<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, 1999
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 4,
2000: 16,462,032
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PART I - FINANCIAL INFORMATION
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ITEM 1. Financial Statements.
--------------------
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and March 31, 1999
________________________________________________________________________________
ASSETS
<TABLE>
<CAPTION>
(In thousands) December 31, 1999 March 31, 1999
----------------- --------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 829 $ 1,552
Accounts receivable, net of allowances of
$3,830 - December 31, 1999;
$3,475 - March 31, 1999 15,201 11,954
Inventories (Note 2) 20,147 16,691
Royalties and distribution fee advances 7,200 3,173
Prepaid expenses and other assets 2,368 807
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$6,185 - December 31, 1999;
$5,295 - March 31, 1999 13,639 14,494
Goodwill, net of accumulated amortization of
$488 - December 31, 1999;
$111 - March 31, 1999 7,141 7,774
----------------- --------------
$ 66,525 $ 56,445
================= ==============
</TABLE>
See accompanying notes to consolidated financial statements
-1-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and March 31, 1999
________________________________________________________________________________
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
(In thousands, except share data) December 31, 1999 March 31, 1999
----------------- --------------
(unaudited)
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued liabilities $ 20,999 $ 16,101
Accrued royalties and distribution fees 4,044 2,665
Revolving credit and term loan facility (Note 4) 7,622 1,874
Real estate credit facility (Note 4) 3,219 3,348
Distribution equipment lease facility (Note 4) 1,520 1,775
Convertible subordinated note payable 5,000 5,000
Note payable (Note 4) -- 1,350
----------------- --------------
Total liabilities 42,404 32,113
----------------- --------------
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, 3,366,000 shares
authorized; none issued and outstanding -- --
Common stock, no par value, 30,000,000 shares authorized;
16,462,000 and 16,417,000 issued and outstanding
at December 31, 1999 and March 31, 1999, respectively 31,809 31,725
Additional paid-in capital 3,064 3,064
Accumulated deficit (10,752) (10,457)
----------------- --------------
Net shareholders' equity 24,121 24,332
----------------- --------------
$ 66,525 $ 56,445
================= ==============
</TABLE>
See accompanying notes to consolidated financial statements
-2-
<PAGE>
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Three Months Ended December 31, 1999 and 1998
________________________________________________________________________________
<TABLE>
<CAPTION>
(In thousands, except per share data) 1999 1998
---------------- ----------------
<S> <C> <C>
NET SALES $ 25,067 $ 22,715
OPERATING COSTS AND EXPENSES:
Cost of sales 18,106 17,302
Selling expenses 2,214 1,468
General and administrative expenses 2,040 1,565
Amortization of production costs 1,032 906
Amortization of goodwill 128 --
---------------- ----------------
23,520 21,241
---------------- ----------------
OPERATING INCOME 1,547 1,474
OTHER EXPENSES (INCOME):
Interest expense, net 397 301
Other (111) --
---------------- ----------------
286 301
---------------- ----------------
INCOME BEFORE INCOME TAXES 1,261 1,173
INCOME TAX EXPENSE -- 44
---------------- ----------------
NET INCOME $ 1,261 $ 1,129
================ ================
NET INCOME PER SHARE (Note 3):
Basic $ .08 $ .08
Diluted $ .08 $ .08
================ ================
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Note 3):
Basic 16,459 13,551
================ ================
Diluted 17,843 14,994
================ ================
</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, 1999 and 1998
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
(In thousands, except per share data) 1999 1998
-------------- ------------
<S> <C> <C>
NET SALES $ 60,904 $ 53,689
OPERATING COSTS AND EXPENSES:
Cost of sales 44,999 41,105
Selling expenses 6,426 3,982
General and administrative expenses 5,819 4,194
Amortization of production costs 2,896 3,099
Amortization of goodwill 377 --
-------------- ------------
60,517 52,380
-------------- ------------
OPERATING INCOME 387 1,309
OTHER EXPENSES (INCOME):
Interest expense, net 1,119 607
Other (437) --
-------------- ------------
682 607
-------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES (295) 702
INCOME TAXES -- 55
-------------- ------------
NET INCOME (LOSS) $ (295) $ 647
============== ============
NET INCOME (LOSS) PER SHARE (Note 3):
Basic $ (.02) $ .05
Diluted $ (.02) $ .05
============== ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (Note 3):
Basic 16,449 13,534
============== ============
Diluted 16,449 13,624
============== ============
</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, 1999 and 1998
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
(In thousands) 1999 1998
---------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (295) $ 647
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Amortization of production costs 2,896 3,099
Amortization of goodwill 377 --
Depreciation and other amortization 1,235 511
Amortization of restricted stock units 150 59
Provision for slow-moving inventories 699 1,133
Provision for estimated doubtful accounts 15 134
Gain on sale of land (23) --
Changes in assets and liabilities associated
with operating activities:
Accounts receivable (3,262) (6,198)
Inventories (2,846) (4,078)
Royalty and distribution fee advances, net (4,027) 1,332
Production cost expenditures (3,947) (3,998)
Prepaid expenses and other assets (1,561) (549)
Accounts payable, accrued royalties and liabilities 6,201 5,256
---------- --------
Net cash used in operating activities (4,388) (2,652)
---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,799) (2,275)
Net proceeds from sale of land 1,823 --
---------- --------
Net cash provided by (used in) investing activities 24 (2,275)
---------- --------
</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, 1999 and 1998
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
(In thousands) 1999 1998
-------------- -------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit and term loan facility $ 64,029 $ 31,252
Repayment of advances under revolving credit and
term loan facility (58,662) (26,360)
Repayment of advances under real estate credit facility (129) (43)
Repayment of note payable (1,350) --
Principal payments under lease facility (255) --
Net proceeds from exercise of stock options 60 162
Additional offering costs from issuance of common stock (52) --
-------------- -------------
Net cash provided by financing activities 3,641 5,011
-------------- -------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS: (723) 84
Cash and cash equivalents at beginning of period 1,552 1,015
-------------- -------------
Cash and cash equivalents at end of period $ 829 $ 1,099
============== =============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 1,049 $ 721
============== =============
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During the nine months ended December 31, 1999, the Company incurred costs of
$381,000 relating to the purchase and installation of DVD authoring and
compression equipment. These costs were funded under the Company's term loan
facility.
On June 30, 1999, the Company issued 11,407 shares of common stock to officers
(net of shares withheld for payment of related income taxes) pursuant to
restricted stock units which vested on June 30, 1999. The Company increased
common stock at June 30, 1999 by approximately $76,000, the value of the net
shares issued.
See accompanying notes to consolidated financial statements
-6-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------------------
Note 1. Basis of Presentation.
The accompanying condensed consolidated financial statements include the
accounts of Image Entertainment, Inc., its wholly-owned subsidiaries Image
Newco, Inc. ("Ken Crane's," which was acquired on January 11, 1999) and U.S.
Laser Video Distributors, Inc. ("U.S. Laser," which ceased operations on July
15, 1998), and the 50%-owned joint venture, Aviva International, LLC (which
began operations during the June 1999 quarter -- see Note 5) (collectively, the
"Company"). All significant intercompany balances and transactions have been
eliminated in consolidation.
The accompanying condensed consolidated financial statements are unaudited and
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. They do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. However, except as disclosed herein, there has been no material
change in the information disclosed in the notes to consolidated financial
statements included in the Annual Report on Form 10-K of the Company for the
year ended March 31, 1999. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation have been included. Operating results for the three and nine months
ended December 31, 1999, are not necessarily indicative of the results that may
be expected for the fiscal year ending March 31, 2000. The accompanying
consolidated financial information for the three and nine months ended December
31, 1999 and 1998 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 Annual Report on Form 10-K
for the period ended March 31, 1999.
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's estimates relate to allowances for slow-moving inventories,
doubtful accounts receivables, unrecouped royalty/distribution fee advances and
sales returns. These estimates are based on management's knowledge of current
events and actions management may undertake in the future, therefore, actual
results may ultimately differ from management's estimates.
Note 2. Inventories.
Consolidated inventories at December 31, 1999 and March 31, 1999 are summarized
as follows:
<TABLE>
<CAPTION>
December 31, March 31,
(In thousands) 1999 1999
------------------ ------------------
<S> <C> <C>
DVD $ 15,192 $ 9,724
LD 6,974 12,125
Other 495 500
------------------ -----------------
22,661 22,349
Reserve for slow-moving inventories:
DVD (484) (231)
LD and other (6,714) (9,060)
------------------ -----------------
(7,198) (9,291)
------------------ -----------------
15,463 13,058
Production costs, net 4,684 3,633
------------------ -----------------
$ 20,147 $ 16,691
================== =================
</TABLE>
-7-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- -------------------------------------------------------------------------------
Inventories consist primarily of finished product for sale and are stated at the
lower of average cost or market.
Production costs are net of accumulated amortization of $6,811,000 and
$6,955,000 at December 31, 1999 and March 31, 1999, respectively.
Note 3. Net Income (Loss) per Share.
The following presents a reconciliation of the numerators and denominators used
in computing basic and diluted net income (loss) per share for the three and
nine months ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three months Three months Nine months Nine months
ended ended ended ended
December 31, December 31, December 31, December 31,
(In thousands, except per share data) 1999 1998 1999 1998
----------------- ----------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Net income (loss)
(basic numerator) $ 1,261 $ 1,129 $ (295) $ 647
================= ================= ================== ==================
Interest, net of taxes, on assumed
conversion of dilutive security 100 95 -- --
----------------- ----------------- ------------------ ------------------
Net income (loss) (diluted numerator) $ 1,361 $ 1,224 $ (295) $ 647
================= ================= ================== ==================
Weighted average common shares
outstanding (basic denominator) 16,459 13,551 16,449 13,534
================= ================= ================== ==================
Effect of dilutive securities 1,384 1,443 -- 90
----------------- ----------------- ------------------ ------------------
Weighted average common shares
outstanding (diluted denominator) 17,843 14,994 16,449 13,624
================= ================= ================== ==================
Basic and diluted net income
(loss) per share $ .08 $ .08 $ (.02) $ .05
================= ================= ================== ==================
</TABLE>
Diluted net loss per share for the nine months ended December 31, 1999 is based
only on the weighted average number of common shares outstanding for the period
as inclusion of common stock equivalents (common stock options and common stock
underlying the convertible subordinated note payable) would be antidilutive.
Outstanding common stock options not included in the computation of diluted net
income per share totaled 1,301,000 and 1,065,000, respectively, for the three
months ended December 31, 1999 and 1998. Outstanding common stock options and
common shares underlying the convertible security not included in the
computation of diluted net income (loss) for the nine months ended December 31,
1999 and 1998 were 2,696,000 and 2,289,000, respectively. The stock options were
excluded because their exercise prices were greater than the average market
price of the common stock for the respective periods and the assumed exercise
would be antidilutive. The common shares underlying the convertible security
were excluded because the assumed conversion for the respective periods would be
antidilutive.
Note 4. Debt.
Revolving Credit and Term Loan Facility. At December 31, 1999, the Company had
- ---------------------------------------
$7,257,000 outstanding under its revolving credit facility and $365,000
outstanding under its term loan facility with Foothill Capital Corporation
("Foothill") and had borrowing availability of $7,193,000 and $119,000,
respectively, net of amounts utilized for outstanding standby letters of credit.
Borrowings under the revolving credit and term loan facility bear
-8-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- ------------------------------------------------------------------------------
interest at prime plus 0.75% (9.25% at December 31, 1999). In November 1999, the
Company and Foothill amended the December 28, 1998 Loan and Security Agreement
increasing the maximum revolving advance limit from $12,000,000 to $15,000,000.
At December 31, 1999, the Company had $550,000 of outstanding standby letters of
credit issued by Foothill of which $300,000 expire on June 30, 2000 and $250,000
expire on November 18, 2000. These standby letters of credit secure trade
payables due to program suppliers.
Real Estate Credit Facility. At December 31, 1999, $3,219,000 in borrowings were
- ---------------------------
outstanding under the revolving real estate credit facility with Bank of America
National Trust and Savings Association in Nevada. Borrowings bear interest at
LIBOR plus 2.25% (8.38% at December 31, 1999).
Distribution Equipment Lease Facility. At December 31, 1999, $1,520,000 in
- -------------------------------------
borrowings were outstanding under the distribution equipment lease facility with
BankAmerica Leasing and Capital Corporation. Borrowings bear interest at LIBOR
plus 2.719% (8.85% at December 31, 1999).
Note Payable to Bank. On December 6, 1999, the Company closed escrow for the
- --------------------
sale (to a real estate developer) of approximately 3.8 acres of the 8.8 acres of
land (adjacent to the Company's 8.4 acre warehouse and distribution facility
site in Las Vegas, Nevada) for net proceeds of $1,823,000. The Company recorded
a gain of approximately $23,000 on the sale of the land which is included in the
accompanying consolidated statements of operations as other income for the three
and nine months ended December 31, 1999. Concurrent with the close of escrow,
the Company repaid the $1,215,000 in outstanding borrowings with Pioneer
Citizens Bank of Nevada, which bore interest at prime plus 1.75% (10.25% at
December 31, 1999). The remaining proceeds of $608,000 were used to pay down
outstanding borrowings under the Foothill revolving credit facility.
Note 5. Formation of Joint Venture Limited Liability Company.
In June 1999, the Company completed the joint venture formation of Aviva
International, LLC, a California limited liability company ("Aviva"), with
Michael Lopez ("Lopez"), President of International Consulting & Business
Management. Aviva is 50% owned by each of the Company and Lopez. Aviva acts as
international sales agent for the Company's licensed programming for which it
holds distribution rights for worldwide broadcast and international home video.
In accordance with the joint venture's operating agreement, the initial term of
the joint venture will be one year with an option to renew for additional
successive periods upon mutual agreement of the Company and Lopez. Lopez serves
as Manager of Aviva. Both the Company and Lopez contribute funds to Aviva (as
initial working capital) in the form of interest-bearing loans. Although the
Company owns 50% of the joint venture, it can exercise control over the
operations of Aviva. As a result, Aviva's operating results are consolidated
with the operating results of the Company. Accordingly, Aviva's operating loss,
since its formation, is included in the Company's statement of operations for
the three and nine months ended December 31, 1999.
For the three and nine months ended December 31, 1999, Aviva, as a start-up
entity, recognized sales agency revenue of $9,000 and had net losses totaling
$176,000 and $430,000, respectively. The Company has recognized 50% of Aviva's
net loss for the three and nine months ended December 31, 1999, approximately
$88,000 and $215,000, respectively, in its consolidated statements of operations
for the three and nine months ended December 31, 1999.
Note 6. Segment Information.
In accordance with the requirements of SFAS No. 131, "Disclosures about Segments
of and Enterprise and Related Information," selected financial information
regarding the Company's reportable business segments, wholesale
-9-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- -------------------------------------------------------------------------------
distribution, retail distribution (through Ken Crane's), and Aviva (recognized
by management as a separate reporting segment at December 31, 1999), are
presented below. Management evaluates segment performance based primarily on net
sales and income (loss) before income taxes. Interest income and expense is
evaluated on a consolidated basis and not allocated to the Company's business
segments. Comparable data for the three and nine months ended December 31, 1998
is not presented as Ken Crane's was acquired in January 1999, Aviva was formed
in June 1999 and the Company's subsidiary, U.S. Laser, was closed in July 1998
(and not material for the 1998 periods).
For the three and nine months ended December 31, 1999:
<TABLE>
<CAPTION>
Three months Nine months
ended ended
(In thousands) December 31, 1999 December 31, 1999
---------------------- ----------------------
<S> <C> <C>
Net sales:
Wholesale distribution (Image Entertainment, Inc.) $ 24,553 $ 58,812
Retail distribution (Ken Crane's) 4,175 11,401
Aviva (International) 9 9
---------------------- ----------------------
28,737 70,222
Inter-segment eliminations/(1)/ (3,670) (9,318)
---------------------- ----------------------
Consolidated net sales $ 25,067 $ 60,904
====================== ======================
Income (loss) before income taxes:
Wholesale distribution $ 1,844 $ 1,690
Retail distribution/(2)/ (483) (1,716)
Aviva (88) (215)
---------------------- ----------------------
1,273 (241)
Inter-segment eliminations/(3)/ (12) (54)
---------------------- ----------------------
Consolidated income (loss) before income taxes $ 1,261 $ (295)
====================== ======================
As of
(In thousands) December 31, 1999
----------------------
Total assets:
Wholesale distribution $ 59,819
Retail distribution 7,058
Aviva 137
----------------------
67,014
Inter-segment eliminations/(4)/ (489)
----------------------
Consolidated total assets $ 66,525
======================
</TABLE>
________________________________________________________
(1) Elimination of inter-segment net sales.
(2) Includes goodwill amortization of $128,000 and $377,000 for the three and
nine months ended December 31, 1999, respectively.
(3) Elimination of inter-segment profit in ending inventory.
(4) Elimination of primarily inter-segment receivables.
Note 7. Adversary Proceeding -- One Stop Recovery LLC.
On July 12, 1999, the Company was named as a defendant in an adversary
proceeding (filed by One Stop Recovery LLC, as Trustee for AEC One Stop, Inc.
("Plaintiff") in connection with the Chapter 11 bankruptcy of Alliance
Entertainment Corp. ("Alliance"). The proceeding is pending in the United States
Bankruptcy Court for
-10-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
the Southern District of New York. In the proceeding, the Plaintiff is seeking
to recover approximately $1,740,000 in alleged preferential transfers (including
payments made and the value of goods returned) made by Alliance within the 90-
day period immediately preceding the commencement of its bankruptcy case. The
Company intends to vigorously defend itself in the proceeding. While it is not
feasible to predict or determine the outcome of the proceeding, management does
not believe that the ultimate outcome will have a material adverse effect on the
Company's financial position, results of operations or liquidity.
-11-
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations.
---------------------
GENERAL
The Company licenses and distributes a broad range of entertainment
programming on digital video disc ("DVD"), and a rapidly declining range of
entertainment programming on laserdisc ("LD"). Prior to fiscal 1998, the
Company's net sales were derived almost entirely from the distribution of
programming in the LD format. In March 1997, DVD was introduced and the Company
began distributing DVD programming on a nonexclusive wholesale basis. The
Company began releasing exclusively licensed DVD programming in June 1997. In
fiscal 1998, DVD represented 21% and LD 79% of the Company's net sales. In
fiscal 1999, DVD represented 60% and LD 36% of the Company's net sales. For the
nine months ended December 31, 1999, DVD represented 84% and LD 11% of the
Company's net sales. The Company also distributes music programming on compact
disc ("CD") encoded in the DTS Digital Surround multichannel audio format as
well as certain of its exclusive programming on videocassette ("VHS").
The Company continues to aggressively seek DVD programming for
exclusive distribution. The Company has agreements with numerous program
suppliers for the exclusive release of titles on DVD. According to VideoScan, an
independent entertainment software sales tracking service, out of 40 DVD
suppliers indexed for calendar 1999, the Company ranked ninth: Warner Home Video
(30.63%), Universal Home Entertainment (12.36%), Disney (10.47%), Columbia
TriStar (10.02%), Paramount Home Video (7.87%), Twentieth Century Fox Home
Entertainment (5.56%), MGM (4.39%), Artisan Entertainment (3.58%) and Image
Entertainment (2.51%). In calendar 1998, the Company was also ranked ninth in
market share by VideoScan with 2.96%. VideoScan tracks point-of-sale data from
an estimated 70 percent of the retail market. VideoScan's data includes sales by
mass merchants and retailers but not most discount outlets and Internet
retailers and excludes sales data on music video DVD programming sold, a growing
component of the Company's exclusive DVD revenue. It is likely that actual
market share data would differ from the above reported sales data had VideoScan
captured sales data from all retailers including Internet retailers as well as
sales data on music video DVD programming.
The Company also distributes DVD programming on a nonexclusive basis
from virtually all program suppliers with whom it does not have an exclusive
agreement, making it a "one-stop" source for all DVD programming, meaning that
customers who purchase exclusive titles from the Company can also purchase
additional nonexclusive titles at the same time.
The Electronics Industries Association ("EIA") reported that from
March 1997 (when DVD was first introduced) to January 28, 2000, approximately
5,870,000 DVD players were sold to consumer electronics retailers. For the first
4 weeks of calendar 2000 (ended January 28, 2000), approximately 370,000 DVD
players were sold to consumer electronics retailers, a 193.7% increase over the
approximately 126,000 DVD players sold for the comparable calendar 1999 period.
The Company's wholly-owned subsidiary, Image Newco, Inc. ("Ken
Crane's") is engaged in the Internet/direct-to-consumer retailing of DVD and LD
programming. Since the Company's acquisition of Ken Crane's in January 1999, Ken
Crane's has fulfilled consumer orders from its web site at www.kencranes.com out
of its Westminster, California warehouse. Over the past months, the Company and
Ken Crane's have been upgrading its systems (hardware and software) to
accommodate direct-to-consumer fulfillment of Ken Crane's orders out of the
Company's Las Vegas, Nevada distribution center. The Company and Ken Crane's
have nearly completed the process of redesigning the layout, navigation and
content of www.kencranes.com. The redesigned web site is expected to be
officially launched under the new name of DVDPlanet.com and begin fulfillment of
DVDPlanet.com's orders out of the Company's Nevada distribution facility by
March 31, 2000, the end of the Company's fourth quarter.
-12-
<PAGE>
In June 1999, the Company completed the joint venture formation of
Aviva International, LLC, a California limited liability company ("Aviva"), with
Michael Lopez ("Lopez"), President of International Consulting & Business
Management. Aviva is 50% owned by each of the Company and Lopez. Aviva acts as
international sales agent for the Company's licensed programming for which it
holds distribution rights for worldwide broadcast and international home video.
In accordance with the joint venture operating agreement, the initial term of
the joint venture will be one year, with an option to renew for additional
successive periods upon mutual agreement of the Company and Lopez. Lopez serves
as Manager of Aviva. Both the Company and Lopez contribute funds to Aviva (as
initial working capital) in the form of interest-bearing loans. Although the
Company owns 50% of the joint venture, it can exercise control over the
operations of Aviva. As a result, Aviva's operating results are consolidated
with the operating results of the Company. Accordingly, Aviva's operating loss,
since its formation, is included in the Company's statement of operations for
the three and nine months ended December 31, 1999. Pro forma information has not
been provided as its impact on the consolidated statements of operations for the
periods presented is not material. Royalties and distribution fees payable to
program suppliers in connection with international distribution revenues
generated by Aviva's sales agency efforts will generally be used to recoup
advance royalties and distribution fees paid by the Company to program suppliers
for exclusive international distribution rights.
The Company and Aviva recently entered into exclusive distribution
agreements for international distribution of certain of the Company's exclusive
DVD and VHS programming with Direct Video Distribution, Ltd. for distribution
throughout the United Kingdom, ICESTORM Entertainment for distribution
throughout Germany, Austria and German-speaking Switzerland and Video Film
Express, b.v. for distribution throughout Belgium, The Netherlands and
Luxembourg. The Company and Aviva are negotiating additional distribution
agreements for other key territories throughout the world.
The first title to be released under the new international
distribution agreements will be "Sheryl Crow: Rockin' the Globe Live," scheduled
for release by the end of the Company's fourth quarter ended March 31, 2000.
Seasonality and Variability. The Company has generally experienced
---------------------------
higher sales 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. In
addition to seasonality issues, other factors have contributed to variability in
the Company's DVD and LD net sales on a quarterly basis. These factors include:
(i) DVD's negative impact on LD sales; (ii) the popularity of titles then in
release; (iii) the Company's licensing and distribution activities relating to
new video programming; (iv) the extension, termination or non-renewal of
existing license and distribution rights; (v) the Company's marketing and
promotional activities; and (vi) general and economic changes affecting the
buying habits of the Company's customers, particularly those changes affecting
consumer demand for DVD and LD hardware and software. Accordingly, the Company's
revenues and results of operations may vary significantly from period to period,
and the results of any one period may not be indicative of the results of any
future periods.
The accompanying consolidated financial information for the three and
nine months ended December 31, 1999 and 1998 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
Annual Report on Form 10-K for the period ended March 31, 1999.
-13-
<PAGE>
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO THE THREE MONTHS ENDED
DECEMBER 31, 1998
The following table presents consolidated net sales by business
segment for the three months ended December 31, 1999 and 1998.
<TABLE>
<CAPTION>
Three months ended
December 31,
-------------------------------
1999 1998 % Change
------------- -------------- -----------
(in thousands)
<S> <C> <C> <C>
Net sales:
Wholesale distribution $ 24,553 $ 22,715 8.1%
Retail distribution 4,175 -- *
Aviva 9 -- *
Inter-segment eliminations (3,670) -- *
------------- -------------- -------------
Consolidated $ 25,067 $ 22,715 10.4%
============= ============== =============
</TABLE>
___________________________
* = not meaningful
Consolidated net sales for all segments for the December 1999 quarter
increased 10.4% to $25,067,000 from $22,715,000 for the December 1998 quarter.
This increase is a result of growing sales of DVD programming partially offset
by declining LD and other net sales. The Company experienced continued growth in
its sales of DVD programming benefitting from the Holiday selling season and the
continued growth in DVD player sales. Consolidated net sales of DVD programming
for the December 1999 quarter increased 44.9% to $23,100,000, or 92.2% of
consolidated net sales, from $15,943,000, or 70.2 % of net sales, for the
December 1998 quarter. Approximately 59% of consolidated net sales of DVD
programming for the December 1999 quarter were derived from exclusively licensed
or distributed programming as compared to 51% for the December 1998 quarter.
Consolidated net sales of LD programming for the December 1999 quarter decreased
84.5% to $854,000, or 3.4% of consolidated net sales, from $5,521,000, or 24.3%
of net sales, for the December 1998 quarter. Net sales of VHS and CD programming
for the December 1999 quarter were $1,113,000, or 4.4% of consolidated net
sales, as compared to $1,251,000, or 5.5% of consolidated net sales for the
December 1998 quarter.
Net sales for the Company's wholesale distribution segment for the
December 1999 quarter increased 8.1% to $24,553,000 from net sales of
$22,715,000 for the December 1998 quarter. Net sales of the wholesale
distribution segment for the December 1999 quarter are reflected prior to
elimination of $3,670,000 in inter-segment sales from the wholesale distribution
segment to the retail distribution segment. In addition to positive market
factors, the Company has continued to aggressively license DVD programming which
has contributed to the Company's release of a greater number of new release DVD
programming. During the December 1999 quarter, the Company released 120
exclusive DVD titles, a 62.2% increase from 74 exclusive DVD titles released
during the December 1998 quarter. Additionally as DVD player sales grow, sales
of the Company's previously released exclusive DVD programming are expected to
grow.
The Company's retail distribution segment, consisting solely of the
Company's Ken Crane's subsidiary, contributed net sales of $4,175,000 for the
December 1999 quarter, down approximately 8.0% from $4,538,000 for the December
1998 quarter (prior to the Company's acquisition of Ken Crane's). Although
comparative net sales for Ken Crane's for the December 1999 quarter were down
due to declining LD sales, DVD sales were significantly higher. Ken Crane's net
sales of DVD programming were up 75.6% to $3,391,000, or 81.2% of segment sales,
for the December 1999 quarter from $1,931,000, or 42.6% of segment net sales,
for the December 1998 quarter. Net sales of DVD programming via Internet/mail
order increased 65.4% to $2,444,000 for the
-14-
<PAGE>
December 1999 quarter from $1,478,000 for the December 1998 quarter. The Holiday
selling season and increased DVD Internet customer transactions contributed to
the increase in DVD sales. Ken Crane's was acquired in January 1999. Net revenue
and customer transaction information for the December 1998 quarter (prior to
acquisition) was provided by Ken Crane's Magnavox City, Inc. and is unaudited.
The Company's 50%-owned joint venture, Aviva recognized minimal sales
agency revenues during the December 1999 quarter generated from international
broadcast of certain of the Company's exclusively distributed DVD programming.
The Company's and Aviva's first international home video releases are scheduled
for the end of the Company's fourth quarter ending March 31, 2000.
Consolidated cost of sales for the December 1999 quarter was
$18,106,000, or 72.2% of net sales, compared to $17,302,000, or 76.2% of net
sales, for the December 1998 quarter. Accordingly, consolidated gross profit
margin improved to 27.8% for the December 1999 quarter from 23.8% for the
December 1998 quarter. The increase in gross profit margin primarily reflects
the shift in sales mix from exclusive LD to higher profit margin exclusive DVD
programming, the incremental gross profit margin contributed by Ken Crane's
operations and the December 1999 quarter's comparatively lower provision for
slow-moving inventory. The increase in gross profit margin was partially offset
by comparatively higher labor costs associated with operating the Nevada
warehouse and distribution facility.
The following tables present consolidated selling expenses by business
segment and as a percentage of related segment net sales for the three months
ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three months ended
December 31,
-------------------------------
1999 1998 % Change
------------- -------------- -------------
(in thousands)
<S> <C> <C> <C>
Selling expenses:
Wholesale distribution $ 1,550 $ 1,468 5.6%
Retail distribution 534 -- *
Aviva 130 -- *
------------- -------------- -------------
Consolidated $ 2,214 $ 1,468 50.8%
============= ============== =============
As a percentage of segment net sales:
Wholesale distribution 6.3% 6.5% (0.2)%
Retail distribution 12.8 -- 12.8
Aviva * -- *
------------- -------------- -------------
Consolidated 8.8% 6.5% 2.3%
============= ============== =============
</TABLE>
_____________________________
* = not meaningful
Consolidated selling expenses for the December 1999 quarter increased
50.8% to $2,214,000 from $1,468,000 for the December 1998 quarter. As a
percentage of consolidated net sales, consolidated selling expenses for the
December 1999 quarter increased to 8.8% from 6.5% for the December 1998 quarter.
The increase in consolidated selling expenses in absolute dollars and as a
percentage of consolidated net sales is primarily due to the selling expenses of
Ken Crane's and Aviva. Ken Crane's was acquired and Aviva was formed subsequent
to the December 1998 quarter. Selling expenses for the retail distribution and
Aviva segments will continue to be higher as a percentage of segment net sales
than for the wholesale distribution segment.
Selling expenses for the wholesale distribution segment were up 5.6%
to $1,550,000 for the December 1999 quarter from $1,468,000 for the December
1998 quarter. However, as a percentage of wholesale distribution net sales,
selling expenses for the December 1999 quarter were down 0.2% to 6.3% from 6.5%
for the December 1998 quarter. The 5.6% increase in absolute dollar selling
expenses results primarily from higher
-15-
<PAGE>
net freight expenses (higher by $97,000) and higher compensation expenses
(higher by $96,000), offset by lower trade advertising costs (lower by
$101,000).
Ken Crane's, the retail distribution segment, incurred selling
expenses of $534,000 during the December 1999 quarter consisting primarily of
compensation expense, promotional expenditures and freight expenses, net of
freight and handling fee income. Ken Crane's has increased its sales and
customer service staff to accommodate the increase in its DVD net sales and
incurs promotional expenditures for bi-monthly sales catalog mailings. Aviva,
the international distribution segment, incurred selling expenses of $130,000,
consisting primarily of compensation, convention and travel expenses. These
expenses are incurred in connection with Aviva's activities as the international
sales agent for the Company's internationally licensed programming.
The following tables present consolidated general and administrative
expenses by business segment and as a percentage of related segment net sales
for the three months ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three months ended
December 31,
-------------------------
1999 1998 % Change
------------- ---------- --------------
(in thousands)
<S> <C> <C> <C>
General and administrative expenses:
Wholesale distribution $ 1,626 $ 1,565 3.9%
Retail distribution 369 -- *
Aviva 45 -- *
------------- -------------- -------------
Consolidated $ 2,040 $ 1,565 30.4%
============= ============== =============
As a percentage of segment net sales:
Wholesale distribution 6.6% 6.9% (0.3)%
Retail distribution 8.8 -- 8.8
Aviva * -- *
------------- -------------- -------------
Consolidated 8.1% 6.9% 1.2%
============= ============== =============
</TABLE>
_____________________________
* = not meaningful
Consolidated general and administrative expenses for the December 1999
quarter increased 30.4% to $2,040,000 from $1,565,000 for the December 1998
quarter. As a percentage of consolidated net sales, consolidated general and
administrative expenses for the December 1999 quarter increased to 8.1% from
6.9% for the December 1998 quarter. The increase in consolidated general and
administrative expenses in absolute dollars and as a percentage of consolidated
net sales is primarily due to the general and administrative expenses of Ken
Crane's and Aviva. Ken Crane's was acquired and Aviva was formed subsequent to
the December 1998 quarter.
General and administrative expenses for the wholesale distribution
segment for the December 1999 quarter were up 3.9% to $1,626,000 from $1,565,000
for the December 1998 quarter. However, as a percentage of wholesale
distribution net sales, general and administrative expenses for the December
1999 quarter were down 0.3% to 6.6% from 6.9% for the December 1998 quarter. The
3.9% increase in absolute dollar general and administrative expenses for the
December 1999 quarter results primarily from higher depreciation expenses
associated with the Nevada distribution facility (higher by $214,000), offset by
lower legal expenses (lower by $122,000).
The retail distribution segment, Ken Crane's incurred general and
administrative expenses of $369,000 consisting primarily of compensation
expense, bank credit card servicing fees, depreciation expense and management
information systems expenses. The Aviva segment incurred general and
administrative expenses of $45,000 consisting primarily of compensation and
legal expenses.
-16-
<PAGE>
Amortization of production costs for the December 1999 quarter
increased 13.9% to $1,032,000, or 4.1% of consolidated net sales, from $906,000,
or 4.0% of consolidated net sales, for the December 1998 quarter. This increase
in the amortization costs is attributable to the increased number of exclusively
licensed programs placed into production during the December 1999 quarter as
compared to the December 1998 quarter partially, offset, by lower comparative
per-title authoring and compression costs. The Company has been authoring and
compressing an increasing number of its exclusive DVD programming in house,
which is less expensive on a per-title basis.
For the December 1999 quarter, amortization of goodwill from the
acquisition of Ken Crane's was $128,000, or 0.5% of net sales.
Interest expense, net of interest income, for the December 1999 quarter
increased 31.9% to $397,000, or 1.6% of net sales, from $301,000, or 1.3% of net
sales, for the December 1998 quarter. The increase is attributable primarily to
higher weighted average debt levels during the December 1999 quarter.
During the December 1999 quarter, other income of $111,000 consisted of
a minority interest in the Aviva joint venture of $88,000 and a gain on sale of
land in Las Vegas, Nevada of $23,000.
The Company did not record income tax expense in the December 1999
quarter due to cumulative to-date recorded net losses for financial statement
reporting purposes. The provision for income taxes is based on the annual
effective tax rate which is subject to ongoing review and evaluation.
Consolidated net income for the December 1999 quarter was $1,261,000,
or $.08 per basic and diluted share, as compared to $1,129,000, or $.08 per
basic and diluted share, for the December 1998 quarter.
The Company's wholesale distribution segments pre-tax income for the
December 1999 quarter increased 56.2% to $1,832,000 (after inter-segment
eliminations) from $1,173,000 for the December 1998 quarter. The Company's
retail distribution segment, Ken Crane's, recorded a pre-tax loss for the
December 1999 quarter of $483,000, which includes goodwill amortization of
$128,000. The Company's Aviva segment contributed a pre-tax loss for the
December 1999 quarter of $88,000 (net of minority interest).
THE NINE MONTHS ENDED DECEMBER 31, 1999 COMPARED TO THE NINE MONTHS ENDED
DECEMBER 31, 1998
The following table presents consolidated net sales by business segment
for the nine months ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Nine months ended
December 31,
-------------------------------
1999 1998 % Change
------------- -------------- -----------
(in thousands)
<S> <C> <C> <C>
Net sales:
Wholesale distribution $ 58,812 $ 53,235 10.5%
Retail distribution 11,401 619 *
Aviva 9 -- *
Inter-segment eliminations (9,318) (165) *
------------- -------------- -------------
Consolidated $ 60,904 $ 53,689 13.4%
============= ============== =============
</TABLE>
_________________________________
* = not meaningful
Consolidated net sales for all segments for the nine months ended
December 31, 1999 increased 13.4% to $60,904,000 from $53,689,000 for the
comparative December 1998 period. This increase is a result of
-17-
<PAGE>
growing sales of DVD programming partially offset by declining LD and other net
sales. The Company experienced continued growth in its sales of DVD programming
benefitting from the December 1999 quarter Holiday selling season and the
continued growth in DVD player sales to consumers. Consolidated net sales of DVD
programming for the nine months ended December 31, 1999 increased 75.4% to
$51,416,000, or 84.4% of consolidated net sales, from $29,318,000, or 54.6% of
net sales, for the comparable December 1998 period. Approximately 58% of
consolidated net sales of DVD programming for the December 1999 nine-month
period were derived from exclusively licensed or distributed programming as
compared to 53% for the comparable December 1998 period. Consolidated net sales
of LD programming for the nine months ended December 31, 1999 decreased 69.1% to
$6,901,000, or 11.3% of consolidated net sales, from $22,360,000, or 41.6% of
net sales, for the comparable December 1998 period. Net sales of VHS and CD
programming for the nine months ended December 31, 1999 were $2,587,000, or 4.3%
of consolidated net sales, as compared to $2,011,000, or 3.8% of net sales for
the comparable December 1998 period.
Net sales for the Company's wholesale distribution segment for the nine
months ended December 31, 1999 increased 10.5% to $58,812,000 from net sales of
$53,235,000 for the comparable December 1998 period. Net sales of the wholesale
distribution segment for the December 1999 nine-month period are reflected prior
to elimination of $9,318,000 in inter-segment sales from the wholesale
distribution segment to the retail distribution segment. In addition to positive
market factors, the Company has continued to aggressively license DVD
programming which has contributed to the Company's release of a greater number
of new exclusive DVD programming. During the December 1999 nine-month period,
the Company released 342 exclusive DVD titles, a 103.6% increase from 168
exclusive DVD titles released during the comparable December 1998 period.
Additionally, as DVD player sales grow, sales of the Company's previously
released exclusive DVD programming are expected to grow.
The Company's retail distribution segment, consisting solely of the
Company's Ken Crane's subsidiary, contributed net sales of $11,401,000 for the
nine months ended December 31, 1999, down approximately 8.7% from $12,486,000
for the comparable 1998 period. Although comparative net sales for Ken Crane's
for the nine months ended December 31, 1999 were down due to declining LD sales,
DVD sales were significantly higher. Net sales of DVD programming for the nine
months ended December 31, 1999 were up 57.9% to $7,620,000, or 66.8% of the
segment net sales from $4,825,000, or 38.6% of segment net sales, for the
comparative 1998 period. Net sales of DVD programming via Internet/mail order
increased 55.5% to $5,553,000 for the nine months ended December 31, 1999 from
$3,570,000 for the comparable 1998 period. Approximately $619,000 in net sales
was recognized during the nine months ended December 31, 1998 by the Company's
subsidiary U.S. Laser, which ceased operations in July 1998. Net revenue
information for the nine months ended December 31, 1998 (prior to acquisition)
was provided by Ken Crane's Magnavox City, Inc. and is unaudited.
The Company's 50%-owned joint venture, Aviva recognized minimal sales
agency revenues during the December 1999 nine-month period generated from
international broadcast of certain of the Company's exclusively distributed DVD
programming. The Company's and Aviva's first international home video release is
scheduled for the end of the Company's fourth quarter ending March 31, 2000.
Consolidated cost of sales for the nine months ended December 31, 1999
was $44,999,000, or 73.9% of consolidated net sales, compared to $41,105,000, or
76.6% of consolidated net sales, for the comparable December 1998 period.
Accordingly, consolidated gross profit margin improved to 26.1% for the December
1999 nine-month period from 23.4% for the comparable December 1998 period. The
increase in gross profit margin primarily reflects the shift in sales mix from
exclusive LD to higher profit margin exclusive DVD programming, the incremental
gross profit margin contributed by Ken Crane's operations and the December 1999
nine-month period's comparatively lower provision for slow-moving inventory. The
increase in gross profit margin was partially offset, by comparatively higher
labor costs associated with operating the Nevada warehouse and distribution
facility including those expenses associated with expedited order processing
necessitated by difficulties encountered implementing the software required to
run the facility.
-18-
<PAGE>
The following tables present consolidated selling expenses by business
segment and as a percentage of related segment net sales for the nine months
ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Nine months ended
December 31,
--------------------------------------------------
1999 1998 % Change
------------- -------------- -------------
(in thousands)
<S> <C> <C> <C>
Selling expenses:
Wholesale distribution $ 4,070 $ 3,883 4.8%
Retail distribution 2,036 99 *
Aviva 320 -- *
------------- -------------- -------------
Consolidated $ 6,426 $ 3,982 61.4%
============= ============== =============
As a percentage of segment net sales:
Wholesale distribution 6.9% 7.3% (0.4)%
Retail distribution 18.4 * *
Aviva * -- *
------------- -------------- -------------
Consolidated 10.6% 7.4% 3.2%
============= ============== =============
</TABLE>
_____________________________
* = not meaningful
Consolidated selling expenses for the nine months ended
December 31, 1999 increased 61.4% to $6,426,000 from $3,982,000 for the
comparable December 1998 period. As a percentage of consolidated net sales,
consolidated selling expenses for the nine months ended December 31, 1999
increased to 10.6% from 7.4% for the comparable December 1998 period. The
increase in consolidated selling expenses in absolute dollars and as a
percentage of consolidated net sales is primarily due to the selling expenses of
Ken Crane's and Aviva. Ken Crane's was acquired and Aviva was formed subsequent
to the December 1998 quarter. Selling expenses for the retail distribution and
Aviva segments will continue to be higher as a percentage of segment net sales
than for the wholesale distribution segment.
Selling expenses for the wholesale distribution segment were up 4.8% to
$4,070,000 for the nine months ended December 31, 1999 from $3,883,000 for the
comparable December 1998 period. However, as a percentage of wholesale
distribution net sales, selling expenses for the nine months ended December 31,
1999 were down 0.4% to 6.9% from 7.3% for the comparable December 1998 period.
The 4.8% increase in absolute dollar selling expenses results primarily from
higher net freight expenses (higher by $340,000) and higher compensation expense
(higher by $227,000), offset by lower trade advertising costs (lower by
$356,000).
The retail distribution segment, Ken Crane's, incurred selling expenses
of $2,036,000 during the nine months ended December 31, 1999, consisting
primarily of promotional expenses, compensation expense, and freight expenses,
net of freight and handling fee income. Included during the nine-month period is
a net $366,000 charge related to free goods distributed and other promotional
expenses incurred in connection with a joint national DVD hardware promotion
with Thomson Consumer Electronics. Consumers who purchased select RCA brand DVD
players between June 1 and August 16, 1999 received five free DVD titles
fulfilled by Ken Crane's. Management believes the promotion has been an
excellent opportunity for Ken Crane's to gain national recognition as a DVD
retailer by reaching new DVD consumers through RCA's national network of dealers
as well as gain an extensive customer list of new DVD hardware consumers. The
Aviva segment incurred selling expenses of $320,000, composed primarily of
compensation, convention and travel expenses. The nine months ended December 31,
1998 includes $99,000 in selling expenses from the Company's subsidiary, U.S.
Laser, which was winding up its operations through its closure in July 1998.
The following tables present consolidated general and administrative
expenses by business segment and as a percentage of related segment net sales
for the nine months ended December 31, 1999 and 1998:
-19-
<PAGE>
<TABLE>
<CAPTION>
Nine months ended
December 31,
-------------------------------
1999 1998 % Change
------------- -------------- -----------
(in thousands)
<S> <C> <C> <C>
General and administrative expenses:
Wholesale distribution $ 4,704 $ 4,066 15.7%
Retail distribution 1,006 128 *
Aviva 109 -- *
------------- -------------- -------------
Consolidated $ 5,819 $ 4,194 38.7%
============= ============== =============
As a percentage of segment net sales:
Wholesale distribution 8.0% 7.6% 0.4%
Retail distribution 8.8 * *
Aviva * -- *
------------- -------------- -------------
Consolidated 9.5% 7.8% 1.7%
============= ============== -------------
</TABLE>
_________________________________
* = not meaningful
Consolidated general and administrative expenses for the nine months
ended December 31, 1999 increased 38.7% to $5,819,000 from $4,194,000 for the
comparative December 1998 period. As a percentage of consolidated net sales,
consolidated general and administrative expenses for the nine months ended
December 31, 1999 increased to 9.5% from 7.8% for the comparable December 1998
period. The increase in consolidated general and administrative expenses in
absolute dollars and as a percentage of consolidated net sales is primarily due
to the general and administrative expenses of Ken Crane's and Aviva. Ken Crane's
was acquired and Aviva was formed subsequent to the December 1998 quarter.
General and administrative expenses for the wholesale distribution
segment for the nine months ended December 31, 1999 were up 15.7% to $4,704,000
from $4,066,000 for the comparable December 1998 period. As a percentage of
wholesale distribution net sales, general and administrative expenses for the
nine months ended December 31, 1999 were up 0.4% to 8.0% from 7.6% for the
comparable December 1998 period. The 15.7% increase in absolute dollar general
and administrative expenses for the December 1999 nine-month period results
primarily from higher depreciation expenses primarily associated with the Nevada
distribution facility (higher by $603,000), higher compensation expense (higher
by $140,000) and higher investor relations expense (higher by $82,000). This
absolute dollar increase in the nine-month period ended December 1999 was
partially offset by lower legal expenses relating (lower by $118,000) and lower
provision for doubtful accounts receivable (lower by $116,000).
The retail distribution segment, Ken Crane's incurred general and
administrative expenses of $1,006,000 consisting primarily of compensation
expense, bank credit card servicing fees, depreciation expense and management
information systems expenses. The Aviva segment incurred general and
administrative expenses of $109,000 consisting primarily of compensation and
legal expenses. The nine months ended December 31, 1998 includes $128,000 in
general and administrative expenses from the Company's subsidiary U.S. Laser,
which was winding up its operations through its closure in July 1998.
Amortization of production costs for the nine months ended December 31,
1999 decreased 6.6% to $2,896,000, or 4.8% of consolidated net sales, from
$3,099,000, or 5.8% of consolidated net sales, for the nine months ended
December 31, 1998. The decrease in amortization costs for the nine months ended
December 31, 1999 is attributable to operational efficiencies attained by the
creative services and production departments, as well as lower comparative per-
title authoring and compression costs as a result of this aspect of DVD
production being brought in-house offset, in part, by the increase number of
exclusively licensed programs placed into production during the nine months
ended December 31, 1999.
-20-
<PAGE>
For the nine months ended December 31, 1999, amortization of goodwill
from the acquisition of Ken Crane's was $377,000, or 0.6% of net sales.
Interest expense, net of interest income, for the nine months ended
December 31, 1999 increased 84.3% to $1,119,000, or 1.8% of net sales, from
$607,000, or 1.1% of net sales, for the nine months ended December 31, 1998. The
increase is attributable primarily to higher weighted average interest rate and
debt levels during the nine months ended December 31, 1999 .
For the nine months ended December 31, 1999, other income of $437,000
consisted primarily of a confidential settlement with one of the nondebtor
defendants to the Company's continuing litigation against LEI Partners, L.P. of
$190,000, a minority interest in the Aviva joint venture of $215,000 and a gain
on sale of land in Las Vegas, Nevada of $23,000.
The Company did not record income tax expense in the nine months ended
December 31, 1999 due to cumulative to-date recorded net losses for financial
reporting purposes. The provision for income taxes is based on the annual
effective tax rate which is subject to ongoing review and valuation.
Consolidated net loss for the nine months ended December 31, 1999 was
$295,000, or $.02 per basic and diluted share, as compared to consolidated net
income of $647,000, or $.05 per basic and diluted share, for the comparable
December 1998 period. The principal reason for this decline was due to the
losses of $1,931,000 (net of inter-segment eliminations and minority interest)
in the retail distribution (Ken Crane's) and Aviva segments acquired and formed,
respectively, during fiscal 2000.
The Company's wholesale distribution segment pre-tax income for the
nine months ended December 31, 1999 increased 133.0% to $1,636,000 (after inter-
segment eliminations) from $702,000 for the comparable December 1998 period. The
Company's retail distribution segment, Ken Crane's, recorded a pre-tax loss for
the nine months ended December 31, 1999 of $1,716,000, which includes goodwill
amortization of $377,000. The Company's Aviva segment contributed a pre-tax loss
for the nine months ended December 31, 1999 of $215,000 (net of minority
interest).
INFLATION
Management believes that inflation is not a material factor in the
operation of the Company's business at this time.
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. Non-recurring uses during the 1999 and 1998 nine-month periods were
attributable to the development of the Company's Las Vegas, Nevada warehouse and
distribution facility. Working capital has historically been provided by cash
flows from operations, private and public sales of common stock, notes
representing short- and long-term debt and bank borrowings.
Sources and Uses of Working Capital, Nine Months Ended
-------------------------------------------------------
December 31, 1999 and 1998. Net cash used in operating activities for the nine
- --------------------------
months ended December 31, 1999 increased 65.5% to $4,388,000 from $2,652,000 for
the comparable December 1998 period. The increase is primarily due to a dramatic
increase in royalty and distribution fee advances paid during the nine months
ended December 31, 1999 to secure future exclusive DVD rights for both domestic
and international distribution and when available, worldwide broadcast,
-21-
<PAGE>
VHS distribution and digital downloading and streaming rights. In growing its
DVD business, the Company has used its operating cash flows to grow its
exclusive and nonexclusive DVD inventory and to increase the number of exclusive
DVD titles it releases quarterly (production cost expenditures). As the Company
distributes DVD programming on a nonexclusive basis from virtually all program
suppliers with whom it does not have an exclusive distribution agreement, it
carries an extremely broad range of DVD programming in inventory. As new titles
are released, they will be represented in the Company's inventory. The Company
utilizes its return allowances with the respective program suppliers to manage
its inventory. Additionally, comparative growth in the Company's accounts
receivable and accounts payable, accrued royalties and liabilities for the nine
months ended December 31, 1999 reflects the Company's growth in DVD sales and
DVD purchases.
Investing activities consisted primarily of capital expenditures. Such
amounts aggregated $1,799,000 and $2,275,000 during the 1999 and 1998 nine-month
periods, respectively. Net cash provided by investing activities for the nine
months ended December 31, 1999 was $24,000 as compared to net cash used in
investing activities of $2,275,000 for the comparable 1998 period. For both the
1999 and 1998 periods, the Company incurred capital expenditures primarily for
its Nevada warehouse and distribution facility. In December 1999, the Company
sold land in Nevada for net proceeds of $1,823,000 See - Note Payable to Bank
below.
Net cash provided by financing activities for the nine months ended
December 31, 1999 decreased 27.3% to $3,641,000 from $5,011,000 for the
comparable 1998 period. The decrease is primarily due to the repayment of a note
payable with net proceeds from the sale of land in Nevada. See - Note Payable to
Bank below.
Financing Activities.
--------------------
Revolving Credit and Term Loan Facility. At December 31, 1999, the
Company had $7,257,000 outstanding under its revolving credit facility and
$365,000 outstanding under its term loan facility with Foothill Capital
Corporation ("Foothill") and had borrowing availability of $7,193,000 and
$119,000, respectively, net of amounts utilized for outstanding standby letters
of credit. Borrowings under the revolving credit and term loan facility bear
interest at prime plus 0.75% (9.25% at December 31, 1999). In November 1999 and
in anticipation of a seasonal increase in business activity, the Company and
Foothill amended the December 28, 1998 Loan and Security Agreement increasing
the maximum revolving advance limit from $12,000,000 to $15,000,000.
Real Estate Credit Facility. At December 31, 1999, $3,219,000 in
borrowings were outstanding under the revolving real estate credit facility with
Bank of America National Trust and Savings Association in Nevada. Borrowings
bear interest at LIBOR plus 2.25% (8.38% at December 31, 1999).
Distribution Equipment Lease Facility. At December 31, 1999,
$1,520,000 in borrowings were outstanding under the distribution equipment lease
facility with BankAmerica Leasing and Capital Corporation. Borrowings bear
interest at LIBOR plus 2.719% (8.85% at December 31, 1999).
Note Payable to Bank. On December 6, 1999, the Company closed escrow
for the sale (to a real estate developer) of approximately 3.8 acres of the 8.8
acres of land (adjacent to the Company's 8.4 acre warehouse and distribution
facility site in Las Vegas, Nevada) for $1,823,000. The Company recorded a gain
of approximately $23,000 on the sale of the land which is included in the
accompanying consolidated statements of operations as other income for the three
and nine months ended December 31, 1999. Concurrent with the close of escrow,
the Company repaid the $1,215,000 in outstanding borrowings with Pioneer
Citizens Bank of Nevada, which bore interest at prime plus 1.75% (10.25% at
December 31, 1999). The remaining proceeds of $608,000 were used to pay down
outstanding borrowings under the revolving credit facility with Foothill.
-22-
<PAGE>
Other Obligations.
-----------------
At December 31, 1999, the Company had future license obligations for
royalty advances, minimum guarantees and other fees of $3,411,000 due during the
remainder of fiscal 2000, $7,298,000 due during fiscal 2001 and $269,000 due
during fiscal 2002. These advances and guarantees are recoupable against
royalties and distribution fees earned (in connection with Company revenues) by
the licensors and program suppliers, respectively. Depending upon the
competition for license and exclusive distribution rights, the Company may have
to pay increased advances, guarantees and/or royalty rates in order to acquire
or retain such rights in the future.
At December 31, 1999, the Company had $550,000 of outstanding standby
letters of credit issued by Foothill of which $300,000 expire on June 30, 2000
and $250,000 expire on November 18, 2000. These letters of credit secure trade
payables due program suppliers.
Summary.
-------
Management believes that its projected cash flows from operations,
borrowing availability under its lender revolving lines of credit, cash on hand
and trade credit will provide the necessary capital to meet its projected cash
requirements for at least the next 12 months. However, any projections of future
cash needs and cash flows are subject to substantial uncertainty. If cash flows
to be generated from operations, future borrowing availability under its lender
revolving lines of credit and future cash on hand are insufficient to satisfy
the Company's continuing licensing and acquisition of exclusive DVD programming
which require significant advance royalty or distribution fee payments, the
Company will need to seek additional debt and/or equity financing. Failure to
obtain this additional financing could significantly restrict the Company's
growth plans. There can be no assurance that additional financing will be
available in amounts or on terms acceptable to the Company, if at all.
Impact of Year 2000.
-------------------
The Company (including its wholly-owned subsidiary Ken Crane's) has
been aware of the complexity and significance of the Year 2000 issue. Certain
computer programs written with two digits rather than four to define the
applicable year may experience problems handling dates beyond January 1, 2000.
As a result, computer applications may fail or create erroneous results unless
corrective measures are taken. During the past year, the Company acted to
minimize the risk of disruption from a Year 2000 related problem. The Company
established a Year 2000 compliance program which was comprised of five phases:
discovery, planning, resolution, testing and implementation. The scope of the
Company's compliance program included information technology systems (computer
hardware and software) and non-information technology systems (facilities,
telecommunication systems, distribution center machinery, security systems and
video and sound processing equipment which may include embedded technology).
Also included in the scope of the Company's compliance program was the Year 2000
readiness of significant third-party suppliers (product manufacturers and
suppliers and major service providers such as financial institutions, freight
carriers, securities agents and other service providers) and customers.
Completion of the discovery and planning phases for both the Company's
information and non-information technology systems revealed that approximately
25% of the systems addressed were found to require some level of remediation or
replacement. The Company completed the resolution phase to such systems, for
which all affected hardware, software and equipment has been repaired, upgraded
or replaced. During the December 1999 quarter, the Company completed the testing
and implementation phases for the majority of both its information and non-
information technology systems. Additionally, during the December 1999 quarter,
the Company completed its comprehensive Year 2000 supplier/customer readiness
assessment with all of its significant third-party suppliers and customers. This
assessment consisted of distributing a questionnaire to
-23-
<PAGE>
significant third-party suppliers (including those which manufacture/supply the
majority of the exclusive optical discs and packaging and finished nonexclusive
optical disc programming purchased by the Company) and significant third-party
customers (including the Company's largest retail customers). Substantially all
responses to the Company's questionnaire indicated that the Company's major
suppliers and customers have a comprehensive plan in place to be Year 2000
compliant by December 31, 1999.
The Company primarily utilized internal management information systems
personnel for the installation of maintenance updates and completion of
modifications to existing computer systems. The total cost of our Year 2000
compliance program was approximately $40,000 which was expensed as incurred and
was funded through operating cash flows.
The Company has not experienced any significant Year 2000 related
system failures or service disruptions. Additionally, the Company has not
experienced any service disruptions from its significant third-party suppliers
and customers, nor is it aware of any significant Year 2000 related system
failures, which may have been experienced by them. The Company intends to
monitor its systems for ongoing Year 2000 compliance. Management does not
currently anticipate that internal system failures will result in a material
adverse effect on the Company's operations or financial condition. Management
cannot guarantee the computer systems of the Company's significant third-party
suppliers and customers will not be adversely affected by problems associated
with the Year 2000 issue.
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: (1) the expected launch date of the new
www.DVDPlanet.com web site (the redesigned version of www.kencranes.com) and the
ability of our distribution system to handle fulfillment for the new web site;
(2) the expected release date of the Company's and Aviva's first title for
international home video; (3) the sales of the Company's previously released DVD
programming growing with DVD player sales; and (4) potential internal system
failures relating to the Year 2000 issue will not result in a material adverse
effect on the Company's operations of financial condition. 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: (1)
unexpected difficulties our internal and external information systems resources
encounter in programming our systems for expedited order processing, third party
fulfillment and web site integration; (2) unexpected difficulties or delays in
the mastering, production or coordination processes for international
distribution; (3) changing customer and consumer tastes and preferences with
regard to the Company's DVD offerings and those offered by other program
suppliers; and (4) that all Year 2000 remedial actions taken by the Company will
continue to be successful in avoiding a Year 2000 related problem. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. Unless otherwise required by law, 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.
-24-
<PAGE>
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
----------------------------------------------------------
Market risk is the potential loss arising from adverse changes in market rates
and prices, such as interest rates and foreign currency exchange rates. Changes
in interest rates and, in the future, changes in foreign currency exchange rates
have and will have an impact on the Company's results of operations.
Interest Rate Fluctuations
- --------------------------
Approximately $12.4 million of the Company's outstanding borrowings are subject
to changes in interest rates; however, the Company does not use derivatives to
manage this risk. This exposure is linked to the prime rate and the LIBOR. The
Company believes that moderate changes in the prime rate or the LIBOR would not
materially affect the operating results or financial condition of the Company.
For example, a one- percent change in interest rates would result in an
approximate $124,000 annual impact on pre-tax income (loss) based upon those
outstanding borrowings at December 31, 1999 subject to interest rate
fluctuations.
Foreign Exchange Rate Fluctuations
- ----------------------------------
The Company will be exposed to foreign exchange rate risk in the future
associated with its accounts receivable and accounts payable denominated in
foreign currencies (initially Eurodollars and British Pounds). The Company is
beginning to distribute certain of its licensed DVD and videotape programming
(for which the Company has international distribution rights) internationally
through international sub-distributors. Any exposure at December 31, 1999 was
immaterial. The Company's first international video releases are scheduled for
the fourth quarter ending March 31, 2000.
-25-
<PAGE>
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The condensed consolidated financial statements as of December 31,
1999 and for the three- and nine-month periods ended December 31, 1999 and 1998
in this Form 10-Q have been reviewed by KPMG LLP, independent certified public
accountants, in accordance with established professional standards and
procedures for such a review.
The report of KPMG LLP commenting upon their review follows.
-26-
<PAGE>
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 December 31, 1999, and the related
condensed consolidated statements of operations and cash flows for the three-and
nine-month periods ended December 31, 1999 and 1998. These condensed
consolidated financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our 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, 1999, and the related consolidated statements of
operations, shareholders' equity and cash flows for the year then ended; and in
our report dated May 21, 1999, 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, 1999, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ KPMG LLP
Los Angeles, California
February 3, 2000
-27-
<PAGE>
================================================================================
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 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"). 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 systematically dissipated and 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 Company also contends that all of
the defendants are or were the alter egos of LEI and each other. 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 the Company 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 sought punitive damages in
the 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 three 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 automatically stayed the prosecution of the court ordered
arbitration proceedings against LEI, and the prosecution of the Superior Court
Action against LEI and the other debtor defendants. In connection with the
bankruptcy proceedings, the Company availed itself of provisions in the
Bankruptcy Code to conduct discovery relating to the acts, conduct, property,
liabilities and financial condition of LEI and the other debtors. In July 1998,
the Company filed motions to compel LEI and the other debtors and
-28-
<PAGE>
the debtors' accountants to produce documents and appear for examination under
Bankruptcy Rule 2004. The Bankruptcy Court granted all of the Company's motions,
issuing orders compelling the four debtor entities and their principals
(Mark Kreloff and Paul Haigney), as well as the debtors' former accountants
(Kress & Rosenbaum Accountancy Corporation and Calvin Leong) to produce
documents and appear for Rule 2004 examinations. In connection with the Rule
2004 motions, the Company has obtained and reviewed thousands of pages of
documents from the debtors' former accountants and the debtors, relating to the
assets, liabilities, and financial condition of the debtors and other matters
which may affect the administration of the debtor's estate or their right to a
discharge. The Company has also taken Rule 2004 examinations of three of the
debtors' former accountants, and has also completed Rule 2004 examinations of
the debtors and their principals.
Effective as of April 30, 1999, the Company entered into a
confidential settlement agreement with one of the nondebtor defendants, who has
since been dismissed from the Superior Court Action. On May 4, 1999, the
Superior Court granted the Company's motion to lift the stay of the Superior
Court Action, thereby permitting the Company to prosecute the Superior Court
Action against all remaining nondebtor defendants. Once the stay was lifted, the
Company added as defendants in the Superior Court Action two additional
companies alleged to be affiliated with LEI and its principals. On June 3, 1999,
all nondebtor defendants, including the two new defendants, filed an answer to
the First Amended Complaint denying liability. Although the defendants alleged
affirmative defenses based on the rejected counterclaim that LEI attempted to
assert in the arbitration proceeding, they filed no cross-complaint and
therefore currently have no claim for affirmative relief against the Company.
On May 7, 1999, the debtors filed motions in the Bankruptcy Court
objecting to the claims of the Company, attempting to resolve in the Bankruptcy
Court the claims pending in the Superior Court Action. On June 10, 1999, the
Bankruptcy Court denied the debtors' motions in their entirety and overruled
their objections to the Company's claims, proofs of which had not been filed.
Before the hearing of the debtors' objections, on May 28, 1999, the trustee in
each of the bankruptcy cases filed "no asset reports" for each of the debtors,
notifying all creditors not to file proofs of claim, as there appeared to be no
assets of any debtor. This means the trustee placed no value on the purported
counterclaim of LEI identified in the bankruptcy schedules, and also means that
the bankruptcy cases will eventually be closed. Once the cases are closed, the
automatic stay of proceedings against the debtors will be lifted and they will
likely rejoin the Superior Court action. Whether the counterclaim will be
asserted at that time in the Superior Court action is not known.
The Company is continuing to prosecute its Superior Court Action by
conducting further discovery and preparing the case for trial. The Company has
also been engaged in settlement negotiations with defendants.
On November 13, 1998, the Company filed a complaint in the Superior
Court of the State of California, County of Los Angeles (Case No. SC 054918),
against its former attorney for breach of fiduciary duty and legal malpractice.
The claims alleged arise out of defendants' representation of LEI and its
principals, without the Company's informed and written consent, in matters
directly related to the subject of defendants' prior representation of the
Company. The complaint seeks compensatory damages of not less than $5 million
plus interest. The parties have reached a confidential agreement in principal to
settle the litigation and are in the process of finalizing the settlement
papers.
On July 12, 1999, the Company was named as a defendant in an Adversary
Proceeding (the "Adversary Proceeding") filed by One Stop Recovery LLC, as
Trustee for AEC One Stop, Inc. ("Plaintiff") in connection with the Chapter 11
bankruptcy of Alliance Entertainment Corp. ("Alliance"). The Adversary
Proceeding is pending in the United States Bankruptcy Court for the Southern
District of New York. In the Adversary Proceeding, the Plaintiff is seeking to
recover approximately $1,740,000 in alleged preferential transfers (including
payments made and the value of goods returned) made by Alliance within the
90-day period immediately preceding the commencement of its bankruptcy case. The
Company intends to vigorously defend itself in the Adversary Proceeding. While
it is not feasible to predict or determine the outcome of the Adversary
Proceeding,
-29-
<PAGE>
management does not believe that it would have a material adverse effect on the
Company's financial position, results of operations or liquidity.
In the normal course of business, the Company is 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 and the adversary 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
ITEM 3. Defaults upon Senior Securities.
-------------------------------
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------
Not applicable.
ITEM 5. Other Information.
-----------------
Not Applicable
ITEM 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page i
(b) Reports on Form 8-K
None
-30-
<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 11, 2000 By: /s/ MARTIN W. GREENWALD
----------------------------------
Martin W. Greenwald
Chairman of the Board, Chief
Executive Officer,
President and Treasurer
Date: February 11, 2000 By: /s/ JEFF M. FRAMER
----------------------------------
Jeff M. Framer
Chief Financial Officer
-31-
<PAGE>
================================================================================
EXHIBIT INDEX
================================================================================
Exhibit No. Description
- --------------------------------------------------------------------------------
10.1 * Amendment No. 2 dated as of February 8, 2000 to Loan and
Security Agreement dated as of December 28, 1998 by and between
the Company and Foothill Capital Corporation.
15 * Consent Letter of KPMG LLP, Independent Certified Public
Accountants.
27 * Financial Data Schedule as of and for the Nine Months Ended
December 31, 1999.
____________________________________________
* Exhibit(s) not previously filed with the Securities
and Exchange Commission.
+ Management Contracts, Compensatory Plans or Arrangements.
i
<PAGE>
EXHIBIT 10.1
AMENDMENT NO. TWO TO THE LOAN
AND SECURITY AGREEMENT
IMAGE ENTERTAINMENT, INC.
THIS AMENDMENT NO. TWO TO LOAN AND SECURITY AGREEMENT (this
"Amendment") is entered into as of the 8/th/ day of February, 2000, by and
between IMAGE ENTERTAINMENT, INC., a California corporation ("Borrower"), whose
chief executive office is located at 9333 Oso Avenue, Chatsworth, California
91311 and FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"),
with a place of business located at 11111 Santa Monica Boulevard, Suite 1500,
Los Angeles, California 90025-3333, in light of the following facts:
FACTS
FACT ONE: Foothill and Borrower have previously entered into that
--------
certain Loan and Security Agreement, dated December 28, 1998 (as amended and
supplemented, the "Agreement").
FACT TWO: Foothill and Borrower desire to amend the Agreement as
--------
provided herein. Terms defined in the Agreement which are used herein shall have
the same meanings as set forth in the Agreement, unless otherwise specified.
NOW, THEREFORE, Foothill and Borrower hereby modify and amend the
Agreement as follows:
1. Effective as of December 1, 1999, Section 7.9 of the Agreement
is hereby amended in its entirety to read as follows:
"7.9 Capital Expenditures. Make any capital
--------------------
expenditure, or any commitment therefor, (a) with
respect to individual transactions: (i) in excess of
Eight Hundred Thousand Dollars ($800,000) for any
individual transaction made or committed during
Borrower's fiscal year ended March 31, 2000 and each
subsequent fiscal year thereafter; or (b) with respect
to aggregate capital expenditures made or committed
for in any fiscal year, in an aggregate amount in
excess of (i) Two Million Five Hundred Thousand
Dollars ($2,500,000) for each subsequent fiscal year
thereafter; provided, however, that if the amount
-------- -------
available under this covenant is not expended in any
particular year, one hundred percent (100%) thereof
shall be available to be expended in the following
fiscal year, but only in such subsequent fiscal year,
with the amount so carried over being deemed to have
been expended last in such subsequent year."
2. Foothill shall charge Borrower's loan account a fee in the amount
of $2,000. Said fee shall be fully-earned, non-refundable, and due and payable
on the date Borrower's loan account is charged.
3. In the event of a conflict between the terms and provisions of
this Amendment and the terms and provisions of the Agreement, the terms and
provisions of this Amendment shall govern. In all other respects, the Agreement,
as supplemented, amended and modified, shall remain in full force and effect.
IN WITNESS WHEREOF, Borrower and Foothill have executed this Amendment
as of the day and year first written above.
FOOTHILL CAPITAL CORPORATION IMAGE ENTERTAINMENT, INC.
By: /s/ SHERI FENEBOCK By: /s/ JEFF M. FRAMER
---------------------------------- -------------------------
Print Name: Sheri Fenenbock Print Name: Jeff M. Framer
---------------------------- -----------------
Its: Vice President Its: Chief Financial Officer
--------------------------------- ------------------------
<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 3, 2000 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 LLP
Los Angeles, California
February 10, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10-Q
DECEMBER 31, 1999 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-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 829
<SECURITIES> 0
<RECEIVABLES> 19,031
<ALLOWANCES> 3,830
<INVENTORY> 20,147
<CURRENT-ASSETS> 0<F1>
<PP&E> 19,824
<DEPRECIATION> 6,185
<TOTAL-ASSETS> 66,525
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
31,809
0
<COMMON> 0
<OTHER-SE> (7,688)
<TOTAL-LIABILITY-AND-EQUITY> 66,525
<SALES> 60,904
<TOTAL-REVENUES> 60,904
<CGS> 44,999
<TOTAL-COSTS> 44,999
<OTHER-EXPENSES> 2,896
<LOSS-PROVISION> 15
<INTEREST-EXPENSE> 1,119
<INCOME-PRETAX> (295)
<INCOME-TAX> 0
<INCOME-CONTINUING> (295)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (295)
<EPS-BASIC> (.02)
<EPS-DILUTED> (.02)
<FN>
<F1>The Company has an unclassified balance sheet due to the nature of its
industry.
</FN>
</TABLE>
