SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarter ended June 30, 1999 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) 481-2000
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
13-3/4% Convertible Subordinated Debentures, Series B due
2000
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
There were 13,788,703 shares of outstanding Common Stock of the Registrant
as of August 13, 1999.
Total number of pages: 42. Exhibit Index begins on page 41.
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Form 10-Q for the Quarter ended June 30, 1999
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Cash Flows
Condensed Consolidated Statements of Stockholders' Equity
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings: Not Applicable.
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities: Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Item 5. Other Information: Not Applicable.
Item 6. Exhibits and Reports on Form 8-K: None.
(a) Exhibits: Exhibits filed as part of this report are
listed on the "Index to Exhibits" which follows the
signature pages hereto.
(b) Reports on Form 8-K: None.
<PAGE>
PART I
Item 1.
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
(unaudited)
------------ ------------
<S> <C> <C>
Assets
Cash and cash equivalents $46,926,000 $1,255,000
Reserved cash 216,000 66,000
Restricted cash 1,992,000 1,988,000
Accounts receivable, net of allowance for
doubtful accounts 30,964,000 40,418,000
Due from affiliates 3,688,000 2,488,000
Note receivable from related party -- 231,000
Film and television property costs, net of
accumulated amortization 93,154,000 73,773,000
Investments in unconsolidated entities, at
Equity 9,929,000 10,798,000
Other assets 10,725,000 6,088,000
------------ ------------
$198,579,000 $137,105,000
============ ============
Liabilities and Stockholders' Equity
Accounts payable and accrued liabilities $10,316,000 $6,031,000
Income taxes 659,000 --
Notes payable 86,111,000 73,151,000
Deferred film license fees 4,079,000 4,111,000
Contractual obligations 13,758,000 13,851,000
Production advances 2,489,000 2,969,000
Convertible subordinated debentures, net of
deferred issuance costs 2,352,000 11,526,000
------------ ------------
Total liabilities 119,764,000 111,639,000
------------ ------------
Minority interest 14,080,000 --
------------ ------------
Stockholders' equity:
Common stock, no par value. Authorized
50,000,000 shares; issued and outstanding
13,746,201 shares at June 30, 1999 and
9,217,029 shares at September 30, 1998 67,996,000 39,571,000
Additional paid-in capital 1,529,000 --
Accumulated deficit (4,790,000) (14,105,000)
------------ ------------
Net stockholders' equity 64,735,000 25,466,000
------------ ------------
$198,579,000 $137,105,000
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
----------------------- ------------------------
1999 1998 1999 1998
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenues:
Film and television
programming $6,028,000 $12,634,000 $24,582,000 $54,977,000
Search and individual
reference services 3,983,000 2,689,000 9,623,000 4,792,000
---------- ---------- ---------- ----------
Total operating
revenues 10,011,000 15,323,000 34,205,000 59,769,000
---------- ---------- ---------- ----------
Costs related to
operating revenues:
Film and television
programming (9,516,000) (10,670,000) (25,261,000) (48,469,000)
Search and individual
reference services (1,497,000) (1,129,000) (3,857,000) (2,180,000)
---------- ---------- ---------- ----------
Total costs related
to operating
revenues (11,013,000) (11,799,000) (29,118,000) (50,649,000)
---------- ---------- ---------- ----------
Gross profit (loss) (1,002,000) 3,524,000 5,087,000 9,120,000
Selling, general and
administrative
expenses (8,917,000) (3,458,000) (20,270,000) (6,476,000)
Provision for doubtful
accounts and notes (1,798,000) (758,000) (2,999,000) (1,108,000)
---------- --------- --------- ----------
Earnings (loss)
from operations (11,717,000) (692,000) (18,182,000) 1,536,000
Gain on sale of
interest in
subsidiary 13,148,000 -- 13,148,000 --
Gain on issuance of
stock by
subsidiary 21,152,000 -- 21,152,000 --
Interest income 1,000 27,000 104,000 64,000
Interest expense (2,061,000) (1,572,000) (6,167,000) (4,326,000)
---------- --------- --------- ----------
Earnings (loss)
before income
taxes 20,523,000 (2,237,000) 10,055,000 (2,726,000)
Income tax expense (658,000) (6,000) (740,000) (18,000)
---------- --------- ---------- ---------
Net earnings (loss) $19,865,000 ($2,243,000) $9,315,000 ($2,744,000)
========== ========= ========== =========
Earnings (loss)
available
for common
stockholders $19,865,000 ($2,243,000) $9,315,000 ($2,744,000)
========== ========= ========== =========
Earnings (loss)
per share:
Basic $1.53 ($0.24) $0.84 ($0.30)
===== ===== ===== =====
Diluted $1.41 ($0.24) $0.79 ($0.30)
===== ===== ===== =====
Average number of
shares of common
stock outstanding 12,948,000 9,204,000 11,062,000 9,170,000
========== ========= ========== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended June 30,
-------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $9,315,000 $(2,744,000)
Adjustments to reconcile net loss
to net cash used by operating activities:
Amortization of film costs 25,832,000 29,885,000
Gain on issuance of stock by subsidiary (21,152,000) --
Gain on sale od interest in subsidiary (13,148,000) --
Depreciation and amortization 283,000 195,000
Amortization of other assets 787,000 760,000
Provision for doubtful accounts and notes 2,807,000 1,572,000
Other 35,000 --
Reserved and restricted cash (154,000) (332,000)
Accounts receivable 6,902,000 (20,462,000)
Due from affiliates (1,199,000) 13,000
Increase in film and television property costs (45,213,000) (20,136,000)
Other assets (6,281,000) (1,458,000)
Accounts payable and accrued liabilities 4,283,000 1,417,000
Income taxes 659,000 --
Deferred film license fees (32,000) 712,000
Contractual obligations (93,000) (2,917,000)
Production advances (480,000) (5,840,000)
----------- -----------
Net cash used by operating activities (36,849,000) (19,335,000)
----------- -----------
Cash flows from investing activities:
Decrease (increase) in investments in
unconsolidated entities 844,000 (336,000)
Increase in other assets (260,000) (668,000)
----------- -----------
Net cash provided (used) by investing
Activities 584,000 (1,004,000)
----------- -----------
Cash flows from financing activities:
Borrowings under notes payable 34,443,000 33,095,000
Repayment of notes payable (21,483,000) (27,457,000)
Public offering of subsidiary stock 48,818,000 --
Private placement of common stock 5,456,000 --
Exercise of warrants and stock options 9,398,000 --
Other 5,304,000 1,000
----------- -----------
Net cash provided by financing activities 81,936,000 5,639,000
----------- -----------
Net increase (decrease) in cash 45,671,000 (14,700,000)
Cash and cash equivalents at beginning of period 1,255,000 15,077,000
----------- -----------
Cash and cash equivalents at end of period $46,926,000 $377,000
=========== ===========
</TABLE>
Supplemental disclosure of non-cash investing and financing activities:
(1) During the nine months ended June 30, 1999, $9,247,000 of convertible
subordinated debentures were converted into 1,275,193 shares of common
stock. In April 1999 the Company issued 468,883 shares of common
stock to The Harvey Entertainment Company ("Harvey") in exchange for
55,000 shares of Series A Preferred Stock and warrants of Harvey. On
a fully-diluted basis, the Company would own 12% of the voting shares
of Harvey. In June 1999 the Company converted $5,500,000
of advances to its subsidiary US SEARCH.com, Inc. ("US SEARCH.com")
into 2,493,651 shares of US SEARCH.com common stock.
(2) During the nine months ended June 30, 1998, $300,000 of convertible
subordinated debentures were converted into 51,282 shares of common
stock and the Company acquired control of US SEARCH.com.
See accompanying notes to condensed consolidated financial statements.
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders' Equity
Nine Months ended June 30, 1999
(unaudited)
<TABLE>
<CAPTION>
Additional
Number of Common Paid-in Accumulated
Shares Stock Capital Deficit Net
--------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balance at
September 30,
1998 9,217,029 $39,571,000 $-- $(14,105,000) $25,466,000
Private
placement
of common
stock 1,200,000 5,456,000 -- -- 5,456,000
Issuance of
common stock
to The Harvey
Entertainment
Company 468,883 5,820,000 -- -- 5,820,000
Exercises of
Warrants,
stock options
and
restricted
stock grants 1,585,096 9,398,000 -- -- 9,398,000
Conversion of
subordinated
debentures 1,275,193 9,247,000 -- -- 9,247,000
Other -- 33,000 -- -- 33,000
Options
granted by
subsidiary -- -- 1,529,000 -- 1,529,000
Net earnings -- -- -- 9,315,000 9,315,000
---------- ---------- ------- ---------- ----------
Balance at
June 30,
1999 13,746,201 $67,996,000 1,529,000 (4,790,000) 64,735,000
========== ========== ========= ========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
THE KUSHNER-LOCKE COMPANY
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The Company
The Kushner-Locke Company is a leading independent entertainment company
which principally develops, produces, and distributes original feature
films and television programming. Our feature films are developed and
produced for the theatrical, made-for-video and pay cable motion picture
markets. Our television programming has included television series, mini-
series, movies-for-television, animation, reality and game show
programming for the major networks, cable television, first-run
syndication and international markets.
We established our feature film production operations in 1993. In 1994,
we established an international theatrical film subsidiary to expand into
foreign theatrical distribution. In 1995, we formed KLC/New City Tele-
Ventures ("KLC/New City"), a joint venture 82.5% owned by us, to acquire
films for distribution through emerging new delivery systems, including
pay cable, pay-per-view, basic cable, video-on-demand and satellite
systems. In late 1997, we acquired control of US SEARCH.com Inc.("US
SEARCH.com"), a leading provider of fee-based public record search and
other customized individual reference services. In February 1998 we
established KL/Phoenix, an 80% owned entity, which distributes feature
films, television and video product throughout Latin America. In November
1998 KL/Phoenix launched a 24 hour Spanish language movie channel called
Gran Canal Latino.
Generally, theatrical films are first distributed in the theatrical and
home video markets. Subsequently, theatrical films are made available for
worldwide 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 accompanying condensed 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.
Entities in which the Company holds a 20% to 50% interest and exercises
significant influence are accounted for under the equity method. Entities
in which the Company holds less than a 20% interest are accounted for
under the cost method. All material intercompany balances and
transactions have been eliminated.
During November 1997, the Company obtained control of US SEARCH.com and
established a new 80%-owned joint venture for Latin American distribution
and satellite television broadcasting. Those entities' accounts are
consolidated in the accompanying financial statements from the date of
acquisition or establishment. In June 1999 US SEARCH.com issued 4,500,000
new shares of its common stock in its initial public offering and the
Company sold 1,500,000 out of its holdings of the shares of US
SEARCH.com to the public. The Company currently retains a 55.2% interest
in the subsidiary. Because US SEARCH.com and Kushner-Locke's new Latin
American distribution and satellite television broadcasting subsidiaries
have incurred net losses since inception or acquisition and the Company
has funded 100% of such losses through June 30,1999, the Company has
recognized 100% of those incurred net losses in its consolidated financial
statements. As a result of the public offering, as of June 30, 1999 the
Company recognized a minority interest of $14,080,000 in its consolidated
financial statements, which represents the net third party interest in the
net equity of US SEARCH.com. No minority interest in the reported losses
of US SEARCH.com were recognized for the three or nine month periods ended
June 30, 1999, as the public investment occurred at the end of the period.
However in the future the Company will give effect in its consolidated
statements of operations to a minority interest in the net earnings or
losses of US SEARCH.com proportionate to the ownership portion of third
parties (which is presently 44.8%).
These unaudited consolidated financial statements and notes thereto have
been condensed and, therefore, do not contain certain information included
in the Company's annual consolidated financial statements and notes
thereto. The unaudited condensed consolidated financial statements and
notes thereto should be read in conjunction with the Company's annual
consolidated financial statements and notes thereto.
The unaudited condensed consolidated financial statements reflect, in the
opinion of management, all adjustments, all of which are of a normal
recurring nature, necessary to present fairly the financial position of
the Company as of June 30, 1999, and the results of its operations and its
cash flows for the three and nine month periods ended June 30, 1999 and
1998. Interim results are not necessarily indicative of results to be
expected for a full fiscal year.
Gain on Sale of Interest in Subsidiary
On June 24, 1999 the Company sold 1,500,000 of its shares in US SEARCH.com
to the public in conjunction with the subsidiary's initial public
offering. The Company retains a 55.2% interest in the subsidiary and
continues to consolidate the subsidiary in the accompanying financial
statements. The Company recognized a gain on the sale of the subsidiary
shares.
Gain on Issuance of Stock by Subsidiary
At the time a subsidiary sells its stock to unrelated parties at a price
in excess of its book value, the value of the Company's net investment in
that subsidiary increases. If at that time the subsidiary is an operating
entity, the Company recognizes an increase in its revised proportionate
share of the subsidiary's net equity as a gain.
Investments in Equity Securities
Included in other assets are investments in preferred stock and warrants
of The Harvey Entertainment Company. Such investments are not accounted for
pursuant to Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," as
they are not traded in a secondary market in which readily determinable
fair values can be measured. The amounts of such investments are reported
at cost. If converted or exercised in the future, the Company will obtain
publicly-traded Harvey common stock.
Restricted and Reserved Cash
At June 30, 1999, out of $49,134,000 of total cash the Company had
$1,992,000 in restricted cash principally related to deposits held at a
British bank pursuant to film sale/leaseback transactions. In addition,
at June 30, 1999, the Company had $216,000 in cash collected by the
Company and reserved for use principally by Chase Manhattan Bank to be
applied against the Company's outstanding borrowings under the Company's
credit facility.
Income Taxes
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. 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 of such change. The accompanying consolidated financial statements
include no deferred tax assets or liabilities due to the existence of net
operating loss carryforwards and valuation allowances.
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 and the collectibility of accounts receivable. Actual results
may differ from estimated amounts.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting
Comprehensive Income." This statement established standards for the
reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Comprehensive income
generally represents all changes in shareholders' deficit during the
period except those resulting from investments by, or distributions to,
shareholders. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997, and requires restatement of earlier periods presented.
SFAS No. 130 defines comprehensive income as net income plus all other
changes in equity from nonowner sources. The Company had no other
comprehensive income items and accordingly no separate statement of
comprehensive income is presented.
(2) US SEARCH.com Public Offering
On June 24, 1999 the Company's majority-owned subsidiary US SEARCH.com
issued 4,500,000 new shares of its common stock to the public and obtained
$36,263,000 of net proceeds. On the same date the Company sold 1,500,000
of its shares in US SEARCH.com to the public in conjunction with the
offering and obtained $12,555,000 of net proceeds. The Company retains a
55.2% interest in the subsidiary and continues to consolidate the
subsidiary in the accompanying financial statements. The Company
recognized a $13,148,000 pre-tax gain on the sale of the 1,500,000 shares
and a $21,152,000 pre-tax gain on the increased value of its remaining
equity in the subsidiary in comparison to its previously existing
investment net of consolidated US SEARCH.com net losses.
(3) Film and Television Property Costs
Film and television property costs consist of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
----------- -----------
<S> <C> <C>
In process or development $22,916,000 $10,570,000
Released, principally feature films and
television productions, net of accumulated
amortization 70,238,000 63,203,000
----------- -----------
$93,154,000 $73,773,000
=========== ===========
</TABLE>
(4) Notes Payable
Notes payable consist of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
----------- -----------
<S> <C> <C>
Note payable to bank, under the revolving
credit facility collateralized by
substantially all Company assets, interest
at varying rates, outstanding principal
balance due June 2000 $66,695,000 $58,980,000
Notes payable to banks and financial
institutions, principally consisting of
production loans collateralized by film
rights, interest at varying rates, and
maturities at varying dates 19,416,000 14,171,000
---------- ----------
$86,111,000 $73,151,000
========== ==========
</TABLE>
In June 1996 the Company obtained a $40,000,000 syndicated borrowing base
revolving credit facility. In September 1997 the facility was increased
to $60,000,000 and the maturity was extended to June 2000. In December
1998 the facility was increased to a maximum of $75,000,000, subject to
the addition of new banks to the syndicated group and to the availability
of sufficient collateral. In July 1999 the Company repaid $10,750,000 of
borrowings under the facility. As of August 13, 1999 a maximum of
$68,000,000 could be borrowed based upon available collateral, and
$58,300,000 was then outstanding.
(5) Convertible Subordinated Debentures
Convertible Subordinated Debentures consist of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
------------ ------------
<S> <C> <C>
Series A Convertible Subordinated Debentures
due December 2000, bearing interest at 10%
payable June 15 and December 15, net $-- $73,000
Series B Convertible Subordinated Debentures
due December 2000, bearing interest at
13.75% payable monthly, net 1,571,000 3,061,000
8% Convertible Subordinated Debentures due
December 2000, interest payable February 1
and August 1 781,000 4,513,000
9% Convertible Subordinated Debentures due
July 2002, interest payable January 1 and
July 1, net -- 3,879,000
----------- -----------
$2,352,000 $11,526,000
=========== ===========
</TABLE>
Series A Debentures
On April 13, 1999 the Company called the Series A Debentures for
redemption on or before May 14, 1999. Holders of $49,000 principal amount
of such debentures converted such debentures into 6,435 newly-issued
shares of common stock, and the remaining $28,000 was redeemed. As of
June 30, 1999 no Series A Debentures were outstanding. Approximately
$4,000 of issuance costs were amortized as interest expense for the nine
months ended June 30, 1999.
Series B Debentures
As of June 30, 1999 the Company had outstanding $1,620,000 principal
amount of Series B Debentures due 2000. The Series B Debentures are
recorded net of unamortized underwriting discounts and expenses associated
with the offering totaling $49,000 at June 30, 1999, which are amortized
using the interest method to interest expense over the term of the
debentures. During the nine months ended June 30, 1999, $1,575,000
principal amount of the Series B Debentures converted into 170,000 newly-
issued shares of common stock. Approximately $796,000 of issuance costs
were amortized as interest expense for the nine months ended June 30,
1999.
8% Debentures
As of June 30, 1999, the Company had outstanding $802,000 principal amount
of 8% Debentures. The debentures are recorded net of unamortized
underwriting discounts and expenses associated with the offering totaling
$21,000 at June 30, 1999, which are amortized using the interest method to
interest expense over the term of the debentures. During the nine months
ended June 30, 1999, $3,898,000 principal amount of the 8% Debentures
converted into 666,000 shares of common stock. Approximately $166,000 of
issuance costs were amortized as interest expense for the nine months
ended June 30, 1999.
9% Debentures
During the nine months ended June 30, 1999, holders converted all 9%
Debentures into 401,000 newly-issued shares of common stock.
Approximately $221,000 of issuance costs were amortized as interest
expense for the nine months ended June 30, 1999.
(6) Income Taxes
Income taxes for the three and nine month periods ended June 30, 1999 and
1998 were computed using the effective income tax rate estimated to be
applicable for the full fiscal year, which is subject to ongoing review
and evaluation by management. Management currently expects that Federal
and state taxable income for the fiscal year except for alternative
minimum taxes will be offset by utilization of existing net operating loss
carryforwards.
(7) Commitments and Contingencies
The Company is party to certain legal proceedings and claims arising out
of the normal course of its business. Reference is made to the Company's
annual report on Form 10-K, as amended, for the fiscal year ended
September 30, 1998 for a description of certain legal proceedings.
Management of the Company believes that the ultimate resolution of all of
these matters will not have a material adverse effect upon the Company's
results of operations, liquidity or financial condition.
In its normal course of business as an entertainment distributor, the
Company makes contractual down payments to acquire film and television
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
materials, proof of rights held and insurance policies that may be
required for the Company to begin exploitation of the product. As of June
30, 1999 the Company had agreed to pay approximately $3,900,000 should
those third party producers complete delivery to the Company. These
amounts are estimated to be payable over the next eighteen months.
US SEARCH.com has non-cancelable advertising and marketing agreements with
several Internet companies. The agreements provide for varying levels of
exclusivity and require US SEARCH.com to make monthly minimum payments based on
the number of impressions displayed on affiliate Web sites. As of June 30,
1999, the minimum non-cancelable payments required under the agreements are
approximately $5,700,000 for the remainder of calendar 1999, $9,000,000 in
calendar 2000, $3,900,000 in calendar 2001, and $1,000,000 in calendar 2002.
In July 1999, US SEARCH.com entered into an agreement with a supplier of online
public record data pursuant to which US SEARCH.com has committed to purchase
approximately $20,000,000 of such data and public record information over a
five and one-half year term.
(8) Earnings (Loss) Per Share
The table below reconciles net earnings (loss) and average shares of
common stock outstanding to those amounts used to calculate basic and
diluted earnings (loss) per share.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------ --------------------
1999 1998 1999 1998
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic
earnings per share -
earnings (loss)
available to
common stockholders $19,865,000 $(2,243,000) $9,315,000 $(2,744,000)
Effect of dilutive
securities: interest on
convertible debt 65,000 -- 43,000 --
Numerator for diluted
earnings per share -
earnings (loss)
available to common
stockholders after ----------- --------- ---------- ---------
assumed conversions $19,930,000 $(2,243,000) $9,358,000 $(2,744,000)
=========== ========= ========== =========
Denominator:
Denominator for basic
earnings per share -
weighted average
shares 12,948,000 9,204,000 11,062,000 9,170,000
Effect of dilutive
securities:
Employee stock options 651,000 -- 528,000 --
Warrants 216,000 -- 181,000 --
Convertible debentures 312,000 -- 43,000 --
---------- ---------- ---------- ---------
Dilutive potential
common shares 1,179,000 -- 752,000 --
Denominator for diluted
earnings per
share - adjusted
weighted average
shares and ---------- ---------- ---------- ---------
assumed conversions 14,127,000 9,204,000 11,814,000 9,170,000
========== ========== ========== =========
Basic earnings (loss)
per share $1.54 $(0.24) $0.84 $(0.30)
====== ====== ====== ======
Diluted earnings (loss)
per share $1.41 $(0.24) $0.79 $(0.30)
====== ====== ====== ======
</TABLE>
A total of 167,000 shares representing the potential conversion of
debentures were not included in the calculation of diluted loss per share
for the nine month period ended June 30, 1999, as the impact of including
such securities would be antidilutive. Shares of common stock representing
the potential exercise of approximately 1,105,000 options and 1,651,000
warrants to acquire common stock, and 1,597,000 shares representing the
potential conversion of debentures were not included in the calculation of
diluted loss per share for the three month period ended June 30, 1998, as
the impact of including such securities would be antidilutive. Shares of
common stock representing the potential exercise of approximately 712,000
options and 1,584,000 warrants to acquire common stock, and 1,608,000
shares representing the potential conversion of debentures were not
included in the calculation of diluted loss per share for the nine month
period ended June 30, 1998, as the impact of including such securities
would be antidilutive.
(9) Investment
On April 26, 1999 the Company issued 468,883 shares of restricted common
stock to The Harvey Entertainment Company ("Harvey") in exchange for
55,000 shares of Series A Preferred Stock of Harvey and 388,215 warrants
exerciseable into common stock of Harvey, all pursuant to a stock purchase
agreement involving a new Harvey investor group which includes the
Company. The Harvey Series A Preferred Stock are convertible into 814,814
shares of Harvey common stock commencing October 26, 1999 and require
payment of quarterly dividends in cash or additional shares of Harvey
Series A Preferred Stock at a 7% annual rate. The Company holds certain
demand and piggyback registration rights relating to its Harvey
securities. On a fully-diluted basis, assuming all securities
exerciseable or convertible into Harvey common stock are so exercised or
converted, the Company would own 12% of the voting shares of Harvey. In
June 1999 the Company filed a registration statement registering the
shares of its restricted common stock issued to Harvey.
(10) Redemptions of Certain Subordinated Debt and Warrants
Effective May 14, 1999 the Company redeemed all of its Class C Redeemable
Common Stock Purchase Warrants (the "Class C Warrants") and its
outstanding 10% Convertible Subordinated Debentures, Series A due 2000. A
total of 792,282 Class C Warrants were exercised for 792,282 shares of
Common Stock and the Company received proceeds of $5,406,000. The Company
issued 6,435 new shares of common stock in connection with the conversion
of $49,000 aggregate principal amount of the Series A Debentures. The
Company redeemed $28,000 aggregate principal amount of the Series A
Debentures.
<PAGE>
Item 2.
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 rights to the films and
television programs in international territories. The Company generally
finances all or a substantial portion of the budgeted production costs of
its programming through advances obtained from licensees and borrowings
secured by domestic and international licenses. The Company typically
retains rights in its programming which may be exploited in future periods
or in additional markets or media. In 1993 the Company established a
feature film operation which produces low and medium budget films for
theatrical and/or home video or cable release. The Company also has
produced 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. In 1994, the Company established an
international theatrical film subsidiary to expand 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
systems.
In late 1997, the Company acquired control of US SEARCH.com Inc. ("US
SEARCH.com"), a leading provider of fee-based people search and other
customized individual reference services. In June 1999 US SEARCH.com sold
4,500,000 shares to the public and the Company sold 1,500,000 of the
shares of US SEARCH.com that it held. The Company retains 55.2% of the
outstanding shares of US SEARCH.com.
In February 1998 the Company established KL/Phoenix, an 80% owned entity,
which distributes film and television product in Latin America and
broadcasts Spanish-language movies via Gran Canal Latino, a satellite
distributor system to cable operators in Latin America.
Film and television program licensing. 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 television programs. Production advances or
license fees received prior to delivery or completion of a program are
deferred. Production advances and deferred license fees are recognized as
revenue on the date of product availability and/or delivery. Activities
conducted by joint ventures, wherein the Company reports its equity in the
ventures' earnings as revenues, also can significantly affect the
comparability of revenues.
The Company generally capitalizes all costs incurred to produce a film or
television program. 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 film or 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 future gross revenues associated with a particular film or program,
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.
Gross profits for any period are a function, in part, of the number of
films and 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 film or 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 can materially affect 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 this 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.
US SEARCH.com. In November 1997, the Company acquired control of US
SEARCH.com, a leading provider of fee-based people search and other
customized individual reference services. In June 1999 US SEARCH.com sold
4,500,000 shares to the public and the Company sold 1,500,000 of the
shares of US SEARCH.com that it held. Since its acquisition, US
SEARCH.com's financial position and results of operations have been
consolidated in the Company's financial statements. The consolidation of
US SEARCH.com has resulted in a substantial change in the presentation of
the Company's results of operations due to the inclusion of this new line
of business. Since such acquisition, the Company has consolidated
$17,478,000 of revenues and over ($11,434,000) of net losses attributable
to US SEARCH.com. Commencing July 1, 1999, the Company will give effect in
its consolidated statements of operations to a minority interest in US
SEARCH.com's net earnings or losses proportionate to the ownership portion
of third parties (which is presently 44.8%). US SEARCH.com management's
strategy is to build its long-term value through continued investment in
enhancing brand awareness and market position through increased
advertising and marketing alliances. As a result, the Company believes
that US SEARCH.com will continue to adversely affect the Company's
consolidated results of operations for the foreseeable future.
Gran Canal Latino. In November 1998, the Company launched Gran Canal
Latino ("GCL"), its first satellite channel. GCL broadcasts 24 hours a
day, with a selection of films mostly from Spain. GCL's satellite
transmission reaches the United States and all of Latin America. Through July
31, 1999, cable operators have advised the Company that there is a base of
250,000 subscribers. To date GCL has generated minimal revenues as almost all
of its subscribers have been in a free subscription period with various cable
operators. A limited number of subscribers have paid for services to date.
The
Company expects most GCL subscribers to be paying for service by October 1,
1999, and also anticipates an increase of 125,000 in the number of subscribers
based upon completing a new agreement with a satellite distributor. Under a
distribution agreement with Enrique Cerezo, the Company is broadcasting
selections from approximately 1,500 Spanish language movie titles. Until
subscriber receipts exceed operating costs, the Company's new satellite
operations will adversely affect the Company's consolidated results of
operations. Such adverse effect will continue throughout the remainder of
fiscal 1999.
Forward Looking Statements
Except for the historical information contained herein, certain of the
matters discussed in this quarterly report are "forward-looking
statements" as defined in Section 21E of the Securities Exchange Act of
1934, as amended, 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 and
adjustments of the film costs, dependence on key personnel, production
deficits, risks involved in the Internet, television and theatrical film
industries, competition, government regulation, labor relations, limited
operating history and continued operating losses of US SEARCH.com and GCL,
reliance of US SEARCH.com on strategic relationships in Internet market,
uncertain acceptance and maintenance of the US Search.com brand, risks
associated with offering new services, risks associated with growth and
expansion, liability for online content, rapidly changing technology,
standards and consumer demands, online commerce security risks, including
credit card fraud, system disruptions and capacity constraints for US
SEARCH.com, risks associated with domain names, year 2000 compliance,
shares available for future sale, 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-3
(Registration No. 333-80521), as filed with the Securities and Exchange
Commission on June 16, 1999, 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. See also the risks and uncertainties pertaining
to US SEARCH.com in its amended registration statement on Form S-1
(Registration No. 333-76099), as filed with the Securities and Exchange
Commission on June 24, 1999.
Results of Operations
Comparison of Three Months Ended June 30, 1999 and 1998
The Company's operating revenues for its third quarter ended June 30, 1999
were $10,011,000, a decrease of $(5,312,000) or (35%) from $15,323,000
from the prior fiscal year's third quarter ended June 30, 1998. The
decrease resulted from a $(6,606,000) or (52%) decline in film and
television program revenues due primarily to the timing of delivery and/or
availability of films and television programs. Included in film and
television operating revenues for the third quarter ended June 30, 1999
are ($403,000) of equity in the net losses of seven joint ventures whose
gross revenues are not consolidated in the accompanying financial
statements. This represents a ($406,000) decrease from the $3,000 of
equity in net earnings of unconsolidated joint ventures recognized in the
quarter ended June 30, 1998. Partially offsetting this decrease was a
$1,294,000 or 48% increase in quarterly revenues from Search versus the
year-earlier quarter.
Operating revenues for the third quarter included $3,983,000 (31% of total
revenues) from US SEARCH.com. The Company recognized $5,344,000 (53%) of
operating revenues during the third quarter of fiscal 1999 primarily from
the delivery and/or availability of eight feature films. In addition,
$612,000 (6%) of quarterly operating revenues came from continuing
licenses of completed product from the Company's library to domestic cable
channel operators and international sub-distributors, including $280,000
from our KL/Phoenix subsidiary in Latin America. The balance of the
Company's quarterly operating revenues came from a diversified mix of
product, including licensing of television programming, and distribution
of Christian music on behalf of TV First, a Company joint venture. To
date GCL has generated minimal revenues as it approaches the end of
initial free subscription periods with many cable operators.
The Company recognized $8,800,000 (57%) of revenues during the third
quarter of fiscal 1998 from the delivery and/or availability of four
feature films, including Girl starring Dominique Swain, One Man's Hero
starring Tom Berenger, and Taxman starring Joe Pantoliano. Revenues of
$700,000 (5%) came from deliveries in the Company's family division of
direct-to-video product. In addition, the Company recognized $2,000,000
(13%) of revenues this quarter from continuing licenses of product from
the Company's library to domestic cable channel operators through its
majority-owned subsidiary KLC/New City, and through international sub-
distributors. Of the remaining 25% of revenues, $2,700,000 (17%) came
from the Company's recently acquired subsidiary, US SEARCH.com, which
experienced a 78% increase in revenues from those recognized in the
previous quarter.
Currently in post production for the remainder of the Company's 1999
distribution slate is Picking Up The Pieces, starring Woody Allen, Sharon
Stone, Kiefer Sutherland, David Schwimmer, Elliott Gould, Cheech Marin and
Lou Diamond Phillips, and directed by Alfonso Arau, and The Last Producer,
starring and directed by Burt Reynolds, and also starring Charles Durning,
Ann-Margaret, Joe Mantenga, Robert Costanzo, Sean Austin, Greg Germann and
Robert Goulet. In addition, the Company continues to acquire international
distribution rights to films for distribution through Kushner Locke
International, Inc. and KL/Phoenix.
Costs relating to operating revenues were $11,013,000 during the third
quarter of fiscal 1999, a decrease of $786,000 (7%) as compared to
$11,799,000 during the third quarter of fiscal 1998. As a percentage of
operating revenues, costs relating to operating revenues were 110% for the
third quarter of fiscal 1999 compared to 77% for the third quarter of
fiscal 1998. The (7%) cost decrease resulted from a $(1,154,000) or (11%)
decrease in film and television costs due to reduced
deliveries/availabilities. Despite the reduced costs, the Company's film
and television gross profits declined $5,452,000 (278%) principally
because management reduced its estimates of likely future revenues on
several released titles. Partially offsetting the film and television
licensing margin decrease was a $926,000 (59%) increase in gross profits
realized from US SEARCH.com Inc. operations. US SEARCH.com's gross profit
margin increased from 58% in the June 30, 1998 quarter to 62% in the June
30, 1999 quarter due primarily to increased Internet sales which involve
less direct labor costs.
Gross profit (loss) was ($1,002,000) during the third quarter of fiscal
1999, a decrease of ($4,526,000) (128%) as compared to gross profit of
$3,524,000 during the third quarter of fiscal 1998. As a percentage of
operating revenues, gross profit (loss) was (10%) for the third quarter of
fiscal 1999 compared to 23% for the third quarter of fiscal 1998. The
(33%) margin decrease resulted from reduced film and television
programming revenues and management reducing its estimates of likely
future revenues on several released titles.
Selling, general and administrative expenses increased $5,447,000 or 158%
to $8,905,000 in the quarter of fiscal 1999 from $3,458,000 in the third
quarter of fiscal 1998. The increase in such expenses is principally due
to a $2,017,000 (109%) increase in US SEARCH.com advertising expenses, a
$1,900,000 (379%) increase in US SEARCH.com administrative expenses, and a
$1,110,000 increase in bonuses. As a percentage of US SEARCH.com's net
revenues, advertising and marketing expenses increased to approximately
98% for the three months ended June 30, 1999, from approximately 79% for
the three months ended June 30, 1998. This increase is primarily
attributable to an increase in the level of Internet-based advertising.
US SEARCH.com has non-cancelable advertising and marketing agreements with
several Internet companies. The agreements provide for varying levels of
exclusivity and require US SEARCH.com to make monthly minimum payments
based on the number of impressions displayed on affiliate Web sites. As
of June 30, 1999, the minimum non-cancelable payments required under the
agreements are approximately $5,700,000 for the remainder of calendar
1999, $9,000,000 in calendar 2000, $3,900,000 in calendar 2001, and
$1,000,000 in calendar 2002. In July 1999, US SEARCH.com entered into an
agreement with a supplier of online public record data pursuant to which
US SEARCH.com has committed to purchase approximately $20,000,000 of such
data and public record information over a five and one-half year term. As
a percentage of US SEARCH.com's net revenues, general and administrative
expenses increased to approximately 43% for the three months ended June
30, 1999, from approximately 21% for the three months ended June 30, 1998.
This increase in US SEARCH.com's general and administrative expenses in
absolute dollars is primarily attributable to the cost associated with the
hiring of additional management and administrative personnel in 1999. Also
included in US SEARCH.com's 1999 selling, general and administrative
expenses is $653,000 of US SEARCH.com non-cash director and officer stock
option costs in connection with options granted in 1999. US SEARCH.com's
management expects to incur a charge of approximately $728,000 for the
remainder of calendar 1999, $735,000 for 2000, $315,000 for 2001, $75,000
for 2002 and $1,000 for 2003 in connection with these options. No options
were granted in the corresponding three month period ended June 30, 1998.
Also included in 1999 expenses are $1,110,000 of bonuses to the Co-
Chairmen and Co-Chief Executive Officers, the President and Chief
Operating Officer, and the Chief Financial Officer of the Company. No
such bonuses were included in 1998 expenses. In addition, the Company's
Latin American operations, which commenced operations in the fiscal
1998 second quarter, incurred $1,720,000 of administrative expenses during the
fiscal 1999 third quarter and none in the earlier year.
The provisions for doubtful accounts and notes increased $1,040,000 or
137% during the third quarter of fiscal 1999 principally due to a $850,000
increase in such provisions for film and television license receivables
based upon estimated collections.
During the third quarter of fiscal 1999 the Company recognized a
$21,152,000 pre-tax gain on the issuance of stock by its subsidiary, US
SEARCH.com. This resulted from the subsidiary's initial public offering
on June 24, 1999, in which new shareholders invested an amount per share
substantially in excess of the Company's per-share investment in the
subsidiary, resulting in a substantial increase in the subsidiary's net
worth. The gain represents the increase in the Company's revised
proportionate share of the subsidiary's net equity. No comparable
transaction occurred in the third quarter of fiscal 1998.
During the third quarter of fiscal 1999 the Company recognized a
$13,148,000 pre-tax gain on sale of 1,500,000 shares out of its holdings
in its subsidiary US SEARCH.com at the time of the initial public offering
by the subsidiary. No comparable transaction occurred in the third
quarter of fiscal 1998.
Interest expense for the third quarter ended June 30, 1999 was $2,042,000,
a $470,000 or 30% increase as compared to $1,572,000 for the third quarter
ended June 30, 1998. The increase was due to higher average borrowings
under the Company's line of credit and increased bank fees, partially
offset by reduced subordinated debenture interest due to conversions of
$5,532,000 of subordinated debentures into common stock during the three
months ended June 30, 1999. Total indebtedness for borrowed money
increased 11% to $88,463,000 at June 30, 1999 from $79,757,000 at June 30,
1998.
Earnings before income taxes of $20,554,000 were reported for the quarter
ended June 30, 1999, versus a loss before income taxes of ($2,237,000) for
the quarter ended June 30, 1998.
The Company's estimated effective income tax expense was 3% for the third
fiscal quarter ended June 30, 1999 compared to an estimated effective
income tax rate of less than (1%) for the third fiscal quarter ended June
30, 1998. Income tax expense for the quarter ended June 30, 1999 are
calculated so year-to-date expense as a proportion of earnings before
income taxes equal the estimated annual income tax rates expected for the
fiscal year ended September 30, 1999. Income tax expense for the quarter
ended June 30, 1998 pertained to estimated alternative minimum taxes and
state minimum income taxes. Through September 30, 1998 the Company had
Federal and state net operating loss carryforwards totaling $31,000,000
and $5,000,000, respectively, which exceed presently expected taxable
income for fiscal 1999. The Federal net operating loss carryforwards
expire from fiscal 2009 through fiscal 2013. The state net operating loss
carryforwards expire from fiscal 2006 through fiscal 2013. Due to the
sale of US SEARCH.com common stock in connection with the subsidiary's
initial public offering in June 1999, effective July 1999 US SEARCH.com
taxable income or loss will not be consolidated in the Company's income
tax returns.
The Company reported net earnings of $19,896,000 or $1.54 per basic share
and $1.41 per diluted share, for the third quarter ended June 30, 1999 as
compared to a net loss of ($2,243,000), or ($.24) per basic and diluted
share, for the third quarter ended June 30, 1998. The principal factors
resulting in the reported net earnings were the gains on the Company's
increased net equity in US SEARCH.com resulting from the issuance of stock
by the subsidiary and on the Company's sale of a portion of its holdings
in US SEARCH.com. Adversely impacting net results are US SEARCH.com
operations which have yielded significant continuing operating losses, the
decline in total revenues for the film and television segment, the reduced
estimates of likely future revenues on several released film and
television titles, the inclusion of new Latin American operations which
are yielding start-up net losses, increases in provisions for doubtful
accounts and notes, and increases in interest expense and income taxes.
Weighted number of common shares for the compared third quarters were
12,990,000 (basic) and 14,127,000 (diluted) in fiscal 1999 and 9,204,000
(basic and diluted) in fiscal 1998.
Comparison of Nine Months Ended June 30, 1999 and 1998
The Company's operating revenues for the nine months ended June 30, 1999
were $34,205,000, a decrease of ($25,564,000) (43%) from $59,769,000 from
the prior fiscal year's nine month period. The decrease resulted from a
$(30,394,000) or (55%) decline in film and television licensing revenues
due primarily to the timing of delivery and/or availability of films and
television programs. Partially offsetting this decrease was a $4,830,000
or 101% increase in nine month revenues from US SEARCH.com versus the
year-earlier period.
The Company recognized $9,623,000 (26%) of revenues during the nine
months ended June 30, 1999 from US SEARCH.com. The Company recognized
$15,390,000 (45%) of revenues during the nine months ended June 30, 1999
from the delivery and/or availability of thirteen feature films, including
Ringmaster, starring Jerry Springer which was released in the United
States by Artisan Entertainment and One Man's Hero starring Tom Berenger,
which is licensed for United States release to MGM. The Company recognized
$6,478,000 (19%) of revenues in the fiscal 1999 period from continuing
licenses of product from the Company's library to domestic cable channel
operators through its majority-owned subsidiary KLC/New City, and through
international sub-distributors including KL/Phoenix Revenues of
$1,135,000 (3%) came from producer fees on third party productions.
Revenues of $861,000 (3%) came from deliveries in the Company's family
division of direct-to-video product. Remaining revenues came from a
variety of sources, including the sales of contemporary Christian music on
behalf of a joint venture.
The Company recognized $22,450,000 (38%) of revenues during the nine
months ended June 30, 1998 from the delivery and/or availability of 16
feature films, including Girl starring Dominique Swain, One Man's Hero
starring Tom Berenger, Possums starring Mac Davis, and Denial starring
Jason Alexander and directed by Adam Rifkin. In addition, the Company
recognized $17,600,000 (29%) of revenues during the nine months ended June
30, 1998, including revenues from the delivery and/or availability of the
remaining episodes of the first-run syndication series Hammer and Mowgli:
The New Adventures of The Jungle Boy, and the net earnings from the
delivery by a joint venture of the remaining episodes of the ABC network
series Cracker. Revenues of $4,400,000 (7%) came from deliveries in the
Company's family division of direct-to-video product. In addition, the
Company recognized $5,800,000 (10%) of revenues from continuing licenses
of product from the Company's library to domestic cable channel operators
through its majority-owned subsidiary KLC/New City, and through
international sub-distributors. Revenues of approximately $4,800,000 (8%)
came from services provided by US SEARCH.com. Remaining revenues
principally came from the sales of contemporary Christian music on behalf
of a joint venture.
Costs relating to operating revenues were $29,118,000 during the nine
months ended June 30, 1999, a decrease of $21,531,000 (43%) as compared to
$50,649,000 during the nine months ended June 30, 1998. As a percentage
of operating revenues, costs relating to operating revenues were 85% for
the nine months ended June 30, 1999, equal to the 85% rate for the nine
months ended June 30, 1998. Film and television costs declined 48%, which
was less than the revenue decline principally because management reduced
its estimates of likely future revenues on several released titles in the
1999 period. US SEARCH.com costs increased 77%, which was less than the
revenue increase as Internet-sourced revenues were less costly to provide
to consumers.
Gross profit was $5,087,000 during the nine months ended June 30, 1999, a
decrease of ($4,033,000) (44%) as compared to $9,120,000 during the nine
months ended June 30, 1998. As a percentage of operating revenues, gross
profit was 15% for the nine months ended June 30, 1999, equal to the 15%
rate for the nine months ended June 30, 1998. Film and television gross
profits declined 110%, principally because management reduced its
estimates of likely future revenues on several released titles in the 1999
period. US SEARCH.com gross profits increased 121%, as Internet-sourced
revenues were less costly to provide to consumers.
Selling, general and administrative expenses increased $13,794,000 or 213% to
$20,270,000 for the nine months ended June 30, 1999 from $6,476,000 for the
nine months ended June 30, 1998. The increase in such expenses is principally
due to a $5,794,000 (216%) increase in US SEARCH.com advertising expenses and a
$6,730,000 (633%) increase in US SEARCH.com administrative expenses. As a
percentage of US SEARCH.com's net revenues, advertising and marketing expenses
increased to approximately 89% for the nine months ended June 30, 1999, from
approximately 56% for the nine months ended June 30, 1998. This increase is
primarily attributable to an increase in the level of Internet-based
advertising. As a percentage of net revenues, general and administrative
expenses increased to approximately 81% for the nine months ended June 30,
1999, from approximately 22% for the nine months ended June 30, 1998. This
increase in general and administrative expenses in absolute dollars is
primarily attributable to the cost associated with the hiring of additional
management and administrative personnel in 1999. Also included in
US SEARCH.com's 1999 selling, general and administrative expenses is
$1,529,000 of US SEARCH.com non-cash director and officer stock option costs
in connection with options granted in 1999. No options were granted in the
corresponding nine month period ended June 30, 1998. Also included in 1999
expenses are $1,110,000 of bonuses to the Co-Chairmen and Co-Chief Executive
Officers, the President and Chief Operating Officer, and the Chief Financial
Officer. No such bonuses were included in 1998 expenses. In addition, the
Company's new Latin American operations, which commenced operations in the
fiscal 1998 second quarter, incurred $1,720,000 of administrative expenses
during the nine months ended June 30, 1999 and none in the corresponding 1998
period.
The provisions for doubtful accounts and notes increased $1,891,000 or
170% during the first nine months of fiscal 1999 versus 1998 principally
due to a $1,591,000 increase in such provisions for film and television license
receivables based upon estimated collections, and a $300,000 increase in such
provisions for US SEARCH.com. The SEARCH.com increase is primarily due to
increases in the accruals for potential chargebacks regarding
uncollectible consumer checks, credit card charges and 900 number
telephone sales. The remaining US SEARCH.com increase represents
forgiveness of a $299,000 related party note receivable from a founding
employee and shareholder of US SEARCH.com in connection with an agreement
to enter into both a three year employment contract and a shareholder
agreement, among other items.
During the nine months ended June 30, 1999 the Company recognized a
$21,152,000 pre-tax gain on the issuance of stock by its subsidiary, US
SEARCH.com. This resulted from the subsidiary's initial public offering
on June 24, 1999, in which new shareholders invested an amount per share
substantially in excess of the Company's per-share investment in the
subsidiary, resulting in a substantial increase in the subsidiary's net
worth. The gain represents the increase in the Company's revised
proportionate share of the subsidiary's net equity. No comparable
transaction occurred in the nine months ended June 30, 1998.
During the nine months ended June 30, 1999 the Company recognized a
$13,148,000 pre-tax gain on sale of 1,500,000 shares out of its holdings
in its subsidiary US SEARCH.com at the time of the initial public offering
by the subsidiary. No comparable transaction occurred in the nine months
ended June 30, 1998.
Interest expense during the nine months ended June 30, 1999 was $6,148,000
as compared to $4,326,000 for the nine months ended June 30, 1998. The
42% increase was principally attributable to the increased overall levels
of borrowing in the current period and increased bank fees. Total
indebtedness for borrowed money increased 11% to $88,463,000 at June 30,
1999 from $79,757,000 at June 30, 1998.
Earnings before income taxes of $10,086,000 were reported for the nine
months ended June 30, 1999, versus a loss before income taxes of
($2,744,000) for the nine months ended June 30, 1998.
The Company's estimated effective income tax rate was 7% for the nine
months ended June 30, 1999 compared to an estimated effective income tax
rate of (1%) for the nine months ended June 30, 1998. Income tax expense
for the nine months ended June 30, 1999 are calculated so that, as a
proportion of earnings before income taxes, they equal the estimated
annual income tax rates expected for the fiscal year ended September 30,
1999. Income tax expense for the nine months ended June 30, 1998
consisted of estimated alternative minimum taxes and state minimum income
taxes. Through September 30, 1998 the Company had Federal and state net
operating loss carryforwards totaling $31,000,000 and $5,000,000,
respectively, which exceed presently expected taxable income for fiscal
1999. The Federal net operating loss carryforwards expire from fiscal
2009 through fiscal 2013. The state net operating loss carryforwards
expire from fiscal 2006 through fiscal 2013. Due to the sale of US
SEARCH.com common stock in connection with the subsidiary's initial public
offering in June 1999, effective July 1999 US SEARCH.com taxable income or
loss will not be consolidated in the Company's income tax returns.
The Company reported net earnings of $9,346,000, or $0.84 per basic share
and $0.79 per diluted share, for the nine months ended June 30, 1999 as
compared to a net loss of ($2,744,000), or ($0.30) per basic and diluted
share, for the nine months ended June 30, 1998. Weighted number of common
shares for the compared nine-month periods were 11,103,000 (basic) and
11,814,000 (diluted) in fiscal 1999 and 9,170,000 (basic and diluted) in
fiscal 1998.
Liquidity and Capital Resources
The Company's production and distribution operations are capital
intensive. The Company has funded its working capital requirements
through receipt of third party domestic license payments and international
licensing, as well as other operating revenues, and proceeds from debt and
equity financings, and has relied upon its line of credit and
transactional production loans to provide bridge production financing
prior to receipt of license fees or other operating revenues. The Company
funds production and acquisition costs out of its working capital,
including its line of credit, and through certain pre-sales of rights in
international markets. In addition, the expansion of the Company's Search
business and international distribution business and the commencement of
satellite broadcasting in Latin America have significantly increased the
Company's working capital requirements and demand for capital.
Cash and cash equivalents at June 30, 1999 increased to $49,134,000
(including $33,754,000 of unrestricted cash held by US SEARCH.com, a
majority-owned subsidiary, $1,992,000 of restricted cash being used
principally as collateral for film sale/leaseback transactions and
$216,000 of reserved cash to be applied against the Company's outstanding
borrowings under its credit facility) from $3,309,000 (including
$1,988,000 of restricted cash being used principally as collateral for a
film sale/leaseback transaction and $66,000 of reserved cash to be applied
against the Company's outstanding borrowings under its credit facility) at
September 30, 1998. Unrestricted and unreserved cash and cash equivalents
increased $45,671,000 since September 30, 1998.
The Company experienced net negative cash flows from operating activities
of ($23,701,000) during the nine months ended June 30, 1999, resulting
primarily from expenditures on new film and television productions. The
Company capitalized $45,213,000 in new film and television property costs,
which is $19381,000 greater than the $25,832,000 of film and television
property amortization included in results of operations. In addition to
borrowings, those newly capitalized film and television property costs
were principally funded by increased accounts payable. The Company
received net proceeds of $5,673,000 in December 1998 ($6,000,000 of gross
proceeds) through a private placement of 1,200,000 newly-issued shares of
common stock and incurred costs of $217,000 in connection with the private
placement. The Company advanced most of those private placement net
proceeds to US SEARCH.com to fund its operations. On June 24, 1999, the
Company's subsidiary US SEARCH.com consummated an initial public offering
("IPO") of newly-issued common stock. The subsidiary sold 4,500,000 newly-
issued shares and obtained $36,263,000 of net proceeds. US SEARCH.com is
funding operating cash requirements out of its IPO proceeds, not from the
Company. Also on June 24, 1999 the Company sold 1,500,000 shares out of
its holdings of US SEARCH.com common stock and obtained $12,555,000 of net
proceeds. In connection with the IPO, the Company agreed not to sell
additional shares of stock of US SEARCH.com for six months from the date
of the IPO. In addition, the Company obtained $9,398,000 from the
exercise of warrants and stock options, and obtained net cash inflows from
borrowing activities of $12,960,000 during the period as a result of new
borrowings in excess of repayments. As a result primarily of the
foregoing factors, net unrestricted cash increased during the nine month
period by $45,671,000 to $46,926,000 on June 30, 1999 before taking into
consideration amounts available under the Company's line of credit as of
such dates. See "Credit Facility" below. As the Company continues
production and distribution activities, funds increased operations in
Latin America and increases its debt service burdens, it expects to
experience net negative cash flows from operating activities, pending
receipt of licensing revenues, US SEARCH.com revenues, broadcast revenues,
sales from its library, and further proceeds, if any, from its US
SEARCH.com investment.
Credit Facility
In June 1996, the Company obtained a $40,000,000 syndicated revolving line
of credit from a group of banks led by The Chase Manhattan Bank N.A.
("Chase"). In September 1997 that agreement was amended to increase the
maximum amount of revolving credit to $60,000,000 and to extend its
maturity to June 2000. In December 1998 the facility was increased to a
maximum of $75,000,000. Such agreement provides for borrowing by the
Company of up to $60,000,000 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 (5.25% as of August
13, 1999) 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% as of August 13, 1999), (b) Chase's
Base 30-Day CD Rate (5.26% as of August 13, 1999) plus 1% or (c) the
Federal Funds Effective Rate (5.10% as of August 13, 1999) 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 loans made under the production
tranche). The Company is required to pay a commitment fee of 0.5% per
annum of the unused portion of the credit line. The amount outstanding
under the credit facility as of June 30, 1999 was $66,695,000 out of a
borrowing base availability of $68,000,000, and as of August 13, 1999
$58,300,000 was outstanding out of a borrowing base availability of
$68,000,000.
The credit facility expires in June 2000. The Company is currently in
discussions with the existing group of banks regarding extending the
secured revolving financing beyond June 2000. The discussions are
presently in an early stage.
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).
Other Loans
The Company's other borrowings, totaling $19,416,000 as of June 30, 1999,
consisted of production loans from Comerica Bank - California ("Comerica")
and Far East National Bank to consolidated production entities. The
Kushner-Locke Company provided limited corporate guarantees for portions
of the production loans which are callable in the event that the
respective borrower does not repay the loans by the respective maturity
date. Deposits paid by the distributing licensees prior to the delivery
of the financed pictures are held as restricted cash collateral by the
Lenders.
In February 1997, a $6,300,000 production loan was obtained by a
consolidated subsidiary from Banque Paribas (Los Angeles Agency) to cover
a portion of the production budget of Basil. In June 1999 the $229,000
remaining balance of the loan was repaid.
In November 1997, an $8,200,000 production loan was obtained from Comerica
by an unconsolidated company 25%-owned by the Company to cover a portion
of the production budget of Beowulf. The loan bears interest at Prime (8%
as of August 13, 1999) plus 1% or at LIBOR (5.25% as of August 13, 1999)
plus 2%. The Company has provided a corporate guaranty in the reduced
amount of $500,000 in connection with this loan. The loan is
collateralized by the rights, title and assets related to the film. As
extended, the loan matures on December 31, 1999.
In April 1998, a $4,625,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Susan's Plan.
The loan bears interest at Prime (8% as of August 13, 1999) plus 1% or at
LIBOR (5.25% as of August 13, 1999) plus 2%. The loan is collateralized
by the rights, title and assets related to the film. The Company provided
a corporate guaranty in the amount of $600,000 in connection with this
loan. As extended, the loan matures on June 30, 2000.
In April 1998, a $1,850,000 production loan was obtained by a consolidated
subsidiary from Comerica to cover the production budget of Black and
White. The loan bore interest at Prime (8% as of August 13, 1999) plus 2%
or at LIBOR (5.25% as of August 13, 1999) plus 2.25%. The loan was
collateralized by the rights, title and assets related to the film. In
July 1999 the $379,000 remaining balance of the loan was repaid.
In August 1998, a $2,900,000 production loan was obtained by a
consolidated subsidiary from Comerica to cover the production budget of
Ringmaster. In November 1998, the loan amount was increased to
$4,200,000. The loan bears interest at Prime (8% as of August 13, 1999)
plus 1% or at LIBOR (5.25% as of August 13, 1999) plus 2%. The loan is
collateralized by the rights, title and assets related to the film. The
Company provided a corporate guaranty in the amount of $800,000 in
connection with this loan. As extended, the loan matures on December 31,
1999.
In October 1998, a $1,400,000 production loan was obtained by a
consolidated subsidiary from Far East National Bank to cover the
production budget of Mambo Cafe. The loan bears interest at Prime (8% as
of August 13, 1999) plus 1.5%. The loan is collateralized by the rights,
title and assets related to the film. The loan matures on October 30,
1999.
In October 1998, a $2,500,000 production loan was obtained by a
consolidated subsidiary from Far East National Bank to cover the
production budget of Freeway II: Confessions of a Trickbaby. The loan
bears interest at Prime (8% as of August 13, 1999) plus 1.5%. The loan is
collateralized by the rights, title and assets related to the film. The
Company provided a corporate guaranty in the amount of $400,000 in
connection with this loan. The loan matures on October 30, 1999.
In April 1999 a $12,000,000 loan was obtained by a consolidated subsidiary
from Comerica to cover the production budget of Picking Up The Pieces.
The loan bears interest at Prime (8% at August 13, 1999 plus 1% or at
LIBOR (5.25% at August 13, 1999) plus 2%. The loan is collateralized by
the rights, title and assets related to the film. The Company provided a
corporate guaranty in the amount of $700,000 in connection with this loan.
The loan matures on March 31, 2000.
In June 1999, a $1,626,000 production loan was obtained by a consolidated
subsidiary from Far East National Bank to cover a portion of the
production budget of The Last Producer. The loan bears interest at Prime
(8% as of August 13,1999) plus 1%. The loan is collateralized by the
rights, title and assets related to the film. The loan matures on June
30, 2000.
Securities Offerings
The Company obtained net proceeds of $5,673,000 in December 1998
($6,000,000 of gross proceeds) through a private placement of 1,200,000
newly-issued shares of common stock.
As of June 30, 1999, $802,000 principal amount of 8% Convertible
Subordinated Debentures and $1,620,000 of Series B Debentures were
outstanding. During the nine months ended June 30, 1999, $28,000
principal amount of the Series A Debentures, $1,575,000 principal amount
of the Series B Debentures, $3,898,000 principal amount of the 8%
Debentures and $4,100,000 principal amount of the 9% Debentures were
converted into approximately 1,275,000 shares of Common Stock.
On June 24, 1999, the Company's subsidiary US SEARCH.com consummated an
initial public offering of newly-issued common stock. The subsidiary sold
4,500,000 newly-issued shares and obtained $36,263,000 of net proceeds.
Also on June 24, 1999 the Company sold 1,500,000 shares out of its
holdings of US SEARCH.com common stock and obtained $12,555,000 of net
proceeds. The Company retains a 55.2% interest in the subsidiary and
continues to consolidate the subsidiary in the accompanying financial
statements. The Company recognized a $13,148,000 pre-tax gain on the sale
of the 1,500,000 shares and a $21,152,000 gain on the increased value of
its proportion of the net equity of the subsidiary.
On April 26, 1999 the Company issued 468,883 shares of restricted common
stock to The Harvey Entertainment Company ("Harvey") in exchange for
55,000 shares of Series A Preferred Stock of Harvey and 388,215 warrants
exerciseable into common stock of Harvey, all pursuant to a stock purchase
agreement involving a new Harvey investor group which includes the
Company. The Harvey Series A Preferred Stock are convertible into 814,814
shares of Harvey common stock commencing October 26, 1999 and require
payment of quarterly dividends in cash or in additional shares of Harvey
Series A Preferred Stock at a 7% annual rate. The Company holds certain
demand and piggyback registration rights relating to its Harvey
securities. On a fully-diluted basis, assuming all securities
exerciseable or convertible into Harvey common stock are so exercised or
converted, the Company would own 12% of the voting shares of Harvey. In
June 1999 the Company filed a registration statement registering the
shares of its restricted common stock issued to Harvey.
Effective May 14, 1999 the Company redeemed all of its Class C Redeemable
Common Stock Purchase Warrants (the "Class C Warrants") and its
outstanding 10% Convertible Subordinated Debentures, Series A due 2000. A
total of 792,282 Class C Warrants were exercised for 792,282 shares of
Common Stock and the Company received proceeds of $5,406,000. The Company
issued 6,435 new shares of common stock in connection with the conversion
of $49,000 aggregate principal amount of the Series A Debentures. The
Company redeemed $28,000 aggregate principal amount of the Series A
Debentures.
Other
The Company has entered into an agreement in principle with Universal
Studios, Inc. whereby the Company has the right to distribute in
international territories up to nine moderate to high-budget motion
pictures over a three-year period. The Company has the right to select
the motion pictures, if any, to be distributed among titles made available
by Universal Studios, Inc. In the event the Company and Universal
Studios, Inc. agree upon one or more films under the arrangement,
management currently expects to finance its acquisition of the
distribution rights via credit facilities not presently in place. There
can be no assurance that definitive agreements for this distribution
arrangement will be agreed to, that financing will be obtained, or that
such activities will ultimately be profitable if undertaken.
With four other companies including Digital Domain, the Company has
obtained a 20% interest in a German company that owns and operates a
German special effects production facility. A German state government
agency is providing substantial monetary subsidies to that business to
enable it to attract an increased flow of special effects business. The
Company is investing $300,000 in the German company, and the Company is
due to receive a $150,000 return of capital this year. The Company has no
additional financial obligations related to the facility.
Summary
Management believes that existing resources and cash generated from
operating activities, together with amounts expected to be available under
the syndicated credit facility with Chase (assuming that it is extended or
replaced) will be sufficient to meet the Company's working capital
requirements for at least the next twelve months. The credit facility
expires in June 2000. The Company is currently in discussions with the
existing group of banks regarding secured revolving financing beyond June
2000. The discussions are presently in an early stage. No assurances can
be provided that such facility will be extended or, alternatively,
substantially modified or replaced by other satisfactory financial
arrangements. The Company (including its subsidiaries) from time to time
may be required to seek additional financing through the issuance of new
debt or equity securities, additional bank financings, or other means
available to the Company. No assurance can be given that such financing
will be available or, if available, will be at costs comparable to current
financings or on terms acceptable to the Company. In addition to
expanding production and its distribution business and its investment
activities, whether internally or by acquisition, the Company also
considers acquisition and investment 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.
Year 2000 Issues
The "Year 2000 Issue" is typically the result of certain firmware
limitations and of limitations of certain software written using two
digits rather than four to define the applicable year. If software and
firmware with date-sensitive functions are not Year 2000 compliant, they
may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, interruptions in
customer service operations, a temporary inability to process
transactions, conduct searches, or engage in similar normal business
activities.
Corporate operations and film and television segment. The Company has
upgraded or replaced virtually all firmware in part to mitigate Year 2000
exposure. The Company utilizes off-the-shelf and custom software
developed internally and by third parties. The Company believes that its
off-the-shelf software is Year 2000 compliant. However, there is no
assurance that the Company will not be required to modify or replace
significant portions of its software so that its systems will function
properly with respect to dates in the year 2000 and thereafter.
The Company has completed a Year 2000 evaluation including Information
Technology ("IT") systems, non-IT systems, and critical third-party
entities with which the Company transacts business. If required
modifications to existing software and firmware or conversions to new
software or firmware are not made, or are not completed timely, or if
there is a malfunction in software or firmware used on computer systems
utilized by those upon whom the Company depends for provision of its
services, there is no assurance that potential systems interruptions or
the cost necessary to update such software or firmware or any outages or
delays in services will not have a material adverse effect on the
Company's business, financial condition, results of operations and
prospects. Further, the failure of the Company to successfully resolve
such issues could result in a shut-down of some or a substantial portion
of the corporate or film and television operations, which could have a
material adverse effect on the business, financial condition, results of
operations and prospects of the Company.
US SEARCH.com The Year 2000 Issue could result in a system failure or
miscalculations causing significant disruption of operations, including,
among other things, interruptions in Internet traffic, accessibility of
the Web site, delivery of service, transaction processing or searching and
other features of our services. It is possible that this disruption will
continue for an extended period of time. US SEARCH.com depends on
information contained primarily in electronic format in databases and
computer systems maintained by third parties, including governmental
agencies. The disruption of third-party systems or our systems interacting
with these third-party systems could prevent us from receiving orders or
delivering search results in a timely manner. In addition, US SEARCH.com
relies on the integration of many systems in aggregating search data from
multiple sources. The failure of any of those systems as a result of Year
2000 compliance issues could prevent us from delivering products and
services. Failure of our systems or third-party systems providing
information used in our services could materially adversely affect US
SEARCH.com's business and results of operations. We have received
information confirming the Year 2000 compliance from present data
suppliers. We have also confirmed Year 2000 compliance with key third
party vendors.
US SEARCH.com is conducting an evaluation of internal systems. Our
objective is to ensure uninterrupted transition into the Year 2000. The
scope of the Year 2000 objective includes: (1) information technology
("IT") such as software and hardware, (2) non-IT systems such as
components contained in various safety systems, facilities and utilities,
and (3) readiness of key third parties, including suppliers and customers.
We are seeking written confirmation of the Year 2000 status of our third
party software. We are also utilizing internal resources to test
internally developed software for Year 2000 compliance. We may be
required to modify or replace significant portions of our software so that
our systems will function properly with respect to dates in the year 2000
and thereafter. If we are unable to make the required modifications or
conversions in a timely and cost-effective manner or if there is a
malfunction in our systems, potential systems interruptions or delays in
services may have a material adverse effect on our business, financial
condition and results of operations. Further, if we fail to successfully
resolve these issues, some or all of US SEARCH.com's operations may shut-
down, which would have a material adverse effect on our business,
financial condition and results of operations.
US SEARCH has a process in place to assess the Year 2000 readiness of our
business critical vendors and customers, and are involved in working with
these vendors and customers on Year 2000 compliance issues. Disruptions
with respect to computer systems of vendors or customers, whose systems
are outside our control, could impair our ability to provide support to
our customers, and could have a material adverse effect on our financial
condition and results of operations.
Overall. We are currently developing contingency plans to be implemented
as part of our efforts to identify and correct Year 2000 problems with our
internal and Web-based systems. We expect to complete the majority of our
plan by September 30, 1999, with the balance by October 31, 1999. Within
the plans, we are addressing various problems, including disruptions to
our Web-servers, significant interruption of data flow between us and
third party data providers, and failures associated with internal systems.
The contingency plans emphasize the identification and accessibility of
additional data sources for our services. There is no assurance that our
contingency plans will adequately address all Year 2000 issues.
We are currently evaluating (1) the use of multiple Web-hosting sites to
assure availability of our services, (2) additional data sources, (3)
manual procedures for order processing and delivery of search results (4)
standby equipment and accelerated availability of replacement parts, and
(5) increased staffing levels for resolution of information technology
issues and to manually process orders. Failure to implement any of these
plans, if and when necessary, may have a material adverse effect on the
Company's business and results of operations.
Finally, the Company is also vulnerable to external forces that might
generally affect industry and commerce, such as utility or transportation
company or Internet Year 2000 compliance failures and related service
interruptions. Any significant interruption of general access to the
Internet, or the customary function and operations of, the Internet could
have a material adverse effect on the Company's business, financial
condition, results of operations and prospects. Some commentators have
predicted significant litigation regarding Year 2000 compliance issues.
Because of the unprecedented nature of such litigation, it is uncertain
whether or to what extent the Company may be affected by it.
The Company currently believes that this issue will not pose significant
operational problems for its corporate or film and television operations,
however delays in the modification or conversion of its or US SEARCH.com's
systems, or those of vendors and suppliers of services to the Company and
US SEARCH.com, or the failure to fully identify all Year 2000 dependencies
in the systems could have a material adverse effect on the Company's
business, financial condition, results of operations and prospects.
The Company cannot quantify the impact of the Year 2000 issue; however,
failure of critical internal IT systems, non-IT systems, third-party
vendors and financial institutions may limit or prevent the Company from
performing services for its customers, and could have a material adverse
effect on the Company's business, financial condition, results of
operations and prospects. We estimate that the total cost of implementing
and maintaining our Year 2000 compliance program will not exceed $300,000
and most of these expenses will be incurred during 1999. This estimate
includes implementation of redundant hardware, software and communications
systems. Our costs incurred to date with respect to Year 2000 compliance
have not been significant.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of interest rate changes, foreign
currency exchange rate changes, and changes in the market values of its
investments as described below.
Interest Rate Risk
The Company's exposure to market rate risk for changes in interest rates
relates primarily to US SEARCH.com's investment portfolio, and to the
Company's variable rate loans.
US SEARCH.com has not used derivative financial instruments in its
investment portfolio. US SEARCH.com invests its excess cash in debt
instruments (either directly or through money market or mutual funds) of
the U.S. Government and its agencies, and in high-quality corporate
issuers and, by policy, limits the amount of credit exposure to any one
issuer. US SEARCH.com protects and preserves its invested funds by
limiting default, market and reinvestment risk. Investments in both fixed
rate and floating rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market
value adversely impacted due to a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates
fall. Due in part to these factors, US SEARCH.com's future investment
income may fall short of expectations due to changes in interest rates, or
US SEARCH.com may suffer losses in principal if forced to sell securities
which have declined in market value due to changes in interest rates.
The following table is a summary of available-for-sale securities:
<TABLE>
<CAPTIONS>
Fair Fair
Market Value % Rate Market Value % Rate
9/30/98 of Return 9/30/97 of Return
------- --------- ------- ---------
<S> <C> <C> <C> <C>
US Government
Securities $ -- --% $-- --%
Other debt
Securities $ -- --% $-- --%
</TABLE>
Virtually all of the Company's loans bear variable interest rates. The
Company has not used derivative financial instruments in conjunction with
its lending arrangements. Variable rate loans may produce higher expense
if commercial lending interest rates rise, or the Company may lose its
present liquidity if it cannot obtain loans at reasonable rates when
alternative sources of financing are not available.
The Company's total outstanding interest-bearing indebtedness at June 30,
1999 and September 30, 1998 was $88,463,000 and $84,677,000, respectively.
Foreign Currency Exchange Risk
The Company licenses film and television programming throughout the world
under payment arrangements almost exclusively denominated in US dollars.
The Company has not used derivative financial instruments in conjunction
with its licensing arrangements. As a result, foreign exchange
fluctuations will not alter the amounts due to the Company, but may impact
licensees' ability to pay. In such event, the Company may experience
increased difficulties in obtaining licensee payments or in profitably
licensing subsequent film and television programming to international
licensees.
The effect of foreign currency exchange rate fluctuations on the Company
in 1998 was not material.
Investment Risk
In late 1997, the Company acquired control of US SEARCH.com. In June 1999
US SEARCH.com sold 4,500,000 shares to the public and the Company sold
1,500,000 of the shares of US SEARCH.com that it held. The Company
retains 55.2% of the outstanding shares of US SEARCH.com. Since acquiring
its interest in the subsidiary, the Company has generated a material
amount of revenue and significant net losses from its ownership interest
in US SEARCH.com. This investment is consolidated.
In February 1998 the Company established KL/Phoenix, an 80% owned entity,
which distributes film and television product in Latin America and
broadcasts Spanish-language movies via Gran Canal Latino, a satellite
distributor system to cable operators in Latin America. The Company owns
80% of the joint venture. To date, the Company has not generated a
material amount of revenue from its ownership interest in KL/Phoenix. This
investment is consolidated.
Since 1995 the Company has invested seven in joint ventures in which the
Company owns 25% to 50% interests. These investments are included in other
assets and are accounted for under the equity method. To date, the Company has
not generated a material amount of revenue from its ownership interest in
these joint ventures.
On April 26, 1999 the Company invested in 55,000 shares of Series A
Preferred Stock of Harvey and 388,215 warrants exerciseable into common
stock of Harvey. The Harvey Series A Preferred Stock are convertible into
814,814 shares of Harvey common stock commencing October 26, 1999. On a
fully-diluted basis, the Company would own 12% of the voting shares of
Harvey. This investment is included in other assets and is accounted for
under the cost method. The Company's Harvey holdings are not presently
registered with the Securities and Exchange Commission. Market prices of
Harvey common stock have declined since the investment was made.
The Company's policy is to regularly review the assumptions underlying the
operating performance and cash flow forecasts in assessing the carrying
value of these investments. The Company identifies and records impairment
losses on long-lived assets when events and circumstances indicate that
such assets might be impaired. To date, no such impairment has been
recorded.
<PAGE>
PART II
OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On April 26, 1999 the Company issued 468,883 shares of restricted common
stock to The Harvey Entertainment Company ("Harvey") in exchange for
55,000 shares of Series A Preferred Stock of Harvey and 388,215 warrants
exerciseable into common stock of Harvey, all pursuant to a stock purchase
agreement involving a new Harvey investor group which includes the
Company. The Harvey Series A Preferred Stock are convertible into 814,814
shares of Harvey common stock commencing October 26, 1999 and require
payment of quarterly dividends in cash or additional shares of Harvey
Series A Preferred Stock at a 7% annual rate. The Company holds certain
demand and piggyback registration rights relating to its Harvey
securities. On a fully-diluted basis, assuming all securities
exerciseable or convertible into Harvey common stock are so exercised or
converted, the Company would own 12% of the voting shares of Harvey. In
June 1999 the Company filed a registration statement registering the
shares of its restricted common stock issued to Harvey. In June 1999 such
registration statement was declared effective by the Securities and
Exchange Commission.
Effective May 14, 1999 the Company redeemed all of its Class C Redeemable
Common Stock Purchase Warrants (the "Class C Warrants") and its
outstanding 10% Convertible Subordinated Debentures, Series A due 2000. A
total of 792,282 Class C Warrants were exercised for 792,282 shares of
Common Stock and the Company received proceeds of $5,406,000. The Company
issued 6,435 new shares of common stock in connection with the conversion
of $49,000 aggregate principal amount of the Series A Debentures. The
Company redeemed $28,000 aggregate principal amount of the Series A
Debentures.
On June 24, 1999, the Company's subsidiary US SEARCH.com consummated an
initial public offering of newly-issued common stock. The subsidiary sold
4,500,000 newly-issued shares and obtained $36,263,000 of net proceeds. On
June 24, 1999 the Company sold 1,500,000 shares out of its holdings of US
SEARCH.com common stock and obtained $12,555,000 of net proceeds. The
Company retains a 55.2% interest in the subsidiary and continues to
consolidate the subsidiary in the accompanying financial statements. The
Company utilized the proceeds principally to repay advances under its
syndicated revolving line of credit.
Item 4. Submission of Matters to a Vote of Security Holders
On April 29, 1999 the shareholders of the Company voted in the annual
meeting to elect five directors and to amend the Company's 1988 Stock
Incentive Plan to increase the number of shares of Common Stock reserved for
issuance from 1,250,000 to 1,820,000. The results of the voting were as
follows:
<TABLE>
<CAPTION>
Election of directors:
FOR AGAINST ABSTAIN
<S> <C> <C> <C>
Peter Locke 9,793,741 32,991 4,582
Donald Kushner 9,793,508 33,490 4,316
Irwin Friedman 9,796,103 27,077 8,134
Stuart Hersch 9,797,056 26,763 9,012
John Lannan 9,796,237 26,065 9,012
</TABLE>
Amend the Company's 1988 Stock Incentive Plan to increase the number of
shares of Common Stock reserved for issuance from 1,250,000 to 1,820,000:
<TABLE>
<S> <C> <C> <C>
FOR AGAINST ABTAIN
8,924,395 869,111 37,808
</TABLE>
The Company is unaware of any withheld votes or broker non-votes.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits: Exhibits filed as part of this report
are listed on the "Index to Exhibits" which follows the signature pages
hereto.
(b) Reports on Form 8-K: None.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<S> <C>
THE KUSHNER-LOCKE COMPANY
(Registrant)
Dated: August 16, 1999 /s/ PETER LOCKE
-------------------------
Peter Locke
Co-Chairman of the Board,
Co-Chief Executive Officer
Dated: August 16, 1999 /s/ DONALD KUSHNER
-------------------------
Donald Kushner
Co-Chairman of the Board,
Co-Chief Executive Officer
and Secretary
Dated: August 16, 1999 /s/ ROBERT SWAN
-------------------------
Robert Swan
Senior Vice President and Chief Financial
Officer
</TABLE>
<PAGE>
<PAGE>
EXHIBITS
None.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> JUN-30-1999
<CASH> 49134
<SECURITIES> 0
<RECEIVABLES> 34636
<ALLOWANCES> 3672
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 0<F2>
<PP&E> 2529
<DEPRECIATION> 1544
<TOTAL-ASSETS> 198511
<CURRENT-LIABILITIES> 0<F3>
<BONDS> 2352
0
0
<COMMON> 69584
<OTHER-SE> (4759)
<TOTAL-LIABILITY-AND-EQUITY> 198511
<SALES> 494
<TOTAL-REVENUES> 34205
<CGS> 469
<TOTAL-COSTS> 29118
<OTHER-EXPENSES> 20270
<LOSS-PROVISION> 2999
<INTEREST-EXPENSE> 6148
<INCOME-PRETAX> 10086
<INCOME-TAX> 740
<INCOME-CONTINUING> 9346
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9346
<EPS-BASIC> 0.84
<EPS-DILUTED> 0.79
<FN>
<F1>FILM AND TELEVISION PROPERTY ASSETS TOTALLING $93,154 ARE NOT
CLASSIFIED AS INVENTORY.
<F2>UNCLASSIFIED BALANCE SHEET.
<F3>UNCLASSIFIED BALANCE SHEET.
</FN>
</TABLE>
