UNITED STATES
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: March 31, 1999
or
[ ] 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 of (I.R.S. Employer Identification Number)
incorporation or organization)
4540 West Valerio Street
Burbank, California 91505-1046
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (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 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 .
----- -----
The number of shares outstanding of the registrant's Common Stock, $0.001 par
value, at May 13, 1999 was 12,388,902 shares
<PAGE>
IWERKS ENTERTAINMENT, INC.
INDEX
PART I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 1999 and June 30, 1998 3-4
Condensed Consolidated Statements of Operations
for the Three and Nine Months ended
March 31, 1999 and 1998 5
Condensed Consolidated Statements of Cash Flows
for the Nine Months ended March 31, 1999 and 1998 6
Notes to the Condensed Consolidated
Financial Statements 7-8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9-18
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
(Unaudited) (Audited)
---------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ......................................... $ 6,330 $ 7,542
Short-term investments ............................................ -- 2,922
Accounts receivable, net of allowance for doubtful accounts ....... 4,412 3,521
Costs and estimated earnings in excess of billings
on uncompleted contracts ........................................ 1,090 1,574
Inventories and other current assets .............................. 5,425 4,072
-------- -------
Total current assets .......................................... 17,257 19,631
Portable simulation theatres at cost,
net of accumulated depreciation .................................... 2,944 3,413
Property and equipment at cost, net of accumulated depreciation ...... 5,069 4,329
Film inventory at cost, net of amortization .......................... 4,998 5,308
Goodwill, net of amortization ........................................ 14,272 14,742
Investments in joint ventures and other assets ....................... 3,686 3,380
-------- -------
Total assets ......................................................$ 48,226 $50,803
======= =======
</TABLE>
See accompanying notes.
Page 3
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
(Unaudited) (Audited)
---------- ----------
<S> <C> <C>
Current liabilities:
Accounts payable ................................................ $ 2,351 $ 1,982
Accrued expenses ................................................ 7,101 6,823
Billings in excess of costs and estimated earnings
on uncompleted contracts ...................................... 2,552 2,971
Deferred revenue ................................................ 254 308
Capital leases, current portion ................................. 782 803
-------- --------
Total current liabilities ................................... 13,040 12,887
Capital lease obligations, excluding current portion ............ 496 1,082
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares-1,000,000
None issued and outstanding ................................. -- --
Common stock, $.001 par value: 50,000,000 authorized;
Issued and outstanding shares--12,384,557
and 12,344,807 respectively ................................. 57 57
Additional paid-in capital ...................................... 78,112 78,024
Treasury Stock, 32,400 shares at cost ........................... (32) --
Accumulated deficit ............................................. (43,447) (41,247)
-------- --------
Total stockholders' equity ...................................... 34,690 36,834
-------- --------
Total liabilities and stockholders' equity ...................... $ 48,226 $ 50,803
======== ========
</TABLE>
See accompanying notes.
Page 4
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------- --------------------
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Revenue ............................................. $ 10,423 $ 4,483 $ 26,445 $ 18,524
Cost of sales ....................................... 7,669 4,195 19,193 14,152
-------- -------- -------- --------
Gross profit ........................................ 2,754 288 7,252 4,372
Selling, general and administrative expenses .... 3,174 4,637 9,612 12,553
Merger related expenses ......................... -- 888 -- 1,419
-------- -------- -------- --------
Loss from operations ................................ (420) (5,237) (2,360) (9,600)
Interest income ..................................... 68 219 284 710
Interest expense .................................... (37) (59) (124) (193)
-------- -------- -------- --------
Net loss ............................................ $ (389) $ (5,077) $ (2,200) $ (9,083)
======== ======== ======== ========
Basic and diluted net loss per common share (note 4) $ (0.03) $ (0.42) $ (0.18) $ (0.75)
======== ======== ======== ========
Weighted average shares outstanding-basic and diluted 12,375 12,199 12,362 12,173
======== ======== ======== ========
</TABLE>
See accompanying notes.
Page 5
<PAGE>
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
------------------
1999 1998
------- -------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss ............................................ $(2,200) $(9,083)
Depreciation and amortization ....................... 3,791 3,558
Changes in operating assets and liabilities ......... (1,586) 6,199
------- -------
Net cash provided by operating activities ......... 5 674
INVESTING ACTIVITIES
Investments in joint ventures ....................... (717) 125
Investments in portable simulation theatres ......... (11) (46)
Purchases of property and equipment ................. (1,463) (1,970)
Additions to film inventory ......................... (1,441) (3,046)
Investments in debt securities ...................... 2,922 7,901
------- -------
Net cash (used in) provided by investing activities (710) 2,964
FINANCING ACTIVITIES
Principal payments on long-term debt ................ -- (81)
Payments on capital leases .......................... (607) (551)
Net proceeds on exercise of stock options ........... 88 --
Stock repurchase program ............................ (32) --
Other ............................................... 44 --
------- -------
Net cash used in financing activities ............. (507) (632)
------- -------
Net (decrease) increase in cash and cash equivalents (1,212) 3,006
Cash and cash equivalents at beginning of period .... 7,542 3,608
------- -------
Cash and cash equivalents at end of period .......... $ 6,330 $ 6,614
======= =======
Supplemental disclosures
Interest paid during the period ................ $ 130 $ 188
======= =======
Income taxes paid during the period ............ $ 15 $ 8
======= =======
</TABLE>
See accompanying notes.
Page 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 March 31, 1999 and the results of its
operations for the three and nine months ended March 31, 1999 and 1998 and the
cash flows for the nine months ended March 31, 1999 and 1998 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. 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.
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.
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<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Nine months Ended
March 31, March 31,
----------------------- ------------------------
1999 1998 1999 1998
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Depreciation on fixed assets ..... $ 288,000 $ 247,000 $1,016,000 $ 695,000
Depreciation on touring equipment 160,000 171,000 480,000 523,000
Amortization of film ............. 1,025,000 586,000 1,751,000 1,571,000
Amortization of goodwill and other 181,000 295,000 544,000 769,000
---------- ---------- ---------- ----------
Total depreciation and amortization $1,654,000 $1,299,000 $3,791,000 $3,558,000
========== ========== ========== ==========
</TABLE>
Depreciation and amortization included in cost of sales was
$1,241,000 and $766,000 for the quarter ended March 31, 1999 and
1998, respectively, and $2,301,000 and $2,122,000 for the nine
months ended March 31, 1999 and 1998, respectively.
NOTE 4. NET LOSS PER COMMON SHARE
For the nine months ended March 31, 1999 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 nine months ended March 31, 1999, 39,750 shares of common stock
were issued as a result of exercises of stock options.
NOTE 5. LITIGATION
The proceedings to which the Company is a defendant consist of litigation
arising in the ordinary 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.
Page 8
<PAGE>
IWERKS ENTERTAINMENT, INC.
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 publicly 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 fiscal 1999, and any
current reports on Form 8-K filed by the Company.
GENERAL
The Company is engaged in the business of designing, engineering,
manufacturing, marketing and servicing high-tech entertainment attractions which
employ a variety of projection, show control, ride simulation and software
technologies. The Company is currently in the business of: (a) selling and
installing ride simulation attractions in specialty theatres, (b) selling and
installing large format theatres (generally such theatres require projection
technology which utilize film sizes ranging between five perforations per frame
by 70 millimeters (5/70) and fifteen perforations per frame by 70 millimeter
(15/70)), (c) licensing and distributing the films in its library to ride
simulation and large format theatres, (d) producing films in the 5/70, 8/70 and
15/70 film format for its film library and for third parties, (e) investing in
joint ventures by contributing its ride simulation technology, design and
equipment and participating in the theatre profits, (f) operating a fleet of 16
mobile ride simulation attractions and (g) leasing camera equipment and the
rental of post production facilities.
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<PAGE>
RESULTS OF OPERATIONS
HARDWARE SALES AND SERVICE
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.
OWNED AND OPERATED
Revenues from owned and operated (O&O) consist of portable ride simulation
theatre (touring) revenues derived primarily from corporate sponsorship or
ticket sales at state fairs, air shows, and similar events; as well as revenues
derived from fixed site joint venture revenues 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.
FILM LICENSING
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.
FILM PRODUCTION AND OTHER
Revenue from film production and other is generated primarily through the
leasing of camera equipment, the rental of post production facilities, and the
production of films for third parties.
The following table presents summary information regarding revenues
(amounts in thousands):
<TABLE>
<CAPTION>
Periods Ended March 31,
Three Months Nine Months
---------------- -----------------
1999 1998 1998 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Hardware Sales & Service .... $ 5,545 $ 1,233 $14,977 $ 8,325
Owned and Operated .......... 909 1,272 4,010 5,312
Film Licensing .............. 3,016 1,785 6,121 4,544
Film Production and Other ... 953 193 1,337 343
------- ------- ------- -------
Total ................... $10,423 $ 4,483 $26,445 $18,524
======= ======= ======= =======
</TABLE>
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<PAGE>
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998.
For the three months ended March 31, 1999, the Company recorded revenues of
$10,423,000 compared to $4,483,000 for the same period last year. For the three
months ended March 31, 1999, the Company recorded a net loss of $389,000 or $.03
per share compared to a net loss of $5,077,000 or $.42 per share for the same
period last year.
REVENUES
Hardware Sales and Service revenues increased by approximately $4.3 million
as compared to the same period last year. Sales recognized from North America
and Europe increased by approximately $1.9 million and $2.4 million
respectively. Typically, sales outside the United States are denominated in U.S.
dollars and are backed by letters of credit, which reduce the risks related to
international sales.
Owned and Operated revenue decreased by approximately $363,000 as compared
to the same period last year, primarily due to declining sales of approximately
$493,000 in the touring division partially offset by an increase in revenue from
the fixed site joint ventures of approximately $130,000. The decline in sales,
and related expenses, in the touring division is due to the Company's decision
to participate in fewer events than the prior year, focusing on the more
profitable events. The increase in joint venture revenue is the result of three
additional joint venture sites opened during the second quarter of the current
fiscal year. The Company expects the lower touring revenue trend to continue.
The Company is actively seeking additional sponsors and other revenue sources
for the touring division.
Film Licensing revenues increased by approximately $1,231,000 compared to
the same period last year. These results are due to new film venues in fiscal
1999, specifically theme park attractions, several of which have signed multiple
year license agreements. These new venues are a direct result of new films which
the Company released this year.
Film Production and Other revenue increased by approximately $760,000
primarily due to a new film production project for Discovery Channel Pictures.
There were no film production projects in the prior year.
COST OF SALES AND GROSS PROFIT MARGIN
The gross profit margin for the three months ended March 31, 1999 and 1998
were 26.4% and 6.4%, respectively. The increase in gross profit margin in the
1999 quarter compared to the same quarter last year is primarily due to the
increased revenue in the hardware division.
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 relation costs, outside consulting and professional
fees, depreciation on fixed assets, amortization of
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goodwill, departmental administrative costs and research and development costs.
Selling, general and administrative expenses for the three months ended
March 31, 1999 decreased by approximately $1.5 million over the same period in
the prior year. This decrease was primarily due to a prior year charge of
approximately $1.5 million related to severance costs that were made to fifteen
employees including the former CEO and two other officers whose employment
terminated in the third quarter of fiscal 1998. In addition, bad debt expense
was approximately $0.7 million larger in the prior year's quarter than in the
1999 period due to the economic problems effecting the Asian region. These
savings were partially offset by an increase in sales commissions, research and
development costs, and sales and marketing due to the Company's new corporate
brand and other selling initiatives launched in the 1999 fiscal year.
MERGER RELATED EXPENSES
During the three months ended March 31, 1998 the Company incurred $888,000
of transaction expenses associated with the proposed merger with Showscan
Entertainment, Inc. which did not receive the required shareholder vote in March
1998. There were no such expenses in the three months ended March 31, 1999.
INTEREST INCOME AND EXPENSE
Interest income for the three months ended March 31, 1999 decreased by
approximately $151,000. The decrease in interest income resulted primarily from
the decrease in the invested balances during the three months ended March 31,
1999. Interest expense for the three months ended March 31, 1999 decreased by
approximately $22,000. The decrease is due to a reduction of the principal
balance owed under capital leases.
NINE MONTHS ENDED MARCH 31, 1999 COMPARED TO NINE MONTHS ENDED MARCH 31, 1998.
For the nine months ended March 31, 1999 the Company recorded revenues of
$26,445,000 compared to $18,524,000 for the same period last year. For the nine
months ended March 31, 1999, the Company recorded a net loss of $2,200,000 or
$.18 per share compared to a net loss of $9,083,000 or $.75 per share for the
same period last year.
REVENUES
Hardware Sales and Service revenues increased by approximately $6.6 million
as compared to the same period last year. Sales recognized from Asia increased
by approximately $2.3 million as compared to the same period last year. Sales
recognized by North America and Europe increased by approximately $2.8 million
and $2.9 million respectively. These increases were partically offset by a
decrease in sales recognized in South America and the Middle East of
approximately $1.3 million compared to the same period last year. The Company is
continuing to experience an increase in the signing of new sales contracts in
Asia during fiscal 1999. Sales from Asian customers were adversely impacted in
fiscal 1998 as a result of economic problems in that region. Typically, sales
outside the United States are denominated in U.S. dollars and are backed by
letters of credit, which
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<PAGE>
reduces the risks related to international sales.
Owned and Operated revenue decreased by approximately $1.3 million as
compared to the same period last year, primarily due to a $1.5 million decrease
in touring revenue partially offset by an increase in revenue from the fixed
site joint ventures of approximately $201,000. The decline in sales, and related
expenses, in the touring division is due to the Company's decision to
participate in fewer events than the prior year focusing on the more profitable
events. The increase in the joint ventures are the result of three additional
sites opening during the current fiscal year. The Company expects the lower
touring revenue trend to continue. The Company is actively seeking additional
sponsors and other revenue sources for the touring division.
Film Licensing revenues increased by approximately $1.6 million compared to
the same period last year. These results are due to new film venues in fiscal
1999, specifically theme park attractions, several of which have signed multiple
year license agreements. These new venues are a direct result of new films which
the Company released this year.
Film Production and Other revenue increased by approximately $1.0 million
primarily due to a new film production project for Discovery Channel Pictures
and an increase in camera rentals.
COST OF SALES AND GROSS PROFIT MARGIN
The overall gross profit margin percentages for the nine months ended March
31, 1999 and 1998 were 27.4% and 23.6%, respectively. The increase is primarily
related to the increased revenue in the film license division. The additional
film revenue generated by new venues are experiencing higher gross margins.
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 relation 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 decreased for the nine months
ended March 31, 1999 by approximately $2.9 million over the same period in the
prior year. This decrease was primarily due to a prior year charge of
approximately $1.5 million related to severance costs that were made to fifteen
employees including the former CEO and two other officers whose employment
terminated in the third quarter of fiscal 1998. In addition, there was a
reduction in bad debt expense, staffing levels and recruitment costs.
MERGER RELATED EXPENSES
During the nine months ended March 31, 1998 the Company incurred $1,419,000
of transaction expenses associated with the proposed merger with Showscan
Entertainment, Inc. which did not receive the required shareholder vote in March
1998. There were no such expenses in the
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nine months ended March 31, 1999.
INTEREST INCOME AND EXPENSES
Interest income for the nine months ended March 31, 1999 decreased by
approximately $426,000. The decrease in interest income resulted primarily from
the decrease in the invested balances during the nine months ended March 31,
1999. Interest expense for the nine months ended March 31, 1999 decreased by
approximately $69,000. The decrease is due to a reduction of the principal
balance owed under capital leases.
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.
The Company has 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 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 the first four phases and is in the process of implementation. 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
has notified these customers of this concern and has provided the necessary
tools to test their equipment. The Company has not incurred material costs to
test or correct products initially sold by the Company.
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<PAGE>
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, assessment phase, replacement and testing phase. The Company
is currently in the implementation phase.
On May 3, 1999 the Company went live with its new general ledger, billing
and inventory system modules. There will be an ongoing implementation of other
modules the Company felt were of less critical nature.
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.
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 $510,000
and will be funded through operating cash flows or leasing of hardware and
software. To date, the Company has incurred approximately $400,000 related to
all phases of the Year 2000 project. Of the total remaining project costs,
approximately $90,000 is attributable to remaining consulting time, which will
be capitalized. The remaining $20,000 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 the final phase of the Year 2000 program. In the event that
the Company does not complete the final phase, 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.
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CONTINGENCY PLAN
The Company currently has no contingency plans in place in the event it
does not complete the final phase of the Year 2000 program. The Company is in
the implementation phase (the final phase), and believes that a contingency plan
is not required at this time.
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 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 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 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) theatre
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 theatres. 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 in addition to its 15/70 sales efforts. Imax does not offer an
8/70 product.
In addition to competition in the large screen market, the Company faces
competition in the
Page 16
<PAGE>
simulation industry from Showscan Entertainment and a large number of other
competitors. The Company competes in this market based upon the breadth of 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 theatres.
Revenues from the Company's owned and operated attractions (primarily
portable simulation theatres) have been declining since the first quarter of
fiscal 1998 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. 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 theatre system deliveries, contract
signing, sponsorships, the mix of theatre systems shipped, the completion of
custom film contracts, the existence of world expos, the amount of revenues from
portable simulation theatre 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
theatre system sales and deliveries from quarter to quarter can materially
affect quarterly and periodic operating results, and theatre 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 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.
Page 17
<PAGE>
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 nine months ended March
31, 1999 was approximately $5,000. This was primarily attributable to the net
loss of approximately $2.2 million offset by non-cash charges of approximately
$3.8 million for depreciation and amortization along with negative changes in
operating assets and liabilities of approximately $1.6 million. Investing
activities for the nine months ended March 31, 1999 consisted primarily of
maturities of debt securities partially offset by 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 March 31, 1999, the Company had cash and cash equivalents of
approximately $6.3 million. The Company believes that its existing cash balances
and cash equivalents on hand at March 31, 1999, combined with anticipated cash
flow 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, planned additions to film inventory and other capital
expenditures. Consequently, the Company expects its cash balance to continue to
decline during the next twelve months.
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 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 nine
months 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 profitability
and increased 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 operation 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
Page 18
<PAGE>
of which could have a material adverse affect on the Company's future
operations. At March 31, 1999 the Company was committed to approximately $1.0
million of capital expenditures to be made in the remainder of fiscal 1999 and
an additional $780,000 committed during the first six months of fiscal 2000.
Page 19
<PAGE>
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 based in part
on the advice of counsel, 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
A. EXHIBITS:
11.1 Schedule of earnings per share
27.1 Schedule of financial data
B. REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED MARCH 31,
1999:
i) A form 8-K was filed on February 5, 1999, item 5, regarding
a press release dated February 2, 1999.
Page 20
<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 14th day of May, 1999.
IWERKS ENTERTAINMENT, INC.
(Registrant)
By: /S/ JEFFREY M. DAHL
---------------------------
Senior Vice President
Chief Financial Officer
(Principal Finance Officer)
By: /S/ BRUCE E. PALMORE
---------------------------
Vice President / Controller
(Principal Accounting Officer)
DATE: MAY 14, 1999
Page 21
EXHIBIT 11.1
IWERKS ENTERTAINMENT, INC.
EARNINGS PER SHARE
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended March 31, Ended March 31,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Denominator for Basic Earnings per
Share - Weighted average shares
Outstanding .................................... 12,375 12,199 12,362 12,173
Effect of dilutive securities:
Options and warrants ......................... (a) (b) (c) (d)
-------- -------- -------- --------
Denominator for Diluted Earnings per
Share .......................................... 12,375 12,199 12,362 12,173
-------- -------- -------- --------
Net Loss ....................................... $ (389) $ (5,077) $ (2,200) $ (9,083)
-------- -------- -------- --------
Basic loss per share ........................... $ (0.03) $ (0.42) $ (0.18) $ (0.75)
-------- -------- -------- --------
Diluted loss per share ......................... $ (0.03) $ (0.42) $ (0.18) $ (0.75)
-------- -------- -------- --------
</TABLE>
(a) Options to purchase 16 shares of common stock were not included in the
computation of diluted loss per common share as the effect would be
antidilutive
(b) Options to purchase 86 shares of common stock were not included in the
computation of diluted loss per common share as the effect would be
antidilutive
(c) Options to purchase 32 shares of common stock were not included in the
computation of diluted loss per common share as the effect would be
antidilutive
(d) Options to purchase 98 shares of common stock were not included in the
computation of diluted loss per common share as the effect would be
antidilutive
Page 22
<TABLE> <S> <C>
<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>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 6,330
<SECURITIES> 0
<RECEIVABLES> 5,858
<ALLOWANCES> (1,446)
<INVENTORY> 4,568
<CURRENT-ASSETS> 17,257<F1>
<PP&E> 22,174<F2>
<DEPRECIATION> (14,161)<F3>
<TOTAL-ASSETS> 48,226
<CURRENT-LIABILITIES> 13,040
<BONDS> 0<F4>
0
0
<COMMON> 78,137
<OTHER-SE> (43,447)
<TOTAL-LIABILITY-AND-EQUITY> 48,226
<SALES> 26,445
<TOTAL-REVENUES> 26,729
<CGS> 19,193
<TOTAL-COSTS> 28,929
<OTHER-EXPENSES> 9,612
<LOSS-PROVISION> 497
<INTEREST-EXPENSE> 124
<INCOME-PRETAX> (2,200)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,200)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,200)
<EPS-PRIMARY> (0.18)
<EPS-DILUTED> (0.18)
<FN>
<F1> Includes Costs and estimated earnings in excess of billings on uncompleted
contracts of $1,090 and other current assets of $857.
<F2> Includes portable simulation theaters and film inventory.
<F3> Includes portable simulation theaters and film inventory.
<F4> Includes a non-current portions of capital leases.
<F5> Accumulated deficit.
<F6> Includes interest income of $284.
</FN>
</TABLE>
