<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For The Quarterly Period Ended September 30, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For The Transition Period From _______ To ________
Commission File Number 0-11071
_______________________
IMAGE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
_______________________
California 84-0685613
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification Number)
9333 Oso Avenue, Chatsworth, California 91311
(Address of principal executive offices, including zip code)
(818) 407-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ( x ) NO ( )
Number of shares outstanding of the registrant's common stock on November 4,
1997: 13,722,993
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PART I - FINANCIAL INFORMATION
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ITEM 1. Financial Statements.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and March 31, 1997
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ASSETS
<TABLE>
<CAPTION>
September 30, 1997 March 31, 1997
------------------- --------------
(In thousands) (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,061 $ 1,090
Accounts receivable, net of allowances of
$3,405 - September 30, 1997;
$4,809 - March 31, 1997 8,639 10,759
Inventories (Note 3) 16,492 17,776
Royalties, distribution fee and license
fee advances 8,023 8,454
Prepaid expenses and other assets 763 751
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$4,397 - September 30, 1997;
$3,972 - March 31, 1997 7,575 7,618
------- -------
$42,553 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and March 31, 1997
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LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, 1997 March 31, 1997
------------------- ---------------
(In thousands, except share data) (unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $13,699 $15,922
Accrued royalties 3,439 3,481
Revolving credit facility (Note 5) 5,630 8,709
Construction credit facility (Note 6) 400 --
Note payable (Note 7) 1,350 285
------- -------
Total liabilities 24,518 28,397
------- -------
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, 3,366,000 shares
authorized; none issued and outstanding -- --
Common stock, no par value, 25 million shares
authorized; 13,723,000 and 13,343,000 issued
and outstanding at September 30, 1997 and
March 31, 1997, respectively 17,952 17,642
Stock warrants (24) (73)
Additional paid-in capital 3,064 3,064
Accumulated deficit (2,957) (2,582)
------- -------
Net shareholders' equity 18,035 18,051
------- -------
$42,553 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Three Months Ended September 30, 1997 and 1996
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<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
-------- --------
<S> <C> <C>
NET SALES $16,412 $17,762
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 13,283 13,851
Selling expenses 1,185 1,234
General and administrative expenses 1,124 1,353
Amortization of production costs 888 741
------- -------
16,480 17,179
------- -------
OPERATING INCOME (LOSS) (68) 583
OTHER EXPENSES (INCOME):
Interest expense 129 82
Interest income (7) (49)
------- -------
122 33
------- -------
INCOME (LOSS) BEFORE INCOME TAXES (190) 550
INCOME TAX (BENEFIT) EXPENSE (6) 54
------- -------
NET INCOME (LOSS) $ (184) $ 496
======= =======
NET INCOME (LOSS) PER SHARE (Note 4) $ (.01) $ .04
======= =======
WEIGHTED AVERAGE SHARES
OUTSTANDING (Note 4) 13,623 15,265
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Six Months Ended September 30, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
-------- --------
<S> <C> <C>
NET SALES $33,314 $37,908
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 27,332 29,832
Selling expenses 2,232 2,315
General and administrative expenses 2,133 2,815
Amortization of production costs 1,719 1,513
------- -------
33,416 36,475
------- -------
OPERATING INCOME (LOSS) (102) 1,433
OTHER EXPENSES (INCOME):
Interest expense 332 108
Interest income (53) (144)
------- -------
279 (36)
------- -------
INCOME (LOSS) BEFORE INCOME TAXES (381) 1,469
INCOME TAX (BENEFIT) EXPENSE (6) 367
------- -------
NET INCOME (LOSS) $ (375) $ 1,102
======= =======
NET INCOME (LOSS) PER SHARE (Note 4) $ (.03) $ .08
======= =======
WEIGHTED AVERAGE SHARES
OUTSTANDING (Note 4) 13,527 15,656
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
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IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Six Months Ended September 30, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (375) $ 1,102
Adjustments to reconcile net income
to net cash (used) provided by operating activities:
Amortization of production costs 1,719 1,513
Depreciation and amortization 430 401
Amortization of stock warrants 49 112
Provision for doubtful accounts, net of recoveries (315) 321
Changes in assets and liabilities associated
with operating activities:
Accounts receivable 2,435 1,805
Optical disc inventory 1,423 (2,658)
Royalty, distribution and license fee advances, net 431 (6,150)
Production cost expenditures (1,858) (1,522)
Prepaid expenses and other assets (17) (1,067)
Accounts payable, accrued royalties
and accrued liabilities (2,287) 1,563
------- -------
Net cash provided (used) by operating activities 1,635 (4,580)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (360) (515)
------- -------
Net cash used by investing activities (360) (515)
------- -------
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(unaudited)
For the Six Months Ended September 30, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
--------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 19,641 $ 16,702
Advances under construction credit facility 400 --
Proceeds from issuance of debt 1,350 --
Repayment of advances under revolving
credit facility (22,720) (13,465)
Repayment of short-term debt (285) --
Repurchase of common stock -- (1,796)
Net proceeds from exercise of stock options 310 48
-------- --------
Net cash provided (used) by financing activities (1,304) 1,489
-------- --------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (29) (3,606)
Cash and cash equivalents at beginning of period 1,090 4,666
-------- --------
Cash and cash equivalents at end of period $ 1,061 $ 1,060
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 284 $ 55
Income taxes $ 90 $ 668
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Note 1. Basis of Presentation.
The accompanying consolidated financial statements as of and for the periods
ended September 30, 1997 and 1996 include the accounts of Image Entertainment,
Inc. and its wholly-owned subsidiary U.S. Laser Video Distributors, Inc.
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
The accompanying consolidated balance sheet at September 30, 1997 and the
related consolidated statements of operations and cash flows for the periods
ended September 30, 1997 and 1996 of the Company included herein are unaudited;
however, such information reflects all adjustments of a normal recurring nature
which management believes are necessary for a fair presentation of results for
the interim periods. The accompanying consolidated financial information for
the periods ended September 30, 1997 and 1996 should be read in conjunction with
the Financial Statements, the Notes thereto and Management's Discussion and
Analysis of Financial Condition and Results of Operations in the Company's March
31, 1997 Form 10-K.
The preparation of the Company's consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in these financial
statements and accompanying notes. The more significant areas requiring the use
of management estimates related to allowances for slow-moving inventory,
doubtful accounts receivable, royalty and other advances and sales returns.
Actual results could differ from those estimates.
Certain fiscal 1997 amounts have been reclassified to conform with the fiscal
1998 presentation.
Seasonality and Variability. The Company has generally experienced higher sales
- ---------------------------
of laserdiscs in the quarters ended December 31 and March 31 due to increased
consumer spending associated with the year-end holidays and the home video
release of many high profile, high budget summer theatrical releases; however,
since most sales of a title occur in the first few months after its release,
seasonal sales also vary with the popularity of titles in release. In addition
to seasonality issues, other factors have contributed to the fluctuation in the
Company's net sales on a quarterly basis. These factors include: (i) the
popularity of titles in release during the quarter; (ii) the Company's marketing
and promotional activities; (iii) the Company's rights and distribution
activities; (iv) the extension, termination or non-renewal of existing license
and distribution rights; and (v) general economic changes affecting consumer
demand for laserdisc hardware and software and affecting the buying habits of
the Company's customers. The Company expects that its digital video disc
("DVD") sales patterns and net sales on a quarterly basis will be similarly
affected. The results of operations for the periods ended September 30, 1997
are not necessarily indicative of the results to be expected for the entire
fiscal year ending March 31, 1998.
Note 2. Recently Issued Accounting Pronouncements.
In June 1997, Statement of Financial Accounting Standards No. 130 ("SFAS No.
130") "Reporting Comprehensive Income" was issued. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and
-7-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
its components in a full set of general purpose financial statements. SFAS No.
130 is effective for both interim and annual periods beginning after December
15, 1997. The Company will adopt SFAS No. 130 in its quarter ending March 31,
1998.
In February 1997, Statement of Financial Accounting Standards No. 128 ("SFAS No.
128") "Earnings Per Share" was issued. SFAS No. 128 supersedes Accounting
Principles Board Opinion No. 15, "Earnings Per Share" and specifies the
computation, presentation, and disclosure requirements for earnings per share
("EPS") for entities with publicly held common stock. SFAS No. 128 was issued
to simplify the computation of EPS and to make the U.S. standard more compatible
with the EPS standards of other countries and that of the International
Accounting Standards Committee. SFAS No. 128 is effective for financial
statements for both interim and annual periods ending after December 15, 1997.
The Company will adopt SFAS No. 128 in its quarter ending December 31, 1997.
Note 3. Inventories.
Inventories at September 30, 1997 and March 31, 1997 are summarized as follows:
<TABLE>
<CAPTION>
September 30, March 31,
(In thousands) 1997 1997
------------- ------------
<S> <C> <C>
Optical disc inventory, net $ 14,777 $ 16,200
Production costs, net 1,715 1,576
------------- ------------
$ 16,492 $ 17,776
============= ============
</TABLE>
Optical disc inventory consists of finished optical discs (laserdiscs and DVDs)
for sale and is stated at the lower of average cost or market and is net of
reserves for slow-moving inventory of $4,081,000 and $3,070,000 at September 30,
1997 and March 31, 1997, respectively.
Production costs are net of accumulated amortization of $5,442,000 and
$5,011,000 at September 30, 1997 and March 31, 1997, respectively.
Note 4. Net Income per Share.
Net income per share was based on the weighted average number of common shares
and common share equivalents (e.g., options and warrants), if dilutive,
outstanding for each of the periods presented. The amount of dilution to be
reflected in net income per share was computed by application of the treasury
stock method. In periods where the amount of common stock issuable, if all
options and warrants are deemed exercised, exceeds 20% of the total shares
outstanding at the end of the period, the treasury stock method is modified, as
required by Accounting Principles Board Opinion No. 15, to adequately reflect
the dilutive effect of options and warrants on net income per share.
-8-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Under the modified treasury stock method, net income per share data were
computed as if all outstanding options and warrants were exercised at the
beginning of the period (or on the issuance date, if issued during the period)
and as if the funds obtained thereby were applied as follows: first to
repurchase up to 20% of the outstanding shares at the average market price
during the period, then any remaining proceeds were applied to reduce any
outstanding long-term debt and, if any proceeds remained thereafter, such
proceeds were applied to invest in U.S. government securities. If the result of
the foregoing application of proceeds has an aggregate dilutive effect on net
income per share, the net income per share calculation must reflect the shares
issuable upon the assumed exercise of options and warrants, net of the assumed
repurchase of shares, and adjustments to net income resulting from the assumed
application of proceeds. If, on the other hand, the aggregate effect was anti-
dilutive, common share equivalents and adjustments to net income resulting from
the assumed application of proceeds are excluded from the calculation of net
income per share.
For the periods ended September 30, 1997, the calculation of net loss per share
did not include common share equivalents as their effect would be antidilutive.
The modified treasury stock method was applied in determining net income per
share for the periods ended September 30, 1996.
Fully diluted net income per share was not presented for the periods ended
September 30, 1997 and 1996 since the amounts did not differ significantly from
the primary net income per share.
-9-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
The following table sets forth the calculation of net income per share for the
periods ended September 30, 1997 and 1996:
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months Three months Six months Six months
ended ended ended ended
September 30, September 30, September 30, September 30,
1997 1996 1997 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
As Presented
- ------------
Net income (loss) $ (184) $ 496 $ (375) $ 1,102
------- ------- ------- -------
Adjustment
- ----------
Add: reduction of interest
expense on assumed
reduction of debt,
net of taxes -- 48 -- 54
Add: interest income on
assumed investment in
U.S. government
securities, net of taxes -- 71 -- 171
------- ------- ------- -------
Adjustment to net income -- 119 -- 225
------- ------- ------- -------
As Adjusted
- -----------
Net income (loss) $ (184) $ 615 $ (375) $ 1,327
======= ======= ======= =======
Weighted average common
shares and common share
equivalents outstanding:
Common shares 13,623 13,635 13,527 13,679
Common stock options
and warrants -- 1,630 -- 1,977
------- ------- ------- -------
13,623 15,265 13,527 15,656
======= ======= ======= =======
Net income (loss) per share $ (.01) $ .04 $ (.03) $ .08
======= ======= ======= =======
</TABLE>
Note 5. Revolving Credit Facility.
In December 1996, the Company entered into a Loan Agreement (the "Agreement")
with Union Bank. The Agreement, as amended in October 1997, provides for
revolving advances and the issuance of standby letters of credit under a two-
year, $15,000,000 revolving credit facility. Borrowings under the Agreement are
at Union Bank's prime rate plus .25% (8.75% at September 30, 1997). The
Agreement provides the Company the option of borrowing for fixed periods at the
London Interbank Offered Rate ("LIBOR") plus 2.5% (8.28% at September 30, 1997).
Borrowings under the Agreement are secured by substantially all of the Company's
assets located in California and New Jersey. Funds available for borrowing may
not exceed the borrowing base specified in the Agreement.
-10-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
At September 30, 1997, $5,630,000 was outstanding under the Agreement, all of
which was borrowed under the prime rate plus .25% option, and $2,122,000, net of
amounts utilized for outstanding letters of credit, was available for borrowing.
The Agreement requires the Company to comply with certain quarterly financial
and operating covenants. At September 30, 1997, the Company was in compliance
with financial and operating covenants or had received waivers of noncompliance
from Union Bank.
Note 6. Construction Credit and Warehouse and Distribution Equipment Lease
Facilities.
Construction Credit Facility.
- ----------------------------
In March 1997, the Company entered into a Business Loan Agreement (the "Loan
Agreement") with Bank of America National Trust and Savings Association in
Nevada. The Loan Agreement provides for a construction line of credit (the
"Construction Line") through January 31, 1998. The maximum available under the
line ( the "Maximum Commitment") is $3,434,000 which shall be reduced quarterly
beginning December 31, 1997 by $43,000. The Construction Line converts to a
revolving line of credit (the "Revolving Line") on January 31, 1998. Under the
Revolving Line, the Company may repay and reborrow principal amounts provided
the Revolving Line does not exceed the Maximum Commitment. The Revolving Line is
available from February 1, 1998 through its maturity date of January 31, 2008.
Borrowings under the Loan Agreement are secured by a deed of trust on the
approximate 8.4 acres of land in Las Vegas, Nevada on which the Company intends
to construct a new warehouse and distribution facility as well as any of the
Company's personal property located in Nevada, excluding inventory held for
sale. Interest under the Construction Line and the Revolving Line is at the
bank's prime rate plus 1.25% (9.75% at September 30, 1997). The Loan Agreement
provides the Company the option, under the Revolving Line, of borrowing for
fixed periods of time at LIBOR plus either 2.25% or 2.65% depending on level of
the Company's debt service coverage ratio, as defined in the Loan Agreement. At
September 30, 1997, there were $400,000 in borrowings outstanding under the
Construction Line. The Loan Agreement requires the Company to comply with
certain quarterly financial and operational covenants. At September 30, 1997,
the Company was not in compliance with a certain financial covenant. Based upon
discussions with the bank, the Company anticipates receiving a waiver of
noncompliance. Should the Company not receive the waiver, the Company believes
it has adequate resources to repay the $400,000 in outstanding borrowings.
Warehouse and Distribution Equipment Lease Facility.
- ---------------------------------------------------
At September 30, 1997 there were no borrowings outstanding under the Company's
March 1997 $2,500,000 warehouse and distribution equipment lease facility with
BankAmerica Leasing and Capital Corporation. The lease contains certain
quarterly financial and operating covenants. At September 30, 1997, the Company
was not in compliance with a certain financial covenant. Based upon discussions
with the bank, the Company anticipates receiving a waiver of noncompliance.
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<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Note 7. Recent Debt Financings.
Convertible Debt Financing.
- --------------------------
On September 29, 1997, the Company entered into a credit agreement (the "Credit
Agreement") with Image Investors Co. ("IIC"), a principal stockholder of the
Company owned and controlled by John W. Kluge and Stuart Subotnick, pursuant to
which the Company borrowed $5,000,000 from IIC, with interest payable quarterly
at 8% per annum, and principal due in five years. The loan is unsecured and
subordinate to any obligations to Union Bank and is convertible into the
Company's common stock at any time during the term at a conversion price of
$3.625 per share, the closing price of the Company's common stock on September
29, 1997. The loan was funded on October 29, 1997 and proceeds were used to pay
down the Company's outstanding balance under its revolving credit facility with
Union Bank.
Secured Debt Financing.
- ----------------------
In July 1997, the Company borrowed $1,350,000 under a Business Loan Agreement
(the "Business Loan Agreement") with Pioneer Citizens Bank in Nevada. The
Business Loan Agreement bears interest at prime plus 1.75% (10.25% at September
30, 1997), matures February 1, 1998 and is secured by a deed of trust on the
approximately 8.8 acres of land adjacent to the Company's proposed warehouse and
distribution facility construction site in Las Vegas, Nevada.
To provide security for the aforementioned Pioneer Citizens Bank loan,
concurrent with the closing of the Business Loan Agreement, the Company repaid a
note payable in the amount of $281,000 plus accrued interest representing unpaid
purchase consideration for the January 1997 purchase of a portion of the
aforementioned Nevada land.
-12-
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations.
-------------
GENERAL
The Company operates in one industry segment, the domestic home video
market. The Company has distributed a broad range of programming on laserdisc
("LD") since 1983. In addition to the distribution of LD product, the Company
began distributing programming on the recently introduced digital video disc
("DVD") format. The Company generally enters into license agreements whereby it
acquires the exclusive right to manufacture and distribute LD and DVD
programming. In addition, the Company acts as an exclusive and nonexclusive
wholesale distributor of LD and DVD programming.
RESULTS OF OPERATIONS
The Company recorded operating losses of $68,000 and $102,000 for the three
and six months ended September 30, 1997, respectively, versus operating income
of $583,000 and $1,433,000 for the three and six months ended September 30,
1996, respectively. The Company recorded net losses of $184,000, or $.01 per
share, and $375,000, or $.03 per share, for the three and six months ended
September 30, 1997, respectively, versus net income of $496,000, or $.04 per
share, and $1,102,000, or $.08 per share, for the three and six months ended
September 30, 1996, respectively.
THE THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1996
Net sales for the September 1997 quarter decreased 7.6% to $16,412,000 from
$17,762,000 for the September 1996 quarter. During the September 1997 quarter,
the Company, in addition to its nonexclusive DVD distribution activities,
released 18 exclusive DVD titles, a significant increase over the two exclusive
titles released during the Company's first quarter ended June 30, 1997.
Exclusive and nonexclusive DVD sales accounted for approximately 18% of the
Company's net sales during the September 1997 quarter. The Electronics
Industries Association ("EIA") reported approximately 245,000 DVD players have
been sold to electronic hardware dealers from DVD's March 1997 introduction
through October 24, 1997 (the unit sales figure includes DVD/LD combination
players). The Company expects DVD sales to grow, as a percentage of net sales,
in the future.
LD sales for the September 1997 quarter were down approximately 25%
compared to the September 1996 quarter. Management believes that competition
from the DVD format, introduced in March 1997, will continue to adversely impact
the LD marketplace. The EIA reported calendar 1997 LD hardware sales through
October 24, 1997 at approximately 41,000 units, down 67.6% from calendar 1996, a
trend which management believes adversely impacts sales of the Company's
catalogue LD programming. Management believes that the introduction of DVD has
caused certain of the larger retailers to become more cautious in their LD
purchasing. Additionally, the financial difficulties experienced by certain of
the Company's largest customers have impacted the volume and breadth of their LD
purchasing and, accordingly, has had a negative impact on the Company's
-13-
<PAGE>
overall quarterly sales. See "Summary and Outlook -- Distressed Condition of the
Retail Entertainment Software Market" and "-- DVD and LD Outlook."
In the future, the Company expects that net sales will continue to be
affected by the popularity of new LD and DVD releases, the level of LD and DVD
hardware sales, the extent of the Company's distribution of the DVD format,
DVD's market penetration, the financial condition of the retail entertainment
software market and the prevailing economic environment.
Cost of optical disc sales (LDs and DVDs collectively) for the September
1997 quarter decreased to $13,283,000 from $13,851,000 for the September 1996
quarter. As a percentage of net sales, cost of optical disc sales for the
September 1997 quarter increased to 80.9% from 78.0% for the September 1996
quarter. The margin deterioration primarily reflects an increased provision for
slow-moving LD inventory for the September 1997 quarter over that for the
September 1996 quarter.
The sales mix of higher-margin exclusive product and lower-margin
nonexclusive product and the margins within each category vary with the
availability and popularity of titles and the Company's marketing emphasis.
Nonexclusive product sales (including nonexclusive DVD sales) in the September
1997 quarter accounted for 21.1% of net sales compared to 29.6% in the September
1996 quarter.
Selling expenses decreased 4.0% to $1,185,000 for September 1997 quarter
from $1,234,000 for the September 1996 quarter. As a percentage of net sales,
selling expenses for the September 1997 quarter increased to 7.2% from 6.9% for
the September 1996 quarter. During the September 1997 quarter, the Company
incurred higher freight costs, as a percentage of net sales, resulting from an
increase in freight rates, as compared to the September 1996 quarter.
General and administrative expenses decreased 16.9% to $1,124,000 for the
September 1997 quarter from $1,353,000 for the September 1996 quarter. As a
percentage of net sales, general and administrative expenses for the September
1997 quarter decreased to 6.8% from 7.6% for the September 1996 quarter. The
decrease is principally attributable to recoveries of previously reserved
accounts receivable from certain customers, offset in part, by higher legal and
depreciation expenses for the September 1997 quarter versus the September 1996
quarter.
Amortization of production costs for the September 1997 quarter increased
19.8% to $888,000 from $741,000 for the September 1996 quarter. As a percentage
of net sales, amortization of production costs for the September 1997 quarter
increased to 5.4% from 4.2% for the September 1996 quarter. The increase is
primarily attributable to more exclusive titles (both LD and DVD) placed into
production and higher overhead in the Company's creative services and production
departments necessary to produce the higher volume of titles. The Company
expects amortization of production costs to continue to be a function of the
timing and number of exclusive titles placed into production.
-14-
<PAGE>
Interest expense for the September 1997 quarter increased 57.3% to $129,000
from $82,000 for the September 1996 quarter. Interest income for the September
1997 quarter decreased 85.7% to $7,000 from $49,000 for the September 1996
quarter. The Company had higher borrowings outstanding and less cash invested
during the September 1997 quarter versus the September 1996 quarter.
THE SIX MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE SIX MONTHS ENDED
SEPTEMBER 30, 1996
Net sales for the six months ended September 30, 1997 decreased 12.1% to
$33,314,000 from $37,908,000 for the six months ended September 30, 1996. During
the six months ended September 1997, the Company has released 20 exclusive DVD
titles. Exclusive and nonexclusive DVD sales accounted for approximately 13% of
the Company's net sales during the six months ended September 30, 1997. The
Company expects DVD sales to grow, as a percentage of net sales, in the future.
LD sales for the 1997 period were down approximately 24% compared to the
1996 period. Management believes that competition from the DVD format,
introduced in March 1997, will continue to adversely impact the LD marketplace.
Calendar 1997 LD hardware sales are sharply down compared to calendar 1996, a
trend which management believes adversely impacts sales of the Company's
catalogue LD programming. Management believes that the introduction of DVD has
caused certain of the larger retailers to become more cautious in their LD
purchasing. Additionally, the financial difficulties experienced by certain of
the Company's largest customers have impacted the volume and breadth of their LD
purchasing and, accordingly, has had a negative impact on the Company's overall
fiscal 1998 sales to date. See "Summary and Outlook -- Distressed Condition of
---
the Retail Entertainment Software Market" and "-- DVD and LD Outlook."
In the future, the Company expects that net sales will continue to be
affected by the popularity of new LD and DVD releases, the level of LD and DVD
hardware sales, the extent of the Company's distribution of the DVD format,
DVD's market penetration, the financial condition of the retail entertainment
software market and the prevailing economic environment.
Cost of optical disc sales (LDs and DVDs collectively) for the six months
ended September 30, 1997 decreased to $27,332,000 from $29,832,000 for the six
months ended September 30, 1997. As a percentage of net sales, cost of optical
disc sales for the six months ended September 30, 1997 increased to 82.0% from
78.7% for the six months ended September 30, 1997. The margin deterioration
primarily reflects an increased provision for slow-moving LD inventory for the
six months ended September 30, 1997 over that for the six months ended September
30, 1996.
The sales mix of higher-margin exclusive product and lower-margin
nonexclusive product and the margins within each category vary with the
availability and popularity of titles and the Company's marketing emphasis.
Nonexclusive product sales (including nonexclusive DVD sales) in the six months
ended September 30, 1997 accounted for 22.9% of net sales compared to 27.6% in
the six months ended September 30, 1996.
-15-
<PAGE>
Selling expenses decreased 3.6% to $2,232,000 for six months ended
September 30, 1997 from $2,315,000 for the six months ended September 30, 1996.
As a percentage of net sales, selling expenses for the six months ended
September 30, 1997 increased to 6.7% from 6.1% for the six months ended
September 30, 1996. During the 1997 period, the Company incurred higher freight
costs, as a percentage of net sales, resulting from an increase in freight rates
and higher rent associated with U.S. Laser's retail space, offset, in part, by
reduced trade advertising of exclusive titles and reduced costs for market
development funds offered to customers, versus the September 1996 period.
General and administrative expenses decreased 24.2% to $2,133,000 for the
six months ended September 30, 1997 from $2,815,000 for the six months ended
September 30, 1996. As a percentage of net sales, general and administrative
expenses for the six months ended September 30, 1997 decreased to 6.4% from 7.4%
for the six months ended September 30, 1996. The decrease is principally
attributable to recoveries of previously reserved accounts receivable from
certain customers and lower overhead resulting from continued consolidation of
administrative support at U.S. Laser, offset, in part, by higher legal,
accounting and depreciation expenses for the six months ended September 30, 1997
versus the six months ended September 30, 1996.
Amortization of production costs for the six months ended September 30,
1997 increased 13.6% to $1,719,000 from $1,513,000 for the six months ended
September 30, 1996. As a percentage of net sales, amortization of production
costs for the six months ended September 30, 1997 increased to 5.2% from 4.0%
for the six months ended September 30, 1996. The increase is primarily
attributable to more exclusive titles (both LD and DVD) placed into production
and higher overhead in the Company's creative services and production
departments necessary to produce the higher volume of titles. The Company
expects amortization of production costs to continue to be a function of the
timing and number of exclusive titles placed into production.
Interest expense for the six months ended September 30, 1997 increased
207.4% to $332,000 from $108,000 for the six months ended September 30, 1996.
Interest income for the six months ended September 30, 1997 decreased 63.2% to
$53,000 from $144,000 for the six months ended September 30, 1996. The Company
had higher borrowings outstanding and less cash invested during the six months
ended September 30, 1997 versus the six months ended September 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital requirements vary primarily with the level of
its licensing, production and distribution activities. The principal recurring
uses of working capital in operations are for program licensing costs (i.e.,
royalty payments, including advances, to program suppliers), distribution fee
advances, manufacturing and production costs, costs of acquiring finished
product for wholesale distribution and selling, general and administrative
expenses. Working capital has historically been provided by cash flows from
operations, private sales of common stock, notes payable to private and
institutional investors and bank borrowings. For the six months ended September
30, 1997, operating activities provided cash and cash
-16-
<PAGE>
equivalents of $1,635,000, investing activities, consisting of capital
expenditures, used cash and cash equivalents of $360,000 and financing
activities, consisting primarily of repayments of bank borrowings, used cash and
cash equivalents of $1,304,000, resulting in a net decrease in cash and cash
equivalents of $29,000.
The Company's Liquidity Position at September 30, 1997 and Management's
-----------------------------------------------------------------------
Assessment of the Company's Liquidity Position in Fiscal 1998.
- -------------------------------------------------------------
At March 31, 1997, the Company had cash and cash equivalents of $1,090,000,
outstanding borrowings of $8,994,000 and available borrowings of $1,300,000, net
of amounts utilized for outstanding letters of credit (under its revolving
credit facility and note payable). At June 30, 1997, the Company had cash and
cash equivalents of $299,000, outstanding borrowings of $5,825,000 and available
borrowings of $1,497,000, net of amounts utilized for outstanding letters of
credit (under its revolving credit facility and note payable and excluding
construction and equipment lending facilities).
At September 30, 1997, the Company had cash and cash equivalents of
$1,061,000, outstanding borrowings of $6,980,000 and available borrowings of
$2,122,000, net of amounts utilized for outstanding letters of credit (under its
revolving credit facility and note payable and excluding construction and
equipment lending facilities).
Certain significant developments during the second half of fiscal 1997 and
the first quarter of fiscal 1998 caused management to grow concerned that the
Company's current sources of working capital may have been insufficient to fund
working capital requirements in fiscal 1998 unless certain discretionary
licensing and capital investment programs were curtailed and additional sources
of working capital were secured. The developments included: (i) the February
1997 suspension of $2,700,000 in accounts receivable due from Musicland (the
Company's largest customer); (ii) the July 1997 Chapter 11 Bankruptcy filing by
Alliance Entertainment Corp. (the Company's second largest customer); (iii) the
unsuccessful efforts to sell the front 8.8 acres of its Nevada land; (iv) the
ongoing adverse impact of DVD on LD sales; and, (v) the increased cash
requirements to exclusively license DVD programming.
In response to the aforementioned significant developments and the related
concerns these events raise regarding the Company's liquidity during fiscal
1998, management developed a fiscal 1998 action plan ("Action Plan"). The Action
Plan principally involved: (i) reducing or suspending certain discretionary
expenditures such as suspending the Company's stock buy-back program, reducing
or eliminating, when possible, up-front payments for advance royalties,
distribution fees and contractual inventory purchases on new exclusive license
and distribution agreements, increasing levels of trade vendor support and
deferring construction of a proposed warehouse and distribution facility in Las
Vegas, Nevada; and (ii) seeking additional working capital through such sources
as debt and/or equity financing, monetizing a portion of the delinquent
Musicland and Camelot Music receivables, selling the front 8.8 acres of its
Nevada land and generating revenues from exclusive DVD distribution.
To date, the Company has implemented certain elements of its Action Plan.
In July 1997, the Company entered into assignment agreements with third-party
investors whereby the Company assigned its right, title and interest in and to
approximately $3,000,000 in accounts receivable due from Musicland and Camelot
Music. The
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<PAGE>
receivables were irrevocably assigned without recourse as to the economic risk
of Musicland's or Camelot Music's ultimate inability to pay. The third-party
investors purchased the receivables for cash at certain discounts.
In September 1997, the Company entered into a convertible debt agreement to
borrow $5,000,000 from a principal stockholder of the Company. See "Liquidity
---
and Capital Resources -- Convertible Subordinated Debt Financing."
In July 1997, the Company borrowed $1,350,000 from Pioneer Citizens Bank in
Nevada. See "Liquidity and Capital Resources -- Banking Activities."
---
At October 31, 1997, the Company had cash and cash equivalents of $632,000,
outstanding borrowings of $1,749,000 and available borrowings of $7,044,000, net
of amounts utilized for outstanding letters of credit (under its credit
facilities and notes payable and excluding its construction and equipment
lending facilities).
Management believes that the Company, has implemented sufficient elements
of its Action Plan and its internal and external sources of funding are adequate
to meet anticipated needs within the next 12 months. See "Summary and Outlook --
---
Las Vegas Warehouse and Distribution Facility and Adjacent Land."
Banking Activities.
------------------
Revolving Credit Facility. In December 1996, the Company entered into a
Loan Agreement (the "Agreement") with Union Bank. The Agreement, as amended in
October 1997, provides for revolving advances and the issuance of standby
letters of credit under a two-year, $15,000,000 revolving credit facility.
Borrowings under the Agreement are at Union Bank's prime rate plus .25% (8.75%
at September 30, 1997). The Agreement provides the Company the option of
borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus
2.5% (8.28% at September 30, 1997).
Borrowings under the Agreement are secured by substantially all of the Company's
assets located in California and New Jersey. Funds available for borrowing may
not exceed the borrowing base specified in the Agreement. At September 30, 1997,
$5,630,000 was outstanding under the Agreement, all of which was borrowed under
the prime rate plus .25% option, and $2,122,000, net of amounts utilized for
outstanding letters of credit, was available for borrowing. The Agreement
requires the Company to comply with certain quarterly financial and operating
covenants. At September 30, 1997, the Company was in compliance with financial
and operating covenants or had received waivers of noncompliance from Union
Bank.
At September 30, 1997, the Company had $2,500,000 of outstanding letters of
credit issued by Union Bank of which $200,000 will expire on November 15, 1997
and the remainder on November 15, 1998. These letters of credit secure balances
due to program suppliers.
Construction Credit Facility. In March 1997, the Company entered into
a Business Loan Agreement (the "Loan Agreement") with Bank of America National
Trust and Savings Association in Nevada. The Loan
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<PAGE>
Agreement provides for a construction line of credit (the "Construction Line")
through January 31, 1998. The maximum available under the line ( the "Maximum
Commitment") is $3,434,000 which shall be reduced quarterly beginning December
31, 1997 by $43,000. The Construction Line converts to a revolving line of
credit (the "Revolving Line") on January 31, 1998. Under the Revolving Line, the
Company may repay and reborrow principal amounts provided the Revolving Line
does not exceed the Maximum Commitment. The Revolving Line is available from
February 1, 1998 through its maturity date of January 31, 2008.
Borrowings under the Loan Agreement are secured by a deed of trust on the
approximate 8.4 acres of land in Las Vegas, Nevada on which the Company intends
to construct a new warehouse and distribution facility as well as any of the
Company's personal property located in Nevada, excluding inventory held for
sale. Interest under the Construction Line and the Revolving Line is at the
bank's prime rate plus 1.25% (9.75% at September 30, 1997). The Loan Agreement
provides the Company the option, under the Revolving Line, of borrowing for
fixed periods of time at LIBOR plus either 2.25% or 2.65% depending on level of
the Company's debt service coverage ratio, as defined in the Loan Agreement. At
September 30, 1997, $400,000 in borrowings were outstanding under the
Construction Line. The Loan Agreement requires the Company to comply with
certain quarterly financial and operational covenants. At September 30, 1997,
the Company was not in compliance with a certain financial covenant. Based upon
discussions with the bank, the Company anticipates receiving a waiver of
noncompliance. Should the Company not receive the waiver, the Company believes
it has adequate resources the repay the $400,000 in outstanding borrowings. See
---
"Summary and Outlook -- Las Vegas Warehouse and Distribution Facility and
Adjacent Land."
Warehouse and Distribution Equipment Lease Facility. At September 30,
1997, there were no borrowings outstanding under the Company's March 1997
$2,500,000 warehouse and distribution equipment lease facility with BankAmerica
Leasing and Capital Corporation. The lease contains certain quarterly financial
and operating covenants. At September 30, 1997, the Company was in not
compliance with a certain financial covenant. Based upon discussions with the
bank, the Company anticipates receiving a waiver of noncompliance. See "Summary
---
and Outlook -- Las Vegas Warehouse and Distribution Facility and Adjacent Land."
Other Debt. In July 1997, the Company borrowed $1,350,000 under a
Business Loan Agreement (the "Business Loan Agreement") with Pioneer Citizens
Bank in Nevada. The Business Loan Agreement bears interest at prime plus 1.75%
(10.25% at June 30, 1997), matures February 1, 1998 and is secured by a deed of
trust on the approximately 8.8 acres of land adjacent to the Company's proposed
warehouse and distribution facility construction site in Las Vegas, Nevada.
To provide security for the aforementioned Pioneer Citizens Bank loan,
concurrent with the closing of the Business Loan Agreement, the Company repaid a
note payable in the amount of $281,000 plus accrued interest representing unpaid
purchase consideration for the January 1997 purchase of a portion of the
aforementioned Nevada land.
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<PAGE>
Convertible Subordinated Debt Financing.
---------------------------------------
In September 1997, the Company entered into a credit agreement (the "Credit
Agreement") with Image Investors Co. ("IIC"), a principal stockholder of the
Company owned and controlled by John W. Kluge and Stuart Subotnick, pursuant to
which the Company borrowed $5,000,000 from IIC, with interest payable quarterly
at 8% per annum and principal due in five years. The loan is unsecured and
subordinate to any obligations to Union Bank and is convertible into the
Company's common stock at any time during the term at a conversion price of
$3.625 per share, the closing price of the Company's common stock on September
29, 1997. The loan was funded on October 29, 1997 and proceeds were used to pay
down the Company's outstanding balance under its revolving credit facility with
Union Bank.
Other Obligations.
-----------------
At September 30, 1997, the Company had future license obligations for
royalty advances, minimum guarantees and other fees of $5,051,000 due during
fiscal 1998, $11,515,000 due during fiscal 1999 and $6,573,000 due during fiscal
2000. These advances and guarantees are recoupable against royalties earned by
the licensors and program suppliers, respectively. Depending upon competition
for license and exclusive distribution rights, the Company may have to pay
increased advances, guarantees and/or royalty rates in order to acquire or
retain such rights in the future.
SUMMARY AND OUTLOOK
As discussed in "Liquidity and Capital Resources -- The Company's Liquidity
Position at September 30, 1997 and Management's Assessment of the Company's
Liquidity Position in Fiscal 1998," the Company believes it has resolved
short-term liquidity constraints experienced during the first six months of
fiscal 1998. The Company's longer-term operating cash flow and liquidity will
depend upon the viability of the LD marketplace, the ultimate success of DVD,
the Company's role in the distribution of DVD, the success of the LD/DVD/Compact
Disc ("LD/DVD/CD") combination player and management's belief of the player's
positive affect on catalogue LD sales and the overall strengthening of the
retail entertainment software market.
Distressed Condition of the Retail Entertainment Software Market.
----------------------------------------------------------------
The overall economic slump in the dedicated entertainment software market
appears to be continuing although certain major entertainment software retailers
have recently reported improved results versus those of their comparative
prior-year periods. While the 1997 holiday season will be a critical factor in
assessing whether a positive overall continuing trend has developed, management
is guardedly optimistic that such a positive trend is developing.
Management believes that many of the negative factors contributing to the
prevailing economic environment in the retail entertainment software market will
be mitigated in the long-term. Specifically, recent contraction in excess
numbers of retail stores, cyclical improvement in the music industry,
anticipated
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<PAGE>
improvements in target demographics for entertainment software and development
of more effective retailing strategies should have a positive effect on the
entertainment software retailing sector in the long-term.
DVD and LD Outlook.
------------------
DVD's ultimate success will depend upon consumer acceptance, the
participation and extent of participation by the major studios, market
penetration, the number and breadth of titles that are available in the future,
the level of DVD hardware sales and the commitment by DVD program suppliers to
at least sustain, on future DVD releases, the same level of video and audio
quality and variety of software features as are available on current DVD
releases, while maintaining or lowering prices. Although there can be no
assurance, management believes that the LD and DVD formats can co-exist for
several years because, initially, participating program suppliers are expected
to only release new and certain of the more popular catalogue titles on DVD and
it will require participation by all studios and program suppliers and active
and aggressive releasing efforts for DVD's library of available titles to rival
the number of LDs currently available.
The Company believes that the LD format, with over 10,000 titles currently
available and a current average of over 70 new releases each month, will remain
a viable format for several years even assuming all the major studios
participate in DVD, and perhaps longer if they do not. LD enjoys an established
domestic consumer base of approximately 2 million households. The LD consumer
typically owns a large collection of LD titles and purchases not only popular
new release titles but esoteric, special interest and catalogue titles. The DVD
format is in its infancy and is subject to numerous market forces, not the least
of which is consumer acceptance of DVD as another home video delivery medium.
Management believes the LD/DVD/CD combination player can grow both the LD and
DVD formats and attract new consumers to LD while they wait for the number of
titles available on DVD to grow. Notwithstanding the introduction and
uncertainty surrounding DVD, the DVD format has potential in the market place
and the Company is continuing its efforts to secure additional DVD license and
exclusive distribution opportunities to remain competitive and diversify its
core business.
DVD Activities.
--------------
The Company continues to secure exclusive distribution rights for DVD
programming. Under its September 1997 exclusive distribution agreement with
Universal Studios Home Video covering 50 catalogue titles, the Company plans to
release titles including THE ANDROMEDA STRAIN, MAD DOG AND GLORY, MONTY PYTHON:
THE MEANING OF LIFE, SIXTEEN CANDLES and WEIRD SCIENCE, as well as classic and
collectible titles such as the Abbott and Costello comedies IN THE FOREIGN
LEGION and IN THE NAVY, the Mae West comedies BELLE OF THE NINETIES and I'M NO
ANGEL, and the classic Marx Brothers comedies ANIMAL CRACKERS, DUCK SOUP and
HORSE FEATHERS. Under its April 1997 exclusive distribution agreement with Orion
Home Video, the Company's recent and upcoming releases include DANCES WITH
WOLVES, SILENCE OF THE LAMBS and ROBOCOP. Under its May 1997 exclusive
distribution agreement with Central Park Media, the Company plans to release
Japanese animation titles, known as "anime," which have a devoted following of
avid fans and collectors. Under its February 1997 exclusive distribution
agreement with Playboy Home Video, the Company
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<PAGE>
plans to release a total of 20 Playboy DVD titles during fiscal 1998. Under
individual exclusive distribution agreements, the Company's recent and upcoming
releases include such diverse programming as the original THE TERMINATOR, TINA
TURNER'S WILDEST DREAMS CONCERT and Stephen Sondheim's award-winning musical
INTO THE WOODS. Lastly, certain of the Company's LD license agreements with
independent program suppliers also provided for DVD rights which the Company
intends to exploit. Some of the DVD titles the Company plans to release under
these agreements include PHANTOM OF THE OPERA, the Lon Chaney, Sr. version, THE
CABINET OF DR. CALIGARI, NOSFERATU and WEIRD AL YANKOVIC: THE VIDEOS.
Assuming that the DVD format continues to grow, and assuming further that
the Company can continue to successfully secure and distribute additional DVD
programming, the Company believes it is well-positioned to enhance its
reputation and presence in the DVD market. The Company believes its licensing,
sales, production, creative services, marketing and distribution expertise it
has developed as the largest LD licensee and distributor in North America should
translate to the DVD format, thereby enhancing the Company's DVD efforts.
Exclusive Distribution of DTS Encoded Software.
----------------------------------------------
In September 1997, the Company reached an agreement in principle with
Digital Theatre Systems (DTS) to distribute DTS's music programming on CD and
continue to encode DTS multi-channel sound on LD and DVD programming. The
Company's three-year agreement with DTS affords the Company an opportunity to
diversify its core exclusive distribution business into exclusive distribution
of music programming (e.g., music CDs). In the beginning of calendar 1997, the
Company began releasing a series of major motion pictures on LD featuring DTS
multi-channel audio.
Software encoded with DTS multi-channel audio can only be played when
processed through a DTS decoder. To date, several high-end audio component
producers have brought decoders to the market. As a relatively new technology,
the DTS system has been out of the price range of most collectors. The Company
believes the market is beginning to change and several mainstream audio hardware
manufacturers are expected to introduce DTS component technology. This
equipment will decode DTS multi-channel audio from all types of DTS encoded
software (LD, CD and DVD). As a result, the Company believes that prices for
surround processors with the ability to play all DTS multi-channel audio
platforms will soon drop below $1,000. The Company believes that the largest
potential for DTS software growth is in DTS audio software. In the past year,
DTS has released a wide spectrum of DTS/CD software, including high-profile
titles. Under the agreement, Image will be responsible for all marketing,
sales, inventory management and distribution of DTS/CD software.
Las Vegas Warehouse and Distribution Facility and Adjacent Land.
---------------------------------------------------------------
Construction of a 76,000 square foot automated warehouse and distribution
facility on 8.4 acres of the Company's unimproved real property adjacent to
McCarran International Airport in Las Vegas, Nevada had been deferred for
approximately six months as part of the Company's Action Plan. See "The
---
Company's Liquidity Position at September 30, 1997 and Management's Assessment
of the Company's Liquidity Position in
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<PAGE>
Fiscal 1998." With sufficient elements of its Action Plan implemented, the
Company plans to commence construction during its third quarter ending December
31, 1997. At September 30, 1997, the Company was not in compliance with a
certain quarterly financial covenant under the Company's construction and
equipment lease financing facilities. Based upon discussions with the bank, the
Company anticipates receiving a waiver of noncompliance. Should the Company not
receive the waiver, the Company believes it will be able to secure alternative
construction and equipment lease financing through other sources; however,
commencement of construction could be delayed.
The Company has taken the remaining 8.8 acres of its adjacent street
frontage property, previously held for sale, off the market. In an effort to
attract potential buyers and increase the market value of the parcel, the
Company's plans to subdivide the parcel and remarket it after construction of
the warehouse and distribution facility is underway.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, are
contained throughout this Form 10-Q. Such statements are based on the beliefs
of the Company's management as well as assumptions made by and information
currently available to the Company's management. When used in this report, the
words "anticipate," "believe," "estimate," "may," "plan," "expect" and similar
expressions, variations of such terms or the negative of such terms as they
relate to the Company or its management are intended to identify such forward-
looking statements and should not be regarded as a representation by the
Company, its management or any other person that the future events, plans or
expectations contemplated by the Company will be achieved. Such statements are
based on management's current expectations and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should the underlying assumptions prove incorrect,
the Company's actual results, performance or achievements could differ
materially from those expressed in, or implied by, any such forward-looking
statements. The Company has made forward-looking statements in this Form 10-Q
concerning, among other things, (i) the viability of the LD format for several
years despite the introduction of the DVD format; (ii) the success of the
LD/DVD/CD combination player in growing the LD and DVD formats and attracting
new customers to LD; (iii) the strengthening of the retail entertainment
software market over the long term; (iv) commencement of construction of the Las
Vegas, Nevada warehouse and distribution facility during the December 1997
quarter; (v) seeking investment opportunities in growth-oriented companies and
securing necessary acquisition financing; (vi) the Company's ability to enhance
its reputation and presence in the DVD market, experience continued sales of its
licensed DVD programing and secure additional LD and DVD rights; (vii) the
estimated number of exclusive DVD releases for the fiscal year; (viii) the
market for the DTS system is changing and that several mainstream audio hardware
manufacturers will ultimately enter the market; (ix) prices for complete
surround processors with the ability to decode DTS encoded software will soon
drop below $1,000; (x) DTS/DVD programming will become a reality; and (xi)
projected growth in DTS audio software. These statements are only predictions.
Actual events or results may differ materially as a result of risks facing the
Company. These risks include, but are not limited to: (i) the number of and
breadth of titles that will ultimately be available on DVD; (ii) the financial
condition of key customers; (iii) competition from other
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<PAGE>
distributors of the DVD format; (iv) ability to sustain its core LD business
until a transition can be made into DVD, if ever; or whether current LD program
suppliers, LD retailers and LD hardware manufacturers will continue to support
the LD format during the transition period; (v) shifts in industry distribution
channels; (vi) shifts in retail consumer and wholesale customer buying habits;
(vii) difficulties and delays which may be encountered in the compression and
authoring production process required to produce DVD programming; and (viii)
other factors referenced in this Form 10-Q. Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such forward-
looking statements. The Company disclaims any obligation to update any such
factors or to announce publicly the result of any revisions to any of the
forward-looking statements contained in this and other Securities and Exchange
Commission filings of the Company to reflect future events or developments.
-24-
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The consolidated financial statements as of September 30, 1997 and for the
periods ended September 30, 1997 and 1996 in this Form 10-Q have been reviewed
by KPMG Peat Marwick LLP, independent certified public accountants, in
accordance with established professional standards and procedures for such a
review.
The report of KPMG Peat Marwick LLP commenting upon their review follows.
-25-
<PAGE>
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
--------------------------------------
The Board of Directors
Image Entertainment, Inc.
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. as of September 30, 1997, and the related condensed
consolidated statements of operations and cash flows for the three- and six-
month periods ended September 30, 1997 and 1996 in accordance with Statements on
Standards for Accounting and Review Services issued by the American Institute of
Certified Public Accountants. All information included in these financial
statements is the representation of the management of Image Entertainment, Inc.
A review of interim financial information consists principally of obtaining an
understanding of the system for the preparation of interim financial
information, applying analytical review procedures to financial data, and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit in accordance with general accepted
auditing standards, the objective of which is the expression of an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Image Entertainment, Inc. as of
March 31, 1997, and the related consolidated statements of operations and cash
flows for the year then ended (not presented herein); and in our report dated
June 6, 1997, we expressed an unqualified opinion on those financial statements.
In our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of March 31, 1997, is fairly presented, in all
material respects, in relation to the balance sheet from which it has been
derived.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
November 4, 1997
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<PAGE>
================================================================================
PART II - OTHER INFORMATION
================================================================================
ITEM 1. Legal Proceedings.
-----------------
Not Applicable
ITEM 2. Changes in Securities.
---------------------
Not Applicable
ITEM 3. Defaults upon Senior Securities.
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------
On September 5, 1997, the Company held its annual meeting of
shareholders. Represented at the meeting in person or by proxy were
12,130,395 shares of common stock (approximately 90.02% of the shares
entitled to vote), constituting a quorum.
At the meeting, Martin W. Greenwald, Stuart Segall, Ira S. Epstein and
Russell Harris were elected as directors of the Company to serve until
their respective successors have been elected and qualified. With
respect to Mr. Greenwald's election, there were 11,977,150 votes for
and 153,245 votes withheld. With respect to Mr. Segall's election there
were 12,011,250 votes for and 119,145 votes withheld. With respect to
Mr. Epstein's election, there were 12,010,454 votes for and 119,941
votes withheld. With respect to Mr. Harris's election, there were
12,011,642 votes for and 118,753 votes withheld.
At the meeting, the Company's shareholders voted upon and ratified the
appointment of KPMG Peat Marwick LLP as the Company's independent
auditors for the fiscal year ending March 31, 1998. With respect to
this matter, there were 12,071,425 votes for, 34,584 votes against and
24,386 abstentions.
ITEM 5. Other Information.
-----------------
Not Applicable
ITEM 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits
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<PAGE>
See Exhibit Index on page i
(b) Reports on Form 8-K
None
-28-
<PAGE>
- --------------------------------------------------------------------------------
SIGNATURES
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMAGE ENTERTAINMENT, INC.
Date: November 12, 1997 By: /S/ MARTIN W. GREENWALD
----------------------------------------------
Martin W. Greenwald
Chairman of the Board, Chief Executive Officer,
President and Treasurer
Date: November 12, 1997 By: /S/ JEFF M. FRAMER
----------------------------------------------
Jeff M. Framer
Chief Financial Officer
-29-
<PAGE>
================================================================================
EXHIBIT INDEX
================================================================================
<TABLE>
<CAPTION>
Exhibit No. Description
- --------------------------------------------------------------------------------
<S> <C>
10.1* Credit Agreement between the Company and Image
Investors Co. dated September 29, 1997, including
Convertible Subordinated Promissory Note dated
October 29, 1997.
15* Letter re unaudited interim financial information.
27* Financial Data Schedule.
</TABLE>
*Exhibit(s) not previously filed with the Securities
and Exchange Commission.
-1-
<PAGE>
EXHIBIT 10.1
CREDIT AGREEMENT, dated as of September 29, 1997, between Image
Investors Co., a Delaware corporation (the "Lender"), and Image Entertainment,
Inc., a California corporation and its subsidiary ("Borrower").
The parties hereto hereby agree as follows:
SECTION A DEFINITIONS
---------------------
Defined Terms. As used in this Agreement, the following terms shall have
-------------
the following meanings:
"Agreement": this Credit Agreement, as amended, supplemented or
---------
otherwise modified from time to time.
"Business Day": a day other than a Saturday, Sunday or other day on
------------
which commercial banks in New York City are authorized or required by law to
close.
"Closing Date": the date on which the conditions precedent set forth in
------------
Section 3 shall be satisfied or waived by Lender.
"Code": the Internal Revenue Code of 1986, as amended from time to time.
"Commitment": the obligation of the Lender to loan to the Borrower
----------
hereunder the principal amount of Five Million Dollars ($5,000,000).
"Commitment Period": the period from and including the Closing Date to
-----------------
but not including the Termination Date or such earlier date on which the
Commitment shall terminate as provided herein.
"Contractual Obligation": as to any Person, any provision of any
----------------------
security issued by such Person or of any material agreement, instrument or other
undertaking to which such Person is a party or by which it or any of its
property is bound.
"Default": any of the events specified in Section 5, whether or not any
-------
requirement for the giving of notice, the lapse of time, or both, or any other
condition, has been satisfied.
"Dollars" and "$": dollars in lawful currency of the United States of
------- -
America.
"Equity Interest": any and all shares, interests, participations or
---------------
other equivalents (however designated) of capital stock of a corporation, any
and all equivalent ownership interests in a Person (other than a corporation),
including, without limitation, all partnership interests in any Person, and any
and all warrants or options to purchase any of the foregoing.
<PAGE>
"Event of Default": any of the events specified in Section 5, provided
---------------- --------
that any requirement for the giving of notice, the lapse of time, or both, or
any other condition, has been satisfied.
"GAAP": generally accepted accounting principles in the United States of
----
America in effect from time to time.
"Governmental Authority": any nation or government, any state or other
----------------------
political subdivision thereof and any entity exercising executive, legislative,
judicial, regulatory or administrative functions of or pertaining to government.
"Interest Payment Date": the first day of each December, March, June,
---------------------
September during the Commitment Period, beginning December 1, 1997.
"Loan": as defined in subsection 1.1.
----
"Loan Documents": this Agreement, the Note and the acknowledgment by
--------------
Borrower concerning the Registration Statement.
"Material Adverse Effect": a material adverse effect on (a) the
-----------------------
business, operations, property, financial condition of the Borrower or (b) the
validity or enforceability of this Agreement, the Note or any of the other Loan
Documents or the rights or remedies of the Lender hereunder or thereunder.
"Note": as defined in subsection 1.2.
----
"Person": an individual, partnership, corporation, business trust, joint
------
stock company, trust, unincorporated association, joint venture, Governmental
Authority or other entity of whatever nature.
"Registration Statement": as defined in Subsection 1.10.
----------------------
"Regulation U": Regulation U of the Board of Governors of the Federal
------------
Reserve System as in effect from time to time.
"Requirement of Law": as to any Person, the Certificate of Incorporation
------------------
and By-Laws or other organizational or governing documents of such Person, and
any law, treaty, rule or regulation or determination of an arbitrator or a court
or other Governmental Authority, in each case applicable to or binding upon such
Person or any of its property or to which such Person or any of its property is
subject.
<PAGE>
"Responsible Officer": the President and Chief Executive Officer of the
-------------------
Borrower.
"Termination Date": October 1, 2002.
----------------
Other Definitional Provisions. The words "hereof," "herein" and
-----------------------------
"hereunder" and words of similar import when used in this Agreement shall refer
to this Agreement as a whole and not to any particular provision of this
Agreement, and Section, subsection, Exhibit references are to this Agreement
unless otherwise specified.
The meanings given to terms defined herein shall be equally applicable to
both the singular and plural forms of such terms.
SECTION 1 AMOUNT AND TERMS OF COMMITMENT
----------------------------------------
1.1 Commitment. Subject to the terms and conditions hereof, the Lender
----------
agrees to loan ("the Loan") to the Borrower on the Closing Date and for the
----
Commitment Period an aggregate principal amount of the Lender's Commitment.
Such commitment will be sent to Borrower by wire transfer on the Closing Date.
1.2 Note. The Loan made by the Lender shall be evidenced by a
----
convertible promissory note of the Borrower, substantially in the form of
Exhibit A (the "Note"), payable to the order of the Lender and in a principal
----
amount equal to $5,000,000.
1.3 Optional Prepayments. The Borrower may at any time and from time to
--------------------
time upon three (3) days advance notice to the Lender, prepay the Loan, in whole
or in part, without premium or penalty. Upon receipt of such notice, Lender may
no longer convert the principal amount of the Loan in accordance with Subsection
1.7. Such prepayment shall be applied first to interest and then to principal.
1.4 Interest Rates and Payment Dates.
--------------------------------
1.4.1 The Loan shall bear interest (the "Interest Rate") at a rate
equal to eight percent (8%) per annum.
1.4.2 If (i) the principal amount of the Loan, or (ii) any interest
payable thereon shall not be paid when due (whether at the stated maturity, by
acceleration or otherwise), such overdue amount shall bear interest at a rate
per annum which is 8% plus 2% in each case from the date of such non-payment
until such amount is paid in full.
1.4.3 Interest shall be payable in arrears on each Interest Payment
Date.
1.5 Computation of Interest. Interest shall be calculated on the basis
-----------------------
of a 365-day year for the actual days elapsed.
1.6 Payments. All payments (including prepayments) to be made by the
--------
<PAGE>
Borrower hereunder and under the Note, whether on account of principal,
interest, or otherwise, shall be made without set off or counterclaim and shall
be made prior to 12:00 Noon, New York City time, on the due date thereof to the
Lender by wire transfer in immediately available funds. If any payment
hereunder becomes due and payable on a day other than a Business Day, such
payment shall be extended to the next succeeding Business Day, and, with respect
to payments of principal, interest thereon shall be payable at the then
applicable rate during such extension.
1.7 Conversion.
----------
1.7.1 The Lender may, at its option, at any time and in accordance
with the terms and conditions of the Note, convert all or any portion of the
outstanding principal amount of such Note into the number of shares of common
stock of Borrower equal to the dollar amount converted divided by $3.625, the
closing price of the Borrower's stock on September 29, 1997.
1.7.2 In the event of any reorganization or recapitalization of
Borrower or in the event Borrower consolidates with or merges with or into
another corporation or transfers all or substantially all its assets to another
entity, then and in each such event, the Lender, upon conversion of the Note at
any time after the consummation of such reorganization, recapitalization,
consolidation, merger or transfer, shall be entitled to receive the stock or
other securities or property to which the Lender would have been entitled if the
Lender had converted the Note immediately prior thereto. In such case, the
terms of the Note shall survive the consummation of any such reorganization,
recapitalization, consolidation, merger or transfer and shall be applicable to
such shares of stock or other securities or property receivable on the
conversion of the Note after such consummation.
1.8 Payment Date. Unless otherwise prepaid in accordance with
------------
Subsection 1.3, the principal amount and any unpaid interest outstanding
hereunder shall be due and payable in full on the Termination Date.
1.9 North Option. At the Closing, the Borrower will execute the
------------
Assignment Agreement attached hereto as Exhibit B pursuant to which Borrower
will assign to Lender its option to purchase 2% of the stock of North
Communications, Inc. In consideration for such agreement, Lender will pay to
the Borrower $50,000 by wire transfer upon the execution of the Assignment
Agreement.
<PAGE>
1.10 Registration Rights.
-------------------
1.10.1 At any time after the execution of this Agreement, Lender
shall, subject to all of the provisions of this Section 1.10, if requested in
writing to do so by Borrower, file with the Securities and Exchange Commission
under the Securities and Exchange Act of 1933, as amended (the "Act"), a
registration statement on an appropriate form covering the 1,379,310 Shares (the
"Shares") of Common Stock issuable upon conversion of the Loan which Lender
requests to be registered. Borrower shall keep effective the registration
statement filed pursuant to this subsection 1.10.1 during the period commencing
on the initial effective date of such registration statement and ending on the
earlier of (i) eighteen (18) months thereafter or (ii) the completion of the
sale of the Shares owned by Lender which are covered thereby.
1.10.2 If at any time or times Borrower shall propose to file a
registration statement under the Act covering any of its Common Stock being sold
by any stockholder of Borrower, Borrower agrees that it shall, each such time,
give written notice to Lender of such proposal not later than twenty (20)
business days prior to the date such registration statement is proposed to be
filed and such notice shall offer Lender the opportunity to register its Shares
therein. Upon the written request of Lender, which request must be received by
Borrower no fewer than seven (7) business days prior to the date of such
proposed filing and must specify the number of Shares it is requesting to be
included in such registration statement, Borrower shall include therein, or
shall cause the managing underwriter or underwriters, if any, of a proposed
underwritten offering to include therein, the Shares on the same terms and
conditions as the other common stock included in such registration statement.
Borrower agrees that it shall keep effective any registration statement which
pursuant to this subsection 1.10.2 includes any of the Shares during the period
commencing on the initial effective date of such registration statement and
ending on the earlier of (i) eighteen (18) months thereafter and (ii) the
completion of the sale of the Shares which are covered thereby.
1.10.3 If the managing underwriter or underwriters of an
underwritten public offering made pursuant to any registration statement
pursuant to Section 1.10 above delivers a written opinion to Lender that the
total number or kind of securities which Lender and any other person or entities
intend to include in such offering would materially and adversely affect the
success of such offering (including, without limitation, the marketing of the
shares of Common Stock to be sold thereunder), then the number of Shares of
Lender and such other persons or entities to be included in such offering may be
reduced to the extent necessary to reduce the total number of shares of common
stock to be included in such offering to the number recommended by such managing
underwriter. Any such reduction shall be a proportionate reduction to all such
persons based upon the number of shares proposed to be registered by each such
person.
<PAGE>
1.10.4 Borrower's obligations under this Section 1.10 with
respect to Lender shall be conditioned upon such Lender's furnishing to Borrower
such information and material as may be reasonably requested by Borrower or its
counsel in connection with such registration statement and any public offering
thereunder, including information and material concerning Lender as may be
required to be included in such registration statement under the Act and the
applicable rules and regulations of the Securities and Exchange Commission, and
upon the further condition that Lender shall undertake to take all reasonable
steps to comply with the Act and the applicable rules and regulations thereunder
and with the securities laws of the states in which any such public offering is
made. Borrower agrees to take all reasonable steps to comply in all respects
with the Act and all applicable rules and regulations thereunder and with the
securities laws of the states in which any such public offering is made.
1.10.5 Borrower shall bear all costs and expenses in connection
with any registration statement demanded by Lender pursuant to Section 1.10.1
hereof, and of each registration statement filed pursuant to Section 1.10.2
hereof, including the fees and expenses for the audited and other financial
statements of Borrower included in such registration statements, and the
expenses of printing, filing, legal and Blue Sky and other similar expenses. In
connection with any registration statement pursuant to Section 1.10 including
any Shares owned by Lender, Borrower agrees to take all reasonable steps to
comply with such Blue Sky or state securities laws as may be reasonably
requested by Lender (except that it shall in no event be required to qualify as
a foreign corporation or give a general consent to the service of process), and
to furnish to Buyer such number of prospectuses or other documents incident to
such registration as it may from time to time reasonably request.
1.10.6 In connection with any registration statement which
pursuant to this Section 1.10 includes any of the Shares, Borrower will
indemnify and hold harmless Lender against and in respect of any losses, claims,
damages or liabilities (including legal or other expenses reasonably incurred by
Lender in connection with investigating or defending any such loss, claim,
damage, liability or action), to which Lender may become subject under the Act
or otherwise insofar as such losses, claims, damages or liabilities (or actions
with respect thereto) arise out of or are based upon any untrue statement or
alleged untrue statement of any material fact contained in such registration
statement, or arise out of or are based upon the omission or alleged omission to
state therein a material fact required to be stated therein or necessary to make
the statements therein not misleading.
1.10.7 In connection with any registration statement which
pursuant to this Section 1.10 includes any of the Shares, Lender will indemnify
and hold harmless Borrower, its officers and its directors and any controlling
persons of Borrower against and in respect of any losses, claims, damages or
liabilities (including legal or other expenses reasonably incurred by any of
them in connection with investigating or defending any such loss, claim, damage,
liability or action) to which Borrower or any such persons may become subject
under the Act or otherwise insofar as such losses, claims, damages or
liabilities (or
<PAGE>
actions with respect thereto) arise out of or are based upon any untrue
statement or alleged untrue statement, or arise out of or are based upon the
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statement therein no misleading, but
only to the extent that any such untrue statement or omission is based upon
information furnished in writing to Borrower by Lender or any of its authorized
representatives for inclusion in such registration statement.
1.10.8 Any party(ies) seeking indemnification (the "Indemnitee")
shall give prompt written notice to the party(ies) from whom it is seeking
indemnification (the "Indemnitor") of any claim by the Indemnitee against the
Indemnitor based on the indemnities contained in Sections 1.10.6 and 1.10.7
hereof, or any claim against the Indemnitee, which might give rise to a claim
based on the aforesaid indemnitees, stating the nature and basis of such claim
and the amount thereof. Failure by the Indemnitee to give the Indemnitor prompt
written notice of any such claim shall not release the Indemnitor from liability
with respect thereto unless such failure to give notice has a materially adverse
effect on the Indemnitor's ability to defend such claim. Prompt written notice
shall mean within thirty (30) days after the Indemnitee receives notice of the
claim from the person asserting the claim. The Indemnitee shall permit the
Indemnitor a reasonable opportunity to assume the defense, settlement or
compromise (herein called "defense" or "defend"), of any such claim. Failure by
the Indemnitor to notify the Indemnitee of its election to defend within thirty
(30) days after such notice thereof shall have been given shall be deemed a
waiver by the Indemnitor of its right to defend any such claim. If the
Indemnitor elects to defend such claim, it shall do so at its expense through
counsel or other representatives of its own choosing. If Lender is involved in
such action, suit or proceeding it shall make available to Borrower, its
attorneys and accountants all books and records relating to any such action,
suit or proceeding, and Borrower shall make available to Lender, its attorneys
and accountants, all books and records of Borrower relating to any such action,
suit or proceeding, as the case may be. Lender and Borrower agree to render to
each other such assistance as may reasonably be required in order to insure the
proper and adequate defense of any such action, suit or proceeding.
1.10.9 Lender shall not make any settlement of any claims which
might give rise to liability of Borrower under the indemnities contained in
Section 10.1.6 hereof, without the prior written consent of Borrower, which
consent shall not be unreasonably withheld. Borrower shall not make any
settlement of any claims which might give rise to liability of Lender under the
indemnities contained in Section 10.1.7 hereof, without the prior written
consent of the Lender, which consent shall not be unreasonably withheld.
1.11 Subordination. The Loan shall be subordinated to "Senior
-------------
Indebtedness", as defined a set forth in the Note.
SECTION 2 REPRESENTATIONS AND WARRANTIES
----------------------------------------
To induce the Lender to enter into this Agreement and to make the Loan, the
Borrower
<PAGE>
hereby represents and warrants to the Lender that:
2.1 Existence; Compliance with Law. The Borrower:
------------------------------
2.1.1 is duly organized, validly existing and in good standing
under the laws of its jurisdiction of organization,
2.1.2 has the corporate power and authority, and the legal right,
to own and operate its property, to lease the property it operates as lessee and
to conduct the business in which it is currently engaged, and
2.1.3 is in compliance with all Requirements of Law except to the
extent that the failure to comply therewith could not, in the aggregate,
reasonably be expected to have a Material Adverse Effect.
2.2 Power; Authorization; Enforceable Obligations. The Borrower has the
---------------------------------------------
corporate power and authority, and the legal right, to make, deliver and perform
the Loan Documents and to borrow hereunder and the Borrower has taken all
necessary action to authorize the borrowings on the terms and conditions of this
Agreement and the Note and to authorize the execution, delivery and performance
of the Loan Documents. No consent or authorization of, filing with, notice to
or other act by or in respect of, any Governmental Authority or any other Person
is required in connection with the borrowings hereunder or with the execution,
delivery, performance, validity or enforceability of the Loan Documents. This
Agreement and each other Loan Document has been duly executed and delivered on
behalf of the Borrower. This Agreement and each other Loan Document constitutes
a legal, valid and binding obligation of the Borrower enforceable against the
Borrower in accordance with its terms, except as enforceability may be limited
by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws
affecting the enforcement of creditors' rights generally and by general
equitable principles (whether enforcement is sought by proceedings in equity or
at law).
2.3 No Legal Bar. The execution, delivery and performance of the Loan
------------
Documents, the borrowings hereunder and the use of the proceeds thereof will not
violate any Requirement of Law or Contractual Obligation of the Borrower and
will not result in, or require, the creation or imposition of any Lien on any of
its properties or revenues pursuant to any such Requirement of Law or
Contractual Obligation, except to the extent such violations could not, in the
aggregate, be reasonably expected to have a Material Adverse Effect.
<PAGE>
2.4 No Material Litigation. No litigation, investigation or proceeding
----------------------
of or before any arbitrator or Governmental Authority is pending or threatened
in writing by or against the Borrower or against any of its properties or
revenues (a) with respect to any of the Loan Documents or any of the
transactions contemplated hereby or thereby, or (b) which could reasonably be
expected to have a Material Adverse Effect.
2.5 No Default. Except as set forth on Schedule 2.5, the Borrower is
----------
not in default under or with respect to any of its Contractual Obligations in
any respect which could reasonably be expected to have a Material Adverse
Effect. No Default or Event of Default has occurred and is continuing.
2.6 Taxes. The Borrower has filed or caused to be filed all tax returns
-----
which are required to be filed or applied for extensions and have paid all taxes
that are due and payable as set forth in such returns, and have paid any
assessments made against Borrower or its property and all other taxes, fees or
other charges imposed on it or any of its property by any Governmental Authority
(other than any taxes, assessments, fees or other charges the amount of which
are currently being contested in good faith by appropriate proceedings and with
respect to which reserves in conformity with GAAP have been provided on the
books of the Borrower).
2.7 No Untrue Statement. No statement contained in this Agreement, nor
-------------------
in any certificate or other document delivered to the Lender by the Borrower (or
its representatives) in connection with this Agreement or the transactions
contemplated hereby, contains any untrue statement of a material fact, or omits
to state a material fact necessary in order to make the statements contained
therein or herein not misleading.
2.8 Federal Regulations. No part of the proceeds of the Loan will be
-------------------
used for "purchasing" or "carrying" any "margin stock" within the respective
meanings of each of the quoted terms under Regulation G or Regulation U of the
Board of Governors of the Federal Reserve System as now and from time to time
hereafter in effect or for any purpose which violates the provisions of the
Regulations of such Board of Governors.
2.9 Investment Company Act. The Borrower is not an "investment company"
----------------------
or a company "controlled" by an "investment company," within the meaning of the
Investment Company Act of 1940, as amended.
2.10 Financial Statements. The financial statements of the Borrower on
--------------------
Form 10-K for the year ended March 31, 1997 and all Forms 10-Q filed subsequent
thereto have been prepared in accordance with generally accepted accounting
principles applied on a consistent basis during the periods involved and fairly
present the financial position of the Borrower as of the dates thereof and the
results of their operations for the periods then ended (subject, in the case of
any unaudited interim financial statements, to normal year-end adjustments and
to the lack of complete footnotes).
2.11 Absence of Certain Changes or Events. Since the date of the most
------------------------------------
recent financial statements, there has not been: (i) any material adverse change
in the
<PAGE>
business, assets, financial condition or the results of operations of the
Borrower ; (ii) any declaration, payment or setting aside for payment of any
dividend or any redemption, purchase or other acquisition of any shares of
capital stock or securities of the Borrower; (iii) any return of any capital or
other distribution of assets to stockholders of the Borrower; (iv) any material
investment of a capital nature by the Borrower either by the purchase or any
property or assets or by any acquisition (by merger, consolidation or
acquisition of stock or assets) of any corporation partnership or other business
organization or division thereof except in the ordinary course of business; (v)
any agreement to take, whether in writing or otherwise, any action which, if
taken prior to the date hereof, would have made any representation or warranty
in this Section 2 untrue or incorrect in any material respect; and (vi) any
failure by the Borrower to conduct its business only in the ordinary course
consistent with past practice.
2.12 Compliance with Laws. The business of the Borrower has been
--------------------
operated in compliance with all laws, ordinances, regulations and orders of all
governmental entities, except for any instances of non-compliance which do not
and will not reasonably be expected to have a Material Adverse Effect.
2.13 Liabilities. Except as set forth on its most recent financial
-----------
statements or as does not and will not reasonably be expected to have a Material
Adverse Effect, the Borrower does not have any direct or indirect liabilities,
whether or not of a kind required by generally accepted accounting principles to
be set forth in its financial statements. Except as set forth in the most recent
financial statements, the Borrower does not have material (i) obligations in
respect of borrowed money, (ii) obligations evidenced by bonds, debentures,
notes or other similar instruments, (iii) obligations which would be required by
generally accepted accounting principles to be classified as "capital leases",
(iv) obligations to pay the deferred purchase price of property or services,
except trade accounts payable arising in the ordinary course of business and
payable not more than twelve (12) months from the date of incurrence, and (v)
any guaranties of any obligations of any other person.
2.14 Intellectual Property. (i) The Borrower owns, or is licensed to, or
---------------------
otherwise has, the right to use all patents, trademarks, service marks, trade
names, copyrights and franchises it uses and (ii) the Borrower's rights in the
property in such patents, service marks, trademarks, trade names, copyrights and
franchises are free and clear of any liens or other encumbrances and the
Borrower has not received written notice of any adversely-held patent,
invention, trademark, service mark or trade name of any other person, or notice
of any charge or claim of any person relating to such intellectual property or
any process or confidential information of the Borrower and the Borrower does
not know of any basis for any such charge or claim, and (iii) the Borrower, and
its predecessors, if any, have not conducted business at any time during the
period beginning five years prior to the date hereof under any corporate or
partnership, trade or fictitious names, except in the case of clauses (i) and
(ii) above, any of the foregoing which do not and will not have a Material
Adverse Effect.
2.15 Real Estate.
-----------
<PAGE>
(a) All of the real property the Borrower owns is free and clear of
any liens or other encumbrances except for the liens on the Borrower's Las Vegas
property.
(b) The Borrower holds the leasehold estate under and interest in
each lease, sublease, license or other agreement under which it uses or occupies
any real property or improvements thereon (the "Real Property Leases") free and
clear of all material liens, encumbrances and other rights of occupancy. All
Real Property Leases are valid and binding on the lessors thereunder in
accordance with their respective terms and there is not under any such Real
Property Leases any existing default, or any condition, event or act which with
notice or lapse of time or both would constitute such a default, which in either
case, considered individually or in the aggregate with all such other Real
Property Leases under which there is such a default, condition, event or act,
would reasonably be expected to have a Material Adverse Effect.
2.16 Title to and Condition of Personal Property. The Borrower has good
-------------------------------------------
and marketable title to the material personal property reflected in its
financial statements or that it currently uses in the operation of its business
(other than leased property or personal property which is not material to the
business of the Borrower and such equipment is the sole security for any
financing associated therewith), and such property is free and clear of all
liens, claims, charges, security interests, options, or other title defects or
encumbrances. All such personal property is in good operating condition and
repair, is suitable for the use to which the same is customarily put, is free
from defects and is merchantable and is of a quality and quantity presently
usable in the ordinary course of the operation of the business of the Borrower,
other than such matters as would not have a Material Adverse Effect.
2.17 No Adverse Actions. There is no existing, pending or threatened in
------------------
writing termination, cancellation, limitation, modification or change in the
business relationship of the Borrower with any supplier, customer or other
person or entity except those which do not and will not reasonably be expected
to have a Material Adverse Effect. Neither the Borrower, nor any director,
officer or employee of Borrower has used any corporate funds for unlawful
contributions, payments, gifts, entertainment or other unlawful expenses
relating to political activity, or governmental or regulatory officials.
2.18 Insurance. The Borrower has not received notice of default under,
---------
or intended cancellation or nonrenewal of, any material policies of insurance
which insure the properties, business or liability of the Borrower.
<PAGE>
The Lender represents and warrants to the Borrower as follows:
2.19 Lender hereby represents, warrants and covenants to Borrower, which
representations and warranties shall survive the execution of this Credit
Agreement and the consummation of the transactions contemplated hereby, as
follows:
2.19.1 Lender has the financial ability to bear the economic risk
of its investment in the Note and in the Shares (i.e., Lender can afford a
complete loss of its investment).
2.19.2 Lender has adequate means of providing for its current needs
and possible contingencies, and has no need for liquidity in the investment in
the Note and in the Shares and has no reason to anticipate any change in
circumstances, financial or otherwise, which may cause or require any sale or
distribution of the Shares.
2.19.3 Lender's overall commitment to investments which are not
readily marketable is not disproportionate to its net worth and its investment
in the Note and in the Shares will not cause such overall commitment to become
excessive. Lender has determined that the purchase of the Shares is consistent
with its investment objectives and income prospects.
2.19.4 Lender has the requisite knowledge and experience in
financial and business matters to be capable of evaluating the merits and risks
of an investment in the Note and in the Shares.
2.19.5 Lender understands that the Note and the Shares have not
been registered under the Securities Act of 1933, as amended (the "Act"), or
under applicable state securities laws.
2.19.6 Lender is acquiring the Note and the Shares solely for its
own account, for investment purposes only and not with the intention of, or a
view toward, the subdivision, resale, transfer or further distribution thereof
or for sale in connection with any distribution.
2.19.7 Lender shall not sell or otherwise dispose of the Shares
unless and until a registration statement covering such proposed disposition
shall be in effect under the Act, and under applicable state securities laws, or
the disposition of such shares is made pursuant to the requirements of Rule 144
promulgated by the Securities and Exchange Commission or Borrower shall have
received a written opinion of counsel to Lender to the effect that such proposed
disposition would be exempt from the registration requirements of the Act and of
applicable state securities laws.
<PAGE>
2.19.8 Lender understands that the foregoing representations,
warranties and covenants are being relied upon by Borrower in connection with
Borrower's entering into this Credit Agreement.
2.19.9 Lender has not engaged or dealt with any person or entity
who would be entitled to any broker's or finder's fee or commission with respect
to the execution of this Credit Agreement or any of the transactions described
herein and contemplated hereby.
2.19.10 Lender has been given an opportunity to speak to management
of Borrower regarding the business and financial condition of Borrower.
2.19.11 Lender agrees and acknowledges that the stock certificates
evidencing the Shares will each bear a restrictive legend in substantially the
following form:
"THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THEY MAY NOT BE SOLD UNLESS THERE
IS A REGISTRATION STATEMENT IN EFFECT COVERING SUCH SHARES OR THE DISPOSITION OF
SUCH SHARES IS MADE PURSUANT TO THE REQUIREMENTS OF RULE 144 PROMULGATED BY THE
SECURITIES AND EXCHANGE COMMISSION, OR AN OPINION OF COUNSEL TO THE HOLDER OF
THE SHARES IS OBTAINED TO THE EFFECT THAT THE TRANSFER OF THE SHARES SATISFIES
THE CONDITIONS FOR AN EXEMPTION FROM THE SECURITIES ACT OF 1933, AS AMENDED."
2.19.12 Lender agrees and acknowledges that stop transfer orders
will be placed in Borrower's records with respect to the Shares.
SECTION 3 CONDITIONS PRECEDENT
------------------------------
3.1 Conditions to Loan. The agreement of the Lender to make the Loan is
------------------
subject to the satisfaction, immediately prior to or concurrently with the
making of such Loan on the Closing Date, of the following conditions precedent:
3.1.1 Loan Documents. The Lender shall have received (i) this
--------------
Agreement, executed and delivered by a duly authorized officer of the Borrower,
(ii) the Note, executed and delivered by a duly authorized officer of the
Borrower, and (iii) the North Option Assignment, executed by the Borrower.
3.1.2 Corporate Proceedings of the Borrower. The Lender shall
-------------------------------------
have received a copy of the resolutions, in form and substance satisfactory to
the Lender, of the Borrower authorizing (i) the execution, delivery and
performance of this Agreement, the Note and the other Loan Documents and (ii)
the borrowing contemplated hereunder and
<PAGE>
certified by the Secretary or an Assistant Secretary of the Borrower as of the
Closing Date, which certificate shall be in form and substance satisfactory to
the Lender and shall state that the resolutions thereby certified have not been
amended, modified, revoked or rescinded.
3.1.3 Borrower Incumbency Certificate. The Lender shall have
-------------------------------
received a Certificate of the Borrower dated the Closing Date, as to the
incumbency and signature of the officers of the Borrower executing any Loan
Document satisfactory in form and substance to the Lender, executed by the
President or any senior officer and the Secretary or any Assistant Secretary of
the Borrower.
3.1.4 Opinions. The Lender shall have received opinion of counsel
--------
to the Borrower, in the form of Exhibit C of this Agreement.
3.1.5 Representations and Warranties. Each of the representations
------------------------------
and warranties made by the Borrower in or pursuant to the Loan Documents shall
be true and correct in all material respects on and as of such date as if made
on and as of such date.
3.1.6 No Default. No Default or Event of Default shall have
----------
occurred and be continuing on such date or after giving effect to the Loan.
SECTION 4 COVENANTS
-------------------
The Borrower hereby agrees that, so long as the Note remains outstanding and
unpaid or any other amount is owing to the Lender hereunder, the Borrower shall:
4.1 Use of Proceeds. The proceeds of the Loan shall be used by the
---------------
Borrower for general working capital purposes.
4.2 Payment of Obligations. Pay, discharge or otherwise satisfy at or
----------------------
before maturity or before they become delinquent, as the case may be, all of its
material obligations of whatever nature, except where the amount or validity
thereof is currently being contested in good faith by appropriate proceedings
and reserves in conformity with GAAP with respect thereto have been provided on
the books of the Borrower.
4.3 Compliance of Laws. Comply with all applicable laws regulations,
------------------
and orders of Governmental Authorities and obtain and comply with and maintain
any and all material licenses, approvals, notifications, registrations or
permits required by applicable laws, regulations or orders, except in each such
case to the extent that failure to do so could not reasonably be expected to
have a Material Adverse Effect.
<PAGE>
4.4 Maintenance of Existence. Preserve, renew and keep in full force
------------------------
and effect its existence and take all reasonable action to maintain all its
respective rights, privileges and franchises in the normal conduct of its
business.
4.5 Maintenance of Property; Insurance. Keep all property necessary to
----------------------------------
its business in good working order and condition; maintain with financially
sound and reputable insurance companies insurance on all its property in at
least such amounts and against at least such risks (but including in any event
public liability, product liability and business interruption) as are usually
insured against in the same general area by companies engaged in the same or a
similar business; and furnish to the Lender, upon written request, full
information as to the insurance carried.
4.6 Notices. Promptly give notice to the Lender of:
-------
4.6.1 the occurrence of any Default or Event of Default; and
4.6.2 the occurrence of any event which causes any representation
or warranty of the Borrower to be cease to be true or a breach of any covenant
of the Borrower set forth in this Agreement; and
4.6.3 any material adverse change in the business, operations,
property, financial condition of the Borrower or any development or event which
could reasonably be expected to have a Material Adverse Effect.
4.7 Maintenance of Assets. Except in the ordinary course of business,
---------------------
not pledge, sell or transfer any of its assets without the express written
consent of Lender; provided however, that the Borrower may pledge, sell or
transfer its assets if the Lender expressly agrees that the proceeds of any such
pledge, sale or transfer will be used by the Borrower to pay to Lender the
payments set forth in section 1 hereof.
SECTION 5 EVENTS OF DEFAULT
---------------------------
If any of the following events shall occur and be continuing:
5.1 The Borrower shall fail to pay any principal of the Note when due in
accordance with the terms hereof; or the Borrower shall fail to pay any interest
on the Note, or any other amount payable hereunder, within three (3) Business
Days after written notice thereof is delivered to Borrower; or
5.2 Any representation or warranty made or deemed made by the Borrower
herein or in any other Loan Document or which is contained in any certificate,
document or financial or other statement furnished by it at any time under or in
connection with this Agreement or any such other Loan Document shall prove to
have been incorrect in any material respect on or as of the date made or deemed
made and the same is not cured
<PAGE>
within thirty (30) Business Days after written notice thereof is delivered to
Borrower; or
5.3 The Borrower shall default in the observance or performance of any
other agreement contained in this Agreement or any other Loan Document, and such
default shall continue unremedied for a period of five thirty (30) Business Days
after written notice thereof is delivered to Borrower; or
5.4 (i) The Borrower shall commence any case, proceeding or other action
(A) under any existing or future law of any jurisdiction, domestic or foreign,
relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking
to have an order for relief entered with respect to it, or seeking to adjudicate
it bankrupt or insolvent, or seeking reorganization, arrangement, adjustment,
winding-up, liquidation, dissolution, composition or other relief with respect
to its debts, or (B) seeking appointment of a receiver, trustee, custodian,
conservator or other similar official for it or for all or substantially all of
its assets, or the Borrower shall make a general assignment for the benefit of
its creditors or (ii) there shall be commenced against the Borrower any case,
proceeding or other action of a nature referred to in clause (i) above which (A)
results in the entry of an order for relief or any such adjudication or
appointment or (B) remains undismissed, undischarged or unbonded for a period of
60 days; or (iii) there shall be commenced against the Borrower any case,
proceeding or other action seeking issuance of a warrant of attachment,
execution, distraint or similar process against all or substantially all of its
assets which results in the entry of an order for any such relief which shall
not have been vacated, discharged, or stayed or bonded pending appeal within 60
days from the entry thereof; or (iv) the Borrower shall take any action in
furtherance of, or indicating its consent to, approval of, or acquiescence in,
any of the acts set forth in clause (i), (ii), or (iii) above; or
5.5 One or more judgments or decrees shall be entered against the
Borrower involving in the aggregate liability (not paid or fully covered by
insurance) of $250,000 or more, and all such judgments or decrees shall not have
been vacated, discharged, stayed or bonded pending appeal within 60 days from
the entry thereof; or
5.6 Any warrant of attachment, levy or execution involving an amount in
excess of $250,000 shall be issued or levied against the Borrower and such
warrant of attachment, levy or execution shall not be released, vacated, stayed
or bonded within 60 days of its issue or levy; or
5.7 A material adverse change in the business, operations, property,
financial condition of the Borrower shall have occurred since the date of this
Agreement;
then, and in any such event, the Loan (with accrued interest thereon) and
all other amounts owing under this Agreement and the Note shall immediately
become due and payable. Except as expressly provided above in this Section,
demand, protest upon the giving of notice to Borrower and all other notices of
any kind are hereby expressly waived.
<PAGE>
SECTION 6 MISCELLANEOUS
-----------------------
6.1 Amendments and Waivers. Neither this Agreement, the Note or any
----------------------
other Loan Document, nor any terms hereof or thereof may be amended,
supplemented or modified except in an instrument executed by the Lender and the
Borrower in accordance with the provisions of this subsection. The Lender may,
from time to time, waive, on such terms and conditions as the Lender may specify
in such instrument, any of the requirements of this Agreement, the Note or the
other Loan Documents or any Default or Event of Default and its consequences.
Any such wavier and any such amendment, supplement or modification shall be
binding upon the Borrower and the Lender. In the case of any waiver, the
Borrower and the Lender shall be restored to their former position and rights
hereunder and under the Note and any other Loan Documents, and any Default or
Event of Default waived shall be deemed to be cured and not continuing; but no
such waiver shall extend to any subsequent or other Default or Event of Default,
or impair any right consequent thereon.
6.2 Costs and Expenses. The Borrower agrees to pay or reimburse the
------------------
Lender for all of its costs and expenses incurred in connection with the
enforcement of any rights under this Agreement, the Note or any other Loan
Documents, including, without limitation, the reasonable fees and disbursements
of outside counsel to the Lender.
6.3 Further Assurances. From and after the date hereof, upon the
------------------
reasonable request of any party to this Agreement, the other party shall
execute, acknowledge and deliver, all such further agreements, instruments and
assurances as may be necessary and appropriate to carry out the transactions
contemplated by this Agreement and the other Loan Documents.
6.4 Notices. All notices, requests and demands to or upon the
-------
respective parties hereto to be effective shall be in writing (including by
telecopy), and, unless otherwise expressly provided herein, shall be deemed to
have been duly given or made when delivered, or three days after being deposited
in the mail, postage prepaid, or, in the case of telecopy notice, when received,
addressed as follows, or to such other address as may be hereafter notified by
the respective parties hereto and any future holders of the Note:
The Lender: Image Investors Co.
c/o Metromedia Company
One Meadowlands Plaza
East Rutherford, New Jersey 07073
Attention: General Counsel
The Borrower: Image Entertainment, Inc.
9333 Oso Avenue
Chatsworth, CA 91311-6089
Attention: General Counsel
<PAGE>
6.5 No Waiver; Cumulative Remedies. No failure to exercise and no delay
------------------------------
in exercising, on the part of the Lender, any right, remedy, power or privilege
hereunder or under the other Loan Documents shall operate as a waiver thereof;
nor shall any single or partial exercise of any right, remedy, power or
privilege hereunder preclude any other or further exercise thereof or the
exercise of any other right, remedy, power or privilege. The rights, remedies,
powers and privileges herein provided are cumulative and not exclusive of any
rights, remedies, powers and privileges provided by law.
6.6 Survival of Representations and Warranties. All representations and
------------------------------------------
warranties made hereunder, in the other Loan Documents and in any document,
certificate or statement delivered pursuant hereto or in connection herewith
shall survive the execution and delivery of this Agreement and the Note and the
making of the Loan hereunder.
6.7 Successors and Assigns. This Agreement shall be binding upon and
----------------------
inure to the benefit of the Lender and its successors and assigns; the Borrower
may not assign or transfer any of its rights or obligations under this Agreement
without the prior written consent of the Lender.
6.8 Counterparts. This Agreement may be executed by one or more of the
------------
parties to this Agreement on any number of separate counterparts, and all of
said counterparts taken together shall be deemed to constitute one and the same
instrument.
6.9 Severability. Any provision of this Agreement which is prohibited
------------
or unenforceable in any jurisdiction shall, as to such jurisdiction, be
ineffective to the extent of such prohibition or unenforceability without
invalidating the remaining provisions hereof, and any such prohibition or
unenforceability in any jurisdiction shall not invalidate or render
unenforceable such provision in any other jurisdiction.
6.10 Integration. This Agreement and the other Loan Documents represent
-----------
the agreement of the Borrower and the Lender with respect to the subject matter
hereof, and there are no promises, undertakings, representations or warranties
by the Lender relative to the subject matter hereof not expressly set forth or
referred to herein or in the other Loan Documents.
6.11 GOVERNING LAW. THIS AGREEMENT AND THE NOTE AND THE RIGHTS AND
-------------
OBLIGATIONS OF THE PARTIES UNDER THIS AGREEMENT AND THE NOTE SHALL BE GOVERNED
BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF
NEW YORK.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed and delivered by their proper and duly authorized officers this
____ day of October, 1997.
LENDER:
Image Investors Co.
By:/s/ STUART SUBOTNICK
--------------------
Name: Stuart Subotnick
Title: Executive Vice President
BORROWER:
Image Entertainment, Inc.
By:/s/ MARTIN W. GREENWALD
-----------------------
Name: Martin W. Greenwald
Title: President
<PAGE>
CONVERTIBLE SUBORDINATED PROMISSORY NOTE
$5,000,000 New York, New York
October 29, 1997
FOR VALUE RECEIVED, the undersigned, Image Entertainment, Inc., a
California corporation ("Borrower"), hereby unconditionally promises to pay to
--------
the order of Image Investors Co., a Delaware corporation (the "Lender"), in
------
lawful money of the United States of America and in immediately available funds,
on the Termination Date, or such earlier date as payment shall be due, whether
by acceleration or otherwise in accordance with the Credit Agreement (as defined
below), at such office as the Lender may designate in writing, from time to
time, the principal amount of FIVE MILLION DOLLARS ($5,000,000). The Borrower
further agrees to pay interest in like money on the unpaid principal amount
outstanding at the rates and on the dates specified in subsection 1.4 of the
Credit Agreement.
This Note (a) is the Note referred to in the Credit Agreement dated as of
September 29, 1997 (as amended, supplemented or otherwise modified from time to
time, the "Credit Agreement"), between the Borrower and the Lender, (b) is
----------------
entitled to the benefits of and is subject to the provisions of the Credit
Agreement, except to the extent such provisions conflict with the provisions of
this Note, and (c) is subject to optional and mandatory prepayment in whole or
in part as provided in the Credit Agreement.
This Note may be converted into shares of common stock of the Borrower in
accordance with Subsection 1.7 of the Credit Agreement.
As set forth in Subsection 1.11 of the Credit Agreement, the indebtedness
represented by this Note is subordinated in accordance with the following
provisions (the "Subordination Provisions"):
------------------------
1. Borrower covenants and agrees, and Lender by its acceptance hereof
likewise covenants and agrees, that, to the extent and in the manner
hereinafter set forth in Sections 1 through 5 of these Subordination
Provisions, the indebtedness represented by this Note and the payment of
principal of this Note and interest thereon and any other obligations or
claims in respect hereof (including but not limited to any fees or
expenses of collection, post-petition interest or claims for indemnity)
is hereby expressly made subordinate and subject in right of payment and
in reorganization, liquidation or bankruptcy to the prior payment in full
of all Senior Indebtedness (defined below).
a. "Senior Indebtedness" means all Indebtedness (defined below),
whenever created or incurred, under that certain Loan Agreement,
dated as of December 17, 1996, between Borrower and Union Bank
<PAGE>
of California, N.A., as amended and as may be further amended,
modified, restated, renewed and extended, other than Indebtedness
under the Credit Agreement or this Note or Indebtedness expressly
excluded as Senior Indebtedness hereinbelow.
i. Union Bank of California may expressly rely on these
Subordination Provisions.
ii. Notwithstanding anything to the contrary set forth above,
"Senior Indebtedness" shall not include any Indebtedness
which by the express terms of the agreement or instrument
creating, evidencing or governing the same is pari passu
with or subordinate in right of payment to the
obligations under this Note.
b. "Indebtedness" means (A) all indebtedness, obligations and other
liabilities (contingent or otherwise) for or in respect of
borrowed money or evidenced by bonds, debentures, notes or
similar instruments (whether or not the recourse of the lender is
to the whole of the assets of Borrower or to only a portion
thereof); (B) all reimbursement obligations and other liabilities
(contingent or otherwise) of Borrower with respect to letters of
credit or bankers' acceptances issued for the account of such
person or with respect to interest rate protection agreements or
currency exchange agreements; (iii) all obligations and other
liabilities (contingent and otherwise) of Borrower with respect
to any conditional sale, installment sale or other title
retention agreement, purchase money mortgage or security
interest, or otherwise to pay the deferred purchase price of
property or services (except trade accounts payable and accrued
expenses arising in the ordinary course of business) or in
respect of any sale and leaseback arrangement; (iv) all
obligations and liabilities (contingent or otherwise) in respect
of leases by Borrower as lessee which, in conformity with
generally accepted accounting principles, are required to be
accounted for as capitalized lease obligations on the balance
sheet of Borrower; and (v) all direct or indirect guaranties or
similar agreements in respect of, and obligations or liabilities
(contingent or otherwise) to purchase or otherwise acquire or
otherwise to assure a creditor against loss in respect of,
indebtedness, obligations or liabilities of others.
2. In the event of (a) any insolvency or bankruptcy case or proceeding, or
any receivership, liquidation, reorganization or other similar case or
proceeding in connection therewith, relative to Borrower or to its
creditors, as such, or to its
2
<PAGE>
assets, or (b) any liquidation, dissolution, whether voluntary or
involuntary and whether or not involving insolvency or bankruptcy, or (c)
any assignment for the benefit of creditors or any other marshaling of
assets and liabilities of Borrower, then and in any such event the holder
of the Senior Indebtedness shall be entitled to received payment in full
of all amounts due or to become due on or in respect of all Senior
Indebtedness, before the Lender is entitled to receive any payment on
account of principal of or interest or any other amount on or in respect
of this Note, and to that end the holder of the Senior Indebtedness shall
be entitled to received, for application to the payment thereof, any
payment or distribution of any kind or character, whether in cash,
property or securities, including any such payment or distribution which
may be payable or deliverable by reason of the payment of any other
indebtedness of Borrower being subordinated to the payment of this Note,
which may be payable or deliverable in respect to this Note in any such
case, proceeding, dissolution, liquidation or other winding up or event.
3. If notwithstanding the foregoing provisions of Sections 1 and 2, the
Lender shall have received any payment or distribution of assets of
Borrower of any kind or character, whether in cash, property or
securities, including any such payment or distribution which may be
payable or deliverable by reason of the payment of any other indebtedness
of Borrower being subordinated to the payment of this Note, before all
Senior Indebtedness is paid in full or payment thereof provided for, and
if such fact shall, at or prior to the time of such payment or
distribution, have been made known to the Lender, any such payment or
distribution of assets so received shall be held in trust for the holder
of Senior Indebtedness and (x) shall be paid to such holder (pro rata) to
the extent necessary to make payment in full in cash or cash equivalent
of all Senior Indebtedness (and, in the case of Senior Indebtedness in
respect of letters of credit not yet drawn upon, necessary to be fully
secured by cash collateral) after giving effect to any concurrent payment
or distribution to or for the benefit of such holder or (y) shall be paid
over or delivered forthwith to the trustee in bankruptcy, receiver,
liquidating trustee, custodian, assignee, agent or other person making
payment or distribution of assets of Borrower for application to the
payment of all Senior Indebtedness remaining unpaid, to the extent
necessary to pay all Senior Indebtedness in full, after giving effect to
any concurrent payment or distribution to or for the holder of the Senior
Indebtedness.
4. Upon the maturity of any Senior Indebtedness by lapse of time,
acceleration or otherwise, then unless such acceleration shall have been
rescinded or shall have otherwise ceased to exist, or the time for
payment extended, all principal thereof and premium, if any, and interest
thereon and all other claims with respect thereto shall first be paid in
full, before any payment is made on account of principal of or interest
on or any other claim with respect to this Note. Upon
3
<PAGE>
any event of default (or upon the receipt by Borrower of written notice
of any other event of default) with respect to any Senior Indebtedness,
then, unless and until such payment has been made or the event of default
shall have been cured or waived in writing or shall have ceased to exist
or the holder of the Senior Indebtedness shall have otherwise agreed in
writing, no direct or indirect payment shall be made by Borrower with
respect to the principal of or interest on or any other amount or claim
with respect to this Note.
5. Nothing contained in this Note shall prevent Borrower, at any time except
during the pendency of an event of default under any Senior Indebtedness
or any case, proceeding, dissolution, liquidation or other winding up,
assignment for the benefit of creditors or other marshaling of assets and
liabilities of Borrower referred to in Section 2 above, from making
payments of principal of or interest on this Note when otherwise due.
6. Subject to the payment in full of all Senior Indebtedness, the Lender
shall be subrogated to the extent of the payments or distributions made
to the holder of such Senior Indebtedness pursuant to the provisions of
these Subordination Provisions to the rights of the holder of such Senior
Indebtedness to receive payments and distributions of cash, property and
securities applicable to the Senior Indebtedness until the principal of,
and interest, if any, on this Note shall be paid in full. For purposes
of such subrogation, no payments or distributions to the holder of the
Senior Indebtedness of any cash, property or securities to which the
Lender would be entitled except for the provisions of these Subordination
Provisions, and no payments made pursuant to the provisions of these
Subordination Provisions to the holder of Senior Indebtedness by Lender,
shall, as among Borrower, its creditors other than holder of Senior
Indebtedness and Lender, be deemed to be a payment or distribution by
Borrower to or on account of the Senior Indebtedness.
7. The provisions of these Subordination Provisions are and are intended
solely for the purpose of defining the relative rights of the Lender of
this Note, on the one hand, and the holder of Senior Indebtedness, on the
other hand. Such provisions are for the benefit of the holder of Senior
Indebtedness (and their successors and assigns) and shall be enforceable
by them directly against the Lender (and its successors and assigns) of
this Note. These Subordination Provisions shall constitute a continuing
offer to all persons who become holder of, or continue to hold, Senior
Indebtedness (whether such Senior Indebtedness was created or acquired
before or after the issuance of this Note). These Subordination
Provisions may not be amended without the consent of each Lender of
Senior Indebtedness that may be adversely affected thereby. Nothing
contained in these Subordination Provisions or elsewhere in this Note is
intended to or shall: (i) impair, as among Borrower, its creditors other
than
4
<PAGE>
Lenders of Senior Indebtedness and the Lender, the obligation of
Borrower, which is absolute and unconditional, to pay to the Lender the
principal of and interest on this Note as and when the same shall become
due and payable in accordance with its terms; or (ii) affect the relative
rights against Borrower of the Lender and creditors of Borrower other
than the holder of Senior Indebtedness; or (iii) prevent the Lender from
exercising all remedies otherwise permitted by applicable law upon
default under this Note, subject to the rights, if any, under or by
reason of these Subordination Provisions, of the holder of Senior
Indebtedness to receive cash, property and securities otherwise payable
or deliverable to or received by Lender.
8. No right of any present or future holder of any Senior Indebtedness to
enforce subordination as provided herein shall at any time in any way be
prejudiced or impaired by any act or failure to act on the part of
Borrower or by any act or failure to act, in good faith, by any such
holder, or by any noncompliance by Borrower with the terms of this Note.
The holder of Senior Indebtedness may extend, renew, modify or amend the
terms of the Senior Indebtedness or any security therefor and release,
sell or exchange such security and otherwise deal freely with Borrower,
all without affecting the liabilities and obligations of the Lender of
this Note. The Lender of this Note by its acceptance authorizes and
expressly directs Borrower on the Lender's behalf to take such action as
may be necessary or appropriate to effectuate the subordination provided
in these Subordination Provisions and appoints the Company as attorney-
in-fact for such purpose.
Upon the occurrence of any one or more of the Events of Default, all
amounts then remaining unpaid on this Note shall become, or may be declared to
be, immediately due and payable, all as provided in the Credit Agreement.
No delay or omission on the part of the Lender or any holder hereof in
exercising its rights under this Note, or delay or omission on the part of the
Lender in exercising its rights under the Credit Agreement or under any other
Loan Document, or course of conduct relating thereto, shall operate as a waiver
of such rights or any other right of the Lender or any holder hereof, nor shall
any waiver by the Lender of any such right or rights on any one occasion be
deemed a bar to, or waiver of, the same right or rights on any future occasion.
Upon an Event of Default, the Borrower agrees to pay or reimburse the
Lender for all of its out-of-pocket costs and expenses incurred in connection
with the collection of the principal amount of this Note, including reasonable
outside attorneys' fees, if this Note is collected by or through an attorney-at-
law or under advice therefrom.
5
<PAGE>
All parties now and hereafter liable with respect to this Note, whether
maker, principal, surety, guarantor, endorser or otherwise, hereby waive
presentment, demand, protest and all other notices of any kind.
Unless otherwise defined herein, terms defined in the Credit Agreement
and used herein shall have the meanings given to them in the Credit Agreement.
THIS NOTE SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN
ACCORDANCE WITH, THE LAW OF THE SATE OF NEW YORK.
Image Entertainment, Inc.
By: /s/ MARTIN W. GREENWALD
-----------------------
Martin W. Greenwald,
President
6
<PAGE>
EXHIBIT 15
INDEPENDENT ACCOUNTANTS' CONSENT
--------------------------------
Image Entertainment, Inc.
Chatsworth, California
Gentlemen:
Re: Registration Statement Nos. 33-43241, 33-55393 and 33-57336
With respect to the subject registration statement, we acknowledge our awareness
of the use therein of our report dated November 4, 1997 related to our review of
interim financial information.
Pursuant to Rule 436(c) under the Securities Act of 1933, such report is not
considered a part of a registration statement prepared or certified by an
accountant or a report prepared or certified by an accountant within the meaning
of Sections 7 and 11 of the Act.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
November 4, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q
SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,061
<SECURITIES> 0
<RECEIVABLES> 12,044
<ALLOWANCES> 3,405
<INVENTORY> 16,492
<CURRENT-ASSETS> 0<F1>
<PP&E> 11,972
<DEPRECIATION> 4,397
<TOTAL-ASSETS> 42,553
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 17,952
<OTHER-SE> 83
<TOTAL-LIABILITY-AND-EQUITY> 42,553
<SALES> 33,314
<TOTAL-REVENUES> 33,314
<CGS> 27,332
<TOTAL-COSTS> 27,332
<OTHER-EXPENSES> 1,719
<LOSS-PROVISION> (315)
<INTEREST-EXPENSE> 332
<INCOME-PRETAX> (381)
<INCOME-TAX> (6)
<INCOME-CONTINUING> (375)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (375)
<EPS-PRIMARY> (.03)
<EPS-DILUTED> 0<F2>
<FN>
<F1>The Company has an unclassified balance sheet due to the nature of its
industry.
<F2>Not presented since the amounts do not differ significantly from the primary
net income per share.
</FN>
</TABLE>
