<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For THE QUARTERLY PERIOD ENDED DECEMBER 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For The Transition Period From ........To.......
Commission File Number 0-11071
_______________________
IMAGE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
_______________________
CALIFORNIA 84-0685613
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification Number)
9333 OSO AVENUE, CHATSWORTH, CALIFORNIA 91311
(Address of principal executive offices, including zip code)
(818) 407-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ( x ) NO ( )
Number of shares outstanding of the registrant's common stock on February 6,
1998: 13,771,645
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<PAGE>
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PART I -- FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and March 31, 1997
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<TABLE>
<CAPTION>
ASSETS
December 31, 1997 March 31, 1997
----------------- --------------
(In thousands) (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,421 $ 1,090
Accounts receivable, net of allowances of
$3,977 -- December 31, 1997;
$4,809 -- March 31, 1997 12,570 10,759
Inventories (Note 3) 16,658 17,776
Royalties, distribution fee and license fee advances 9,818 8,454
Prepaid expenses and other assets 760 751
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$4,609 -- December 31, 1997;
$3,972 -- March 31, 1997 7,478 7,618
------- -------
$48,705 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-1-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and March 31, 1997
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LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
December 31, 1997 March 31, 1997
------------------ ---------------
(In thousands, except share data) (unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $18,710 $15,922
Accrued royalties 3,576 3,481
Revolving credit facility (Note 5) 500 8,709
Construction credit facility (Note 6) 400 --
Convertible subordinated note payable (Note 7) 5,000 --
Note payable (Note 7) 1,350 285
------- -------
Total liabilities 29,536 28,397
------- -------
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, 3,366,000 shares
authorized; none issued and outstanding -- --
Common stock, no par value, 25 million shares
authorized; 13,751,000 and 13,343,000 issued and
outstanding at December 31, 1997 and
March 31, 1997, respectively 17,975 17,642
Stock warrants -- (73)
Additional paid-in capital 3,064 3,064
Accumulated deficit (1,870) (2,582)
------- -------
Net shareholders' equity 19,169 18,051
------- -------
$48,705 $46,448
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
-------- --------
<S> <C> <C>
NET SALES $26,297 $24,948
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 20,957 19,751
Selling expenses 1,332 1,143
General and administrative expenses 1,490 2,173
Amortization of production costs 1,051 794
------- -------
24,830 23,861
------- -------
OPERATING INCOME 1,467 1,087
OTHER EXPENSES (INCOME):
Interest expense 162 118
Interest income (26) (44)
Other -- 662
------- -------
136 736
------- -------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM 1,331 351
INCOME TAX EXPENSE 244 50
------- -------
INCOME BEFORE EXTRAORDINARY ITEM 1,087 301
EXTRAORDINARY ITEM -- COSTS ASSOCIATED WITH
EARLY RETIREMENT OF DEBT, NET OF TAXES -- 143
------- -------
NET INCOME $ 1,087 $ 158
======= =======
NET INCOME PER SHARE
-- BASIC AND DILUTED (Note 4):
Income before extraordinary item $.08 $ .02
Extraordinary item -- (.01)
------- -------
Net income $.08 $ .01
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-3-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Nine Months Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands, except per share data) 1997 1996
-------- --------
<S> <C> <C>
NET SALES $59,610 $62,856
OPERATING COSTS AND EXPENSES:
Cost of optical disc sales 48,289 49,582
Selling expenses 3,563 3,458
General and administrative expenses 3,624 4,989
Amortization of production costs 2,770 2,308
------- -------
58,246 60,337
------- -------
OPERATING INCOME 1,364 2,519
OTHER EXPENSES (INCOME):
Interest expense 493 226
Interest income (79) (189)
Other -- 662
------- -------
414 699
------- -------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM 950 1,820
INCOME TAX EXPENSE 238 417
------- -------
INCOME BEFORE EXTRAORDINARY ITEM 712 1,403
EXTRAORDINARY ITEM -- COSTS ASSOCIATED WITH
EARLY RETIREMENT OF DEBT, NET OF TAXES -- 143
------- -------
NET INCOME $ 712 $ 1,260
======= =======
NET INCOME PER SHARE
-- BASIC AND DILUTED (Note 4):
Income before extraordinary item $.05 $ .10
Extraordinary item -- (.01)
------- -------
Net income $.05 $ .09
======= =======
</TABLE>
See accompanying notes to consolidated financial statements
-4-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 712 $ 1,260
Adjustments to reconcile net income
to net cash provided (used) by operating activities:
Amortization of production costs 2,770 2,308
Depreciation and amortization 644 630
Amortization of stock warrants 73 136
Provision for doubtful accounts, net of recoveries (290) 1,154
Loss on disposition of assets -- 26
Changes in assets and liabilities associated
with operating activities:
Accounts receivable (1,521) (2,482)
Optical disc inventory 1,381 (4,275)
Royalty, distribution and license
fee advances, net (1,364) (6,919)
Production cost expenditures (3,033) (2,369)
Prepaid expenses and other assets (16) 162
Accounts payable, accrued royalties
and accrued liabilities 2,883 5,482
------- -------
Net cash provided (used) by
operating activities 2,239 (4,887)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (497) (4,963)
------- -------
Net cash used by investing activities (497) (4,963)
------- -------
</TABLE>
See accompanying notes to consolidated financial statements
-5-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(UNAUDITED)
For the Nine Months Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
(In thousands) 1997 1996
--------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit facility $ 28,695 $ 42,173
Advances under construction credit facility 400 --
Proceeds from issuance of convertible
subordinated note payable 5,000 --
Proceeds from issuance of note payable 1,350 --
Repayment of advances under revolving
credit facility (36,904) (33,550)
Repayment of short-term debt (285) --
Repurchase of common stock -- (2,356)
Net proceeds from exercise of stock options 333 49
-------- --------
Net cash (used) provided by financing activities (1,411) 6,316
-------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 331 (3,534)
Cash and cash equivalents at beginning of period 1,090 4,666
-------- --------
Cash and cash equivalents at end of period $ 1,421 $ 1,132
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 475 $ 152
Income taxes $ 90 $ 668
======== ========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
In November 1996, the Company purchased 16.5 acres of unimproved real property
in Las Vegas, Nevada for approximately $4 million which included a note payable
for approximately $950,000 of the consideration.
See accompanying notes to consolidated financial statements
-6-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION.
The accompanying consolidated financial statements as of and for the periods
ended December 31, 1997 and 1996 include the accounts of Image Entertainment,
Inc. and its wholly-owned subsidiary U.S. Laser Video Distributors, Inc.
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
The accompanying consolidated balance sheet at December 31, 1997 and the related
consolidated statements of operations and cash flows for the periods ended
December 31, 1997 and 1996 of the Company included herein are unaudited;
however, such information reflects all adjustments of a normal recurring nature
which management believes are necessary for a fair presentation of results for
the interim periods. The accompanying consolidated financial information for
the periods ended December 31, 1997 and 1996 should be read in conjunction with
the Financial Statements, the Notes thereto and Management's Discussion and
Analysis of Financial Condition and Results of Operations in the Company's March
31, 1997 Form 10-K.
The preparation of the Company's consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in these financial
statements and accompanying notes. The more significant areas requiring the use
of management estimates related to allowances for slow-moving inventory,
doubtful accounts receivable, royalty and other advances and sales returns.
Actual results could differ from those estimates.
Certain fiscal 1997 amounts have been reclassified to conform with the fiscal
1998 presentation.
Seasonality and Variability. The Company has generally experienced higher sales
- ---------------------------
of laserdiscs in the quarters ended December 31 and March 31 due to increased
consumer spending associated with the year-end holidays and the home video
release of many high profile, high budget summer theatrical releases; however,
since most sales of a title occur in the first few months after its release,
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 on a quarterly basis. These factors include: (i) competition from DVD, a
competing video format, which affects wholesale and retail customer demand for
laserdisc programming; (ii) the popularity of laserdisc 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 laserdisc and DVD video programming; (v) the extension, termination or non-
renewal of existing laserdisc and DVD license and distribution rights; and (vi)
general economic changes affecting consumer demand for laserdisc and DVD
hardware and software and the buying habits of the Company's customers. The
results of operations for the periods ended December 31, 1997 are not
necessarily indicative of the results to be expected for the entire fiscal year
ending March 31, 1998.
-7-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
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NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS.
In June 1997, Statement of Financial Accounting Standards No. 130 ("SFAS No.
130") "Reporting Comprehensive Income" was issued. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. SFAS No. 130 is
effective for both interim and annual periods beginning after December 15, 1997.
The Company will adopt SFAS No. 130 in its quarter ending March 31, 1998.
In June 1997, Statement of Financial Accounting Standards No. 131 ("SFAS No.
131") "Disclosures about Segments of an Enterprise and Related Information" was
issued. SFAS No. 131 requires that public business enterprises report certain
information about operating segments in complete sets of financial statements of
the enterprise and in condensed financial statements of interim periods issued
to shareholders. It also requires that public business enterprises report
certain information about their products and services, the geographic areas in
which they operate, and their major customers. SFAS No. 131 is effective for
annual periods beginning after December 15, 1997 and interim periods in the
second year of application. The Company will adopt SFAS No. 131 in its fiscal
year ending March 31, 1999.
<TABLE>
<CAPTION>
NOTE 3. INVENTORIES.
<S> <C>
</TABLE>
Inventories at December 31, 1997 and March 31, 1997 are summarized as follows:
<TABLE>
<CAPTION>
(In thousands) December 31, March 31,
1997 1997
------------ ---------
<S> <C> <C>
Optical disc inventory:
Laserdisc $18,009 $19,067
DVD 1,405 203
------- -------
19,414 19,270
Reserve for slow-moving inventory (4,595) (3,070)
------- -------
14,819 16,200
Production costs, net 1,839 1,576
------- -------
$16,658 $17,776
======= =======
</TABLE>
Optical disc inventory consists of finished optical discs for sale. Optical disc
inventory is stated at the lower of average cost or market.
Production costs are net of accumulated amortization of $5,764,000 and
$5,011,000 at December 31, 1997 and March 31, 1997, respectively.
-8-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
------------------------------------------------------
NOTE 4. NET INCOME PER SHARE.
In February 1997, Statement of Financial Accounting Standards No. 128 ("SFAS No.
128") "Earnings Per Share" was issued. SFAS No. 128 supersedes Accounting
Principles Board Opinion No. 15, "Earnings Per Share" and specifies the
computation, presentation, and disclosure requirements for earnings per share
("EPS") for entities with publicly held common stock. SFAS No. 128 is effective
for both interim and annual periods ending after December 15, 1997. The Company
adopted SFAS No. 128 in the quarter ending December 31, 1997.
Accordingly, the accompanying net income per share information, including all
information restated for periods prior to fiscal 1998, has been calculated and
presented in accordance with the provisions of SFAS No. 128.
Basic net income per share was calculated by dividing net income by the weighted
average number of common shares outstanding during the periods presented.
Diluted net income per share was calculated in a manner consistent with basic
net income per share except that the weighted average number of common shares
outstanding also includes the diluted effect of stock options and warrants
outstanding (using the treasury stock method).
The following presents a reconciliation of the numerators and denominators used
in computing basic and diluted net income per share:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Three months ended Nine months ended
December 31, December 31,
------------ ------------
1997 1996 1997 1996
--- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (basic and diluted numerator) $ 1,087 $ 158 $ 712 $ 1,260
======= ======= ======= =======
Weighted average common shares
outstanding (basic denominator) 13,740 13,501 13,575 13,617
======= ======= ======= =======
Effect of dilutive stock options
and warrants 428 418 307 471
------- ------- ------- -------
Weighted average common shares
outstanding (diluted denominator) 14,168 13,919 13,882 14,088
======= ======= ======= =======
Basic and diluted net income per share $ .08 $ .01 $ .05 $ .09
======= ======= ======= =======
</TABLE>
-9-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
------------------------------------------------------
During the three months ended December 31, 1997 and 1996 and the nine months
ended December 31, 1997 and 1996, there were 2,732,000, 2,011,000, 2,732,000,
and 1,832,000, respectively, of outstanding stock options and warrants and
common shares underlying a convertible security (in the 1997 periods) which were
not included in the computation of diluted net income per share. In the case of
the stock options and warrants, the exercise prices were greater than the
average market price of the common stock for the respective periods and in the
case of the convertible security, the assumed conversion or exercise would
result in antidilution when applying the treasury stock method for the periods
presented. Basic and diluted net income per share for all periods presented are
identical.
NOTE 5. REVOLVING CREDIT FACILITY.
In December 1996, the Company entered into a Loan Agreement (the "Agreement")
with Union Bank. The Agreement, as amended in January 1998, provides for
revolving advances and the issuance of standby letters of credit under a
$15,000,000 revolving credit facility which expires December 31, 1999.
Borrowings under the Agreement are at Union Bank's prime rate plus .25% (8.75%
at December 31, 1997). The Agreement provides the Company the option of
borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus
2.5% (8.31% at December 31, 1997).
Borrowings under the Agreement are secured by substantially all of the Company's
assets (located in California and New Jersey). Funds available for borrowing
may not exceed the borrowing base specified in the Agreement. At December 31,
1997, there were $500,000 in borrowings outstanding under the Agreement, all of
which was borrowed under the prime rate plus .25% option, and $10,962,000, 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 December 31, 1997, the Company was in
compliance with the financial and operating covenants or had received waivers of
noncompliance from Union Bank.
NOTE 6. CONSTRUCTION CREDIT AND WAREHOUSE AND DISTRIBUTION EQUIPMENT LEASE
FACILITIES.
Construction Credit Facility. In March 1997, the Company entered into a
- ----------------------------
Business Loan Agreement (the "Loan Agreement") with Bank of America National
Trust and Savings Association in Nevada. The Loan Agreement, as amended in
February 1998, 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 December 31, 1997). At
December 31, 1997, there were $400,000 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,
-10-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
------------------------------------------------------
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 requires the Company to comply with certain quarterly
financial and operating covenants. At December 31, 1997, the Company was in
compliance with the financial and operating covenants.
Warehouse and Distribution Equipment Lease Facility. At December 31, 1997 there
- ---------------------------------------------------
were no borrowings outstanding under the Company's March 1997 $2,500,000
warehouse and distribution equipment lease facility with BankAmerica Leasing and
Capital Corporation, as amended in February 1998. The lease contains certain
quarterly financial and operating covenants. At December 31, 1997, the Company
was in compliance with the financial and operating covenants.
NOTE 7. OTHER NOTES PAYABLE.
Convertible Subordinated Note Payable. On September 29, 1997, the Company
- -------------------------------------
entered into a credit agreement (the "Credit Agreement") with Image Investors
Co. ("IIC"), a principal stockholder of the Company owned and controlled by John
W. Kluge and Stuart Subotnick, pursuant to which the Company borrowed $5,000,000
from IIC, with interest payable quarterly at 8% per annum, and principal due in
five years. The loan is unsecured and subordinate to any obligations to Union
Bank and is convertible into the Company's common stock at any time during the
term at a conversion price of $3.625 per share, the closing price of the
Company's common stock on September 29, 1997. Proceeds from the loan were used
to pay down the Company's outstanding balance under its revolving credit
facility with Union Bank.
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 in February 1998, bears
interest at prime plus 1.75% (10.25% at December 31, 1997), matures August 1,
1998 and is secured by a deed of trust on the approximately 8.8 acres of land
adjacent to the Company's warehouse and distribution facility construction site
in Las Vegas, Nevada.
To provide security for the aforementioned Pioneer Citizens Bank loan,
concurrent with the closing of the Business Loan Agreement, the Company repaid a
note payable in the amount of $281,000 plus accrued interest which represented
unpaid purchase consideration for the January 1997 purchase of a portion of the
aforementioned Nevada land.
-11-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS.
-------------
GENERAL
The Company operates in one industry segment, the domestic home video
market. The Company has distributed a broad range of programming on laserdisc
("LD") since 1983. In addition to the distribution of LD product, the Company
began distributing programming on the new digital video disc ("DVD") format
first introduced in March 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 and
nonexclusive 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. See "Summary and
---
Outlook -- Exclusive Distribution of DTS Encoded Software."
DVD is directly competitive with LD. The Electronics Industries
Association ("EIA") reported approximately 349,000 DVD players have been sold to
electronic hardware dealers from DVD's March 1997 introduction through January
2, 1998 (the unit sales figure includes DVD/LD combination players). In
contrast, the EIA reported that, during calendar 1997, LD player sales to
electronic hardware dealers were approximately 49,000 units, down 68.5% from
calendar 1996, a trend which management believes has significantly impacted
sales of the Company's LD programming.
As discussed more fully in "Summary and Outlook -- DVD and LD Outlook" the
Company is distributing DVD on an exclusive and nonexclusive basis. The
Company's nonexclusive DVD distribution activities began with the format's March
1997 launch. Since then, the Company has secured exclusive distribution rights
to certain DVD programming and, in addition to its nonexclusive DVD distribution
activities, has released 26 exclusive DVD video programs in the quarter ended
December 31, 1997, up from 18 DVD titles and 2 DVD titles in the quarters ended
September 30 and June 30, 1997, respectively. Exclusive and nonexclusive DVD
sales accounted for approximately 17.6% and 15.2% of the Company's net sales
during the three and nine months ended December 31, 1997, respectively.
LD sales for the three and nine months ended December 31, 1997 were down
approximately 13.2% and 19.6%, respectively, compared to the three and nine
months ended December 31, 1996. Management believes that competition from DVD
will continue to adversely impact sales of LD programming. Management also
believes that the introduction of DVD has caused certain of the larger retailers
to become more cautious in their LD purchasing. Additionally, the financial
difficulties experienced by certain of the Company's largest customers have
impacted the volume and breadth of their entertainment software purchasing
(including LD programming) and, accordingly, has had a negative impact on the
Company's overall quarterly sales. The Company significantly increased its
reserve for slow-moving inventory during the three and nine months ended
December 31, 1997 as compared to the three and nine months ended December 31,
1996. The Company is continually evolving its inventory management strategy in
light of the prevailing uncertainty in the LD market place and is evaluating its
inventory reserves accordingly. See
---
-12-
<PAGE>
"Summary and Outlook -- Distressed Condition of the Retail Entertainment
Software Market" and "-- DVD and LD Outlook."
In the future, the Company expects that net sales will continue to be
affected by the popularity of new LD and DVD releases, the level of LD and DVD
hardware sales, the extent of the Company's distribution of the DVD format,
DVD's market penetration, the financial condition of the retail entertainment
software market and the prevailing economic environment.
NEW ACCOUNTING PRONOUNCEMENT
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share." This Statement
requires companies to replace the presentation of primary earnings per share
("EPS") with a presentation of basic EPS. It also requires dual presentation of
basic and diluted EPS on the face of the statements of operations and a
reconciliation of the basic EPS computation to the diluted EPS computation. All
prior period EPS data has been restated to conform with the provisions of SFAS
No. 128. See Note 4 to the Consolidated Financial Statements for the
---
reconciliation.
RESULTS OF OPERATIONS
The Company recorded operating income of $1,467,000 and $1,364,000 for the
three and nine months ended December 31, 1997, respectively, versus operating
income of $1,087,000 and $2,519,000 for the three and nine months ended December
31, 1996, respectively. The Company recorded net income of $1,087,000, or $.08
per basic and diluted share, and $712,000, or $.05 per basic and diluted share,
for the three and nine months ended December 31, 1997, respectively, versus net
income of $158,000, or $.01 per basic and diluted share, and $1,260,000, or $.09
per basic and diluted share, for the three and nine months ended December 31,
1996, respectively.
THE THREE MONTHS ENDED DECEMBER 31, 1997 COMPARED TO THE THREE MONTHS ENDED
DECEMBER 31, 1996
Net sales for the December 1997 quarter increased 5.4% to $26,297,000 from
$24,948,000 for the December 1996 quarter. The increase was due to net sales
from the Company's distribution of DVD programming, offset, in part, by a
decline in net sales of LD programming.
Cost of optical disc sales (LDs and DVDs collectively) for the December
1997 quarter increased to $20,957,000 from $19,751,000 for the December 1996
quarter. As a percentage of net sales, cost of optical disc sales for the
December 1997 quarter increased to 79.7% from 79.2% for the December 1996
quarter. The margin decline for the December 31, 1997 quarter primarily
reflects an increased provision for slow-moving LD inventory offset, in part, by
a lower average cost of sales for exclusive DVD programming versus LD
programming and lower LD manufacturing costs as compared to the December 1996
quarter.
Selling expenses increased 16.5% to $1,332,000 for the December 1997
quarter from $1,143,000 for the December 1996 quarter. As a percentage of net
sales, selling expenses for the December 1997
-13-
<PAGE>
quarter increased to 5.1% from 4.6% for the December 1996 quarter. As a
percentage of net sales, the Company, in the December 1997 quarter, experienced
higher market development funds provided to customers and higher freight costs
due to an increase in rates offset, in part, by reduced distribution expenses
for U.S. Laser due to the consolidation of the majority of U.S. Laser's
distribution activities as compared to the December 1996 quarter.
General and administrative expenses decreased 31.4% to $1,490,000 for the
December 1997 quarter from $2,173,000 for the December 1996 quarter. As a
percentage of net sales, general and administrative expenses for the December
1997 quarter decreased to 5.7% from 8.7% for the December 1996 quarter. During
the three months ended December 31, 1997 and 1996, general and administrative
expenses were affected by certain significant charges. The December 1996
quarter included a significant provision for uncollectible accounts receivable
over that for the December 1997 quarter. The December 1997 quarter included
$150,000 in severance payments to former principals of U.S. Laser, whose
employment ended as part of the Company's consolidation of the majority of the
distribution activities of U.S. Laser. Exclusive of the December 1996 quarter's
significant increase in the provision for uncollectible accounts receivable and
the December 1997 quarter's charge for severance payments, general and
administrative expense, as a percentage of net sales, for the December 1997 and
1996 quarters was 5.0% and 5.5%, respectively. During the December 1997
quarter, the Company experienced lower overhead from U.S. Laser due to the
consolidation of certain administrative support as compared to the December 1996
quarter.
Amortization of production costs for the December 1997 quarter increased
32.4% to $1,051,000 from $794,000 for the December 1996 quarter. As a
percentage of net sales, amortization of production costs for the December 1997
quarter increased to 4.0% from 3.2% for the December 1996 quarter. The increase
is primarily attributable to 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 higher volume of titles. The Company
expects amortization of production costs to continue to be a function of the
timing and number of exclusive LD and DVD titles placed into production.
Interest expense for the December 1997 quarter increased 37.3% to $162,000
from $118,000 for the December 1996 quarter. Interest income for the December
1997 quarter decreased 40.9% to $26,000 from $44,000 for the December 1996
quarter. The Company had higher borrowings outstanding and less cash invested
during the December 1997 quarter versus the December 1996 quarter.
Other expense for the December 1996 quarter consists of a nonrecurring
charge of $662,000, composed primarily of professional fees, relating to the
acquisition of Essex Entertainment, Inc., a privately-held independent music
company headquartered in New Jersey. Negotiations to acquire Essex
Entertainment, Inc. terminated in December 1996.
During the December 1996 quarter, the Company recorded an extraordinary
item charge of $143,000, net of related taxes of $40,000, associated with the
early retirement of debt. The Company refinanced its $15 million revolving
credit facility with Foothill Capital Corporation with a facility from Union
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<PAGE>
Bank of California. The charge related to a prepayment penalty paid and
amortization of deferred financing costs, accelerated as a result of the early
retirement ($41,000 represents noncash charges).
THE NINE MONTHS ENDED DECEMBER 31, 1997 COMPARED TO THE NINE MONTHS ENDED
DECEMBER 31, 1996
Net sales for the nine months ended December 31, 1997 decreased 5.2% to
$59,610,000 from $62,856,000 for the nine months ended December 31, 1996. The
decrease was due to declining net sales from the distribution of LD programming
offset, in part, by net sales from the Company's distribution of DVD
programming.
Cost of optical disc sales (LDs and DVDs collectively) for the nine months
ended December 31, 1997 decreased to $48,289,000 from $49,582,000 for the nine
months ended December 31, 1997. As a percentage of net sales, cost of optical
disc sales for the nine months ended December 31, 1997 increased to 81.0% from
78.9% for the nine months ended December 31, 1996. The margin decline primarily
reflects an increased provision for slow-moving LD inventory offset, in part, by
a lower average cost of sales for exclusive DVD programming versus LD
programming and lower LD manufacturing costs for the nine months ended December
31, 1997 as compared to the 1996 period.
Selling expenses increased 3.0% to $3,563,000 for nine months ended
December 31, 1997 from $3,458,000 for the nine months ended December 31, 1996.
As a percentage of net sales, selling expenses for the nine months ended
December 31, 1997 increased to 6.0% from 5.5% for the nine months ended December
31, 1996. As a percentage of net sales, the Company, during the nine months
ended December 31, 1997, experienced higher freight costs due to an increase in
rates and increased personnel and distribution costs associated with DVD
distribution offset, in part, by reduced LD trade advertising of exclusive LD
titles and reduced distribution expenses for U.S. Laser due to the consolidation
of the majority of U.S. Laser's distribution activities as compared to the 1996
period.
General and administrative expenses decreased 27.4% to $3,624,000 for the
nine months ended December 31, 1997 from $4,989,000 for the nine months ended
December 31, 1996. As a percentage of net sales, general and administrative
expenses for the nine months ended December 31, 1997 decreased to 6.1% from 7.9%
for the nine months ended December 31, 1996. The decrease is principally
attributable to net recoveries of previously reserved accounts receivable from
certain customers during the nine months ended December 31, 1997 as compared to
a significant provision for uncollectible accounts receivable recorded during
the nine months ended December 31, 1996. During the nine months ended December
31, 1997, the Company experienced lower overhead from U.S. Laser due to the
consolidation of certain administrative support offset, in part, by severance
payments to the former principals of U.S. Laser and higher legal and accounting
expenses as compared to the 1996 period.
Amortization of production costs for the nine months ended December 31,
1997 increased 20.0% to $2,770,000 from $2,308,000 for the nine months ended
December 31, 1996. As a percentage of net sales, amortization of production
costs for the nine months ended December 31, 1997 increased to 4.6% from 3.7%
for the nine months ended December 31, 1996. The increase is primarily
attributable to the
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incremental production of exclusive DVD titles and an increase in exclusive LDs
placed into production as well as the higher overhead in the Company's creative
services and production departments necessary to produce the higher volume of
titles. The Company expects amortization of production costs to continue to be a
function of the timing and number of exclusive LD and DVD titles placed into
production.
Interest expense for the nine months ended December 31, 1997 increased
118.1% to $493,000 from $226,000 for the nine months ended December 31, 1996.
Interest income for the nine months ended December 31, 1997 decreased 58.2% to
$79,000 from $189,000 for the nine months ended December 31, 1996. The Company
had higher borrowings outstanding and less cash invested during the nine months
ended December 31, 1997 versus the nine months ended December 31, 1996.
Other expenses for the nine months ended December 31, 1996 consists of a
nonrecurring charge of $662,000, composed primarily of professional fees,
relating to the acquisition of Essex Entertainment, Inc., a privately-held
independent music company headquartered in New Jersey. Negotiations to acquire
Essex Entertainment, Inc. terminated in December 1996.
During the nine months ended December 1996, the Company recorded an
extraordinary item charge of $143,000, net of related taxes of $40,000,
associated with the early retirement of debt. The Company refinanced its $15
million revolving credit facility with Foothill Capital Corporation with a
facility from Union Bank of California. The charge related to a prepayment
penalty paid and amortization of deferred financing costs, accelerated as a
result of the early retirement ($41,000 represents noncash charges).
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital requirements vary primarily with the level of
its licensing, production and distribution activities. The principal recurring
uses of working capital in operations are for program licensing costs (i.e.,
royalty payments, including advances, to program suppliers), distribution fee
advances, manufacturing and production costs, costs of acquiring finished
product for wholesale distribution and selling, general and administrative
expenses. Working capital has historically been provided by cash flows from
operations, private sales of common stock, notes payable to private and
institutional investors and bank borrowings. For the nine months ended December
31, 1997, operating activities provided cash and cash equivalents of $2,239,000,
investing activities, consisting of capital expenditures, used cash and cash
equivalents of $497,000 and financing activities, consisting primarily of net
repayments of bank borrowings, used cash and cash equivalents of $1,411,000,
resulting in a net increase in cash and cash equivalents of $331,000.
At December 31, 1997, the Company had cash and cash equivalents of
$1,421,000 and had outstanding borrowings of $500,000 and available borrowings
of $10,962,000, net of amounts utilized for outstanding letters of credit, under
its revolving credit facility with Union Bank.
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FINANCING ACTIVITIES.
- --------------------
Revolving Credit Facility. In December 1996, the Company entered into a
-------------------------
Loan Agreement (the "Agreement") with Union Bank. The Agreement, as amended in
January 1998, provides for revolving advances and the issuance of standby
letters of credit under a $15,000,000 revolving credit facility which expires
December 31, 1999. Borrowings under the Agreement are at Union Bank's prime
rate plus .25% (8.75% at December 31, 1997). The Agreement provides the Company
the option of borrowing for fixed periods at the London Interbank Offered Rate
("LIBOR") plus 2.5% (8.31% at December 31, 1997).
Borrowings under the Agreement are secured by substantially all of the Company's
assets (located in California and New Jersey). Funds available for borrowing
may not exceed the borrowing base specified in the Agreement. At December 31,
1997, there were $500,000 in borrowings outstanding under the Agreement, all of
which was borrowed under the prime rate plus .25% option, and $10,962,000, 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 December 31, 1997, the Company was in
compliance with the financial and operating covenants or had received waivers of
noncompliance from Union Bank.
At December 31, 1997, the Company had $2,300,000 of outstanding 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. The Loan Agreement, as amended in
February 1998, 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 December 31, 1997). At
December 31, 1997, there were $400,000 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 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 requires the Company to comply with certain quarterly
financial and operating covenants. At December 31, 1997, the Company was in
compliance with the financial and operating covenants.
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<PAGE>
Warehouse and Distribution Equipment Lease Facility. At December 31, 1997,
---------------------------------------------------
there were no borrowings outstanding under the Company's March 1997 $2,500,000
warehouse and distribution equipment lease facility with BankAmerica Leasing and
Capital Corporation, as amended in February 1998. The lease contains certain
quarterly financial and operating covenants. At December 31, 1997, the Company
was in compliance with the financial and operating covenants.
Convertible Subordinated Note Payable. On September 29, 1997, the Company
-------------------------------------
entered into a credit agreement (the "Credit Agreement") with Image Investors
Co. ("IIC"), a principal stockholder of the Company owned and controlled by John
W. Kluge and Stuart Subotnick, pursuant to which the Company borrowed $5,000,000
from IIC, with interest payable quarterly at 8% per annum, and principal due in
five years. The loan is unsecured and subordinate to any obligations to Union
Bank and is convertible into the Company's common stock at any time during the
term at a conversion price of $3.625 per share, the closing price of the
Company's common stock on September 29, 1997. Proceeds from the loan were used
to pay down the Company's outstanding balance under its revolving credit
facility with Union Bank.
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 in February 1998, bears
interest at prime plus 1.75% (10.25% at December 31, 1997), matures August 1,
1998 and is secured by a deed of trust on the approximately 8.8 acres of land
adjacent to the Company's warehouse and distribution facility construction site
in Las Vegas, Nevada.
To provide security for the aforementioned Pioneer Citizens Bank loan,
concurrent with the closing of the Business Loan Agreement, the Company repaid a
note payable in the amount of $281,000 plus accrued interest which represented
unpaid purchase consideration for the January 1997 purchase of a portion of the
aforementioned Nevada land.
OTHER OBLIGATIONS.
- -----------------
At December 31, 1997, the Company had future license obligations for
royalty advances, minimum guarantees and other fees of $2,058,000 due during
fiscal 1998, $6,515,000 due during fiscal 1999, $1,453,000 due during fiscal
2000, and $120,000 due during fiscal 2001. These advances and guarantees are
recoupable against royalties earned by the licensors and program suppliers,
respectively. Depending upon competition for license and exclusive distribution
rights, the Company may have to pay increased advances, guarantees and/or
royalty rates in order to acquire or retain such rights in the future.
SUMMARY AND OUTLOOK
Management believes the Company's long-term operating cash flow and
liquidity will depend upon the viability of the LD marketplace, the ultimate
success of DVD and DTS encoded software, the Company's role in the licensing and
distribution of DVD and DTS encoded software and the overall strengthening of
the retail entertainment software market's economic condition.
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Management believes that its internal and external sources of funding are
adequate to meet anticipated needs within the next 12 months.
DISTRESSED CONDITION OF THE RETAIL ENTERTAINMENT SOFTWARE MARKET.
- ----------------------------------------------------------------
During the past six months, the dedicated entertainment software market,
within which several of the Company's largest customers operate, appears to be
experiencing moderately improving financial performance relative to the three-
year period ended mid-calendar 1997. Certain major entertainment software
retailers have recently reported improved same-store sales, overall sales, and
cash flow improvement during the 1997 holiday season versus the comparable 1996
season. Cyclical improvement in the music industry, highlighted by certain
successful major artists releases, combined with continued growth in video sales
drove improved financial performance in the 1997 holiday season. Additionally,
major entertainment software retailers have recently implemented certain
operating strategies which are having a positive effect on their financial
performance. Management is guardedly optimistic that this positive trend will
continue.
Management believes that many of the negative factors contributing to the
prevailing economic environment in the retail entertainment software market will
be mitigated in the long-term. Specifically, recent contraction in excess
numbers of retail stores, cyclical improvement in the music industry,
anticipated improvements in target demographics for entertainment software and
continued development of more effective retailing strategies should have a
positive effect on the entertainment software retailing sector in the long-term.
DVD AND LD OUTLOOK.
- ------------------
The DVD format was introduced at the end of March 1997. In the nine months
since DVD's introduction, the EIA reported approximately 349,000 DVD players
were sold to electronic hardware dealers which is substantially lower than early
industry projections. The Company estimates that approximately 50% of these
players have sold through to consumers. The DVD format is in its infancy and is
subject to numerous market forces:
. LIMITED DVD SOFTWARE AVAILABILITY: Currently, the Company estimates that
there are approximately 600 DVD titles in release as compared to over
10,000 available LD titles. To date, not all of the major film studios
are participating in DVD and those studios which are participating are
often not releasing major titles on a concurrent (i.e., "day-and-date")
----
basis with their videotape releases. Additionally, both the major and
independent programming sources participating in the DVD format are
currently releasing a lower volume and narrower breadth of titles on DVD,
as compared to LD. All of the major film studios continue to release the
majority of their home video titles on LD and, combined with independent
producers of programming, provide over 80 new LD releases each month, of
which the Company releases over 40 titles each month.
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<PAGE>
. LIMITED AWARENESS OF THE DVD FORMAT: Despite heavy holiday season print
and television advertising, there is currently limited mass-market
awareness of the DVD format. DVD is not currently perceived by videotape
consumers as a replacement format for videotape.
. COMPETING FORMAT TO DVD: In September 1997, Digital Video Express
("DIVX") announced plans to release a competing DVD format in early 1998.
DIVX is a pay-per-view format requiring the purchase of a DIVX feature-
enhanced DVD player (which is reported to be backward compatible with
existing non-DIVX DVD software). Although currently not in release, DIVX
has received significant attention within the video industry. Management
believes that the widely publicized release of the DIVX format has
contributed to considerable confusion as some consumers may delay their
consideration of a DVD player purchase as they await further
clarification of the DVD format.
. TECHNOLOGICAL ASPECTS OF LD AND DVD: While DVD provides appreciably
higher audio and video quality as compared to videotape, it does not
provide certain basic functions which the Company believes will be
required to drive mass-market acceptance, including, most significantly,
recordability. In the absence of recordability, the Company believes
that DVD may develop into a significant but niche format similar to but
larger than the current LD market. The incremental improvement in video
quality offered by DVD as compared to LD is significantly less
appreciable than the difference between DVD and videotape and, although
DVD affords other advantages of a digital medium, such as smaller size
and increased storage capacity, basic functionality for both LD and DVD
is similar. Management believes a significant portion of the estimated
2,000,000 LD households continues to support the LD format given its
competitive functionality and, more importantly, its current software
availability. While the Company believes DVD has been embraced by early
adopters of electronic entertainment technology, such as the more avid LD
consumers, who appreciate its improved video and audio quality over
videotape, DVD has yet to crossover to mass-market consumers.
While the aforementioned factors have contributed to slower then expected
penetration of the DVD format, the Company believes that many of these
uncertainties will be resolved in the future. Although there can be no
assurance, management currently believes that the LD and DVD formats can co-
exist for several years. Management further believes that DVD has significant
long-term potential in the marketplace and the Company is continuing its efforts
to secure additional DVD license and exclusive distribution opportunities to
remain competitive through the diversification of its core business.
DVD Licensing and Distribution. In December 1997, the Company entered into
------------------------------
an exclusive distribution agreement with Universal Studios Home Video for the
release of 50 catalogue DVD titles. In May 1997, the Company entered into an
exclusive distribution agreement with Central Park Media Corp. for the release
of 10 Japanese animation DVD titles. In April 1997, the Company entered into an
exclusive distribution agreement with Orion Home Video for the release of 12
catalogue DVD titles. In February 1997, the Company entered into an exclusive
license output agreement with Playboy Home Video for the release of their video
programming on DVD. The Company has also entered into numerous other exclusive
distribution agreements with independent program suppliers for the release of
certain of their titles on DVD.
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<PAGE>
Lastly, certain of the Company's LD license agreements also provided for a broad
grant of optical disc rights, including DVD.
As the DVD format continues to grow, and assuming that the Company can
continue to successfully secure and distribute additional DVD programming, the
Company believes it is well-positioned to enhance its reputation and presence in
the DVD market. The Company believes the licensing, sales, production, creative
services, marketing and distribution expertise it has developed as the largest
LD licensee and distributor in North America should translate to the DVD format,
thereby enhancing the success of the Company's DVD efforts.
EXCLUSIVE DISTRIBUTION OF DTS ENCODED SOFTWARE.
- ----------------------------------------------
In September 1997, the Company entered into a three-year agreement with
Digital Theater Systems, Inc. ("DTS Inc."), a corporation whose shareholders
include Universal City Studios, Inc. and an entity controlled by Steven
Spielberg, for the exclusive distribution of CDs, and, if and when applicable,
DVDs, encoded in the DTS Digital Surround ("DTS") multichannel audio format.
DTS Inc. holds the patent rights in DTS, a unique system for delivering
multichannel digital sound for motion pictures, which was first introduced
theatrically with the 1993 release of "Jurassic Park." The DTS format is
currently utilized in over 12,000 movie theaters worldwide. The same technology
has been recently integrated for use in home theater systems. DTS is an
encode/decode system that delivers six channels (5.1) of master-quality, 20-bit
audio. Each of the six channels is audibly superior to the 16-bit linear PCM
audio found on conventional CDs. The Company's agreement with DTS Inc. covers
all DTS Inc.'s releases on CD. The agreement also extends the term of a
previously granted license to the Company for the exclusive right to encode DTS
sound on LDs.
In December 1997, the Company entered into a three-year agreement with
Miller Nevada, Ltd., Inc. ("Miller") for the exclusive distribution of all of
Miller's DTS encoded CDs. Miller releases third party music programming encoded
with DTS sound under the "HDS" label.
The Company's distribution agreements with DTS Inc. and Miller provide the
Company exclusive North American distribution rights to virtually all DTS
encoded CDs and LDs. The agreements also provide that if either DTS Inc. or
Miller release DTS programming on DVD, the Company will also have the exclusive
right to distribute these DVDs. Under both agreements, Image will be
responsible for all marketing, sales, inventory management and distribution of
all DTS encoded software.
These agreements afford the Company an opportunity to diversify its core
exclusive distribution business to include exclusive distribution of DTS encoded
CDs. Although the Company continues to market and sell DTS encoded LDs and may
release DVDs encoded in DTS, the Company believes that the largest potential for
DTS software growth is in DTS encoded CDs. The Company began its exclusive sale
of DTS/CDs in January 1998. There are currently over 40 DTS/CD titles
available. In early calendar 1997, the Company began releasing certain major
motion pictures on LD featuring DTS multichannel audio and had, as of December
31, 1997, released over 40 DTS encoded LDs. The Company plans to continue
releasing a wide variety of DTS encoded LDs.
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Software encoded with DTS multichannel audio can only be played in DTS when
processed through a DTS decoder. To date, several high-end audio component
producers have brought decoders to the market. As a relatively new technology,
the DTS enabled hardware has been priced beyond the price range of most
consumers. Several mainstream audio hardware manufacturers have announced plans
to introduce DTS enabled hardware in calendar 1998. This hardware will decode
DTS multichannel audio from all types of DTS encoded software (LD, CD and DVD).
As a result, the Company believes that prices for DTS enabled hardware with the
ability to decode all DTS multichannel audio platforms will decline in the
future.
LAS VEGAS WAREHOUSE AND DISTRIBUTION FACILITY AND ADJACENT LAND.
- ---------------------------------------------------------------
In December 1997, the Company began construction of a 76,000 square foot
automated warehouse and distribution facility on approximately 8.4 acres of the
Company's real property adjacent to McCarran International Airport in Las Vegas,
Nevada. The Company expects the facility to be operational by September 1998.
The Company plans to sublease its existing 48,000 square foot warehouse located
in Chatsworth, California through the end of its March 31, 2000 lease term.
The Company has taken the remaining 8.8 acres of its adjacent street
frontage property, previously held for sale, off the market. In an effort to
attract potential buyers and increase the market value of the parcel, the
Company has filed for a commercial subdivision and expects to remarket the
parcel in the coming months, after construction of the warehouse and
distribution facility is substantially underway.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, are
contained throughout this Form 10-Q. Such statements are based on the beliefs
of the Company's management as well as assumptions made by and information
currently available to the Company's management. When used in this report, the
words "anticipate", "believe", "estimate", "may", "plan", "expect" and similar
expressions, variations of such terms or the negative of such terms as they
relate to the Company or its management are intended to identify such forward-
looking statements and should not be regarded as a representation by the
Company, its management or any other person that the future events, plans or
expectations contemplated by the Company will be achieved. Such statements are
based on management's current expectations and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should the underlying assumptions prove incorrect,
the Company's actual results, performance or achievements could differ
materially from those expressed in, or implied by, any such forward-looking
statements. The Company has made forward-looking statements in this Form 10-Q
concerning, among other things, (i) the viability of the LD format for several
years despite the introduction of the DVD format; (ii) that DVD has significant
long-term potential in the marketplace; (iii) that the recordability function
for DVD is required to drive mass-market acceptance of the format; (iv) the
strengthening of the retail entertainment software market over the long term;
(v) the Company's ability to enhance its reputation and presence in the DVD
market, experience continued sales of its licensed LD and DVD programing and
secure additional LD and DVD rights; (vi) the introduction of newly announced
DTS enabled hardware; (vii) prices for DTS enabled hardware with the ability to
decode DTS encoded software will decline; (viii) DTS encoded
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DVD programming will become a reality; (ix) projected growth in DTS encoded CDs;
and, (x) the date which the Company's Las Vegas warehouse and distribution
system 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) the number of and breadth of titles
that will ultimately be available on DVD; (ii) the financial condition of key
customers; (iii) competition from other distributors of the DVD format; (iv)
whether current LD program suppliers, LD retailers and LD hardware and software
manufacturers will continue to support the LD format in the future; (v) the
potential impact of the DIVX format on DVD; (vi) shifts in industry distribution
channels; (vii) shifts in retail consumer and wholesale customer buying habits;
(viii) difficulties and delays which may be encountered in the compression and
authoring production process required to produce DVD programming; and (ix) other
factors referenced in this Form 10-Q. Given these uncertainties, prospective
investors are cautioned not to place undue reliance on such forward-looking
statements. The Company disclaims any obligation to update any such factors or
to announce publicly the result of any revisions to any of the forward-looking
statements contained in this and other Securities and Exchange Commission
filings of the Company to reflect future events or developments.
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REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The consolidated financial statements as of December 31, 1997 and for the
periods ended December 31, 1997 and 1996 in this Form 10-Q have been reviewed by
KPMG Peat Marwick LLP, independent certified public accountants, in accordance
with established professional standards and procedures for such a review.
The report of KPMG Peat Marwick LLP commenting upon their review follows.
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INDEPENDENT ACCOUNTANTS' REVIEW REPORT
--------------------------------------
The Board of Directors
Image Entertainment, Inc.
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. as of December 31, 1997, and the related condensed
consolidated statements of operations and cash flows for the three- and nine-
month periods ended December 31, 1997 and 1996 in accordance with Statements on
Standards for Accounting and Review Services issued by the American Institute of
Certified Public Accountants. All information included in these financial
statements is the representation of the management of Image Entertainment, Inc.
A review of interim financial information consists principally of obtaining an
understanding of the system for the preparation of interim financial
information, applying analytical review procedures to financial data, and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit in accordance with general accepted
auditing standards, the objective of which is the expression of an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Image Entertainment, Inc. as of
March 31, 1997, and the related consolidated statements of operations and cash
flows for the year then ended (not presented herein); and in our report dated
June 6, 1997, we expressed an unqualified opinion on those financial statements.
In our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of March 31, 1997, is fairly presented, in all
material respects, in relation to the balance sheet from which it has been
derived.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
February 5, 1998
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================================================================================
PART II -- OTHER INFORMATION
================================================================================
ITEM 1. LEGAL PROCEEDINGS.
-----------------
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. Item 8. "Note 6. Default of Notes Receivable" of
the Company's Annual Report on Form 10-K for the year ended March 31, 1997 is
incorporated herein by reference. 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 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 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 and counterclaim in the arbitration,
alleging among other things fraud in the inducement, recission and breach of
written contract. The counterclaim seeks compensatory damages of $1 million
plus accrued interest, attorney's fees and costs, and also seeks punitive
damages in an amount of $2 million. The Company intends to contest vigorously
the allegations of LEI in the counterclaim and has submitted a request to
dismiss the counterclaim.
No hearing date for the arbitration has been set.
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 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.
ITEM 2. CHANGES IN SECURITIES.
---------------------
Not Applicable
-26-
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
-------------------------------
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
None
ITEM 5. OTHER INFORMATION.
-----------------
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page i
(b) Reports on Form 8-K
None
-27-
<PAGE>
================================================================================
SIGNATURES
================================================================================
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMAGE ENTERTAINMENT, INC.
Date: February 12, 1998 By: /s/ MARTIN W. GREENWALD
-----------------------
Martin W. Greenwald
Chairman of the Board,
Chief Executive Officer,
President & Treasurer
Date: February12, 1998 By: /s/ JEFF M. FRAMER
------------------
Jeff M. Framer
Chief Financial Officer
-28-
<PAGE>
================================================================================
EXHIBIT INDEX
================================================================================
EXHIBIT NO. DESCRIPTION
- --------------------------------------------------------------------------------
10.1 Credit Agreement between the Company and Image Investors Co.
dated September 29, 1997, including Convertible Subordinated
Promissory Note dated October 29, 1997.
15* Letter re unaudited interim financial information.
27* Financial Data Schedule.
*EXHIBIT(S) NOT PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION.
-i-
<PAGE>
EXHIBIT 15
INDEPENDENT ACCOUNTANTS' CONSENT
--------------------------------
Image Entertainment, Inc.
Chatsworth, California
Gentlemen:
Re: Registration Statement Nos. 33-43241, 33-55393 and 33-57336
With respect to the subject registration statement, we acknowledge our awareness
of the use therein of our report dated February 5, 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
February 5, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,421
<SECURITIES> 0
<RECEIVABLES> 16,547
<ALLOWANCES> 3,977
<INVENTORY> 16,658
<CURRENT-ASSETS> 0<F1>
<PP&E> 12,087
<DEPRECIATION> 4,609
<TOTAL-ASSETS> 48,705
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 17,975
<OTHER-SE> 1,194
<TOTAL-LIABILITY-AND-EQUITY> 48,705
<SALES> 59,610
<TOTAL-REVENUES> 59,610
<CGS> 48,289
<TOTAL-COSTS> 48,289
<OTHER-EXPENSES> 2,770
<LOSS-PROVISION> (290)
<INTEREST-EXPENSE> 493
<INCOME-PRETAX> 950
<INCOME-TAX> 238
<INCOME-CONTINUING> 712
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 712
<EPS-PRIMARY> .05<F2>
<EPS-DILUTED> .05
<FN>
<F1>THE COMPANY HAS AN UNCLASSIFIED BALANCE SHEET DUE TO THE NATURE OF ITS
INDUSTRY.
<F2>THE COMPANY ADOPTED SFAS NO. 128 WHICH REQUIRES THE COMPANY TO REPLACE THE
PRESENTATION OF PRIMARY EPS WITH A PRESENTATION OF BASIC EPS.
</FN>
</TABLE>
