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DIGITAL DOMAIN MEDIA GROUP, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
| Edgar Online, Inc. |
Management's discussion and analysis is intended to help the reader understand the results of operations and financial condition ofDigital Domain Media Group, Inc. The following discussion should be read in conjunction with our Form S-1/A and the unaudited Condensed Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which are subject to the "safe harbor" created by those sections. Forward-looking statements are based on our management's beliefs and assumptions and on information currently available to our management. All statements other than statements of historical fact are "forward-looking statements" for purposes of these provisions. In some cases you can identify forward-looking statements by terms such as "may," "will," "should," "could," "would," "expect," "plan," "anticipate," "believe," "estimate," "project," "predict," and "potential," and similar expressions intended to identify forward-looking statements. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" in this Quarterly Report. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview We are an award-winning digital production company. Since our inception in 1993, we have been a leading provider of computer-generated imagery animation and VFX for major motion picture studios and advertisers. Our company, work and employees have been recognized with numerous entertainment industry awards and nominations, including seven awards issued by theAcademy of Motion Picture Arts and Sciences (the ''Academy'') - three Academy Awards for Best Visual Effects and four awards for Scientific and Technical Achievement. Our Business Digital Production We are one of the leading digital production companies. We offer our clients innovative, end-to-end solutions across multiple media platforms spanning the entire content production process from idea generation and pre-production to design, directing, live-action production and post-production. We have three key digital production business units:Digital Domain Productions - VFX for feature films and advertising;Mothership Media, Inc. - digital advertising and marketing solutions; and In-Three- creation and conversion of 3D content.Animation Studio Our animation feature film business focuses on the development of our original full-length, family-oriented CG animated feature films. Our business is led by a creative storytelling team of accomplished directors, producers, story artists and animators who joined us from leading companies in the family animation film industry. To house this business, we are currently leasing a 64,000 square foot building while we complete the construction of a 115,000 square foot facility. Since establishing our animation studio in 2009, we have executed Grant Agreements with theState of Florida and theCity of Port St. Lucie, Florida to provide grant packages consisting of$80.0 million in cash, land and low interest financing to help us establish this studio. We have also been certified for$20.0 million in potential tax credits from theState of Florida to offset the expenses of producing our first several projects. Education We foundedDigital Domain Institute, Inc. ("DDI"), a for-profit post-secondary educational institution in partnership withFlorida State University , ("FSU"). InApril 2011 , we entered into agreements withFSU establishing what we believe is a first-of-its-kind public/private education partnership whereby DDI graduates will receive fully-accredited four-year Bachelor degrees fromFSU . Working closely withFSU's College of Motion Picture Arts and theFlorida Department of Education , we have designed a curriculum for DDI that we expect will produce workforce-ready graduates possessing both traditional motion picture arts and state-of-the-art technical animation and visual effects CG skills. We expect to also provide our graduates with the skills to compete in the broader digital economy, which includes commercial applications such as military simulation, medical simulation, architecture, engineering, software development and related technologies. We believe this partnership between DDI and FSU represents a cutting-edge collaboration between an industry-leading technology and entertainment company and one of the nation's top film schools. 26
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Table of Contents Key Metrics The Company relies on certain key performance indicators to manage and assess our business activities. The key indicator described below assists us in evaluating growth trends, establishing budgets, recruiting and hiring employees, and assessing our overall operational efficiencies. The Company discusses revenue and cash flow from operating activities, respectively, under "Results of Operations" and "Liquidity and Capital Resources" below. An important measure of our quarterly and annual performance, Non-GAAP Adjusted EBITDA, is discussed below. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States , or U.S. GAAP. Accounting principles generally accepted inthe United States of America require our management to make estimates and assumptions in the preparation of our condensed consolidated financial statements that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. The most significant areas that require management judgment are fair values of consideration issued and net assets acquired in connection with business combinations; revenue and cost recognition; collectability of contract receivables; deferred grant revenues; deferred income tax valuation allowances; amortization of long-lived assets and intangible assets; impairment of long-lived assets, intangible assets and goodwill; accrued expenses; advance billings and deferred revenue; recognition of stock-based compensation; calculation of the warrant and other debt-related liabilities; and contingencies and litigation. The accounting policies for these areas are discussed in this section and in the notes to our accompanying consolidated financial statements. However, estimates inherently relate to matters that are uncertain at the time the estimates are made, and are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions. Digital Imagery Revenue - The Company recognizes digital imagery revenue from fixed-price contracts, each consisting of an accepted written bid and agreed-upon payment schedule, for the development of digital imagery and image creation for the entertainment and advertising industries. Contracts to provide digital imagery are accounted for in accordance with FASB ASC Subtopic 605-35, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Revenue recognition is initiated when persuasive evidence of an arrangement with a customer is established, which is upon entry by the Company, or Digital Domain ("the Predecessor" or "DD") and the customer into a legally enforceable agreement. In accounting for the contracts, the cost to- cost measures of the percentage-of-completion method of accounting are utilized in accordance with FASB ASC Subtopic 605-35. Under this method, revenues, including estimated earned fees or profits, are recorded as costs are incurred. For all contracts, revenues are calculated based on the percentage of total costs incurred compared to total estimated costs at completion. Contract costs include direct materials, direct labor costs and indirect costs related to contract performance, such as indirect labor, supplies and tools. These costs are included in cost of revenues. The customer contracts in the digital imagery business represent binding agreements to provide digital effects to the customers' specifications. The contracts contain subjective standards applicable to the delivered digital effects and objective specifications that relate to the technical format for the digital effects delivered to customers. In all instances, the customer receives complete ownership rights in and to the digital effects as the effort progresses. In the event of a termination of a contract, ownership in the digital effects transfers to the customer, and the Company or Predecessor as the contractor is entitled to receive reimbursement of costs incurred up to that point and a reasonable profit. The contracts contain production schedules setting forth a timeline for production and a final delivery date for the completed digital effects. Payments for the services are received over the term of the contract, including payments required to be delivered in advance of work to fund a portion of the costs to produce the digital effects. Cash received from customers in excess of costs incurred and gross profit recognized on the related projects are recorded as advance payments. Unbilled receivables represent revenues recognized in excess of amounts billed. The digital effects produced are delivered to the customer at the end of the contract and the customer is not required to deliver the final scheduled payment until receipt and acceptance of the digital effects. A review of uncompleted contracts is performed on an ongoing basis. Amounts representing contract change orders or claims are included in revenues only when they meet the criteria set forth in FASB ASC Subtopic 605-35. In the period in which it is determined that a loss will result from the performance of a contract, the entire amount of the estimated ultimate loss is charged against income. Changes in estimates of contract sales, costs and profits are recognized in the current period based on the cumulative effect of the changes on current and prior periods. Hence, the effect of the changes on future periods of contract performance is recognized as if the revised estimates had been the original estimates. A significant change in one or more projects could have a material adverse effect on the consolidated financial position or results of operations. 27
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Fair Value of Financial Instruments - We have adopted FASB ASC Subtopic 820-10, Fair Value Measurements, which clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosure on fair value measurements. FASB ASC Subtopic 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Subtopic 820-10 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC Subtopic 820-10 describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices for identical assets or liabilities in active markets.
Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that relate to financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation. Our financial instruments, including Cash and cash equivalents; Cash, held in trust; Contract receivables; Accounts payable and accrued liabilities; Advance payments and deferred revenue and Contract obligations, are carried at amounts that approximate fair value due to the short maturity of such instruments.
Our loans are carried at the principal amount less unamortized discounts and debt issuance costs.
Certain non-financial assets are measured at fair value on a nonrecurring basis. Accordingly, these assets are not measured and adjusted to fair value on an ongoing basis but are subject to periodic impairment tests. These items primarily include long-lived assets, Goodwill and Other intangible assets.
Warrants and other debt-related liabilities are measured at fair value on a recurring basis using Level 3 inputs. In valuing warrant and other debt-related liabilities, a combination of valuation techniques is used including the income approach (based on the cash outlays estimated to be paid by us) and the market approach (which allocates the resulting value to various classes of equity using the option pricing method). The value of the warrants is then calculated by multiplying the resulting fair value per share of our Common Stock by the number of shares of our Common Stock into which the warrants are exercisable. Segment Reporting - Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's reportable segments are Feature Films, Commercials and Animation. The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes within the enterprise for making operating decisions, allocating resources, and monitoring performance, which is primarily based on the sources of revenue. 28 --------------------------------------------------------------------------------
Table of Contents Non-GAAP Adjusted EBITDA Non-GAAP Adjusted EBITDA represents net income (loss) adjusted for (1) interest expense, net of interest income, (2) income tax provision (benefit), (3) depreciation and amortization, (4) amortization of intangible assets, (5) stock-based compensation expense, (6) amortization of debt and equity issuance costs, (7) other (income) expense and (8) our grant receipts from government agencies that were received in a given period so that these receipts are reflected on a cash basis. Items (1) through (7) are excluded from net income (loss) internally when evaluating our operating performance. Item (8) is included as we believe this adjustment for grant receipts is indicative of our core operating performance both because it reflects our ability to secure and receive grant receipts in a given period and such receipts are matched with the expenses associated with initiating the business operations that those grant receipts were designed, in part, to offset. Management believes Non-GAAP Adjusted EBITDA allows investors to make a more meaningful comparison between our operating results over different periods of time, as well as with those of other companies in our industry, because it both includes grant receipts from government agencies and excludes items such as interest expense and other adjustments related to financing activities that we believe are not representative of our operating performance. We believe that Non-GAAP Adjusted EBITDA, which is a non-GAAP financial measure, when viewed with our results under U.S. GAAP and the accompanying reconciliations, provides useful information about our operating performance and period-over-period growth, and provides additional information that is useful for evaluating our operating performance. Additionally, we believe that Non-GAAP Adjusted EBITDA provides a more meaningful comparison of our operating results against those of other companies in our industry, as well as on a period-to-period basis, because this measure both includes grant receipts from government agencies and matches such receipts with the expenses that those grant receipts were designed, in part, to offset and excludes items that are not representative of our operating performance, such as the fair value adjustments associated with our historical financings as a private company. We believe that including these costs and excluding cash grant receipts in our results of operations results in a lack of comparability between our operating results and those of our peers in the industry, the majority of which do not have comparable start-up costs or amortization costs related to intangible assets. However, Non-GAAP Adjusted EBITDA is not a measure of financial performance under U.S. GAAP and, accordingly, should not be considered as an alternative to net income (loss) as an indicator of operating performance.
A reconciliation of net income (loss), a U.S. GAAP measure, to Adjusted EBITDA, is provided in "- Results of Operations" presented below.
Results of Operations The following table sets forth certain information regarding the Company's unaudited condensed consolidated results of operations for the three and nine months endedSeptember 30, 2011 andSeptember 30, 2010 , and the pro forma results of operations for the three and nine months endedSeptember 30, 2010 , assuming the acquisition of In-Three occurred onJanuary 1, 2010 (in thousands). 29
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Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2011 2010 2010 2011 2010 2010 Pro forma Pro forma Revenues: Revenues $ 15,889 $ 29,009 $ 29,009 $ 75,289 $ 70,706 $ 71,552 Grant revenues from governmental agencies 747 585 585 2,208 2,753 2,753 Total revenues 16,636 29,594 29,594 77,497 73,459 74,305 Costs and expenses: Cost of revenues, excluding depreciation and amortization 17,932 26,775 26,775 67,514 61,021 61,862 Depreciation expense 3,607 1,836 1,877 9,283 5,237 5,360 Selling, general and administrative expenses 16,475 6,154 7,633 48,092 15,772 20,021 Amortization of intangible assets 863 733 862 2,588 2,201 2,588 Total costs and expenses 38,877 35,498 37,147 127,477 84,231 89,831 Operating loss (22,241 ) (5,904 ) (7,553 ) (49,980 ) (10,772 ) (15,526 ) Other income (expenses): Interest and finance expense: Issuance of and changes in fair value of warrant and and other debt-related liabilities (7,520 ) (6,115 ) (6,116 ) (82,780 ) (8,193 ) (8,194 ) Amortization of discount and issuance costs on notes payable (4,098 ) (687 ) (687 ) (10,656 ) (1,672 ) (1,672 ) Loss on debt extinguishment (4,477 ) - - (6,703 ) - - Interest expense on notes payable (1,067 ) (604 ) (997 ) (2,420 ) (2,066 ) (3,220 ) Interest expense on capital lease obligations (76 ) (88 ) (88 ) (245 ) (190 ) (190 ) Other income (expense), net 152 228 82 1,656 321 (229 ) Loss before income taxes (39,327 ) (13,170 ) (15,359 ) (151,128 ) (22,572 ) (29,031 ) Income tax provision (161 ) - - 89 7 7 Net lossbefore non-controlling interests (39,166 ) (13,170 ) (15,359 ) (151,217 ) (22,579 ) (29,038 ) Net loss attributable to non-controlling interests 916 677 677 1,983 3,714 3,714 Net loss attributable to common stockholders $ (38,250 ) $ (12,493 ) $
(14,682 ) $ (149,234 ) $ (18,865 ) $ (25,324 )
Non-GAAP Adjusted EBITDA $ (9,693 ) $ (2,822 ) $ (4,660 ) $ (10,200 ) $ 4,521 $ 277
A reconciliation of net loss before non-controlling interests, a U.S. GAAP measure, to Non-GAAP Adjusted EBITDA, a non-GAAP measure, is presented in the table below (in thousands):
Three Months Ended September 30, Nine Months Ended September 30, 2011 2010 2010 2011 2010 2010 Pro forma Pro forma Net loss before non-controlling interests $ (39,166 ) $ (13,170 ) $ (15,359 ) $ (151,217 ) $ (22,579 ) $ (29,038 ) Add back (reverse) charges (income) pertaining to: Losses on debt extinguishment 4,477 - - 6,703 - - Share-based compensation and share exchange expense 9,293 511 511 23,897 1,194 1,194 Income tax expense (benefit) (161 ) - - 89 7 7 Interest expense, net 5,241 1,379 1,772 13,321 3,928 5,082 Depreciation expense 3,607 1,836 1,877 9,283 5,237 5,360 Amortization of intangible assets 863 733 862 2,588 2,201 2,588 Changes related to fair value of warrant and other debt-related liabilities 7,520 6,115 6,116 82,780 8,193 8,194 Acquisition-related non-cash adjustments - 359 - - 2,393 2,393 Other EBITDA addbacks: Grant cash receipts in excess of grant revenue recognized (1,367 ) (585 ) (585 ) 1,922 2,247 2,247 Write-off of deferred offering costs - - - 434 - Other expenses - - 146 - 1,700 2,250 Non-GAAP Adjusted EBITDA $ (9,693 ) $ (2,822 ) $ (4,660 ) $ (10,200 ) $ 4,521 $ 277 Operating Segments FASB ASC Topic 280, Segment Reporting, establishes standards for reporting information about operating segments. This standard requires segmentation based on our internal organization and reporting of revenue and operating income based upon internal accounting methods. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. Our three operating segments are Feature Films, Commercials and Animation. These segments are presented in the way the Company internally manage and monitor our performance. Our reporting systems present various data used by management to operate the business. However, certain expenses are not allocated to the various segments (primarily consisting of support staff salaries and benefits, fees for outside professional services, insurance costs, and utilities costs, all of which are included in selling, general and administrative expenses), and thus a reconciliation is provided between the consolidated financial statements and the data related to the combined segments. Interest and other income are not allocated to the various segments, as the chief operating decision maker does not evaluate segment operations beyond the income (loss) from operations level. 30 --------------------------------------------------------------------------------
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Our digital production business (containing the segments of Feature Films and Commercials) has historically dominated our operations. The revenue for each of the segments is derived from external customers. A majority of all revenues have been generated inthe United States from customers located inthe United States .
The table below sets forth certain unaudited information regarding the results of operations of our segments for the periods indicated (in thousands):
For the Three Months Ended September 30, For the Nine Months Ended September 30, 2011 2010 2010 2011 2010 2010 (Pro Forma) (Pro Forma) Feature Films Revenues $ 12,522 $ 24,481 $ 24,481 $ 59,240 $ 56,091 $ 56,937 Cost of revenues 14,055 23,663 23,663 53,227 49,437 50,278 SG&A 114 - - 840 - - Operating income $ (1,647 ) $ 818 $ 818 $ 5,173 $ 6,654 $ 6,659 Commercials Revenues $ 3,367 $ 4,528 $ 4,528 $ 16,049 $ 14,615 $ 14,615 Cost of revenues 3,877 3,112 3,112 14,287 11,584 11,584 SG&A 98 157 157 350 495 495 Operating income (loss) $ (608 ) $ 1,259 $ 1,259 $ 1,412 $ 2,536 $ 2,536 Animation/Content Revenues $ - $ - $ - $ - $ - $ - Cost of revenues - - - - - - SG&A - 48 48 - 48 48 Operating loss $ - $ (48 ) $ (48 ) $ - $ (48 ) $ (48 ) Corporate & Other Revenues $ 747 $ 585 $ 585 $ 2,208 $ 2,753 $ 2,753 Cost of revenues - - - - - - Depreciation 3,607 1,836 1,877 9,283 5,237 5,360 SG&A (excluding stock-based compensation and share exchange expense) 6,970 5,438 6,917 23,005 14,035 18,284 Stock-based compensation and share exchange expense 9,293 511 511 23,897 1,194 1,194 Amortization 863 733 862 2,588 2,201 2,588 Operating loss $ (19,986 ) $ (7,933 ) $ (9,582 ) $ (56,565 ) $ (19,914 ) $ (24,673 ) Consolidated Revenues $ 16,636 $ 29,594 $ 29,594 $ 77,497 $ 73,459 $ 74,305 Cost of revenues 17,932 26,775 26,775 67,514 61,021 61,862 Depreciation 3,607 1,836 1,877 9,283 5,237 5,360 SG&A (excluding stock-based compensation and share exchange expense) 7,182 5,643 7,122 24,195 14,578 18,827 Stock-based compensation and share exchange expense 9,293 511 511 23,897 1,194 1,194 Amortization 863 733 862 2,588 2,201 2,588 Operating loss $ (22,241 ) $ (5,904 ) $ (7,553 ) $ (49,980 ) $ (10,772 ) $ (15,526 )
Three Months Ended
Summary of operating results The operating loss increased$16.4 million to$22.2 million for the three months endedSeptember 30, 2011 from$5.9 million for the same period of the prior year. The gross margin, defined as revenues less cost of revenues, declined$4.1 million , primarily due to increases in unutilized labor as we elected to maintain our trained and experienced work force and infrastructure in anticipation of future projects, including those projects in which we hold an ownership stake. Additional detail on the components included in our cost of revenues is provided below. Stock-based compensation and share exchange expense increased from$0.5 million to$9.3 million . Other Selling, general and administrative ("S,G&A") expenses increased by$1.5 million over the prior period to$7.2 million over the prior period, primarily resulting from increased rent and other occupancy costs during the three months endedSeptember 30, 2011 . Depreciation and amortization increased$1.9 million over the prior period. Interest and other financing costs increased$9.3 million to$17.2 million for the three months endedSeptember 30, 2011 from$7.5 million for the same period of the prior year. The principal causes of this increase were a$1.4 million increase in the non-cash changes in fair value of warrant and other debt-related liabilities,$3.4 million increase in the amortization of debt discounts and$4.5 million for losses recognized on debt extinguishments. The net losses before non-controlling interests were$39.2 million and$13.2 million for the three months endedSeptember 30, 2011 and 2010, respectively. These increases are explained in greater detail below. Revenues
The
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Feature film revenues decreased to$12.5 million for the three months endedSeptember 30, 2011 , of which revenues from four features accounted for$9.2 million of this total. Feature film revenues for the three months endedSeptember 30, 2010 aggregated$24.5 million , of which revenues from one feature film accounted for$14.6 million of this total. The aggregate decrease is due to a larger number of smaller projects that were in production during the three months endedSeptember 30, 2011 . Commercials revenues decreased to$3.3 million for the three months endedSeptember 30, 2011 from$4.5 million for the same period of the prior year. We recognized revenue from one commercials project of$0.8 million for the three months endedSeptember 30, 2011 . The largest amount of revenue recognized from one project for the three months endedSeptember 30, 2010 was$0.7 million . The aggregate decrease was due to a smaller number of projects completed during the three months endedSeptember 30, 2011 .
Grant revenues from governmental sources
Grant revenues from governmental sources decreased by$0.2 million during the three months endedSeptember 30, 2011 as compared to the corresponding period of the prior year. During the three months endedSeptember 30, 2011 andSeptember 30, 2010 , we recognized$0.4 million each from a grant from theState of Florida . During the three months endedSeptember 30, 2011 , we recognized$0.3 million from a new grant from theCity of West Palm Beach, Florida . Cost of revenues The table below lists sets forth the components of cost of revenues (in thousands): Three Months Ended September 30, 2011 2010 % of % of Amount Total Revenues Amount Total Revenues Cost of Revenues: Direct cost of revenues $ 8,069 49 % $ 20,366 69 % Unutilized labor 3,787 23 % 131 - Production and other costs 6,076 37 % 6,278 21 % Total cost of revenues $ 17,932 108 % $ 26,775 90 % Our direct cost of revenues represents the labor required to deliver projects to customers. Unutilized labor represents expenses related to the staff that we retain while we await the start of new projects. Production and other costs represent that portion of our overhead that is allocated to cost of revenues. Our direct cost of revenues decreased during the three months endedSeptember 30, 2011 as compared to the corresponding period of the prior year, to 49% of revenue from 69%. This decrease is due primarily to the inclusion of box office-related compensation that we received in the third quarter of 2011 which helped expand our margins. It is also due to the inclusion of a downward adjustment in our expected margin for a film in the third quarter of 2010. We believe that this improvement reflects the benefits of our movement toward a content-ownership economic model. Our unutilized labor increased during the three months endedSeptember 30, 2011 as compared to the corresponding period of the prior year, by$3.7 million as we retained digital artists in anticipation of future projects, including those projects in which we are an equity investor.
Our production and other costs decreased during the three months ended
Depreciation expense The$1.8 million increase in depreciation expense is primarily due to the growth of our fixed assets. Of the total increase,$1.1 million was due to the growth in ourFlorida operations.
Selling, general and administrative expenses ("S,G&A")
The composition of the S,G&A expenses for the three months ended
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Table of Contents Three Months Ended September 30, 2011 2010 Increase Stock-based compensation and share exchange expense: Senior executive option grant $ 170 $ - $ 170 Stock exchanges of subsidiary stock 6,928 -
6,928
Other stock option compensation expense 2,196 510
1,686
Total stock-based compensation and share exchange expense 9,294 510 8,784 Florida operations payroll 1,911 1,333 578 Professional fees 896 396 500 Other S,G&A expenses 4,374 3,915 459 Total S,G&A $ 16,475 $ 6,154 $ 10,321 Of the$10.3 million increase in our S,G&A expense during the three months endedSeptember 30, 2011 as compared to the corresponding period of the prior year,$8.7 million was due primarily to an increase in stock-based compensation and share exchange expense. During the three months endedSeptember 30, 2011 , we granted options to the former Chief Executive Officer of our subsidiary Digital Domain to purchase shares of the Company's Common Stock which vested immediately. Four stockholders of Digital Domain, including our Chief Financial Officer, exchanged 3.1 million shares of Digital Domain common stock for 1.9 million shares of our common stock during this three month period. We recognized$6.9 million of stock compensation expense from these stock exchanges. Total S,G&A expenses increased$10.3 million to$16.5 million for the three months endedSeptember 30, 2011 from$6.2 million for the same period of the prior year, reflecting the ramp-up of expenses in ourFlorida studio, and our work to begin co-producing live-action films.
Changes in fair value of warrant and other debt-related liabilities
We recognize warrant liabilities for warrants issued in connection with various debt transactions. These warrants are recorded initially at fair value and are adjusted to fair value at each financial reporting date. These fair values are obtained from a third-party independent valuation firm. During the three months endedSeptember 30, 2011 , we recognized$7.5 million of net increases to warrant liabilities for increased number of warrants granted due to anti-dilution protection of existing warrants and the increase in the fair value of the Company's common stock. The amount of increase in warrant liabilities recognized in the three months endedSeptember 30, 2010 was$6.1 million . This is a non-cash expense.
Amortization of discount and issuance costs on notes payable
During the three months endedSeptember 30, 2011 and 2010, we amortized debt discounts of$4.1 million and$0.7 million , respectively. This increase was due to the increased level of indebtedness. This is a non-cash expense. Loss on debt extinguishments The loan with our former commercial lender was acquired by Comvest onJuly 1, 2011 . The unamortized debt discount on that date was$3.4 million . We recognized a loss on debt extinguishment of that amount upon this debt retirement. InJuly 2011 , a convertible note payable toPBC Digital Holdings II LLC with an outstanding principal balance of$4.2 million was mandatorily converted to common stock. We recognized a loss of$1.1 million upon this conversion. There were no such losses on debt extinguishments for the three months endedSeptember 30, 2010 .
Interest expense on notes payable
The interest expense on notes payable increased
Net loss attributable to non-controlling interests
During the three months endedSeptember 30, 2011 and 2010, the net losses of the Company's subsidiary Digital Domain ("DD") were$5.2 million and$3.5 million , respectively. The portions of Digital Domain not owned by us during these same periods were 16.5% and 19.4%, respectively. Therefore, the net loss to non-controlling interests related to DD was$0.8 million and$0.7 million during these respective periods. The non-controlling interests' portion of the net loss of another subsidiary,Digital Domain Institute, Inc. , was$0.1 million for the three months endedSeptember 30, 2011 . 33 --------------------------------------------------------------------------------
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Three Months Ended
Explanatory Note - The results of operations for the pro forma three months ended
Summary of operating results The operating loss increased by$14.7 million to$22.2 million for the three months endedSeptember 30, 2011 from$7.5 million for the corresponding pro forma period of the prior year. The gross margin, defined as revenues less cost of revenues, declined by$4.1 million , primarily due to increases in unutilized labor as we elected to maintain our trained and experienced work force and infrastructure in anticipation of future projects, including those projects in which we hold an ownership stake. Stock-based compensation and share exchange expense increased from$0.5 million to$9.3 million and S,G&A expense increased over these two periods by$0.1 million to$7.2 million . Depreciation and amortization increased by$1.9 million for the three months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year . Interest and other financing costs increased$9.3 million to$17.2 million for the three months endedSeptember 30, 2011 from$7.9 million for the corresponding pro forma period of the prior year. The principal causes of this increase were a$1.4 million increase in the changes in fair value of warrant and other debt-related liabilities,$3.4 million for amortization of debt discounts and$4.5 million for losses on debt extinguishments. The net losses before non-controlling interests were$39.2 million and$15.4 million for the three months endedSeptember 30, 2011 and 2010, respectively. These increases are explained below. Revenues
The
Feature film revenues decreased to
Commercials revenues decreased to$3.3 million for the three months endedSeptember 30, 2011 from$4.5 million for the corresponding pro forma period of the prior year. We recognized revenue from one commercials project of$0.8 million for the three months endedSeptember 30, 2011 . The largest amount of revenue recognized from one project for the pro forma three months endedSeptember 30, 2010 was$0.7 million .
Grant revenues from governmental sources
Grant revenues from governmental sources increased$0.2 million . During the three months endedSeptember 30, 2011 and the corresponding pro forma period of the prior year, we recognized$0.4 million each from theState of Florida grants. We recognized$0.3 million from a new grant from theCity of West Palm Beach, Florida during the three months endedSeptember 30, 2011 . Cost of revenues The table below lists sets forth the components of cost of revenues (in thousands): Three Months Ended September 30, 2011 2010 % of % of Amount Total Revenues Amount Total Revenues Pro Forma Cost of Revenues: Direct cost of revenues $ 8,069 49 % $ 20,366 69 % Unutilized labor 3,787 23 % 131 - Production and other costs 6,076 37 % 6,278 21 % Total cost of revenues $ 17,932 108 % $ 26,775 90 % 34
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Our direct cost of revenues represents the labor required to deliver projects to customers. Unutilized labor represents expenses related to the staff that we retain while we await the start of new projects. Production and other costs represent that portion of our overhead that is allocated to cost of revenue. Our direct cost of revenue decreased, during the three months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year to 49% of revenue from 69%. This decrease is due primarily to the inclusion of box office-related compensation that we received in the third quarter of 2011 which helped expand our margins. We believe that this improvement reflects the benefits of our movement toward a content-ownership economic model.
Our unutilized labor increased, during the three months ended
Our production and other costs decreased, during the three months ended
Depreciation expense
The
Selling, general and administrative expenses ("S,G&A")
The composition of the S,G&A expenses for the three months ended
Three Months Ended September 30, Actual Pro Forma 2011 2010 Increase Stock-based compensation and share exchange expense: Senior executive option grant $ 170 $ - $ 170 Stock exchanges of subsidiary stock 6,928 -
6,928
Other stock option compensation expense 2,196 510
1,686
Total stock-based compensation and share exchange expense 9,294 510 8,784 Florida operations payroll 1,911 1,333 578 Professional fees 896 396 500 Other S,G&A expenses 4,374 5,394 (1,020 ) Total S,G&A $ 16,475 $ 7,633 $ 8,842 The$8.8 million increase in our total S,G&A expense, during the three months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year included an$8.8 million increase in stock-based compensation and share exchange expense. During the three months endedSeptember 30, 2011 , we granted options to the former Chief Executive Officer of our subsidiary Digital Domain to purchase shares of the Company's Common Stock, which vested immediately. Four stockholders of Digital Domain, including our Chief Financial Officer, exchanged 3.1 million shares of Digital Domain common stock for 1.9 million shares of our common stock. We recognized$6.9 million of stock compensation expense from these stock exchanges.
Total S,G&A expenses increased
Changes in fair value of warrant and other debt-related liabilities
We recognize warrant liabilities for warrants issued in connection with various debt transactions. These warrants are recorded initially at fair value and are adjusted to fair value at each financial reporting date. These fair values are obtained from a third-party independent valuation firm. During the three months endedSeptember 30, 2011 , we recognized$7.5 million of net increases to warrant liabilities for increased number of warrants granted due to anti-dilution protection of existing warrants and the change in the fair value of the Company, based on independent valuation. The amount of the net increase in warrant liabilities recognized in the pro forma three months endedSeptember 30, 2010 was$6.1 million . 35 --------------------------------------------------------------------------------
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Amortization of discount and issuance costs on notes payable
During the three months ended
Loss on debt extinguishments The loan with our former commercial lender was acquired by Comvest onJuly 1, 2011 . The unamortized debt discount on that date was$3.4 million . We recognized a loss on debt extinguishment of that amount related to this debt retirement. InJuly 2011 , the convertible note payable toPBC Digital Holdings II LLC with an outstanding principal balance of$4.2 million was mandatorily converted to common stock. We recognized a loss of$1.1 million upon this conversion. There were no such losses on debt extinguishments for the three months endedSeptember 30, 2010 .
Interest expense on notes payable
The interest expense on notes payable increased
Net loss attributable to non-controlling interests
During the three months endedSeptember 30, 2011 and 2010 (pro forma), the net losses of Digital Domain were$5.2 million and$3.5 million , respectively. The portions of Digital Domain not owned by us during these same periods were 16.5% and 19.4%, respectively. Therefore, the net loss to non-controlling interests related to Digital Domain was$0.8 million and$0.7 million for the respective periods. The non-controlling interest portion of the net loss of another subsidiary,Digital Domain Institute, Inc. , was$0.1 million for the three months endedSeptember 30, 2011 .
Nine Months Ended
Summary of operating results The operating loss increased by$39.2 million to$50.0 million for the nine months endedSeptember 30, 2011 from$10.8 million for the same period of the prior year. The gross margin, defined as revenues less cost of revenues, declined by$2.5 million primarily due to increases in unutilized labor as we elected to maintain our trained and experienced work force and infrastructure in anticipation of future projects, including those projects in which we hold an ownership stake. Stock-based compensation and share exchange expense increased by$22.7 million to$23.9 million and other S,G&A increased over these two periods by$9.6 million to$24.2 million , primarily resulting from increased rent and other occupancy costs. Depreciation and amortization increased over these two periods by$4.4 million . Interest and other financing costs increased$90.7 million to$102.8 million for the nine months endedSeptember 30, 2011 from$12.1 million for the same period of the prior year. The principal causes of this increase were a$74.6 million in increase in the non-cash changes in fair value of warrant and other debt-related liabilities, a$9.0 million increase in the amortization of debt discounts and$6.7 million of losses recognized on debt extinguishments. The net loss before non-controlling interests was$151.2 million and$22.6 million for the nine months endedSeptember 30, 2011 and 2010, respectively. These increases are explained below. Revenues The$4.0 million increase in revenues for the nine months endedSeptember 30, 2011 as compared to the same period of the prior year was primarily due to a$3.1 million increase in feature film revenues and a$1.4 million increase in commercial revenues. Feature film revenues increased to$59.2 million for the nine months endedSeptember 30, 2011 , of which revenues from four features accounted for$54.0 million of this total. Feature film revenues for the nine months endedSeptember 30, 2010 aggregated$56.1 million , of which revenues from one feature film accounted for$42.3 million of this total. Commercials revenues increased to$16.0 million for the nine months endedSeptember 30, 2011 from$14.6 million for the same period of the prior year. We recognized revenue from one commercial project of$4.5 million for the nine months endedSeptember 30, 2011 . The largest amount of revenue recognized from one project for the nine months endedSeptember 30, 2010 was$1.5 million .
Grant revenues from governmental sources
Grant revenues from governmental sources decreased$0.6 million for the nine months endedSeptember 30, 2011 as compared to the corresponding period of the prior year. During the nine months endedSeptember 30, 2010 , we recognized$2.2 million from theState of Florida grant, which decreased to$1.2 million for the nine months endedSeptember 30, 2011 . This was partially offset by$0.3 million from a new grant from theCity of West Palm Beach, Florida and$0.1 from a grant from Workforce Florida, recognized during the nine months endedSeptember 30, 2011 . 36
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Table of Contents Cost of revenues The table below sets forth the components of cost of revenues (in thousands): Nine Months Ended September 30, 2011 2010 % of % of Amount Total Revenues Amount Total Revenues Cost of Revenues: Direct cost of revenues $46,730 60 % $49,628 68 % Unutilized labor 6,399 8 % 877 1 % Production and other costs 14,385 19 % 10,516 14 % Total cost of revenues $67,514 87 % $61,021 83 % Our direct cost of revenues represents the labor required to deliver projects to customers. Unutilized labor represents staff that we retain while we await the start of new projects. Production and other costs represent that portion of our overhead that is allocated to cost of revenue. Our direct cost of revenues decreased during the nine months endedSeptember 30, 2011 as compared to the corresponding period of the prior year to 60% of revenue from 68%. This decrease is due to the inclusion of box office-related compensation that we received in the third quarter of 2011 which helped expand our margins. We believe that this improvement reflects the benefits of our movement toward a content-ownership economic model. Our unutilized labor increased during the nine months endedSeptember 30, 2011 as compared to the corresponding period of the prior year by$5.5 million as we retained digital artists in anticipation of future projects, including those projects in which we are an equity investor. Our production and other costs increased during the nine months endedSeptember 30, 2011 as compared to the corresponding period of the prior year by$3.9 million , reflecting the growth in the scale of our facilities and infrastructure as we prepare for future projects, including those projects in which we are an equity investor. Depreciation expense The$4.0 million increase in depreciation expense for the nine months endedSeptember 30, 2011 as compared to the same period of the prior year is primarily due to the growth of our fixed assets. Of the total increase,$3.1 million was due to the growth in ourFlorida operations.
Selling, general and administrative expenses ("SG&A")
The composition of S,G&A expenses for the nine months ended
Nine Months Ended September 30, 2011 2010 Increase Stock-based compensation and share exchange expense: Senior executive option grant $ 3,553 $ - $ 3,553 Chief executive office option grant 2,502 -
2,502
Stock exchanges of subsidiary stock 13,426 -
13,426
Other stock option compensation expense 4,417 1,194
3,223
Total stock-based compensation and share exchange expense 23,898 1,194 22,704 Florida operations payroll 7,395 2,845 4,550 Professional fees 3,191 1,338 1,853 Other S,G&A expenses 13,608 10,395 3,213 Total S,G&A $ 48,092 $ 15,772 $ 32,320 Of the$32.4 million increase in our S,G&A expense during the nine months endedSeptember 30, 2011 as compared to the corresponding period of the prior year,$22.7 million was due primarily to an increase in stock-based compensation and share exchange expense. 37
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During the nine months ended
Five stockholders of Digital Domain, including our Chief Executive Officer and our Chief Financial Officer, exchanged 4.6 million shares of Digital Domain common stock for 2.9 million shares of our common stock during the nine months endedSeptember 30, 2011 . We recognized$13.4 million of stock compensation expense from these stock exchanges. The growth of ourFlorida operations increased payroll-related expenses by$4.6 million during the nine months endedSeptember 30, 2011 as compared to the comparable period in the prior year. Professional fees increased$1.8 million over these two periods as we prepared our initial public offering. Other S,G&A expenses increased by$3.2 million , primarily due to increased rent and occupancy costs. Total S,G&A expenses increased by$32.3 million to$48.1 million for the nine months endedSeptember 30, 2011 from$15.8 million for the same period of the prior year.
Changes in fair value of warrant and other debt-related liabilities
We recognize warrant liabilities for warrants issued in connection with various debt transactions. These warrants are recorded initially at fair value and are adjusted to fair value at each financial reporting date. These fair values are obtained from a third-party independent valuation firm. During the nine months endedSeptember 30, 2011 , we recognized$82.8 million of net increases in warrant liabilities for warrants issued to new debt holders, increased number of warrants granted due to anti-dilution protection of existing warrants and the change in the fair value of the Company, based on independent valuation. The amount of net increase in warrant liabilities recognized in the nine months endedSeptember 30, 2010 was$8.2 million . This increase was primarily driven by increases in the valuation of our common stock.
Amortization of discount and issuance costs on notes payable
During the nine months endedSeptember 30, 2010 , we had two loans to which we applied amortized debt discounts totaling$1.7 million . During the nine months endedSeptember 30, 2011 , we had four loans to which we applied amortized debt discounts totaling$10.7 million . Loss on debt extinguishments During the nine months endedSeptember 30, 2011 , we recognized a loss on debt extinguishment of$2.2 million related to changes to the convertible note payable toPBC Digital Holdings II, LLC to adjust this note to fair value as of the date of a loan modification. The loan with our former commercial lender was acquired by Comvest onJuly 1, 2011 . The unamortized debt discount on that date was$3.4 million . We recognized a loss on debt extinguishment of that amount upon this debt retirement. InJuly 2011 , the convertible note payable toPBC Digital Holdings II LLC was mandatorily converted to common stock. We recognized a loss of$1.1 million upon this conversion. There was no such loss on debt extinguishments for the nine months endedSeptember 30, 2010 .
Interest expense on notes payable
The interest expense on notes payable increased$0.4 million for the nine months endedSeptember 30, 2011 as compared to the same period of the prior year due to increased levels of indebtedness.
Net loss attributable to non-controlling interests
During the nine months endedSeptember 30, 2011 and 2010, the net losses of Digital Domain were$10.8 million and$8.2 million , respectively. The portions of Digital Domain not owned by us during these same periods were 17.8% and 45.4%, respectively. Therefore, the net loss attributable to non-controlling interests related to Digital Domain for these respective periods was$1.9 million and$3.7 million . During the nine months endedSeptember 30, 2011 , we also recognized$0.1 million of a net loss attributable to non-controlling interests for another subsidiary,Digital Domain Institute, Inc.
Nine Months Ended
Summary of operating results
Explanatory Note - The results of operations for the pro forma nine months ended
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The operating loss increased$34.5 million to$50.0 million for the nine months endedSeptember 30, 2011 from$15.5 million for the corresponding pro forma period of the prior year. The gross margin, defined as revenues less cost of revenues, declined$2.5 million primarily due to increases in unutilized labor as we elected to maintain our trained and experienced work force and infrastructure in anticipation of future projects, including those projects in which we hold an ownership stake. Stock-based compensation and share exchange expense by$22.7 million to $23.9 million and other S,G&A increased over these two periods by$5.4 million to $24.2 million , primarily resulting from increased rent and other occupancy costs. Depreciation and amortization increased by$3.9 million . Interest and other financing costs increased$89.5 million to$102.8 million for the nine months endedSeptember 30, 2011 from$13.2 million for the corresponding pro forma period of the prior year. The principal causes of this increase were a$74.6 million increase in the non-cash changes in fair value of warrant and other debt-related liabilities, a$9.0 million increase in the amortization of debt discounts and$6.7 million of losses recognized on debt extinguishments. The net loss before non-controlling interests were$151.2 million and$29.0 million for the nine months endedSeptember 30, 2011 and the pro forma nine months endedSeptember 30, 2010 , respectively. These increases are explained below. Revenues The$3.2 million increase in revenues for the nine months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year was due primarily to a$2.3 million increase in feature film revenues and a$1.4 million increase in commercial revenues. Revenues from In-Three aggregated$0.8 for the pro forma nine months endedSeptember 30, 2010 . Feature film revenues increased to$59.2 million for the nine months endedSeptember 30, 2011 , of which revenues from four features accounted for$55.3 million of this total. Feature film revenues for the pro forma nine months endedSeptember 30, 2010 aggregated$56.9 million , of which revenues from one feature film accounted for$42.3 million of this total.
Commercials revenues increased to
Grant revenues from governmental sources
Grant revenues from governmental sources decreased$0.6 million during the nine months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year. During the pro forma nine months endedSeptember 30, 2010 , we recognized$2.2 million from theState of Florida grant, which decreased to$1.2 million for the nine months endedSeptember 30, 2011 . This was partially offset by$0.3 million from a new grant from theCity of West Palm Beach, Florida and$0.1 from a grant from Workforce Florida, recognized during the nine months endedSeptember 30, 2011 . Cost of revenues The table below sets forth the components of cost of revenues (in thousands): Nine Months Ended September 30, 2011 2010 % of % of Amount Revenue Amount Revenue Pro Forma Cost of Revenues: Direct cost of revenues $ 46,730 60 % $ 50,469 68 % Unutilized labor 6,399 8 % 877 1 %
Production and other costs 14,385 19 % 10,516 14 % Total cost of revenues
The$5.7 million increase in cost of revenues during the nine months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year was partially due to the$3.2 million increase in revenues discussed above. As a percent of revenues, cost of revenues increased to 87% for the nine months endedSeptember 30, 2011 from 83% for the corresponding pro forma period of the prior year. This increase is primarily due to increases in unutilized labor as we elected to maintain our trained and experienced work force and infrastructure in anticipation of future projects, including those projects in which we hold an ownership stake. Cost of revenues for In-Three aggregated$0.8 million for the pro forma nine months endedSeptember 30, 2010 , which was equal to the revenues recognized. 39
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Table of Contents Depreciation expense
The
Selling, general and administrative expenses ("S,G&A")
The composition of the S,G&A expenses for the nine months endedSeptember 30, 2011 and the pro forma nine months endedSeptember 30, 2010 are as follows (in thousands): Nine Months Ended September 30, Actual Pro Forma 2011 2010 Increase Stock-based compensation and share exchange expense: Senior executive option grant $ 3,553 $ - $ 3,553 Chief executive office option grant 2,502 -
2,502
Stock exchanges of subsidiary stock 13,426 -
13,426
Other stock option compensation 4,417 1,194
3,223
Total stock-based compensation and share exchange expense 23,898 1,194 22,704 Florida operations payroll 7,395 7,094 301 Professional fees 3,191 1,338 1,853 Other S,G&A expenses 13,608 10,395 3,213 Total S,G&A $ 48,092 $ 20,021 $ 28,071
Of the
During the nine months endedSeptember 30, 2011 , we granted options to the former Chief Executive Officer of our subsidiary Digital Domain to purchase shares of the Company's Common Stock, which vested immediately. We recognized$3.6 million of expense from this option grant. Additionally during this period, we issued options to purchase shares of Digital Domain to our Chief Executive Officer and recognized$2.5 million for this option grant. Five stockholders of Digital Domain, including our Chief Executive Officer and our Chief Financial Officer, exchanged 4.6 million shares of Digital Domain common stock for 2.9 million shares of our common stock during the nine months endedSeptember 30, 2011 . We recognized$13.4 million of stock compensation expense from these stock exchanges. The growth of ourFlorida operations increased payroll-related expenses by$0.3 million during the nine months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year. Professional fees increased over these two periods by$1.8 million as we prepared our initial public offering. Other S,G&A expenses increased over these two periods by$3.2 million , primarily due to increased rent and occupancy costs during the nine months endedSeptember 30, 2011 . Total S,G&A expenses increased$28.1 million to$48.1 million for the nine months endedSeptember 30, 2011 from$20.0 million for the corresponding pro forma period of the prior year. S,G&A expenses for In-Three aggregated$4.2 million for the pro forma nine months endedSeptember 30, 2010 .
Changes in fair value of warrant and other debt-related liabilities
We recognize warrant liabilities for warrants issued in connection with various debt transactions. These warrants are recorded initially at fair value and are adjusted to fair value at each financial reporting date. These fair values are obtained from a third-party independent valuation firm. During the nine months endedSeptember 30, 2011 , we recognized$82.8 million of net increases to warrant liabilities for warrants issued to new debt holders, increased number of warrants granted due to anti-dilution protection of existing warrants and the change in the fair value of the Company, based on independent valuation. The amount of net increase to warrant liabilities recognized in the pro forma nine months endedSeptember 30, 2010 was$8.2 million . 40 --------------------------------------------------------------------------------
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Amortization of discount and issuance costs on notes payable
During the pro forma nine months endedSeptember 30, 2010 , we had two loans to which we applied amortized debt discounts totaling$1.7 million . During the nine months endedSeptember 30, 2011 , we had four loans to which we applied amortized debt discounts totaling$10.7 million .
Loss on debt extinguishments
During the nine months endedSeptember 30, 2011 , we recognized a loss on debt extinguishment of$2.2 million upon changes to the convertible note payable toPBC Digital Holdings II LLC to adjust this note to fair value as of the date of a loan modification. The loan with our former commercial lender was acquired by Comvest onJuly 1, 2011 . The unamortized debt discount on that date was$3.4 million . We recognized a loss on debt extinguishment of that amount upon this debt retirement. InJuly 2011 , the convertible note payable toPBC Digital Holdings II LLC was mandatorily converted to common stock. We recognized a loss of$1.1 million upon this conversion. There was no such loss on debt extinguishments for the pro forma nine months endedSeptember 30, 2010 .
Interest expense on notes payable
The interest expense on notes payable decreased$0.8 million for the nine months endedSeptember 30, 2011 as compared to the corresponding pro forma period of the prior year. Interest expense for the pro forma nine months endedSeptember 30, 2010 related to In-Three aggregated$1.2 million .
Net loss attributable to non-controlling interests
During the nine months endedSeptember 30, 2011 and 2010 (pro forma), the net losses of Digital Domain were$10.4 million and$8.2 million , respectively. The portions of Digital Domain not owned by us during these same periods were 17.8% and 45.4%, respectively. Therefore, the net loss attributable to non-controlling interests related to Digital Domain for these two periods was$1.8 million and$3.7 million , respectively. During the nine months endedSeptember 30, 2011 , we also recognized$0.1 million of a net loss attributable to non-controlling interests forDigital Domain Institute, Inc.
Liquidity and Capital Resources
As of
OnNovember 18, 2011 , we conducted the initial public offering ("IPO") of our common stock. We began trading on theNew York Stock Exchange under the ticker symbol "DDMG" onNovember 18, 2011 . On that day, we sold 4.92 million shares of our common stock at the IPO offering price of$8.50 per share. The proceeds of the offering were$41.8 million , before payment of commissions and other then unpaid offering costs aggregating$3.4 million . Upon the completion of the IPO, convertible debt and warrants representing$128.4 million in debt and warrant liabilities on our balance sheet were automatically converted or exercised, as applicable, into shares of our common stock.
After the automatic conversion of our debt and warrant exercise upon the completion of the IPO discussed above, the remaining principal of our debt was
We believe, based on our current operating plan, that our existing cash and cash equivalents and available borrowings under our credit facility will be sufficient to meet our anticipated cash needs for at least the next 12 months.
Cash Flows for the Nine Months Ended
We used net cash from operating activities aggregating$30.3 million for the nine months endedSeptember 30, 2011 compared to net cash provided by operating activities of$10.3 million for the same period of the prior year. This change was primarily due to changes in working capital that resulted in a decrease in cash from operating activities of$27.8 million over the two periods. Much of this was caused by a decrease during the 2011 period in advance billings and deferred revenue of$19.0 million . During the nine months endedSeptember 30, 2011 , we used cash from investing activities of$14.7 million . Purchases of property and equipment aggregated$12.3 million of this amount. We also invested$3.3 million in film projects during this period. In connection with Comvest's purchase of our former commercial lender's loan onJuly 1, 2011 , our former commercial lender released the restricted cash aggregating$0.9 million onSeptember 30, 2011 . During the nine months endedSeptember 30, 2010 , we used cash from investing activities of$8.7 million . Purchases of property and equipment aggregated$5.1 million of this amount and we purchased stock of Digital Domain during this period for$3.6 million . Net cash provided by financing activities aggregated$43.1 million for the nine months endedSeptember 30, 2011 . During that period, we sold 2,025,001 shares of our Common Stock to a group of investors in a private placement at a price per share of$9.63 . The aggregate gross proceeds of this offering were$19.5 million . An investor purchased 1.5 million shares of common stock of Digital Domain for$2.5 million during this period. Our subsidiary,Digital Domain Institute ("DDI") sold 3.25 million shares of its common stock to a group of investors in a private placement at a price per share of$8.00 . The aggregate gross proceeds of this offering were$26.0 million . ThroughSeptember 30, 2011 , we paid$5.3 million in commissions and other expenses in connection with these private placements. During this period, PBC Digital Holdings II exercised its option to lend us$2.0 million under an additional convertible note payable, and we also borrowed$2.0 million from PBC Digital Holdings II for equipment financing. In this same period, we borrowed$8.0 million of convertible notes payable from Comvest. We also borrowed$7.4 million from our revolving loan facility from Comvest during the nine months endedSeptember 30, 2011 . During this period, we exercised our put right on Digital Domain's Series B Preferred Stock warrants for$5.0 million , and paid$1.0 million to pay off in full certain notes payable,$0.9 million of capital lease obligations and$3.6 million of deferred offering expenses. In connection with the Comvest borrowings, we paid$0.5 million of deferred debt issue costs. Finally, we paid$8.0 million to our Commercial Lender to repurchase warrants to purchase shares of our common stock that had been issued to that lender in 2009. Net cash provided by financing activities aggregated$0.5 million for the nine months endedSeptember 30, 2010 . During this period, we generated cash from a private placement of stock of$1.0 million . We also borrowed$2.0 million from our former Commercial Lender in this period and issued promissory notes in the amount of$2.4 million to two individuals in this period. We paid$0.6 million of deferred debt issue costs in connection with this transaction. We also borrowed$7.0 million fromPBC Capital Fund 1 in a convertible note payable. We paid$10.0 million to retire the Falcon notes payable debt that was carried by Digital Domain. During this period, we also made payments on capital lease obligations of$1.5 million .
The following table shows the pro forma effect of the IPO on our balance sheet, assuming the IPO had occurred on
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Table of Contents Historical Offering Offering September 30 Pro Forma Pro (In Thousands) 2011 Adjustments Forma (Unaudited) (Unaudited) (Unaudited) Balance Sheet Data: Cash and cash equivalents $ 9,978 $ (2,035 )(1) $ 43,323 41,820 (2) (4,402 )(2) (2,038 )(3) Working capital (38,261 ) 42,670 (8) 4,409 Deferred debt issue costs - net 6,916 (3,167 )(5) 3,749 Other assets 8,485 (4,403 )(2) 4,082 Total assets 178,882 25,775 (9) 204,657 Accounts payable and accrued liabilities 13,391 (35
)(1) 12,293
(1,063
)(3)
Convertible and other notes payable - net (current portion) 25,301 (2,000 )(1) 17,074 (15,715 )(5) 9,488 (5) Warrant and other debt-related liabilities (long-term) 133,592 (13,343 )(4) 23,179 (31,966 )(5) (80,643 )(6) 15,539 (7) Total stockholders' equity (deficit) (85,720 ) 33,015 (2) 59,793 (975 )(3) 13,343 (4) 35,026 (5) 80,643 (6) (15,539 )(7)
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(1) Subsequent to the consummation of the IPO, we repaid an equipment financing loan and accrued interest aggregating
(2) We received gross proceeds of$41.8 million from the IPO, paid investment banking fees and other then unpaid related costs aggregating$4.4 million and reclassed deferred offering costs aggregating$4.4 million from other assets to stockholders' equity. The net equity infusion was$33.0 million .
(3) Reflects the payment of accrued expenses related to the IPO and payment of certain other costs related to the offering.
(4) Reflects the decrease in warrant liabilities due to the decrease in the value per share based on the IPO price per share.
(5) Reflects the conversion to common stock of the senior convertible note payables aggregating$15.7 million , the elimination of the unamortized discounts on such notes of$9.5 million , the write-off of deferred debt issuance costs of$3.2 million as well as the elimination of warrant liabilities aggregating$32.0 million . The loss from this debt extinguishment was$12.7 million and the fair value of the stock issued was$47.7 million . (6) Reflects the conversion of the Series A Preferred Stock warrants, Junior Debt conversion warrants and certain other warrants to stockholders' equity upon consummation of the IPO. (7) Reflects the recording of the warrant liabilities for the fair value of the common stock conversion option of the Comvest convertible debt of$15.5 million , reversal of the beneficial conversion feature previously recorded of$3.5 million and additional interest expense of$12.0 million .
(8) The increase in working capital as a result of the IPO is as follows (in thousands):
Net increase in cash and cash equivalents$ 33,345
Pay off equipment financing loan and accrued interest 2,035 Pay off of accrued offering costs
1,063
Conversion of convertible notes payable to equity 6,227 Net increase in working capital
$ 42,670 42
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(9) Increase in total assets is as follows:
Net increase in cash and cash equivalents $
33,345
Write-off of deferred debt issuance costs upon conversion of debt to equity
(3,167 ) Reclassification of deferred offering costs to stockholders' equity
(4,403 ) Total increase in total assets $ 25,775 Part I. Financial Information
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