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Form 10KSB for HEADLINERS ENTERTAINMENT GROUP, INC.


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15-Apr-2005

Annual Report



Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations

At the beginning of 2002 Headliners embarked on a new business plan. From its founding in 1984 through 2001, Headliners' business consisted entirely of the operation of stand-alone restaurant/comedy club facilities: two in New Jersey since the 1980s and one that we operated in Miami, Florida for only a year. In 2002 we began to develop alternative locations for Rascals' comedy by organizing hotel-based clubs and by granting licenses to utilize the name "Rascals." We also began to develop multiple channels of distribution for the comedic entertainment produced in our clubs, such as home video sales and pay-per-view sales. As the year progressed, however, it became apparent that our efforts in developing and managing these multiple channels of distribution, though profitable, were not cost-effective. So, in the third quarter of 2002 we refocused our attention on the development of new Rascals clubs, both hotel-based and licensed. Our focus today is on developing a sufficient number of clubs to achieve an efficient level of operations.

Recently we have expanded our new direction from hotel-based clubs to clubs in entertainment venues, where a large, pre- existing clientele can be converted into customers of our club. As our first effort in this new type of environment, in December 2003 we signed a ten year lease for 7,000 square feet in the Palisades Center, the second largest retail mall in the United States. Although we did not at that time have the funds needed to build the club, we committed to the lease with the expectation that our Standby Equity Distribution Agreement with Cornell Capital Partners would provide us the necessary capital. We are currently building a 350-seat comedy club in the Palisades Mall that we expect to open in the Spring of 2005.

The most dramatic example of our new focus on entertainment venues is our acquisition in March 2005 of six dance clubs, two of which contain Rascals comedy clubs. We acquired the clubs from JHF Properties LLC, which is the developer of a chain of dance clubs that operate under one of the followings trade names:
"Banana Joe's,""Margarita Mama's," "Red Cheetah," "Parrot Beach" or "Cactus Cafe."

During 2004 we owned only a passive interest in three of those clubs. Therefore, for 2004, we did not consolidate their results with our financial statements. Instead we accounted for our investment in these clubs using the cost method. We adopted this method of accounting for the investments because we did not exercise significant influence over the operations of the clubs in 2004. Since March 31, 2005, however, we have owned five of the clubs and have held the rights to the net profits of a sixth. Beginning in the second quarter of 2005, therefore, we will consolidate the financial results of the clubs with our other operations. This will result in a significant increase in our revenues, as the six clubs reported $11,353,827 in revenue for 2004, although three of the clubs only commenced operations in Spring of that year.


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While we have been undertaking these capital intensive efforts to increase the number of our clubs, we have also been offering licensing arrangements that will increase the numbers of Rascals Comedy Clubs with minimal capital commitment by Headliners. Our first such licensing arrangement permitted our licensee to open a 300-seat "Rascals Comedy Club" in Jersey City, New Jersey during the first quarter of 2004. Headliners provides the group with its plans and designs for the club, consulted with the group during the development stage, and is providing bookings for a fee. In return, the licensee pays a monthly royalty to Headliners equal to five percent of its gross receipts throughout the ten-year term of the license. During 2004 the Jersey City club had paid us only $12,500, and we anticipate that our revenue from this arrangement will remain modest. However, almost all of the revenue flows through to our bottom line, since we have no operational responsibility for the club, and it has been achieved with no capital commitment.

In 2003 86% of our revenue came from the two New Jersey restaurant-clubs that we have operated since the 1980s. However we closed our restaurant-club in West Orange NJ in the summer of 2003, and closed our restaurant-club in Ocean NJ in May 2004. On our statement of operations for 2004 and 2003, therefore, the results of the operations of these two facilities have been summarized as "Discontinued Operations." The "Continuing Operations" reflected on our Statement of Operations consists only of:

* our hotel-based club in Cherry Hill NJ, which has been contributing to revenue since December 2002;
* our restaurant and club in Montclair NJ in June, which has been contributing to revenue since June 2004; and
* our video licensing activities, which have made a modest contribution to revenue since 2002.

The discontinuance of the operations of our principal clubs in 2003 has resulted in marked differences in the results of operations for 2004 compared to the results for 2003. The $1,317,898 in net sales and $582,687 in cost of sales reported for 2004 are attributable to the operations of both the new Montclair club and restaurant and our club at the Cherry Hill Hilton. The $264,317 in net sales and $145,465 in cost of sales reported for 2003 were contributed by the Cherry Hill club only.

The transitions in our business plan have resulted in a marked disparity between revenues and expenses. In 2004 we incurred general and administrative expenses totaling $9,445,982, including $3,650,133 in expenses that were or will be settled in


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cash and $5,795,849 in expenses that we settled by issuance of stock. The dramatic increase in general and administrative expenses reflects, in part, the fact that in the second quarter of 2004 we received cash from loans and private sales of stock totaling $4,740,000. A portion of the recent general and administrative expense represents expenses we incurred in obtaining these funds that are not capital expenses. Another, larger portion of the general and administrative expenses occurred as we promptly utilized a portion of the funds we had raised to implement growth strategies for the future. Finally, our lack of cash requires us to pay with stock both our executives and the network of individuals who are assisting us in developing and implementing our business plan, which results in a large expense for "stock issued for consulting services."

In 2005 we expect a number of new revenue sources to contribute to our financial results. The components of revenue in 2005 will include:

(1) Cherry Hill. We are now realizing approximately $22,000 per month in revenue from our Cherry Hill hotel-based operation, which commenced operations in December 2002. Although this sales level is far lower than the levels we maintained in West Orange or Ocean, we generate it with only one full-time and three part-time employees (compared to dozens at our restaurant- club combinations). So we are realizing an average monthly profit in Cherry Hill of approximately $13,000.

(2) Montclair. To replace our West Orange and Ocean restaurant-clubs, in June 2004 we opened a 13,000 square foot restaurant and comedy club in Montclair, New Jersey. The restaurant and bar in our Montclair facility seats 150, and the showroom seats 400. The property was initially owned by a separate corporation organized by members of Headliners' management. In October 2004, however, they contributed their ownership interest in that corporation to Headliners.

(3) Dance Clubs. The six dance clubs that we acquired in March 2005 generated $11,353,827 in revenue and $415,917 in net income in 2004. The three most profitable of the clubs, those in Louisville, Jackson and Omaha, were in operation for only a portion of 2004. So we expect results for 2005 to be an improvement over 2004. Commencing in the second quarter of 2005, those results will be consolidated with our other operations.

(4) Palisades Center. We expect this club to open to begin to contribute to our revenue in the second quarter of 2005.

These new directions in our operations bode well for the future. So while 2004 was a year of transition, our goal is to return to profitability in 2005. We believe that is an achievable goal.


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Liquidity and Capital Resources

In order to obtain the funds necessary to acquire our six new dance clubs and construct our facilities in Montclair and the Palisades Center, we have borrowed nearly $10 million from Cornell Capital Partners. At December 31, 2005, we owed Cornell Capital Partners $3,025,000. Today the debt totals $7,500,000, consisting of two notes. One note, for $4,500,000, requires Headliners to make monthly payments of $750,000 plus interest, commencing on August 25, 2005. If Headliners defaults in making any payment, Cornell Capital Partners will be entitled to convert the note into common stock at a conversion price equal to the lesser of $12.00 or 80% of the then-current bid price. The note is secured by a pledge of all of Headliners' assets. The second note, for $3,000,000, provides that Headliners will make monthly principal payments of $100,000 plus accrued interest commencing on May 23, 2005. Headliners' obligation is secured by a pledge of all of its assets. Headliners also pledged 100,000,000 shares of its common stock to secure its obligations under the second note.

In order to satisfy our debt to Cornell Capital Partners we have entered into a "Standby Equity Distribution Agreement" with Cornell Capital Partners. The Standby Equity Distribution Agreement becomes effective when we provide Cornell Capital Partners with a prospectus that will permit it to resell to the public any shares it acquires from Headliners. During the two years after the Securities and Exchange Commission declares that prospectus effective, Headliners may demand that Cornell Capital Partners purchase shares of common stock from Headliners. Headliners may make a demand no more than once every seven trading days. The maximum purchase price on each demand is $500,000. The Standby Equity Distribution Agreement recites that Headliners may demand from Cornell Capital Partners up to $30,000,000 during its term. The number of shares that Cornell Capital Partners will purchase after a demand will be determined by dividing the dollar amount demanded by a per share price. The per share price used will be 98% of the lowest daily volume- weighted average price during the five trading days that follow the date a demand is made by Headliners. Cornell Capital Partners is required by the Agreement to pay each amount demanded by Headliners, unless (a) there is no prospectus available for Cornell Capital Partners to use in reselling the shares, (b) the purchase would result in Cornell Capital Partners owning over 9.9% of Headliners outstanding shares, or (c) the representations made by Headliners in the Agreement prove to be untrue.

Our plan is to sell common stock to Cornell Capital Partners in order to meet our debt service obligations. This will result in a significant increase in our outstanding common stock. At the market price of $4.38 per share on April 12, 2005, satisfaction of our entire debt to Cornell Capital Partners would require that we issue approximately 1,750,000 shares. However, the influx of shares in that quantity into the market is likely to result in a reduction in the market price for our common stock. Therefore it is likely that considerably more shares will have to be sold in order to satisfy our obligations to Cornell Capital Partners.


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With the proceeds of our sale of notes to Cornell Capital Partners, we have substantially alleviated our capital commitments. Nevertheless, in addition to the ongoing expenses of operating its business, Headliners faces the following cash commitments:

* We are currently building our new club in the Palisades Center in Nyack NY. We expect that completion of the club will require approximately $750,000, most of which we have reserved from our most recent transaction with Cornell Capital Partners. Once the club opens, it will require some capital to pay start-up costs until it achieves break-even operations. Our lease for the facility requires that we pay an annual rental equal to the sum of $119,000 plus 8% of our gross receipts in excess of $1.5 million plus an allocated portion of common area expenses and taxes. However, as the landlord has provided us a rent abatement equal to approximately one year's lease costs, we do not anticipate a significant immediate capital requirement beyond the costs of completing the build-out.

* We have a management services agreement with JHF Properties LLC, under which JHF Properties is managing our six new dance clubs. In compensation for its services, we have issued and will continue to issue common stock to the owner of JHF Properties. The management services agreement provides that if JHF Properties obtains less than $2,300,000 in proceeds from the sale of that common stock during the next year, it may call upon Headliners to pay the shortfall in cash at certain times during the year. If Headliners fails to do so, JHF Properties may terminate the arrangements under which it is required to transfer to Headliners the new facility in Hampton VA and/or the existing facility in Louisville KY.

* We had over $2.4 million in accounts and notes payable on December 31, 2004, not including the notes payable to Cornell Capital Partners that totaled $3,025,000 on that date (subsequently increased to $7,500,000). We do not expect that cash flow from operations will, in the near term, effect any significant reduction in our accounts and notes payable. Therefore we will either need to obtain extended payment terms from our creditors or we will have to obtain additional capital to pay those creditors whose debts are most pressing.

Once we have passed the current period of rapid expansion, our capital requirements will be much easier to control. Once clubs are established, they either operate profitably or they are closed. So the capital requirements of ongoing operations should not be significant. Our plan is to continue to expand, but at a pace commensurate with available capital and capital commitments, either from equity sources or secured lending sources that should become available once we have a portfolio of assets to offer as collateral.


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Critical Accounting Policies and Estimates

In preparing our financial statements we are required to formulate working policies regarding valuation of our assets and liabilities and to develop estimates of those values. In our preparation of the financial statements for 2004, there were two estimates made which were (a) subject to a high degree of uncertainty and (b) material to our results. One was our determination, detailed in Note 11 to the Consolidated Financial Statements, that we should record a valuation allowance for the full value of the deferred tax asset created by our net operating loss carryforward. The primary reason for the determination was our lack of certainty as to if and when Headliners would commence profitable operations. A second was our determination, detailed in Note 4 to the Consolidated Financial Statements, that we should write-off $1,958,510 in prepaid consulting at December 31, 2004. The primary reason for that determination was our uncertainty as to whether we would continue to receive economic benefit from the consulting contracts.

We have made no material changes to our critical accounting policies in connection with the preparation of financial statements for 2004.

Off-Balance Sheet Arrangements

We do not have any "off-balance sheet arrangements," as defined in the Regulations of the Securities and Exchange Commission.

Risk Factors That May Affect Future Results

Our expectations regarding the future of Headliners will be realized only if we are able to avoid the adverse effects of many risks and contingencies. You should carefully consider the risks described below before buying our common stock. If any of the risks described below actually occurs, that event could have a substantial adverse effect on our future financial results. Those adverse results, in turn, could cause the trading price of our common stock to decline, and you could lose all or part of your investment.

I. RISKS ATTENDANT TO OUR BUSINESS


WE MAY NOT BECOME PROFITABLE.
Headliners Entertainment Group has incurred substantial operating losses during the past three years. In order to achieve profitability it will be necessary that we either expand operations to a point sufficient to cover overhead or establish new sources of revenue. Failing such developments, it is likely that we will continue to sustain net losses.


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WE MAY BE UNABLE TO SATISFY OUR CURRENT DEBTS.
We currently owe Cornell Capital Partners $7,500,000 and have other debts and liabilities in excess of $3,000,000. The cash flow from our operations is not sufficient to service those debts. So we will be required to sell large amounts of our common stock in order to satisfy those debts. If we are unable to do so, our business will fail.


CURRENT SHAREHOLDERS WILL SUFFER DILUTION AS A RESULT OF OUR
FINANCING ACTIVITIES.
If we are able to sell equity in Headliners Entertainment Group and raise the capital we need to pay our debts, it is almost certain that the sale will occur at a price which is less than the market price for our common stock when the sale occurs. For example, our equity line of credit agreement with Cornell Capital Partners provides that we will sell shares to that entity at a price equal to 98% of the lowest daily volume-weighted average price during the five trading days after we put the shares to them. Because the market price of our shares is volatile, the price at which we sell to Cornell has to date generally been 80% to 90% of the market price on the date we made the put. In addition, we pay fees totaling 8% of the purchase price in connection with each put to Cornell, with the result that we generally obtain only 70% to 80% of the market price for shares we sell to Cornell Capital Partners.

Other terms may be negotiated with investors which could have the effect of diluting the interest of current shareholders in the equity of Headliners Entertainment Group. For example, in May, June and July 2004, our relationship with JHF Properties would have terminated if we could not obtain immediate funds to satisfy our commitment to JHF Properties. The only offers we received at that time were from 31 investors who agreed to purchase shares for prices that ranged from 20% to 50% of the market price when the sales were effected. If such an urgent need for cash were to occur in the future, we might again be forced to sell our equity at below-market prices. Our Standby Equity Distribution Agreement with Cornell Capital Partners provides that Headliners is not permitted to sell its common stock at prices below the public bid. However, Cornell Capital Partners has waived that provision in the past, and may do so in the future if Headliners requires capital funds that can only be obtained by a below-market sale of equity. Such sales would dilute the equity of existing shareholders.


COMPETITION FROM WELL-CAPITALIZED COMPANIES INVOLVED IN THE
COMEDY CLUB BUSINESS COULD HINDER OUR GROWTH.
The comedy club business is dominated by a small number of well-known, well-financed companies. As we seek advantageous locations for our clubs, we may face competition from one or more of these competitors. If one of these well-established competitors were to make a concerted effort to secure a location, it would be very difficult for us to compete effectively. This may limit our access to business opportunities.


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LIABILITY FROM LAWSUITS BASED ON "DRAM SHOP" LAWS COULD
EXCEED OUR INSURANCE COVERAGE.
In most states where Headliners locates clubs, there will be liquor liability ("dram shop") laws. These laws vary from state to state. In general, dram shop laws impose liability on the proprietor of an establishment for damage caused by a customer of the establishment, if the service of alcoholic beverages by the establishment to that customer was a cause of the damage and the establishment service was negligent or otherwise culpable. Since we will serve alcoholic beverages in all of our clubs, we will be subject to the risk that lawsuits arising under dram shop laws could produce judgments that exceed our insurance coverage and imperil our capital.

II. RISKS ATTENDANT TO OUR MANAGEMENT


OUR BUSINESS DEVELOPMENT WOULD BE HINDERED IF WE LOST THE
SERVICES OF OUR PRESIDENT.
Eduardo Rodriguez is the President of Headliners Entertainment Group. Mr. Rodriguez is the only executive employed on a full-time basis by Headliners Entertainment Group. Mr. Rodriguez is responsible for strategizing not only our business plan but also the means of financing it. If Mr. Rodriguez were to leave Headliners Entertainment Group or become unable to fulfill his responsibilities, our business would be imperiled. At the very least, there would be a delay in the development of Headliners Entertainment Group until a suitable replacement for Mr. Rodriguez could be retained.

SINCE THE SIX DANCE CLUBS THAT WE RECENTLY OBTAINED REPRESENT THE LARGEST PORTION OF OUR BUSINESS, OUR SUCCESS WILL DEPEND ON THE MANAGEMENT SKILLS OF THE INDIVIDUALS WHO NOW MANAGE THOSE DANCE CLUBS.

In March 20005 we acquired six dance clubs and paid a $1.4 million fee to build one additional club. The revenue from those clubs will far exceed the revenue we now realize from our comedy clubs. However, neither of our present officers has any experience in the business of operating dance clubs. We will, therefore, rely on the company from which we are acquiring the dance clubs to provide us sound management in the future. If its services became unavailable, or if its management decisions were unsound, it would have a serious adverse effect on our business.


HEADLINERS ENTERTAINMENT GROUP IS NOT LIKELY TO HOLD ANNUAL
SHAREHOLDER MEETINGS IN THE NEXT FEW YEARS.
Delaware corporation law provides that members of the board of directors retain authority to act until they are removed or replaced at a meeting of the shareholders. A shareholder may petition the Delaware Court of Chancery to direct that a


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shareholders meeting be held. But absent such a legal action, the board has no obligation to call a shareholders meeting. Unless a shareholders meeting is held, the existing directors elect directors to fill any vacancy that occurs on the board of directors. The shareholders, therefore, have no control over the constitution of the board of directors, unless a shareholders meeting is held.

Since it became a public company in 1999, Headliners Entertainment Group has never held an annual or a special meeting of shareholders. The Board of Directors of Headliners Entertainment Group consists of the same individuals who served in 2000. Management does not expect to hold annual meetings of shareholders in the next few years, due to the expense involved. Therefore, any new members of the Board of Directors or any replacements for current members will be nominated and elected by the present members of the Board.


RELATED PARTY TRANSACTIONS MAY OCCUR ON TERMS THAT ARE NOT
FAVORABLE TO HEADLINERS ENTERTAINMENT GROUP.
The two members of our Board of Directors, Eduardo Rodriguez and Michael Margolies, directly and through their families, control 59% of the voting power of Headliners Entertainment Group. For the foreseeable future, therefore, they will control the operations of Headliners Entertainment Group. In the past they have been the Managers of limited liability companies that were senior secured creditors of Headliners and that owned the properties where Headliners' New Jersey restaurant clubs operated. It is possible that they will engage in other transactions with Headliners Entertainment Group. It is unlikely that they will obtain independent confirmation that the terms of such related party transactions are fair. If the terms are unfair to Headliners Entertainment Group, the transactions could harm our operating results.



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Headliners Entertainment Group Signs Agreement with Emerging Web-Based Broadcast Entertainment Channel-TVNet.net
Monday April 18, 6:45 am ET
Rascal's Before They Were Stars Comedy Classics Now Available on PCs and Wireless Devices


MONTCLAIR, N.J., April 18, 2005 (PRIMEZONE) -- Headliners Entertainment Group, Inc. (OTC BB:HLEG.OB - News) announced today that it has entered into an agreement with the Internet's premiere wired and wireless entertainment group- TVNET.net (http://www.tvnet.net). Per this agreement, Headliners will provide TVNET.net with high-resolution video of its Rascal's Comedy Classics and Rising Stars library content, which TVNET.net will market through different portals and to various broadcast mediums. In return, Headliners will receive an equity percentage of TVNET.net's advertising revenues.
ADVERTISEMENT


TVNET.net, a veritable Internet-based broadcast entertainment channel, specializes in producing and aggregating various content that is marketed to the personal computer-via the many emerging portal or destination websites-as well as to PMCs, PDAs and other handheld video devices, and eventually to HD Televisions as a legitimate alternative to cable and satellite broadcast technologies. TVNET touts itself as being able to deliver high-resolution content ``in any manner, over any medium''. Currently the company is able to effectively stream its content through satellite, cable, wireless and plain old telephone lines. TVNET.net intends to expand and establish brand-name awareness through a growing international subscriber base, increased industry partnering and Live-Event Internet streaming.

Headliners' agreement with TVNET.net is a first step towards its recently announced goal of moving into multi-media markets and emerging new broadcast technologies. According to the terms of the agreement, Headliners Entertainment Group will receive 15 percent of all advertising revenues TVNET.net produces through its subscriber-based website.