<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1996 COMMISSION FILE NO. 0-17295
THE KUSHNER-LOCKE COMPANY
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
CALIFORNIA 95-4079057
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
11601 WILSHIRE BLVD., 21ST FLOOR, LOS ANGELES, CALIFORNIA 90025
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (310) 445-1111
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Not Applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, without par value
10% Convertible Subordinated Debentures, Series A due 2000
13 3/4% Convertible Subordinated Debentures, Series B due 2000
Common Stock Purchase Warrants, Class A
Common Stock Purchase Warrants, Class C
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value based on the closing price of the Registrant's
Common Stock held by nonaffiliates of the Registrant was approximately
$21,556,767 as of December 23, 1996.
There were 53,062,810 shares of outstanding Common Stock of the Registrant
as of December 23, 1996.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for its 1997 Annual
Meeting of Stockholders to be filed pursuant to Regulation 14A not later than
120 days after the end of the Registrant's fiscal year (September 30, 1996) are
incorporated by reference in Part III Items 10, 11, 12 and 13 of this Form 10-K.
Total number of pages 59. Exhibit Index begins on page 56
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART I
1. BUSINESS
GENERAL
The Kushner-Locke Company (the "Company") is a leading independent
entertainment company principally engaged in the development, production, and
distribution of original feature films and television programming. The Company's
feature films are developed and produced for the made-for-video, pay cable and
theatrical motion picture markets. The Company's television programming has
included television series, mini-series, movies-for-television, animation and
reality and game show programming for the major networks, cable television,
first-run syndication and international markets. The Company established its
feature film production operations in April 1993. In September 1994, the Company
employed certain new, experienced international theatrical film sales personnel
to expand the Company into foreign theatrical distribution. In 1995, the Company
formed KLC/New City Tele-Ventures ("KLC/ New City"), a joint venture 82.5% owned
by the Company, to acquire films for distribution through emerging new delivery
systems, including pay cable, pay-per-view, basic cable, video-on-demand and
satellite.
The Company's feature film activities can be grouped into three areas:
production and distribution of higher-budget films intended for wide--screen
domestic theatrical release (historically, no more than one project per year),
production and distribution licensing of low-to-moderate budget films released
direct-to-video or on pay cable television and films, and distribution licensing
of film rights acquired for distribution only. In certain cases, the Company's
low-to-moderate budget films may have a limited theatrical release or a pay
cable premiere before being released in home video. For fiscal 1996, in the
higher-budget film category, the Company's feature film THE ADVENTURES OF
PINOCCHIO, starring Martin Landau, Jonathan Taylor Thomas and a puppet from Jim
Henson's Creature Shop and budgeted at approximately $29 million, was released
theatrically July 1996 in the U.S. by New Line Pictures (a division of Turner
Entertainment Co., "New Line"). The Company's lower-budget feature slate for
fiscal 1996 included SERPENT'S LAIR starring Jeff Fahey, THE GRAVE starring
Gabrielle Anwar, Eric Roberts and Craig Sheffer, FREEWAY executive produced by
Oliver Stone and starring Reese Witherspoon, Keifer Sutherland and Brooke
Shields, THE WHOLE WIDE WORLD starring Vincent D'Onofrio and Renee Zellweger and
being distributed in the U.S. by Sony Classics, THE LAST TIME I COMMITTED
SUICIDE starring Keanu Reeves, and five children's fantasy adventure films for
Paramount Pictures under Paramount Pictures' MAGIC ADVENTURES label. In various
stages of production for the Company's fiscal 1997 slate as of December 23, 1996
are (a) the feature film BASIL starring Christian Slater, (b) the feature film
WAITING FOR THE MAN starring Rae Dawn Chong and Darren McGavin, (c) a film
executive produced by Oliver Stone, (d) the two animated feature films for Buena
Vista Home Video, a division of the Walt Disney Company, entitled BRAVE LITTLE
TOASTER GOES TO MARS and BRAVE LITTLE TOASTER GOES TO SCHOOL, which are sequels
to the Company's successful direct-to-video title THE BRAVE LITTLE TOASTER, and
(e) five additional new direct to video films under Paramount Pictures' MAGIC
ADVENTURES label. The Company's distribution activities consist primarily of
foreign distribution of product produced, overseen or acquired by the Company
and, through KLC/New City, domestic distribution of 75 low-budget feature films
as of December 23, 1996 to the pay-per-view, pay cable, basic cable and other
ancillary markets.
In May 1996, the Company and Decade Entertainment ("Decade") entered into an
agreement to produce four theatrical action motion pictures. The motion pictures
will be produced, subject to approval by the Company of certain creative aspects
of such movies, by Decade and executive produced by Joel Silver (producer of
EXECUTIVE DECISION, the LETHAL WEAPON series, and two DIE HARD action pictures)
and Richard Donner (director/producer of THE OMEN and SUPERMAN). Under the
agreement, the Company has agreed to guarantee payment up to $3,200,000 per
picture payable upon the delivery of the "mandatory delivery items" (as defined
in such agreement) for each picture in consideration of receipt of foreign
distribution rights. The agreement is for a minimum of four feature-length
motion pictures and may be
2
<PAGE>
extended, at Decade's option, to include a fifth picture. The initial two films
under the agreement are DOUBLE TAP starring Heather Locklear and Stephen Rea and
MADE MEN, both of which are currently expected to be delivered in calendar 1997.
Since its inception in 1983, the Company has produced or distributed over
1,000 hours of original television programming, including various television
series, movies-for-television and mini-series. The Company's movies-of-the-week
which have aired or will air include PRINCESS IN LOVE, starring Julie Cox in the
book version of Princess Diana's affair, for CBS, EVERY WOMAN'S DREAM starring
Jeff Fahey for CBS, A HUSBAND, A WIFE AND A LOVER starring Judith Light, for
CBS, ECHO starring Jack Wagner, for ABC, JACK REED V starring Brain Dennehy, for
NBC, and UNLIKELY ANGEL starring Dolly Parton, for CBS. The Company is also
producing six one hour prime time episodes of a mid-season replacement series
for ABC entitled THE GUN, including episodes starring Jennifer Tilly, Randy
Quaid, Darryl Hannah, Rosanna Arquette and Peter Horton. The series is
co-executive produced by Robert Altman (director of M*A*S*H, THE PLAYER and
PRET-A-PORTER) who is directing the first episode. The series is tentatively
scheduled to air in the spring of 1997. The Company is also co-producing with
Franklin/Waterman MIRACLES, a one-hour reenactment series hosted by Robert Culp
and airing in first run syndication (a 24 episode order) and MOWGLI, a half-hour
series for the Fox Television Network. As of September 30, 1996, the Company had
13 movies-for-television and various television series in different stages of
development for potential production. The Company is also purchasing weekly
media time for a Christian music infomercial produced by TVFirst, a partnership
which markets the sale of compact discs and audio and video cassettes. Sales for
calendar 1996 for this infomercial exceed $7,000,000.
The Company's operating revenues were $20,407,000 for the year ended
September 30, 1995 and $80,157,000 for the year ended September 30, 1996, an
increase of approximately 292%, reflecting in part the Company's significant
increase in its investment in feature film projects completed or released in the
fiscal year. In its production activities, the Company generally seeks to
finance all or a substantial portion of its costs through domestic and
international pre-sales, output arrangements or joint venture or distribution
agreements with third parties, while retaining the benefit of ownership rights
or profit participations in each film or television program. However, as the
Company has shifted a significant portion of its product mix from its
traditional base of network-television programming, the Company has become
subject to the increased risks of feature film activities, including the longer
lead times for completion of new product and receipt of related cash flow from
exploitation of such product.
The Company's executive offices are located at 11601 Wilshire Boulevard,
Suite 2100, Los Angeles, California 90025, and its telephone number is (310)
445-1111.
FORWARD LOOKING STATEMENTS
Except for the historical information contained herein, certain of the
matters discussed in this annual report are "forward-looking statements" as
defined in the Private Securities Litigation Reform Act of 1995 which involve
certain risks and uncertainties which could cause actual results to differ
materially from those discussed herein. Such risks and uncertainties include,
but are not limited to, liquidity and financing requirements, variability of
quarterly results and prior losses, increased interest expense, dependence on a
limited number of projects, certain accounting policies including amortization
of film costs, dependence on key personnel, production deficits, the risk
involved in the television and theatrical film industries, competition,
government regulation, labor relations, broad discretion as to use of proceeds,
absence of cash dividends, and the volatility of public markets. See the
relevant discussions elsewhere herein, and in the Company's registration
statement on Form S-2 (Registration No. 333-05089), as declared effective on
July 24, 1996, and the Company's periodic reports and other documents filed with
the Securities and Exchange Commission for further discussions of these and
other risks and uncertainties applicable to the Company and its business.
3
<PAGE>
THE U.S. MOTION PICTURE INDUSTRY OVERVIEW
The business of the motion picture industry may be broadly divided into two
major segments: production, involving the development, financing and making of
motion pictures, and distribution, involving the promotion and exploitation of
completed motion pictures in a variety of media.
Historically, the largest companies, or the so-called "Majors" and
"mini-Majors," have dominated the motion picture industry by both producing and
distributing in the United States a majority of those theatrical motion pictures
which generate significant box office receipts. Over the past decade, however,
"Independents" or smaller film production and distribution companies, such as
the Company, have played a significant role in the production and distribution
of motion pictures to fill the increasing worldwide demand for filmed
entertainment product.
The Majors (and mini-Majors) include MCA Universal Pictures, Warner Bros.
Pictures, Metro-Goldwyn-Mayer Inc., New Line Pictures (a division of Turner
Entertainment Co.), Twentieth Century Fox Film Corporation, Paramount Pictures
Corporation, Sony Pictures Entertainment (including Columbia Pictures, TriStar
Pictures and Triumph Releasing) and The Walt Disney Company (Buena Vista
Pictures, Touchstone Pictures and Hollywood Pictures). Generally, the Majors own
their own production studios (including lots, sound stages and post-production
facilities), have a nationwide or worldwide distribution organization, release
pictures with direct production costs generally ranging from $25 million to $75
million, and provide a continual source of pictures to film exhibitors. In
addition, some of the Majors have divisions which are promoted as "Independent"
distributors of motion pictures. These "Independent" divisions of Majors include
Miramax Films (a division of The Walt Disney Company) and Sony Classics (a
division of Sony Pictures).
In addition to the Majors, the Independents engaged primarily in the
distribution of motion pictures produced by companies other than the Majors
include, among others, Trimark Holdings (through Trimark Pictures and Vidmark
Entertainment), Live Entertainment, October Films, Republic Pictures (a division
of Viacom), The Samuel Goldwyn Company and Fine Line Pictures (a division of New
Line Pictures). The Independents typically do not own production studios or
employ as large a development or production staff as the Majors.
MOTION PICTURE PRODUCTION AND FINANCING
The production of a motion picture usually involves four steps: development,
pre-production, production and post-production. The development stage includes
obtaining an original screenplay or a screenplay based on a pre-existing
literary work, or a screenplay may be acquired and rewritten. Creative personnel
may be contacted to determine availability and for planning the timing of the
project, or in some cases actually hired. In pre-production, a budget is
prepared, the remaining creative personnel, including a director, actors and
various technical personnel are hired, shooting schedules and locations are also
planned and other steps necessary to prepare the motion picture for principal
photography are completed. Production is the principal photography of the
project and generally continues for a period of not more than three months. In
post-production, the film is edited and synchronized with music and dialogue
and, in certain cases, special effects are added. The final edited synchronized
product, the negative, is used to manufacture release prints suitable for public
exhibition.
The production of a motion picture requires the financing of the direct
costs of production. Direct production costs include film studio rental,
cinematography, post-production costs and the compensation of creative and other
production personnel. Distribution costs (including costs of advertising and
release prints) are not included in direct production costs.
The Majors generally have sufficient cash flow from their motion picture and
related activities, or in some cases, from unrelated businesses (e.g., theme
parks, publishing, electronics, and merchandising) to pay or otherwise provide
for their production costs, and the studios themselves generally absorb the
4
<PAGE>
considerable overhead costs involved in a production. Overhead costs are, in
substantial part, the salaries and related costs of the production staff and
physical facilities which the Majors maintain on a full-time basis. The Majors
often enter into contracts with writers, producers and other creative personnel
for multiple projects or for fixed periods of time.
Independent production companies generally avoid incurring substantial
overhead costs by hiring creative and other production personnel and retaining
the other elements required for pre-production principal photography and
post-production activities on a project-by-project basis. Unlike the Major
studios, the Independents also typically finance their production activities
from various sources, including bank loans, "pre-sales," equity offerings and
joint ventures. Independents generally attempt to complete their financing of a
motion picture production prior to commencement of principal photography, at
which point substantial production costs begin to be incurred and to require
payment.
"Pre-sales" are often used by independent film companies to finance all or a
portion of the direct production costs of a motion picture. Pre-sales consist of
fees or advances paid or guaranteed to the producer by third parties in return
for the right to exhibit the completed motion picture in theaters or to
distribute it in home video, television, international or other ancillary
markets. Producers with distribution capabilities may retain the right to
distribute the completed motion picture either domestically or in one or more
international markets. Other producers may separately license theatrical, home
video, television, international and all other distribution rights among several
licensees. Commitments in a pre-sale are typically subject to delivery and to
the approval of a number of prenegotiated factors, including script, production
budget, cast and director.
Both Major studios and Independent film companies often acquire motion
pictures for distribution through a customary industry arrangement known as a
"negative pickup" under which the studio or Independent film company agrees to
acquire from an Independent production company some or all rights to a film upon
completion of production. The Independent production company normally finances
production of the motion picture pursuant to financing arrangements with banks
or other leaders in which the lender is granted a security interest in the film
and the Independent production company's rights under its distribution
arrangement with the Major or Independent. When the Major or Independent "picks
up" the completed motion picture, it may assume some or all of the production
financing indebtedness incurred by the production company in connection with the
film. In addition, the Independent production company is paid a production fee
and generally is granted a participation in the profits from distribution of the
motion picture.
Both Major studios and Independent film companies generally grant various
third-party participations in connection with the distribution and production of
a motion picture. These participations are contractual rights of actors,
directors, screenwriters, producers, owner of rights and other creative and
financial contributors entitling them to share in revenues or profits (each as
defined in the respective agreements) from a particular motion picture. Except
for the most sought-after talent, participations are generally payable only
after all distribution and marketing fees and costs, direct production costs
(including overhead) and financing costs are paid in full.
MOTION PICTURE DISTRIBUTION
Distribution of a motion picture involves the domestic and international
licensing of the picture for (i) theatrical exhibition, (ii) home video, (iii)
presentation on television, including pay-per-view, video-on-demand, satellites,
pay cable, network, basic cable and syndication, (iv) non-theatrical exhibition,
which includes airlines, hotels, armed forces facilities and schools and (v)
marketing of the other rights in the picture, which may include books, CD-ROM,
merchandising and soundtrack recordings.
THEATRICAL DISTRIBUTION AND EXHIBITION. Theatrical distribution of motion
pictures is the exhibition of a film in a theater open to the public where an
admission fee is charged. Theatrical distribution involves the manufacture of
release prints; licensing of motion pictures to theatrical exhibitors; and
promotion of the
5
<PAGE>
motion picture through advertising and promotional campaigns. The size and
success of the promotional and advertising campaign may materially affect the
revenues realized from its theatrical release, generally referred to as "box
office gross." Box office gross represents the total amounts paid by patrons at
motion picture theaters for a particular film, as determined from reports
furnished by exhibitors. The ability to exhibit films during summer and holiday
periods, which are generally considered peak exhibition seasons, may affect the
theatrical success of a film. Competition among distributors to obtain
exhibition dates in theaters during these seasons is significant. In addition,
the costs incurred in connection with the distribution of a motion picture can
vary significantly depending on the number of screens on which the motion
picture is to be exhibited and the ability to exhibit motion pictures during
peak exhibition seasons. Similarly, the ability to exhibit motion pictures in
the most popular theaters in each area can affect theatrical revenues.
Exhibition arrangements with theater operators for the first run of a film
generally provide for the exhibitor to pay the greater of 90% of ticket sales in
excess of fixed amounts relating to the theater's costs of operation and
overhead, or a minimum percentage of ticket sales which varies from 40% to 70%
for the first week of an engagement at a particular theater, decreasing each
subsequent week to 25% to 30% for the final weeks of the engagement. The length
of an engagement depends principally on the audience response to the film.
Films with theatrical releases (which generally may continue for up to six
months) typically are made available for release in other media as follows:
<TABLE>
<CAPTION>
MONTHS AFTER APPROXIMATE RELEASE
MARKET INITIAL RELEASE PERIOD
- --------------------------------------------------------------------- ----------------- -----------------------
<S> <C> <C>
Domestic home video.................................................. 4 - 6 months --
Domestic pay-per-view................................................ 6 - 9 months 3 months
Domestic pay cable................................................... 10 - 18 months 12 - 21 months
Domestic network or basic cable...................................... 30 - 36 months 18 - 36 months
Domestic syndication................................................. 30 - 36 months 3 - 15 years
International theatrical............................................. -- 4 - 6 months
International home video............................................. 6 - 12 months --
International television............................................. 18 - 24 months 18 months - 10 years
</TABLE>
HOME VIDEO. The home video distribution business involves the promotion and
sale of videocassettes and videodiscs to local, regional and national video
retailers (including video specialty stores, convenience stores, record stores
and other outlets), which then rent or sell the videocassettes and videodiscs to
consumers for private viewing. In the last decade, while home video has been one
of the fastest growing motion picture distribution media with total distribution
revenues generated larger than the domestic theatrical exhibition market, its
growth has been slowed in the last year by the rise of the Internet and its
impact on the marketplace.
Major feature films are usually scheduled for release in the home video
market within four to six months after theatrical release to capitalize on the
theatrical advertising and publicity for the film. Promotion of new home video
releases is generally undertaken during the nine to twelve weeks before the home
video release date. Videocassettes of feature films are generally sold to
domestic wholesalers either on a unit basis or pay-per-transaction basis. Unit
based sales typically involve the sales of individual videocassettes to
wholesalers or distributors at approximately $50 to $60 per unit and generally
are rented by consumers for fees ranging from $1 to $5 per day (with all rental
fees retained by the retailer). Sales involve the sale of a videocassette at a
nominal price ($5-$10) with rental fees divided between the video retailer and
the video distributor. Wholesalers who meet certain sales and performance
objectives may earn rebates, return credits and cooperative advertising
allowances. Selected titles including certain made-for-video programs, are
priced significantly lower to encourage direct purchase by consumers. The market
for direct sale to consumers is referred to as the "priced-for-sale" or
"sell-through" market.
6
<PAGE>
Technological developments, including videoserver and compression
technologies which regional telephone companies and others are developing, could
make competing delivery systems economically viable and could significantly
impact the Company's home video revenues.
PAY-PER-VIEW. Pay-per-view television allows cable television subscribers
to purchase individual programs, primarily recently released theatrical motion
pictures, sporting events and music concerts, on a "per use" basis. The fee a
subscriber is charged is typically split among the program distributor, the
pay--per-view operator and the cable operator.
PAY CABLE. The domestic pay cable industry (as it pertains to motion
pictures) currently consists primarily of HBO/Cinemax, Showtime/The Movie
Channel, Encore/Starz, The Disney Channel and a number of regional pay services.
Pay cable services are sold to cable system operators for a monthly license fee
based on the number of subscribers receiving the service. These pay programming
services are in turn offered by cable system operators to subscribers for a
monthly subscription fee. The pay television networks generally acquire their
film programming by purchasing the distribution rights from motion picture
distributors.
INTERNATIONAL MARKETS. The worldwide demand for motion pictures has
expanded significantly as evidenced by the development of new international
markets and media. This growth is primarily driven by the overseas privatization
of television stations, introduction of direct broadcast satellite services,
growth of home video and increased cable penetration. Accordingly, in September
1994 the Company established its own foreign theatrical distribution operations
for its own and third party product.
NON-THEATRICAL MARKETS. In addition to the distribution media described
above, a number of sources of revenue exist for motion picture distribution
through the exploitation of other rights, including the right to distribute
films to airlines, schools, libraries, hotels, armed forces facilities and
hospitals.
MOTION PICTURE ACQUISITION
In addition to its own production activities, the Company is actively
engaged in the acquisition of rights to films and other programming from
Independent film producers, distribution companies and others for use in the
emerging new delivery systems. The Company is continually seeking to identify
and negotiate the acquisition of motion picture distribution rights in order to
maximize the number of films it can distribute. To be successful, the Company
must locate and track the development and production of numerous independent
feature films.
TYPES OF MOTION PICTURES ACQUIRED. The Company generally seeks to produce
or acquire motion pictures across a broad range of genres--drama, thriller,
comedy, science fiction, family, action and fantasy/adventure, etc.--which will
individually appeal to a targeted audience. Historically, the Company has not
attempted to acquire higher production budget (over $3.5 million) films because
of the interest that the Majors have shown in acquiring such films, and the
associated competition and higher production advances, minimum guarantees and
other costs. The Company has at times considered and acquired higher production
budget projects when it believes it can limit its financial risk on such
projects through, for example, significant presales, and when it believes that a
project has significant marketability. In most cases, the Company attempts to
acquire rights to motion pictures with a recognizable marquis "name" with public
recognition, thereby enhancing promotion of the motion pictures in the home
video or international markets. The Company believes that this approach enhances
the marketability of a film and increases the likelihood of generating a product
capable of producing cash flow, ancillary rights income and the possibility of a
theatrical release.
METHOD OF ACQUISITIONS. The Company has typically acquired films on a
"pick-up" basis or "pre-buy" basis. Films acquired on a "pick-up" basis are
those films to which the Company has acquired distribution
7
<PAGE>
rights following completion of most or all of the production and editing
process. These films are generally acquired after management of the Company has
viewed the film to evaluate its commercial viability.
Films acquired on a "pre-buy" basis are films to which the Company acquires
distribution rights prior to completion of a substantial portion of production
and editing. The Company's willingness to acquire films on a pre-buy basis will
be based upon factors which generally include the track record and reputation of
the picture's producer, the quality and commercial value of the screenplay, the
"package" elements of the picture, including the director and principal cast
members, the budget of the picture and the genre of the picture. Before making
an acquisition offer on a film to be acquired on a pre-buy basis, the Company
may work with the producer to modify certain of these elements. If the matters
considered are acceptable, the Company's obligation to accept delivery and make
payment will be conditioned upon receipt of a finished film conforming to the
script reviewed by the Company and other specifications considered important by
the Company.
SOURCES OF DISTRIBUTION RIGHTS. Typically, projects which may be suitable
for the Company are submitted directly to the Company for consideration. In
order to promote the submission of projects, the Company relies primarily on its
reputation as an Independent having significant access to the international
markets. The Company also relies upon the personal contacts of its senior
officers, which contacts have been generated through their prior business and
personal dealings with Independent production companies, Majors, other
Independents, entertainment, legal and accounting firms, business management
firms, talent agencies, production lenders and personnel managers who are
actively involved in the production community.
ACQUISITION PROCESS. If the Company locates a motion picture which it
believes satisfies the criteria set forth above in "--Types of Motion Pictures
Acquired" above for which it desires to acquire the distribution rights, the
Company may pay the production company granting those rights an advance or a
guaranteed minimum payment conditioned upon delivery of a completed film
(either, a "minimum guarantee") against a share or participation in the revenue
actually received by the Company from the exploitation of a film in each
licensed media. The minimum guarantee is generally paid prior to the film's
release. Typically, the Company will recoup the minimum guarantee and certain
other amounts from the distribution revenues realized by the Company prior to
paying any additional revenue participation to the production company.
FILM LIBRARY. The Company's distribution rights generally range from seven
to 21 years from the date of acquisition, or continue in perpetuity, and
primarily extend to home video and free, basic cable and pay cable television
and international territories.
MULTI-PICTURE DISTRIBUTION. In May 1996, the Company and Decade entered
into an agreement to produce four theatrical action motion pictures. The motion
pictures will be produced, subject to approval by the Company of certain
creative aspects of such movies, by Decade and executive produced by Joel Silver
and Richard Donner. Under the agreement, the Company has agreed to guarantee
payment up to $3,200,000 per picture payable upon the delivery of the "mandatory
delivery items" (as defined in such agreement) for each picture in consideration
of receipt of foreign distribution rights. The agreement is for a minimum of
four feature-length motion pictures and may be extended, at Decade's option, to
include a fifth picture. The initial two films under the agreement are DOUBLE
TAP starring Heather Locklear and Stephen Rea and MADE MEN, both of which are
currently expected to be delivered in calendar 1997.
COMPANY FEATURE FILM PRODUCTION
The Company's feature film division was established in April 1993 to develop
and produce low and medium budget films. The Company's low to medium budget
films to date have had production budgets ranging from approximately $1 million
to $3.5 million, although the Company from time to time may release a higher
budget or moderate budget film having higher budgets. The Company anticipates
that its
8
<PAGE>
low-budget films primarily will be targeted for direct distribution to home
video and cable television markets and that its medium-budget films may be
targeted for theatrical release. The Company generally retains distribution
rights for licensing to third parties outside of the U.S. market with regard to
such films. The Company's films generally are distributed by third parties in
the U.S. market, but, in certain circumstances, the Company may undertake
limited U.S. distribution or co-distribution activities for films it produces or
acquires.
The Company's feature film strategy generally is to develop and produce
feature films when the production budgets for the films are expected to be
substantially covered through a combination of pre-sales, output arrangements,
equity arrangements and production loans with "gap" financing. To further limit
the Company's financing risk or to obtain production loans, the Company expects
to purchase completion bonds when necessary to guarantee the completion of
production.
The following films were released or delivered by the Company in fiscal
1996. Unless otherwise indicated, each of the films released or scheduled to be
released theatrically (other than THE ADVENTURES OF PINOCCHIO), was scheduled to
have a limited theatrical release.
<TABLE>
<CAPTION>
DELIVERY/RELEASE
PICTURE INITIAL MEDIA DATE FILM TYPE PRINCIPAL TALENT
- ------------------------- --------------- ------------------- --------------------- -------------------------
<S> <C> <C> <C> <C>
CAFE SOCIETY Pay Cable Feb-96 Drama Laura Flynn Boyle; Peter
Gallager
FREEWAY Pay Cable Jun-96 Drama Kiefer Sutherland; Reese
Witherspoon; Brooke
Shields
THE GRAVE Pay Cable Apr-96 Thriller Craig Sheffer; Gabrielle
Anwar; Eric Roberts
SERPENT'S LAIR Pay Cable Jul-96 Thriller Jeff Fahey; Lisa B
THE LAST TIME I COMMITTED Theatrical Sep-96 Drama Keanu Reeves
SUICIDE
THE ADVENTURES OF Theatrical Jul-96 Fantasy/Adventure Martin Landau; Jonathan
PINOCCHIO Taylor Thomas
RED RIBBON BLUES Theatrical Feb-96 Drama Debbie Mazar
THE WHOLE WIDE WORLD Theatrical Mar-96 Drama Vincent D'Onofrio; Rene
Zellweger
</TABLE>
The following films were released or delivered or are scheduled for release
or delivery by the Company in fiscal 1997. Unless otherwise indicated, each of
the films released or scheduled to be released theatrically (other than BASIL)
are expected to have a limited theatrical release:
<TABLE>
<CAPTION>
DELIVERY/RELEASE
PICTURE INITIAL MEDIA DATE FILM TYPE PRINCIPAL TALENT
- ------------------------- --------------- ------------------- --------------------- -------------------------
<S> <C> <C> <C> <C>
THE BRAVE LITTLE TOASTER Home Video Apr-97 Animated N/A
GOES TO MARS
THE BRAVE LITTLE TOASTER Home Video Apr-97 Animated N/A
GOES TO SCHOOL
GENIE Home Video Jan-97 Fantasy/Adventure N/A
DRAGON WORLD II Home Video Feb-97 Fantasy/Adventure N/A
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
DELIVERY/RELEASE
PICTURE INITIAL MEDIA DATE FILM TYPE PRINCIPAL TALENT
- ------------------------- --------------- ------------------- --------------------- -------------------------
JOHNNY MYSTO: BOY WIZARD Home Video Dec-96 Fantasy/Adventure N/A
<S> <C> <C> <C> <C>
KID MIDAS Home Video Dec-96 Fantasy/Adventure N/A
LITTLE GHOST Home Video Dec-96 Fantasy/Adventure N/A
5 MAGIC ADVENTURE Home Video Summer and Fall-97 Fantasy/Adventure N/A
WAITING FOR THE MAN Theatrical Dec-96 Drama Darren McGavin; Rae Dawn
Chong
BASIL Theatrical Fall-97 Drama Christian Slater
</TABLE>
There is no assurance that any motion picture which has not yet been
released will be released, that a change in the scheduled release dates of any
such films will not occur or, if such motion picture is released, it will be
successful. The Company has various additional potential feature films under
development, including REALLY BIG BUGS, a higher budgeted theatrical film in
development with the 20th Century Fox Corporation. There is no assurance that
any project under development will be produced.
TELEVISION INDUSTRY OVERVIEW
The United States television market is the largest in the world, consisting
of the principal broadcast networks and their affiliates, independent television
stations and cable television networks. Expanding international television
broadcast, cable and satellite delivery systems offer further opportunities for
the exploitation of television programming.
DOMESTIC MARKET. The U.S. market for television programming primarily is
composed of four submarkets: the broadcast television networks (ABC, CBS, NBC
and Fox and emerging networks consisting of UPN and WBN), pay cable services
(such as HBO/Cinemax, The Disney Channel, Encore/Starz and Showtime/The Movie
Channel, Inc.), basic cable services (such as USA Network, the Arts &
Entertainment Network, Lifetime, The Family Channel and Turner Broadcasting
Network) and syndicators of first-run programming (such as MCA, King World
Productions and Multimedia, Inc.). The U.S. television market currently is
dominated by the three major networks, each of which has approximately 200
affiliated stations and the Fox network, which has over 125 affiliated stations.
The affiliates broadcast network-supplied programming and national commercials
in return for payments by the major networks. This relationship results in the
networks being able to reach virtually all of the significant television markets
in the U.S. There are also a significant number of independent commercial
television stations in the U.S. These stations offer an alternative to network
distribution through syndication. The network schedule provides affiliates with
only a portion of their daily program schedule, and the balance of the time is
filled with programs acquired through television syndication companies or
produced locally by the station. Cable services generally are classified as
being in one of four categories: telephone delivery, superstations (e.g., Turner
Broadcasting System), pay cable services (e.g., HBO/Cinemax) and basic cable
networks (advertiser-supported, e.g., The Family Channel). The most successful
cable networks reach more than 60% of the U.S. television households. Recently
developed digital compression technology combined with fiber optics or
small-sized satellite dishes may permit cable companies, telephone companies or
direct broadcast satellite systems to expand the domestic television market up
to 500 or more channels.
TELEVISION PROGRAMMING. Each of the three major television networks
currently broadcasts approximately 22 hours of prime-time programming and
approximately 30 hours of daytime programming each week. Prime-time programming
generally consists of half-hour series (often situation comedies), reality
shows, hour-length series, movies-for-television (films of two hours or less)
and mini-series (dramatic epic of three hours or more). The increased channel
capacity and large base of cable subscribers that have developed during the
1980s and 1990s have made possible the development of a number of pay cable and
10
<PAGE>
basic cable networks which have become important purchasers of both original and
rerun television programming, including movies-for-television, mini-series and
series. Suppliers of television programming include the production division or
affiliated companies of the major networks, major film studios, station owners
and independent producers, such as the Company.
INTERNATIONAL MARKETS. The number of outlets for television programming
outside the U.S. has been increasing with the worldwide proliferation of
broadcast, cable and satellite delivery systems. Over the last ten years,
European governments have privatized television systems in several countries,
including Germany, Italy, France and Spain. The Company believes privatized
systems are more likely to broadcast American programming than government-owned
networks. In addition, both the number of pay and satellite television systems
in Europe and the number of subscribers to these systems have increased. Pay
television and satellite distribution systems also are developing in other
geographic areas, including many Asian countries. In international markets,
suppliers of programming may be subject to local content and quota requirements
which prohibit or limit the amount of American programming in particular
markets. See "Business--Government Regulations."
COMPANY TELEVISION STRATEGY
The Company was founded in 1983 to engage in the business of developing and
producing, on a cost-effective basis, quality television programming with broad
appeal. The Company's television business has evolved from the production of
programs owned by third parties and typically airing on local television
stations in the first-run syndication market, such as the long-running daytime
series DIVORCE COURT, to the development, production and ownership of series,
movies-for-television and mini-series for major domestic and international
television networks and the expanding pay and basic cable markets. In August
1991, the Company implemented a key element of its business strategy by
establishing an international distribution licensing operation for its own and
acquired television programming. The Company believes that through the control
of the distribution licensing of its own programming this operation has
increased its ability to cover the cost of new programs and to retain the fees
and profit potential previously realized by third parties.
The Company's television strategy is principally focused on increasing the
amount of programming it provides to the major U.S. networks, primarily one-hour
series, movies-of-the-week and mini-series, in part because the Company believes
network exhibition enhances a television program's potential value (both in
international markets and potential rerun syndication). In order to increase the
likelihood of developing programs that will be licensed by the networks, the
Company has made significant investments in expanding its roster of network
approved writers, producers and actors and acquiring literary materials and
rights. As of September 30, 1996, the Company had 34 movies-for-television and
various television series in different stages of development for potential
production which were being funded at least in part by the networks or other
third parties.
The Company believes that the worldwide proliferation of television delivery
systems has expanded the potential purchasers of television programming beyond
the major U.S. networks and other traditional purchasers of television
programming. As part of its strategy, the Company actively seeks to supply
programming to these non-traditional purchasers. The Company has sold original
programming developed for pay cable (e.g., The Disney Channel and HBO) and for
basic cable (e.g., The Family Channel and the Arts & Entertainment Network).
To position itself for the perceived growth in this market, the Company is
actively acquiring various forms of U.S. cable, video-on-demand and satellite
rights from third party producers for time periods ranging from seven years to
perpetuity through its KLC/New City joint venture. The customary order for
release is a period of approximately six months of pay-per-view followed by
18-24 months of pay cable and 24-48 months of basic cable, which completes a
cycle.
11
<PAGE>
In connection with its programming activities, the Company utilizes
licensing and co-production arrangements to fund the costs of production, and
generally retains additional licensing rights including, in the case of series,
rerun syndication rights which offer future upside profit potential. The Company
generally does not commence principal photography of its television programming
without first obtaining license or other revenue commitments or production
financing which equal all or a substantial portion of the budgeted production
costs. By obtaining license fees and other pre-committed revenues through the
efforts of its international television distribution division to cover a
substantial portion or all of its budgeted production costs, the Company
believes that it reduces many of the financial risks associated with an
individual production.
TELEVISION PROGRAM FINANCING
DEVELOPMENT COSTS. The Company generally finances project development costs
without third-party participation until the script commitment stage. Because of
the substantial likelihood that the significant costs in producing scripts and
pilots will not be recovered, the Company generally attempts to limit its
financial investment by obtaining financial commitments from networks or other
third parties to cover all or a substantial portion of these costs. See
"Business--Television Projects in Development."
PROGRAM LICENSING. Generally, the Company will license to a network the
right to broadcast a program for a period ending the earlier of the second
broadcast of the program or four years from delivery in exchange for a license
fee equal to 70% to 90% of the program's budgeted production cost (any remaining
amount is referred to as the "production deficit"). The Company generally
retains all other rights to the program and will usually license certain rights
to international broadcasters, enabling the Company to recoup all, or a portion,
of the production deficit. In addition, the Company will typically license
additional domestic releases in other media to cover the remainder, if any, of
the production deficit. A production order sets forth the principal terms for a
license of the Company's product to a network and specifies the license fee to
be paid and the conditions to be met for payment. Production orders typically
are contingent on the producer's obtaining certain approvals from the network,
such as script, principal cast and director, prior to commencement of principal
photography. The Company usually receives its license fee in installments, e.g.,
one-third on or prior to commencement of principal photography, one-third upon
completion of principal photography and one-third upon delivery of the completed
program. International distribution typically involves licensing the rights to
exhibit programming in international territories to broadcasters within those
territories for a fixed license fee usually payable after the program has been
completed. Due to timing differences between the Company's receipt of license
fees and its payment of production costs, the Company generally is required to
fund at least a portion of its production costs from working capital or
financing of the contracts receivable, even if the original license fees equal
or exceed budgeted production costs.
In the case of first-run syndication programs, the license agreements with
the first-run syndicator generally provide that the Company is entitled to a
fixed license fee and a percentage of revenues from distribution after the
syndicator recoups the fixed license fee it pays the Company and deducts its
distribution fees and costs. The Company's operating revenues from first-run
syndication have not been material in the past three fiscal years.
An alternate first-run syndication revenue source is called "barter" sales.
A television station, in lieu of, or in combination with, licensing fees may
grant to the Company's distributor the right to sell advertising spots during
the exhibition of the Company's television program. For a program to be
barterable, exhibition of the program on stations reaching at least 70% of the
U.S. television households and in most of the top ten major metropolitan areas
typically is required. The amount of the fee paid by the advertiser is
conditioned upon the program achieving certain agreed upon ratings. If the
specified rating is not achieved, the distributor is required to "make good" by
giving the advertiser additional advertising time or cash payment, and the
Company's share of barter revenues decreases. As an example of barter
syndication, the Company is currently syndicating a television series entitled
COULD IT BE A MIRACLE, a
12
<PAGE>
one hour show hosted by Robert Culp. The television series is being distributed
by MG/Perin with Eyemark, a division of CBS, selling the advertising time of
such program. The Company is handling the series' international distribution.
See "Rerun Syndication."
While the Company seeks to cover most or all of its production costs with
license fees and other pre-committed revenues, it may finance some of the
production costs on its own and rely on subsequent licensing in international or
other ancillary markets to recoup the remaining production costs. In many cases,
additional profit potential from a television program initially shown on a
network or cable service is sought from subsequent reruns of the program on
local television stations, international delivery systems and cable services
after exhibition on a major network or cable service. In any event, any
production is subject to the risk of cost overruns, and there is no assurance
that the Company will be able to recover any investment it undertakes in a
deficit-financed project.
INTERNATIONAL CO-PRODUCTIONS. An international co-production is a joint
venture or partnership between entities in two or more countries which in
certain cases may take advantage of tax or nationality benefits in one or more
of the countries. In a typical co-production arrangement, the Company transfers
all or part of its copyright ownership in the project to third parties (the
co-production entities), which generally provide a portion of the production
financing and other services. Typically, the co-production partners grant
distribution rights to the Company. The revenues received by the Company from
its distribution of the project are allocated to the various parties for
recoupment of production funding, production fees, talent participations,
distribution fees and expenses. Any remaining receipts are distributed to the
various parties in accordance with their agreed-upon profit participation. THE
ADVENTURES OF PINOCCHIO is an example of a coproduction with German, French and
English participation.
The Company has utilized co-productions with international producers in
certain cases in order to take advantage of alternative sources of financing for
its productions, to utilize international tax benefits, to pass foreign quota
restrictions and to benefit from lower pre-production costs in certain foreign
countries.
PRODUCER-FOR-HIRE. In addition to developing and producing programs that it
owns, the Company may be hired as a producer-for-hire in connection with a
creative concept or literary property owned by another person. There are at
least two types of producer-for-hire arrangements. Under the first type of
arrangement, the Company receives a set package fee and agrees to deliver the
completed program for that fee. The Company's profit is the excess of the
package fee over its production costs. If production costs exceed the package
fee, the Company bears the deficit. Under the second type of produce-for-hire
arrangement, the Company furnishes personnel as a producer, receives a fixed fee
per episode and the production costs of the program are reimbursed directly by
the distributor. The Company's production of 860 episodes of DIVORCE COURT from
1984 to 1988 was on a producer-for-hire basis. The Company's current strategy
generally is to obtain ownership and control of distribution of its television
programming.
RERUN SYNDICATION. Domestic rerun syndication typically involves the
exhibition of programming on local television stations and cable services after
exhibition on a major network. Since production costs for network series may
exceed network license fees and other pre-committed revenues, some television
production companies may depend on successful syndication of their programming
for profitable operations. Generally, to be successful in rerun syndication, a
television series must have at least 66 episodes (the equivalent of three full
television seasons). In the past, the Company has licensed rerun syndication
distribution rights to 1ST AND TEN to HBO in consideration of certain advances.
HBO entered into an agreement with Western International Syndication ("WIS")
pursuant to which WIS acquired certain exclusive rights (including rerun
syndication) to distribute 1ST AND TEN for a ten-year period. The Company also
licensed rerun syndication of the first 26 episodes of SWEATING BULLETS for a
one-year period to Multimedia, Inc.
13
<PAGE>
TELEVISION PRODUCTION ACTIVITIES
As a producer of television programming, the Company first develops or
acquires literary properties either internally or from third parties. The
Company may undertake expenditures to refine the concept of an acquired property
and then attempts to interest one of the networks or another buyer in the
project. If the buyer is interested in a concept presented to it, the buyer will
usually order a script from the Company. Once the script is delivered, the buyer
may order production of a single pilot episode or a limited number of episodes,
in the case of a series, or the entire production, in the case of a
movie-for-television or mini-series.
Once production is ordered, the Company and the buyer negotiate a financing
arrangement. The Company then undertakes pre-production activities in which a
budget is prepared, the screenplay is polished or rewritten, creative personnel
(including director and actors), a line producer and technical personnel are
engaged, filming is scheduled, locations are arranged and other steps are taken
to prepare the project for principal photography. By this point, the Company
generally has negotiated license fees and obtained other commitments to cover a
substantial portion of the budgeted production costs. Principal photography is
then completed, followed by post-production, in which the film is edited,
synchronized with music and dialogue and, in certain cases, special effects are
added. In the case of a series, if episodes are ordered and the ratings are
sufficiently strong, additional episodes may be ordered for the entire season
and then for additional seasons. The production of episodes for subsequent
seasons is usually dependent upon the audience ratings for the prior season.
In undertaking production of its programming, the Company hires writers,
directors, cast and crew members on a project-by-project basis. The terms of
employment and compensation are negotiated in light of an individual's previous
experience, the prevailing market conditions and, where applicable, collective
bargaining agreements. The Company also obtains locations, sets and
post-production personnel and facilities on an as-needed basis by paying
prevailing rates. The Company believes that production and post-production
personnel and facilities are in ample supply at competitive rates.
The production of animated programming is a labor intensive process that
commences with artistic sketches of the various characters and the story line.
Storyboards, models, songs and voice elements are then sent to various
production companies, typically in Asia, where drawings of the animation frames
are prepared. The frames are painted and then subsequently photographed to
create film. The film is then usually sent back to the United States, where
final editing of footage and mixing of sound effects, dialogue and music is
completed, although on occasion final editing and mixing may be completed in
Asia.
The following table summarizes the Company's television programming for
fiscal year 1996, the type of program and the network where such programming
initially exhibited or will exhibit:
<TABLE>
<CAPTION>
FIRST
TITLE TYPE OF PROGRAM EXHIBITION
- -------------------------------------- --------------------- --------------
<S> <C> <C>
JACK REED IV: A KILLER AMONGST US Movie-of-the-week NBC
JACK REED V: DEATH AND VENGEANCE Movie-of-the-week NBC
PRINCESS IN LOVE Movie-of-the-week CBS
ECHO Movie-of-the-week ABC
EVERY WOMAN'S DREAM Movie-of-the-week CBS
A HUSBAND, A WIFE AND A LOVER Movie-of-the-week CBS
INNOCENT VICTIMS Mini-series ABC
COULD IT BE A MIRACLE One-hour Series Syndication
</TABLE>
14
<PAGE>
The following table summarizes the Company's television programming for
fiscal year 1997 which are in pre-production or production, or scheduled to air,
or have aired, after September 30, 1996, the type of program and the network
where such programming initially exhibited or will exhibit:
<TABLE>
<CAPTION>
FIRST
TITLE TYPE OF PROGRAM EXHIBITION
- -------------------------------------- --------------------- --------------
<S> <C> <C>
THE GUN One-hour Series ABC
UNLIKELY ANGEL Movie-of-the-week CBS
COULD IT BE A MIRACLE One hour Series Syndication
MOWGLI: JUNGLE BOOK 1/2 hour Series Fox
EROTIC CONFESSIONS 1/2 hour Series HBO
</TABLE>
There is no assurance that any television program which has nor yet aired
will be aired, that a change in the scheduled airing date of such programming
will not occur or, if such television program is aired, that it will be
successful.
TELEVISION PROJECTS IN DEVELOPMENT
The Company's results of operations largely depend on its having adequate
access to program concepts, ideas and scripts that are capable of being
acquired, produced and successfully marketed. Such access is dependent upon
numerous factors, including the reputation and credibility of the Company in the
creative community, the relationships the Company has in the entertainment
industry and the Company's financial and other resources. In order to provide a
supply of ideas and projects, the Company from time to time enters into
agreements with producers and writers for the purpose of developing or acquiring
new programming. While the Company may finance the early development of its
projects, the Company typically does not proceed with the preparation of a
script or the production of a pilot, which involves a more significant financial
commitment, unless a network or other buyer has agreed to fund all or a
substantial portion of the costs associated therewith.
The following table sets forth potential television movies and television
series in various stages of development:
<TABLE>
<CAPTION>
WORKING TITLE NETWORK TYPE OF PROGRAM
- -------------------------------------- ----------------------- ---------------------
<S> <C> <C>
PRODIGAL SON CBS Movie-of-the-week
ROGERS AND HART WOMAN CBS Movie-of-the-week
BEAT COP FOX Movie-of-the-week
IF I CAN'T HAVE YOU ABC Movie-of-the-week
JACK LONDON USA Movie-of-the-week
FAST TRACK ABC Movie-of-the-week
DOWN THE ROAD HBO Original movie
JACK REED VI NBC Movie-of-the-week
COME HERE CBS Movie-of-the-week
THE LIFE SHE LEFT BEHIND ABC Movie-of-the-week
THE MALL NBC Movie-of-the-week
CHILDREN USA Movie-of-the-week
FAMILY IN FEAR USA Movie-of-the-week
MIKE HAMMER Syndication or Cable One Hour Series
CRACKER ABC One Hour Series
SILICON VALLEY ABC One Hour Series
</TABLE>
15
<PAGE>
Although the Company has numerous projects in development, as is typical in
the industry, only a relatively small number of such projects are ultimately
produced (with the likelihood of production being more remote in the case of
television series), and it is rare for any projects in development to have
production commitments until late in the development process. There is no
assurance that the Company's efforts in developing or acquiring potential new
programs, including any of the projects in development described above, will
lead to production commitments or that any programs that are ultimately produced
will be successful.
TELEVISION DISTRIBUTION ACTIVITIES
DOMESTIC DISTRIBUTION. The Company's original programming generally has
been initially licensed to a network or cable broadcaster for a period expiring
on the earlier of two network broadcasts or a license period of up to four years
from delivery. Following the expiration of the license, the rights typically
revert to the Company's library and become available for additional licensing.
Further revenues may be sought from subsequent licensing in the domestic market
in other media, including syndication, cable and home video.
INTERNATIONAL DISTRIBUTION. In August 1991, the Company added experienced
personnel and commenced the distribution licensing of its own television
programming and, to a lesser extent, acquired television programs for
distribution in international markets. Prior to such time the Company generally
utilized third parties to arrange for the distribution of its television
programming in international markets. Programming is distributed primarily to
local international broadcasters and, where appropriate, for the home video
market, pay television and cable services. The establishment of the Company's
international television distribution operation has increased its ability to
cover the costs of new programs and to retain the fees and profit potential
previously realized by outside distributors through the control of the
distribution of its own television programming, including the ability to package
such product for distribution in different media. The Company also believes the
establishment of its international television distribution operation will enable
it to increase its activity as a distributor of programs produced by others. In
December 1994, the Company expanded its activities in international distribution
by hiring personnel from August Entertainment, Inc., who are experienced in
feature film sales. This combined division now gives the Company more control
over the marketing of its product line and allows the Company to be more
responsive to its customers on a more cost effective basis. In June 1995, the
Company hired Marvinia Anderson from World International Network to enhance its
television sales.
The Company's strategy has been to remove more of its business risks in
international territories by locking in its business relationships with strong
local distributors and broadcasters. The Company has recently entered into
output arrangements in certain foreign territories with broadcasters and
distributors who have agreed to license distribution rights in such territories
for the Company's product for the next three to five years at a fixed price for
specified types of film or television product.
LIBRARY
Since its inception in 1983, the Company has produced for itself and others
or acquired more than 1,000 hours of television programming. In addition, as a
producer for hire, the Company among other productions produced 860 episodes of
DIVORCE COURT, 65 episodes of the NIGHT GAMES game show, 34 episodes of the
children's game show THE KRYPTON FACTOR, the animated feature film POUND
PUPPIES: THE LEGEND OF BIG PAW and the FAMILY DOG episode of Steven Spielberg's
AMAZING STORIES.
The Company's current library includes a variety of feature films,
movies-for-television, television series, game shows and talk shows produced or
acquired by the Company since its inception. The following
16
<PAGE>
table sets forth, as of September 30, 1996, certain feature films and television
programming in which the Company has ownership rights, distribution rights or
the right to share in future profit participation:
FEATURE FILM
<TABLE>
<CAPTION>
TITLE NUMBER PRODUCED FIRST EXHIBITION
- ---------------------------------------- ---------------- ----------------
<S> <C> <C>
ANIMALYMPICS 1 NBC
THE BRAVE LITTLE TOASTER 1 Disney Channel
ANDRE 1 Theatrical
BABYSITTERS 1 Home Video
CAFE SOCIETY 1 Showtime
CLOSER, THE 1 Theatrical
CYBERELLA 1 Home Video
DEADLY EXPOSURE 1 Home Video
DRAGON WORLD II 1 Home Video
DREAM MASTER 1 Home Video
EGGS FROM 70 MILLION B.C. 1 Home Video
FLESH SUITCASE 1 Home Video
FREEWAY 1 Pay Cable
GENIE 1 Home Video
THE GRAVE 1 Pay Cable
THE HUMAN PETS 1 Home Video
INDECENT BEHAVIOR 1 Home Video
JOHNNY MYSTO: BOY WIZARD 1 Home Video
JOURNEY TO THE MAGIC CAVERN 1 Home Video
KID MIDAS 1 Home Video
LADY-IN-WAITING 1 Home Video
LAST GASP 1 Home Video
LAST BATTLE FOR THE UNIVERSE 1 Home Video
THE LAST TIME I COMMITTED SUICIDE 1 Theatrical
LITTLE GHOST 1 Home Video
LOST WORLD OF THE GIANTS 1 Home Video
MEDIUM RARE 1 Home Video
MESMER 1 Home Video
NAKED SOULS 1 Home Video
OBLIVION 1 HBO
THE ADVENTURES OF PINOCCHIO 1 Theatrical
PLANET OF THE DINO-KNIGHTS 1 Home Video
RED HOT 1 Home Video
RED RIBBON BLUES 1 Cable/Home Video
SENSATION 1 HBO
SERPENT'S LAIR 1 Pay Cable
SHRUNKEN HEADS 1 Home Video
TEST TUBE TEENS 1 Home Video
TRAPPED IN TOYWORLD 1 Home Video
WES CRAVEN PRESENTS: MINDRIPPER 1 Home Video
THE WHOLE WIDE WORLD 1 Theatrical
ALIEN ABDUCTION 1 Cable/Home Video
ANGEL OF PASSION 1 Cable/Home Video
BANISHED BEHIND BARS 1 Cable/Home Video
BARE EXPOSURE 1 Cable/Home Video
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
TITLE NUMBER PRODUCED FIRST EXHIBITION
- ---------------------------------------- ---------------- ----------------
<S> <C> <C>
BIKINI DRIVE IN 1 Cable/Home Video
BLONDE HEAVEN 1 Cable/Home Video
CAGED HEARTS 1 Cable/Home Video
CALL GIRL 1 Cable/Home Video
CAVE GIRL ISLAND 1 Cable/Home Video
CELLBLOCK SISTERS 1 Cable/Home Video
CENTERFOLD 1 Cable/Home Video
DONOR, THE 1 Cable/Home Video
ELECTRA 1 Cable/Home Video
ELKE'S EROTIC NIGHTS 1 Cable/Home Video
FORBIDDEN GAMES 1 Cable/Home Video
HARD BOUNTY 1 Cable/Home Video
ILLICIT DREAMS II 1 Cable/Home Video
IMPROPER CONDUCT 1 Cable/Home Video
INNOCENCE BETRAYED 1 Cable/Home Video
INTERNATIONAL BEACH 1 Cable/Home Video
IRRESISTIBLE IMPULSE 1 Cable/Home Video
JACKO 1 Cable/Home Video
JUNGLE LAW 1 Cable/Home Video
LAP DANCER 1 Cable/Home Video
LOVE ME TWICE 1 Cable/Home Video
LOVER'S CONCERTO 1 Cable/Home Video
LURID TALES 1 Cable/Home Video
MASSEUSE, THE 1 Cable/Home Video
MIAMI MODELS 1 Cable/Home Video
MIDNIGHT CONFESSIONS 1 Cable/Home Video
MIDNIGHT TEASE II 1 Cable/Home Video
MIDNIGHT TEMPTATIONS 1 Cable/Home Video
PETTICOAT PLANET 1 Cable/Home Video
PLEASURE IN PARADISE 1 Cable/Home Video
POWDER BURN 1 Cable/Home Video
PRELUDE TO LOVE 1 Cable/Home Video
PRIVATE OBSESSION 1 Cable/Home Video
PROFESSIONAL AFFAIR 1 Cable/Home Video
RAVEN'S KISS 1 Cable/Home Video
SECOND SIGHT 1 Cable/Home Video
SEDUCTION OF INNOCENCE 1 Cable/Home Video
SENSUOUS SUMMER 1 Cable/Home Video
SHADOW DANCER 1 Cable/Home Video
SIREN'S KISS 1 Cable/Home Video
SOFTBODIES, THE MOVIE 1 Cable/Home Video
SPIRIT OF THE NIGHT 1 Cable/Home Video
STOLEN HEART 1 Cable/Home Video
TARGET OF SEDUCTION 1 Cable/Home Video
TOTALLY EXPOSED 1 Cable/Home Video
TROPICAL TEASE 1 Cable/Home Video
UNDER LOCK AND KEY 1 Cable/Home Video
UNDER THE GUN 1 Cable/Home Video
UNINHIBITED 1 Cable/Home Video
VIRTUAL DESIRE 1 Cable/Home Video
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
TITLE NUMBER PRODUCED FIRST EXHIBITION
- ---------------------------------------- ---------------- ----------------
<S> <C> <C>
WAGER OF LOVE 1 Cable/Home Video
</TABLE>
TELEVISION MOVIES AND MINI-SERIES
<TABLE>
<CAPTION>
TITLE NUMBER PRODUCED FIRST EXHIBITION
- ---------------------------------------- ---------------- ----------------
<S> <C> <C>
ALADDIN 1 International
GLORY YEARS 6 HBO
FAMILY PICTURES 1 ABC
JFK: RECKLESS YOUTH 1 ABC
CAROLINA SKELETONS 1 NBC
CONFESSIONS: TWO FACES OF EVIL 1 NBC
FATHER AND SON: DANGEROUS RELATIONS 1 NBC
FIRE IN THE DARK 1 CBS
GETTING GOTTI: THE DIANE GIACALONE STORY 1 CBS
GOOD COPS, BAD COPS 1 NBC
JACK REED III: A SEARCH FOR JUSTICE 1 NBC
JACK REED IV: A KILLER AMONGST US 1 NBC
JACK REED V: DEATH AND VENGEANCE 1 NBC
DANGEROUS INTENTIONS 1 CBS
LADY KILLER 1 CBS
MURDER C.O.D. 1 NBC
KISS SHOT 1 CBS
LIBERACE: BEHIND THE MUSIC 1 CBS
OVERRULED 1 NBC
SINS OF THE MOTHER 1 CBS
SWEET BIRD OF YOUTH 1 NBC
THEN THERE WERE GIANTS 1 NBC
TO SAVE THE CHILDREN 1 CBS
YOUR MOTHER WEARS COMBAT BOOTS 1 NBC
CANDLES IN THE DARK 1 Family Channel
CITY BOY 1 PBS
EVERY WOMAN'S DREAM 1 CBS
A HUSBAND, A WIFE AND A LOVER 1 CBS
INNOCENT VICTIMS 1 NBC
PRINCESS IN LOVE 1 CBS
ECHO 1 ABC
UNLIKELY ANGEL 1 CBS
</TABLE>
TELEVISION SERIES/GAME SHOW
<TABLE>
<CAPTION>
TITLE EPISODES PRODUCED FIRST EXHIBITION
- ----------------------------------------------- ------------------------- ---------------------
<S> <C> <C>
SWEATING BULLETS 66 CBS
PIGASSO'S PLACE 13 Syndication
TEEN WOLF 21 CBS
MAPLETOWN 39 Syndication
CINEMATRACTIONS 26 Syndication
1ST AND TEN 80 HBO
HARTS OF THE WEST 15 CBS
TRIAL WATCH 118 NBC
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
TITLE EPISODES PRODUCED FIRST EXHIBITION
- ----------------------------------------------- ------------------------- ---------------------
THE BARBARA DE ANGELIS SHOW 70 CBS
<S> <C> <C>
HEROES: MADE IN THE USA 38 Syndication
PROFILES--UNAUTHORIZED BIOGRAPHIES 4 A&E
RELATIVELY SPEAKING 90 Syndication
EROTIC CONFESSIONS 26 HBO
MIRACLES 24 Syndication
</TABLE>
At any given time, a significant portion of the Company's library will be
under license in many of the major domestic and international markets. For
example, in fiscal 1996 the Company licensed portions of its libraries in
Germany and Spain. Following the expiration of the licenses, rights generally
revert to the Company where the Company is the copyright owner for resale in the
second cycle.
JOINT VENTURES TO EXPLOIT ANCILLARY MARKETS
The Company has expanded its business through joint ventures and
partnerships into areas which exploit the characters and story ideas in its
feature films and television programs. These activities provide additional
sources of revenues in certain cases without significant additional associated
expenses. The Company is actively marketing the music used in its productions
through an arrangement with Cherry Lane Music, Inc., a music publisher. In
addition, the Company has entered into an agreement with Decca Records, a
division of Polygram, to distribute the soundtrack of THE ADVENTURES OF
PINOCCHIO, which includes two original recordings by Stevie Wonder. Concepts
used in films are being developed into CD-ROM computer games under an agreement
with IBM. Using its expertise as a television producer, the Company has two
infomercials in production through a partnership known as TVFirst. One
infomercial is a Christian music infomercial in which a recording of Christian
music sung by Contemporary Christian artists is marketed. This infomercial has
been airing since March 1996 under the name KEEP THE FAITH. The results have
been favorable through September 30, 1996 with sales in excess of $7 million for
calendar year 1996. The other infomercial is a work-in-process on the subject of
personal relationships which is not currently being marketed. Responding to the
increased demand for product by the pay-per-view, telephone delivery, pay cable
and basic cable services, the Company formed a joint venture called KLC/New City
Tele-Ventures to acquire product from third parties for distribution in the
cable, pay service and satellite markets, as well as other emerging markets. The
joint venture has acquired over 75 films for this purpose as of December 23,
1996.
GOVERNMENT REGULATIONS
In a decision released September 6, 1995, the FCC repealed its financial
interest and syndication rules effective as of September 21, 1995. Those FCC
rules, which were adopted in 1970 to limit television network control over
television programming and thereby foster the development of diverse programming
sources, restricted the ability of the three established, major U.S. television
networks (i.e., ABC, CBS and NBC), to own and syndicate television programming.
The ultimate impact of the repeal of the FCC's financial interest and
syndication rules on the Company's operations cannot be predicted at the present
time, although there has been an increase in in-house productions of programming
for the networks' own use since the effective date of the repeal of the FCC's
financial interest and syndication rules.
Under the Telecommunications Act of 1996 (the "1996 Act"), manufacturers of
television set equipment will be required to equip all new television receivers
with a so-called "V-Chip" which would allow for parental blocking of violent,
sexually-explicit or indecent programming based on a rating for any given
program that would be broadcast along with the program. Unless the television
industry establishes a voluntary ratings system by February 1997, the FCC is
directed by the 1996 Act to develop a ratings system based upon the
recommendations of an advisory committee selected by the FCC. A coalition of
various segments of the entertainment industry has introduced its proposed
ratings guidelines in December 1996.
20
<PAGE>
The FCC and other regulatory and governmental agencies currently have these
suggested ratings guidelines under review. Other provisions of the 1996 Act
revise the broadcast multiple ownership rules, allow local exchange telephone
companies to offer multichannel video programming service, subject to certain
regulatory requirements, and allow for cable companies to offer local exchange
telephone service, subject to certain regulatory requirements.
The impact on the Company of the changes brought about by the 1996 Act,
including the ratings guidelines proposed by the television industry, and by
accompanying changes in FCC rules cannot be predicted at the present time,
although it is expected that there will be an increase in the demand for video
programming product as a result of the likelihood that these regulatory changes
will facilitate the advent of additional exhibition sources for such
programming. However, it is possible that recent alliances of certain program
producers and television station group owners, coupled with the recent FCC rule
revisions allowing a single television station licensee to own television
stations reaching up to 35% of the nation's television households, may place
additional competitive pressures on program suppliers, such as the Company, to
the extent they are unaligned with the major networks or any television station
group owners.
In international markets, the Company's programming may be subject to local
content and quota requirements, and/or other limitations, which prohibit or
limit the amount of programming produced outside of the local market. Although
the Company believes these requirements have not affected the Company's
licensing of its programs in international markets to date, such restrictions,
or new or different restrictions, could have an adverse impact on the Company's
operations in the future should opportunities to obtain foreign content not be
available.
2. PROPERTIES
The Company leases approximately 23,000 square feet of office space on the
20th and 21st floors at 11601 Wilshire Boulevard, Los Angeles, California under
a lease agreement through March 31, 2000. The annual rent under the lease is
approximately $527,500. The Company's film service subsidiary, Kushner Locke
International (U.K.) Limited, leases approximately 560 square feet of office
space at 83 Marylebone High Street in London, United Kingdom under a lease
agreement through June 24, 2000. The annual rent under this lease is
approximately $13,825 (L8,400).
The Company rents studio facilities as needed for production, except that
certain post-production off-line editing is performed at the Company's executive
offices.
3. LEGAL PROCEEDINGS
The Company is party to certain legal proceedings and claims arising out of
the normal course of business. The Company believes that the ultimate resolution
of all of these matters will not have a material adverse effect upon the
Company's financial position, results of operations or liquidity.
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the fiscal year covered by this report.
PART II
5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the NASDAQ National Market ("NNM")
under the symbol "KLOC." Additionally, the stock is listed on the Pacific Stock
Exchange under the symbol "KLO."
21
<PAGE>
The following table sets forth the range of high and low sale price for the
Common Stock, as reported on the NNM, for the periods indicated.
<TABLE>
<CAPTION>
COMMON
STOCK
----------
HIGH LOW
---- ----
<S> <C> <C>
FISCAL 1995
First Quarter (ended December 31,
1994).................................. 1.03 0.69
Second Quarter (ended March 31, 1995)... 0.97 0.69
Third Quarter (ended June 30, 1995)..... 0.88 0.69
Fourth Quarter (ended September 30,
1995).................................. 0.81 0.50
FISCAL 1996
First Quarter (ended December 31,
1995).................................. 0.75 0.47
Second Quarter (ended March 31, 1996)... 1.06 0.58
Third Quarter (ended June 30, 1996)..... 1.50 0.91
Fourth Quarter (ended September 30,
1996).................................. 1.44 0.56
FISCAL 1997
First Quarter (through December 23,
1996).................................. 0.71 0.38
</TABLE>
On December 23, 1996, the last sale price for the Common Stock as reported
on the NNM was $0.41 for the Common Stock. At December 23, 1996, there were
approximately 775 record holders of the Common Stock.
In a notice to its members in November 1996, the Board of Directors of the
Nasdaq National Stock Market, Inc. informed its members that it had approved
certain changes to the entry and maintenance standards for the NNM and the
NASDAQ SmallCap Market. The Board of Directors has solicited comments on such
proposed changes and is currently reviewing such comments. Included in such
proposed changes would be the removal of an alternative to the $1 minimum bid
price maintenance standard. If such proposal were to be adopted and implemented,
as to which there is no assurance, the Company could be subject to delisting
from the NNM if its bid price remained below $1.00. The Company is considering
alternatives, including the possibility of a reverse stock split, to meet such
proposed maintenance standards. There is no assurance that the Company will be
able to implement any such alternatives or, if necessary, obtain the approval of
the shareholders of the Company for such an alternative.
DIVIDENDS
The Company has never paid any cash dividends and has no present intention
to declare or to pay cash dividends. The payment of dividends also is restricted
by covenants in the Company's credit agreement and the indentures and fiscal
agency agreements under which the Company's Convertible Subordinated Debentures
were issued. It is the present policy of the Company to retain any earnings to
finance the growth and development of the Company's business.
6. SELECTED FINANCIAL DATA
The following table summarizes selected consolidated financial data for the
Company and should be read in conjunction with the certain detailed consolidated
financial statements included elsewhere in this Annual Report. The selected
consolidated financial data for the fiscal years are derived from the
consolidated financial statements audited by KPMG Peat Marwick LLP, independent
certified public accountants, whose report with respect to the consolidated
balance sheets of the Company as of September 30, 1996 and 1995, and the related
consolidated statements of operations, cash flows and stockholders' equity for
each of the years in the three year period ended September 30, 1996 appears
elsewhere in this Annual Report.
22
<PAGE>
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Operating revenues...................... $ 80,157 $ 20,407 $ 50,736 $ 42,487 $ 24,052
Costs relating to operating revenues.... (70,648) (17,404) (54,952) (41,497) (20,082)
Selling, general and administrative
expenses.............................. (3,595) (3,838) (3,208) (2,797) (2,441)
-------- -------- -------- -------- --------
Earnings/(loss) from operations......... 5,914 (835) (7,424) (1,807) 1,529
Interest income......................... 198 300 197 78 54
Interest expense........................ (4,027) (3,409) (2,209) (1,173) (1,217)
Interest expense related to bridge note
financing............................. (943) -- -- -- --
-------- -------- -------- -------- --------
Earnings/(loss) before income taxes and
cumulative effect of a change in
accounting principle and extraordinary
item.................................. 1,142 (3,944) (9,436) (2,902) 366
Income taxes............................ (47) (31) 2,277 1,076 (122)
-------- -------- -------- -------- --------
Earnings/(loss) before cumulative effect
of a change in accounting principle
and extraordinary item................ 1,095 (3,975) (7,159) (1,826) 244
Cumulative effect of a change in
accounting for income taxes........... -- -- 394 -- --
-------- -------- -------- -------- --------
1,095 (3,975) (6,765) (1,826) 244
Extraordinary item: costs associated
with repayment of credit facility..... (365) -- -- -- --
-------- -------- -------- -------- --------
Net earnings/(loss)..................... $ 730 $ (3,975) $ (6,765) $ (1,826) $ 244
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Earnings/(loss) per common and common
equivalent share:
Before cumulative effect of a change in
accounting for income taxes and
extraordinary items................... $ .03 $ (.13) $ (.24) $ (.06) $ .01
Cumulative effect of a change in
accounting for income taxes........... -- -- .01 -- --
Extraordinary item...................... (.01) -- -- -- --
-------- -------- -------- -------- --------
Net earnings/(loss)..................... $ .02 $ (.13) $ (.23) $ (.06) $ .01
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Weighted average number of common and
common equivalent shares
outstanding........................... 40,013 31,713 29,373 28,372 20,958
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
23
<PAGE>
CONDENSED CONSOLIDATED BALANCE SHEET DATA:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------------------
1996 1995 1994 1993 1992
-------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents............... $ 11,636(1) $ 4,301(1) $15,681 $ 6,542 $ 2,491
Accounts receivable, net................ 22,885 7,864 6,177 5,360 2,936
Film costs, net of accumulated
amortization........................... 58,463 73,716 30,688 43,031 42,680
Total assets............................ 100,152 88,952 54,254 56,131 49,847
Notes payable........................... 41,481 28,398 9,600 8,007 5,582
Convertible subordinated debentures,
net.................................... 12,039 17,745 22,056 4,296 4,942
Total liabilities....................... 65,902 69,745 35,713 32,252 31,674
Stockholders' equity.................... 34,250 19,207 18,541 23,879 18,173
</TABLE>
- ------------------------
(1) $419 of cash and cash equivalents are restricted deposits that are
collateral for certain production loans for 1996 ($1,162 for 1995) and
$4,126 for 1996 is cash collected by the Company and reserved for use by
Chase Manhattan Bank to pay down outstanding borrowings under the Company's
credit facility.
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
The Company's revenues are currently derived primarily from the production
or the acquisition of distribution rights of films released in the U.S. by
studios, pay cable, basic cable and videocassette companies; and from the
development, production and distribution of television programming for the major
U.S. television networks, basic and pay cable television and first-run
syndication; as well as from the licensing of all rights to the films and
television programs in international territories. While the Company generally
finances all or a substantial portion of the budgeted production costs of its
programming through domestic and international licensing and other arrangements,
the Company typically retains rights in its programming which may be exploited
in future periods or in additional territories. In April 1993, the Company
established a feature film operation to produce low and medium budget films for
theatrical and/ or home video or cable release. The Company produces a limited
number of higher-budget theatrical films to the extent the Company is able to
obtain an acceptable domestic studio to release the film theatrically in the
U.S.
The Company's revenues and results of operations are significantly affected
by accounting policies required for the industry and management's estimates of
the ultimate realizable value of its films and programs (See Note 1 of Notes to
Consolidated Financial Statements). Production advances or license fees received
prior to delivery or completion of a program are treated as deferred revenues
and are recorded as either production advances or deferred license fees.
Production advances are generally recognized as revenue on the date the program
is delivered or available for delivery. Deferred license fees are recognized as
revenue on the date of availability and/or delivery of the item of product.
The Company generally capitalizes all costs incurred to produce a film. Such
costs include the actual direct costs of production, certain exploitation costs,
production overhead, and interest expense relating to financing the project.
Capitalized exploitation or distribution costs include those costs that clearly
benefit future periods such as film prints and prerelease and early release
advertising that is expected to benefit the film in future markets. These costs,
as well as participation and talent residuals, are amortized each period on an
individual film or television program basis in the ratio that the current
period's gross revenues from all sources for the program bear to management's
estimate of anticipated total gross revenues for such film or program from all
sources. In the event management reduces its estimates of the
24
<PAGE>
future gross revenues associated with a particular item of product, which had
been expected to yield greater future proceeds, a significant write-down and a
corresponding decrease in the Company's earnings for the quarter and fiscal year
end in which such write-down is taken could result. See "Results of
Operations--Comparison of Fiscal Years Ended September 30, 1996 and 1995" and
"Results of Operations--Comparison of Fiscal Years Ended September 30, 1995 and
1994."
Gross profits for any period are a function in part of the number of
programs delivered in that period and the recognition of costs in that period.
Because initial licensing revenues and related costs generally are recognized
either when the program has been delivered or is available for delivery,
significant fluctuations in revenues and net earnings may occur from period to
period. Thus, a change in the amount of entertainment product available for
delivery from period to period has materially affected a given period's revenues
and results of operations and year-to-year results may not be comparable. The
continuing shift of the Company's product mix during the fiscal year may further
affect the Company's quarter-to-quarter or year-to-year results of operations as
new products may be amortized differently as determined by length of product
life cycle and the number of related revenue sources. Film costs, net of
accumulated amortization, decreased to $58,463,000 at September 30, 1996 from
$73,716,000 at September 30, 1995. Film costs in process or development at
September 30, 1996 decreased to $16,527,000 from $42,115,000 at ending September
30, 1995. See "Results of Operations--Comparison of Fiscal Years Ended September
30, 1996 and 1995" below.
RESULTS OF OPERATIONS
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1996 AND 1995
The Company's operating revenues for the fiscal year ended September 30,
1996 were $80,157,000, an increase of $59,750,000 or approximately 292%, from
$20,407,000 from the prior fiscal year. The increase was due primarily to the
delivery and/or availability of a substantially increased slate of films and
television programs. The Company shifted its product mix during fiscal 1996
towards an increased number of feature films due to opportunities available to
the Company.
The Company recognized approximately $44,100,000, or approximately 55%, of
revenues during fiscal 1996 from the delivery and/or availability of 16 feature
films, including approximately $26,300,000 from the initial release of the
feature film THE ADVENTURES OF PINOCCHIO (with certain anticipated revenues to
be recognized in fiscal 1997) and approximately $9,000,000 from the films
SERPENT'S LAIR starring Jeff Fahey, THE GRAVE starring Gabrielle Anwar, Eric
Roberts and Craig Sheffer, FREEWAY executive produced by Oliver Stone and
starring Reese Witherspoon, Keifer Sutherland and Brooke Shields, THE WHOLE WIDE
WORLD starring Vincent D'Onofrio and Renee Zellweger and being distributed in
the U.S. by Sony Classics, and THE LAST TIME I COMMITTED SUICIDE starring Keanu
Reeves. In addition, the Company recognized approximately $22,800,000, or
approximately 28% of revenues during fiscal 1996 from the delivery and/or
availability of 4 network movies, the network mini-series INNOCENT VICTIMS and
the network pilot for the Company's mid-season series THE GUN, including,
approximately $13,700,000 for the Company's four television network movies
including PRINCESS IN LOVE, starring Julie Cox in the book version of Princess
Diana's affair, for CBS, EVERY WOMAN'S DREAM starring Jeff Fahey for CBS, A
HUSBAND, A WIFE AND A LOVER starring Judith Light, for CBS and ECHO starring
Jack Wagner, for ABC. Twelve other film and video projects generated
approximately $8,800,000, or approximately 11%, of revenues during fiscal 1996.
In addition, the Company recognized approximately $4,100,000, or approximately
5%, of revenues from distribution to domestic cable for films acquired through
KLC/New City. The Company also recognized additional revenues from continuing
licenses of completed product from the Company's library to foreign
distributors, domestic cable channel operators and international
sub-distributors and from the national rollout of an infomercial marketing
contemporary Christian music on compact discs.
Operating revenues for fiscal 1995 were primarily attributable to the
delivery and/or availability of the three low budget feature films LADY IN
WAITING, THE LAST GASP and WES CRAVEN PRESENTS: MINDRIPPER to
25
<PAGE>
WarnerVision and approximately $9,500,000 for the three television network
movies Dangerous Intentions for CBS, LADY KILLER for CBS and JACK REED IV: A
KILLER AMONGST US for NBC. The majority of remaining revenues for the period
came from the release of six adult thriller direct-to-video films; from two
fantasy adventure feature films for Paramount Pictures under the banner JOSH
KIRBY: TIME WARRIOR; and from continuing sales of licenses for completed product
from the Company's library of titles to international distributors.
In various stages of production for the Company's fiscal 1997 slate are (a)
the feature film BASIL starring Christian Slater, (b) the feature film WAITING
FOR THE MAN starring Rae Dawn Chong and Darren McGavin, (c) a film executive
produced by Oliver Stone, (d) the two animated feature films for Buena Vista
Home Video, a division of the Walt Disney Company, entitled BRAVE LITTLE TOASTER
GOES TO MARS and BRAVE LITTLE TOASTER GOES TO SCHOOL, that are sequels to the
successful direct-to-video title THE BRAVE LITTLE TOASTER, and (e) five
additional titles of the direct to video MAGIC ADVENTURES series. The Company is
also producing six one hour prime time episodes of a mid-season replacement
series for ABC entitled THE GUN, including episodes starring Jennifer Tilly,
Randy Quaid, Darryl Hannah and Rosanna Arquette. In addition, the Company
continues to acquire domestic cable rights for films for distribution through a
joint venture called KLC/New City and the international distribution rights to
films for distribution through Kushner Locke International, Inc.
Costs relating to operating revenues were $70,648,000 during fiscal 1996 as
compared to $17,404,000 during fiscal 1995. As a percentage of operating
revenues, costs relating to operating revenues were approximately 88% for fiscal
1996 compared to approximately 85% for fiscal 1995. During the fourth quarter of
fiscal 1996, the Company revised its estimates of the future revenues of certain
film and television product resulting in a net decrease of the carrying value of
film and television inventory of approximately $500,000. Without such reduction,
costs relating to operating revenues would have been approximately $70,148,000
for fiscal 1996. During the fourth quarter of 1995, the Company revised its
estimates of future revenues for certain older television programs which
resulted in reductions of the carrying value of such programs and an expense of
approximately $888,000 recorded during the fourth quarter of fiscal 1995.
Without such reduction, costs related to operating revenues would have been
approximately $16,500,000,000 approximately 81% of revenues for fiscal 1995.
Selling, general and administrative expenses decreased to $3,595,000 in
fiscal 1996 compared to $3,838,000 in fiscal 1995. This decrease resulted from
the capitalization of certain production overhead items to theatrical,
television and cable product partially offset by an overall increase in staffing
and personnel costs.
Interest expense for the year ended September 30, 1996 was $4,970,000 as
compared to $3,409,000 for the year ended September 30, 1995. The increase was
primarily due to a $943,000 charge to interest expense related to the issuance
of shares of common stock as part of the refinancing of Bridge Notes issued by
the Company, plus an approximately $365,000 charge relating to the repayment of
the Company's previous $15 million credit facility for fees including a non-cash
charge of $65,000 related to the issuance of warrants to the former lender and
the increased interest costs associated with the higher amount of borrowings
under the new credit facility. The previous credit facility was replaced by an
increased $40 million credit facility led by The Chase Manhattan Bank. Total
indebtedness for borrowed money increased to $53,520,000 at September 30, 1996
from $46,143,000 at September 30, 1995 due to increased production borrowings to
finance a larger off-balance-sheet production slate, including THE ADVENTURES OF
PINNOCHIO and MAGIC ADVENTURES. The weighted average interest rate under the
line of credit was 9.98% during fiscal 1996 compared to 10% during fiscal 1995,
while the Convertible Subordinated Debentures Series A, Series B, 8% and 9% bear
interest fixed at 10%, 13 3/4%, 8% and 9%, respectively.
The Company's effective income tax rate was 4% for the year ended September
30, 1996 compared to an effective income tax rate of approximately 1% for the
year ended September 30, 1995. At September 30,
26
<PAGE>
1996, the Company had net operating loss carryforwards of approximately
$33,030,000 for federal tax purposes compared to $24,631,000 at September 30,
1995. Such carryforwards expire in fiscal 2011.
The Company reported net earnings of $730,000, or $.02 per share, for the
fiscal year ended September 30, 1996, and a net loss of ($3,975,000), or ($.13)
per share, for the fiscal year ended September 30, 1995. The loss in fiscal 1995
resulted primarily from the above described non-cash reductions in the carrying
value of certain programs no longer being produced by the Company and the
increased interest expense and amortization of capitalized issuance costs. The
losses in fiscal 1995 were impacted by certain expenses associated with the
large amount of development and production of work in process scheduled to be
delivered after the 1995 fiscal year and the expansion of the Company's feature
film and international distribution divisions.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1995 AND 1994
The Company's operating revenues for the fiscal year ended September 30,
1995 were $20,407,000, a decrease of $30,329,000, or 60%, from $50,736,000 from
the prior fiscal year. This decrease was due primarily to the timing of delivery
and/or availability of films and television programs. The Company had shifted
its current product mix towards a greater percentage of feature films due to
opportunities available to the Company. Feature films generally have a longer
lead time than television programs from the time of financial commitment to the
recognition of related revenues.
The Company recognized approximately $4,000,000 of revenues during fiscal
1995 from the delivery and/or availability of the three low budget feature films
LADY IN WAITING, THE LAST GASP and WES CRAVEN PRESENTS: MINDRIPPER to
WarnerVision and approximately $9,500,000 for the three television network
movies DANGEROUS INTENTIONS for CBS, LADY KILLER for CBS and JACK REED IV: A
KILLER AMONGST US for NBC. The majority of remaining revenues for the period
came from the release of six adult thriller direct-to-video films; from two
fantasy adventure feature films for Paramount Pictures under the banner JOSH
KIRBY: TIME WARRIOR; and from continuing sales of licenses for completed product
from the Company's library of titles to international distributors.
Operating revenues for fiscal 1994 were primarily attributable to the
delivery and/or availability of the major theatrical feature film Andre of
approximately $10,000,000, the three network television movies TO SAVE THE
CHILDREN for CBS, GETTING GOTTI for CBS, and JACK REED III: A SEARCH FOR JUSTICE
for NBC of approximately $9,300,000, and to the network mini-series JFK:
RECKLESS YOUTH for ABC of approximately $9,300,000. The Company also recognized
approximately $14,500,000 of revenues from the delivery and/or commencement of
distribution of fifteen episodes of the television series HARTS OF THE WEST for
CBS.
Costs relating to operating revenues were $17,404,000 during fiscal 1995 as
compared to $54,952,000 during fiscal 1994. As a percentage of operating
revenues, costs relating to operating revenues were approximately 85% for fiscal
1995 compared to approximately 108% for fiscal 1994. During the fourth quarter
of fiscal 1995, the Company revised its estimate of future revenue for certain
older television programs which resulted in reductions of the carrying value of
such programs and an expense of approximately $888,000 recorded during the
fourth quarter of fiscal 1995. Without such reductions, costs related to
operating revenues would have been approximately $16,516,000, or approximately
81% of revenues for fiscal 1995. During the fourth quarter of fiscal 1994, the
Company revised its estimate of future revenue programming no longer being
produced by the Company resulting in a write-down expense of approximately
$7,800,000 for fiscal 1994. The major component of such reductions consisted of
the episodic series 1ST AND TEN starring O.J. Simpson. Without such reductions,
costs relating to operating revenues would have been $47,152,000, or
approximately 93% of revenues, for fiscal 1994.
Selling, general and administrative expenses increased to $3,838,000 in
fiscal 1995 from $3,280,000 in fiscal 1994. Expenses associated with increased
staffing and personnel, primarily in the feature film and international
distribution divisions, were the major factors contributing to the increase. In
addition, the Company is funding overhead and development costs associated with
its entry into new business segments
27
<PAGE>
including interactive/multimedia, cable distribution and infomercial production,
which are conducted through joint ventures or partnerships.
Interest expense for the year ended September 30, 1995 was $3,409,000 as
compared to $2,209,000 for the year ended September 30, 1994. The increase was
due to incurring interest costs for the full period on the Company's four issues
of Convertible Subordinated Debentures during the 1995 fiscal year; and increase
in amortization of capitalized issuance costs related to the Convertible
Subordinate Debentures and higher average borrowings under the Company's line of
credit associated with increased production and acquisition financing of
non-network movies. Total borrowings increased to $46,143,000 at September 30,
1995 from $31,656,000 at September 30, 1994. The weighted average interest rate
under the line of credit was 10% during fiscal 1995 compared to 7.81% in fiscal
1994, while the Convertible Subordinated Debentures Series A, Series B, 8% and
9% bear interest fixed at 10%, 13 3/4%, 8% and 9%, respectively. The Company's
estimated effective income tax rate was 1% for the year ended September 30, 1995
compared to an estimated effective income tax rate of approximately 24% for the
year ended September 30, 1994. The tax benefit in fiscal 1994 was due to partial
recognition of the benefit of deferred taxes during the fiscal year ended
September 30, 1994.
The Company reported a net loss of ($3,975,000), or ($.13) per share, for
the fiscal year ended September 30, 1995 and net loss of ($6,765,000), or ($.23)
per share, for the year ended September 30, 1994 when the Company reported a
loss before cumulative effect of a change in accounting principle from Statement
of Financial Accounting Standards (SFAS) No. 96 to SFAS No. 109 "Accounting for
Income Taxes" of ($7,159,000), or ($.24) per share. The losses in fiscal 1995
and 1994 resulted primarily from the above described non-cash reductions in the
carrying value of certain programs no longer being produced by the Company and
the increased interest expense and amortization of capitalized issuance costs.
The losses in fiscal 1995 were augmented by certain expenses associated with the
expansion of the Company's feature film and international distribution
divisions.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995, and will require that the
Company either recognize in its financial statements costs related to its
employee stock-based compensation plans, such as stock option and stock purchase
plans, or make pro forma disclosures in a footnote to the financial statements.
The Company expects to continue to use the intrinsic value-based method
under Accounting Principles Board Opinion No. 25, as allowed under SFAS 123, to
account for all of its employee stock-based compensation plans. Therefore, in
its consolidated financial statements for fiscal 1997, the Company will make the
required pro forma disclosures in a footnote to the financial statements. SFAS
No. 123 is not expected to have a material effect on the Company's results of
operations or financial position.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased to $11,636,000 (including $419,000 of
restricted cash being used as collateral for certain production loans and
$4,126,000 of reserved cash to be applied against the Company's outstanding
borrowings under its credit facility) at September 30, 1996 from $4,301,000
(including $1,162,000 of restricted cash) at September 30, 1995 primarily from
an increase in cash flow from financing activities consisting of the issuance of
common stock and an increase in notes payable.
The Company's production and distribution operations are capital intensive.
The Company has funded its working capital requirements through receipt of third
party domestic and international licensing payments as well as other operating
revenues, and proceeds from debt and equity financing, and has relied
28
<PAGE>
upon its line of credit and transactional production loans to provide bridge
production financing prior to receipt of license fees. The Company funds
production and acquisition costs out of its working capital, including the line
of credit, and through certain pre-sale of rights in international markets. In
addition, the expansion of the Company's international distribution business and
the establishment of its feature film division have significantly increased the
Company's working capital requirements and use of related production loans.
The Company experienced net negative cash flows from operating activities
(resulting from the Company's significant expansion of production) of
$13,119,000 during the twelve months ended September 30, 1996, which was offset
by net cash of $20,641,000 provided by financing activities from production
loans, common stock issuance and greater usage of the Company's revolving line
of credit. As a result primarily of common stock issuance, net unrestricted cash
increased by $3,952,000 to $7,091,000 on September 30, 1996. As the Company
expands production and distribution activities and increases its debt service
burdens, it will continue to experience net negative cash flows from operating
activities, pending receipt of licensing revenues, other revenues and sales from
its library.
CREDIT FACILITY
On June 25, 1996, the Company closed a $40,000,000 syndicated revolving
credit agreement with a group of banks led by The Chase Manhattan Bank N.A.
("Chase"). Such agreement provides for borrowing by the Company of up to
$40,000,000 based on specified percentages of domestic and international
accounts and contracts receivable and a specified percentage of the Company's
book value of unamortized library film costs (as adjusted). In addition, the
Company may from time to time allocate a production tranche in its line of
credit for the Company's productions. Such tranche will allow the Company to
borrow up to 50% of the production deficit after accounting for specified
percentages of pre-sales, licensing fees and similar revenues from third parties
and a required Company equity participation. All loans made pursuant to such
agreement are secured by substantially all of the Company's otherwise
unencumbered assets and bear interest, at the Company's option, either (i) at
LIBOR (5.594% as of December 23, 1996) plus 3% (for that portion of the
borrowing base supported by accounts or contracts receivable) or 4% (for that
portion of the borrowing base supported by unamortized library film costs or for
loans made under the production tranche) or (ii) at the Alternate Base Rate
(which is the greater of (a) Chase's Prime Rate (8.25% as of December 23, 1996),
(b) Chase's Base CD Rate (5.63% as of December 23, 1996) plus 1% or (c) the
Federal Funds Effective Rate (5.25% as of December 23, 1996) plus 1/2%) plus 2%
(for that portion of the borrowing base supported by accounts or contracts
receivable) or 3% (for that potion of the borrowing base supported by
unamortized library film costs or loans made under the production tranche). The
Company is required to pay a commitment fee of .5% per annum of the unused
portion of the credit line. As of December 23, 1996, the Company had drawn down
$24,100,000 under the credit facility out of a total net borrowing base
availability of $30,200,000. On December 27, 1996, the Company drew down an
additional $4,200,000, which has not been disbursed by the Company.
The credit agreement contains various restrictive covenants to which the
Company must adhere. These covenants, among other things, include limitations on
additional indebtedness, liens, investments, disposition of assets, guarantees,
deficit financing, capital expenditures, affiliate transactions and the use of
proceeds and prohibit payment of cash dividends and prepayment of subordinated
debt. In addition, the credit agreement requires the Company to maintain a
minimum liquidity level, limits overhead expense and requires the Company to
meet certain ratios. The credit agreement also contains a provision permitting
the bank to declare an event of default if either of Messrs. Locke or Kushner
fails to be the Chief Executive Officer of the Company or if any person or group
acquires ownership or control of capital stock of the Company having voting
power greater than the voting power at the time controlled by Messrs. Kushner
and Locke combined (other than any institutional investor able to report its
holdings on Schedule 13G which holds no more than 15% of such voting power). On
December 27, 1996 the Company
29
<PAGE>
received a waiver of the limitation on overhead expenses for the amount of
allocated and unallocated overhead expenses in fiscal year 1996.
SECURITIES OFFERINGS
During March and April 1994, the Company sold $16,437,000 principal amount
of 8% Convertible Subordinated Debentures due 2000. In connection with the
issuance of the 8% Debentures, the Company issued warrants to purchase up to 10%
of the aggregate principal amount of Debentures sold at an exercise price equal
to 120% of the principal amount of the Debentures. The 8% Debentures are
convertible into shares of common stock at a rate of $.975 per share, subject to
customary anti-dilutive provisions and provisions in the event of certain
payment defaults. The Company will have the right to redeem the 8% Debentures at
redemption prices commencing at 102.7% of par on or after February 1, 1998 and
declining to par on or after February 1, 2000. The Debentures are subordinate in
right of payment to all Senior Indebtedness (as defined) of the Company and rank
pari passu with the Company's Series A and Series B Debentures. The fiscal
agency agreement, under which the Company's 8% Debentures were issued, contains
various covenants to which the Company must adhere.
During July 1994, the Company sold $5,050,000 principal amount of 9%
Convertible Subordinated Debentures due 2002. In connection with the issuance of
the 9% Debentures, the Company issued warrants to purchase up to 9% of the
aggregate principal amount of the Debentures sold at an exercise price equal to
120% of the principal amount of the Debentures. The 9% Debentures are
convertible into shares of common stock at a rate of $1.58 per share, subject to
customary anti-dilutive provisions and provisions in the event of certain
payment defaults. The Company has the right to redeem the 9% Debentures at
redemption prices commencing at 103% of par on or after July 1, 1998 and
declining to par on or after July 1, 2000. The Debentures are subordinated in
right of payment to all Senior Indebtedness (as defined) of the Company and rank
pari passu with the Company's Series A, Series B and 8% Debentures. The fiscal
agency agreement, under which the Company's 9% Debentures were issued, contains
various covenants to which the Company must adhere. As of September 30, 1996,
approximately $4,821,000 principal amount of 8% Debentures and $4,174,000
principal amount of 9% Debentures were outstanding. Through December 23, 1996,
an additional $217,000 aggregate principal amount of the 8% Debentures were
converted into an aggregate of 222,563 shares of Common Stock and no additional
shares of 9% Debentures were converted. As of September 30, 1996, approximately
$68,000 principal amount of Series A Debentures (convertible into common stock
at a rate of approximately $1.27 per share) and $2,976,000 of Series B
Debentures (convertible into common stock at a rate of approximately $1.54 per
share) were outstanding. The Company has the right to redeem the Series A
Debentures at redemption prices at 103% of par after September 30, 1996 and
declining to par after September 30, 1997 and to redeem the Series B Debentures
at redemption prices at 101% of par at October 1, 1996 and declining to par
after October 1, 1997.
In September 1994, the Company filed a registration statement covering an
aggregate of 21,388,064 shares of common stock comprising the shares of common
stock issuable upon conversion of the 8% Convertible Subordinated Debentures and
the 9% Convertible Subordinated Debentures and certain warrants issued to
underwriters. Since the end of the fiscal year (September 30, 1995), primarily
as a result of the conversion of the 8% and 9% Debentures and the secondary
public offering described below, the number outstanding shares of common stock
has increased from 35,466,598 to 52,665,247 as of September 30, 1996.
In May 1996, the Company issued $1,500,000 of short-term bridge notes in a
private placement which were repaid in July 1996 in connection with the
secondary public offering referred to below.
In July 1996, the Company closed a secondary public offering of an aggregate
of 4,750,000 units (a "Unit"), each unit consisting of two shares of Common
Stock and one five year Class C Redeemable Common Stock Purchase Warrant to
purchase Common Stock at an exercise price of $1.14375 per share.
30
<PAGE>
The Company received net proceeds in the amount of $9,203,125. In connection
with such offering, the Company issued warrants to purchase up to an aggregate
of 475,000 Units at $3.146875 per Unit to the underwriter thereof and a
consultant.
PRODUCTION/DISTRIBUTION LOANS
The Company's other short term borrowings, totaling $12,444,000 as of
September 30, 1996, consisted of production loans from Newmarket Capital Group
L.P. ("Newmarket"), Banque Paribas (Los Angeles Agency) ("Paribas") and Imperial
Bank to consolidated production entities. The Kushner-Locke Company provided
limited corporate guarantees for a portion of the Newmarket and Paribas loans
which are callable in the event that the production companies do not repay the
loans by the respective maturity date. The balance of the production loans are
recourse only to the production entities. Deposits on the purchase price paid by
the distributing licensees are held as restricted cash collateral by the
Lenders. To the extent the collateral value securing the loans exceeds the
amount outstanding, the Company may determine in the future to assume such
obligations in full under its Chase facility and take title to such assets.
The table below shows certain production loans as of September 30, 1996.
<TABLE>
<CAPTION>
KUSHNER-LOCKE
AMOUNTS WEIGHTED CORPORATE
FILM LENDER LOAN AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY
- --------------------------------- ---------- ------------- ----------- ----------- -------------- -----------
<S> <C> <C> <C> <C> <C> <C>
THE LEGEND OF PINOCCHIO.......... Newmarket $12,500,000 $7,494,000 8.21% $2,800,000(1) 9-30-96(1)
INNOCENT VICTIMS................. Paribas $ 975,000 $ 680,000 8.61% $ 300,000 12-31-96(2)
MAGIC ADVENTURES................. Imperial $ 5,150,000 $4,270,000 10.92% $ 0 11-15-97
------------- ----------- --------------
$18,625,000 1$2,444,000 $3,100,000
------------- ----------- --------------
------------- ----------- --------------
</TABLE>
- ------------------------
(1) As of December 23, 1996, the amount outstanding had been reduced to
approximately $3,615,000. The Company believes that The Kushner-Locke
Company corporate guarantee has been reduced to zero (0) by virtue of the
value of various foreign licenses entered into by the Company and in any
event terminated due to the delay in delivery of the picture. The remaining
balance owed by the production entity is collateralized by license
obligations in excess of the loan balance (including $1,750,000 owed from
one territory backed by a letter of credit).
(2) As of December 23, 1996, the amount outstanding had been reduced to
approximately $530,000. The Company is currently in discussions with the
lender concerning an extension of the maturity date (thereby avoiding any
call on The Kushner-Locke Company corporate guarantee). The remaining
balance (and the amount subject to such corporate guarantee) is fully
collateralized by distribution license obligations which exceed the loan
balance.
The Company entered into a long form agreement dated as of February 6, 1995
with Savoy Pictures, Inc. ("Savoy") relating to the development, production,
financing and distribution of a live-action feature-length theatrical motion
picture titled THE ADVENTURES OF PINOCCHIO. The film opened domestically on July
26, 1996 in a wide theatrical release by New Line Pictures ( a subsidiary of
Turner Entertainment Co.) which has acquired the domestic distribution rights
and 50% of certain ancillary rights from Savoy. The film is being distributed in
foreign territories by the Company. Pursuant to the February 6, 1995 letter
agreement, the Company licensed those domestic and ancillary rights to Savoy in
exchange for Savoy funding 50% of the budget to the production entity up to
$25,000,000 (which budget was subsequently increased to approximately
$29,450,000, the majority of which has been financed by Savoy in exchange for
certain profit participations). In order to fund the Company's approximately
$12,850,000 share of the budgeted negative costs, the Company has assisted the
film's production company, a consolidated entity, in obtaining loan
documentation from Newmarket and the Bank of America in the amount of 50% of the
film's original budget up to $12,500,000, a portion of which is reserved to pay
the lender's financing fees and costs. The loan bears interest at LIBOR (5.594%
as of December 23, 1996) plus 2% and fees were determined on a sliding scale
related to the amount of acceptable contracts receivable at the time of initial
31
<PAGE>
funding. Newmarket also has the right to certain profit participations in
connection with the film. There is no assurance that THE ADVENTURES OF
PINOCCHIO, which represents the Company's biggest budget theatrical motion
picture to date, will be ultimately successful to an extent sufficient to repay
the loan in full.
In March 1996, a new production loan was obtained from Paribas in the
aggregate amount of $1,200,000 to cover the Company's acquisition price of
distribution rights in the mini-series entitled INNOCENT VICTIMS. The loan bears
interest at the Company's option at LIBOR (5.594% as of December 23, 1996) plus
2.50% or Bank of America's published reference rate (8.25% as of December 23,
1996) plus certain loan fees. The loan is secured by the Company's right, title
and interest in and related to the mini-series. The loan matures on December 31,
1996, subject to an extension of not more than 90 days.
In April 1996, a new production loan was obtained from Imperial Bank in the
aggregate available amount of $5,100,000 to cover a portion of the production
budgets of the MAGIC ADVENTURES home video series. The loan bears interest at
Prime (8.25% as of December 23, 1996) plus 1 1/2% payable monthly plus certain
loan fee amounts. The loan was secured by the rights, title and assets related
to the film series which are in various stages of production and will ultimately
be delivered to domestic and international sub-distributors. The loan matures in
November 1997.
In May 1996, the Company and Decade entered into an agreement to produce
four theatrical action motion pictures. The motion pictures will be produced,
subject to approval by the Company of certain creative aspects of such movies,
by Decade and executive produced by Joel Silver and Richard Donner. Under the
agreement, the Company has agreed to guarantee payment up to $3,200,000 per
picture payable upon the delivery of the "mandatory delivery items" (as defined
in such agreement) for each picture in consideration of receipt of foreign
distribution rights. The agreement is for a minimum of four feature-length
motion pictures and may be extended, at Decade's option, to include a fifth
picture. The initial two films under the agreement are DOUBLE TAP starring
Heather Locklear and Stephen Rea, and MADE MEN, both of which are currently
expected to be delivered in calendar 1997.
SUMMARY
Management believes that existing resources and cash generated from
operating activities, together with amounts expected to be available under the
syndicated revolving credit agreement with Chase will be sufficient to meet the
Company's working capital requirements for at least the next twelve months.
However, the Company from time to time may seek additional financing through the
issuance of additional debt or equity securities, additional bank financings, or
other means available to the Company to increase its working capital. In
addition to expanding production and its distribution business, whether
internally or by acquisition, the Company may also consider acquisition
possibilities from time to time, including film libraries and companies
ancillary to the Company's business, subject to the availability of financing as
necessary.
The Company's business and operations have not been materially affected by
inflation.
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Item 8 are set
forth in the pages indicated in Item 14.
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
32
<PAGE>
PART III
10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information called for in Item 10 of Part III shall be filed not later
than 120 days after the Company's fiscal year end (September 30, 1996) in the
Company's definitive Proxy Statement in connection with its 1997 Annual Meeting
of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, or in an amendment to this Annual Report of Form 10-K.
11. EXECUTIVE COMPENSATION
The information called for in Item 11 of Part II I shall be filed not later
than 120 days after the Company's fiscal year end (September 30, 1996) in the
Company's definitive Proxy Statement in connection with its 1997 Annual Meeting
of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, or in an amendment to this Annual Report of Form 10-K.
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for in Item 12 of Part III shall be filed not later
than 120 days after the Company's fiscal year end (September 30, 1996) in the
Company's definitive Proxy Statement in connection with its 1997 Annual Meeting
of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, or in an amendment to this Annual Report of Form 10-K.
13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The information called for in Item 13 of Part III shall be filed not later
than 120 days after the Company's fiscal year end (September 30, 1996) in the
Company's definitive Proxy Statement in connection with its 1997 Annual Meeting
of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, or in an amendment to this Annual Report of Form 10-K.
33
<PAGE>
PART IV
14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE
---------
<C> <S> <C>
(a)(1) Financial Statements:
Independent Auditors' Report.................................................................... F-1
Consolidated Balance Sheets at September 30, 1996 and 1995...................................... F-2
Consolidated Statements of Operations for the years ended September 30, 1996, 1995, and 1994.... F-3
Consolidated Statements of Cash Flows for the years ended September 30, 1996, 1995, and 1994.... F-4
Consolidated Statements of Stockholder Equity for the years ended September 30, 1996, 1995, and
1994.......................................................................................... F-6
Notes to Consolidated Financial Statements...................................................... F-7
(2) Financial Statement Schedule
Schedule II for the years ended September 30, 1996, 1995, and 1994.............................. F-26
All other schedules are inapplicable and, therefore, have been omitted.
(3) Exhibits........................................................................................
Exhibits filed as part of this report are listed in the Exhibit Index, which follows the
Signatures....................................................................................
(b) Report on Form 8-K:
None.
</TABLE>
34
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
The Kushner-Locke Company:
We have audited the accompanying consolidated balance sheets of The
Kushner-Locke Company and subsidiaries as of September 30, 1996 and 1995, and
the related consolidated statements of operations, cash flows and stockholders'
equity for each of the years in the three-year period ended September 30, 1996.
In connection with our audits of the consolidated financial statements, we have
also audited the accompanying financial statement schedule. These consolidated
financial statements and the financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements and the financial statement schedule
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The
Kushner-Locke Company and subsidiaries as of September 30, 1996 and 1995, and
the results of their operations and their cash flows for each of the years in
the three-year period ended September 30, 1996, in conformity with generally
accepted accounting principles. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Los Angeles, California
December 26, 1996
F-1
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
-------------- -------------
<S> <C> <C>
Cash and cash equivalents......................................................... $ 7,091,000 $ 3,139,000
Reserved cash..................................................................... 4,126,000 --
Restricted cash................................................................... 419,000 1,162,000
Accounts receivable, net of allowance for doubtful accounts of $693,000 in 1996
and $400,000 in 1995............................................................ 22,885,000 7,864,000
Due from affiliates............................................................... 1,238,000 309,000
Note receivable from related party................................................ 540,000 676,000
Film and television property costs, net of accumulated amortization............... 58,463,000 73,716,000
Property and equipment, at cost, net of accumulated depreciation and amortization
of $1,067,000 in 1996 and $877,000 in 1995...................................... 465,000 515,000
Other assets...................................................................... 4,925,000 1,571,000
-------------- -------------
$ 100,152,000 $ 88,952,000
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities.......................................... $ 3,277,000 $ 3,245,000
Notes payable..................................................................... 41,481,000 28,398,000
Deferred film license fees........................................................ 3,460,000 2,753,000
Contractual obligations, principally participants' share payable and talent
residuals....................................................................... 3,512,000 995,000
Production advances............................................................... 2,133,000 16,609,000
Convertible subordinated debentures, net of deferred issuance costs............... 12,039,000 17,745,000
-------------- -------------
Total liabilities......................................................... 65,902,000 69,745,000
-------------- -------------
Stockholders' equity:
Common stock, no par value. Authorized 80,000,000 shares at September 30, 1996
and at September 30, 1995: issued and outstanding 52,665,248 shares at
September 30, 1996 and 35,466,599 shares at September 30, 1995................ 37,650,000 23,337,000
Accumulated deficit............................................................... (3,400,000) (4,130,000)
-------------- -------------
Total stockholders' equity................................................ 34,250,000 19,207,000
-------------- -------------
$ 100,152,000 $ 88,952,000
-------------- -------------
-------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------------- -------------- --------------
<S> <C> <C> <C>
Operating revenues............................................... $ 80,157,000 $ 20,407,000 $ 50,736,000
Costs related to operating revenues.............................. (70,648,000) (17,404,000) (54,952,000)
Selling, general and administrative expenses..................... (3,595,000) (3,838,000) (3,208,000)
-------------- -------------- --------------
Earnings/(loss) from operations.................................. 5,914,000 (835,000) (7,424,000)
Interest income.................................................. 198,000 300,000 197,000
Interest expense................................................. (4,027,000) (3,409,000) (2,209,000)
Interest expense related to Bridge Note financing................ (943,000) -- --
-------------- -------------- --------------
Earnings/(loss) before income taxes and cumulative effect of a
change in accounting principle and extraordinary item.......... 1,142,000 (3,944,000) (9,436,000)
Income tax (expense)............................................. (47,000) (31,000) 2,277,000
-------------- -------------- --------------
Loss before cumulative effect of a change in accounting principle
and extraordinary item......................................... 1,095,000 (3,975,000) (7,159,000)
Cumulative effect of a change in accounting for income taxes..... -- -- 394,000
-------------- -------------- --------------
Earnings/(loss) before extraordinary item........................ 1,095,000 (3,975,000) (6,765,000)
-------------- -------------- --------------
Extraordinary item: costs associated with repayment of credit
facility....................................................... (365,000) -- --
-------------- -------------- --------------
Net earnings/(loss).............................................. $ 730,000 $ (3,975,000) $ (6,765,000)
-------------- -------------- --------------
-------------- -------------- --------------
Earnings/loss per common and common equivalent share:
Before cumulative effect of a change in accounting for income
taxes and extraordinary items................................ $ .03 $ (.13) $ (.24)
Cumulative effect of a change in accounting for income taxes... -- -- .01
Extraordinary item............................................. (.01) -- --
-------------- -------------- --------------
Net earnings/(loss).............................................. $ .02 $ (.13) $ (.23)
-------------- -------------- --------------
-------------- -------------- --------------
Weighted average number of common and common equivalent shares
outstanding.................................................... 40,013,000 31,713,000 29,373,000
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings/(loss)............................................ $ 730,000 $ (3,975,000) $ (6,765,000)
Adjustments to reconcile net earnings/(loss) to net cash used
by operating activities:
Cumulative effect of a change in accounting principle........ -- -- (394,000)
Amortization of film costs................................... 70,068,000 16,977,000 54,281,000
Depreciation and amortization................................ 190,000 239,000 250,000
Amortization of capitalized issuance costs and warrants...... 299,000 414,000 222,000
Interest on bridge loan...................................... 750,000 -- --
Changes in assets and liabilities:
Restricted cash.............................................. 743,000 (1,162,000) --
Reserved cash................................................ (4,126,000) -- --
Deferred income taxes........................................ -- -- (2,321,000)
Accounts receivable, net..................................... (15,021,000) (1,687,000) (817,000)
Other receivables............................................ (717,000) (766,000) (209,000)
Film costs................................................... (54,815,000) (60,005,000) (41,938,000)
Accounts payable and accrued liabilities..................... 32,000 860,000 (3,323,000)
Deferred film license fees................................... 707,000 2,389,000 (266,000)
Contractual obligations...................................... 2,517,000 (221,000) (1,134,000)
Production advances.......................................... (14,476,000) 16,527,000 (8,464,000)
Other........................................................ -- (10,000) 10,000
-------------- -------------- --------------
Net cash used by operating activities.................... (13,119,000) (30,420,000) (10,843,000)
-------------- -------------- --------------
Cash flows from investing activities:
Increase in property and equipment, net........................ (140,000) (317,000) (134,000)
Increase in other assets....................................... (3,430,000) (518,000) (442,000)
-------------- -------------- --------------
Net cash used by investing activities.................... (3,570,000) (835,000) (576,000)
-------------- -------------- --------------
Cash flows from financing activities:
Increase in notes payable...................................... 34,081,000 21,398,000 31,600,000
Repayment of notes payable..................................... (20,998,000) (2,600,000) (30,007,000)
Net proceeds from issuance of common stock..................... 7,202,000 -- --
Net proceeds from exercise of stock options.................... 412,000 -- 105,000
Net proceeds from issuance of debentures and warrants.......... -- -- 18,911,000
Repayment of debentures/exercise of conversion options......... (56,000) (25,000) (37,000)
Other.......................................................... -- (60,000) (14,000)
-------------- -------------- --------------
Net cash provided by financing activities................ 20,641,000 18,713,000 20,558,000
-------------- -------------- --------------
Net increase (decrease) in cash.......................... 3,952,000 (12,542,000) 9,139,000
Cash and cash equivalents at beginning of year 3,139,000 15,681,000 6,542,000
-------------- -------------- --------------
Cash and cash equivalents at end of year......................... $ 7,091,000 $ 3,139,000 $ 15,681,000
-------------- -------------- --------------
-------------- -------------- --------------
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest..................................................... $ 3,557,000 $ 2,952,000 $ 1,888,000
-------------- -------------- --------------
-------------- -------------- --------------
Income taxes................................................. $ 47,000 $ 27,200 $ 8,800
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
(1) In fiscal 1994, $1,537,000 of convertible subordinated debentures before
unamortized capitalized issuance costs of $201,000 were converted into
989,052 shares of common stock.
(2) In fiscal 1995, $5,260,000 of convertible subordinated debentures before
unamortized capitalized issuance costs of $559,000 were converted into
5,397,498 shares of common stock.
(3) In fiscal 1996, $6,500,000 of convertible subordinated debentures before
unamortized capitalized issuance costs of $551,000 were converted into
7,093,490 shares of common stock including 631,734 shares of common stock,
valued at $750,000, relating to interest on the bridge loan.
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
RETAINED
EARNINGS
NUMBER OF (ACCUMULATED
SHARES COMMON STOCK DEFICIT) TOTAL
------------ ------------- --------------- -------------
<S> <C> <C> <C> <C>
Balance at September 30, 1993.................. 29,575,049 $ 17,269,000 $ 6,610,000 $ 23,879,000
Retirement of common stock......................... (600,000) -- -- --
Stock options exercised............................ 105,000 105,000 -- 105,000
Costs related to registration statement............ -- (14,000) -- (14,000)
Conversion of subordinated debentures.............. 989,052 1,336,000 -- 1,336,000
Net loss........................................... -- -- (6,765,000) (6,765,000)
------------ ------------- --------------- -------------
Balance at September 30, 1994.................. 30,069,101 $ 18,696,000 $ (155,000) $ 18,541,000
Conversion of subordinated debentures.............. 5,397,498 4,641,000 -- 4,641,000
Net loss........................................... -- -- (3,975,000) (3,975,000)
------------ ------------- --------------- -------------
Balance at September 30, 1995.................. 35,466,599 $ 23,337,000 $ (4,130,000) $ 19,207,000
Issuance of common stock........................... 9,500,000 7,202,000 -- 7,202,000
Stock options exercised............................ 450,000 412,000 -- 412,000
Stock purchase warrants exercised.................. 155,159 0 -- --
Issuance of bridge loan stock...................... 631,734 750,000 -- 750,000
Conversion of subordinated debentures.............. 6,461,756 5,949,000 -- 5,949,000
Net earnings....................................... -- 0 730,000 730,000
------------ ------------- --------------- -------------
Balance at September 30, 1996.................. 52,665,248 $ 37,650,000 $ (3,400,000) $ 34,250,000
------------ ------------- --------------- -------------
------------ ------------- --------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
The Kushner-Locke Company (the "Company") is principally engaged in the
development, production and distribution of feature films, direct-to-video
films, television series, movies-for-television, mini-series and animated
programming. In the last two years, the Company expanded its operations into
related business lines in ancillary markets for its product such as
merchandising, home video, cable and interactive/ multimedia applications for
characters and story ideas developed by the Company.
Generally, theatrical films are first distributed in the theatrical and home
video markets. Subsequently, theatrical films are made available for world-wide
television network exhibition or pay television, television syndication and
cable television. Generally, television films are first licensed for network
exhibition and foreign syndication or home video, and subsequently for domestic
syndication or cable television. Certain films are produced and/or distributed
directly for initial exhibition by local television stations,
advertiser-supported cable television, pay television and/or home video. The
revenue cycle generally extends 7 to 10 years on film and television product.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The
Kushner-Locke Company, its wholly-owned subsidiaries and certain less than
wholly-owned entities which the Company controls. All material intercompany
balances and transactions have been eliminated.
Certain reclassifications have been made to conform prior year balances with
the current presentation.
REVENUE RECOGNITION
Revenues from feature film and television program distribution licensing
agreements are recognized on the date the completed film or program is delivered
or becomes available for delivery, is available for exploitation in the relevant
media window purchased by that customer or licensee and certain other conditions
of sale have been met pursuant to criteria specified by SFAS No. 53, Financial
Reporting By Producers and Distributors of Motion Picture Films. Revenues from
barter transactions, whereby the program is exchanged for television advertising
time which is sold to product sponsors, are recognized when the television
program has aired and all conditions precedent have been satisfied.
Producer fees received from production of films and television programs for
outside parties where the Company has no continuing ownership interest in the
project are recognized on a percentage-of-completion basis as determined by
applying the cost-to-cost method. The cost of such films and television series
is expensed as incurred.
ACCOUNTING FOR FILM AND TELEVISION PROPERTY COSTS
The Company capitalizes costs incurred to produce a film or television
project, including the interest expense funded under the production loans. Such
costs also include the actual direct costs of production, certain exploitation
costs and production overhead. Capitalized exploitation or distribution costs
include those costs that clearly benefit future periods such as film prints and
prerelease and early release advertising that is expected to benefit the film in
future markets. These costs, as well as expected revenue
F-7
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
or profit participations and talent residuals, are amortized each period on an
individual film or television program basis in the ratio that the current
period's gross revenues from all sources for the program bear to management's
estimate of anticipated total gross revenues for such film or program from all
sources. Revenue estimates are reviewed quarterly and adjusted where appropriate
and the impact of such adjustments could be material.
Film and television property costs are stated at the lower of unamortized
cost or estimated net realizable value. Losses which may arise because
unamortized costs of individual films or television series exceed anticipated
revenues are charged to operations through additional amortization.
The Company capitalized interest of $1,735,000, $631,000 and $451,000 to
film and television property costs for the years ended September 30, 1996, 1995,
and 1994, respectively.
PARTICIPANTS' SHARE PAYABLE AND TALENT RESIDUALS
The Company charges profit participation and talent residual costs to
expense in the same manner as amortization of production costs, based on the
ratio of current period gross revenues to management's estimate of total
ultimate gross revenues, if it is anticipated such amounts will be payable.
Payments for profit participations are made in accordance with the participants'
contractual agreements. Payments for talent residuals are remitted to the
respective guilds in accordance with the provisions of their union agreements.
PRODUCTION ADVANCES
The Company receives license fees for projects in the production phase.
Production advances are generally nonrefundable and are recognized as earned
revenue when the film or television program is available for delivery.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company provides for doubtful accounts based on historical collection
experience and periodically adjusts the allowance based on the aging of accounts
receivable and other conditions. Receivables are written off against the
allowance in the period they are deemed uncollectible.
PROPERTY AND EQUIPMENT
Property and equipment, at cost, is depreciated using the straight-line
method over the estimated useful lives of the assets (ranging from four to eight
years).
CASH AND CASH EQUIVALENTS
The Company considers certificates of deposit and other highly liquid
investments with original maturities of three months or less to be cash
equivalents.
RESTRICTED AND RESERVED CASH
At September 30, 1996, the Company had $419,000 in restricted cash related
to advances made by the Company to film producers for the acquisition of
distribution rights or films not yet completed. These cash
F-8
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
advances are held in escrow accounts as collateral by financial institutions
providing production loans to those producers. In addition, the Company has
$4,126,000 in cash collected by the Company and reserved for use by Chase
Manhattan Bank to be applied against the Company's outstanding borrowings under
the Company's credit facility.
INTERNATIONAL CURRENCY TRANSACTIONS
The majority of the Company's foreign sales transactions are payable in U.S.
dollars. Accordingly, international currency transaction gains and losses
included in the consolidated statements of operations for the three years ended
September 30, 1996 were not significant.
INCOME TAXES
Effective October 1, 1993, the Company adopted Statement of Financial
Accounting Standards ("SFAS No. 109"), "Accounting for Income Taxes." Under the
asset and liability method of SFAS 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statements carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in operating results in the period encompassing the
enactment date.
The Company elected to reflect the cumulative effect of adopting this
pronouncement as a change in accounting principle at the beginning of fiscal
1994 with a credit to results of operations of $394,000. Prior year consolidated
financial statements were not restated.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles.
Significant estimates are primarily related to ultimate revenues and ultimate
costs relating to the Company's film and television properties. Actual results
may differ from estimated amounts.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for
fiscal years beginning after December 15, 1995, and requires that the Company
either recognize in its consolidated financial statements costs related to its
employee stock-based compensation plans, such as stock option and stock purchase
plans, or make pro forma disclosures of such costs in a footnote to the
consolidated financial statements.
The Company expects to continue to use the intrinsic value-based method of
Accounting Principles Board Opinion No. 25, as allowed under SFAS No. 123, to
account for all of its employee stock-based compensation plans. Therefore, in
its consolidated financial statements for fiscal 1997, the Company will make the
required pro forma disclosures in a footnote to the consolidated financial
statements. SFAS
F-9
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
No. 123 is not expected to have a material effect on the Company's results of
operations or financial position.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's cash and cash equivalents, accounts
receivable, due from affiliates, accounts payable and accrued liabilities,
contractual obligations and participants' share payable for talent residuals
approximate their recorded value due to the relatively short maturities of these
instruments. The fair value of due from affiliates and note receivable from a
related party have not been estimated due to the related party nature of such
amounts. The fair value of notes payable and convertible subordinated debentures
approximates the recorded value due to the stated interest rate on such
instruments and the indeterminate nature of the value of the convertibility
feature of such debt instrument.
EARNINGS/(LOSS) PER SHARE
Earnings (loss) per common and common equivalent share is based upon the
weighted average number of shares of common stock outstanding plus common
equivalent shares consisting of dilutive outstanding warrants and stock options.
The weighted average number of common and common equivalent shares outstanding
for the calculation of primary earnings per share was 40,013,000, 31,713,000,
and 29,373,000 for the years ended September 30, 1996, 1995 and 1994,
respectively. The inclusion of the additional shares assuming the conversion of
the Company's convertible subordinated debentures would have been anti-dilutive
for all periods.
(2) FILM AND TELEVISION PROPERTY COSTS
Film and television property costs consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
------------- -------------
<S> <C> <C>
In process or development...................................... $ 16,527,000 $ 42,115,000
Released, principally feature films and television productions,
net of accumulated amortization.............................. $ 41,936,000 31,601,000
------------- -------------
$ 58,463,000 $ 73,716,000
------------- -------------
------------- -------------
</TABLE>
Based upon the Company's present estimates of anticipated future revenues at
September 30, 1996, approximately 70% of the film costs related to released
films and television series will be amortized during the three-year period
ending September 30, 1999.
F-10
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
------------- -------------
<S> <C> <C>
Note payable to bank, under the revolving credit facility
secured by substantially all Company assets, interest at
varying rates as discussed below, outstanding principal
balance due June 25, 1999.................................... $ 29,037,000 $ 14,804,000
Notes payable to banks and/or financial institutions consisting
of three production loans secured by certain film rights held
by producers, priced at different rates for each loan........ $ 12,444,000 $ 13,594,000
------------- -------------
$ 41,481,000 $ 28,398,000
------------- -------------
------------- -------------
</TABLE>
On June 25, 1996 the Company obtained a new syndicated borrowing base
revolving credit facility. In conjunction with this new facility, the Company
repaid amounts outstanding under its previously existing credit facility.
Unamortized issuance costs of $365,000 relating to this previous credit facility
have been expensed as an extraordinary item.
The new revolving credit facility bears interest at the Company's option,
either (i) at LIBOR (5.594% as of December 23, 1996) plus 3% (for that portion
of the borrowing base supported by accounts or contracts receivable) or LIBOR
(5.594% as of December 23, 1996) plus 4% (for that portion of the borrowing base
supported by unamortized library film costs or for loans made under the
production tranche) or (ii) at the Alternate Base Rate (which is the greater of
(a) the agent bank's Prime Rate (8.25% as of December 23, 1996), (b) the agent
bank's Base CD Rate (5.594% as of December 23, 1996) plus 1% or (c) the Federal
Funds Effective Rate (5.25%) as of December 23, 1996) plus 1/2) plus 2% (for
that portion of the borrowing base supported by accounts or contracts
receivable) or 3% (for that portion of the borrowing base supported by
unamortized library film costs or for loans made under the production tranche).
The credit agreement contains various restrictive covenants to which the Company
must adhere. These covenants, among other things, include limitations on
additional indebtedness, liens, investments, disposition of assets, guarantees,
deficit financing, capital expenditures, affiliate transactions and the use of
proceeds and prohibit payment of cash dividends and prepayment of subordinated
debt. In addition, the credit agreement requires the Company to maintain a
minimum liquidity level, limits overhead expense and requires the Company to
meet certain ratios. The credit agreement also contains a provision permitting
the bank to declare an event of default if either of Messrs. Locke or Kushner
fails to be the Chief Executive Officer of the Company or if any person or group
acquires ownership or control of capital stock of the Company having voting
power greater than the voting power at the time controlled by Messrs. Kushner
and Locke combined (other than any institutional investor able to report its
holdings on Schedule 13G which holds no more than 15% of such voting power). On
December 27, 1996 the Company received a waiver of the limitations on overhead
expenses for the amount of allocated and unallocated overhead expenses in fiscal
year 1996.
The Company's other short term borrowings totaling $12,444,000 as of
September 30, 1996, consist of production loans from Newmarket Capital Group
L.P. ("Newmarket"), Banque Paribas (Los Angeles Agency) ("Paribas") and Imperial
Bank ("Imperial") to consolidated production entities. Newmarket's
F-11
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) NOTES PAYABLE (CONTINUED)
loans require an interest rate of Prime (8.25% as of December 23, 1996) plus 1%
on the first $500,000 advanced under the loan, then pricing options are at
either (a) Prime plus 1% or (b) LIBOR plus 3% on the remaining loan balance plus
loan fees of $60,000 plus a net profit participation. The Paribas loan bears
interest at either (a) Reference Rate (8.25% as of December 13, 1996) plus 1/2%
or (b) LIBOR plus 2% plus loan fees of $120,000. The Imperial loan bears
interest at Prime (8.25% as of December 13, 1996) plus 1 1/2% plus certain loan
fees. The Kushner-Locke Company provided limited corporate guarantees for
portions of the Newmarket and Paribas loans which are callable in the event that
the production companies do not repay the loans made by the respective maturity
date. The Company believes that The Kushner-Locke Company corporate guarantee to
Newmarket has been reduced to zero (0) by virtue of the value of various foreign
licenses entered into by the Company and in any event terminated due to the
delay in delivery of the picture. The Company is currently in discussions with
Paribas concerning an extension of the maturity date (thereby avoiding any call
on the corporate guarantee). Deposits on the purchase price paid by the
distributing licensees are held as restricted cash collateral by the Lenders.
The table below shows production loans as of September 30, 1996. Any events
of default have been waived and all loans are in compliance with Lender's
covenants:
<TABLE>
<CAPTION>
ORIGINAL LOAN AMOUNTS WEIGHTED
FILM LENDER AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY
- ------------------------ ------------- ------------- ------------- ----------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
THE LEGEND OF PINOCCHIO Newmarket $ 12,500,000 $ 7,494,000 8.21% $ 2,800,000(1) 9-30-96(1)
INNOCENT VICTIMS Paribas $ 975,000 680,000 8.61% 300,000 12-31-96(2)
MAGIC ADVENTURES Imperial $ 5,150,000 4,270,000 10.92% 0 11-15-97
------------- ------------- ---------------
$ 18,625,000 $ 12,444,000 $ 3,100,000
------------- ------------- ---------------
------------- ------------- ---------------
</TABLE>
- ------------------------
(1) As of December 23, 1996, the amount outstanding has been reduced to
approximately $3,615,000. The Company believes that The Kushner-Locke
Company corporate guarantee has been reduced to zero (0) by virtue of the
value of various foreign licenses entered into by the Company and in any
event terminated due to the delay in delivery of the picture. The remaining
balance owed by the production entity is collateralized by license
obligations in excess of the loan balance (including $1,750,000 owed from
one territory backed by a letter of credit).
(2) As of December 23, 1996, the amount outstanding had been reduced to
approximately $530,000. The Company is currently in discussions with the
lender concerning an extension of the maturity date (thereby avoiding any
call on The Kushner-Locke Company corporate guarantee). The remaining
balance (and the amount subject to such corporate guarantee) is fully
collateralized by distribution license obligations which exceed the loan
balance.
The Company entered into a long form agreement dated as of February 6, 1995
with Savoy Pictures, Inc. ("Savoy") relating to the development, production,
financing and distribution of a live-action feature-length theatrical motion
picture titled THE ADVENTURES OF PINOCCHIO. The film opened domestically on July
26, 1996 in a wide theatrical release by New Line Pictures (a subsidiary of
Turner Entertainment Co.) which has acquired the domestic distribution rights
and 50% of certain ancillary rights from Savoy. The film is being distributed in
foreign territories by the Company. Pursuant to the February 6, 1995 letter
agreement, the Company licensed those domestic and ancillary rights to Savoy in
exchange for Savoy
F-12
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) NOTES PAYABLE (CONTINUED)
funding 50% of the budget to the production entity up to $25,000,000 (which
budget was subsequently increased to approximately $29,450,000, the majority of
which has been financed by Savoy in exchange for certain profit participations).
In order to fund the Company's $12,850,000 share of the budgeted negative costs,
the Company's has assisted the film's production company, a consolidated entity,
in obtaining loan documentation from Newmarket and the Bank of America in the
amount of 50% of the film's original budget up to approximately $12,500,000, a
portion of which is reserved to pay the lender's financing fees and costs. The
loan bears interest at LIBOR (5.594% as of December 23, 1996) plus 2% and fees
were determined on a sliding scale related to the amount of acceptable contracts
receivable at the time of initial funding. Newmarket also has the right to
certain profit participations in connection with the film. There is no assurance
that THE ADVENTURES OF PINOCCHIO, which represents the Company's biggest budget
theatrical motion picture to date, will be ultimately successful to an extent
sufficient to repay the loan in full.
In March 1996, a new production loan was obtained from Paribas in the
aggregate amount of $1,200,000 to cover the Company's acquisition price of
distribution rights in the mini-series entitled INNOCENT VICTIMS. The loan bears
interest at LIBOR (5.594% as of December 23, 1996) plus 2.50% or Bank of
America's published reference rate (8.25% as of December 29, 1996). The loan is
secured by the Company's right, title and interest in and related to the
mini-series. The loan matures on December 31, 1996, subject to an extension of
not more than 90 days.
In April 1996, a new production loan was obtained from Imperial Bank in the
aggregate available amount of $5,100,000 to cover a portion of the production
budgets of the MAGIC ADVENTURE home video series. The loan bears interest at
Prime (8.25% as of December 23, 1996) plus 1 1/2% payable monthly plus certain
loan fee amounts. The loan was secured by the rights, title and assets related
to the film series which are in various stages of production and will ultimately
be delivered to domestic and international sub-distributors. The loan matures in
November 1997.
F-13
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) CONVERTIBLE SUBORDINATED DEBENTURES
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
1996 1995
------------- -------------
<S> <C> <C>
Series A Convertible Subordinated Debentures due December 15, 2000, bearing
interest at 10% per annum payable June 15 and December 15, net of unamortized
capitalized issuance costs and warrants of $9,000 and $13,000, respectively...... $ 68,000 $ 84,000
Series B Convertible Subordinated Debentures due December 15, 2000, bearing
interest at 13 3/4% per annum payable monthly, net of unamortized capitalized
issuance costs of $284,000 and $354,000, respectively............................ 2,976,000 2,972,000
Convertible Subordinated Debentures due December 15, 2000, bearing interest at 8%
per annum payable February 1 and August 1, net of unamortized capitalized
issuance costs of $396,000 and $1,058,000, respectively.......................... 4,821,000 10,129,000
Convertible Subordinated Debentures due July 1, 2002, bearing interest at 9% per
annum payable January 1 and July 1, net of unamortized capitalized issuance costs
of $376,000 and $490,000, respectively........................................... 4,174,000 4,560,000
------------- -------------
$ 12,039,000 $ 17,745,000
------------- -------------
------------- -------------
</TABLE>
SERIES A DEBENTURES
During fiscal 1991, the Company sold $1,500,000 principal amount of Series A
Convertible Subordinated Debentures due 2000 and 4,200 units which represented
an additional $4,200,000 principal amount of Series A Debentures. Each unit
included warrants to purchase 500 shares of common stock of the Company at $2.00
per share. Each warrant has been valued at $.25 (2.1 million warrants with a
total value of $525,000) and is included in common stock.
As of September 30, 1996, the Company had outstanding $77,000 principal
amount of Series A Debentures. The debentures are recorded net of unamortized
underwriting discounts, expenses associated with the offering and warrants
totaling $9,000 which are amortized using the interest method to interest
expense over the term of the debentures. Approximately $1,000 of capitalized
issuance costs have been amortized to interest expense for the year ended
September 30, 1996.
The Series A Debentures bear interest at 10% per annum, payable on June 15
and December 15 in each year. The Series A Debentures are convertible into
common stock of the Company at the rate of 788 shares for each $1,000 principal
amount of debentures, subject to adjustment under certain circumstances. For the
year ended September 30, 1996, approximately $20,000 principal amount of Series
A Debentures and unamortized capitalized issuance costs and warrants of $3,000
had been converted into 15,748 shares of common stock of the Company.
The debentures are redeemable at the option of the Company in whole or in
part at 110% of the face amount of the debentures provided that the closing bid
price (or, if applicable, closing price) of the common stock has equaled or
exceeded 150% of the conversion price for the 20 consecutive trading days ending
five trading days prior to the date of notice of redemption. The Company may
also redeem the debentures at redemption prices commencing at 105% of par and
declining to par after September 30,
F-14
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
1997. The debentures are subordinated to all existing and future "senior
indebtedness." The term "senior indebtedness" is defined to mean the principal
of (and premium, if any) and interest on any and all indebtedness of the Company
that is (i) incurred in connection with the borrowing of money from banks,
insurance companies and similar institutional lenders, (ii) issued as a result
of a public offering of debt securities pursuant to registration under the
Securities Act of 1933, or (iii) incurred in connection with the borrowing of
money with an original principal amount of at least $100,000 secured at least in
advanced by companies engaged in the ordinary course of their business in the
entertainment industry. Senior indebtedness does not include (i) the Series B
Debentures, (ii) indebtedness to affiliates and (iii) indebtedness expressly
subordinated to or on parity with the Series A Debentures, whether outstanding
on the date of execution of the indenture or thereafter created, incurred,
assumed or guaranteed.
SERIES B DEBENTURES
During fiscal 1991, the Company sold $6,000,000 principal amount of Series B
Convertible Subordinated Debentures due 2000.
As of September 30, 1996 the Company had outstanding $3,260,000 principal
amount of Series B Debentures due 2000. The debentures bear interest at 13 3/4%
per annum. The Series B Debentures are recorded net of unamortized underwriting
discounts and expenses associated with the offering totaling $284,000, which are
amortized using the interest method to interest expense over the term of the
debentures. Approximately $68,000 of capitalized issuance costs had been
amortized as interest expense for the year ended September 30, 1996.
The terms of the Series B Debentures are generally similar to those of the
Series A Debentures other than with respect to the interest rates, except that
(i) interest is payable monthly on the Series B Debentures and (ii) the Series B
Debentures are convertible into common stock of the Company at $1.5444 per
share. The Series B Debentures rank PARI PASSU (i.e., equally) in right of
payment with the Company's other debentures. For the year ended September 30,
1996, approximately $10,000 principal amount of the Series B Debentures and
unamortized costs of $1,000 had been converted to 6,732 shares of common stock
of the Company in fiscal year 1995. An additional $56,000 principal amount of
Series B Debentures were repurchased upon the death of bondholders pursuant to
the "Flower Bond" provision of the Series B Debentures.
8% DEBENTURES
During fiscal 1994, the Company sold $16,437,000 principal amount of 8%
Convertible Subordinated Debentures due 2000. In connection with the issuance,
the Company issued warrants to purchase up to 10% of the aggregate principal
amount of debentures sold at an exercise price equal to 120% of the principal
amount of the debentures which are exercisable during the four year period
commencing March 10, 1995 for $9,613,700 principal amount and April 12, 1995 for
$30,000 principal amount.
As of September 30, 1996, the Company had outstanding $5,217,000 principal
amount of 8% Debentures. The debentures are recorded net of unamortized
underwriting discounts and expenses associated with the offering totaling
$396,000 which are amortized using the interest method to interest expense over
the term of the debentures. Approximately $159,000 of capitalized issuance costs
had been amortized as interest expense for the year ended September 30, 1996.
Approximately $5,970,000 principal
F-15
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
amount of the 8% Debentures net of unamortized capitalized issuance costs of
$503,000 had been converted into 6,123,076 shares of common stock of the Company
in fiscal year 1996.
The terms of the 8% Debentures are generally similar to those of the Series
A Debentures, other than with respect to the interest rates, except that (i)
interest is payable on February 1 and August 1 in each year; (ii) the 8%
Debentures are convertible into common stock of the Company at $.975 per share;
and (iii) the Company has the right to redeem the 8% Debentures at redemption
prices commencing at 102.7% of par on or after February 1, 1998 and declining to
par on or after February 1, 2000. The 8% Debentures rank pari passu in right of
payment with the Company's other debentures.
9% DEBENTURES
During fiscal 1994, the Company sold $5,050,000 principal amount of 9%
Convertible Subordinated Debentures due 2002. In connection with the issuance,
the Company issued warrants to purchase up to 9% of the aggregate principal
amount of debentures sold at an exercise price equal to 120% of the principal
amount of debentures which are exerciseable during the four year period
commencing July 25, 1995.
As of September 30, 1996, the Company had outstanding $4,550,000 principal
amount of 9% Debentures. The debentures bear interest at 9% per annum. The
debentures are recorded net of unamortized underwriting discounts and expenses
associated with the offering totaling $376,000, which are amortized using the
interest method to interest expense over the term of the debentures.
Approximately $70,000 of capitalized issuance costs had been amortized as
interest expense for the year ended September 30, 1996. Approximately $500,000
principal amount of the 9% Debentures net of unamortized capitalized issuance
costs of $44,000 had been converted into 316,457 shares of common stock of the
Company in fiscal year 1996.
The terms of the 9% Debentures are generally similar to those of the Series
A Debentures, other than with respect to the interest rates, except that: (i)
interest is payable on January 1 and July 1 in each year; (ii) the 9% Debentures
are convertible into common stock of the Company at $1.58 per share; and (iii)
the Company has the right to redeem the 9% Debentures at redemption prices
commencing at 103% of par on or after July 1, 1998 and declining to par on or
after July 1, 2000. The 9% Debentures rank pari passu in right of payment with
the Company's other debentures.
(5) INCOME TAXES
As discussed in Note 1 of "Notes to Consolidated Financial Statements," the
Company adopted SFAS No. 109 as of October 1, 1993.
F-16
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INCOME TAXES (CONTINUED)
Income tax expense (benefit) consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------------
1996 1995 1994
--------- --------- -------------
<S> <C> <C> <C>
Current:
Federal.......................................................... $ -- $ -- $ --
State............................................................ 47,000 31,000 44,000
--------- --------- -------------
47,000 31,000 44,000
--------- --------- -------------
Deferred:
Federal.......................................................... $ -- $ -- $ (2,036,000)
State............................................................ -- -- (285,000)
--------- --------- -------------
-- -- (2,321,000)
--------- --------- -------------
Total income tax expense (benefit)............................. $ 47,000 $ 31,000 $ (2,277,000)
--------- --------- -------------
--------- --------- -------------
</TABLE>
A reconciliation of the statutory Federal income tax rate to the Company's
effective rate is presented below:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Statutory Federal income tax rate............................................... 34% (34)% (34)%
Change in valuation allowance................................................... (34) 34 13
State income taxes, net of Federal tax benefit.................................. 4 1 (3)
-- -- --
4% 1% (24)%
-- -- --
-- -- --
</TABLE>
F-17
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities,
at September 30, 1996 and September 30, 1995 are as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
1996 1995
------------- -------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................................... $ 11,492,000 $ 8,652,000
Tax and general business tax credit carryforwards...................... 751,000 559,000
Allowance for doubtful accounts and other reserves..................... 250,000 145,000
Deferred film license fees............................................. 1,295,000 995,000
Other reserves......................................................... 409,000 65,000
Depreciation........................................................... 100,000 --
------------- -------------
Total gross deferred assets.......................................... 14,297,000 10,416,000
Valuation allowance.................................................. (2,908,000) (3,679,000)
------------- -------------
Net deferred tax assets.............................................. $ 11,389,000 $ 6,737,000
------------- -------------
------------- -------------
Deferred tax liabilities:
Film amortization...................................................... $ 11,389,000 $ 6,701,000
Depreciation........................................................... -- 36,000
------------- -------------
Total deferred tax liabilities....................................... $ 11,389,000 $ 6,737,000
------------- -------------
------------- -------------
</TABLE>
At September 30, 1996, the Company had total net operating loss
carryforwards of approximately $33,030,000 for federal income tax purposes. Such
carryforwards expire in fiscal 2011. For state tax purposes, the Company had net
operating loss carryforwards of $2,816,000 which expire in fiscal 1999 through
2001. The Company's international tax credits, amounting to approximately
$386,000, expire in fiscal 1997 through 2000. The Company's general business
credit carryforwards, amounting to approximately $190,700, expire in fiscal 2002
and 2003. Finally, the Company's alternative minimum tax credit carryforwards,
amounting to approximately $173,000, have no expiration date.
(6) WARRANTS
In fiscal 1991, in connection with the Series A Convertible Subordinated
Debenture offering, the Company issued warrants to the underwriter to purchase
up to $150,000 principal amount of Series A Debentures for $1,200 for each
$1,000 principal amount of Series A Debentures purchased. The warrants were
exerciseable through December 20, 1995. The Company issued warrants to the
underwriter to purchase up to 400 units of Series A Debentures at $1,200 per
unit. Each unit consists of $1,000 principal amount of Series A Debentures and
warrants to purchase 500 shares of common stock of the Company at $2.00 per
share. The warrants, sold as part of the unit, were exerciseable through March
20, 1996 and the Company extended the exercise period through March 20, 1997.
The Company issued 2,100,000 warrants valued at $525,000 to purchase common
stock at $2.00 per share, subject to adjustment in certain circumstances.
Through September 30, 1996, no warrants had been exercised.
F-18
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) WARRANTS (CONTINUED)
In fiscal 1992, in connection with its public offering of common stock, the
Company issued warrants to the underwriters of the offering to purchase 700,000
shares of common stock. The warrants are exerciseable during the four-year
period commencing on November 13, 1993 at a price of $1.25 per share subject to
adjustment in certain circumstances.
In fiscal 1994, in connection with the 8% Convertible Subordinated
Debentures offering, the Company issued warrants to the underwriter to purchase
up to 10% of the aggregate principal amount of debentures sold ($1,643,700) at
an exercise price equal to 120% of the principal amount of the debentures,
subject to adjustment in certain circumstances. The warrants are exerciseable
during the four year period commencing March 10, 1995 for $1,613,700 principal
amount and April 12, 1995 for $30,000 principal amount. In connection with the
9% Convertible Subordinated Debenture offering, the Company issued warrants to
the underwriters to purchase up to 10% of the aggregate principal amount of
debentures sold ($505,000) at an exercise price equal to 120% of the principal
amount of the debentures, subject to adjustments in certain circumstances.
The warrants are exercisable during the four year period commencing July 25,
1995. As of September 30, 1996, no warrants had been exercised.
In fiscal 1996, in connection with its public offering of 4,750,000 units
consisting of two shares of common stock and one warrant to purchase one share
of common stock (a "Unit") for $1.9375 per unit, the Company issued 4,750,000
warrants to purchase common stock and warrants to the underwriter to purchase up
to 427,000 units at an exercise price of $3.196875 per Unit, subject to
adjustment in certain circumstances. In addition, the Company issued warrants to
a consultant to purchase up to 47,500 Units at $3.196875 per Unit, subject to
adjustment in certain circumstances. The warrants underlying the Units are
exercisable at an exercise price of $1.14375 per share subject to adjustments in
certain circumstances through June 23, 2001.
(7) OPTIONS
In fiscal 1989, the Board of Directors approved a stock incentive plan (the
"Plan") that covers directors, third party consultants and advisors, independent
contractors, officers and other employees of the Company. In May 1994, the
stockholders of the Company voted to increase the authorized number of shares
available under the Plan from 1,500,000 to 4,500,000. The Plan allows for the
issuance of options to purchase shares of the Company's common stock at an
option price at least equal to the fair value of the stock on the date of grant.
As of September 30, 1996, 3,880,000 stock options had been granted and were
outstanding under the Plan.
F-19
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) OPTIONS (CONTINUED)
The schedule below includes stock options that the Company has granted as of
September 30, 1996:
<TABLE>
<CAPTION>
OUTSIDE EXERCISE
THE PLAN TOTAL PRICES
---------- --------- ---------- -------------
<S> <C> <C> <C> <C>
Balance at September 30, 1993............................. 743,500 652,096 1,395,596
Granted Fiscal 1994........................................... 2,962,500 20,000 2,982,500 $.75-$1.16
Options Expired/Canceled...................................... (83,500) -- (83,500) $1.00-$1.94
Options Exercised............................................. (105,000) -- (105,000) $1.00
---------- --------- ----------
Balance at September 30, 1994............................. 3,517,500 672,096 4,189,596
Granted Fiscal 1995........................................... 615,000 -- 615,000 $.75-$.78
Options Expired/Canceled...................................... (72,500) -- (72,500) $.75-$2.63
Options Exercised............................................. -- -- --
Balance at September 30, 1995............................. 4,060,000 672,096 4,732,096
Granted Fiscal 1996........................................... 100,000 -- 100,000 $.75
Options Expired/Canceled...................................... (160,000) (25,000) (185,000) $.75-$1.16
Options Exercised............................................. (450,000) -- (450,000) $.75-$1.00
---------- --------- ----------
Balance at September 30, 1996............................. 3,550,000 647,096 4,197,096
---------- --------- ----------
---------- --------- ----------
Exercisable at September 30, 1996............................. 1,735,000 647,096 2,382,096
---------- --------- ----------
---------- --------- ----------
</TABLE>
On November 21, 1996 the shareholders of the Company voted in a special
meeting to amend the Company's Amended Articles of Incorporation to increase the
number of authorized shares of Common Stock of the Company from the present
amount of 80,000,000 shares to 150,000,000 shares. In addition the shareholders
voted to make certain amendments to the Company's 1988 Stock Incentive Plan,
including increasing the number of shares of Common Stock reserved for issuance
by 3,000,000 shares from 4,500,000 shares to 7,500,000 shares, as well as
certain changes in accordance with new rules enacted under Section 16 of the
Securities Exchange Act of 1934, as amended.
(8) COMMITMENTS AND CONTINGENCIES
OFFICER COMPENSATION
MESSRS. KUSHNER AND LOCKE. In March 1994, Messrs. Kushner and Locke each
amended his respective employment agreement with the Company to (i) extend the
term of the agreement to five years from the effective date thereof (March 1999)
and (ii) reduce the maximum annual performance bonus that each may receive to 4%
of pre-tax earnings for the applicable period up to a maximum of $200,000 in
fiscal 1994, $220,000 in fiscal 1995, $250,000 in fiscal 1996, $270,000 in
fiscal 1997 and $290,000 in fiscal 1998. In fiscal 1992, Messrs. Kushner and
Locke elected to forego certain executive production and incentive bonuses.
Under the revised employment agreements, Messrs. Kushner and Locke each have a
base salary of $400,000 in fiscal 1994 and $425,000 in fiscal 1995 through
fiscal 1998, subject to potential increase upon review by the Company's Board of
Directors after fiscal 1995. As approved by the Board of Directors in February
1996 and May 1996, Messrs. Kushner and Locke amended their employment agreements
to waive their pre-tax earnings performance bonus in the event the Company's
annual net income in fiscal 1996 is less than $1,250,000, but shall receive 6%
of pre-tax earnings of the Company for fiscal 1996 in excess of $1,250,000 and
up to $3,166,666; and shall receive 4% of pre-tax earnings of the Company for
F-20
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
fiscal 1996 in excess of $3,166,666, but in no event shall either one of them be
entitled to receive greater than $250,000 of performance bonus.
In order to induce Messrs. Kushner and Locke to amend their employment
agreements, the Company granted to each as of March 10, 1994 options to purchase
900,000 shares of Common Stock at an exercise price per share equal to $0.84
(the last reported sale price of the Common Stock on the date of the initial
closing of the 8% Debentures). The options vest over a five year period, with
20% vesting at each anniversary of the date of grant (subject to possible
acceleration following a "change-in-control").
The Company also provides Messrs. Kushner and Locke with certain fringe
benefits, including payment of an amount equal to the premiums in respect of
$3,500,000 of term life insurance with beneficiaries to be designated by each
person (Messrs. Kushner and Locke have designated the other person as the
beneficiary) and disability insurance for each person. After the employment
agreements expire or are terminated, Messrs. Kushner and Locke will be entitled
to certain payments should they continue to provide executive producer or
consulting services to the Company. The agreements permit Messrs. Kushner and
Locke to collect outside compensation to which they may be entitled and to
provide incidental and limited services outside of their employment with the
Company and to receive compensation therefor, so long as such activities do not
materially interfere with the performance of their duties under the agreements.
Each of Messrs. Kushner and Locke also may require the Company to change its
name to remove his name within one year after the expiration or termination of
the term of his employment, except for product released prior to such
termination, and except that the Company may continue to use such name for a
period of one year after such notice. In fiscal 1992, in connection with the
Company's public offering of common stock, Messrs. Kushner and Locke each
deposited 600,000 shares of the Company's common stock with an escrow agent.
Under the agreement with the Company, as revised, if a designated earnings
before income taxes and extraordinary items requirement was not met for the year
ending September 30, 1993, Messrs. Kushner and Locke would make capital
contributions by releasing the shares of common stock to the Company. Effective
October 1, 1993, these shares were contributed back to the Company for no
consideration and retired.
MR. LILLISTON. On September 14, 1996, the Company entered into an
employment agreement with Bruce St. J. Lilliston pursuant to which the Company
agreed to hire Mr. Lilliston as the President and Chief Operating Officer of the
Company effective October 1, 1996 for a three year term. As part of the
agreement, Mr. Lilliston will be paid a base salary of $400,000 per year. In
addition, he was advanced as a loan the sum of $100,000 effective September 3,
1996 and $200,000 in October 1996. The loan was made to assist Mr. Lilliston in
the transition from his private practice to his duties as Chief Operating
Officer of the Company. The loan accrues simple interest at the rate of 8% per
annum and will be repaid over a five year period at certain specified dates
ending October 1, 2001. Mr. Lilliston has the right to receive bonuses equal to
the amount of the payments, and interest, due for such loan repayment if Mr.
Lilliston is still employed by the Company (including the renewal of his
employment agreement if applicable) on certain applicable date (the "Employment
Bonus").
Beginning October 1, 1997, if Mr. Lilliston is still employed by the Company
(including the renewal of his employment agreement if applicable), he shall be
entitled to receive a bonus of $100,000 the first time the "Average Closing
Price" (the average closing price of the common stock over a thirty calendar day
F-21
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
period) is $1.00 or more greater than the "First Day Price" (the average closing
price of the common stock over the thirty calendar day period immediately prior
to October 1, 1996). Thereafter, if Mr. Lilliston is still employed by the
Company (including the renewal of his employment agreement if applicable), he
shall be entitled to receive an additional $100,000 bonus the first time the
Average Closing Price exceeds the First Day Price by $2.00 or more, and each
whole dollar amount through and including $10.00 (each such bonus, a "Stock
Bonus"). The aggregate of such bonuses shall not exceed $1,000,000. The
foregoing Stock Bonuses shall be reduced by an amount equal to the Employment
Bonus up to $150,000 plus interest paid thereon from September 3, 1996.
If the Company realizes pre-tax operating profits or earnings per share for
any fiscal year of employment greater than 100% of the largest pre-tax operating
profit or earnings per share amount for any of the preceding years of Mr.
Lilliston's employment under his employment agreement or in any of the five
fiscal years immediately preceding the commencement of such agreement, and if
Mr. Lilliston is still employed by the Company at the end of the applicable
fiscal year, then Mr. Lilliston shall be entitled to receive a bonus of $50,000.
As part of the agreement, the Company agreed to grant Mr. Lilliston options
to purchase up to 500,000 shares of Common Stock, with 125,000 of such options
being granted and vested immediately, 50,000 and 75,000 of such options to be
granted and vested one and two years, respectively, after the commencement of
the term (the "Term") of the employment agreement (in each case, subject to Mr.
Lilliston reaching certain performance criteria to be established by the Board
of Directors or a committee thereof), and 250,000 of such options to be granted
three years after the commencement of the Term, one-half thereof to vest upon
the grant thereof and the remainder to vest upon the reaching of certain
performance criteria to be established by the Board of Directors or a committee
thereof. If Mr. Lilliston's employment is extended for a second term pursuant to
such agreement (the "Second Term"), the Company has agreed to grant Mr.
Lilliston options to purchase up to an additional 500,000 shares of Common
Stock, 100,000, 150,000 and 250,000 of such options to be granted one, two and
three years, respectively, after the commencement of the Second Term with
one-half of each such grant to vest immediately upon grant and the remainder
thereof to vest upon Mr. Lilliston reaching certain performance criteria to be
established by the Board of Directors or a committee thereof. In the event the
performance goals are not met, such options vest at a fixed date in the future,
contingent solely on future employment. The exercise price for such options
shall be equal to the closing price of the Common Stock on the applicable date
of grant. Finally, as part of Mr. Lilliston's agreement, he is allowed to
maintain not more than two independent outside legal consultancy client
relationships, subject to approval by the Chief Executive Officers, with
earnings from such consultancies limited to $150,000 per year.
DIRECTOR COMPENSATION
During fiscal 1989, the Company entered into a consulting agreement with Mr.
Stuart Hersch to engage his services until September 30, 1994 as an executive
consultant. Mr. Hersch was paid $100,000 as a consulting fee under the amended
consulting agreement during each year in the three years period ended September
30, 1993. Pursuant to the consulting agreement the Company granted Mr. Hersch
stock options to purchase 854,192 shares of common stock at $1.555 per share,
the fair market value on the date the Company committed to make the grant.
During fiscal 1990, the consulting agreement was amended, reducing the options
granted to 427,096 shares. As of September 30, 1996, 427,096 options had vested.
F-22
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
In consideration of the elimination of certain demand registration rights,
the Company indemnified Mr. Hersch in the event Mr. Hersch sold 510,000 shares
of the Company's common stock to third parties at a price less than $1.75 per
share. The Company paid Mr. Hersch a total of $275,000 during the three-year
period ended September 30, 1994 related to such indemnification.
Mr. Hersch became a consultant to the Company effective April 1, 1996 for
which he is paid $7,500 per month. Mr. Hersch is assisting the Company in
analyzing potential strategic acquisitions and is providing the Company
consulting services in connection with the Company's involvement in
infomercials. This agreement is on a month-to-month basis as needed by the
Company.
EMPLOYEE BENEFIT PLANS
The Company participates in various multiemployer defined benefit and
defined contribution pension plans under union and industry agreements. These
plans include substantially all participating film production employees covered
under various collective bargaining agreements. The Company funds the costs of
such plans as incurred. Corporate employees not related to actual film
production are covered under medical, dental and vision care plans, and after
one year of employment, may participate in a 401(k) retirement plan, with an
option for a 125 Flexible Savings plan which are each administered by The
Entrust Group, California Pension Administrators and Consultants, Inc. Costs
related to Employee Benefit Plans are immaterial for the years presented.
LEASE
The Company is obligated under a noncancelable operating lease for office
space on the 20th and 21st floors at its principal executive offices in Los
Angeles, California and for office space in London, England at September 30,
1996 as follows:
<TABLE>
<S> <C>
Fiscal 1997................................................. $ 540,000
Fiscal 1998................................................. $ 540,000
Fiscal 1999................................................. $ 540,000
Fiscal 2000................................................. $ 273,000
---------
Total minimum future lease rental payments...................... $1,893,000
---------
---------
</TABLE>
Rental expense for the years ended September 30, 1996, 1995 and 1994 was
approximately $540,000 $530,000, and $506,000, respectively.
CONTINGENCIES
The Company is involved in certain legal proceedings and claims arising out
of the normal conduct of its business. Management of the Company believes that
the ultimate resolution of these matters will not have a material adverse effect
upon the Company's results of operations or financial position.
In its normal course of business, the Company makes contractual down
payments to acquire film distribution rights. This initial advance for rights
ranges from 10% to 30% of the total purchase price. The balance of the payment
is generally due upon the complete delivery by third party producers of
acceptable film and video materials and other proof of rights held and insurance
policies that may be required for the
F-23
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company to begin exploitation of the product. As of September 30, 1996 the
Company had made contractual agreements for an aggregate of $365,000 in payments
due should those third party producers complete delivery to the Company. About
one half of these obligations have originated in the Company's cable joint
venture known as KLC/New City. These amounts are estimated to be payable over
the next eighteen months.
(9) RELATED PARTY TRANSACTIONS
In December 1994, the Company loaned August Entertainment, Inc. ("August")
$650,000 against distribution rights to third party product. August is majority
owned by Gregory Cascante, who subsequently joined the Company as President of
its new international film distribution division. The loan bears interest at the
lesser of (a) Prime (8.25% at December 13, 1996) plus 2% or (b) 10%. The
distribution agreement is secured by all assets of August, including a pledge of
all sales commissions due to August from the producers of the films SLEEP WITH
ME, LAWNMOWER MAN II and NOSTRADAMUS. While the right of August to receive such
commissions with respect to the film LAWNMOWER MAN II is subordinate to the
interests of the production lenders, The Allied Entertainment Group PLC, and its
subsidiaries which produced the film have guaranteed payment of such commissions
to the extent they would be payable had there been no production loan on that
film. Repayment of principal and interest is by collection of commissions
assigned as collateral. As of September 30, 1996 the Company had been repaid
$217,000 toward interest and principal and approximately $540,000 principal
amount remains outstanding. The loan matures in December 1996, but the Company
is currently in discussions with August concerning an extension of the maturity
date.
Stuart Hersch, in addition to compensation paid to him as a member of the
Board of Directors of the Company, became a consultant to the Company effective
April 1, 1996 for which he is paid $7,500 per month. Mr. Hersch is assisting the
Company in analyzing potential strategic acquisitions and is providing the
Company consulting services in connection with the Company's involvement in
infomercials. This agreement is on a month-to-month basis as needed by the
Company.
In fiscal 1995 the Company became a general partner in TVFirst, which
creates and markets infomercials. The Company's investment in TVFirst on the
equity basis amounted to $1,494,000 as of September 30, 1996, which is included
in other assets. One of TVFirst's current projects is a Christian music
infomercial. TVFirst purchased air time for such infomercial but neither TVFirst
nor either of its partners (including the Company) had the available resources
to fund such purchases. Messrs. Locke and Kushner loaned the Company $355,000
during 1996 to enable TVFirst to purchase such air time. Such loans bore
interest at prime (8.25% during the loan period) plus 1% and were repaid within
the fiscal year. In addition, each lender received an additional amount equal to
10% of the principal amount loaned by such lender when the loans were repaid.
Furthermore, each lender will receive a profit participation in the profits, if
any, related to this Christian music infomercial, up to an amount equal to 5% of
its principal amount, which amount will be payable on the first anniversary of
such repayment. While the infomercial has generated revenues in excess of its
programming and media costs to date, there is no assurance that future revenues
will continue to exceed costs. The foregoing transaction was approved by a
majority of the independent directors of the Company's Board of Directors.
On September 14, 1996, the Company entered into an employment agreement with
Bruce St. J. Lilliston pursuant to which the Company agreed to hire Mr.
Lilliston as the President and
F-24
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) RELATED PARTY TRANSACTIONS (CONTINUED)
Chief Operating Officer of the Company effective October 1, 1996. As part of
such agreement, Mr. Lilliston is allowed to maintain not more than two
independent outside legal consultancy client relationships, subject to approval
by the Chief Executive Officers. Prior to his employment, Mr. Lilliston had an
attorney-client relationship with certain of Kushner-Locke International's
distributing licensees as well as August Entertainment. See Footnote (8),
Commitments and Contingencies for a further description of Mr. Lilliston's
employment agreement with the Company.
The Company has entered into an agreement with New City Releasing ("New
City") pursuant to which the Company has agreed to acquire, on a retroactive
basis, one half of New City's interest in the KLC/New City Tele-Ventures joint
venture (representing a 17.5% ownership interest in the joint venture as to
which the Company already holds a 65% ownership interest) for 1,365,000 shares
of Common Stock. The sale or transfer of such shares is restricted until October
1, 1997 provided that one-half of the shares are subject to such restrictions
solely until March 1, 1997 (the "Restricted Period"). New City has certain
registration rights with respect to such shares of common stock.
(10) MAJOR CUSTOMERS AND EXPORT SALES
Revenues to major customers which exceeded 10% of net operating revenues
represented 24%, 45% and 51% of net operating revenues for the years ended
September 30, 1996, 1995 and 1994, respectively, and consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------
1996 1995 1994
------------- ------------ -------------
<S> <C> <C> <C>
Television Network CBS........................... $ 8,288,000 $ 6,045,000 $ 18,320,000
Television Network ABC........................... 10,550,000 -- 7,440,000
Television Network NBC........................... -- 3,105,000 --
------------- ------------ -------------
$ 18,838,000 $ 9,150,000 $ 25,760,000
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
Accounts receivable from these major customers totaled $108,700, $356,000,
and $235,000 at September 30, 1996, 1995 and 1994, respectively.
Domestic and international accounts receivable consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------
1996 1995
------------- ------------
<S> <C> <C>
Accounts Receivable:
Domestic....................................................... $ 3,266,000 $ 3,560,000
International.................................................. 20,312,000 4,704,000
------------- ------------
23,578,000 8,264,000
Less: Allowance for Doubtful Accounts............................ (693,000) (400,000)
------------- ------------
$ 22,885,000 $ 7,864,000
------------- ------------
------------- ------------
</TABLE>
F-25
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) MAJOR CUSTOMERS AND EXPORT SALES (CONTINUED)
Export sales by geographic areas were as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------
1996 1995 1994
------------- ------------ -------------
<S> <C> <C> <C>
Europe........................................... $ 22,513,000 $ 3,500,000 $ 6,643,000
Canada........................................... 451,000 327,000 1,121,000
Other............................................ 13,069,000 2,408,000 2,486,000
------------- ------------ -------------
$ 36,033,000 $ 6,235,000 $ 10,250,000
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
Other sales were principally to customers in Asia, South America and
Australia.
(11) FOURTH QUARTER ADJUSTMENTS
During the fourth quarter of 1995 and 1996, the Company revised its estimate
of future revenues for certain product no longer being produced by the Company.
The impact of these revised estimates were not material to the statements of
operations.
F-26
<PAGE>
THE KUSHNER--LOCKE COMPANY
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING OF COSTS AND DUE TO END OF
PERIOD EXPENSES WRITE-OFFS PERIOD
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year Ended 9/30/96.......................................... $ 400,000 $ 499,000 ($206,000) $ 693,000
Year Ended 9/30/95.......................................... $ 650,000 $ 450,000 ($700,000) $ 400,000
Year Ended 9/30/94.......................................... $ 450,000 $ 200,000 -- $ 650,000
</TABLE>
F-27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C>
THE KUSHNER-LOCKE COMPANY
(Registrant)
Dated: December 27, 1996
/s/ DONALD KUSHNER
--------------------------------------------
Donald Kushner
Co-Chairman of the Board, Co-Chief Executive
Officer and Secretary
Dated: December 27, 1996
/s/ JAMES L. SCHWAB
--------------------------------------------
James L. Schwab
Chief Financial Officer
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C>
THE KUSHNER-LOCKE COMPANY
(Registrant)
Dated: December 27, 1996
/s/ PETER LOCKE
--------------------------------------------
Peter Locke
Co-Chairman of the Board and Co-Chief
Executive Officer
Dated: December 27, 1996
/s/ DONALD KUSHNER
--------------------------------------------
Donald Kushner
Co-Chairman of the Board, Co-Chief Executive
Officer and Secretary
Dated: December 27, 1996
/s/ JAMES L. SCHWAB
--------------------------------------------
James L. Schwab
Chief Financial Officer
</TABLE>
II-1
<PAGE>
<TABLE>
<S> <C>
Dated: December 27, 1996
/s/ ROBERT SWAN
--------------------------------------------
Robert Swan
Controller
Dated: December 27, 1996
/s/ STUART HERSCH
--------------------------------------------
Stuart Hersch
Director
Dated: December 27, 1996
/s/ MILT OKUN
--------------------------------------------
Milt Okun
Director
Dated: December 27, 1996
/s/ S. JAMES COPPERSMITH
--------------------------------------------
S. James Coppersmith
Director
</TABLE>
II-2
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
<C> <S>
3 Article of Incorporation (A)
4.1 Indenture between the Company and National City
Bank of Minneapolis, as Trustee, dated as of
December 1, 1990 pertaining to 10% Convertible
Subordinated Debentures Due 2000, Series A (E)
4.2 First Supplemental Indenture between the Company
and National City Bank of Minneapolis, as
Trustee, dated as of March 15, 1991 pertaining
to 10% Convertible Subordinated Debentures Due
2000, Series A (F)
4.3 Indenture between the Company and National City
Bank of Minneapolis, as Trustee, dated as of
December 1, 1990 pertaining to 13 3/4%
Convertible Subordinated Debentures Due 2000,
Series B (E)
4.4 Warrant agreement between the Company and City
National Bank, as Warrant Agent, dated as of
March 19, 1991 pertaining to Common Stock
Purchase Warrants (F)
10.1 Employment Agreement dated October 1, 1988 between
the Company and Donald Kushner (A)
10.1.1 Amendment dated August 18, 1992 to the Employment
Agreement dated October 1, 1988 between the
Company and Donald Kushner (J)
10.1.2 Amendment dated January 20, 1994 to the Employment
Agreement dated October 1, 1988 between the
Company and Donald Kushner (K)
10.1.3 Addendum dated July 1, 1994 to the Employment
Agreement dated October 1, 1988 between the
Company and Donald Kushner (M)
10.2 Employment Agreement dated October 1, 1988 between
the Company and Peter Locke (A)
10.2.1 Amendment dated August 18, 1992 to the Employment
Agreement dated October 1, 1988 between the
Company and Peter Locke (J)
10.2.2 Amendment dated January 20, 1994 to the Employment
Agreement dated October 1, 1988 between the
Company and Peter Locke (K)
10.2.3 Addendum dated July 1, 1994 to the Employment
Agreement dated October 1, 1988 between the
Company and Peter Locke (M)
10.3 1988 Stock Incentive Plan of the Company (A)
10.4 Form of Indemnification Agreement (A)
10.5 Kushner-Locke Shareholders' Cross-Purchase
Agreement dated as of October 1, 1988 between
and among Donald Kushner, Rebecca Hight, Peter
Locke, Karen Locke, Peter Locke Productions,
Inc. and Twelfth Street Limited (A)
10.5.1 Amendment dated as of May 14, 1992 to the
Kushner-Locke Shareholders' Cross-Purchase
Agreement dated as of October 1, 1988 between
and among Donald Kushner, Rebecca Hight, Peter
Locke, Karen Locke, Peter Locke Productions,
Inc. and Twelfth Street Limited (I)
10.6 Kushner-Locke Trust Agreement dated as of October
1, 1988 between and among Donald Kushner,
Rebecca Hight, Peter Locke, Karen Locke, Peter
Locke Productions, Inc. and Twelfth Street
Limited (A)
10.6.1 Amendment dated May 14, 1992 to the Kushner-Locke
Trust Agreement dated as of October 1, 1988
between and among Donald Kushner, Rebecca Hight,
Peter Locke, Karen Locke, Peter Locke
Productions, Inc. and Twelfth Street Limited (I)
10.12 Lease Agreement, dated as of November 1989,
between the Company and 11601 Wilshire
Associates (G)
10.12.1 Amended Lease Agreement (G)
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.16 Warrant Agreement between the Company and
Chatfield Dean & Co., Inc. dated as of November
13, 1992 (J)
10.19 Fiscal Agency Agreement dated March 10, 1994
between and among the Company, Bank America
National Trust Company and Bank of America
National Trust and Savings Association (K)
10.19.1 Side letter between the Company and BankAmerica
Trust Company to the Fiscal Agency Agreement
dated March 10, 1994 between and among the
Company, BankAmerica Trust Company and Bank of
America National Trust and Savings Association
(K)
10.20 Warrant Agreement dated March 10, 1994 between the
Company and RAS Securities Corp. (K)
10.21 Warrant Agreement dated March 10, 1994 between the
Company and I. Friedman Equities, Inc. (K)
10.22 Fiscal Agency Agreement dated July 25, 1994
between and among the Company, Bank America
National Trust Company and Bank of America
National Trust and Savings Association (L)
10.24 Employment Agreement dated September 1, 1994
between the Company and Gregory Cascante (M)
10.25 Employment Agreement dated September 1, 1994
between the Company and Eleanor Powell (M)
10.27 Loan and Security Agreement dated December 1, 1994
between the Company and August Entertainment,
Inc., and Guarantees between the Company, August
Entertainment, Inc. and the Allied
Entertainments Group PLC and certain of its
subsidiaries (M)
10.28 Letter Agreement, dated March 23, 1995, by and
between Woodenhead Productions, Ltd. and
Newmarket Capital Group, L.P. (N)
10.30* Letter Agreement dated February 6, 1995 by and
between Savoy Pictures, Inc. and KL Features,
Inc. (N)*
10.32 Guaranty, dated July 7, 1995, by and between The
Kushner-Locke Company and Newmarket Capital
Group, L.P. for loan and interest of Allied
Pinocchio Productions, LTD. (THE LEGEND OF
PINOCCHIO) (O)
10.41 Letter Agreement dated December 5, 1995 from New
Line Cinema to The Kushner Locke Company
summarizing New Line/Savoy deal regarding THE
LEGEND OF PINOCCHIO (Q)
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.44 Amendment to the 1988 Stock Incentive Plan dated
May 17, 1994 (Q)
10.46 First Amendment to Credit Documents dated December
22, 1995 between Allied Pinocchio Productions,
Limited, Newmarket Capital Group L.P., Bank of
American National Trust and Savings
Associations, The Kushner-Locke Company and
Kushner-Locke International, Inc. (THE LEGEND OF
PINOCCHIO) (Q)
10.50 Cross Collateralization Agreement dated as of July
7, 1995 between The Kushner-Locke Company,
Allied Pinocchio Productions Ltd., Dayton Way
Pictures, Inc., Dayton Way Pictures II, Inc.,
Dayton Way Pictures IV, Inc. and Newmarket
Capital Group, L.P. (Q)
10.51 First Amendment to Cross Collateralization
Agreement dated January 10, 1996 between The
Kushner-Locke Company, Allied Pinocchio
Productions Ltd., Dayton Way Pictures, Inc.,
Dayton Way Pictures II, Inc., Dayton Way
Pictures IV, Inc. and Newmarket Capital Group,
L.P. (Q)
10.54 Fourth Amendment to Employment Agreement between
The Kushner-Locke Company and Peter Locke dated
February 13, 1996. (R)
10.55 Fourth Amendment to Employment Agreement between
The Kushner-Lock Company and Donald Kushner
dated February 13, 1996. (R)
10.56 Letter Agreement, dated as of April 12, 1996, by
and among The Kushner-Locke Company, Chemical
Bank and Chase Securities Inc. (T)
10.57 Credit, Security, Guaranty and Pledge Agreement,
dated as of June 19, 1996, among The
Kushner-Locke Company, the Guarantors named
therein, The Chase Manhattan Bank, N.A.,
(formerly Chemical Bank) as Agent, and The Chase
Manhattan Bank, N.A., (formerly Chemical Bank)
as Fronting Bank (T)
10.58 Employment Agreement dated September 14, 1996
between The Kushner-Locke Company and Bruce St.
J Lilliston
10.59 Loan and Security Agreement dated March 1, 1996
between The Kushner-Locke Company and its
subsidiaries and Banque Paribas, Los Angeles
Agency
10.60 Loan and Security Agreement, dated as of April 19,
1996, by and between The Kushner-Locke Company,
I. O. International Ltd., and Imperial Bank.
10.61 Waiver of Section 6.17 OVERHEAD EXPENSES of the
Credit, Security, Guaranty and Pledge Agreement,
dated as of June 19, 1996, among The
Kushner-Locke Company, the Guarantors referred
to therein, the Lenders referred to therein, and
The Chase Manhattan Bank, N.A., (formerly known
as Chemical Bank), as Agent.
23.1 Consent of KPMG Peat Marwick LLP
</TABLE>
- ------------------------
* Confidential Treatment Granted.
(A) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-18, as amended, effective December 5, 1988 (Commission
File No. 33-25101-LA).
(B) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1989.
(C) Incorporated by reference from the Exhibit to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1990.
(D) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 (File No. 33-37192), as initially filed on October 5,
1990 or as amended on November 30, 1990.
(E) Incorporated by reference from the Exhibits to the Company's Registration
Statements on Form S-1, as amended, effective November 30, 1990 (File No.
33-37192), and effective December 20, 1990 (File No. 33-37193).
<PAGE>
(F) Incorporated by reference to the Company's Registration Statement on Form
S-1, as amended, effective March 20, 1991.
(G) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1991.
(H) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1991.
(I) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1992.
(J) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-2, as amended, effective November 12, 1992 (Commission
File No. 33-51544).
(K) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal quarter ended March 31, 1994.
(L) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1994.
(M) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1994.
(N) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1995.
(O) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1995.
(P) Incorporated by reference from the Exhibits to the Company's Report on Form
10-K for the fiscal year ended September 30, 1995.
(Q) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended December 31, 1995.
(R) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended March 31, 1996.
(S) Incorporated by reference from the Exhibits to the Company's Report on Form
10-Q for the fiscal quarter ended June 30, 1996.
(T) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-2, as amended, effective August 15, 1996 (Common File
No. 333-05089).
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> SEP-30-1996
<CASH> 11,636
<SECURITIES> 0
<RECEIVABLES> 23,578
<ALLOWANCES> 693
<INVENTORY> 58,463<F1>
<CURRENT-ASSETS> 0
<PP&E> 1,532
<DEPRECIATION> 1,167
<TOTAL-ASSETS> 100,152
<CURRENT-LIABILITIES> 3,277
<BONDS> 12,039
0
0
<COMMON> 37,650
<OTHER-SE> (3,400)
<TOTAL-LIABILITY-AND-EQUITY> 100,152
<SALES> 0
<TOTAL-REVENUES> 80,157
<CGS> 70,648
<TOTAL-COSTS> 70,648
<OTHER-EXPENSES> 3,595
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,027
<INCOME-PRETAX> 1,142
<INCOME-TAX> 47
<INCOME-CONTINUING> 1,095
<DISCONTINUED> 0
<EXTRAORDINARY> 365
<CHANGES> 0
<NET-INCOME> 730
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
<FN>
<F1>Included as inventory are: completed film and television costs, productions in
progress and development.
</FN>
</TABLE>
