<PAGE>
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 JUNE 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 jurisdiction (I.R.S. Employer
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 August 8, 1997:
13,697,115
<PAGE>
PART I - FINANCIAL INFORMATION
===============================================================================
ITEM 1. FINANCIAL STATEMENTS.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 1997 and March 31, 1997
================================================================================
<TABLE>
<CAPTION>
ASSETS
June 30, 1997 March 31, 1997
-------------- --------------
(In thousands) (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 299 $ 1,090
Accounts receivable, net of allowances of
$4,281 - June 30, 1997;
$4,809 - March 31, 1997 9,319 10,759
Inventories (Note 3) 17,461 17,776
Royalties, distribution fee and license fee advances 7,505 8,454
Prepaid expenses and other assets 816 751
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$4,187 - June 30, 1997;
$3,972 - March 31, 1997 7,678 7,618
------- -------
$43,078 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-1-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 1997 and March 31, 1997
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, 1997 March 31, 1997
-------------- ---------------
(In thousands, except share data) (unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $15,490 $15,922
Accrued royalties 3,299 3,481
Revolving credit facility (Note 5) 5,544 8,709
Construction credit facility (Note 6) 400 -
Note payable (Note 7) 281 285
------- -------
Total liabilities 25,014 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; 13,563,000 and 13,343,000 issued
and outstanding at June 30, 1997 and
March 31, 1997, respectively 17,822 17,642
Stock warrants (49) (73)
Additional paid-in capital 3,064 3,064
Accumulated deficit (2,773) (2,582)
Liquidity (Note 7)
------- -------
Net shareholders' equity 18,064 18,051
------- -------
$43,078 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-2-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended June 30, 1997 and 1996
===============================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
-------- --------
<S> <C> <C>
NET SALES $16,902 $20,146
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 14,049 15,981
Selling expenses 1,047 1,081
General and administrative expenses 1,009 1,462
Amortization of production costs 831 772
------- -------
16,936 19,296
------- -------
OPERATING INCOME (LOSS) (34) 850
OTHER EXPENSES (INCOME):
Interest expense 203 26
Interest income (46) (95)
------- -------
157 (69)
------- -------
INCOME (LOSS) BEFORE INCOME TAXES (191) 919
INCOME TAXES - 313
------- -------
NET INCOME (LOSS) $ (191) $ 606
======= =======
NET INCOME (LOSS) PER SHARE (Note 4) $(.01) $.04
======= =======
WEIGHTED AVERAGE SHARES
OUTSTANDING (Note 4) 13,431 16,033
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-3-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months Ended June 30, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (191) $ 606
Adjustments to reconcile net income
to net cash (used) provided by operating activities:
Amortization of production costs 831 772
Depreciation and amortization 217 190
Amortization of stock warrants 24 87
Provision for doubtful accounts, net of recoveries (252) 216
Changes in assets and liabilities associated
with operating activities:
Accounts receivable 1,692 (828)
Optical disc inventory 393 (360)
Royalty, distribution and license fee advances, net 949 (595)
Production cost expenditures (909) (763)
Prepaid expenses and other assets (67) (620)
Notes receivable - 41
Accounts payable, accrued royalties
and liabilities (635) (1,242)
------ -------
Net cash provided (used) by operating activities 2,052 (2,496)
------ -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (253) (201)
------ -------
Net cash used by investing activities (253) (201)
------ -------
</TABLE>
See accompanying notes to consolidated financial statements
-4-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(UNAUDITED)
For the Three Months Ended June 30, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
--------- --------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 12,848 $ -
Advances under construction credit facility 400 -
Repayment of advances under revolving
credit facility (16,013) -
Principal payments under note payable (4) -
Principal payments under capital lease obligation (1) -
Repurchase of common stock - (172)
Net proceeds from exercise of stock options 180 39
-------- -------
Net cash used by financing activities (2,590) (133)
-------- -------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (791) (2,830)
Cash and cash equivalents at beginning of period 1,090 4,666
-------- -------
Cash and cash equivalents at end of period $ 299 $ 1,836
======== =======
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 179 $ 20
Income taxes $ 90 $ 130
======== =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:
During the June 1997 quarter, a capital lease obligation of $22,000 was incurred
for a new vehicle.
On June 27, 1996, the Board of Directors entered into an agreement to purchase
138,000 shares of the Company's common stock held by Martin W. Greenwald, the
Company's Chairman and Chief Executive Officer for $802,000. At June 30, 1996
the transaction was recorded as a reduction to common stock and an increase to
accounts payable and accrued liabilities.
See accompanying notes to consolidated financial statements
-5-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION.
The accompanying consolidated financial statements as of and for the three
months ended June 30, 1997 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 June 30, 1997 and the related
consolidated statements of operations and cash flows for the three-month periods
ended June 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 three months ended June 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 receivables, royalties 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 three months ended June 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
-6-
<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 June 30, 1997 and March 31, 1997 are summarized as follows:
<TABLE>
<CAPTION>
June 30, March 31,
(In thousands) 1997 1997
-------- ---------
<S> <C> <C>
Optical disc inventory, net $15,807 $16,200
Production costs, net 1,654 1,576
------- -------
$17,461 $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 laserdisc inventory of $3,571 and $3,070 at June 30,
1997 and March 31, 1997, respectively.
Production costs are net of accumulated amortization of $5,085 and $5,011 at
June 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.
-7-
<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 three months ended June 30, 1997, the calculation of net loss per share
did not include common share equivalents (stock options and warrants) as their
effect would be antidilutive. The modified treasury stock method was applied in
determining net income per share for the three months ended June 30, 1996.
Fully diluted net income per share was not presented for the periods ended June
30, 1997 and 1996 since the amounts did not differ significantly from the
primary net income per share.
The following table sets forth the calculation of net income per share for the
quarters ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
---- ----
<S> <C> <C>
As Presented
------------
Net income (loss) $ (191) $ 606
------- -------
Adjustment
----------
Add: interest income on assumed investment
in U.S. government securities, net of taxes - 89
------- -------
As Adjusted
-----------
Net income (loss) $ (191) $ 695
======= =======
Weighted average common shares and
common share equivalents outstanding:
Common shares 13,431 13,723
Common stock options and warrants - 2,310
------- -------
13,431 16,033
======= =======
Net income (loss) per share $ (.01) $.04
======= =======
</TABLE>
-8-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------
NOTE 5. REVOLVING CREDIT FACILITY.
In December 1996, the Company entered into a Loan Agreement (the "Agreement")
with Union Bank. The Agreement provides for revolving advances and the issuance
of standby letters of credit under a two-year, $20 million revolving credit
facility. Borrowings under the Agreement are at Union Bank's prime rate plus
.25% (8.75% at June 30, 1997). The Agreement provides the Company the option of
borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus
2.5% (8.19% at June 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 June 30, 1997,
$5,544,000 was outstanding under the Agreement, of which $3,000,000 was borrowed
under a one-month LIBOR option, and $1,497,000, net of amounts utilized for
outstanding letters of credit, was available for borrowing. The Agreement
requires the Company to comply with certain financial and operating covenants.
At June 30, 1997, the Company was in compliance with financial and operating
covenants or has received waivers of noncompliance from Union Bank. The
Agreement requires that compliance with certain covenants be measured at each
quarter-end. At September 30, 1997, management believes that the Company may
violate a covenant requirement that net income be maintained at $500,000
measured on a two-quarter consecutive average ("Net Income Covenant") as well as
a covenant which requires the Company to maintain minimum tangible net worth of
$18 million ("Tangible Net Worth Covenant"). Management believes that Union
Bank will grant waivers of noncompliance for such technical defaults, similar
to the waivers which the Company received at June 30, 1997. Management believes
that, based on the Company's expectation of seasonally stronger third and
fourth fiscal quarters, the Company will be in compliance with the Net Income
Covenant and Tangible Net Worth Covenant for the last two quarters of fiscal
1998. Should the Company fall into technical noncompliance with the Net Income
Covenant or Tangible Net Worth Covenant during the third and fourth quarters of
fiscal 1998, management believes that Union Bank will grant waivers of
noncompliance at that time.
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.
-9-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------
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 assets 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 June 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 June 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 which were met as of June 30, 1997. In the event that
the financial covenants within the Loan Agreement are violated, future
borrowings may be restricted.
Warehouse and Distribution Equipment Lease Facility.
- ---------------------------------------------------
At June 30, 1997 there were no borrowings outstanding under the Company's March
1997 $2.5 million warehouse and distribution equipment lease facility with
BankAmerica Leasing and Capital Corporation. The lease contains certain
quarterly financial and operating covenants which were met as of June 30, 1997.
NOTE 7. LIQUIDITY.
Working capital has historically been provided by cash flows from operations,
private sales of common stock, notes representing long-term debt and bank
borrowings. For the three months ended June 30, 1997, operating activities
provided cash and cash equivalents of $2,052,000, investing activities ,
consisting of capital expenditures, used cash and cash equivalents of $253,000
and financing activities, consisting primarily of repayments of borrowings, used
cash and cash equivalents of $2,590,000.
The following significant developments have caused management to grow concerned
that the Company's current sources of working capital may be insufficient to
fund working capital requirements in fiscal 1998, unless certain discretionary
licensing and capital investment programs are curtailed and additional sources
of working capital are secured:
. Suspension of $2.7 Million in Musicland Accounts Receivable. In February
-----------------------------------------------------------
1997, the Company's largest customer, Musicland, suspended payment
indefinitely on $2.7 million of outstanding accounts receivable. In May
1997, the suspended receivable aged past Union Bank's borrowing
eligibility requirement and accordingly, the Company's available
borrowings under its revolving line of credit with Union Bank were reduced
by approximately $2.2 million.
. The August 1997 Cancellation of an Escrow to Sell a Portion of Nevada
---------------------------------------------------------------------
Land. In August 1997, the Company's escrow to sell the front 8.8 acres of
----
its land in Las Vegas, Nevada was canceled by the prospective buyer.
-10-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------
. The March 1997 Introduction of DVD and its Impact on the Company's Results
--------------------------------------------------------------------------
of Operations. The introduction of DVD in March 1997 has, in the opinion
-------------
of management, negatively affected the Company's sales and cash flows due
to generally declining sales levels of laserdisc software and hardware.
. The July 1997 Chapter 11 Bankruptcy Filing of Alliance Entertainment Corp.
-------------------------------------------------------------------------
In July 1997, Alliance Entertainment Corp., one of the largest independent
distributors of pre-recorded music and the Company's second largest
customer during fiscal 1997, filed voluntarily to reorganize under Chapter
11 of the Bankruptcy Code. As a result of the filing, the Company's
available borrowings under its revolving line of credit with Union Bank
were reduced by approximately $400,000.
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 involves:
. 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 the commencement of construction of a proposed warehouse and
distribution facility in Las Vegas, Nevada; and
. 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 as
follows:
. MONETIZING A PORTION OF THE DELINQUENT MUSICLAND AND CAMELOT MUSIC
------------------------------------------------------------------
RECEIVABLES.
-----------
In July 1997, the Company entered into assignment agreements with two
different third-party investors whereby the Company assigned its right,
title and interest in and to the suspended $2.7 million in accounts
receivable due from Musicland and $372,000 in accounts receivable due from
Camelot Music, who filed Chapter 11 in August 1996, respectively.
The receivables were irrevocably assigned without recourse as to the
economic risk of Musicland or Camelot Music ultimate inability to pay.
The third-party investors purchased the receivables for cash at a
discount, in the case of Musicland, who has not filed Chapter 11
bankruptcy, and at a substantial discount, in the case of Camelot Music,
who has filed Chapter 11 bankruptcy. The combined amount forgone by the
Company as discounts were substantially less than it had previously
-11-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------
reserved as part of its allowance for doubtful receivables
at March 31, 1997, resulting in a recovery at June 30, 1997.
. OBTAINING ADDITIONAL 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 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.
Concurrent with the closing of the Business Loan Agreement, the Company
repaid a note payable from the January 1997 purchase of a portion of the
aforementioned Nevada land in the amount of $281,000 plus accrued interest
so as to provide security for the aforementioned Pioneer Citizens Bank
loan.
Management believes that the Company, through continued implementation of
sufficient elements of its Action Plan, will be able to meet its cash
requirements for fiscal 1998.
-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 March 1997, the Company began to distribute 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 an operating loss of $34,000 for the three months
ended June 30, 1997 versus operating income of $850,000 for the three months
ended June 30, 1996. The Company recorded a net loss of $191,000, or $.01 per
share, for the June 1997 quarter versus net income of $606,000, or $.04 per
share, for the June 1996 quarter.
In July 1997, Alliance Entertainment Corp. ("Alliance"), one of the
largest independent distributors of pre-recorded music and the Company's second
largest customer in fiscal 1997, filed for protection under Chapter 11 of the
Bankruptcy Code. Although the Company was substantially reserved for its
accounts receivable from Alliance, an additional provision was taken in the June
1997 quarter to reflect Alliance's bankruptcy filing. Also in July 1997,
Montgomery Ward, a mass merchandiser and new customer of the Company (for DVD
product since March 1997), filed for Chapter 11 protection, resulting in a
further increase in the provision for doubtful receivables at June 30, 1997.
These additional provisions for doubtful accounts were offset in full at June
30, 1997 by a recovery of previously reserved accounts receivable of Musicland
and Camelot Music. The Company assigned its delinquent Musicland and Camelot
Music accounts receivable to third-party investors. See "Liquidity and Capital
---
Resources."
Management believes that the financial difficulties experienced by several
of the Company's largest customers have adversely impacted the volume and
breadth of such customers' purchases of LD titles as well as their ability to
pay on a timely basis. Management also believes that speculation, anticipation
and uncertainty preceding and following the launch of the DVD format has
adversely impacted and may continue to adversely impact the LD marketplace. LD
hardware sales are substantially down from the prior fiscal year which
management believes adversely impacts the Company's sales of catalogue titles.
Management also believes that as a result of such customers' financial
difficulties as well as the introduction of the DVD format, certain of the
larger LD retailers are more cautious in their LD purchasing. Responding to the
current trend, the Company increased its provision for slow-moving LD inventory
by approximately $500,000 during the June 1997 quarter. See "Summary and
---
Outlook--Distressed Condition of the Retail Entertainment Software Market" and
- - "DVD and LD Outlook."
-13-
<PAGE>
THE THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1996
Net sales for the June 1997 quarter decreased 16.1% to $16,902,000 from
$20,146,000 for the June 1996 quarter. The June 1996 quarter's net sales
benefitted from MGM/UA hit releases such as GOLDENEYE, GET SHORTY and LEAVING
LAS VEGAS. There were no such MGM/UA releases in the June 1997 quarter. For
the June 1997 quarter, the Company generally experienced weaker net sales of its
new LD releases as well as weaker net sales of its catalogue programming as a
result of the aforementioned distressed condition of the retail entertainment
software market and uncertainty in the LD marketplace preceding and following
the launch of the DVD format. The Company released its first exclusive DVD
title in the June 1997 quarter and continues to sell DVD on a nonexclusive
basis. Net sales of DVD titles, primarily nonexclusive, for the June 1997
quarter were $1,442,000.
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 June 1997
quarter decreased to $14,049,000 from $15,981,000 for the June 1996 quarter. As
a percentage of net sales, cost of optical disc sales for the June 1997 quarter
increased to 83.1% from 79.3% for the June 1996 quarter. The margin
deterioration primarily reflects an increased provision for slow-moving LD
inventory for the June 1997 quarter. The sales mix of higher margin exclusive
product and lower-margin nonexclusive product (now including DVD sales) in the
June 1997 quarter was comparable to that of the June 1996 quarter. Nonexclusive
product sales for the June 1997 and 1996 quarters were approximately 25% of net
sales.
Selling expenses decreased 3.1% to $1,047,000 for the June 1997 quarter
from $1,081,000 for the June 1996 quarter. As a percentage of net sales,
selling expenses for the June 1997 quarter increased to 6.2% from 5.4% for the
June 1996 quarter. During the June 1997 quarter, the Company incurred higher
freight costs, as a percentage of net sales, resulting from an increase in
freight rates from the Company's freight carrier and higher expenses resulting
from changing the publishing frequency of U.S. Laser's LASERVIEWS magazine from
bimonthly to 10 issues a year offset, in part, by reduced market development
funds offered to customers.
General and administrative expenses decreased 31.0% to $1,009,000 for the
June 1997 quarter from $1,462,000 for the June 1996 quarter. As a percentage of
net sales, general and administrative expenses for the June 1997 quarter
decreased to 6.0% from 7.3% for the June 1996 quarter. The decrease is
attributable to a recovery of previously reserved accounts receivable from
Musicland and Camelot Music, offset in part, by additional provisions for
doubtful accounts receivable from Alliance and Montgomery Ward. See "Liquidity
and Capital Resources" regarding the Company's assignment of certain Musicland
and Camelot Music accounts receivable. Additionally, the Company incurred
higher legal, accounting and depreciation expenses in the June 1997 quarter
versus the June 1996 quarter.
-14-
<PAGE>
Amortization of production costs for the June 1997 quarter increased 7.6%
to $831,000 from $772,000 for the June 1996 quarter. As a percentage of net
sales, amortization of production costs for the June 1997 quarter increased to
4.9% from 3.8% for the June 1996 quarter. The increase is primarily due to more
exclusive titles 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 June 1997 quarter was $203,000, a substantial
increase over $26,000 for the June 1996 quarter. Interest income for the June
1997 quarter decreased to $46,000 from $95,000 for the June 1996 quarter. The
Company had higher borrowings outstanding and less cash invested during the June
1997 quarter versus the June 1996 quarter.
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 representing long-term debt and
bank borrowings. For the three months ended June 30, 1997, operating activities
provided cash and cash equivalents of $2,052,000, investing activities,
consisting of capital expenditures, used cash and cash equivalents of $253,000
and financing activities, consisting primarily of repayments of bank borrowings,
used cash and cash equivalents of $2,590,000, resulting in a net decrease in
cash and cash equivalents of $791,000.
THE COMPANY'S LIQUIDITY POSITION AT JUNE 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 and excluding construction and
equipment lending facilities). 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).
The following significant developments have caused management to grow
concerned that the Company's current sources of working capital may be
insufficient to fund working capital requirements in fiscal 1998, unless certain
discretionary licensing and capital investment programs are curtailed and
additional sources of working capital are secured:
-15-
<PAGE>
. Suspension of $2.7 Million in Musicland Accounts Receivable. In February
-----------------------------------------------------------
1997, the Company's largest customer, Musicland, suspended payment
indefinitely on $2.7 million of outstanding accounts receivable. In May
1997, the suspended receivable aged past Union Bank's borrowing eligibility
requirement and accordingly, the Company's available borrowings under its
revolving line of credit with Union Bank were reduced by approximately $2.2
million.
. The August 1997 Cancellation of an Escrow to Sell a Portion of Nevada
---------------------------------------------------------------------
Land. In August 1997, the Company's escrow to sell the front 8.8 acres of
----
its land in Las Vegas, Nevada was canceled by the prospective buyer.
. The March 1997 Introduction of DVD and its Impact on the Company's Results
--------------------------------------------------------------------------
of Operations. The introduction of DVD in March 1997 has, in the opinion
-------------
of management, negatively affected the Company's sales and cash flows due
to generally declining sales levels of LD software and hardware.
. The July 1997 Chapter 11 Bankruptcy Filing of Alliance Entertainment Corp.
------------------------------------------------------------------------
In July 1997, Alliance Entertainment Corp., one of the largest independent
distributors of pre-recorded music and the Company's second largest
customer during fiscal 1997, filed voluntarily to reorganize under Chapter
11 of the Bankruptcy Code. As a result of the filing, the Company's
available borrowings under its revolving line of credit with Union Bank
were reduced by approximately $400,000.
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 involves:
. 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 the commencement of construction of a proposed warehouse and
distribution facility in Las Vegas, Nevada; and
. 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
as follows:
-16-
<PAGE>
. MONETIZING A PORTION OF THE DELINQUENT MUSICLAND AND CAMELOT MUSIC
------------------------------------------------------------------
RECEIVABLES.
-----------
In July 1997, the Company entered into assignment agreements with two
different third-party investors whereby the Company assigned its right,
title and interest in and to the suspended $2.7 million in accounts
receivable due from Musicland and $372,000 in accounts receivable due from
Camelot Music, who filed Chapter 11 in August 1996, respectively.
The 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 a discount,
in the case of Musicland, who has not filed Chapter 11 bankruptcy, and a
substantial discount, in the case of Camelot Music, who has filed Chapter
11 bankruptcy. The combined amount forgone by the Company as discounts
were substantially less than it had previously reserved as part of its
allowance for doubtful receivables at March 31, 1997, resulting in a
recovery at June 30, 1997.
. OBTAINING ADDITIONAL 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 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.
Concurrent with the closing of the Business Loan Agreement, the Company
repaid a note payable from the January 1997 purchase of a portion of the
aforementioned Nevada land in the amount of $281,000 plus accrued interest
so as to provide security for the aforementioned Pioneer Citizens Bank
loan.
At July 31, 1997, the Company had cash and cash equivalents of $1,257,000,
outstanding borrowings of $4,350,000 and available borrowings of $966,000, net
of amounts utilized for outstanding letters of credit (under its revolving
credit and business loan facilities and excluding its construction and equipment
lending facilities).
Management believes that the Company, through continued implementation of
sufficient elements of its Action Plan, will be able to meet its cash
requirements for fiscal 1998.
BANKING ACTIVITIES.
------------------
Revolving Credit Facility. In December 1996, the Company entered into
a Loan Agreement (the "Agreement") with Union Bank. The Agreement provides for
revolving advances and the issuance of standby letters of credit under a two-
year, $20 million revolving credit facility. Borrowings under the Agreement are
at
-17-
<PAGE>
Union Bank's prime rate plus .25% (8.75% at June 30, 1997). The Agreement
provides the Company the option of borrowing for fixed periods at the London
Interbank Offered Rate ("LIBOR") plus 2.5% (8.19% at June 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 June 30, 1997,
$5,544,000 was outstanding under the Agreement, of which $3,000,000 was borrowed
under a one-month LIBOR option, and $1,497,000, net of amounts utilized for
outstanding letters of credit, was available for borrowing. The Agreement
requires the Company to comply with certain financial and operating covenants.
At June 30, 1997, the Company was in compliance with financial and operating
covenants or has received waivers of noncompliance from Union Bank. The
Agreement requires that compliance with certain covenants be measured at each
quarter-end. At September 30, 1997, management believes that the Company may
violate a covenant requirement that net income be maintained at $500,000
measured on a two-quarter consecutive average ("Net Income Covenant") as well as
a covenant which requires the Company to maintain minimum tangible net worth of
$18 million ("Tangible Net Worth Covenant"). Management believes that Union
Bank will grant waivers of noncompliance for such technical defaults, similar
to the waivers which the Company received at June 30, 1997. Management believes
that, based on the Company's expectation of seasonally stronger third and
fourth fiscal quarters, the Company will be in compliance with the Net Income
Covenant and Tangible Net Worth Covenant for the last two quarters of fiscal
1998. Should the Company fall into technical noncompliance with the Net Income
Covenant or Tangible Net Worth Covenant during the third and fourth quarters of
fiscal 1998, management believes that Union Bank will grant waivers of
noncompliance at that time.
At June 30, 1997, the Company had $2.5 million of outstanding letters of credit
issued by Union Bank which expire on November 15, 1997. 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 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 assets 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 June 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 June 30, 1997,
$400,000 in borrowings were outstanding under the
-18-
<PAGE>
Construction Line. The Loan Agreement requires the Company to comply with
certain quarterly financial and operational covenants which were met as of June
30, 1997. In the event that the financial covenants within the Loan Agreement
are violated, future borrowings may be restricted.
Warehouse and Distribution Equipment Lease Facility. At June 30, 1997,
there were no borrowings outstanding under the Company's March 1997 $2.5 million
warehouse and distribution equipment lease facility with BankAmerica Leasing and
Capital Corporation. The lease contains certain quarterly financial and
operating covenants which were met as of June 30, 1997.
Additional Financing. See "Liquidity and Capital Resources--The
---
Company's Liquidity Position at June 30, 1997 and Management's Assessment of the
Company's Liquidity Position in Fiscal 1998" regarding the details of additional
financing obtained.
OTHER ITEMS.
-----------
On August 8, 1997, the Company reached an agreement in principle with
Warner Home Video pursuant to which the Company will exclusively distribute on
laserdisc Warner Home Video's new release titles and library of existing titles.
The parties contemplate entering into a definitive agreement which will include,
among other provisions, a five-year term and the undertaking by Image of all
post-production, creative services, manufacturing, marketing and sales efforts
relating to Warner Home Video's laserdisc programming.
Concurrent with the Warner Home Video laserdisc agreement, the Company
entered into a five-year manufacturing agreement with WEA Manufacturing Inc.,
d/b/a Warner Advanced Media Operations ("WAMO"), an affiliate of Warner Home
Video, pursuant to which the Company will replicate its licensed DVD product
exclusively with WAMO to the extent the Company has the right to control where
the DVDs are replicated.
At June 30, 1997 and including a distribution fee commitment under the
aforementioned August 8, 1997 Warner Home Video laserdisc agreement, the Company
had future license obligations for royalty advances, minimum guarantees and
other fees of $4.7 million due during fiscal 1998, $8.5 million due during
fiscal 1999 and $6.3 million 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 June 30, 1997 and Management's Assessment of the Company's Liquidity
Position in Fiscal 1998," the Company is currently seeking to resolve short-term
liquidity constraints during fiscal 1998. The Company's longer-term operating
cash flow and liquidity will be dependent on 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")
-19-
<PAGE>
combination player and management's belief of its positive affect on catalogue
LD sales and the overall strengthening of the retail entertainment software
market.
DISTRESSED CONDITION OF THE RETAIL ENTERTAINMENT SOFTWARE MARKET.
Late in calendar 1995, the dedicated entertainment software retail sector
entered a period of declining sales growth and deteriorating profitability.
Management believes that several factors contributed to this trend including,
most significantly, a general softness in consumer demand for music product,
over expansion in the number of retail outlets and the competitive impact of
mass merchants (such as Wal-Mart) and other discounters (such as Best Buy) on
the dedicated entertainment software retailers. This economic slump accelerated
throughout calendar 1996 and is continuing in calendar 1997 as many of the
larger dedicated entertainment software retailers reported worsening financial
results, store closing programs, violations of bank financing covenants and
constrained cash positions. As a result, throughout calendar 1996 and early
calendar 1997, the Company took steps to mitigate its exposure to bad debts and
product returns from troubled retailers, such as exercising more discretion
over product shipments and carefully monitoring accounts receivable status. In
August 1996, Camelot Music, a large customer of the Company, filed Chapter 11
bankruptcy and, in February 1997, Musicland, the Company's largest customer,
indefinitely suspended payments on outstanding amounts owing to its trade
vendors. In July 1997, Alliance Entertainment Corp., one of the largest
independent distributors of pre-recorded music and the Company's second largest
customer, and mass merchandiser Montgomery Ward, who carried DVD programming,
also filed Chapter 11 bankruptcies. Management is continually estimating the
net realizable value of the Company's accounts receivables and recording
appropriate reserves to reflect such estimates. Actual results could differ
from these estimates.
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 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.
-20-
<PAGE>
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.
The Company has recently entered into several exclusive DVD license
agreements. The Company plans to release, under its April 1997 exclusive
license agreement with Orion Home Video, some of the best-selling home video
titles of the past decade, including DANCES WITH WOLVES, SILENCE OF THE LAMBS
and ROBOCOP. During the June 1997 quarter, the Company released its first
exclusive DVD title under its February 1997 Playboy exclusive DVD license
agreement and plans to release at least 20 Playboy DVD titles by the end of
fiscal 1998. In May 1997, the Company exclusively licensed, from Central Park
Media, Japanese animation titles, known as "aanime," which have a devoted
following of avid fans and collectors. In addition, the Company has acquired
exclusive DVD rights to a number of individual titles. The Company plans to
release diverse programming such as Arnold Schwarzenegger's original THE
TERMINATOR, TINA TURNER'S: WILDEST DREAMS concert and Stephen Sondheim's award-
winning musical INTO THE WOODS this fall. 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.
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,"
-21-
<PAGE>
"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) management's ability to
implement sufficient elements of its "Action Plan" (as defined in "Liquidity and
Capital Resources"); (v) ultimate construction of the Las Vegas, Nevada
warehouse and distribution facility; (vi) ability to continue restructuring
payment terms with the Company's licensors, product suppliers and other vendors,
if needed; (vii) receiving waivers from the Company's lenders on future
noncompliance of loan covenants; (viii) seeking investment opportunities in
growth-oriented companies and securing necessary acquisition financing; (ix) 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; and (x) the estimated number of exclusive DVD releases for
fall and the remainder of the fiscal year. 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 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.
-22-
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The consolidated financial statements as of June 30, 1997 and for the
three-month periods ended June 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.
-23-
<PAGE>
INDEPENDENT AUDITORS' REVIEW REPORT
-----------------------------------
The Board of Directors
Image Entertainment, Inc.
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. as of June 30, 1997, and the related condensed consolidated
statements of operations and cash flows for the three-month periods ended June
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
August 6, 1997
-24-
<PAGE>
PART II - OTHER INFORMATION
==============================================================================
<TABLE>
<CAPTION>
<C> <S>
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.
---------------------------------------------------
Not Applicable
ITEM 5. OTHER INFORMATION.
-----------------
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page 1
(b) Reports on Form 8-K
None
</TABLE>
-25-
<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: August 12, 1997 By: /S/ MARTIN W. GREENWALD
-----------------------
Martin W. Greenwald
Chairman of the Board,
Chief Executive Officer,
President and Treasurer
Date: August 12, 1997 By: /S/ JEFF M. FRAMER
------------------
Jeff M. Framer
Chief Financial Officer
-26-
<PAGE>
EXHIBIT INDEX
================================================================================
Exhibit No. Description
- --------------------------------------------------------------------------------
15* Letter re unaudited interim financial information.
27* Financial Data Schedule.
* EXHIBIT(S) NOT PREVIOUSLY FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION.
-i-
<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 August 6, 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
August 6, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q JUNE
30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 299
<SECURITIES> 0
<RECEIVABLES> 13,600
<ALLOWANCES> 4,281
<INVENTORY> 17,461
<CURRENT-ASSETS> 0<F1>
<PP&E> 11,865
<DEPRECIATION> 4,187
<TOTAL-ASSETS> 43,078
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 17,822
<OTHER-SE> 242
<TOTAL-LIABILITY-AND-EQUITY> 43,078
<SALES> 16,902
<TOTAL-REVENUES> 16,902
<CGS> 14,049
<TOTAL-COSTS> 14,049
<OTHER-EXPENSES> 831
<LOSS-PROVISION> (252)
<INTEREST-EXPENSE> 203
<INCOME-PRETAX> (191)
<INCOME-TAX> 0
<INCOME-CONTINUING> (191)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (191)
<EPS-PRIMARY> (.01)
<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>
