<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 DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 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 of (I.R.S. Employer
incorporation or organization) 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 February 5,
1997: 13,114,773
<PAGE>
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PART I - FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. FINANCIAL STATEMENTS.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and March 31, 1996
================================================================================
ASSETS
<TABLE>
<CAPTION>
December 31, 1996 March 31, 1996
------------------ --------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,131,623 $ 4,665,942
Accounts receivable, net of allowances of
$4,642,000 - December 31, 1996;
$3,183,000 - March 31, 1996 14,661,504 13,333,372
Inventories 19,612,382 15,275,693
Royalty, distribution fee and license fee advances 10,088,053 3,169,444
Prepaid expenses and other assets 811,050 982,006
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$3,747,178 - December 31, 1996;
$3,145,347 - March 31, 1996 7,244,954 1,979,211
----------- -----------
$53,549,566 $39,405,668
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
-1-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and March 31, 1996
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31, 1996 March 31, 1996
------------------ ---------------
(unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $19,299,804 $13,606,541
Accrued royalties, distribution fees and license fees 5,062,816 5,273,698
Revolving credit facility 8,623,685 --
Note payable 949,628 --
----------- -----------
Total liabilities 33,935,933 18,880,239
----------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, 3,365,385 shares
authorized; none issued and outstanding -- --
Common stock, no par value, 25,000,000 shares
authorized; 13,387,239 and 13,556,160 issued
and outstanding at December 31, 1996 and
March 31, 1996, respectively 18,813,582 21,121,582
Stock warrants (97,500) (233,401)
Additional paid-in capital 3,064,129 3,064,129
Accumulated deficit (2,166,578) (3,426,881)
----------- -----------
Net shareholders' equity 19,613,633 20,525,429
----------- -----------
$53,549,566 $39,405,668
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
-2-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Three Months Ended December 31, 1996 and 1995
================================================================================
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Net Sales $24,947,656 $28,071,730
Operating Costs and Expenses:
Cost of laserdisc sales 19,749,866 21,899,417
Selling expenses 1,142,850 1,340,016
General and administrative expenses 2,173,289 1,474,383
Amortization of production costs 794,347 687,680
----------- -----------
23,860,352 25,401,496
----------- -----------
Operating Income 1,087,304 2,670,234
Other Expenses (Income):
Interest expense 118,038 43,798
Interest income (44,257) (70,762)
Other 662,193 --
----------- -----------
735,974 (26,964)
----------- -----------
Income Before Income Taxes and Extraordinary Item 351,330 2,697,198
Income Taxes 50,000 269,800
----------- -----------
Income Before Extraordinary Item 301,330 2,427,398
Extraordinary Item -- Costs Associated with
Early Retirement of Debt, Net of Taxes 143,308 --
----------- -----------
Net Income $ 158,022 $ 2,427,398
=========== ===========
Net Income per Share (Note 4):
Income before extraordinary item $ .02 $ .15
Extraordinary item - costs associated with
early retirement of debt, net of taxes (.01) --
----------- -----------
Net Income per Share $ .01 $ .15
=========== ===========
Weighted Average Shares Outstanding (Note 4) 13,912,782 17,648,555
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
-3-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Nine Months Ended December 31, 1996 and 1995
================================================================================
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Net Sales $62,855,934 $72,207,892
Operating Costs and Expenses:
Cost of laserdisc sales 49,581,725 56,778,266
Selling expenses 3,457,693 3,251,060
General and administrative expenses 4,988,616 3,834,869
Amortization of production costs 2,307,550 2,115,785
----------- -----------
60,335,584 65,979,980
----------- -----------
Operating Income 2,520,350 6,227,912
Other Expenses (Income):
Interest expense 226,106 123,013
Interest income (188,560) (228,157)
Other 662,193 --
----------- -----------
699,739 (105,144)
----------- -----------
Income Before Income Taxes and Extraordinary Item 1,820,611 6,333,056
Income Taxes 417,000 645,000
----------- -----------
Income Before Extraordinary Item 1,403,611 5,688,056
Extraordinary Item - Costs Associated
with Early Retirement of Debt, Net of Taxes 143,308 --
----------- -----------
Net Income $ 1,260,303 $ 5,688,056
=========== ===========
Net Income per Share (Note 4):
Income before extraordinary item $ .10 $ .36
Extraordinary item - costs associated with early
retirement of debt, net of taxes (.01) --
----------- -----------
Net Income per Share $ .09 $ .36
=========== ===========
Weighted Average Shares Outstanding (Note 4) 14,082,969 17,915,265
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
-4-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Nine Months Ended December 31, 1996 and 1995
================================================================================
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,260,303 $ 5,688,056
Adjustments to reconcile net income
to net cash (used) provided by operating activities:
Amortization of production costs 2,307,550 2,115,785
Depreciation and other amortization 629,924 655,536
Amortization of stock warrants 135,901 261,454
Provision for doubtful accounts 1,154,017 60,715
Loss on disposition of assets 25,588 --
Changes in assets and liabilities associated
with operating activities, net of acquired business:
Accounts receivable (2,482,149) (1,671,029)
Laserdisc inventory (4,274,978) 818,619
Royalty, distribution and license fee
advances, net (6,918,609) 232,301
Production cost expenditures (2,369,261) (2,267,202)
Prepaid expenses and other assets 162,412 (67,206)
Accounts payable, accrued royalties, distribution
fees, license fees and liabilities 5,482,380 1,861,816
----------- -----------
Net cash (used) provided by operating activities (4,886,922) 7,688,845
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (4,963,082) (395,190)
Acquisition of business, less cash acquired -- (3,071,580)
----------- -----------
Net cash used by investing activities (4,963,082) (3,466,770)
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements
-5-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(unaudited)
For the Nine Months Ended December 31, 1996 and 1995
================================================================================
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 42,173,375 $ 27,767,677
Repayment of advances under revolving credit facility (33,549,690) (27,652,937)
Principal payments under capital lease obligations -- (103,358)
Repurchase of common stock (2,356,538) (4,297,243)
Net proceeds from exercise of stock options 48,538 265,416
------------ ------------
Net cash provided (used) by financing activities 6,315,685 (4,020,445)
------------ ------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (3,534,319) 201,630
Cash and cash equivalents at beginning of period 4,665,942 2,187,063
------------ ------------
Cash and cash equivalents at end of period $ 1,131,623 $ 2,388,693
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 152,256 $ 139,790
Income taxes $ 668,000 $ 138,000
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
In November 1996, the Company purchased 16.5 acres of unimproved real property
in Las Vegas, Nevada for approximately $4 million. The Company issued a note
payable for $949,628 as part of the consideration.
See accompanying notes to consolidated financial statements
-6-
<PAGE>
Notes to Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION.
The accompanying consolidated financial statements as of and for the periods
ended December 31, 1996 and 1995 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 December 31, 1996 and the related
consolidated statements of operations and cash flows for the periods ended
December 31, 1996 and 1995 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 December 31, 1996 and 1995 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, 1996 Form 10-K.
Certain fiscal 1996 amounts have been reclassified to conform with the fiscal
1997 presentation.
Acquisition. The consolidated statements of operations for the periods ended
- -----------
December 31, 1996 and 1995 included the operating results of the Company's
wholly-owned subsidiary U.S. Laser Video Distributors, Inc. ("U.S. Laser").
Operating results of U.S. Laser were included for the entire three-month periods
ended December 31, 1996 and 1995, respectively, as well as the nine-month period
ended December 31, 1996. Operating results of U.S. Laser were included for the
nine-month period ended December 31, 1995 commencing on the June 8, 1995
acquisition of U.S. Laser.
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
pending introduction of the new Digital Video Disc ("DVD") format and its affect
on consumers and hardware and software retailers; (ii) general economic
conditions affecting entertainment software retailers; (iii) general economic
conditions affecting consumer demand and buying habits for laserdisc hardware
and software; (iv) the Company's marketing and promotional activities; (v) the
Company's rights acquisition activities; and, (vi) the extension, termination or
non-renewal of existing license and distribution rights. The results of
operations for the periods ended December 31, 1996 are not necessarily
indicative of the results to be expected for the entire fiscal year ending March
31, 1997.
-7-
<PAGE>
Notes to Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
NOTE 2. INVENTORIES.
Inventories at December 31, 1996 and March 31, 1996 are summarized as follows:
<TABLE>
<CAPTION>
December 31, March 31,
1996 1996
------------ -----------
<S> <C> <C>
Laserdisc inventory $18,231,254 $13,956,276
Production costs, net 1,381,128 1,319,417
----------- -----------
$19,612,382 $15,275,693
=========== ===========
</TABLE>
Production costs are net of accumulated amortization of $4,943,820 and
$4,941,715 at December 31, 1996 and March 31, 1996, respectively.
NOTE 3. INCOME TAXES.
Income taxes for the periods ended December 31, 1996 were computed using the
effective tax rate estimated to be applicable for the full fiscal year ending
March 31, 1997, which is subject to ongoing review and evaluation by management.
A portion of Federal income taxes for the periods ended December 31, 1996 was
offset by the utilization of net operating loss carryforwards.
NOTE 4. NET INCOME PER SHARE.
Net income per share is 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 reflected
in net income per share is 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.
Under the modified treasury stock method, net income per share is 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 to
reduce any outstanding long-term debt and, if any proceeds remain thereafter,
such proceeds are 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 is
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.
The treasury stock method was used to determine net income per share for the
periods ended December 31, 1996, and the modified treasury stock method was used
to determine net income per share for the periods ended December 31, 1995.
-8-
<PAGE>
Notes to Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Fully diluted net income per share is not presented for the periods ended
December 31, 1996 and 1995 since the amounts do not differ significantly from
the primary net income per share.
The following table sets forth the calculation of net income per share for the
periods ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
Three months Three months Nine months Nine months
ended ended ended ended
December 31, December 31, December 31, December 31,
1996 1995 1996 1995
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
As Presented
- ------------
Income before extraordinary
item $ 301,330 $ 2,427,398 $ 1,403,611 $ 5,688,056
Extraordinary item, net of
taxes 143,308 -- 143,308 --
----------- ----------- ----------- -----------
Net income 158,022 2,427,398 1,260,303 5,688,056
----------- ----------- ----------- -----------
Adjustments
- -----------
Add: reduction of interest expense
on assumed reduction of debt,
net of taxes -- 24,557 -- 58,957
Add: interest income on assumed
investment in U.S. government
securities, net of taxes -- 244,322 -- 768,578
----------- ----------- ----------- -----------
Adjustment to income before
extraordinary item and net
income -- 268,879 -- 827,535
----------- ----------- ----------- -----------
As Adjusted
- -----------
Income before
extraordinary item 301,330 2,696,277 1,403,611 6,515,591
Extraordinary item, net of
taxes 143,308 -- 143,308 --
----------- ----------- ----------- -----------
Net income $ 158,022 $ 2,696,277 $ 1,260,303 $ 6,515,591
=========== =========== =========== ===========
Weighted average common
shares and common share
equivalents outstanding:
Common shares 13,501,048 13,346,766 13,617,165 13,574,462
Common stock options
and warrants 411,734 4,301,789 465,804 4,340,803
----------- ----------- ----------- -----------
13,912,782 17,648,555 14,082,969 17,915,265
=========== =========== =========== ===========
Net income per share:
Income before
extraordinary item $ .02 $ .15 $ .10 $ .36
Extraordinary item, net of taxes (.01) -- (.01) --
----------- ----------- ----------- -----------
Net income per share $ .01 $ .15 $ .09 $ .36
=========== =========== =========== ===========
</TABLE>
-9-
<PAGE>
Notes to Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
NOTE 5. PURCHASE OF NEVADA REAL PROPERTY.
In November 1996, the Company purchased approximately 16.5 acres of unimproved
real property adjacent to McCarran International Airport in Las Vegas, Nevada.
The purchase price of the property was approximately $4 million consisting of
approximately $3,050,000 in cash and a note payable of $949,628 secured by a
bank letter of credit. The purchase price is reflected as a component of
property, equipment and improvements in the accompanying consolidated balance
sheet at December 31, 1996. The note was repaid in January 1997 and the letter
of credit securing the note was canceled.
Approximately $725,000 of costs incurred to date relating to the design,
engineering and planning of the construction of the Nevada warehouse and
distribution facility is reflected as a component of property, equipment and
improvements in the accompanying consolidated balance sheet at December 31,
1996.
NOTE 6. REVOLVING CREDIT FACILITY.
In December 1996, the Company entered into a Loan Agreement (the "Agreement")
with Union Bank of California. 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 the bank's
prime rate plus .25% (8.5% at December 31, 1996). The Agreement provides the
Company the option of borrowing for fixed periods at the London Interbank
Offered Rate plus 2.5%.
Borrowings under the Agreement are secured by substantially all of the Company's
assets. Funds available for borrowing may not exceed the borrowing base
specified in the Agreement. At December 31, 1996, $8,623,685 was outstanding
under the Agreement and approximately $4,230,000, net of amounts utilized for
outstanding letters of credit, was available for borrowing. The Agreement
requires the Company to comply with certain financial and operational covenants.
At December 31, 1996, the Company was in compliance with all covenants.
Concurrent with the signing of the Agreement, the Company early-terminated its
three-year $15 million Loan and Security Agreement with Foothill Capital
Corporation which was due to expire on November 15, 1997. The accelerated
amortization of deferred financing costs and penalty resulting from the early
retirement of debt totaled $183,308 of which $40,808 represented a noncash
charge. The extraordinary charge is recorded net of taxes of $40,000 for the
periods ended December 31, 1996.
NOTE 7. DEFAULT OF NOTES RECEIVABLE.
On December 31, 1990, the Company entered into a Purchase and Sale Agreement
with LEI Partners, L.P., a California Limited Partnership ("LEI"), pursuant to
which the Company sold all of the assets of its adult laserdisc licensing and
distribution business for $3,828,600 (the "LEI Agreement"). The purchase price
consisted of $300,000 cash, a $1,328,600 note ("Note A") and a $2,200,000 note
("Note B").
On December 31, 1995, LEI defaulted on a $581,600 principal payment due under
Note A and breached the LEI Agreement. As a result of the default, the unpaid
balances of Notes A and B became immediately due and payable.
-10-
<PAGE>
Notes to Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
On February 1, 1996, the Company and LEI entered into a Settlement and
Forbearance Agreement ("Settlement Agreement") to resolve the dispute between
the Company and LEI related to LEI's default and breach. Under the Settlement
Agreement, LEI was able to satisfy obligations otherwise owing under Note A by
making the payments specified in the Settlement Agreement. Contingent upon and
subsequent to LEI's full performance of all of its obligations under the
Settlement Agreement, the remaining principal balance due under Note B would be
discharged in full.
In the event of default (as defined in the Settlement Agreement), including but
not limited to LEI's failure to make all or any one of the scheduled payments
when due, all of the terms and conditions of the Settlement Agreement would be
automatically revoked, the terms and conditions of the LEI Agreement and Notes A
and B would be automatically and immediately reinstated, and the unpaid balances
of Notes A and B would be immediately due and payable.
In November and December 1996 and January 1997, LEI defaulted on scheduled
principal payments due under the Settlement Agreement causing automatic
reinstatement of the LEI Agreement and Notes A and B.
At December 31, 1996, principal and interest due under Note A was approximately
$852,000 and $14,000, respectively, and under Note B was approximately
$1,791,000 and $1,664,000, respectively. The Company is contemplating legal
action to enforce its rights under the LEI Agreement. At December 31, 1996, the
Company's receivable from LEI was fully reserved.
NOTE 8. ACQUISITION EXPENSES.
In December 1996, the Company terminated its negotiations for the acquisition of
Essex Entertainment, Inc., a privately-held independent music company
headquartered in New Jersey. As a result, the Company recorded a nonrecurring
charge of $662,193 consisting primarily of legal and accounting fees. This
nonrecurring charge is reflected as other expense in the accompanying
consolidated statements of operations for the periods ended December 31, 1996.
NOTE 9. SUBSEQUENT EVENT.
On February 6, 1997, Musicland, the Company's largest customer, informed the
Company that it was suspending, indefinitely, payment on all outstanding amounts
owing to its trade vendors, which include the Company and several major
entertainment companies. At February 6, 1997, the total accounts receivable from
Musicland was approximately $3.2 million. The Company has provided a reserve at
December 31, 1996 consistent with management's estimate of the ultimate
collectibility of the $3.2 million. Musicland has asked the Company to continue
shipping product on expedited payment terms. The Company is currently
considering the request. Management is continually estimating the net realizable
value of the Company's accounts receivable with Musicland and will record
appropriate reserves to reflect any change in such estimates. See -- Summary and
Outlook for additional discussion on the softness in the retail entertainment
software market.
-11-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS.
---------------------
GENERAL
Since 1983, the Company has distributed a broad range of programming on
laserdisc for home viewing. The Company generally enters into license
agreements whereby it acquires the exclusive right to manufacture and distribute
laserdisc programming. In addition, the Company acts as an exclusive and
nonexclusive wholesale distributor of laserdisc programming.
RESULTS OF OPERATIONS
The Company's net sales for the three and nine months ended December 31,
1996 decreased 11.1% and 13.0%, respectively, over the comparable prior-year
periods. Operating income decreased 59.3% to $1,087,304 and 59.5% to $2,520,350
for the three and nine months ended December 31, 1996, respectively, from
$2,670,234 and $6,227,912 for the comparable prior-year periods. During the
three and nine months ended December 31, 1996, the Company recorded nonrecurring
charges totaling approximately $650,000, net of taxes, or $.05 per share (for
both periods), relating to the write-off of acquisition expenses and costs
associated with early retirement of debt. Additionally, during the three and
nine months ended December 31, 1996, the Company significantly increased its
provision for doubtful accounts due to the Chapter 11 bankruptcy filing of
Camelot Music, the recent suspension by Musicland of payments owing to the
Company, as described below, and the continued softness in the retail
entertainment software market. For the three and nine months ended December 31,
1996, the provision for doubtful accounts, net of taxes, was approximately
$641,000, or $.05 per share, and $889,000, or $.06 per share, respectively,
versus approximately $26,000, or $.00 per share, and $55,000, or $.00 per share,
for the three and nine months ended December 31, 1995, respectively. Inclusive
of the nonrecurring charges and the increased provision for doubtful accounts,
net income decreased 93.5% to $158,022, or $.01 per share, and 77.8% to
$1,260,303, or $.09 per share, for the three and nine months ended December 31,
1996, respectively, from $2,427,398, or $.15 per share, and $5,688,056, or $.36
per share, for the three and nine months ended December 31, 1995, respectively.
The Company's effective tax rate for fiscal 1997 is estimated to be
approximately 23% versus approximately 10% for both the three and nine months
ended December 31, 1995.
On February 6, 1997, Musicland, the Company's largest customer, informed
the Company that it was suspending, indefinitely, payment on all outstanding
amounts owing to its trade vendors, which include the Company and several major
entertainment companies. At February 6, 1997, the total accounts receivable
from Musicland was approximately $3.2 million. The Company has provided a
reserve at December 31, 1996 consistent with management's estimate of the
ultimate collectibility of the $3.2 million. Musicland has asked the Company to
continue shipping product on expedited payment terms. The Company is currently
considering the request. Management is continually estimating the net
realizable value of the Company's accounts receivable with Musicland and will
record appropriate reserves to reflect any change in such estimates. See --
Summary and Outlook for additional discussion on the softness in the retail
entertainment software market.
THE THREE MONTHS ENDED DECEMBER 31, 1996 COMPARED TO THE THREE MONTHS ENDED
DECEMBER 31, 1995
Net sales for the December 1996 quarter decreased 11.1% to $24,947,656 from
$28,071,730 for the December 1995 quarter (a record quarter for net sales). The
release schedule for the December 1996 quarter was comparable to that of the
December 1995 quarter. The December 1996 quarter's
-12-
<PAGE>
release schedule included exclusive titles such as TOY STORY, THE ROCK and
POCAHONTAS. Comparatively, the December 1995 quarter release schedule included
exclusive titles such as CRIMSON TIDE, JUDGE DREDD, WHILE YOU WERE SLEEPING and
SHOWGIRLS. The Company's net sales of catalogue titles (previously released
laserdisc titles) in the December 1996 quarter were lower versus the December
1995 quarter. The weakness in the December 1996 quarter's catalogue net sales as
compared to the December 1995 quarter's catalogue net sales was primarily a
result of particularly strong December 1995 quarter catalogue sales of the THX
versions of STAR WARS, RETURN OF THE JEDI, and THE EMPIRE STRIKES BACK (packaged
individually and as the STAR WARS TRILOGY: THE DEFINITIVE COLLECTION).
Additionally, laserdisc hardware sales in calendar 1996 declined 40% from
calendar 1995, as reported by the Electronics Industry Association ("EIA").
Management believes the decline in laserdisc hardware sales was attributable to
the continued confusion and uncertainty in the laserdisc marketplace about the
pending introduction of the new 5-inch Digital Video Disc ("DVD") format and its
quality (versus laserdisc). Further, catalogue sales were negatively impacted by
continued softness in the retail entertainment software market. In the future,
the Company expects that net sales will continue to be affected by the
popularity of new releases, laserdisc hardware sales, the extent of the
Company's distribution of the DVD format, DVD's market penetration and the
prevailing economic environment.
Cost of laserdisc sales for the December 1996 quarter decreased to
$19,749,866 from $21,899,417 for the December 1995 quarter. As a percentage of
net sales, cost of laserdisc sales for the December 1996 quarter increased to
79.2% from 78.0% for the December 1995 quarter. The December 1996 quarter's
increase in cost of laserdisc sales as a percentage of net sales is attributable
to increased reserves for slower moving catalogue inventory and increased sales
of slower moving catalogue inventory at discounts higher than normally offered
to customers, all partially offset by laserdisc manufacturing cost savings due
to the comparative strength of the U.S. Dollar against the Japanese Yen.
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.
Lower-margin nonexclusive product sales, including lower-margin U.S. Laser sales
(U.S. Laser has substantially lower margins because it is solely a nonexclusive
distributor), accounted for approximately 20% of net sales for the December 1996
and 1995 quarters.
Selling expenses for the December 1996 quarter decreased 14.7% to
$1,142,850 from $1,340,016 for the December 1995 quarter. As a percentage of
net sales, selling expenses for the December 1996 quarter decreased to 4.6% from
4.8% for the December 1995 quarter. This decrease resulted primarily from the
lower expense for market development funds provided to customers partially
offset by expenses related to U.S. Laser's new retail concept store
"Digitainment," which opened in October 1996. To promote the laserdisc format
and take advantage of the continued delays in the introduction of the
anticipated DVD format, the Company expects to increase the level of
expenditures for market development and trade advertising as well as increase
its sales promotions for the fourth quarter of fiscal 1997 as compared to the
fourth quarter of fiscal 1996.
General and administrative expenses for the December 1996 quarter increased
47.4% to $2,173,289 from $1,474,383 for the December 1995 quarter. As a
percentage of net sales, general and administrative expenses for the December
1996 quarter increased to 8.7% from 5.3% for the December 1995 quarter. The
increase primarily resulted from an increase in the provision for doubtful
accounts partially offset by reduced performance-based executive bonuses and
reduced professional fees. The provision for doubtful accounts was $833,000 for
the December 1996 quarter versus $28,000 for the December 1995 quarter.
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Amortization of production costs for the December 1996 quarter increased
15.5% to $794,347 from $687,680 for the December 1995 quarter. As a percentage
of net sales, amortization of production costs for the December 1996 quarter
increased to 3.2% from 2.5% for the December 1995 quarter. The increase results
from 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 December 1996 quarter increased 169.5% to $118,038
from $43,798 for the December 1995 quarter. Interest income for the December
1996 quarter decreased 37.5% to $44,257 from $70,762 for the December 1995
quarter. The December 1996 quarter saw the utilization of cash and borrowings
under the Company's revolving credit facility to finance the purchase of 16.5
acres of real property in Las Vegas, Nevada as well as the repurchase of the
Company's common stock under the Company's stock repurchase program.
Other expense consists of a nonrecurring charge of $662,193 composed
primarily of legal and accounting fees relating to the acquisition of Essex
Entertainment, Inc., a privately-held independent music company headquartered in
New Jersey. Negotiations to acquire Essex Entertainment, Inc. terminated in
December 1996.
During the December 1996 quarter, the Company recorded an extraordinary
item charge of $143,308, net of related taxes of $40,000, associated with the
early retirement of debt. The Company refinanced its $15 million revolving
credit facility with Foothill Capital Corporation with a $20 million facility
from Union Bank of California. The charge related to a prepayment penalty paid
and amortization of deferred financing costs, accelerated as a result of the
early retirement ($40,808 represents noncash charges).
The effective income tax rate for the December 1996 quarter was
approximately 14%, the tax rate necessary to adjust the cumulative effective tax
rate for the nine months ended December 31, 1996 to approximately 23%, which is
the effective tax rate anticipated by the Company for the full fiscal year
ending March 31, 1997. The effective income tax rate for the December 1995
quarter was approximately 10%. Net operating loss carryforwards for Federal and
state tax purposes were utilized to offset taxable income for the December 1995
quarter. However, the net operating loss carryforward for state tax purposes
was fully utilized during fiscal 1996, and the Federal net operating loss
carryforward is expected to be fully utilized in fiscal 1997, which together
lead to a higher effective income tax rate for Federal and state tax purposes
for fiscal 1997.
THE NINE MONTHS ENDED DECEMBER 31, 1996 COMPARED TO THE NINE MONTHS ENDED
DECEMBER 31, 1995
Net sales for the nine months ended December 31, 1996 decreased 13.0% to
$62,855,934 from $72,207,892 for the nine months ended December 31, 1995 (a
record nine months for net sales). The release schedule for the nine months
ended December 31, 1996 was slightly weaker than that of the nine months ended
December 31, 1995. Additionally, the Company's net sales of catalogue titles
(previously released laserdisc titles) in the nine months ended December 31,
1996 were substantially weaker than those in the nine months ended December 31,
1995. The weakness in catalogue sales was primarily a result of the decline in
laserdisc hardware sales, reported by the EIA to be down approximately 40% for
calendar 1996 versus calendar 1995. Management believes the decline in
laserdisc hardware sales was attributable to the continued confusion and
uncertainty in the laserdisc marketplace about the pending introduction of the
new 5-inch DVD format and its quality (versus
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laserdisc). Further, catalogue net sales for the nine months ended December 31,
1996 versus 1995 were negatively impacted by continued softness in the retail
entertainment software market as well as the inclusion, in the 1995 period, of
substantial sales from the STAR WARS TRILOGY: THE DEFINITIVE COLLECTION which
was no longer available in this three-movie collector's set as of January 1996.
The reduction in net sales for the nine months ended December 31, 1996 versus
1995 resulting from a weaker release schedule and reduced catalogue sales were
slightly offset by the inclusion of the nine months of U.S. Laser sales for the
December 1996 period versus six months and 17 business days for the December
1995 period. In the future, the Company expects that net sales will continue to
be affected by the popularity of new releases, laserdisc hardware sales, the
extent of the Company's distribution of the DVD format, DVD's market penetration
and the prevailing economic environment.
Cost of laserdisc sales for the nine months ended December 31, 1996
decreased to $49,581,725 from $56,778,266 for the nine months ended December 31,
1995. As a percentage of net sales, cost of sales for the nine months ended
December 31, 1996 increased to 78.9% from 78.6% for the nine months ended
December 31, 1995. The December 1996 period's increase in cost of laserdisc
sales as a percentage of net sales is attributable to increased reserves for
slower moving catalogue inventory and the inclusion of U.S. Laser's lower-margin
net sales and cost of laserdisc sales for the full nine month period ended
December 31, 1996 versus six months and 17 business days for the December 1995
period, all offset, in part, by laserdisc manufacturing cost savings due to the
comparative strength of the U.S. Dollar against the Japanese Yen.
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.
Lower-margin nonexclusive product sales, including lower-margin U.S. Laser sales
(U.S. Laser has substantially lower margins because it is solely a nonexclusive
distributor), accounted for 24.8% of net sales in the nine months ended December
31, 1996 compared to 18.3% of in the nine months ended December 31, 1995.
Beginning with the June 1996 quarter, one of the Company's largest exclusive
product customers began buying substantially all of their nonexclusive laserdisc
product from the Company, contributing to the percentage increase in
nonexclusive product sales.
Selling expenses for the nine months ended December 31, 1996 increased 6.4%
to $3,457,693 from $3,251,060 for the nine months ended December 31, 1995. As a
percentage of net sales, selling expenses for the nine months ended December 31,
1996 increased to 5.5% from 4.5% for the nine months ended December 31, 1995.
This increase resulted primarily from increased trade and media advertising of
exclusive titles, expenses associated with the four-month "Laserdisc Roadshow"
promotion, expenses related to U.S. Laser's new retail concept store
"Digitainment," which opened in October 1996 and a full nine months of U.S.
Laser's selling expenses for the 1996 period versus six months and 17 business
days for the 1995 period.
General and administrative expenses for the nine months ended December 31,
1996 increased 30.1% to $4,988,616 from $3,834,869 for the nine months ended
December 31, 1995. As a percentage of net sales, general and administrative
expenses for the nine months ended December 31, 1996 increased to 7.9% from 5.3%
for the nine months ended December 31, 1995. This increase resulted primarily
from an increase in the provision for doubtful accounts, inclusion of nine
months of U.S. Laser's general and administrative expenses in the 1996 period
versus six months and 17 business days for the 1995 period and higher insurance
costs for increased coverage all offset, in part, by reduced performance-based
executive bonuses. The provision for doubtful accounts was $1,154,000 for the
nine months ended December 31, 1996 versus $61,000 for the comparable 1995
period.
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<PAGE>
Amortization of production costs for the nine months ended December 31,
1996 increased 9.1% to $2,307,550 from $2,115,785 for the nine months ended
December 31, 1995. As a percentage of net sales, amortization of production
costs for the nine months ended December 31, 1996 increased to 3.7% from 2.9%
for the nine months ended December 31, 1995. The increase results from 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 nine months ended December 31, 1996 increased
83.8% to $226,106 from $123,013 for the nine months ended December 31, 1995.
Interest income for the nine months ended December 31, 1996 decreased 17.4% to
$188,560 from $228,157 for the nine months ended December 31, 1995. The nine
months ended December 31, 1996 saw the utilization of cash and borrowings under
the Company's revolving credit facility to finance the purchase of 16.5 acres of
unimproved property in Las Vegas, Nevada, advance royalty and certain inventory
purchase and license fee obligations under the May 1996 exclusive laserdisc
output license and distribution agreement with MGM/UA Home Entertainment, as
well as the continued repurchase of common stock under the Company's stock
repurchase program.
Other expense consists of a nonrecurring charge of $662,193 composed
primarily of legal and accounting fees relating to the acquisition of Essex
Entertainment, Inc., a privately-held independent music company headquartered in
New Jersey. Negotiations to acquire Essex Entertainment, Inc. terminated in
December 1996.
During the December 1996 quarter, the Company recorded an extraordinary
charge of $143,308, net of related taxes of $40,000, associated with the early
retirement of debt. The Company refinanced its $15 million revolving credit and
term loan facility with Foothill Capital Corporation with a $20 million
revolving credit facility from Union Bank of California. The charge related to
a prepayment penalty paid and amortization of deferred financing costs,
accelerated as a result of the early retirement ($40,808 represents noncash
charges).
The effective income tax rate for the nine months ended December 31, 1996
was approximately 23% versus approximately 10% for the nine months ended
December 31, 1995. Net operating loss carryfowards for Federal and state tax
purposes were utilized to offset taxable income for the nine months ended
December 31, 1995. However, the net operating loss carryforward for state tax
purposes was fully utilized during fiscal 1996, and the Federal net operating
loss carryforward is expected to be fully utilized in fiscal 1997, which
together lead to a higher effective income tax rate for Federal and state tax
purposes for fiscal 1997.
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. Additionally, since January 1995, the Company has used aggregate
working capital of approximately $14.8 million for the repurchase of its common
stock, the acquisition of the assets of U.S. Laser, and the purchase of 16.5
acres of unimproved real property in Las Vegas, Nevada to construct a new
distribution facility. Working capital has historically been provided by
private sales of common stock, notes representing long-term
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debt, bank borrowings and cash flows from operations. For the nine months ended
December 31, 1996, operating activities used cash and cash equivalents of
$4,886,922, investing activities consisting primarily of capital expenditures,
used cash and cash equivalents of $4,963,082 and financing activities consisting
primarily of bank borrowings, net of stock repurchases, provided cash and cash
equivalents of $6,315,685, resulting in a net decrease in cash and cash
equivalents of $3,534,319.
In December 1996, the Company entered into a Loan Agreement (the
"Agreement") with Union Bank of California. 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 the bank's prime rate plus .25% (8.5% at December 31, 1996). The Agreement
provides the Company the option of borrowing for fixed periods at the London
Interbank Offered Rate plus 2.5%.
Borrowings under the Agreement are secured by substantially all of the
Company's assets. Funds available for borrowing may not exceed the borrowing
base specified in the Agreement. At December 31, 1996, $8,623,685 was
outstanding under the Agreement and approximately $4,230,000, net of amounts
utilized for outstanding letters of credit, was available for borrowing. The
Agreement requires the Company to comply with certain financial and operational
covenants. At December 31, 1996, the Company was in compliance with all
covenants.
Concurrent with the signing of the Agreement with Union Bank of California,
the Company early-terminated its three-year $15 million Loan and Security
Agreement with Foothill Capital Corporation which was due to expire on November
15, 1997.
At December 31, 1996, the Company had $2,500,000 of outstanding letters of
credit issued by the Company's lender and expiring on November 16, 1997. These
letters of credit secure balances due to program suppliers. An additional
$949,628 letter of credit issued by a bank and unsecured was outstanding at
December 31, 1996 and canceled in January 1997. The letter of credit secured
the note payable related to the purchase of real property in Nevada.
In January 1997, the Company's Board of Directors approved a 1 million
share increase to its existing stock repurchase plan. The Board initially
authorized the repurchase of 1 million shares of common stock in January 1995,
and in June 1996 authorized the repurchase of an additional 500,000 shares of
common stock. Purchases are made from time to time in the open market and/or
through privately negotiated transactions based on current market conditions and
other factors. During the nine months ended December 31, 1996, the Company
purchased 485,000 shares of its common stock for $2,356,538 under its stock
repurchase program. Since January 1995 and through December 31, 1996, the
Company has repurchased 1,393,100 shares of its common stock for $8,613,089.
In May 1996, the Company entered into an exclusive laserdisc output license
and distribution agreement pursuant to which the Company acquired the right to
replicate, market and distribute MGM/UA programming on laserdisc in the United
States and Canada through the year 2001. During the quarter ended December 31,
1996, certain commitments under the agreement were met by MGM/UA which required
the Company to pay a $5 million royalty advance as well as a $1 million down
payment on an inventory purchase and elements license commitment, composed of
the purchase of MGM/UA's on-hand laserdisc inventory for approximately $3
million (for which delivery to the Company was substantially completed in
August, 1996) and the license for the use of MGM/UA's laserdisc masters and art
elements relating to catalogue titles for the term of the agreement for
approximately $2.5 million.
At December 31, 1996, the Company had license obligations for royalty
advances, minimum guarantees and other fees of approximately $997,000 for the
remainder of fiscal 1997, $3,661,000 during
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<PAGE>
fiscal 1998, $8,672,000 during fiscal 1999 and $9,365,000 during fiscal 2000.
These advances and guarantees are recoupable against royalties earned by the
licensors and program suppliers, respectively. Depending upon the 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.
Management believes that cash available from operations and its revolving
credit facility will be adequate to meet anticipated working capital
requirements for the next twelve months. The Company is seeking additional
sources of financing in connection with its proposed new distribution facility
in Las Vegas, Nevada and may seek additional sources of financing in connection
with its consideration of acquisition opportunities. See -- Summary and Outlook
---
below.
SUMMARY AND OUTLOOK
During the first nine months of fiscal 1997, the Company experienced weaker
net sales of catalogue titles (previously released laserdisc titles) and, to a
lesser extent, weaker net sales of new releases as compared to the same prior-
year period. Management believes this to be primarily a result of the decline
in laserdisc hardware sales -- reported by the EIA to be down approximately 40%
for calendar 1996 versus calendar 1995. Management believes the decline in
laserdisc hardware sales was a result of the confusion and uncertainty in the
laserdisc marketplace about the pending introduction of the DVD format. Further
contributing to the weakness in catalogue sales was a soft retail entertainment
software market.
The pending introduction of the DVD format has created confusion and
uncertainty in the laserdisc market place. Only two major studios, Warner Home
Video and Columbia TriStar Home Video, plan to release programming on DVD this
spring -- MGM/UA Home Entertainment, which has a distribution deal with Warner,
New Line and Turner which are owned by Warner, and PolyGram, have also announced
plans for a spring launch. The remaining major studios (Disney's Buena Vista,
Twentieth Century Fox Home Entertainment, Universal, and Paramount Home Video)
are not expected to participate in the launch and have not formally committed to
the format. The Company believes that no more than 50 DVD titles will be
available at launch. The success of the DVD format will ultimately depend upon
consumer acceptance, market penetration, pricing, video quality (as compared to
laserdisc quality) and the number and breadth of titles that will be available
following the launch. Although there can be no assurance, the Company believes
that the laserdisc format will remain viable for the foreseeable future despite
the introduction of DVD. Over 10,000 titles in a broad range of categories are
currently available on laserdisc, the frequency and breadth of new titles
released on laserdisc has not been affected by the pending launch of DVD, an
established consumer base exists for laserdisc, many laserdiscs are released in
the special edition format that appeals to laserdisc collectors, and many
laserdisc consumers own large collections of laserdisc titles. Major hardware
manufacturer Pioneer Electronics has announced plans to introduce a combination
laserdisc, DVD and CD player, which management believes will promote the sale of
catalogue titles and new release titles on laserdisc.
Notwithstanding the uncertainty regarding DVD, the Company is striving to
become a major licensee and distributor of the DVD format. In October 1996, the
Company entered into a two-year agreement pursuant to which Thomson Consumer
Electronics, a leading hardware manufacturer whose brands include RCA, GE and
Proscan, granted exclusive rights to the Company for the distribution of DVD
software to authorized Thomson hardware dealers. The two-year term begins with
the release of DVD software by a major home video company. Management believes
there are over 2,500 authorized Thomson locations which are potential customers.
Under the agreement, Thomson and the Company have formulated a strategic
alliance to bring DVD software and hardware together at the retail level.
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Late in calendar 1995, the 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,
overexpansion 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 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 has taken
steps to mitigate its exposure to bad debts and product returns from troubled
retailers including 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. Management is continually
estimating the net realizable value of the Company's accounts receivables and
recording appropriate reserves to reflect such 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.
In November 1996, the Company completed its purchase of 16.5 acres of
unimproved real property in Las Vegas, Nevada for approximately $4 million. The
purchase price consisted of approximately $3,050,000 in cash and a note payable
of approximately $950,000 due January 2, 1997. The note was repaid on its due
date. In January 1997, the Company purchased an additional .68 acres of
adjacent unimproved real property for $335,000 increasing its total acreage
purchased to approximately 17.2 acres. The properties are located adjacent to
McCarran International Airport. The Company intends to build a 76,000 square
foot automated distribution facility on 8.3 of the 17.2 acres of the acquired
property to accommodate anticipated business growth through the year 1999 and
allow for a 24-hour product turn. The architectural plans allow for expansion
up to a maximum of 150,000 square feet to accommodate additional business
growth. In January 1997, the Company entered into escrow to sell approximately
8.9 acres of the acquired property to an ultimate end user for approximately $3
million, net of brokerage commissions. The close of escrow and ultimate sale of
the property is subject to a 45 day feasibility period, delivery of acceptable
title, verification of zoning and buyer's acceptable financing. The Company
expects, although there can be no assurances that, escrow will close on or about
March 31, 1997.
The new distribution facility will replace the Company's existing 48,300
square foot leased facility in Chatsworth, California. The Company intends to
sublease the Chatsworth, California space through the termination of its
leasehold obligation. The Company has revised its estimated completion date of
the new facility to September 1997. The total estimated project cost, assuming
the close of escrow on the 8.9 acres of the new property and inclusive of
building construction and equipment costs, is $7.5 million. The Company is
currently in the final credit approval stage for building construction and
distribution equipment financing with a Nevada bank. There can be no assurances
that the Company will obtain ultimate credit approval with the bank. The
Company is considering the creation of a new division, Image Distribution
Services, that will offer third-party distribution services such as inventory
management, order processing and distribution.
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During the September 1996 quarter, the Company began consolidating
substantially all of U.S. Laser's distribution activities in an effort to
achieve cost savings by eliminating distribution redundancy. In August, the
Company began shipping U.S. Laser's product out of its Chatsworth warehouse.
There can be no assurance that the Company will realize cost savings from the
consolidation of U.S. Laser's distribution operation. U.S. Laser will continue
to service its sales customer accounts, maintain its sales staff and its
customer service and order processing operations, and publish its monthly
magazine LASERVIEWS: America's Laser Disc Magazine out of newly leased corporate
office space. In October 1996, U.S. Laser opened its new retail concept store
"Digitainment" in Whippany, New Jersey. Digitainment offers a large selection of
optical disc software for sale and rental as well as "Home Theater" hardware
systems for sale. Although there can be no assurance, the Company may open
other Digitainment stores should the retail concept store prove successful.
The Company continues to license new programming for laserdisc distribution
as well as seek to renew and extend relationships with existing studios. In
addition, the Company is seeking exclusive and nonexclusive DVD distribution
rights where available.
In December 1996, the Company entered into an exclusive laserdisc output
license and distribution agreement pursuant to which the Company acquired the
right to replicate, market and distribute PolyGram Video programming on
laserdisc in the United States and Canada through the year 2002.
In July 1996, the Company extended its July 1, 1992 exclusive laserdisc
purchase and distribution agreement with Twentieth Century Fox Home
Entertainment giving the Company exclusive laserdisc distribution rights to
Twentieth Century Fox Home Entertainment programming through June 30, 1999.
In addition to its laserdisc licensing and distribution, the Company
continues to seek investment opportunities in growth oriented companies which
would be complementary to the Company's existing operations. Potential
investment opportunities may include companies engaged in the business of
proprietary content production or software distribution. Should suitable
investment opportunities arise that would require funds in excess of those
provided by operations and availability under the Company's revolving credit
facility, additional financing sources may be sought.
FORWARD LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, including without
limitation statements containing the words "believes," "anticipates," "expects"
and words of similar import, constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such forward
looking statements involve known and unknown risks, uncertainties and other
factors which may cause the actual results, performance or achievements of the
Company, or industry results, to be materially different from any future
results, performances or achievements expressed or implied by such forward-
looking statements. The Company has made forward-looking statements in this
Form 10-Q concerning, among other things, (i) viability of the laserdisc format
despite the introduction of DVD; (ii) the number of motion picture studios
participating in the launch of DVD; (iii) the number of DVD titles that will be
available at launch; (iv) the strengthening of the retail entertainment software
market over the long term; (v) anticipated growth through 1999 and desire for a
24-hour product turn necessitated the purchase of real property and the building
of an expandable distribution facility; (vi) the September 1997 anticipated
completion date of the new facility and its approximately $7.5 million total
cost, net of the planned sale of 8.9 acres; (vii) cost savings achieved by the
consolidation of U.S. Laser's distribution activities; and, (viii) the opening
of other Digitainment stores should the retail concept store prove
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successful. 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) actual motion picture studio participation in the
launch of DVD; (ii) DVD's video and audio quality versus laser's video and audio
quality; (iii) the number of and breadth of titles that will ultimately be
available on DVD; (iv) ultimate consumer acceptance of DVD; (v) shifts in
industry distribution channels; (vi) shifts in consumer retail buying habits;
(vii) the availability and financing of future acquisition candidates whose
product Image could distribute out of the Las Vegas facility; (viii) possible
construction delays and unforeseen additional construction costs; (ix) the
current financial strength and future economic trends in the retail
entertainment software market; and (x) 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.
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REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The consolidated financial statements as of December 31, 1996 and for the
three- and nine-month periods ended December 31, 1996 and 1995 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.
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INDEPENDENT AUDITORS' REPORT
----------------------------
The Board of Directors
Image Entertainment, Inc.
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. as of December 31, 1996, and the related condensed
consolidated statements of operations and cash flows for the three and nine
month periods ended December 31, 1996 and 1995 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, 1996, and the related consolidated statements of operations and cash
flows for the year then ended (not presented herein); and in our report dated
May 24, 1996, except for Note 14, which was as of June 5, 1996, 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, 1996, 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
February 6, 1997
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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.
---------------------------------------------------
Not Applicable
ITEM 5. OTHER INFORMATION.
-----------------
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page i
(b) Reports on Form 8-K
None
-24-
<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: February 12, 1997 By: /s/MARTIN W. GREENWALD
----------------------
Martin W. Greenwald,
Chairman of the Board, Chief Executive Officer,
President and Treasurer
Date: February 12, 1997 By: /s/JEFF M. FRAMER
-----------------
Jeff M. Framer,
Chief Financial Officer
-25-
<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 February 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
February 6, 1997
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> APR-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,131,623
<SECURITIES> 0
<RECEIVABLES> 19,303,504
<ALLOWANCES> 4,642,000
<INVENTORY> 19,612,382
<CURRENT-ASSETS> 0 (F1)
<PP&E> 10,992,132
<DEPRECIATION> 3,747,178
<TOTAL-ASSETS> 53,549,566
<CURRENT-LIABILITIES> 0 (F1)
<BONDS> 0
0
0
<COMMON> 18,813,582
<OTHER-SE> 800,051
<TOTAL-LIABILITY-AND-EQUITY> 53,549,566
<SALES> 62,855,934
<TOTAL-REVENUES> 62,855,934
<CGS> 49,581,725
<TOTAL-COSTS> 49,581,725
<OTHER-EXPENSES> 2,307,550
<LOSS-PROVISION> 1,154,017
<INTEREST-EXPENSE> 226,106
<INCOME-PRETAX> 1,820,611
<INCOME-TAX> 417,000
<INCOME-CONTINUING> 1,403,611
<DISCONTINUED> 0
<EXTRAORDINARY> 143,308
<CHANGES> 0
<NET-INCOME> 1,260,303
<EPS-PRIMARY> .09
<EPS-DILUTED> 0 (F2)
(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.
</TABLE>
