<PAGE>
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________
AMENDMENT NO. 1 TO
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, 1998
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 of incorporation) (I.R.S. Employer 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 7, 1998:
13,548,959
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<PAGE>
PART I - FINANCIAL INFORMATION
=================================
ITEM 1. FINANCIAL STATEMENTS.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 1998 and March 31, 1998
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS
June 30, 1998 March 31, 1998
-------------- --------------
(In thousands) (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 745 $ 1,015
Accounts receivable, net of allowances of
$4,303 - June 30, 1998;
$4,604 - March 31, 1998 7,641 6,978
Inventories (Note 3) 10,853 11,205
Royalties, distribution fee and license fee advances 3,853 4,566
Prepaid expenses and other assets 1,397 1,094
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$4,726 - June 30, 1998;
$4,570 - March 31, 1998 8,352 6,223
Land held for sale 2,700 2,700
------- -------
$35,541 $33,781
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 1998 and March 31, 1998
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
June 30, 1998 March 31, 1998
-------------- ---------------
(In thousands, except share data) (unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $ 13,193 $ 12,303
Accrued royalties, distribution fees and license fees 1,896 2,003
Revolving credit facility (Note 5) 1,459 2,315
Construction credit facility (Note 6) 3,174 1,619
Distribution equipment lease facility (Note 7) 526 526
Convertible subordinated note payable (Note 8) 5,000 5,000
Note payable (Note 8) 1,350 1,350
-------- --------
Total liabilities 26,598 25,116
-------- --------
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;
13,533,000 and 13,493,000 issued and outstanding
at June 30, 1998 and March 31, 1998, respectively 17,837 17,764
Additional paid-in capital 3,064 3,064
Accumulated deficit (11,958) (12,163)
-------- --------
Net shareholders' equity 8,943 8,665
-------- --------
$ 35,541 $ 33,781
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended June 30, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands, except per share data) 1998 1997
-------- --------
<S> <C> <C>
NET SALES $17,140 $16,902
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 13,197 14,049
Selling expenses 1,229 1,047
General and administrative expenses 1,221 1,009
Amortization of production costs 1,126 831
------- -------
16,773 16,936
------- -------
OPERATING INCOME (LOSS) 367 (34)
OTHER EXPENSES (INCOME):
Interest expense 176 203
Interest income (25) (46)
------- -------
151 157
------- -------
INCOME (LOSS) BEFORE INCOME TAXES 216 (191)
INCOME TAXES 11 --
------- -------
NET INCOME (LOSS) $ 205 $ (191)
======= =======
NET INCOME (LOSS) PER SHARE (Note 4):
Basic $ .02 $ (.01)
Diluted $ .02 $ (.01)
======= =======
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Note 4):
Basic 13,506 13,431
======= =======
Diluted 13,614 13,431
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months Ended June 30, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands) 1998 1997
-------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 205 $ (191)
Adjustments to reconcile net income
to net cash provided by operating activities:
Amortization of production costs 1,126 831
Depreciation and other amortization 156 217
Amortization of stock warrants -- 24
Provision for slow-moving optical disc inventories 68 501
Provision for estimated doubtful accounts,
net of recoveries 14 (252)
Changes in assets and liabilities associated
with operating activities:
Accounts receivable (677) 1,692
Optical disc inventory 258 (108)
Royalty, distribution and license fee advances, net 713 949
Production cost expenditures (1,100) (909)
Prepaid expenses and other assets (303) (67)
Accounts payable, accrued royalties and liabilities 783 (635)
------- ------
Net cash provided by operating activities 1,243 2,052
------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash used by investing activities -- capital expenditures (730) (253)
------- ------
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(UNAUDITED)
For the Three Months Ended June 30, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In thousands) 1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 15,249 $ 12,848
Advances under construction credit facility -- 400
Repayment of advances under revolving credit facility (16,105) (16,018)
Net proceeds from exercise of stock options 73 180
-------- --------
Net cash used by financing activities (783) (2,590)
-------- --------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (270) (791)
Cash and cash equivalents at beginning of period 1,015 1,090
-------- --------
Cash and cash equivalents at end of period $ 745 $ 299
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 185 $ 179
Income taxes $ -- $ 90
========= ========
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the June 1998 quarter, the Company incurred $1,555,000 relating to the
design, engineering, planning and construction of the Nevada warehouse and
distribution facility. These costs were funded under the Company's construction
credit facility. See "Note 6. Construction Credit Facility."
During the June 1997 quarter, a capital lease obligation of $22,000 was incurred
for a new vehicle.
See accompanying notes to consolidated financial statements
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION.
The accompanying consolidated financial statements as of June 30, 1998 and for
the three months ended June 30, 1998 and 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, 1998 and the related
consolidated statements of operations and cash flows for the three months ended
June 30, 1998 and 1997 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, 1998 and 1997 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, 1998
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 significant areas requiring the use of
management estimates related to allowances for slow-moving inventories, doubtful
accounts receivables, royalties and other advances and sales returns. Although
these estimates are based on management's knowledge of current events and
actions management may undertake in the future, actual results may ultimately
differ from those estimates.
Certain fiscal 1998 balances have been reclassified to conform with the fiscal
1999 presentation.
Seasonality and Variability. The Company has generally experienced higher sales
- ---------------------------
of laserdiscs ("LDs") 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, sales also vary with the popularity of titles in release. The Company
expects sales of its digital video disc ("DVD") programming to follow the same
trend. In addition, other factors contribute to fluctuations in the Company's
net sales of LD and DVD on a quarterly basis. These factors include: (i)
competition from DVD, a competing video format, which affects wholesale and
retail customer demand for LD programming; (ii) the popularity of LD and DVD
titles in release during the quarter; (iii) the Company's marketing and
promotional activities; (iv) the Company's licensing and distribution activities
relating to new LD and DVD video programming; (v) the extension, termination or
non-renewal of existing LD and DVD license and distribution rights; and (vi)
general and economic changes affecting consumer demand for LD and DVD hardware
and software and affecting the buying habits of the Company's customers. The
results of operations for the three months ended June 30, 1998 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending March 31, 1999.
NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS.
The Financial Accounting Standards Board issued Statement No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130") in June, 1997. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The Company adopted SFAS No. 130 on April 1, 1998.
Comprehensive income is the change in equity of a business enterprise during a
period from transactions and all other events and circumstances from nonowner
sources. Other comprehensive income includes foreign currency items, minimum
pension liability adjustments and unrealized gains and losses on certain
investments in debt and equity securities. The Company did not have components
of other comprehensive income during the three months ended June 30, 1998 and
1997. As a result, comprehensive income (loss) is the same as the net income
(loss) for the three months ended June 30, 1998 and 1997.
The Financial Accounting Standards Board issued Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS No. 131") in
June, 1997. SFAS No. 131 establishes standards for the way public business
enterprises are to report information about operating segments in annual
financial statements and requires enterprises to report selected information
about operating segments in interim financial reports issued to shareholders.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. It replaces the "industry
segment" concept of SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," with a "management approach" concept as to basis for identifying
reportable segments. SFAS No. 131 is effective for financial statements for
periods beginning after December 15, 1997. The Company will adopt SFAS No. 131
in the annual financial statements of the fiscal year ending March 31, 1999.
Management believes the adoption of SFAS No. 131 will not have a material impact
on the Company's financial position or results of operations. The Company
operates in one industry segment, the domestic home video market.
NOTE 3. INVENTORIES.
Inventories at June 30, 1998 and March 31, 1998 are summarized as follows:
<TABLE>
<CAPTION>
June 30, March 31,
(In thousands) 1998 1998
--------- ----------
<S> <C> <C>
LD $ 14,686 $ 15,641
DVD 2,555 2,128
Other 592 577
--------- ---------
17,833 18,346
Reserve for slow-moving inventories (8,911) (9,098)
--------- ---------
8,922 9,248
Production costs, net 1,931 1,957
--------- ---------
$ 10,853 $ 11,205
========= =========
</TABLE>
Inventories consist primarily of finished optical discs (LDs, DVDs and CDs) for
sale and are stated at the lower of average cost or market.
Production costs are net of accumulated amortization of $6,382,000 and
$6,013,000 at June 30, 1998 and March 31, 1998, respectively.
NOTE 4. NET INCOME PER SHARE.
In February 1997, Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" ("SFAS No. 128") 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. The Company adopted SFAS
No. 128 in the fiscal year ended March 31, 1998.
Accordingly, the accompanying net income (loss) per share information, including
all information restated for the three months ended June 30, 1997, has been
calculated and presented in accordance with the provisions of SFAS No. 128. In
accordance with SFAS No. 128, the Company has presented both basic and diluted
net income (loss) per share in its consolidated financial statements.
The following presents a reconciliation of the numerators and denominators used
in computing basic and diluted net income (loss) per share for the three months
ended June 30, 1998 and 1997:
<TABLE>
<CAPTION>
(In thousands, except per share data) 1998 1997
------- --------
<S> <C> <C>
Net income (loss) (basic and diluted numerator) $ 205 $ (191)
======= =======
Weighted average common shares outstanding
(basic denominator) 13,506 13,431
======= =======
Effect of dilutive stock options 108 --
------- -------
Weighted average common shares outstanding
(diluted denominator) 13,614 13,431
======= =======
Basic and diluted net income (loss) per share $ .02 $ (.01)
======= =======
</TABLE>
During the three months ended June 30, 1998 and 1997, there were 2,246,000 and
2,384,000, respectively, of outstanding stock options and common shares
underlying a convertible security (in the 1998 period only) which were not
included in the computation of diluted net income (loss) per share. In the case
of the stock options, the exercise prices were greater than the average market
price of the common stock for the three months ended June 30, 1998 and in the
case of the shares underlying the convertible security, the assumed conversion
or exercise would result in antidilution when applying the treasury stock method
for the three months ended June 30, 1998. For the three months ended June 30,
1997, the calculation of diluted net loss per share did not include common stock
equivalents as their effect would be antidilutive.
NOTE 5. REVOLVING CREDIT FACILITY.
In December 1996, the Company entered into a Loan Agreement (the "Agreement")
with Union Bank. The Agreement, as amended, provides for revolving advances and
the issuance of standby letters of credit under a $10 million revolving credit
facility which expires June 30, 1999. Borrowings under the Agreement are at the
bank's prime rate plus .50% (9.00% at June 30, 1998). The Agreement provides
the Company the option of borrowing for fixed periods at the London Interbank
Offered Rate ("LIBOR") plus 3.0% (8.66% at June 30, 1998).
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, as amended. At June
30, 1998, $1,459,000 in borrowings were outstanding under the Agreement, all of
which was borrowed under the prime rate plus .50% option, $4,570,000, net of
amounts utilized for outstanding letters of credit, was available for borrowing.
The Agreement requires the Company to comply with certain quarterly financial
and operating covenants. At June 30, 1998, the Company was in compliance with
the financial and operating covenants.
NOTE 6. 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, as amended, provides for a construction line of
credit (the "Construction Line") through September 30, 1998. The maximum
available under the Construction Line (the "Maximum Commitment") is $3,434,000.
Interest under the Construction Line is at the bank's prime rate plus 1.25%
(9.75% at June 30, 1998). At June 30, 1998, $3,174,000 in borrowings were
outstanding under the Construction Line. The Loan Agreement provides for the
Construction Line to convert to a revolving line of credit (the "Revolving
Line") on September 30, 1998.
Under the Revolving Line, the Company may repay and reborrow principal amounts
provided the Revolving Line does not exceed the Maximum Commitment, which shall
be reduced quarterly beginning December 31, 1998 by $43,000. The Revolving Line
is available from October 1, 1998 through its maturity date of January 31, 2008.
The Loan Agreement provides the Company the option, under the Revolving Line, to
borrow at the bank's prime rate plus 1.25% or for fixed periods 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.
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 is
constructing a new warehouse and distribution facility, as well as any of the
Company's personal property located in Nevada, excluding inventory held for
sale. The Loan Agreement contains cross-default provisions to other borrowing
agreements and imposes certain restrictions on such items as payment of
dividends and stock repurchases. The Loan Agreement requires the Company to
comply with certain quarterly financial and operating covenants. At June 30,
1998, the Company was not in compliance with the bank's maximum total
liabilities to tangible net worth covenant. At the Company's request, the bank
waived the Company's non-compliance with the covenant for the period ended June
30, 1998. The Company was in compliance with all other financial and operating
covenants at June 30, 1998.
NOTE 7. DISTRIBUTION EQUIPMENT LEASE FACILITY.
In March 1997, the Company entered into a Lease Intended As Security Agreement
(the "Lease") with BankAmerica Leasing & Capital Corporation. The Lease, as
amended, provides the Company the ability to lease a substantial portion of the
warehouse and distribution system equipment to be constructed and utilized in
the Company's warehouse and distribution facility in Las Vegas, Nevada. The
maximum amount available under the Lease is $2.5 million. The aggregate amount
of installation, transportation, applicable taxes, software costs or licensing
fees with respect to the aggregate borrowings under the lease may not exceed
20%. The Lease provides for advances for the purchase of equipment prior to its
delivery date (the "Advance Rent Period") which cannot extend past September 30,
1998. Interest during the Advance Rent Period is at the three-month LIBOR plus
2.5% (8.22% at June 30, 1998). There were $526,000 in borrowings outstanding
under the Lease at June 30, 1998.
Subsequent to the delivery and installation of the equipment and on the date the
equipment is accepted by the Company (the "Base Date"), the base rent period
("Base Rent Period") begins. During the Base Rent Period, the outstanding
borrowings on each equipment schedule will be amortized over 24 consecutive
quarterly installments, to a $1 purchase option, with the first such installment
due one quarter after the Base Date. The variable implicit interest for each
leased unit is the three-month LIBOR plus 2.719%. Under the Lease, during the
Base Rent Period, the Company may convert to a fixed implicit interest rate.
The fixed implicit interest rate will be the bond-equivalent yield per annum for
U.S. Treasury obligations with a maturity most closely matching to the nearest
month of the remaining average life of each equipment schedule plus a spread of
3.137%.
Borrowings under the Lease are secured by the underlying equipment leased. The
Lease contains cross-default provisions with other borrowing agreements, early
termination charges and a $1.5 million minimum utilization requirement. The
Lease requires the Company to meet the same quarterly financial and operating
covenants contained in the Loan Agreement with Bank of America National Trust
and Savings Association above. At June 30, 1998, the Company was not in
compliance with the bank's maximum total liabilities to tangible net worth
covenant. At the Company's request, the bank waived the Company's compliance
with the covenant for the period ended June 30, 1998. The Company was in
compliance with all other financial and operating covenants at June 30, 1998.
NOTE 8. OTHER NOTES PAYABLE.
Convertible Subordinated Note Payable. The Company entered into a Credit
- -------------------------------------
Agreement with Image Investors Co. ("IIC"), a principal stockholder of the
Company owned and controlled by John W. Kluge and Stuart Subotnick, dated as of
September 29, 1997, pursuant to which the Company borrowed $5 million from IIC,
with interest payable quarterly at 8% per annum, and principal due in five
years. The loan is unsecured and subordinated to any obligations to Union Bank
and is convertible into the Company's common stock at any time during the term
at a conversion price of $3.625 per share, the closing price of the Company's
common stock on September 29, 1997.
Note Payable to Bank. 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, as amended, bears interest at prime
plus 1.75% (10.25% at June 30, 1998), matures on August 1, 1999 and is secured
by a deed of trust on the approximately 8.8 acres of land adjacent to the
Company's 8.4 acre warehouse and distribution facility construction site in Las
Vegas, Nevada.
<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 licensed and distributed a broad range of programming on
laserdisc ("LD") since 1983. In prior fiscal years, the Company's net sales
were derived almost entirely from the distribution of the LD format. In March
1997, a new optical disc format, the digital video disc ("DVD") was introduced.
The Company began distributing DVD programming on a nonexclusive wholesale basis
in March 1997 and began releasing exclusively licensed DVD programming in June
1997. The Company generally enters into license agreements whereby it acquires
the exclusive right to manufacture and distribute LD and/or DVD programming. In
addition, the Company acts as an exclusive wholesale distributor of LD and DVD
programming. In January 1998, the Company began selling music programming on
compact audio disc ("CD") encoded in the DTS Digital Surround ("DTS")
multichannel audio format as well as certain programming on videocassette tape
("VHS"). The accompanying consolidated financial information for the three
months ended June 30, 1998 and 1997 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, 1998
Form 10-K.
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1997
During the three months ended June 30, 1998, LD and DVD, respectively,
represented approximately 62% and 38% of the Company's net sales as compared to
approximately 92% and 8%, respectively, for the three months ended June 30,
1997. Net sales for the June 1998 quarter increased 1.4% to $17,140,000 from
$16,902,000 for the June 1997 quarter. Net sales of DVD programming increased
to $6,496,000 for the June 1998 quarter from $1,359,000 for the June 1997
quarter. Approximately 50% of total June 1998 quarter DVD net sales were derived
from exclusively distributed or licensed programming versus approximately 6% for
the June 1997 quarter. The slight increase in the June 1998 quarter net sales
was due to the Company's increased distribution of DVD programming offset almost
entirely by a decline in net sales of LD programming. Net sales of LD
programming for the June 1998 quarter declined 32% to $10,644,000 from
$15,543,000 for the June 1997 quarter due to DVD's continued adverse impact on
the LD marketplace. The DVD format directly competes with the LD format. The
major music/video software retailer chains have dramatically reduced their LD
purchasing in favor of DVD purchasing. Net sales from exclusive distribution of
DTS encoded software (LDs and CDs) were $859,000 and $270,000 for the three
months ended June 30, 1998 and 1997, respectively.
Cost of optical disc sales (LDs, DVDs and CDs collectively) for the June 1998
quarter decreased to $13,197,000, or 77.0% of net sales, from $14,049,000, or
83.1% of net sales, for the June 1997 quarter. The margin improvement for the
June 1998 quarter primarily reflects a significantly decreased provision for
slow-moving LD inventory as well as lower average cost of sales for exclusive
DVD programming versus LD programming and lower LD manufacturing costs as
compared to the June 1997 quarter.
Selling expenses for the June 1998 quarter increased 17.4% to $1,229,000, or
7.2% of net sales, from $1,047,000, or 6.2% of net sales, for the June 1997
quarter. June 1998 quarter's increase was primarily due to higher personnel and
distribution costs associated with DVD and DTS distribution and increased
circulation of the Company's monthly Preview Magazine which are distributed free
of charge to retail customers, offset, in part, by reduced distribution expenses
for U.S. Laser which was winding down its operations through its closure in July
1998.
General and administrative expenses for the June 1998 quarter increased 21.0%
to $1,221,000, or 7.1% of net sales, from $1,009,000, or 6.0% of net sales, for
the June 1997 quarter. The June 1997 quarter included net recoveries of
previously provided for doubtful accounts receivable from Musicland and Camelot
Music (doubtful receivables then sold by the Company to third party investors).
Exclusive of the June 1997 quarter net recoveries, general and administrative
expenses for June 1998 quarter decreased 7.7% to $1,221,000, or 7.1% of net
sales, from $1,323,000, or 7.8% of net sales, for the June 1997 quarter. The
June 1998 quarter's decrease is attributable to decreased depreciation of
property, equipment and improvements, and reduced distribution expenses for U.S.
Laser which was winding down its operations through its closure in July 1998.
Amortization of production costs for the June 1998 quarter increased 35.5% to
$1,126,000, or 6.6% of net sales, from $831,000, or 4.9% of net sales, for the
June 1997 quarter. The increase is primarily attributable to costs associated
with the incremental production of exclusive DVD titles as well as the higher
overhead in the Company's creative services and production departments necessary
to produce the greater volume of LD and DVD titles. Amortization of production
costs will vary based upon the mix, timing and number of exclusive DVD and LD
titles placed into production.
Interest expense for the June 1998 quarter decreased 13.3% to $176,000, or
1.0% of net sales, from $203,000, or 1.2% of net sales, for the June 1997
quarter. The decrease is attributable to lower average debt levels during the
June 1998 quarter. Interest capitalized for the three months ended June 30,
1998 was $58,000. The Company did not capitalize interest during the three
months ended June 30, 1997.
Interest income for the June 1998 quarter decreased 45.7% to $25,000, or 0.1%
of net sales, from $46,000, or 0.3% of net sales, for the June 1997 quarter.
The Company had less cash invested and lower interest-bearing royalty and
distribution fee advances during the June 1998 quarter than during the June 1997
quarter.
The Company recorded a net income tax expense of $11,000, at an effective
income tax rate of 5.1%, during the June 1998 quarter which represents estimated
alternative minimum tax liability for the quarter. The June 1998 quarter
effective income tax rate is lower than the statutory rate due to utilization of
net operating loss carryforwards for Federal and state tax purposes generated in
the fiscal year ended March 31, 1998. The effective tax rate is subject to
ongoing review by management on a regular basis.
For the three months ended June 30, 1998, the Company recorded net income of
$205,000, or $.02 per basic and diluted share, compared to a net loss of
$191,000, or $.01 per basic and diluted share, for the three months ended June
30, 1997.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
The Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131") in June, 1997. SFAS No. 131 establishes standards for the way public
business enterprises are to report information about operating segments in
annual financial statements and requires enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. It replaces the
"industry segment" concept of SFAS No. 14, "Financial Reporting for Segments of
a Business Enterprise," with a "management approach" concept as to basis for
identifying reportable segments. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997. The Company will
adopt SFAS No. 131 in the annual financial statements of the fiscal year ending
March 31, 1999. Management believes the adoption of SFAS No. 131 will not have
a material impact on the Company's financial position or results of operations.
The Company operates in one industry segment, the domestic home video market.
IMPACT OF YEAR 2000
The Company is aware of the complexity and the significance of the "Year 2000"
issue. The Company utilizes information systems throughout its business to
effectively carry out its day-to-day operations. The Company is in the process
of assuring that its systems are capable of recognizing and processing
information properly as the year 2000 approaches. The Company has completed a
preliminary assessment of its Year 2000 compliance and is currently correcting,
upgrading or replacing those systems that are not Year 2000 compliant. The
Company believes that it will be able to modify or replace its affected systems
in time to avoid any interruptions in its operations. The Company does not
anticipate that costs associated with this project will have a material impact
on the Company's financial position or results of operations in future periods.
The Company will gather information concerning the Year 2000 compliance status
of its suppliers. In the event that any of the Company's significant suppliers
do not successfully or timely achieve Year 2000 compliance, the Company's
business or operations may be adversely affected.
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. Net cash provided by operations decreased 39.4% to $1,243,000
for the three months ended June 30, 1998 from $2,052,000 for the three months
ended June 30, 1997 due primarily to increased accounts receivable offset, in
part, by increased trade payables. Net cash used by investing activities,
consisting entirely of capital expenditures, increased 188.5% to $730,000 for
the June 1998 quarter from $253,000 for the June 1997 quarter. Net cash used by
financing activities decreased 69.8% to $783,000 for the June 1998 quarter from
$2,590,000 for the June 1997 quarter due to a reduction in net repayments of the
Company's revolving credit facility during the June 1998 quarter. The
aforementioned changes resulted in net cash and cash equivalents decreasing
26.6% to $745,000 at June 30, 1998 from $1,015,000 at March 31, 1998.
Management believes that its internal and external sources of funding are
adequate to meet anticipated needs for the next 12 months. In recent quarters
the Company has not been in compliance with certain financial covenants under
certain of its debt agreements such as minimum tangible net worth, maximum total
debt to tangible net worth ratio and minimum average quarterly profitability
covenants. As a result, the Company has requested and received waivers for its
noncompliance from its lenders. Should the Company not be in compliance with
future covenants, there is no assurance that the Company's lenders will provide
waivers for noncompliance. Without a waiver of noncompliance, the debt would be
in default and would potentially cross default other debt causing such debt to
be immediately due and payable. The Company would attempt to refinance its
current debt with its existing lender or a new lender at terms which may be less
favorable than its current terms, however, there can be no assurance that the
Company would be successful in doing so. The Company continues to seek
investment opportunities in growth oriented companies which would be
complementary to the Company's existing operations, such as proprietary content
production or entertainment software distribution businesses. The Company will
seek acquisition financing should suitable investment opportunities arise.
FINANCING ACTIVITIES.
--------------------
Revolving Credit Facility. In December 1996, the Company entered into a
-------------------------
Loan Agreement ("the Agreement") with Union Bank. The Agreement, as amended,
provides for revolving advances and the issuance of standby letters of credit
under a $10,000,000 revolving credit facility which expires June 30, 1999.
Borrowings under the Agreement are at the Union Bank's prime rate plus .50%
(9.00% at June 30, 1998). The Agreement provides the Company the option of
borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus
3.0% (8.66% at June 30, 1998).
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, as
amended. At June 30, 1998, $1,459,000 in borrowings were outstanding under
the Agreement, all of which was borrowed under the prime rate plus .50% option,
and $4,570,000, net of amounts utilized for outstanding letters of credit,
available for borrowing.
The Agreement imposes restrictions on such items as encumbrances and liens,
payment of dividends, other borrowings, stock repurchases and capital
expenditures. The Agreement requires the Company to comply with certain
financial and operating covenants. At June 30, 1998, the Company was in
compliance with the financial and operating covenants.
At June 30, 1998, the Company had $2,300,000 of outstanding standby letters
of credit issued by Union Bank which expire on November 15, 1998. These letters
of credit secure balances due to program suppliers.
Construction Credit Facility. In March 1997, the Company entered into a
----------------------------
Business Loan Agreement (the "Loan Agreement") with Bank of America National
Trust and Savings Association in Nevada for the purpose of financing the
construction of the Nevada warehouse and distribution facility. The Loan
Agreement, as amended, provides for a construction line of credit (the
"Construction Line") through September 30, 1998. The maximum available under
the Construction Line ( the "Maximum Commitment") is $3,434,000. Interest under
the Construction Line is at the bank's prime rate plus 1.25% (9.75% at June 30,
1998). At June 30, 1998, there were $3,174,000 in borrowings outstanding under
the Construction Line. The Loan Agreement provides for the Construction Line to
convert to a revolving line of credit (the "Revolving Line") on September 30,
1998.
Under the Revolving Line, the Company may repay and reborrow principal
amounts provided the Revolving Line does not exceed the Maximum Commitment,
which shall be reduced quarterly beginning December 31, 1998 by $43,000. The
Revolving Line is available from October 1, 1998 through its maturity date of
January 31, 2008. The Loan Agreement provides the Company the option, under the
Revolving Line, to borrow at the bank's prime rate plus 1.25% or for fixed
periods at LIBOR plus either 2.25% or 2.65% depending on the level of the
Company's debt service coverage ratio, as defined in the Loan Agreement.
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 is
constructing a new warehouse and distribution facility, as well as any of the
Company's personal property located in Nevada, excluding inventory held for
sale. The Loan Agreement contains cross-default provisions to other borrowing
agreements and imposes restrictions on such items as payment of dividends and
stock repurchases. The Loan Agreement requires the Company to comply with
certain quarterly financial and operating covenants. At June 30, 1998, the
Company was not in compliance with the bank's maximum total liabilities to
tangible net worth covenant. At the Company's request, the bank waived the
Company's non-compliance with the covenant for the period ended June 30, 1998.
The Company was in compliance with all other financial and operating covenants
at June 30, 1998. The Company is currently in compliance with all financial and
operating covenants that are measured on an ongoing basis and expects that, at
each measurement date in the foreseeable future, it will be in compliance with
all financial and operating covenants to be measured at such date.
Distribution Equipment Lease Facility. In March 1997, the Company entered
-------------------------------------
into a Lease Intended As Security Agreement (the "Lease") with BankAmerica
Leasing & Capital Corporation. The Lease, as amended, provides the Company the
ability to lease a substantial portion of the warehouse and distribution system
equipment to be constructed and utilized in the Company's warehouse and
distribution facility in Las Vegas, Nevada. The maximum amount available under
the Lease is $2.5 million. The aggregate amount of installation, transportation,
applicable taxes, software costs or licensing fees with respect to the aggregate
borrowings under the lease may not exceed 20%. The Lease provides for advances
for the purchase of equipment prior to its delivery date (the "Advance Rent
Period") which cannot extend past September 30, 1998. Interest during the
Advance Rent Period is at the three-month LIBOR plus 2.5% (8.22% at June 30,
1998). There were $526,000 in borrowings outstanding under the Lease at June 30,
1998.
Subsequent to the delivery and installation of the equipment and on the
date the equipment is accepted by the Company (the "Base Date"), the base rent
period ("Base Rent Period") begins. During the Base Rent Period, the outstanding
borrowings on each equipment schedule will be amortized over 24 consecutive
quarterly installments, to a $1 purchase option, with the first such installment
due one quarter after the Base Date. The variable implicit interest for each
leased unit is the three-month LIBOR plus 2.719%. Under the Lease, during the
Base Rent Period, the Company may convert to a fixed implicit interest rate. The
fixed implicit interest rate will be the bond-equivalent yield per annum for
U.S. Treasury obligations with a maturity most closely matching to the nearest
month of the remaining average life of each equipment schedule plus a spread of
3.137%.
Borrowings under the Lease are secured by the underlying equipment leased.
The Lease contains cross-default provisions with other borrowing agreements,
early termination charges and a $1.5 million minimum utilization requirement.
The Lease requires the Company to meet the same quarterly financial and
operating covenants contained in the Loan Agreement with Bank of America
National Trust and Savings Association above. At June 30, 1998, the Company was
not in compliance with the bank's maximum total liabilities to tangible net
worth covenant. At the Company's request, the bank waived the Company's non-
compliance with the covenant for the period ended June 30, 1998. The Company was
in compliance with all other financial and operating covenants at June 30, 1998.
The Company is currently in compliance with all financial and operating
covenants that are measured on an ongoing basis and expects that, at each
measurement date in the foreseeable future, it will be in compliance with all
financial and operating covenants to be measured at such date.
Convertible Subordinated Note Payable. The Company entered into a credit
-------------------------------------
agreement with Image Investors Co. ("IIC"), a principal stockholder of the
Company owned and controlled by John W. Kluge and Stuart Subotnick, dated as of
September 29, 1997, pursuant to which the Company borrowed $5 million from IIC,
with interest payable quarterly at 8% per annum, and principal due in five
years. The loan is unsecured and subordinated to any obligations to Union Bank
and is convertible into the Company's common stock at any time during the term
at a conversion price of $3.625 per share, the closing price of the Company's
common stock on September 29, 1997.
Note Payable to Bank. 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, as amended, bears interest at
prime plus 1.75% (10.25% at June 30, 1998), matures on August 1, 1999 and is
secured by a deed of trust on the approximately 8.8 acres of land adjacent to
the Company's 8.4 acre warehouse and distribution facility construction site in
Las Vegas, Nevada.
OTHER OBLIGATIONS.
-----------------
At June 30, 1998, the Company had future license obligations for royalty
advances, minimum guarantees and other fees of $3,944,000 due during fiscal
1999, and $1,333,000 due during fiscal 2000. These advances and guarantees are
recoupable against royalties and distribution fees 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.
CLOSURE OF SUBSIDIARY -- U.S. LASER VIDEO DISTRIBUTORS, INC.
-----------------------------------------------------------
The closure of the Company's wholly-owned subsidiary U.S. Laser Video
Distributors, Inc. was completed in July 1998.
LAS VEGAS WAREHOUSE AND DISTRIBUTION FACILITY AND ADJACENT LAND.
---------------------------------------------------------------
In December 1997, the Company began construction of a 76,000 square foot
warehouse and automated distribution facility on approximately 8.4 acres of the
Company's real property adjacent to McCarren International Airport in Las Vegas,
Nevada. The Company expects the facility to be operational by October 1998.
Cancellation of Escrow to Sell a Portion of the Nevada Land. In May 1998,
-----------------------------------------------------------
the Company entered into an Agreement for Purchase and Sale with Jackson-Shaw
Company, a Texas corporation (the "Buyer"), for the sale of the Company's
approximately 8.8 acres of unimproved real property located in Las Vegas, Nevada
adjacent to the Company's property (on which it is constructing its warehouse
and distribution facility) for an ultimate purchase price of $3,100,000. In
July 1998, the escrow was canceled by the Buyer as the property did not meet the
Buyer's requirements for its intended end use. The Company's present intention
is not to remarket the property but rather hold the property near term as an
investment.
SUMMARY AND OUTLOOK
Management believes the Company's long-term operating cash flow and liquidity
will depend upon the success and extent of the Company's licensing and
distribution of DVD software, the viability of the LD marketplace and the
Company's ability to reach the installed LD household base through alternative
distribution channels.
To a lesser extent, future operating cash flow may be positively affected by
the success and extent of the Company's exclusive distribution of complimentary
entertainment programming in other video/audio formats.
The Company intends to continue to actively pursue DVD license and
distribution rights as it has pursued, and will continue to pursue, LD license
and distribution rights.
DVD Hardware Penetration. The Electronics Industries Association ("EIA")
------------------------
reported that from March 1997 (the DVD format's introduction date) to July 31,
1998, approximately 710,000 DVD players have been sold to consumer electronics
retailers. Management estimates that there are currently approximately 425,000
domestic DVD households (approximately 60% of the EIA's estimate above).
Company DVD Market Share. According to VideoScan, which tracks point-of-sale
------------------------
data from more than 16,000 stores reportedly accounting for 70% of all video
sales, the Company's market share of total DVD unit sales from January 1, 1998
through August 2, 1998 is 3.05%. The Company currently ranks eighth in market
share behind Warner Home Video (25.77%), Columbia TriStar (15.87%), Universal
Home Video (11.20%), Disney (10.89%), MGM (10.15%), New Line (7.43%) and Artisan
Entertainment (formerly LIVE Home Entertainment) (4.56%). Sales data includes
mass merchandisers and retailers but not most discount outlets.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995, are contained
throughout this Form 10-Q. Such statements are based on the beliefs of the
Company's management as well as assumptions made by and information currently
available to the Company's management. When used in this report, the words
"anticipate," "believe," "estimate," "may," "plan," "expect" and similar
expressions, variations of such terms or the negative of such terms as they
relate to the Company or its management are intended to identify such forward-
looking statements and should not be regarded as a representation by the
Company, its management or any other person that the future events, plans or
expectations contemplated by the Company will be achieved. Such statements are
based on management's current expectations and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should the underlying assumptions prove incorrect,
the Company's actual results, performance or achievements could differ
materially from those expressed in, or implied by, any such forward-looking
statements. The Company has made forward-looking statements in this Form 10-Q
concerning, among other things, (i) the viability of the LD format and market
place; (ii) the Company's ability to experience continued sales and maintain its
market share of its licensed DVD programing and secure additional exclusive LD
and DVD rights; (iii) seeking investment opportunities in growth-oriented
companies and securing necessary acquisition financing; and (iv) the date which
the Las Vegas, Nevada warehouse and distribution facility will be operational.
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) competition from other distributors of the DVD format;
(ii) 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; (iii) shifts in industry distribution channels; (iv) shifts
in retail consumer and wholesale customer buying habits; (v) difficulties and
delays which may be encountered in the compression and authoring production
process required to produce DVD programming; (vi) potential installation,
implementation and performance difficulties encountered during the testing phase
of the Company's newly constructed distribution equipment and custom programmed
distribution software utilized to run the Las Vegas, Nevada distribution center;
and (vii) 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.
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The condensed consolidated financial statements as of June 30, 1998 and for
the three-month periods ended June 30, 1998 and 1997 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.
INDEPENDENT AUDITORS' REVIEW REPORT
-----------------------------------
The Board of Directors and Shareholders
Image Entertainment, Inc.:
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. and subsidiary as of June 30, 1998, and the related
condensed consolidated statements of operations and cash flows for the three-
month periods ended June 30, 1998 and 1997. These condensed consolidated
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally 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. and
subsidiary as of March 31, 1998, and the related consolidated statements of
operations, shareholders' equity and cash flows for the year then ended; and in
our report dated May 29, 1998 except for Note 8, as to which the date was June
18, 1998, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of March 31, 1998, is fairly stated, in
all material respects, in relation to the consolidated balance sheet from which
it has been derived.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
August 7, 1998
<PAGE>
PART II - OTHER INFORMATION
==============================
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page i
(b) Reports on Form 8-K
None
<PAGE>
SIGNATURES
-------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMAGE ENTERTAINMENT, INC.
Date: November 30, 1998 By: /S/ MARTIN W. GREENWALD
-----------------------
Martin W. Greenwald
Chairman of the Board, Chief Executive
Officer,
President and Treasurer
Date: November 30, 1998 By: /S/ JEFF M. FRAMER
------------------
Jeff M. Framer
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
================
Exhibit No. Description
- -----------------------------------------------------------------------------
15 * Consent Letter of KPMG Peat Marwick LLP, Independent Certified
Public Accountants.
- ----------------
* EXHIBIT(S) NOT PREVIOUSLY FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION.
-i-
<PAGE>
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 statements, we acknowledge our
awareness of the use therein of our report dated August 7, 1998 related to our
review of interim financial information.
Pursuant to Rule 436(c) under the Securities Act of 1933, such report is not
considered a part of a registration statement prepared or certified by an
accountant or a report prepared or certified by an accountant within the meaning
of Sections 7 and 11 of the Act.
/s/ KPMG Peat Marwick LLP
Los Angeles, California
November 25, 1998
