<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1997 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from_________ to __________
Commission file number 0-15939
SHOWSCAN ENTERTAINMENT INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-3940004
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3939 LANDMARK STREET
CULVER CITY, CALIFORNIA 90232
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 558-0150
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 [ ]
As of November 6, 1997, the Registrant had 5,642,058 shares of Common
Stock, $.001 par value, issued and outstanding.
===============================================================================
This report contains 21 consecutively numbered pages.
<PAGE> 2
SHOWSCAN ENTERTAINMENT INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 1997
and March 31, 1997 3
Condensed Consolidated Statements of Operations for the Three
Months and Six Months Ended September 30, 1997 and 1996 5
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended September 30, 1997 and 1996 6
Notes to the Condensed Consolidated Financial Statements 8
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 20
Signatures 21
</TABLE>
2
<PAGE> 3
PART I. - FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS
SHOWSCAN ENTERTAINMENT INC.
Condensed Consolidated Balance Sheets
(Dollars in Thousands Except Share Information)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1997 1997
------------ ---------
(unaudited) (Note)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $2,741 $2,562
Accounts receivable (net of allowances) 3,586 3,600
Unbilled receivables on uncompleted
film and equipment contracts 978 --
Equipment sales inventory 1,094 1,289
Prepaid expenses and other current assets 367 1,072
------- -------
Total current assets 8,766 8,523
Film library (net of amortization) 5,860 5,520
Equipment and leasehold improvements, less
accumulated depreciation and amortization 713 868
Investment in and advances to O&O theatres (Note 2) 1,872 2,123
Patents and other intellectual properties (net of
amortization) 1,118 1,336
Other assets 607 1,558
------- -------
Total assets $18,936 $19,928
======= =======
</TABLE>
Note: The balance sheet at March 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.
(Continued)
3
<PAGE> 4
SHOWSCAN ENTERTAINMENT INC.
Condensed Consolidated Balance Sheets (continued)
(Dollars in Thousands Except Share Information)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1997 1997
------------ --------
(unaudited) (Note)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 380 $ 654
Customer advances on uncompleted film and
equipment contracts 3,518 1,033
Accrued expenses and other current liabilities 1,716 2,308
-------- --------
Total current liabilities 5,614 3,995
-------- --------
8% convertible notes (Note 3) 5,690 5,690
Stockholders' equity:
Series C Convertible Preferred Stock, $.001 par value; 100,000 shares
authorized; 49,000 shares issued and
outstanding -- --
Common stock, $.001 par value; 20,000,000 shares
authorized; 5,642,058 shares issued and outstanding 6 6
Additional paid-in capital 42,567 42,567
Accumulated deficit (34,941) (32,330)
-------- --------
Total stockholders' equity 7,632 10,243
-------- --------
Total liabilities and stockholders' equity $ 18,936 $ 19,928
======== ========
</TABLE>
Note: The balance sheet at March 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.
4
<PAGE> 5
SHOWSCAN ENTERTAINMENT INC.
Condensed Consolidated Statements of Operations
(Dollars in Thousands Except Per Share Information)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------------ -----------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Film licensing and production services $ 1,192 $ 1,189 $ 2,131 $ 2,072
Equipment sales and related services 1,280 4,286 1,580 6,647
------- ------- ------- -------
2,472 5,475 3,711 8,719
Costs of revenues 1,382 3,687 2,117 5,832
------- ------- ------- -------
Gross profit 1,090 1,788 1,594 2,887
Costs and expenses:
General and administrative expenses 1,576 1,790 3,166 3,475
Depreciation and amortization 190 242 389 484
------- ------- ------- -------
1,766 2,032 3,555 3,959
------- ------- ------- -------
Operating loss (676) (244) (1,961) (1,072)
Other income (expense):
Equity in net operations of owned and
operated theatres (202) (126) (364) (186)
Other income, including interest of
$17, $58, $40, and $154,
respectively 23 60 41 162
Interest and other expenses (137) (114) (327) (317)
------- ------- ------- -------
(316) (180) (650) (341)
------- ------- ------- -------
Net loss $ (992) $ (424) $(2,611) $(1,413)
======= ======= ======= =======
Net loss per common share (Note 4) $ (.18) $ (.08) $ (.46) $ (.25)
======= ======= ======= =======
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
5
<PAGE> 6
SHOWSCAN ENTERTAINMENT INC.
Condensed Consolidated Statements of Cash Flows
(Dollars in Thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
1997 1996
--------------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,611) $(1,413)
Adjustments to reconcile net loss
to net cash provided by (used in) operating
activities:
Depreciation and amortization 389 484
Amortization of film library 423 325
Equity in operations of owned and operated
theatres 364 186
Accrued interest on debt 232 241
Provision for doubtful accounts 60 60
Changes in operating assets and liabilities:
Accounts receivable (46) (1,570)
Equipment sales inventory 195 (42)
Unbilled receivables on uncompleted film and
equipment contracts (978) (413)
Prepaid expenses and other assets 706 (23)
Investment in and advances to O&O theatres 278 (43)
Accounts payable, accrued expenses and other
current liabilities (1,097) (1,243)
Customer advances on uncompleted equipment
contracts 2,485 1,124
------- -------
Net cash provided by (used in)
operating activities $ 400 $(2,327)
------- -------
Cash flows from investing activities:
Redemptions of short term investments -- 2,089
Purchases of equipment and leasehold
improvements (15) (42)
Additions to film library (763) (1,741)
Other assets 557 292
------- -------
Net cash provided by (used in)
investing activities $ (221) $ 598
------- -------
</TABLE>
(Continued)
6
<PAGE> 7
SHOWSCAN ENTERTAINMENT INC.
Condensed Consolidated Statements of Cash Flows (Continued)
(Dollars in Thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
1997 1996
--------------------
(Unaudited)
<S> <C> <C>
Balance forwarded $ 179 $(1,729)
------- -------
Cash flows from financing activities:
Other -- (77)
------- -------
Net cash provided by (used in)
financing activities -- (77)
------- -------
Net increase/(decrease) in cash and cash equivalents 179 (1,806)
Cash and cash equivalents, beginning of period 2,562 5,055
------- -------
Cash and cash equivalents, end of period $ 2,741 $ 3,249
======= =======
Supplemental disclosures of cash flow information:
Interest paid $ 232 $ 246
======= =======
Income taxes paid $ -- $ --
======= =======
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
7
<PAGE> 8
SHOWSCAN ENTERTAINMENT INC.
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Note 1--Introduction:
The accompanying unaudited condensed consolidated financial
statements of Showscan Entertainment Inc. (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. 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-month period and the six-month period
ended September 30, 1997 are not necessarily indicative of the results that may
be expected either for any other quarter in the fiscal year ending March 31,
1998 or for the entire fiscal year ended March 31, 1998. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-K for the year ended
March 31, 1997.
Note 2--Owned and Operated theatres:
The Company retains an ownership interest, ranging from 15% to 50%,
in selected Showscan motion simulation theatre attractions ("Showscan
Attractions") through various joint venture arrangements. The Company currently
operates and/or has an ownership interest in Showscan Attractions at Universal
CityWalk in Universal City, California (November 1993), at the Trocadero Arcade
in London (September 1994), Osaka, Japan (August 1995), Austin, Texas (July
1997) and in Darling Harbour in Sydney, Australia (July 1997). Generally, in
each of these arrangements, the Company receives reimbursement for direct
expenses, a percentage of each theatre's cash flow (equal to its ownership
percentage), and receives separately annual film licensing revenues and
management fees (if applicable). The Company accounts for its investment in
owned and operated theatres under the equity method of accounting. The Company
has ceased operations of the theatres at Framingham, Massachusetts (October
1997) and at San Antonio, Texas (September 1997) and has contracted to sell to
non-affiliated third parties the equipment from each theatre. The joint venture
partners of each respective theatre have agreed to these sales. The Company
expects to fully realize the aggregate carrying value of its investment in both
joint ventures upon completion of such sales and the subsequent liquidation of
the related joint ventures.
Note 3--8% Convertible Notes:
On September 1, 1995, the Company completed a private placement of
$7,000,000 in secured convertible notes through a European financial
institution, Banca del Gottardo. The notes have a four-year maturity and an 8%
interest rate payable semi-annually and are convertible at the option of the
holder into 1,217,391 shares of the Company's $.001 par value common stock (the
"Common Stock") at a conversion price of $5.75 per share. Through September 30,
1997, $1,310,000 of notes had been converted into 227,819 shares of Common Stock
leaving an outstanding balance of $5,690,000. The notes are secured by
substantially all of the assets of the Company, although the security excludes
the Company's film library and the capital stock of its subsidiaries (which
thereby
8
<PAGE> 9
excludes its O&O Theatres). In connection with the placement, $619,000 of debt
issue costs were incurred and are being amortized over the life of the notes.
Note 4--Loss per common share:
Loss per common share for the three months ended September 30, 1997
and September 30, 1996 has been determined by using 5,642,058 and 5,577,447
weighted average shares of Common Stock, respectively. For the six months ended
September 30, 1997 and September 30, 1996, the weighted average shares of Common
Stock used to determine loss per common share were 5,642,058 and 5,551,616,
respectively. The impact of common stock equivalents and potentially dilutive
securities, such as the assumed conversion of Series C Convertible Preferred
Stock and the assumed conversion of the 8% Convertible Notes due September 1,
1999 has not been included, as such items are anti-dilutive for all periods
presented.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
No. 128). SFAS No. 128 establishes standards for computing and presenting
earnings per share (EPS) and supersedes APB Opinion No. 15, "Earnings Per Share"
(APB No. 15). SFAS No. 128 replaces the presentation of primary EPS with a
presentation of basic EPS. Basic EPS excludes the dilutive effects, if any, of
common stock equivalents, and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. SFAS No. 128 also requires dual presentation of basic EPS and
diluted EPS on the face of the income statement for all periods presented.
Diluted EPS is computed similarly to fully diluted EPS pursuant to APB No. 15,
with certain modifications. SFAS No. 128 is effective for financial statements
issued for periods ending after December 15, 1997, including interim periods.
Early adoption is not permitted and SFAS No. 128 requires restatement of all
prior period EPS data presented after SFAS No. 128's effective date.
The Company will adopt SFAS No. 128 effective with its March 31, 1998
fiscal year end. Pro forma earnings (loss) per share data calculated in
accordance with SFAS No. 128 has not been presented as it would have been the
same as the historical amounts reported.
Note 5-Merger:
On August 4, 1997, the Company entered into an Agreement and Plan of
Reorganization by and among the Company, Iwerks Entertainment, Inc. ("Iwerks")
and IWK-1 Merger Corporation ("Merger Sub") pursuant to which Merger Sub will be
merged (the "Merger") with and into the Company. As a result of the Merger, (a)
each share of Common Stock which is outstanding immediately prior to the Merger
shall be converted into .85 shares of Iwerks' common stock, $.001 par value
("Iwerks Common Stock"), and (b) each share of Series C Convertible Preferred
Stock will be converted into the right to receive shares of Iwerks Common Stock
in an amount equal to the number of shares of Common Stock into which such share
of Series C Convertible Preferred Stock is convertible immediately prior to the
Merger multiplied by .85. As a result of the Merger, the Company will become a
wholly-owned subsidiary of Iwerks and the shares of Common Stock will cease to
be publicly traded. Consummation of the Merger is subject to certain conditions,
including certain approvals by the stockholders of both the Company and Iwerks.
The Merger and other conditions to the effectiveness thereof are more fully
described in the Company's Current Report on Form 8-K dated August 4, 1997 on
file with the Securities and Exchange Commission. The
9
<PAGE> 10
Company currently anticipates holding a stockholder meeting (and that the Merger
will close) in the fourth calendar quarter of 1997.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview:
Showscan Entertainment Inc. (the "Company") is a leading provider of
movie-based motion simulation theatre attractions ("Showscan Attractions") to
the rapidly expanding out-of-home entertainment market. The Company's business
includes: (i) licensing and distributing the films in its library and the
proprietary technologies necessary to produce and exhibit Showscan films; (ii)
selling and installing motion simulation attractions and specialty theatres
including the equipment necessary for each (including motion bases, projectors,
screens, sound systems, synchronization and show control and theatre design
packages); (iii) producing films using the Showscan process; and (iv)
establishing motion simulation attractions in which the Company has an economic
interest ("O&O Theatres"). The Company is also committed to the continued
recognition of the Showscan(R) brand name worldwide.
The principal sources of the Company's revenues are the licensing of
the Showscan film library and technologies, the sale and installation of
projectors, screens, sound systems and other equipment used to exhibit Showscan
films, and the sale of motion bases and other equipment used in most Showscan
Attractions. The Company currently derives most of its revenues from export
sales. However, the Company plans to increase its domestic sales through its
agreement with United Artists Theatre Circuit, Inc. The agreement calls for 24
sites, eight of which are currently installed and the remaining 16 of which are
in the Company's backlog. The Company does not believe that inflation has had a
material impact on the Company's net revenues or on its results of operations
for the three most recent fiscal years.
On August 4, 1997, the Company entered into an agreement with Iwerks
Entertainment, Inc. ("Iwerks") pursuant to which a subsidiary of Iwerks will be
merged (the "Merger") with and into the Company. As a result of the Merger, each
share of Common Stock which is outstanding immediately prior to the Merger shall
be converted into .85 shares of Iwerks' common stock, $.001 par value. As a
result of the Merger, the Company will become a wholly-owned subsidiary of
Iwerks and the shares of Common Stock will cease to be publicly traded.
Consummation of the Merger is subject to certain conditions, including certain
approvals by the stockholders of both the Company and Iwerks. The Company
currently anticipates holding a stockholder meeting (and that the Merger will
close) in the fourth calendar quarter of 1997.
Comparison of the six months ended September 30, 1997 and 1996:
Revenues for the six-month period ended September 30, 1997 (the "Six
Month Period") decreased by $5 million or 57% from revenues for the six-month
period ended September 30, 1996 due to a substantial decrease in revenues
recognized from equipment sales and related services.
Revenues from equipment sales and related services for the Six Month
Period decreased 76% to $1.6 million from $6.7 million in the six-month period
ended September 30, 1996. Only two Showscan Attractions were shipped in the Six
Month Period as compared to the nine units shipped in the six-month period ended
September 30, 1996.
11
<PAGE> 12
Film licensing and production service revenues increased by 3% to
$2.1 million in the Six Month Period.
The Company recognizes equipment sales under the
percentage-of-completion method of accounting, generally measured by the
percentage that the labor hours incurred to date bears to the estimated total
labor hours of each contract. This results in a disparity in the comparison of
equipment sales revenues over different time periods, as the Company records
revenues under this method rather than on the date that the sales agreement is
signed. The actual signing of a Showscan Attraction sale precedes its delivery
and installation by an average of five to six months. Accordingly, the
recognition of revenue for equipment sales during the current and future
quarters is affected by (i) the timing of such sales; (ii) the schedule of the
build-out of the Showscan Attractions; and (iii) the shipment, delivery and
installation of the equipment and related services.
The Company presently has nine Showscan Attractions in various stages
of manufacturing, delivery and installation.
Costs of revenues were 57% of revenues in the Six Month Period as
compared to 67% in the six-month period ended September 30, 1996. Equipment cost
of sales to total equipment sales decreased to 72% in the Six Month Period from
78% in the six-month period ended September 30, 1996. The decrease was
principally the result of the recognition of four sales in the six-month period
ended September 30, 1996, each of which had higher associated costs of revenues
than the sales in the Six Month Period. Film licensing cost of sales to total
film licensing sales was 46% in the Six Month Period as compared to 32% in the
six-month period ended September 30, 1996. The increase in film licensing cost
of sales is due to the additional distribution expenses associated with new
simulation films that were in initial release or pre-release during the Six
Month Period which did not exist in the six-month period ended September 30,
1996.
General and Administrative expenses decreased in the Six Month
Period, as the Company reduced its overhead in the fourth quarter of fiscal year
ended March 31, 1997, offset by the increase in expenses related to the Merger.
Amortization of the film library for the Six Month Period and the
six-month period ended September 30, 1996 was $423,000 and $325,000,
respectively. The increase in film amortization is due to the additional
amortization from new films in the Six Month Period that did not exist in the
six-month period ended September 30, 1996.
The loss on investment in Owned and Operated Theatres increased to
$364,000 in the Six Month Period from $186,000 in the six-month period ended
September 30, 1996. The loss for the Six Month Period is primarily the result of
the following factors: (i) operating losses at the Framingham, Trocadero, San
Antonio Riverwalk and Universal CityWalk theatres, (ii) offset by the operating
profits of the Osaka theatre. The Company earns film licensing revenues (from
all O&O Theatres) and management fees (from some of the O&O Theatres) which are
recorded separately in the accompanying consolidated statements of operations,
thereby inherently increasing the operating expenses at the specific O&O
Theatres. A formal claim that was filed with the owner of the Trocadero building
to recover damages resulting from the renovation of the Trocadero building and
the related access problems has been settled, wherein the Showscan subsidiary
which owns the
12
<PAGE> 13
theatres will be reimbursed in a future period for a portion of its damages
incurred during the renovation period. The Company has ceased operations at the
Framingham (October 1997) and San Antonio (September 1997) theatres and has
contracted to sell to non-affiliated third parties the equipment from each
theatre location. The joint venture partners of each respective theatre have
agreed to these sales. The Company expects to fully realize the aggregate
carrying value of its investment in both joint ventures upon completion of such
sales and the subsequent liquidation of the related joint ventures. The Company
recently invested in two new O&O Theatres: a 50% ownership interest through the
Showscan/United Artists Theatres Joint Venture in a theatre in Austin, Texas and
a 15% ownership interest through an investment in Reality Cinema Pty Ltd. in a
theatre in Darling Harbour in Australia.
The Company's net loss increased in the Six Month Period to
$2,611,000 from $1,413,000 in the six-month period ended September 30, 1996, due
to (i) the decrease in equipment sales revenues, and (ii) the performance of the
O&O Theatres, all offset in part by (iii) a reduction in general and
administrative expenses. The Company does not believe that these results
necessarily represent a recurring trend.
Comparison of the three months ended September 30, 1997 and 1996:
Revenues for the three-month period ended September 30, 1997 (the
"1998 Second Quarter") decreased $3 million or 55% from revenues for the
three-month period ended September 30, 1996 (the "1997 Second Quarter") due to a
substantial decrease in revenues recognized from equipment sales and related
services in the 1998 Second Quarter.
Revenues from equipment sales and related services for the 1998
Second Quarter decreased 70% to $1.3 million from $4.3 million in the 1997
Second Quarter. Two Showscan Attractions were shipped in the 1998 Second Quarter
as compared to the six units shipped in the 1997 Second Quarter.
Film licensing and production service revenues remained relatively
stable when comparing the 1998 Second Quarter to the 1997 Second Quarter.
The Company recognizes equipment sales under the
percentage-of-completion method of accounting, generally measured by the
percentage that the labor hours incurred to date bears to the estimated total
labor hours of each contract. This results in a disparity in the comparison of
equipment sales revenues over different time periods, as the Company records
revenues under this method rather than on the date that the sales agreement is
signed. The actual signing of a Showscan Attraction sale precedes its delivery
and installation by an average of five to six months. Accordingly, the
recognition of revenue for equipment sales during the current and future
quarters is affected by (i) the timing of such sales; (ii) the schedule of the
build-out of the Showscan Attractions; and (iii) the shipment, delivery and
installation of the equipment and related services.
The Company presently has nine Showscan Attractions in various stages
of manufacturing, delivery and installation.
Costs of revenues were 56% of revenues in the 1998 Second Quarter as
compared to 67% in the 1997 Second Quarter. Equipment cost of sales to total
equipment sales decreased to 70% in
13
<PAGE> 14
the 1998 Second Quarter from 78% in the 1997 Second Quarter. The decrease was
principally the result of the recognition of two sales in the 1997 Second
Quarter, each of which had higher associated costs of revenues than sales in the
1998 Second Quarter. Film licensing cost of sales to total film licensing sales
was 41% in the 1998 Second Quarter as compared to 29% in the 1997 Second
Quarter. The increase in film licensing cost of sales is due to the additional
distribution expenses associated with new simulation films that were in the 1998
Second Quarter which did not exist in the 1997 Second Quarter.
General and Administrative expenses decreased in the 1998 Second
Quarter, as the Company reduced its overhead, offset by the increase in expenses
related to the Merger.
Amortization of the film library for the 1998 Second Quarter and the
1997 Second Quarter was $248,000 and $192,000, respectively. The increase in
film amortization is due to the additional amortization from new films in the
1998 Second Quarter that did not exist in the 1997 Second Quarter.
The loss on investment in Owned and Operated Theatres in the 1998
Second Quarter increased 60% to $202,000 from the 1997 Second Quarter and was
primarily the result of the following factors: (i) operating losses at the
Framingham, Trocadero, San Antonio Riverwalk and Universal CityWalk theatres,
(ii) offset by the operating profits of the Osaka theatre. The Company earns
film licensing revenues (from all O&O Theatres) and management fees (from some
of the O&O Theatres) which are recorded separately in the accompanying
consolidated statements of operations, thereby inherently increasing the
operating expenses at the specific O&O Theatres.
The Company's net loss increased in the 1998 Second Quarter to
$992,000 from $424,000 in the 1997 Second Quarter, due to (i) the decrease in
equipment sales revenues, and (ii) the performance of the O&O Theatres, all
offset in part by (iii) a reduction in general and administrative expenses. The
Company does not believe that these results necessarily represent a recurring
trend.
Liquidity and Capital Resources:
At September 30, 1997, the Company's working capital decreased to
$3,152,000 from $4,528,000 at March 31, 1997. The decrease in working capital
was primarily due to the increase in deferred revenues (net of the associated
unbilled receivables) on uncompleted equipment contracts in the Six Month
Period.
Cash and cash equivalents at September 30, 1997 increased by $179,000
from March 31, 1997, which was primarily the result of $400,000 provided by
operating activities and $221,000 used in investing activities.
Net cash provided by operating activities was primarily due to (i)
the net increase of $1,507,000 in deferred revenues (net of the associated
unbilled receivables) on uncompleted equipment contracts, and (ii) a decrease in
accounts payable, accrued expenses and all other cash uses during operating
activities. The changes are primarily attributable to variations in the timing
of Showscan Attractions sales and the specific contract terms of such sales,
which terms generally affect the timing of collections, shipments, deliveries to
customers, installations and the related payments to vendors.
14
<PAGE> 15
Net cash used in investing activities was primarily due to (i)
expenditures for the production and acquisition of three motion simulation
films, partialy offset by (ii) a decrease in other assets.
As Showscan derives 60-70% of its business from export sales, its
liquidity may be adversely affected by changes in worldwide economic or
political conditions. Such factors as changes in foreign currency exchange rates
(which can significantly affect the affordability of Showscan's products and
services), trade protection measures, and policies with respect to currency and
fiscal controls may negatively affect liquidity.
The Company's business strategy includes a significant increase in
the installed base of Showscan Attractions, new film productions, the securing
of distribution rights to motion simulation films produced by other companies,
new product development and new product lines, enhancement of existing product
lines, possible investments in O&O Theatres and the reduction of overhead by 30%
(which was implemented during the fourth quarter of fiscal year ended March 31,
1997). Following this business strategy, the Company recently invested in two
new O&O Theatres: a 50% ownership interest through the Showscan/United Artists
Theatre Joint Venture in a theatre in Austin, Texas and a 15% ownership interest
through an investment in Reality Cinema Pty Ltd. in a theatre in Darling Harbour
in Australia. The Company also recently obtained certain distribution rights
through May 1, 2002 to two films produced by another company.
If the Merger with Iwerks should not occur, the Company intends to
finance the foregoing business strategy by utilizing its current working capital
resources, the proceeds to be received from its existing backlog and anticipated
future product sales and film licensing agreements, together with proceeds
derived from one or more of the following financing alternatives: the sale of
securities, the obtaining of a line of credit from a banking or another type of
institution, and/or the formation of strategic alliances, joint ventures or
off-balance sheet financing. There can be no assurance that the Company will be
able to obtain any of the aforementioned financing alternatives and the Company
has agreed in the Merger Agreement with Iwerks to not incur additional
indebtedness in excess of $1,000,000. If the Merger with Iwerks should not occur
and if the Company is unable to generate sufficient funds from operations or is
unable to raise additional capital through any of the aforementioned
alternatives, the Company will need to curtail its business strategy,
specifically with regard to new film productions and investments in O&O
Theatres. The Company believes that, given its various business alternatives,
its working capital will be sufficient to fund the cost of its operations for
the next twelve months. At October 1, 1997, the Company has reserved 4,573,573
shares of Common Stock for issuance on the exercise of stock options, warrants,
preferred stock and convertible notes.
Management of the Company has reviewed the provisions of SFAS 130 and
131 and determined that the ultimate adoption of these accounting standards will
not have an impact on the Company's financial statements and related
disclosures.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Portions of this report on Form 10-Q (this "Report") may contain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The reader is cautioned that all forward-looking
statements are necessarily speculative and there are certain risks and
uncertainties that could cause actual events or results to differ materially
from those referred to
15
<PAGE> 16
in such forward-looking statements. The discussion below, together with portions
of the discussion elsewhere in this Report and in the Company's other reports on
file with the Securities and Exchange Commission, highlight some of the more
important risks identified by the management of the Company but should not be
assumed to be the only things that could affect future performance.
Period to Period Fluctuations
The Company's operating results may fluctuate from period to period
for a number of reasons, including (i) the timing of sales of the Company's
motion simulation attractions, (ii) the timing of delivery and installation of
such sales (pursuant to percentage of completion accounting) and any delays
therein caused by permitting or construction delays at the customer's site,
(iii) the size, type and configuration of the attractions sold, (iv) the timing
of film rental payments from existing attractions and the performance of those
attractions that pay film rental based on a percentage of box office, and (v)
the timing of sales and marketing efforts and related expenditures. Accordingly,
the Company's revenues and earnings in any particular period may not be
indicative of the results for any future period. The seasonal fluctuations also
cause gyrations in the Company's stock price.
The Company's performance depends primarily upon the number of motion
simulation attractions that it can sell and install. This dependence has been
lessening as the percentage of the Company's revenues derived from recurring
film licensing revenues has increased though there can be no assurance that this
trend will necessarily continue. The Company's results have followed a seasonal
pattern, with revenues tending to be stronger in the second half of the fiscal
year, reflecting the buying patterns of the Company's customers for new motion
simulation attractions.
Business Strategy
Management of the Company has adopted a business strategy that
includes substantial investments in the installed base of Showscan Attractions,
new film productions, the securing of distribution rights to motion simulation
films produced by other companies, new product development and new product
lines, enhancement of existing product lines, possible investments in O&O
Theatres and the reduction of overhead. This strategy carries with it a number
of risks, including a level of operating expenses that may not be adequately
covered by increased sales, film licensing revenues or additional financing may
not be available on favorable terms. This strategy will have to be curtailed if
adequate funds are not available.
New Product Development
The Company operates in a technology driven segment of the
entertainment business. As such, the Company must continually improve its
products to increase their entertainment value while also facing pressure to
continually reduce the price of its products to respond to competitive
pressures. Since the Company's main competitors, Iwerks Entertainment, Inc.
(until the Merger is completed) and Imax Corporation, have significantly more
capital than the Company, the Company has had to rely more on its suppliers and
other third-parties to improve the Company's existing products and to develop
new ones. The inability of the Company to develop new products and to respond to
technological developments of its competitors could have a materially-adverse
effect on the Company's business, operations and financial condition.
16
<PAGE> 17
International Operations
A significant portion of the Company's sales and film licensing are
made to customers located outside of the United States, primarily, in the Far
East, Europe and South America. During fiscal 1995, 1996 and 1997, 69%, 61% and
62% of the Company's revenues, respectively, were derived from sales outside the
United States. During fiscal 1997, the Japanese market was the only foreign
market with over 10% of the Company's revenues with 17.6%. International
operations and sales of the Company may be subject to political and economic
risks, including political instability, currency controls, exchange rate
fluctuations (which, in the event of a decrease in value of foreign currency to
the dollar, can significantly affect the affordability of the Company's products
overseas), changes in import/export regulations, tariff and freight rates,
longer accounts receivable collection patterns, changes in regional or worldwide
economic or political conditions and natural disasters. In addition, various
forms of protectionist trade legislation have been proposed in the United States
and certain other countries. Any resulting changes in current tariff structures
or other trade and monetary policies could adversely affect the Company's
international operations. Political and economic factors have been identified by
the Company with respect to certain of the markets in which it competes. There
can be no assurance that these factors will not result in customers of the
Company defaulting on payments due to it, or in the reduction of potential
purchases of its products. The Company has not engaged in any currency hedging
programs.
Intellectual Property
The Company has several United States patents on various processes
and elements related to film projection and motion simulation. The most
important of these patents expire in October 2001. Though the Company's patents
have never been challenged and the Company believes that they are valid, third
parties could still challenge the patents and a court could determine that one
or more of them are invalid. Declarations of invalidity, particularly of the
Company's key patents, could adversely affect the marketability of the Company's
products and services. In addition, the Company always faces the risk that new
technologies could be discovered that are superior to the Company's patents.
Intense Competition; Unpredictability of Consumer Tastes
Competition in each of the markets in which the Company competes is
intense. The principal direct competition for customers comes from manufacturers
of competing movie-based attractions, and in the case of amusement and theme
parks, manufacturers of traditional amusement park attractions. In addition to
direct competitors, there is also competition from systems integrators and some
amusement and theme parks developing and constructing their own attractions.
Many of the Company's competitors have better name recognition, and
substantially greater financial and other resources than the Company has.
In the motion simulation business, the Company's main competitor
(until the Merger is completed) is Iwerks Entertainment, Inc. Imax Corporation
("Imax") and a number of smaller competitors are growing competitors of the
Company in the ride simulation business and have dedicated substantial resources
to entering into this market.
17
<PAGE> 18
In the large screen, special format motion picture business, the
Company's main competitor is Imax though Iwerks is also very significant. The 15
perforation 70 millimeter film format appears to be emerging as the most popular
large format due primarily to the large number of films available in that
format. Imax is by far the dominant company in this market.
Additionally, the out-of-home entertainment industry in general is
undergoing significant changes, primarily due to technological developments as
well as changing consumer tastes. Numerous companies are developing and are
expected to develop new entertainment products or concepts for the out-of-home
entertainment industry in response to these developments that are or may be
directly competitive with existing products. There is severe competition for
financial, creative and technological resources in the industry and there can be
no assurance that existing products will continue to compete effectively or that
products under development will ever be competitive. Further, the commercial
success of products is ultimately dependent upon audience reaction. Audience
reaction will to a large extent be influenced by the audience's perception of
how the Company's products compare with other available entertainment options
out of the home. There can be no assurance that new developments in out-of-home
entertainment will not result in changes in consumer tastes that will make the
Company's products less competitive.
Business Disruption
The Company's corporate headquarters, including its research and
development operations, are located in Los Angeles, California, a region known
for seismic activity. Operating results could be materially affected by a
significant earthquake or other natural disaster.
Dependence on Major Customers
The Company's motion simulation business has two significant
concentrations. The first concentration involves ongoing film licenses and is
located in Japan where a single customer, Imagine Japan, presently operates or
is otherwise responsible for fifteen simulation attractions. The second
concentration relates to the Company's sales backlog where United Artists
Theatre Circuit, Inc. and King's Entertainment Co., Ltd. individually and
collectively represent a substantial portion of the outstanding equipment orders
to be delivered in the next few years. The Company's agreement with United
Artists Theatre Circuit, Inc. calls for a build out period extending through
August 1999 while that with King's Entertainment Co., Ltd. extends through May
2002. Each site opened under each agreement shall have an initial film license
period of at least three years. In the fiscal year ended March 31, 1997, the
Company earned revenues from Imagine Japan and United Artists Theatre Circuit,
Inc. in the amounts of $3,117,000 and $5,405,000, respectively. The Company's
short and long term performance could be adversely impacted if disruptions were
to occur in any of these areas of concentration such as order cancellations,
license terminations or payment problems.
Ability to Produce Additional Films
One of the primary factors considered by potential purchasers of
motion simulation attractions is the quality and extent of the films available
to be shown at the attraction. The Company believes that a large portion of its
competitive advantage resides in its popular and extensive library of ride
films. To maintain this competitive edge, the Company must produce or
18
<PAGE> 19
acquire the distribution rights to several new films each year. Film production
is expensive and requires the investment of Company funds (to the extent that
investors cannot be located) with no assurance that the films produced will be
popular. Iwerks and Imax have each indicated that they are devoting substantial
portions of their assets to the production of new motion simulation films. Both
the short and long term financial performance of the Company will be adversely
affected if the perceived quality and popularity of the Company's film library
declines either alone or in comparison to the films of the Company's
competitors.
Volatility of Stock Price
The Company's stock price has been, and could continue to be, highly
volatile. The market price of the Company's Common Stock has fluctuated
substantially in recent periods. During the 12 months prior to September 30,
1997, the Company's market price has ranged from a low of $2 1/8 per share to a
high of $6 3/4 per share. Future announcements concerning the Company or its
competitors, quarterly variations in operating results, the introduction of new
products or changes in product pricing policies by the Company or its
competitors and the acquisition or loss of significant customers may affect or
be perceived to affect the Company's operations, among other factors, could
cause the market price of the Common Stock to fluctuate substantially. In
addition, stock markets have experienced extreme price and volume volatility in
recent years. This volatility has had a substantial effect on the market prices
of securities of many smaller companies for reasons frequently unrelated to the
operating performance of the specific companies. These broad market fluctuations
may adversely affect the market price of the Common Stock.
Environmental Matters and Other Governmental Regulations
Under various Federal, state and local environmental laws and
regulations, a current or previous owner or occupant of real property may become
liable for the costs of removal or remediation of hazardous substances at such
real property. Such laws and regulations often impose liability without regard
to fault. The Company leases its corporate headquarters and the Company could be
held liable for the costs of remedial actions with respect to hazardous
substances on such property under the terms of the governing lease and/or
governing law. Although the Company has not been notified of, nor is otherwise
aware of, any current environmental liability, claim or non-compliance, there
can be no assurance that the Company will not be required to incur remediation
or other costs in the future in connection with the leased property. In
addition, the Company's subcontractors and other third parties, with which it
has contractual relations, are similarly subject to such laws. The Company
believes it is in compliance with all applicable Federal, state and local
environmental laws and regulations.
19
<PAGE> 20
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
Current Report on Form 8-K dated August 4, 1997.
Item 5. Other Events
Announcement of the execution of an Agreement and Plan of
Reorganization By and Among Iwerks Entertainment Inc., IWK-1
Merger Corporation and Showscan Entertainment Inc., August 4,
1997.
No financial statements were filed with the foregoing Report.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) 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, in the City of Culver
City, State of California on the 12th day of November, 1997.
Showscan Entertainment Inc.
---------------------------
(Registrant)
By \s\ DENNIS POPE
-------------------------
Dennis Pope
President - Chief Executive Officer
(Authorized Officer and Principal
Executive Officer)
By \s\ GREGORY W. BETZ
--------------------------
Gregory W. Betz
Vice President - Director of Finance
(Authorized Officer and Principal
Accounting Officer)
21
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 2,741
<SECURITIES> 0
<RECEIVABLES> 3,811
<ALLOWANCES> 225
<INVENTORY> 1,094
<CURRENT-ASSETS> 8,766
<PP&E> 6,173
<DEPRECIATION> 5,460
<TOTAL-ASSETS> 18,936
<CURRENT-LIABILITIES> 5,614
<BONDS> 5,690
0
0
<COMMON> 6
<OTHER-SE> 7,626
<TOTAL-LIABILITY-AND-EQUITY> 18,936
<SALES> 1,280
<TOTAL-REVENUES> 2,472
<CGS> 892
<TOTAL-COSTS> 1,382
<OTHER-EXPENSES> 1,945
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 137
<INCOME-PRETAX> (992)
<INCOME-TAX> 0
<INCOME-CONTINUING> (992)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (992)
<EPS-PRIMARY> (.18)
<EPS-DILUTED> 0
</TABLE>
