FUN Technologies Inc.
TSX : FUN
AIM : FUN

FUN Technologies Inc.

November 13, 2006 21:34 ET

FUN Technologies Files Management Discussion and Analysis

TORONTO, ONTARIO--(CCNMatthews - Nov. 13, 2006) - FUN Technologies Inc. ("FUN" or the "Company")(TSX:FUN)(AIM:FUN), one of the world's leading online and interactive casual games providers, announced today its results for the quarter ended September 30, 2006. The Company's Management Discussion and Analysis for the third quarter is attached herein. All currency amounts are stated in thousands of U.S. dollars ("US$") (except per share figures).



FUN TECHNOLOGIES INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the three and nine months ended September 30, 2006


The following Management's Discussion and Analysis ("MD&A") of the financial condition and results of operations of FUN Technologies Inc. and its subsidiaries ("FUN" or the "Company") as at and for the three and nine months ended September 30, 2006, should be read in conjunction with the unaudited interim consolidated financial statements of the Company, including the notes thereto, as at and for the three and nine months ended September 30, 2006. Additional information regarding the Company is also available through the System for Electronic Document Analysis and Retrieval at www.sedar.com.

ABOUT THIS MD&A

All currency amounts are stated in thousands of U.S. dollars ("US$") (except per share figures), unless otherwise indicated. FUN prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles ("Canadian GAAP").

This MD&A has been prepared as of November 13, 2006 and was reviewed and approved by the Company's Audit Committee prior to filing.

FORWARD-LOOKING STATEMENTS

This MD&A contains forward-looking statements regarding, among other things, the Company's beliefs, plans, objectives, strategies, estimates, intentions and expectations. Generally these forward-looking statements can be identified by the use of forward-looking terminology such as "believe", "potential", "expect", "estimate", "would", "could", "intend", "will", "if" and "may". These forward-looking statements are based on a number of assumptions which may prove to be incorrect, including management's current expectations, estimates and assumptions about the markets in which the Company operates, the global economic environment, interest rates, exchange rates, and the Company's ability to attract and retain customers and to manage its assets and operating costs. Forward-looking statements involve known and unknown risks, uncertainties and other facts which may cause actual results or developments to differ materially from those contemplated or implied by these statements depending on, among others, those factors set out in the "Risk Factors" section of FUN's 2005 Annual Information Form dated March28, 2006, which are incorporated herein by reference. However, the risk factors set out therein are not exhaustive of the factors that may affect any of the Company's forward-looking statements. Investors and others should carefully consider these and other factors and not place undue reliance on these forward-looking statements. Further information regarding these and other factors is included in the Company's public filings with Canadian securities regulatory authorities. The forward-looking statements contained in this MD&A represent the Company's views only as of November 13, 2006. Except as required by applicable law, the Company does not intend, and does not assume any obligation, to update these forward-looking statements, whether as a result of new information, future events or otherwise.

OVERVIEW

The primary business of the Company is the provision of online and interactive casual games and sports content. The Company provides its services through its FUN Games and FUN Sports divisions. The Company's FUN Games division operates its skill games business which involves operating and licensing a skill games which includes pay-for-play, person-to-person and tournament-based interactive skill games, free games, downloadable games and subscription games. The Company's FUN Sports division operates its fantasy sports services offering which includes editorial content, sports data, games and leagues to consumers and corporate distributors.

FUN Games

FUN Games offers a wide range of free and cash-based skill games via its own Internet sites and its distribution partners. Cash-based skill games are games in which participants must pay an entry stake to compete against each other for a prize, and in which the winner is determined based on skill rather than on chance. FUN provides private-label gaming systems and services to large interactive entertainment groups, including AOL, EA POGO and MSN. In addition, Fun Games operates a mobile game developer, Octopi.

FUN Sports

FUN Sports develops, operates and licenses fantasy league-hosting software, content, real-time sports statistics and interactive games delivered via broadband. The FUN Sports division has private-label distribution agreements with AOL, NBA and Nascar.com, among others. Through the Company's own websites, including www.fanball.com and www.CDMSports.com, FUN Sports provides fantasy sports contests, content, strategy and insight. It also owns Fanball.com radio and produces print publications called "Just Cheat Sheets", "Fantasy Racing" and "Fantasy Football Weekly".

The FUN Sports division also provides real-time sports information services for sports enthusiasts through the Company's destination site www.DonBest.com. DonBest provides subscription services for live odds, major line move alerts, injury reports, statistical reports, and offers customized information delivery services and publishes this information real time to the Company's subscribers. DonBest does not accept or make any wagers.

SUMMAY RESULTS OF OPERATIONS

As more fully described in Note 3 of the Company's unaudited interim consolidated financial statements, Liberty Media Corporation ("Liberty") indirectly acquired a controlling interest of FUN on March 10, 2006, pursuant to a Scheme of Arrangement under section 425 of the UK Companies Act 1985, whereby Fun Technologies Plc ("Old Fun") became a wholly-owned subsidiary of FUN. FUN was incorporated on November 18, 2005. Due to the structure of the transaction, Canadian GAAP requires that the acquiring company perform full purchase accounting as if it had acquired 100% of the outstanding shares Old Fun. In addition, as Old Fun was acquired by the Company, the Company is required to only provide operating results for the period from March 10, 2006. As the acquisition of Old Fun by FUN was completed on March 10, 2006, there are no 2005 financial statements of the Company that can be used under Canadian GAAP as comparative results for the current period results. (all amounts in 000's, except per share data)



Three months Nine months
ended ended
September 30, September 30,
2006 2006

(unaudited) (unaudited)

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Revenue $ 13,154,161 $ 25,526,858

Cost of sales 6,283,648 10,057,114
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Gross profit 6,870,513 15,469,744

Software development costs 2,334,242 5,151,565

Selling, general and administrative 8,740,048 17,842,874

Stock based compensation 146,399 146,399

Depreciation and amortization 4,734,369 11,801,951
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Loss from operations (9,084,545) (19,473,045)
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Loss for the period (7,900,019) (17,826,211)
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Basic and diluted loss per share $ (0.12) $ (0.28)
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Total assets - $ 383,874,235

Total liabilities - $ 53,713,128


Revenue

For the third quarter of 2006, revenue was $13.2 million, an increase of 30.1% over the second quarter of 2006. Revenue from FUN Games totaled $6.7 million in the period as compared to the division's second quarter revenue of $5.8 million and revenue from FUN Sports' was $6.4 million as compared to the division's second quarter revenue of $4.3 million. For the nine months ended September 30, 2006, the Company had revenue of approximately $25.5 million.

Substantially all of FUN Games' revenue is generated from cash skill platforms, which include Worldwinner.com, SkillJam.com and their partner destination sites. The increase over the prior quarter includes additional revenue recognized from fixed prize unlimited entry tournaments of $0.9 million where the Company recognizes revenue based on the gross entry fee.

The increase in revenue of Fun Sports from the second quarter included approximately $0.8 million attributed to our CDM Fantasy Sports recent acquisition. The remaining increase in FUN Sports' revenue of $1.3 million primarily relates to the timing of revenue recognition related to the Company's newsstand publications and the impact of the start of the NFL football season.

Cost of sales

Cost of sales during the third quarter was $6.3 million, an increase of $3.3 million over the second quarter of 2006. For the nine months ended September 30, 2006, the Company had cost of sales of approximately $10.1 million. Cost of sales in FUN Games primarily consists of credit card processing and access fees, prize related expenses, and more significantly, affiliate and partner expenses, which are payments made to FUN Games' marketing partners. In addition, depending on the programming of fixed prize tournaments, the Company's cost of sales includes more or less tournament prize expense.

Cost of sales in FUN Sports relate primarily to prize expense, hosting and credit card processing expense, printing and direct development expense. As FUN continues to provide more direct to consumer fantasy sports offerings, cost of sales is expected to grow due the prizing component of our direct to consumer offerings.

The increase over our second quarter cost of sales is primarily due to the (i) overall increase in revenue quarter over quarter and the launching of new partner arrangements (ii) additional cost of sales of approximately $0.5 million due to the prizing related to our CDM operations (iii) increase in our programming of fixed prize unlimited entry tournaments of approximately $0.7 million and (iv) recognition of the tax related matters.

See Note 2 of the Company's unaudited interim consolidated financial statements for a discussion of revenue recognition and cost of sales policies.

Software development expenses

The Company's software development expense was $2.3 million in the third quarter as compared to $2.4 million in the second quarter. For the nine months ended September 30, 2006, the Company had software development expense of approximately $5.2 million. The primary costs included in software development are salaries and benefits for employees working on the continued development of the Company's and its partners' portals, integration of the SkillJam and WorldWinner portals, development of alternative distribution platforms and the development of new casual and skill games. The Company has not capitalized any software development costs.

Selling, general and administrative expenses

Selling, general and administrative expense for the third quarter was $8.5 million as compared to $7.7 million in the second quarter. For the nine months ended September 30, 2006, the Company had selling, general and administrative expense of $17.6 million. The increase in selling, general and administrative expense is primarily due to an increase in our marketing expenditures company wide by approximately $0.6 million. The increase in marketing spend is primarily due to the hosting of the "World Wide Web Championship" held in September and the seasonality of marketing expenditures focused on the start of the NFL football season.

Restructuring Charges

During the third quarter of 2006, the Company completed its analysis of the integration of the FUN Games division. Based on this analysis, the Company reduced its workforce by approximately 53 employees and incurred $363,444 of severance associated costs for employees that were terminated prior to September 30, 2006 or had severance obligations that were non-cancelable.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2006, the Company's principal sources of capital were its cash on hand and its other current assets. Cash on hand was $14.1 million at September 30, 2006. This cash on hand does not include restricted cash of $0.9 million at September 30, 2006 which primarily relates to credit card reserve by the Company's merchant banking partners.

The Company has accrued $3.2 million with respect to potential tax and penalties related to potentially insufficient US tax information returns and related tax withholdings. Due to the timing of the obligation, $2.4 million is accounted for in conjunction with the Liberty purchase accounting and $0.6 million and $0.2 million is included in cost of sales and selling, general and administrative expense, respectively, for the three and nine months ended September 30, 2006.

Cash flow analysis

For the three and nine months ended September 30, 2006, FUN generated negative cash flow from operations of $1.2 million and $11.8 million, respectively. The Company's negative cash from operations before changes in working capital was $4.6 million and $7.5 million, respectively for the three and nine months ended September 30, 2006.

For the three and nine months ended September 30, 2006, FUN had a cash inflow from financing activities of $0.8 million and $201.1 million, respectively. The cash flow from financing activities for the three months ended September 30, 2006 was primarily due to the proceeds from the exercise of outstanding stock options and the cash flow from financing activities for the nine months ended was due to the transaction with Liberty more particularly described in Note 3 to the unaudited interim consolidated financial statements of the Company.

For the three and nine months ended September 30, 2006, FUN had a cash outflow from investing activities of $6.2 million and $175.2 million, respectively. The outflows from investing activities were due to various acquisitions completed in the period, including the Liberty transaction.

The Company's principal sources of funds are cash on hand and cash generated from operations. To the extent that the Company requires additional capital the Company would seek additional funding through the issuance of debt or equity securities with our current shareholders or other third parties. There can be no assurance that the Company would be able to secure additional financing or complete such transactions.

Adjusted EBITDA

In addition to disclosing interim results in accordance with Canadian GAAP, FUN also provides supplementary non-GAAP measures as a method of evaluating the Company's operating performance.

Management uses Adjusted EBITDA as a measure of enterprise-wide performance. Adjusted EBITDA is defined as earnings before interest income, taxes, depreciation and amortization, stock based compensation, restructuring and impairment charges. Management believes Adjusted EBITDA is a useful measure that facilitates period-to-period operating comparisons and allows the Company to compare its operating results with its competitors. Adjusted EBITDA does not have any standardized meaning prescribed by GAAP and is not necessarily comparable to similar measures presented by other companies. Adjusted EBITDA is not a measure of performance under Canadian GAAP and should not be considered in isolation or as a substitute for net earnings (loss) prepared in accordance with Canadian GAAP. The Company has provided a reconciliation of Adjusted EBITDA to Canadian GAAP net earnings (loss) below.



Three months Nine months
ended ended
September 30, September
2006 30, 2006

Loss for the period ($ 7,900,019) ($17,826,211)
Income taxes (1,613,338) (3,982,027)
Interest expense, net 65,368 16,518
Stock based compensation 146,399 146,399
Depreciation and amortization 4,734,369 11,801,951
Impairment of investments - 1,955,231
Restructuring 363,444 363,444
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Adjusted EBITDA ($4,203,777) ($7,524,695)
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Long-term commitments

The Company has long-term commitments in the form of operating leases and revenue and marketing guarantees to several of its partners. Commitments for the remainder of 2006, one to three years and four to five years are $4.6 million, $4.5 million, $0.5 million, respectively. The commitments include $5.4 million of revenue and marketing guarantees to distribution partners.
FUN is contingently obligated to pay the sellers of Fanball an earn-out pursuant to its acquisition, subject to the acquired company attaining certain financial performance criteria. The maximum obligation related to this arrangement is $12.6 million and would be due in the first quarter of 2007 should the operating results warrant a payment.

FUN is contingently obligated to pay the sellers of Octopi an earn-out pursuant to its acquisition, subject to the acquired company attaining certain financial performance criteria. The maximum obligation for this arrangement is $3.0 million and would be due in the first quarter of 2007 should the operating results warrant a payment.

Based on the operating performance of the businesses as compared to the performance thresholds, management does not currently anticipate any payments under these contingent obligations.

Off balance sheet arrangements

FUN does not have any off balance sheet arrangements.

Transactions with related parties

FUN did not have any significant transactions outside the normal course of operations with related parties as at and for the three or nine months ended September 30, 2006.

ACCOUNTING PRINCIPLES

The Company's accounting principles and estimates used in the preparation of its unaudited interim consolidated financial statements are considered appropriate in the circumstances, but are subject to judgments and uncertainties inherent in the financial reporting process. FUN's accounting policies are listed in Note 2 to the unaudited interim consolidated financial statements.

Critical accounting estimates

The preparation of financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reported period. Significant accounting policies and methods used in the preparation of the financial statements are described in Note 2 to the unaudited interim consolidated financial statements. The Company evaluates its estimates and assumptions on a regular basis, based on historical experience and other relevant factors. Actual results could differ materially from these estimates and assumptions. The following critical accounting policies are affected by judgments, assumptions and estimates used in the preparation of the unaudited interim consolidated financial statements.

Revenue recognition:

Revenue from skill games operations is generally recognized net of prizes and other promotions paid. Revenue from tournaments where the Company guarantees the prize pool is recognized as gross entry fees with the related prize expenses included in cost of sales. In either case, fees are recognized as revenue at the conclusion of the participants' games play. The Company also derives revenue from third-party companies by providing the customers with games or websites for end users, which are then customized to reflect the look and feel of each third-party customer. Revenue from these items is unbundled and recognized according to the relative fair value as each contractual element is delivered. If the fair value of the contractual elements is not available, revenue is recognized on a straight-line basis over the life of the contract.

Fair value of acquisition related assets and liabilities:

The Company allocates the purchase price of acquired companies to identified assets acquired and liabilities assumed based on their estimate fair values. In determining fair value, management is required to make estimates and assumptions that affect the recorded amounts. To assist in this process, third- party valuation specialists generally are engaged to value certain of these assets and liabilities. Estimates used in valuing acquired assets and liabilities, include, but are not limited to, expected future cash flows, market comparables and appropriate discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain.

Useful lives of long-lived assets:

The Company estimates the useful lives of its long-lived assets including tangible and intangible assets. In determining the useful lives, the Company considers technological and economical obsolescence. Management's estimates of useful lives are based upon assumptions believed to be reasonable, but which are inherently uncertain.

Valuation of goodwill and other indefinite lived intangible assets

We assess the impairment of goodwill annually and whenever events or changes in circumstances indicate that the carry value may not be recoverable. Factors we consider important which could trigger an impairment review include significant underperformance to projected future operating results, substantial changes in our strategy or the manner of use of our assets, and significant negative industry or economic trends. Fair value of each reporting unit is determined using the use of an outside independent valuation consultant. The Company did not consider that a triggering event occurred in the third quarter and will perform our annual impairment test as of December 31, 2006.

OUTSTANDING SHARE DATA

As of November 13, 2006, the Company had 63,452,312 common shares issued and outstanding. The following table sets out common shares issuable upon exercise of outstanding stock options.



Outstanding common shares: 63,452,312
Issuable on exercise of outstanding stock options: 5,362,002
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Total: 68,814,314


RISKS AND UNCERTAINTIES

The primary risks and uncertainties that affect and may affect the Company and its business, financial condition and results of operations are substantially unchanged from those discussed in FUN's 2005 Annual Information Form dated March 28, 2006.

DISCLOSURE CONTROLS AND PROCEDURES OVER FINANCIAL REPORTING

Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the Chief Executive Officer and the Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosure. Company management, with the participation of the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual and Interim Filings) as of September 30, 2006, and has concluded that such disclosure controls and procedures are effective.

About FUN Technologies

FUN Technologies Inc. is one of the world's leading online casual games providers. FUN's strategy is to provide its cutting-edge games systems to top distribution partners around the world. FUN is 51% owned by Liberty Media Corporation, and FUN's common shares are listed on both the Toronto Stock Exchange and the Alternative Investment Market (AIM) of the London Stock Exchange under the symbol "FUN".

Contact Information

  • FUN Technologies
    Lorne Abony
    CEO
    (416) 840-0806
    or
    FUN Technologies
    Stephen Tucker
    CFO
    (416) 840-0453