<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 SEPTEMBER 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)
_______________________
<TABLE>
<S> <C>
CALIFORNIA 84-0685613
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification Number)
</TABLE>
9333 OSO AVENUE, CHATSWORTH, CALIFORNIA 91311
(Address of principal executive offices, including zip code)
(818) 407-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ( x ) NO ( )
Number of shares outstanding of the registrant's common stock on November 6,
1998: 13,551,038
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<PAGE>
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PART I - FINANCIAL INFORMATION
================================================================================
ITEM 1. FINANCIAL STATEMENTS.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1998 and March 31, 1998
================================================================================
ASSETS
<TABLE>
<CAPTION>
September 30, 1998 March 31, 1998
------------------ ---------------
(In thousands) (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,519 $ 1,015
Accounts receivable, net of allowances of
$4,111 - September 30, 1998;
$4,604 - March 31, 1998 6,464 6,978
Inventories (Note 3) 11,735 11,205
Royalties, distribution fee and license fee advances 3,973 4,566
Prepaid expenses and other assets 1,229 1,094
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$4,898 - September 30, 1998;
$4,570 - March 31, 1998 12,545 8,923
------- -------
$37,465 $33,781
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 1998 and March 31, 1998
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, 1998 March 31, 1998
------------------- ---------------
(In thousands, except share data) (unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $ 12,739 $ 12,303
Accrued royalties, distribution fees and license fees 1,866 2,003
Revolving credit facility (Note 5) 3,760 2,315
Construction credit facility (Note 6) 3,434 1,619
Distribution equipment lease facility (Note 7) 944 526
Convertible subordinated note payable (Note 8) 5,000 5,000
Note payable (Note 8) 1,350 1,350
-------- --------
Total liabilities 29,093 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;
13,549,000 and 13,493,000 issued and outstanding
at September 30, 1998 and March 31, 1998, respectively 17,924 17,764
Additional paid-in capital 3,094 3,064
Accumulated deficit (12,646) (12,163)
-------- --------
Net shareholders' equity 8,372 8,665
-------- --------
$ 37,465 $ 33,781
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended September 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1998 1997
-------- --------
<S> <C> <C>
NET SALES $13,834 $16,412
OPERATING COSTS AND EXPENSES:
Cost of sales 10,607 13,283
Selling expenses 1,284 1,185
General and administrative expenses 1,408 1,124
Amortization of production costs 1,067 888
------- -------
14,366 16,480
------- -------
OPERATING LOSS (532) (68)
OTHER EXPENSES (INCOME):
Interest expense 178 129
Interest income (23) (7)
------- -------
155 122
------- -------
LOSS BEFORE INCOME TAXES (687) (190)
INCOME TAX BENEFIT -- (6)
------- -------
NET LOSS $ (687) $ (184)
======= =======
NET LOSS PER SHARE (Note 4):
Basic $(.05) $(.01)
Diluted $(.05) $(.01)
======= =======
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Note 4):
Basic 13,546 13,486
======= =======
Diluted 13,546 13,486
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Six Months Ended September 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1998 1997
-------- --------
<S> <C> <C>
NET SALES $30,974 $33,314
OPERATING COSTS AND EXPENSES:
Cost of sales 23,804 27,332
Selling expenses 2,514 2,232
General and administrative expenses 2,629 2,133
Amortization of production costs 2,193 1,719
------- -------
31,140 33,416
------- -------
OPERATING LOSS (166) (102)
OTHER EXPENSES (INCOME):
Interest expense 354 332
Interest income (48) (53)
------- -------
306 279
------- -------
LOSS BEFORE INCOME TAXES (472) (381)
INCOME TAX EXPENSE (BENEFIT) 11 (6)
------- -------
NET LOSS $ (483) $ (375)
======= =======
NET LOSS PER SHARE (Note 4):
Basic $(.04) $(.03)
Diluted $(.04) $(.03)
======= =======
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Note 4):
Basic 13,526 13,457
======= =======
Diluted 13,526 13,457
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended September 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (483) $ (375)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Amortization of production costs 2,193 1,719
Depreciation and other amortization 329 430
Amortization of stock warrants -- 49
Amortization of restricted stock grants 30 --
Provision for slow-moving inventories 349 1,011
Provision for estimated doubtful accounts,
net of recoveries 29 (315)
Changes in assets and liabilities associated
with operating activities:
Accounts receivable 485 2,435
Inventories (574) 412
Royalty, distribution and license fee advances, net 593 431
Production cost expenditures (2,498) (1,858)
Prepaid expenses and other assets (135) (17)
Accounts payable, accrued royalties and liabilities 299 (2,287)
------- -------
Net cash provided by operating activities 617 1,635
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash used by investing activities -- capital expenditures (1,718) (360)
------- -------
</TABLE>
See accompanying notes to consolidated financial statements
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(UNAUDITED)
For the Six Months Ended September 30, 1998 and 1997
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 22,161 $ 19,641
Advances under construction credit facility -- 400
Repayment of short-term debt -- (285)
Repayment of advances under revolving credit facility (20,716) (22,720)
Proceeds from issuance of note payable -- 1,350
Net proceeds from exercise of stock options 160 310
-------- --------
Net cash provided (used) by financing activities 1,605 (1,304)
-------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 504 (29)
Cash and cash equivalents at beginning of period 1,015 1,090
-------- --------
Cash and cash equivalents at end of period $ 1,519 $ 1,061
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 436 $ 284
Income taxes $ -- $ 90
======== ========
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the six months ended September 30, 1998, the Company incurred $2,233,000
relating to the construction of the Nevada warehouse and distribution facility,
design and coding of custom warehouse management system software and purchase of
distribution equipment and management information systems hardware. These costs
were funded under the Company's construction credit and distribution equipment
lease facilities. See "Note 6. Construction Credit Facility" and "Note 7.
Distribution Equipment Lease Facility."
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 September 30, 1998 and
for the three- and six-month periods ended September 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 September 30, 1998 and the
related consolidated statements of operations and cash flows for the periods
ended September 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 periods ended September 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 relate to allowances for slow-moving inventories, doubtful
accounts receivables, unrecouped royalty/distribution fee 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 laserdisc ("LD") programming 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 has negatively affected
wholesale and retail customer demand for LD programming; (ii) the popularity of
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 video programming; (v) the extension, termination or non-renewal
of existing 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- and six-month periods ended September 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- and six-month periods ended
September 30, 1998 and 1997. As a result, comprehensive loss is the same as the
net loss for the three- and six-month periods ended September 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 is currently evaluating the impact of SFAS No. 131.
The AICPA's Accounting Standards Executive Committee ("AcSEC") issued Statement
of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software
Developed for Internal Use" in March 1998. SOP 98-1 provides guidance on the
capitalization of software for internal use. SOP 98-1 is effective for
financial statements for periods beginning after December 15, 1998. The Company
will adopt SOP 98-1 in the annual financial statements of the fiscal year ending
March 31, 2000. Management believes adoption of SOP 98-1 will not have a
material impact on the Company's financial position or results of operations.
AcSEC issued SOP 98-5, "Reporting on the Cost of Start-Up Activities" in April
1998. SOP 98-5 requires that all costs of start-up activities, including
organization costs, be expensed as incurred. SOP 98-5 is effective for financial
statements for periods beginning after December 15, 1998. The Company will adopt
SOP 98-5 in the annual financial statements of the fiscal year ending March 31,
2000. Management believes adoption of SOP 98-5 will not have a material impact
on the Company's financial position or results of operations.
NOTE 3. INVENTORIES.
Inventories at September 30, 1998 and March 31, 1998 are summarized as follows:
<TABLE>
<CAPTION>
September 30, March 31,
(In thousands) 1998 1998
------------ ---------
<S> <C> <C>
LD $13,795 $15,641
DVD 3,603 2,128
Other 620 577
------- -------
18,018 18,346
Reserve for slow-moving inventories (8,545) (9,098)
------- -------
9,473 9,248
Production costs, net 2,262 1,957
------- -------
$11,735 $11,205
======= =======
</TABLE>
Inventories consist primarily of finished products for sale and are stated at
the lower of average cost or market.
Production costs are net of accumulated amortization of $6,695,000 and
$6,013,000 at September 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
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 loss per share information, including all
information restated for the three- and six-month periods ended September 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 loss per share in its consolidated financial statements.
The numerators and denominators used in computing basic and diluted net loss per
share for the three- and six-month periods ended September 30, 1998 and 1997 are
as follows:
<TABLE>
<CAPTION>
Three months Three months Six months Six months
ended ended ended ended
September 30, September 30, September 30, September 30,
(In thousands, except per share data) 1998 1997 1998 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net loss (basic and diluted numerator) $ (687) $ (184) $ (483) $ (375)
======= ======= ======= =======
Weighted average common shares outstanding
(basic and diluted denominator) 13,546 13,486 13,526 13,457
======= ======= ======= =======
Basic and diluted net loss per share $ (.05) $ (.01) $ (.04) $ (.03)
======= ======= ======= =======
</TABLE>
During the periods ended September 30, 1998 and 1997, there were 2,764,000 and
2,384,000, respectively, of outstanding stock options and common shares
underlying a convertible security (in the 1998 periods only) which were not
included in the computation of diluted net loss per share. For the three and
six months ended September 30, 1998 and 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
Union Bank's prime rate plus .50% (8.75% at September 30, 1998). The Agreement
provides the Company the option of borrowing for fixed periods at the London
Interbank Offered Rate ("LIBOR") plus 3.0% (8.375% at September 30, 1998).
Borrowings under the Agreement are secured by substantially all of the Company's
assets located in California. Funds available for borrowing may not exceed the
borrowing base specified in the Agreement. At September 30, 1998, $3,760,000 in
borrowings were outstanding under the Agreement, all of which was borrowed under
the prime rate plus .50% option, and $2,289,000, net of amounts utilized for
outstanding letters of credit, was available for borrowing. The Agreement
requires the Company to comply with certain quarterly financial and operating
covenants. At September 30, 1998, the Company was not in compliance with Union
Bank's minimum tangible net worth and minimum quarterly average profitability
covenants. At the Company's request, Union Bank waived the Company's non-
compliance with those covenants for the period ended September 30, 1998. The
Company was in compliance with all other financial and operating covenants at
September 30, 1998.
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%
(9.5% at September 30, 1998). At September 30, 1998, $3,434,000 in borrowings
were outstanding under the Construction Line and in accordance with the Loan
Agreement, the Construction Line converted to a revolving line of credit (the
"Revolving Line").
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
expires January 31, 2008. The Company has 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 has
constructed its 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 September
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
September 30, 1998. The Company was in compliance with all other financial and
operating covenants at September 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 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% of the Company's
total borrowings under the Lease. The Lease provides for advances for the
purchase of equipment prior to its delivery and acceptance date (the "Advance
Rent Period") which cannot extend past November 30, 1998. Interest during the
Advance Rent Period is at the three-month LIBOR plus 2.5% (7.81% at September
30, 1998). There were $944,000 in borrowings outstanding under the Lease at
September 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 September 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 September 30, 1998. The Company was in
compliance with all other financial and operating covenants at September 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% at September 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 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 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 and six months
ended September 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 SEPTEMBER 30, 1998 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997
Net sales for the September 1998 quarter decreased 15.7% to $13,834,000
from $16,412,000 for the September 1997 quarter. Net sales of DVD programming
for the September 1998 quarter increased to $6,600,000, or 48% of net sales,
from $2,956,000, or 18% of net sales, for the September 1997 quarter.
Approximately 58% of total September 1998 quarter DVD net sales were derived
from exclusively distributed or licensed programming versus approximately 42%
for the September 1997 quarter. The decrease in the September 1998 quarter net
sales was due to the decline in net sales of LD programming, offset, in part, by
the Company's increased distribution of DVD programming. Net sales of LD
programming for the September 1998 quarter declined 46% to $7,234,000, or 52% of
net sales, from $13,456,000, or 82% of net sales, for the September 1997 quarter
due to DVD's continued adverse impact on the LD marketplace. 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 (LD and CD) were $885,000 and $350,000 for the September
1998 and 1997 quarters, respectively. Net sales from exclusive distribution of
VHS programming were not material for the September 1998 and 1997 quarters.
Cost of sales (LD, DVD, CD and VHS collectively) for the September 1998
quarter decreased to $10,607,000, or 77% of net sales, from $13,283,000, or 81%
of net sales, for the September 1997 quarter. The margin improvement for the
September 1998 quarter primarily reflects a significantly decreased provision
for slow-moving LD inventory as well as higher average margins from exclusive
DVD programming versus LD programming and lower LD manufacturing costs as
compared to the September 1997 quarter.
Selling expenses for the September 1998 quarter increased 8.4% to $1,284,000,
or 9.3% of net sales, from $1,185,000, or 7.2% of net sales, for the September
1997 quarter. The September 1998 quarter's increase, as a percentage of net
sales, was primarily due to higher personnel and distribution costs associated
with DVD and DTS distribution and increased trade and media advertising costs,
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 September 1998 quarter increased
25.3% to $1,408,000, or 10.2% of net sales, from $1,124,000, or 6.8% of net
sales, for the September 1997 quarter. The September 1998 quarter's increase in
absolute dollars is attributable to higher personnel costs, higher professional
fees and a higher provision for doubtful receivables (the September 1997 quarter
included net recoveries of previously provided for doubtful accounts receivable
from certain customers), offset, in part, by reduced overhead for U.S. Laser
which was winding down its operations through its closure in July 1998.
Amortization of production costs for the September 1998 quarter increased
20.2% to $1,067,000, or 7.7% of net sales, from $888,000, or 5.4% of net sales,
for the September 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 September 1998 quarter increased 38.0% to $178,000,
or 1.3% of net sales, from $129,000, or 0.8% of net sales, for the September
1997 quarter. The increase is attributable to higher average debt levels during
the September 1998 quarter. Interest incurred on funds borrowed to construct
the Nevada warehouse and distribution facility and capitalized for the three
months ended September 30, 1998 was $80,000. The Company did not capitalize
interest during the three months ended September 30, 1997.
Interest income for the September 1998 quarter increased 228.6% to $23,000, or
0.2% of net sales, from $7,000, or less than 0.1% of net sales, for the
September 1997 quarter. The Company had higher interest-bearing royalty and
distribution fee advances during the September 1998 quarter than during the
September 1997 quarter.
For the three months ended September 30, 1998, the Company recorded a net loss
of $687,000, or $.05 per basic and diluted share, compared to a net loss of
$184,000, or $.01 per basic and diluted share, for the three months ended
September 30, 1997.
THE SIX MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE SIX MONTHS ENDED
SEPTEMBER 30, 1997
Net sales for the six months ended September 30, 1998 decreased 7.0% to
$30,974,000 from $33,314,000 for the six months ended September 30, 1997. Net
sales of DVD programming for the six months ended September 30, 1998 increased
to $13,096,000, or 42% of net sales, from $4,315,000, or 13% of net sales, for
the six months ended September 30, 1997. Approximately 54% of total DVD net
sales for the six months ended September 30, 1998 were derived from exclusively
distributed or licensed programming versus approximately 31% for the six months
ended September 30, 1997. The decrease in net sales for the six months ended
September 30, 1998 was due to the decline in net sales of LD programming,
offset, in part, by the Company's increased distribution of DVD programming.
Net sales of LD programming for the six months ended September 30, 1998 declined
38% to $17,878,000, or 58% of net sales, from $28,999,000, or 87% of net sales,
for the six months ended September 30, 1997 due to DVD's continued adverse
impact on the LD marketplace. 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 (LD and CD) were
$1,744,000 and $620,000 for the six months ended September 30, 1998 and 1997,
respectively. Net sales from exclusive distribution of VHS programming were not
material for the six months ended September 30, 1998 and 1997.
Cost of sales (LD, DVD, CD and VHS collectively) for the six months ended
September 30, 1998 decreased to $23,804,000, or 77% of net sales, from
$27,332,000, or 82% of net sales, for the six months ended September 30, 1997.
The margin improvement for the six months ended September 30, 1998 primarily
reflects a significantly decreased provision for slow-moving LD inventory as
well as higher average margins from exclusive DVD programming versus LD
programming and lower LD manufacturing costs as compared to the six months ended
September 30, 1997.
Selling expenses for the six months ended September 30, 1998 increased 12.6%
to $2,514,000, or 8.1% of net sales, from $2,232,000, or 6.7% of net sales, for
the six months ended September 30, 1997. The increase in selling expenses, as a
percentage of net sales, for the six months ended September 30, 1998 was
primarily due to higher personnel and distribution costs associated with DVD and
DTS distribution, increased trade and media advertising, increased circulation
of the Company's monthly Preview Magazine which are distributed free of charge
to retail customers and increased cost of market development funds offered
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 six months ended September 30,
1998 increased 23.3% to $2,629,000, or 8.5% of net sales, from $2,133,000, or
6.4% of net sales, for the six months ended September 30, 1997. General and
administrative expenses for the six months ended September 30, 1997 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 net recoveries recorded during the six
months ended September 30, 1997, general and administrative expenses for the six
months ended September 30, 1998 increased 8.0% to $2,629,000, or 8.5% of net
sales, from $2,435,000, or 7.3% of net sales, for the six months ended September
30, 1997. The increase in general and administrative expenses for the six
months ended September 30, 1998, in absolute dollars, is attributable to higher
personnel costs and higher professional fees, offset, in part, by reduced
overhead for U.S. Laser which was winding down its operations through its
closure in July 1998.
Amortization of production costs for the six months ended September 30, 1998
increased 27.6% to $2,193,000, or 7.1% of net sales, from $1,719,000, or 5.2% of
net sales, for the six months ended September 30, 1997. 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 six months ended September 30, 1998 increased 6.6% to
$354,000, or 1.1% of net sales, from $332,000, or 1.0% of net sales, for the six
months ended September 30, 1997. The increase is attributable to higher average
debt levels during the six months ended September 30, 1998. Interest incurred
on funds borrowed to construct the Nevada warehouse and distribution facility
and capitalized for the six months ended September 30, 1998 was $138,000. The
Company did not capitalize interest during the six months ended September 30,
1997.
Interest income for the six months ended September 30, 1998 decreased 9.4% to
$48,000, or 0.2% of net sales, from $53,000, or 0.2% of net sales, for the six
months ended September 30, 1997. The Company had less cash invested and lower
interest-bearing royalty and distribution fee advances during the six months
ended September 30, 1998 than during the six months ended September 30, 1997.
For the six months ended September 30, 1998, the Company recorded a net
loss of $483,000, or $.04 per basic and diluted share, compared to a net loss of
$375,000, or $.03 per basic and diluted share, for the six months ended
September 30, 1997.
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- and six-month periods ended
September 30, 1998 and 1997. As a result, comprehensive loss is the same as the
net loss for the three- and six-month periods ended September 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 is currently evaluating the impact of SFAS No. 131.
The AICPA's Accounting Standards Executive Committee ("AcSEC") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed for Internal Use" in March 1998. SOP 98-1 provides guidance
on the capitalization of software for internal use. SOP 98-1 is effective for
financial statements for periods beginning after December 15, 1998. The Company
will adopt SOP 98-1 in the annual financial statements of the fiscal year ending
March 31, 2000. Management believes adoption of SOP 98-1 will not have a
material impact on the Company's financial position or results of operations.
AcSEC issued SOP 98-5, "Reporting on the Cost of Start-Up Activities" in
April 1998. SOP 98-5 requires that all costs of start-up activities, including
organization costs, be expensed as incurred. SOP 98-5 is effective for
financial statements for periods beginning after December 15, 1998. The Company
will adopt SOP 98-5 in the annual financial statements of the fiscal year ending
March 31, 2000. Management believes adoption of SOP 98-5 will not have a
material impact on the Company's financial position or results of operations.
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 has established
its Year 2000 compliance methodology which comprises five phases: discovery,
planning, resolution, testing and implementation. The scope of the Company's
compliance program includes information technology systems (computer hardware
and software), non-information technology systems including facilities
(telecommunication systems, distribution center machinery and security systems)
and embedded software in production equipment (video and sound processing
equipment), and the Year 2000 readiness of significant third-party vendors,
which among other things, manufacture the Company's exclusive optical disc
programming as well as supply the Company with finished nonexclusive optical
disc programming.
The Company has completed the discovery and planning phases for 90% of both
its information technology systems and non-information technology systems. The
Company expects to complete the remainder of the discovery and planning phases
by December 31, 1998. Approximately 25% of the systems addressed were found to
require some level of remediation or replacement. The Company is currently in
the resolution phase with respect to such systems for which all affected
hardware, software and equipment is being repaired, upgraded, or replaced. The
Company expects to complete the resolution phase for all systems (information
technology and non-information technology) by March 31, 1999. The Company
expects to have completed the testing phase for all systems by June 30, 1999,
and the implementation phase by September 30, 1999. Through September 30, 1998,
the Company estimates that its resolution and testing phase is approximately 25%
complete.
Through September 30, 1998, the Company has spent approximately $10,000 on
the discovery, planning and resolution phases for both information technology
and non-information technology systems. The Company expects the remainder of
the Year 2000 remediation process to cost approximately $150,000. The Company
believes it has sufficient cash, cash flow and borrowing availability to fund
this project. All costs are being expensed as incurred.
The Company will be conducting a comprehensive Year 2000 vendor readiness
assessment with all significant third-party vendors. This assessment will
consist of distributing a questionnaire to significant third-party vendors
including those which manufacture/supply approximately 75% of the exclusive
optical discs and packaging and finished nonexclusive optical disc programming
purchased by the Company. The Company intends to seek and identify alternative
sources for its optical disc programming if it has not received vendor assurance
by March 31, 1999. The Company believes there are alternative sources for the
manufacturing of its exclusive optical discs. However, in the case of finished
new release nonexclusive optical disc programming, the programming is purchased
from sole source suppliers and it may not be possible to alternatively source
such product.
In the event that any of the Company's significant vendors do not
successfully achieve Year 2000 compliance by December 31, 1999, and in the event
the Company cannot alternatively source certain of its exclusive optical disc
manufacturing and the purchase of nonexclusive optical disc programming by
December 31, 1999, the Company would be unable to obtain certain programming for
distribution. This could lead to a loss of revenue and customer
dissatisfaction, which could, depending upon the extent of programming lost,
have a material adverse effect on the Company's results of operations,
liquidity, and financial condition. The Company will make a determination no
later than March 31, 1999 as to whether it needs to investigate the possibility
of alternatively sourcing such product.
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 62% to $617,000 for
the six months ended September 30, 1998 from $1,635,000 for the six months ended
September 30, 1997 due primarily to an increase in net production cost
expenditures and DVD inventory purchases during the September 1998 period versus
collection of accounts receivable offset, in part, by a decrease in accounts
payable during the September 1997 period. Net cash used by investing
activities, consisting entirely of capital expenditures, increased 377% to
$1,718,000 for the six months ended September 30, 1998 from $360,000 for the six
months ended September 30, 1997. The September 1998 capital expenditures
primarily relate to the Nevada warehouse and distribution facility. Net cash
provided by financing activities was $1,605,000 for the six months ended
September 30, 1998 compared to net cash used by financing activities of
$1,304,000 for the six months ended September 30, 1997. The net cash provided
from financing activities during the six months ended September 30, 1998
resulted from advances under the Company's revolving credit facility. The
aforementioned changes for the September 1998 period resulted in net cash and
cash equivalents increasing 50% to $1,519,000 at September 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. See
"Acquisition Agreement" and "Registration Statement Filing" below.
ACQUISITION AGREEMENT.
---------------------
On August 20, 1998, the Company signed a definitive agreement to acquire
substantially all of the assets used in the operation of the optical disc
software division of Ken Crane's Magnavox City, Inc., one of the Company's
largest customers (the "Division"). The Division is engaged in the business of
wholesale and retail distribution of video programming on DVD and LD through its
approximately 8,000 square foot retail store located in Westminster, California,
mail order and Internet web site located at URL "www.kencranes.com".
The assets purchased include, but are not limited to DVD and LD inventories,
fixed assets and other assets used in the operation of the Division's retail
store, mail order and Internet businesses, all rights and ownership of the
Division's web site and exclusive and perpetual right to use and exploit the
names and logos and derivations thereof used in the operation of the Division.
The Division is to operate as a wholly-owned subsidiary of the Company. Ken
Crane, Jr., the head of the Division, will enter into a multi-year employment
agreement upon the closing of the acquisition and at that time receive a $1.5
million signing bonus from the Company. He will oversee the retail store, mail
order and Internet operations of the subsidiary as Vice President, General
Manager.
The purchase price of approximately $6.5 million, substantially due at the
date of closing, will consist of the assumption of approximately $1.5 million of
specifically identified trade payables plus $3.0 million in cash and 258,370
shares of newly issued common stock of the Company having a value equal to $2
million, subject to adjustments. The Company plans to finance the cash portion
of this acquisition, including the signing bonus to Ken Crane Jr. and other
guaranteed payments to affiliates of the Seller aggregating $2.0 million,
through a registered offering of newly issued common shares of the Company. See
"Registration Statement Filing" below.
The completion of the acquisition is subject to various closing conditions,
including the completion of financing satisfactory to the Company. The
acquisition will be accounted for as a purchase and accordingly the results of
operations of the Division will be included in the Company's consolidated
results of operations from the date of closing of the acquisition. The Company
has capitalized $270,000 in costs relating to this acquisition as a component of
prepaid expenses and other assets in the accompanying consolidated balance sheet
at September 30, 1998. Should the acquisition not be consummated, any
capitalized costs recorded would be written-off.
REGISTRATION STATEMENT FILING.
-----------------------------
On October 14, 1998, the Company filed a Form S-2 registration statement with
the Securities and Exchange Commission covering the sale of up to 2,400,000
shares of newly issued common stock of the Company. The price of the common
stock to be sold in the offering will be determined by the Company's Board of
Directors based primarily on the market price of the Company's common stock at
the time of the pricing, after the registration statement becomes effective. At
that time, if the Board of Directors determines that the price of the offering
would not be in the best interest of the Company's shareholders, the Company
will withdraw the offering.
The Company intends to use the proceeds from the offering to complete the
acquisition of the DVD and LD software business of Ken Crane's Magnavox City,
Inc. and for working capital purposes. If the Company does not raise sufficient
proceeds in the offering to complete the acquisition, it intends to use the
proceeds to acquire additional DVD distribution rights and may also use the
proceeds to develop its own Internet web site for DVD and LD retail sales.
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 million revolving credit facility which expires June 30, 1999.
Borrowings under the Agreement are at Union Bank's prime rate plus .50% (8.75%
at September 30, 1998). The Agreement provides the Company the option of
borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus
3.0% (8.375% at September 30, 1998).
Borrowings under the Agreement are secured by substantially all of the
Company's assets located in California. Funds available for borrowing may not
exceed the borrowing base specified in the Agreement. At September 30, 1998,
$3,760,000 in borrowings were outstanding under the Agreement, all of which was
borrowed under the prime rate plus .50% option, and $2,289,000, net of amounts
utilized for outstanding letters of credit, was 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 September 30, 1998, the Company was not in
compliance with Union Bank's minimum tangible net worth and minimum quarterly
average profitability covenants. At the Company's request, Union Bank waived the
Company's non-compliance with those covenants for the period ended September 30,
1998. The Company was in compliance with all other financial and operating
covenants at September 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.
At September 30, 1998, the Company had $1,300,000 of outstanding standby
letters of credit issued by Union Bank which expire through November 16, 1999.
These letters of credit secure balances due to program suppliers.
Construction Credit Facility. In March 1997, the Company entered into a
----------------------------
Business Loan Agreement (the "Loan Agreement") with Bank of America National
Trust and Savings Association in Nevada. The Loan Agreement, 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% (9.5% at September 30, 1998). At September 30,
1998, there were $3,434,000 in borrowings outstanding under the Construction
Line and in accordance with the Loan Agreement, the Construction Line converted
to a revolving line of credit (the "Revolving Line").
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 expires January 31, 2008. The Company has 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
constructed its 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 September 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 September 30,
1998. The Company was in compliance with all other financial and operating
covenants at September 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 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% of the Company's total borrowings under the Lease. The Lease
provides for advances for the purchase of equipment prior to its delivery and
acceptance date (the "Advance Rent Period") which cannot extend past November
30, 1998. Interest during the Advance Rent Period is at the three-month LIBOR
plus 2.5% (7.81% at September 30, 1998). There were $944,000 in borrowings
outstanding under the Lease at September 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 September 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 September 30, 1998. The
Company was in compliance with all other financial and operating covenants at
September 30, 1887. 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% at September 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 site in Las Vegas,
Nevada.
OTHER OBLIGATIONS.
-----------------
At September 30, 1998, the Company had future license commitments for royalty
advances and other fees of $2,167,000 due during the remainder of fiscal 1999,
$948,000 due during fiscal 2000 and $25,000 due during fiscal 2001. These
advances and fees 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, fees 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 to begin shipping certain product by December 31,
1998.
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 market place 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 October
30, 1998, approximately 1,068,000 DVD players have been sold to consumer
electronics retailers. Management estimates that there are currently
approximately 748,000 domestic DVD households (approximately 70% 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 October 18, 1998 is 3.07%. The Company currently ranks eighth in market
share behind Warner Home Video (24.38%), Columbia TriStar (14.32%), Universal
Home Video (12.07%), MGM (10.34%), Disney (9.92%), New Line (8.98%) and Artisan
Entertainment (formerly LIVE Home Entertainment) (4.18%). 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) completion of the acquisition of the optical disc software
division of Ken Crane's Magnavox City, Inc.; (iv) completion of the offering of
its common stock through the Form S-2 registration statement; (v) seeking
additional investment opportunities in growth-oriented companies and securing
necessary acquisition financing; (vi) the date which the Las Vegas, Nevada
warehouse and distribution facility will be operational and shipping product;
and (vii) the adequacy and effectiveness of the Company's Year 2000 compliance
methodology. 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 programming 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) the
price of the Company's common stock at the date the registration statement
becomes effective; (vi) difficulties and delays which may be encountered in the
compression and authoring production process required to produce DVD
programming; (vii) potential installation, implementation and performance
difficulties encountered during the testing and implementation phases of the
Company's newly constructed distribution equipment and custom programmed
distribution software utilized to run the Las Vegas, Nevada distribution center;
(viii) unforseen difficulties encountered relating to Year 2000 readiness of
embedded software within non-information system's technology; (ix) any ultimate
non-Year 2000 compliance by significant information technology, non-information
technology and optical disc programming third-party vendors when such vendor's
previous public statements of Year 2000 compliance were relied upon by the
Company; 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.
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The condensed consolidated financial statements as of September 30, 1998
and for the three- and six-month periods ended September 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 September 30, 1998, and the related
condensed consolidated statements of operations for the three- and six-month
periods ended September 30, 1998 and 1997 and the statement of cash flows for
the six-month periods ended September 30, 1998 and 1997. These condensed
consolidated financial statements are the responsibility of the Company's
management.
We conducted our reviews 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 reviews, 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
October 30, 1998
<PAGE>
================================================================================
PART II - OTHER INFORMATION
================================================================================
ITEM 1. LEGAL PROCEEDINGS.
-----------------
On July 31, 1998, the Company filed a complaint in the United States
District Court for the Central District of California, Western Division (Case
No. CV 98-6203 AHS ANx), against PolyGram Video, a division of PolyGram Records,
Inc., PolyGram N.V., and The Seagram Company, Ltd. (the "California Action"),
which relates to a dispute concerning, among other things, PolyGram Video's
obligations under a December 23, 1996 license agreement with the Company. The
Company has alleged causes of action for fraud, recision of written contract,
breach of contract, interference with contract, and unfair business practices.
The Company contends that Polygram Video, its president and other officers made
various written and oral representations regarding the number and commercial
success of Polygram Video's future release schedule and the revenues that the
Company would derive from the distribution of those films. The Company further
contends that Polygram Video expressly warranted and represented in the license
agreement that Polygram Video and its affiliates would remain in the film
business "at a level comparable to, or increased from, their current level."
The Company maintains that based on such promises and representations the
Company was induced to enter into the license agreement which provided for a $6
million advance, $3 million of which was due and paid to Polygram Video as of
the filing date of the complaint.
The complaint in the California Action seeks general damages of $3 million
for fraud, complete recision of the 1996 license agreement, and recovery of
unrecouped advances in the approximate amount of $2.4 million. In the
alternative, the complaint seeks damages of $6 million for breach of contract
and interference with contract, and injunctive relief prohibiting the
acquisition of PolyGram N.V. by Seagram, or the sale of all or any part of
PolyGram's film divisions to finance such acquisition, as a violation of certain
provisions of the license agreement. The Company also seeks to recover punitive
damages, prejudgment interest, attorney's fees and costs of suit.
On August 24, 1998, after being served with the complaint in the
California Action, PolyGram Records filed a separate suit against the Company in
the United States District Court for the Southern District of New York (Case No.
98 Civ. 6025 JGK), asserting that the California Action is frivolous and seeking
damages of $1 to $3 million for the Company's alleged breach of the 1996 license
agreement, plus prejudgment interest, attorney's fees and cost of suit (the "New
York Action"). On August 25, 1998, PolyGram filed a motion to have the
California Action dismissed or moved to New York, which is currently set for
hearing on November 23, 1998. After the Company stated its intention to file a
motion to have the New York Action dismissed or moved to California, the New
York Court stayed the New York Action pending a decision on the venue motion in
the California Action.
The Company presently intends to prosecute the California Action to the
fullest extent possible and to vigorously defend the New York Action.
On June 18, 1997, the Company filed a complaint in the Superior Court of
the State of California, County of Los Angeles (Case No. BC173084), against LEI
Partners, L.P. ("LEI") and a number of related entities and individuals, which
relates to a dispute concerning, among other things, LEI's payment obligations
under two promissory notes issued in connection with a December 31, 1990
purchase agreement documenting the Company's sale of a business segment to LEI
(the "Superior Court Action"). See "Note 6. Default of Notes Receivable" of the
Company's Annual Report on Form 10-K for the year ended March 31, 1997. The
Company has alleged, inter alia, breach of contract, intentional
----- ----
misrepresentation, negligent misrepresentation, conspiracy to defraud,
interference with economic relationship, conspiracy to interfere with economic
relationship, and conversion. The Company contends that through an intricate
conspiracy among sham corporations and partnerships LEI and others defrauded the
Company and largely dissipated or diverted the assets of LEI so that LEI was
intentionally rendered incapable of satisfying its obligations under the
purchase agreement and the two promissory notes. This fraudulent scheme
includes, but is not limited to, the misrepresentation of the gross revenues and
pre-tax profits derived from the operation of the acquired business, and the
fraudulent concealment and conspiratorial diversion of assets of that business
(including the revenues generated by that business) from LEI to persons and
entities affiliated with LEI. The complaint seeks compensatory damages of not
less than $5 million plus accrued interest, attorney's fees and punitive damages
in an amount to be proven at trial. On September 16, 1997, the Company filed a
first amended complaint against the same defendants and making the same claims,
but providing additional factual details.
In response to the complaint, defendant LEI filed a petition to compel
arbitration and stay the litigation pending completion of the arbitration, based
upon an arbitration provision in one of the two promissory notes in dispute. On
September 18, 1997, the court ordered the Company and LEI to arbitrate before
the American Arbitration Association ("AAA") in Los Angeles, California, and
stayed the remainder of the litigation pending completion of the arbitration.
On November 17, 1997, the Company commenced the court ordered arbitration
proceedings against LEI, seeking damages in excess of $3.7 million, plus
attorney's fees and costs, for breach of the promissory notes. On January 21,
1998, LEI filed an answering statement denying liability. LEI also submitted a
counterclaim against Image and three of its present or former officers or
directors, but refused to pay the AAA filing fee, and the AAA rejected the
counterclaim. Although LEI's counterclaim was rejected and is not pending, it
alleged claims for, inter alia, fraud in the inducement, recission and breach of
----- ----
written contract. The counterclaim maintained that certain of the Company's
representations and warranties regarding the value of the acquired business and
its projected income were false, and that LEI was therefore fraudulently induced
to execute the purchase agreement and the two promissory notes. LEI also
maintained that the Company breached a seller non-competition agreement, thereby
entitling LEI to an offset against any amount found to be owed under the second
promissory note. The counterclaim sought compensatory damages of $1 million
plus accrued interest, attorney's fees and costs, and also seeks punitive
damages in an amount of $2 million. Should the rejected counterclaim of LEI
ever be filed or prosecuted, the Company intends to contest vigorously its
allegations and purported claims.
On May 4, 1998, LEI and certain other defendants in the Superior Court
Action filed voluntary petitions under Chapter 7 of the Bankruptcy Code in the
United States Bankruptcy Court for the Central District of California. These
bankruptcy filings have automatically stayed the prosecution of the court
ordered arbitration proceedings against LEI, and the prosecution of the Superior
Court Action against LEI and three other defendants. The Company intends to
prosecute the Superior Court Action to the fullest extent possible.
In the normal course of business, the Company and its subsidiary are
subject to proceedings, lawsuits and other claims, including proceedings under
government laws and regulations relating to employment and tax matters. While
it is not possible to predict the outcome of these matters, it is the opinion of
management, based on consultations with legal counsel, that the ultimate
disposition of known proceedings (including the rejected counterclaim in the
above-described arbitration proceeding) will not have a material adverse impact
on the Company's financial position, results of operations or liquidity.
<PAGE>
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 October 30, 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
