<PAGE>
================================================================================
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 September 30, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-22558
IWERKS ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4439361
(State or other jurisdiction (I.R.S. EMPLOYER IDENTIFICATION NO.)
of incorporation or organization)
4540 West Valerio Street
Burbank, California 91505-1046
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(818) 841-7766
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 and 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 10, 1998, the Registrant had 12,357,183 shares of Common
Stock, $.001 par value, issued and outstanding.
================================================================================
<PAGE>
IWERKS ENTERTAINMENT, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
- -----------------------------
Condensed Consolidated Balance Sheets as of September 30, 1998
and June 30, 1998 3
Condensed Consolidated Statements of Operations for the Three
Months ended September 30, 1998 and 1997 5
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 1998 and 1997 6
Notes to the Condensed Consolidated Financial Statements 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9
---------------------------------------------
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 18
- --------------------------
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-k 18
- -----------------------------------------
Signatures 19
</TABLE>
2
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(in thousands)
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
------------------ --------------------
(unaudited) (audited)
<S> <C> <C>
Current assets:
Cash and cash equivalents (note 2) $ 6,307 $ 7,542
Short-term investments 3,000 2,922
Trade accounts receivable, net of allowance
for doubtful accounts 3,313 3,521
Costs and estimated earnings in excess of
billings on uncompleted contracts 1,592 1,574
Inventories and other current assets 5,123 4,072
------------------ --------------------
Total current assets 19,335 19,631
Portable simulation theaters at cost, net of 3,253 3,413
accumulated depreciation
Property and equipment at cost, net of 4,470 4,329
accumulated depreciation
Film inventory at cost, net of amortization 5,438 5,308
Goodwill, net of amortization 14,585 14,742
Investment in joint ventures and other assets 3,513 3,380
------------------ --------------------
Total assets $ 50,594 $ 50,803
================== ====================
</TABLE>
See accompanying notes.
3
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
-------------------- -------------------
(unaudited) (audited)
<S> <C> <C>
Current liabilities:
Accounts payable $ 1,804 $ 1,982
Accrued expenses 6,890 6,823
Billings in excess of costs and estimated
earnings on uncompleted contracts 4,099 2,971
Deferred revenue 265 308
Capital leases, current portion 796 803
-------------------- -------------------
Total current liabilities 13,854 12,887
Capital lease obligations, excluding current portion 892 1,082
Stockholders' equity:
Preferred stock, $.001 par value, 1,000,000 - -
authorized, none issued and outstanding
Common stock, $.001 par value, 50,000,000 57 57
authorized; issued and outstanding
12,352,838 and 12,344,807, respectively
Additional paid-in capital 78,028 78,024
Accumulated deficit (42,237) (41,247)
-------------------- -------------------
Total stockholders' equity 35,848 36,834
-------------------- -------------------
Total liabilities and stockholders' equity $ 50,594 $ 50,803
==================== ===================
</TABLE>
See accompanying notes.
4
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands except per share amounts)
<TABLE>
<CAPTION>
For the three months ended
September 30,
----------------------------
1998 1997
--------- -----------
<S> <C> <C>
Revenue $ 7,373 $ 8,052
Cost of sales 5,378 4,789
--------- ----------
Gross profit 1,995 3,263
Merger related expenses - 313
Selling, general and administrative expenses 3,050 3,605
--------- ----------
Loss from operations (1,055) (655)
Interest income 111 219
Interest expense (46) (70)
--------- ----------
Net loss $ (990) $ (506)
========= ==========
Basic and diluted loss per common share $ (0.08) $ (0.04)
========= ==========
Weighted average shares outstanding - basic
and diluted 12,346 12,160
========= ==========
</TABLE>
See accompanying notes.
5
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
For the three months ended
September 30,
---------------------------
1998 1997
------------ ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (990) $ (506)
Depreciation and amortization 1,096 1,251
Changes in operating assets and liabilities 113 1,889
-------- --------
Net cash provided by operating activities 219 2,634
-------- --------
INVESTING ACTIVITIES
Investment in joint ventures (321) (90)
Purchases of property and equipment (382) (500)
Additions to film inventory (572) (1,621)
Investment in debt securities (78) 250
-------- --------
Net cash used in investing activities (1,353) (1,961)
FINANCING ACTIVITIES
Repayment of notes payable - (81)
Payments on capital leases (197) (179)
Exercise of stock options 4 -
Other 92 -
-------- --------
Net cash used in financing activities (101) (260)
-------- --------
Net (decrease) increase in cash (1,235) 413
Cash and cash equivalents at beginning of period 7,542 3,608
-------- --------
Cash and cash equivalents at end of period $ 6,307 $ 4,021
======== ========
Cash paid during the period for interest $ 48 $ 68
======== ========
Cash paid during the period for income taxes $ 11 $ 8
======== ========
</TABLE>
See accompanying notes.
6
<PAGE>
IWERKS ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Introduction
- ---------------------
The accompanying condensed consolidated financial statements of Iwerks
Entertainment, Inc. (the "Company") have been prepared without audit pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures made are adequate to make information
presented not misleading. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of September 30, 1998 and the results of
its operations for the three months ended September 30, 1998 and 1997 and the
cash flows for the three months ended September 30, 1998 and 1997 have been
included. The results of operations for interim periods are not necessarily
indicative of the results which may be realized for the full year. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's latest Annual Report on Form 10-K as filed
with the SEC.
Note 2 - Restricted Cash
- -----------------------
Included in the September 30, 1998 cash and cash equivalents balance is
$542,000 of cash received from one customer which is restricted as to its use.
This restriction will remain in effect until the Company reaches a certain
milestone in the completion of this customer's project. This milestone is
expected to be reached in the third fiscal quarter at which time this cash will
become available for use.
7
<PAGE>
Note 3 - Depreciation and Amortization
- --------------------------------------
Depreciation expense and amortization expense for goodwill and other is
computed using the straight line method over the estimated useful lives of the
assets. Film costs are amortized using the individual film forecast method.
<TABLE>
<CAPTION>
Three Month ended September 30,
-------------------------------
1998 1997
---------- ----------
<S> <C> <C>
Depreciation on fixed assets $ 241,000 $ 218,000
Depreciation on touring equipment 160,000 168,000
Amortization of film 442,000 618,000
Amortization of goodwill and other 253,000 247,000
---------- ----------
Total depreciation and amortization $1,096,000 $1,251,000
========== ==========
</TABLE>
Depreciation and amortization included in cost of sales was $609,000 and
$796,000 for the quarter ended September 30, 1998 and 1997, respectively.
Note 4 - Net Loss Per Common Share
- ----------------------------------
For the three months ended September 30, 1997 and 1998, the basic and
diluted per share data is based on the weighted average number of common shares
outstanding during the period. Common equivalent shares, consisting of
outstanding stock options and warrants, are not included in the diluted loss per
share calculation since they are antidilutive.
During the three months ended September 30, 1998, 8,031 shares of common
stock were issued as a result of exercises of stock options.
Note 5 - Income Taxes
- ---------------------
At June 30, 1998, the Company had available federal and state tax net
operating loss carryforwards of approximately $30,400,000 and $14,400,000,
respectively. The federal net operating loss carryforwards expire, in varying
amounts, from the year 2009 through 2013. The state net operating loss
carryforwards expire, in varying amounts, from the year 1999 through 2003. As a
result of these net operating loss carryforwards and current period losses, the
Company's effective tax rate was negligible and consequently no income tax
provision or benefit was recorded in the periods presented.
8
<PAGE>
Note 6 Commitments and Contingencies
- -------------------------------------
In fiscal 1996, the Company guaranteed the debt of a customer in connection
with the purchase by the customer of a hardware system from the Company. This
bank debt was completely satisfied subsequent to September 30, 1998 with no
financial impact to the Company.
Note 7 - Litigation
- -------------------
The proceedings to which the Company is a defendant consist of ordinary
routine litigation in the course of business. In the opinion of management,
resolution of these matters will not have a material adverse impact on the
Company's financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
- --------------------------------------------------
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe," and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this filing and include statements regarding the intent,
belief or current expectations of Iwerks, its Directors or Officers with respect
to, among other things (a) trends affecting the financial condition or results
of operations of Iwerks and (b) the business and growth strategies of Iwerks.
The stockholders of Iwerks are cautioned not to put undue reliance on such
forward-looking statements. Such forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in this Report, for the reasons, among
others, discussed in "Future Operating Results" below and under the caption,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Risk Factors" in the Company's Annual Report on Form 10-K for
Fiscal 1998, filed with the Securities and Exchange Commission. Iwerks
undertakes no obligation to publicy revise these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers should
carefully review the risk factors referred to above and the other documents the
Company files from time to time with the Securities and Exchange Commission,
including the Company's Annual Report on Form 10-K for the fiscal year 1998, the
quarterly reports on Form 10-Q filed by the Company during the remainder of
fiscal 1999, and any current reports on Form 8-K filed by the Company.
9
<PAGE>
RESULTS OF OPERATIONS
For the three months ended September 30, 1998 Iwerks Entertainment, Inc.
(the "Company") recorded revenues of $7,373,000 compared to $8,052,000 for the
same period last year. For the three months ended September 30, 1998, the
Company recorded a net loss of $990,000 or $.08 per share compared to a net loss
of $506,000 or $.04 per share for the same period last year.
REVENUES
The Company derives its revenues primarily from the sale and service of
hardware systems ("Hardware Sales and Service"), the operation of 16 mobile
simulation theatres along with, to a lesser extent, the participation through
joint ventures of fixed site theatres ("Owned and Operated") and the licensing
of films ("Film licensing"). The following table presents summary information
regarding revenues (amounts in thousands):
<TABLE>
<CAPTION>
Three Months ended September 30,
------------------------------------------------
1998 1997
---------------------- ------------------------
$ % $ %
------------ -------- ------------- ---------
<S> <C> <C> <C> <C>
Hardware Sales & Service $ 3,258 44% $ 3,472 43%
Owned and Operated 2,193 30% 3,179 39%
Film Licensing 1,713 23% 1,344 17%
Film Production and other 209 3% 57 1%
------------ -------- ------------- ---------
Total $ 7,373 100% $ 8,052 100%
============ ======== ============= =========
</TABLE>
Revenues on sales of theatre systems are recognized on the percentage-of-
completion method, over the life of the contract. The gross margin for each
contract varies based upon pricing strategies, competitive conditions and
product mix.
Revenues from owned and operated (O&O) consist of portable ride simulation
theatre revenues (touring) derived primarily from corporate sponsorship or
ticket sales at state fairs, air shows, and similar events (general admissions),
as well as revenues derived from fixed site joint ventures, which includes
Iwerks' contractual share of the sites' revenues or profits as applicable.
Admission revenues from the portable ride simulation theatres are subject to
variability due to the seasonal nature of these events and are higher during the
summer months. Sponsorship revenues for the portable theatres are recognized
ratably over the term of the contract.
10
<PAGE>
The Company typically licenses its film software under one year film
license agreements. Revenues and related expenses are recognized at the
beginning of the license period at which time the customer is billed the license
fee and film is delivered to the customer.
Hardware sales and service revenue decreased by approximately $214,000 as
compared to the same period last year due to a decrease in revenue recognized
from simulation and large format hardware sales in Asia and South America,
partially offset by increases in North America and Europe. During the fiscal
1999 quarter, the Company signed contracts for new TurboRide installations in
Scotland, Austria, Italy and China, as well as two large format theatre
installations in Scotland and Italy. The Company also signed two additional
contracts with customers in Japan for specialty systems. The revenue from these
recently signed contracts will be recognized in future periods through fiscal
2001. Typically, sales outside the United States are denominated in U.S. dollars
and backed by bank letters of credit, which reduce the risks related to
international sales.
The Owned and Operated (O&O) revenue decreased by $986,000 primarily due to
decreased sales in the touring division. Both corporate sponsorship and general
admissions were lower as compared to the same period in the prior year. The
Company is actively seeking additional sponsors and evaluating other
alternatives regarding touring operations. If the Company is unable to obtain
additional sponsors, O & O revenues will be adversely affected in future
periods.
Film licensing revenue increased as a result of the increasing base of
installed theaters that license the Company's film software. Furthermore, one
customer signed a five year film license agreement relating to a specific film
for which all of the related revenue was recognized in the three months ended
September 30, 1998.
COST OF SALES AND GROSS PROFIT
- ------------------------------
The overall gross profit margin percentages for the three months ended
September 30, 1998 and 1997 were 27.1% and 40.5%, respectively. The decrease in
gross profit percentage was due primarily to lower margins in the touring
division, which experienced a decline in revenues while costs, mostly fixed
(such as depreciation, lease and insurance), remained relatively stable. Also,
to a lesser extent, hardware sales margins have decreased due to a change in the
mix of hardware sales from simulation (with higher margins) to other specialty
theatres (with lower margins). These decreases were partially offset by a
reduction of a royalty accrual as a result of a settlement negotiated in October
1998.
MERGER RELATED EXPENSES
- -----------------------
During the quarter ended September 30, 1997 the Company incurred $313,000
of transaction expenses associated with the proposed merger with Showscan
Entertainment,
11
<PAGE>
Inc. which did not receive the required shareholder vote in March 1998. There
were no such expenses in the first quarter of fiscal 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
- --------------------------------------------
Selling, general and administrative expenses include, among other things,
personnel costs, trade shows and other promotional expenses, sales commissions,
travel expenses, public relations costs, outside consulting and professional
fees, depreciation on fixed assets, amortization of goodwill, departmental
administrative costs and research and development costs.
Selling, general and administrative expenses for the quarter ended
September 30, 1998 and 1997 were $3,050,000 and $3,605,000, respectively. The
$555,000 decrease resulted primarily from reduced employee-related expenses due
to lower staffing levels and lower marketing expenses for trade shows.
INTEREST INCOME AND EXPENSE
- ---------------------------
Interest income for the three months ended September 30, 1998 and 1997 was
$111,000 and $219,000, respectively. The decrease in interest income resulted
primarily from the decrease in investment balances in the comparable periods.
Interest expense for the three months ended September 30, 1998 and 1997 was
$46,000 and $70,000, respectively. This decrease resulted primarily from the
decrease in capitalized lease obligations.
IMPACT OF YEAR 2000
- -------------------
GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE
YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on extensive assessments, the Company determined that it will be
required to modify or replace significant portions of its software and certain
hardware so that those systems will properly utilize dates beyond December 31,
1999. The Company presently believes that with modifications or replacements of
existing software and certain hardware, the Year 2000 Issue can be mitigated.
However, if such modifications and
12
<PAGE>
replacements are not made, or are not completed timely, the Year 2000 Issue
could have a material impact on the operations of the Company.
The Company's plan to resolve the Year 2000 Issue involves the following
five phases: (1) inventorying Year 2000 items; (2) assessing the Year 2000
compliance of items determined to be material to the company; (3) repairing or
replacing material items that are determined not to be Year 2000 compliant; (4)
testing material items; and (5) implementation. To date, the Company has
completed its inventorying of Year 2000 items phase and assessing systems that
could be significantly affected by the Year 2000 phase. The completed
assessment indicated that most of the Company's significant information
technology systems could be affected, particularly the general ledger, billing
and inventory systems. The non-IT systems were assessed and are not material to
the Company's operations. For example, the Company's engineers have reviewed the
Company's significant products and do not believe there is any date sensitive
software included in products sold by the Company since 1994. Some products
sold by Omni Entertainment, a company acquired in 1994, may have date-sensitive
chips which may result in incorrect date displays. The Company is in the
process of notifying these customers of this concern and is providing the
necessary tools to test their equipment. The Company does not expect to incur a
material cost to test or correct products initially sold by the Company.
STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR
COMPLETION OF EACH REMAINING PHASE
For its information technology exposures, the Company has completed the
inventorying phase and assessment phase. The Company expects to complete
software replacement which includes selecting systems vendors no later than
December 31, 1998. Once software is selected and replaced for a system, the
Company will begin testing and implementation. Completion of the testing phase
for all significant systems is expected by March 31, 1999 with complete
implementation targeted for May 31, 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE TO THE YEAR
2000
The Company does not interface directly with third party vendors with
regard to shared information systems. The Company has queried its significant
suppliers and subcontractors that do not share information systems with the
Company (external agents). To date, the Company is not aware of any external
agent with a Year 2000 issue that would materially impact the Company's results
of operations, liquidity, or capital resources. However, the Company has no
means of ensuring that external agents will be Year 2000 ready. The inability
of external agents to complete their Year 2000 resolution process in a timely
fashion could materially impact the Company. The effect of non-compliance by
external agents is not determinable.
13
<PAGE>
COSTS
The Company will utilize both internal and external resources to replace,
test, and implement the software and certain hardware for Year 2000
modifications. The total cost of the Year 2000 project is estimated at $500,000
and will be funded through operating cash flows or leasing of hardware and
software. To date, the Company has incurred approximately $25,000 related to
all phases of the Year 2000 project which has been expensed. Of the total
remaining project costs, approximately $350,000 is attributable to the purchase
of new software and hardware, which will be capitalized. The remaining $125,000
relates to internal systems development and will be expensed as incurred.
RISKS
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. In the event
that the Company does not complete any additional phases, the Company may be
unable to take customer orders, manufacture and ship products, invoice customers
or collect payments. In addition, disruptions in the economy generally
resulting from Year 2000 issues could also materially adversely affect the
Company. The Company could be subject to litigation for computer systems
product failure, for example, equipment shutdown or failure to properly date
business records. The amount of potential liability and lost revenue cannot be
reasonably estimated at this time.
CONTINGENCY PLAN
The Company currently has no contingency plans in place in the event it
does not complete all phases of the Year 2000 program. The Company plans to
evaluate the status of completion in the third quarter of fiscal 1999 and
determine whether such a plan is necessary.
Readers are cautioned that forward-looking statements contained in this
Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Special Note on Forward-looking Statements,"
beginning on page 9 above. Readers should understand that the dates on which
the Company believes the Year 2000 project will be completed are based upon
Management's best estimates, which were derived utilizing numerous assumptions
of future events, including the availability of certain resources, third-party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, or that there will not be a delay in, or
increased costs associated with, the implementation of the Company's Year 2000
Compliance Project. Specific factors that might cause differences between the
estimates and actual results include, but are not limited to, the availability
and cost of personnel trained in these areas, the ability to locate and correct
all relevant computer code, timely responses to and corrections by third parties
and suppliers, the ability to implement interfaces between the new systems and
the systems not being replaced, and other similar
14
<PAGE>
uncertainties. Due to the general uncertainty inherent in the Year 2000 problem,
resulting in part from the uncertainty of the Year 2000 readiness of third
parties and the inter-connection of national and international businesses, the
Company cannot ensure its ability to timely and cost-effectively resolve
problems associated with the Year 2000 issue which may affect its business
operations, or expose it to third party liability.
FUTURE OPERATING RESULTS
The market for the Company's products is intensely competitive and 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. 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.
The Company has experienced a significant decline in revenues in recent
quarterly periods. Historically, a substantial portion of the Company's
revenues from new hardware sales in the ride simulation market have originated
in international markets, particularly in Asia. The Company began to experience
a significant decline in new hardware contracts during the fourth quarter of
fiscal 1997, which trend has continued through fiscal 1998. This decline in
revenues primarily resulted from the continuing impact of the economic downturn
and deflationary environment recently experienced throughout most of the Asian
Pacific region. While the Company is placing greater focus on other markets,
particularly the United States, Latin America and Europe, the trend of declining
sales in Asia could have a continuing negative impact in future periods.
However in the first quarter of fiscal 1999, the Company finalized two sales
contracts with Chinese customers totaling $3.4 million and an additional two
contracts totaling $1.4 million with customers in Japan.
The Company and its principal competitor in the large screen market, Imax
Corporation, are aggressively competing, particularly in the United States
market, for new 15 perforation, 70 millimeter format (15/70) theater
installations. The Company primarily competes in this market based upon the
price and terms of its projection technology. Imax, the dominant competitor in
the market, competes primarily on the basis of its brand identity and its larger
base of installed theaters. These factors, and Imax's access to greater
financial and other resources, are expected to continue to place the Company at
a competitive disadvantage in this market and could have a negative impact on
the Company's gross margins in this market. However, the Company believes there
is potential and is pursuing the 8 perforation, 70 millimeter (8/70) format
theatre market. Imax does not offer an 8/70 product.
In addition to competition in the large screen market, the Company faces
competition in the simulation industry from Showscan Entertainment and a large
number of other competitors. The Company competes in this market based upon the
breadth of
15
<PAGE>
its product offerings and the size and quality of its film library. Few of its
competitors in this market have sufficient financial resources to effectively
compete with the Company based on these criteria. The Company's competitive
position in this market segment could be materially affected if any of its
existing competitors or a new entrant were to assemble the financial, technical
and creative resources required to effectively compete with the Company's range
of product offerings and film library. The Company recognizes these competitive
issues and is in the process of creating new products, such as developing a new
generation of smaller ride simulation configurations that can accommodate the
potential opportunity in the mass retail environment and movie theaters.
Revenues from the Company's owned and operated attractions (primarily
portable simulation theaters) have been declining since the first quarter of
fiscal 1997 when the Company lost its principal sponsorship contract. The
Company has been aggressively pursuing and has signed other sponsorship
contracts since that time. However, it has not been successful in fully
replacing this revenue source and expects the lower sponsorship sales trends to
continue to adversely affect results for at least the next two quarters.
Because this segment of the Company's business has a significant level of fixed
costs regardless of fluctuations in revenues, the Company's gross margins are
expected to continue to be adversely impacted unless it is able to secure
alternate sources of revenue or disposes of all or a portion of this business
segment or otherwise eliminates a portion of the fixed costs associated with its
operation.
Iwerks has experienced quarterly fluctuations in operating results and
anticipates that these fluctuations will continue in future periods. Operating
results and cash flow can fluctuate substantially from quarter to quarter and
periodically as a result of the timing of theater system deliveries, contract
signing, sponsorships, the mix of theater systems shipped, the completion of
custom film contracts, the existence of world expos, the amount of revenues from
portable simulation theater and film licensing agreements, the timing of sales
of ride simulation attractions, 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, the size,
type and configuration of the attractions sold, 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 the timing of sales and
marketing efforts and related expenditures. In particular, fluctuations in
theater system sales and deliveries from quarter to quarter can materially
affect quarterly and periodic operating results, and theater system contract
signing can materially affect quarterly or periodic cash flow. Accordingly,
Iwerks' revenues and earnings in any particular period may not be indicative of
the results for any future period.
The seasonal fluctuations in earnings also may cause volatility in the
stock price of Iwerks. While a significant portion of Iwerks' expense levels
are relatively fixed, the timing of increases in expense levels is based in
large part on Iwerks' forecasts of future sales. If net sales are below
expectations in any given period, the adverse impact on results of operations
may be magnified by Iwerks' inability to adjust spending quickly
16
<PAGE>
enough to compensate for the sales shortfall. Iwerks may also choose to reduce
prices or increase spending in response to market conditions, which may have a
material adverse effect on Iwerks' results of operations.
Additionally, the Company plans to continue to evaluate and, when
appropriate, make acquisitions of complementary technologies, products or
businesses. The Company will continue to evaluate the changing value of its
assets, and when necessary, make adjustments thereto. While the Company cannot
predict what effect these various factors may have on its financial results, the
aggregate effect of these and other factors could result in significant
volatility in the Company's future performance and stock price.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Net cash provided by operating activities for the three months ended
September 30, 1998 was $219,000. This was primarily attributable to the net
loss of $990,000 offset by non-cash charges of $1,096,000 for depreciation and
amortization. Investing activities for the three months ended September 30,
1998 consisted primarily of investments in film inventory, purchases of property
and equipment and investments in joint ventures. Cash used in financing
activities consisted primarily of payments on capital leases.
At September 30, 1998, the Company had cash and short-term investments of
approximately $9.3 million which includes $542,000 of restricted cash (see Note
2 to Condensed Consolidated Financial Statements). The Company believes that its
existing cash balances and short-term investments in debt securities on hand at
September 30, 1998, combined with anticipated cash from operations, are adequate
to meet its cash requirements for at least the next twelve months, after which
time it may be required to raise additional cash through the sale of equity or
debt securities. The Company's operations are expected to generate cash over
the next twelve months, however this positive cash flow is expected to be offset
by cash usages for changes in operating assets and liabilities and planned
additions to film inventory and other assets. Consequently, the Company expects
its cash balance to continue to decline during the remainder of fiscal 1999.
If the Company is unable to achieve its projected cash flow from
operations, the Company may experience significantly reduced cash and short-term
investments, which could result in the Company not being able to meet its
operating needs. Recent operating losses, the Company's declining cash
balances, the ongoing financial turmoil in Asia (historically the Company's
largest market and a significant source of operating revenues), the Company's
historical stock performance, and a general decrease in investor interest in the
Company's industry, may make it difficult for the Company to attract equity
investments on terms that are deemed to be favorable to the Company. In
addition, the losses in fiscal 1997, fiscal 1998 and the first quarter of fiscal
1999 make it more difficult for the Company to attract significant debt
financing. Although the Company anticipates that its cash balances will
decrease during fiscal 1999, management is in the process of implementing a plan
which it believes will facilitate a return to
17
<PAGE>
profitability and increase cash flow beyond fiscal 1999. This plan includes,
among other things, changes to sales management, developing and marketing new
products, seeking new markets for the Company's simulation and film
capabilities, the establishment of new strategic vendor and customer
partnerships and aggressively reducing expenses. In the event that cash flow
from operations is less than that anticipated, in order to preserve cash, the
Company would be required to reduce expenditures for capital projects (including
new films) and research and development, or effect further reductions in its
corporate infrastructure, any of which could have a material adverse affect on
the Company's future operations. At September 30, 1998 the Company was committed
to approximately $2.2 million of capital expenditures to be made in fiscal 1999.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
The Company is a party to various actions arising in the ordinary course of
business which, in the opinion of management, will not have a material adverse
impact on the Company's financial condition; however, there can be no assurance
that the Company will not become a party to other lawsuits in the future, and
such lawsuits could potentially have a material adverse effect on the Company's
financial condition and results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Exhibits:
27.1 Schedule of financial data
(b) Reports on Form 8-K filed during the quarter ended September 30, 1998:
The Company had no 8-K filings during the quarter ended September 30,
1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the city of Burbank,
State of California on the 12th day of November, 1998.
IWERKS ENTERTAINMENT, INC.
(Registrant)
By: /s/ Bruce C. Hinckley
---------------------
Executive Vice President
Chief Financial Officer
(Principal Finance Officer)
By: /s/ Jeffrey M. Dahl
-------------------
Vice President / Controller
(Principal Accounting Officer)
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE ACCOMPANYING
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS. (AMOUNTS IN THOUSANDS)
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 6,307
<SECURITIES> 3,000
<RECEIVABLES> 5,497
<ALLOWANCES> 2,184
<INVENTORY> 4,069
<CURRENT-ASSETS> 19,335<F1>
<PP&E> 42,415<F2>
<DEPRECIATION> (29,254)<F3>
<TOTAL-ASSETS> 50,594
<CURRENT-LIABILITIES> 13,854
<BONDS> 892<F4>
0
0
<COMMON> 78,085
<OTHER-SE> (42,237)<F5>
<TOTAL-LIABILITY-AND-EQUITY> 50,594
<SALES> 7,373
<TOTAL-REVENUES> 7,484<F6>
<CGS> 5,378
<TOTAL-COSTS> 5,378
<OTHER-EXPENSES> 3,050
<LOSS-PROVISION> 300
<INTEREST-EXPENSE> 46
<INCOME-PRETAX> (990)
<INCOME-TAX> 0
<INCOME-CONTINUING> (990)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (990)
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
<FN>
<F1>Includes Costs and estimated earnings in excess of billings on uncompleted
contracts of $1,592 and other current assets of $1,054.
<F2>Includes portable simulation theaters of $8,390 and film inventory of
$21,332.
<F3>Includes portable simulation theaters of $5,137 and film inventory of
$15,894.
<F4>Includes the non-current portions of capital leases.
<F5>Accumulated deficit.
<F6>Includes interest income of $111.
</FN>
</TABLE>
