that may be converted into an estimated 5,015,487,805 shares of common stock at current market prices, and outstanding warrants to purchase 8,203,000 (out of an original 15,000,0000) shares of common stock. In addition, the number of shares of common stock issuable upon conversion of the outstanding convertible debentures may increase if the market price of our stock declines. All of the shares, including all of the shares issuable upon conversion of the debentures and upon exercise of our warrants, may be sold without restriction. The sale of these shares may adversely affect the market price of our common stock.
The continuously adjustable conversion price feature of our convertible debentures could require us to issue a substantially greater number of shares, which will cause dilution to our existing stockholders.
The Company's obligation to issue shares upon conversion of the convertible debentures to Golden Gate Investors, Inc. is essentially limitless. The following is an example of the amount of shares of our common stock that are issuable, upon conversion of the balance of the convertible debenture of $82,027 as of December 31, 2005 (excluding accrued interest), based on market prices 25%, 50% and 75% below the market price as of January 28, 2006 of $0.01:
Number % of % Below Price Per With Discount of Shares Outstanding Market Share at 18% Issuable Stock
25% $0.0075 $0.0060 1,496,000,000 31.24%
50% $0.0050 $0.0040 2,248,000,000 40.58%
75% $0.0025 $0.0020 4,503,000,000 57.77%
As illustrated, the number of shares of common stock issuable upon conversion of the convertible debentures will increase if the market price of the stock declines, which will cause dilution to the existing stockholders.
(b) The Continuously Adjustable Conversion Price Feature of the Debentures may Encourage Short Selling of our Common Stock.
Golden Gate is contractually required to exercise its warrants and convert its convertible debenture on a concurrent basis. The issuance of shares in connection with the exercise of the warrants and conversion of the debentures results in the issuance of shares at an effective 18% discount to the trading price of the common stock prior to the conversion. The significant downward pressure on the price of the common stock as the selling stockholder converts and sells material amounts of common stock could encourage short sales by investors. This could place further downward pressure on the price of the common stock. The selling stockholder could sell common stock into the market in anticipation of covering the short sale by converting their securities, which could cause the further downward pressure on the stock price. In addition, not only the sale of shares issued upon conversion or exercise of debentures, warrants and options, but also the mere perception that these sales could occur, may adversely affect the market price of the common stock.
(c) The Issuance of Shares upon Conversion the Debentures and Exercise of the Warrants May Cause Dilution to our Existing Stockholders.
The issuance of shares upon conversion of the convertible debentures and exercise of warrants may result in substantial dilution to the interests of other stockholders since the selling stockholder may ultimately convert and sell the full amount issuable on conversion. Although the selling stockholder may not convert its convertible debentures and/or exercise its warrants if such conversion or exercise would cause it to own more than 9.9% of our outstanding common stock, this restriction does not prevent the selling stockholder from converting and/or exercising some of its holdings and then converting the rest of its holdings. In this way, the selling stockholder could sell more than this limit while never holding more than this limit. There is no upper limit on the number of shares that may be issued which will have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock, including investors in this offering.
(d) If We are Unable to Issue Shares of upon Conversion of Debenture, We are Required to Pay Penalties to Golden Gate.
If we are unable to issue shares of common stock upon conversion of the convertible debenture as a result of our inability to increase our authorized shares of common stock or as a result of any other reason, we are required to:
- pay late payments to Golden Gate for late issuance of common stock upon conversion of the convertible debenture, in the amount of $100 per business day after the delivery date for each $10,000 of convertible debenture principal amount being converted or redeemed.
- in the event we are prohibited from issuing common stock, or fail to timely deliver common stock on a delivery date, or upon the occurrence of an event of default, then at the election of Golden Gate, we must pay to Golden Gate a sum of money determined by multiplying up to the outstanding principal amount of the convertible debenture designated by Golden Gate by 130%, together with accrued but unpaid interest thereon
- if ten days after the date we are required to deliver common stock to Golden Gate pursuant to a conversion, Golden Gate purchases (in an open market transaction or otherwise) shares of common stock to deliver in satisfaction of a sale by Golden Gate of the common stock which it anticipated receiving upon such conversion (a "Buy-In"), then we are required to pay in cash to Golden Gate the amount by which its total purchase price (including brokerage commissions, if any) for the shares of common stock so purchased exceeds the aggregate principal and/or interest amount of the convertible debenture for which such conversion was not timely honored, together with interest thereon at a rate of 15% per annum, accruing until such amount and any accrued interest thereon is paid in full.
In the event that we are required to pay penalties to Golden Gate or redeem the convertible debentures held by Golden Gate, we may be required to curtail or cease our operations.
(e) Repayment of Debentures, If Required, Would Deplete Available Capital.
In November 2004, we entered into a Securities Purchase Agreement for the sale of an aggregate of $150,000 principal amount of convertible debentures, of which $82,027 is outstanding as of December 31, 2005. The convertible debentures issued to Golden Gate Investors, Inc. are due and payable, with 4 3/4% interest, three years from the date of issuance, unless sooner converted into shares of common stock. In addition, any event of default could require the early repayment of the convertible debentures at a price equal to 125% of the amount due under the debentures. The Company anticipates that the full amount of the convertible debentures, together with accrued interest, will be converted into shares of its common stock, in accordance with the terms of the convertible debentures. If the Company is required to repay the convertible debentures, it would be required to use its limited working capital and/or raise additional funds. If the Company were unable to repay the debentures when required, the debenture holders could commence legal action against the Company and foreclose on assets to recover the amounts due. Any such action may require us to curtail or cease operations.
Risks Relating to Our Common Stock.
(b) Our Common Stock Price May Be Volatile.
The trading price of our common stock may fluctuate substantially. The price of the common stock may be higher or lower than the price you pay for your shares, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include the following:
- Price and volume fluctuations in the overall stock market from time to time;
- Significant volatility in the market price and trading volume of securities of business development companies or other financial services companies;
- Changes in regulatory policies with respect to business development companies;
- Actual or anticipated changes in our earnings or fluctuations in our operating results;
- General economic conditions and trends;
- Loss of a major funding source; or
- Departures of key personnel.
Due to the continued potential volatility of our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management's attention and resources from our business.
(c) Absence Of Cash Dividends May Affect Investment Value Of Our Stock.
The board of directors does not anticipate paying cash dividends on the common stock for the foreseeable future and intends to retain any future earnings to finance the growth of the company's business. Payment of dividends, if any, will depend, among other factors, on earnings, capital requirements and the general operating and financial conditions of the Company as well as legal limitations on the payment of dividends out of paid-in capital.
(c) No Assurance of Public Trading Market and Risk of Low Priced Securities May Affect Market Value of Our Stock.
The Securities and Exchange Commission ("SEC") has adopted a number of rules to regulate "penny stocks." Such rules include Rule 3a51-1 and Rules 15g-1 through 15g-9 under the Securities Exchange Act of 1934, as amended. Because the securities of the Company may constitute "penny stocks" within the meaning of the rules (as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, largely traded in the Over the Counter Bulletin Board or the Pink Sheets), the rules would apply to the Company and to its securities.
The SEC has adopted Rule 15g-9 which established sales practice requirements for certain low price securities. Unless the transaction is exempt, it shall be unlawful for a broker or dealer to sell a penny stock to, or to effect the purchase of a penny stock by, any person unless prior to the transaction: (i) the broker or dealer has approved the person's account for transactions in penny stock pursuant to this rule and (ii) the broker or dealer has received from the person a written agreement to the transaction setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person's account for transactions in penny stock, the broker or dealer must: (a) obtain from the person information concerning the person's financial situation, investment experience, and investment objectives; (b) reasonably determine that transactions in penny stock are suitable for that person, and that the person has sufficient knowledge and experience in financial matters that the person reasonably may be expected to be capable of evaluating the risks of transactions in penny stock; (c) deliver to the person a written statement setting forth the basis on which the broker or dealer made the determination (i) stating in a highlighted format that it is unlawful for the broker or dealer to affect a transaction in penny stock unless the broker or dealer has received, prior to the transaction, a written agreement to the transaction from the person; and (ii) stating in a highlighted format immediately preceding the customer signature line that (iii) the broker or dealer is required to provide the person with the written statement; and (iv) the person should not sign and return the written statement to the broker or dealer if it does not accurately reflect the person's financial situation, investment experience, and investment objectives; and (d) receive from the person a manually signed and dated copy of the written statement. It is also required that disclosure be made as to the risks of investing in penny stock and the commissions payable to the broker-dealer, as well as current price quotations and the remedies and rights available in cases of fraud in penny stock transactions. Statements, on a monthly basis, must be sent to the investor listing recent prices for the penny stock and information on the limited market.
There has been only a limited public market for the common stock of the Company. Our common stock is currently traded on the Over the Counter Bulletin Board ("OTCBB"). As a result, an investor may find it difficult to dispose of, or to obtain accurate quotations as to the market value of our securities. The regulations governing penny stocks, as set forth above, sometimes limit the ability of broker- dealers to sell the Company's common stock and thus, ultimately, the ability of the investors to sell their securities in the secondary market.
Potential shareholders of the Company should also be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (ii) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (iii) "boiler room" practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (iv) excessive and undisclosed bid-ask differential and markups by selling broker- dealers; and (v) the wholesale dumping of the same securities by promoters and broker dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses.
(d) Failure To Remain Current In Reporting Requirements Could Result In Delisting From The Over The Counter Bulletin Board.
Companies trading on the OTCBB, such as the Company, must be reporting issuers under Section 12 of the Securities Exchange Act of 1934, as amended, and must be current in their reports under Section 13, in order to maintain price quotation privileges on the OTCBB. If the Company fails to remain current in its reporting requirements, the company could be delisted from the OTCBB.
In addition, the National Association of Securities Dealers, Inc., which operates the OTCBB, has been approved by the SEC to implement a change to its Eligibility Rule. The change makes those OTCBB issuers that are cited for filing delinquency in their Forms 10- KSB/Form 10-QSB three times in a 24-month period and those OTCBB issuers removed for failure to file such reports two times in a 24- month period ineligible for quotation on the OTCBB for a period of one year. Under this proposed rule, a company filing within the extension time set forth in a Notice of Late Filing (Form 12b-25) would not be considered late. This rule would not apply to a company's Current Reports on Form 8-K.
As a result of these rules, the market liquidity for Company securities could be severely adversely affected by limiting the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.
(e) Failure to Maintain Market Makers May Affect Value of Company's Stock.
If the Company is unable to maintain National Association of Securities Dealers, Inc. member broker/dealers as market makers, the liquidity of the common stock could be impaired, not only in the number of shares of common stock which could be bought and sold, but also through possible delays in the timing of transactions, and lower prices for the common stock than might otherwise prevail. Furthermore, the lack of market makers could result in persons being unable to buy or sell shares of the common stock on any secondary market. There can be no assurance the Company will be able to maintain such market makers.
(f) Shares Eligible For Future Sale.
Most of the shares currently held by management have been issued in reliance on the private placement exemption under the Securities Act of 1933. Such shares will not be available for sale in the open market without separate registration except in reliance upon Rule 144 under the Securities Act of 1933. In general, under Rule 144 a person (or persons whose shares are aggregated) who has beneficially owned shares acquired in a non-public transaction for at least one year, including persons who may be deemed affiliates of the Company (as that term is defined under that rule) would be entitled to sell within any three-month period a number of shares that does not exceed 1% of the then outstanding shares of common stock, provided that certain current public information is then available. If a substantial number of the shares owned by these shareholders were sold pursuant to Rule 144 or a registered offering, the market price of the common stock at that time could be adversely affected.
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