Item 1. "Risk Factors--Competition."
Software Availability. All major studios and a large number of independent program suppliers support the laserdisc format, which has a library of over 10,000 available titles. Currently only certain major studios and a limited number of other program suppliers support DVD; however, given the recent launch of the DVD format it is too early to determine the extent of program supplier support the DVD format will receive in the future. DVD software is generally available through the same retail channels that support laserdisc software, as well as certain nationally recognized entertainment software chain stores; however, distribution of a majority of DVD titles (i.e., titles controlled by Warner and all but one of its affiliates) is currently limited to seven designated markets.
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Hardware Availability. A wide variety of DVD players are available through the same retail channels that support laserdisc and LD/DVD/CD combination players, as well as certain nationally recognized consumer electronic retail chain stores. The LD/DVD/CD combination player is available at nearly all of the locations where laserdisc players are sold and most of the locations where DVD players are sold. Both laserdisc players and DVD players play compact discs. Laserdisc players generally retail from $299 to $5,000, DVD players generally retail from $499 to $5,500, and LD/DVD/CD combination players generally retail from $999 to $1,799.
Video Quality. Both DVD and laserdisc are optical disc formats which are read by a laser beam. DVD's picture is digital while laserdisc's picture is analog. DVD's video image is compressed to fit on a 5-inch disc while laserdisc's video image is transferred compressed to a 12-inch disc. Both provide superior picture quality over videocassette tape and broadcast television. If properly compressed, DVD offers up to 500 scan lines of resolution versus laserdisc's 425 and videocassette's 240.
Audio Quality. The audio format offered on most laserdiscs is Dolby Surround. The audio format offered on all DVDs is Dolby Digital, which offers up to 5.1 channels of discrete audio, however, many laserdisc titles also offer Dolby Digital. DTS digital sound, an audio format arguably superior to Dolby Digital, is also being offered on certain laserdiscs. DVD is also capable of carrying a DTS audio signal, however, no DVDs with DTS capability have been announced or are currently available. Consumers must have hardware compatible with DTS and Dolby Digital technology to take advantage of these audio formats.
Content Capacity. A DVD typically holds 133 minutes of compressed programming per side for a total of 266 minutes (almost 4 1/2 hours), although dual layer technology exists allowing for greater per side storage capacity. Laserdisc can hold 60 minutes of programming per side for a total of 120 minutes (2 hours). Many laserdisc player models will automatically play the second side of a laserdisc after a several second delay, while low-end laserdisc players require manual flipping of the disc. A laserdisc program with a run-time in excess of two hours requires two discs. Currently, DVD players do not automatically play the reverse side of a disc so that programs encoded on both sides of a DVD would require manual flipping of the disc.
Software Features. DVD and laserdiscs are playback-only formats and, unlike videocassette, neither DVD nor laserdisc can record. Just as there has always been speculation regarding the availability of an affordable, consumer- oriented recordable laserdisc machine, there is speculation regarding a recordable DVD machine. The Company believes that, as in the case of laserdisc, an affordable, consumer-oriented recordable DVD player will not be available for several years.
Both DVD and laserdisc offer chapter stops and random/direct program access akin to CD's random track access. Both DVD and laserdisc can offer programming with entertaining and informative ancillary material such as audio commentaries by film talent, deleted scenes, scripts, photos, alternative endings and multiple versions such as a "director's cut."
DVD can offer an on-screen interactive menu allowing access to key scenes or chapters, ancillary material and foreign language dubbing and subtitle choices. Laserdisc typically lists such choices on the back of the laserdisc packaging. Laserdisc provides subtitles for foreign films and sometimes offers foreign language alternatives on separate audio tracks. Although many initial DVD releases have offered ancillary materials and multiple language and subtitle choices, it is uncertain whether future DVD releases will continue to offer the same variety of features and options.
Laserdisc titles are generally released in the preferred widescreen version. Many of the first DVD releases offer both widescreen and pan-and-scan versions on the same disc, a version per side. It is unclear whether the future DVD releases will continue to offer both versions on the same disc. Whether or not all or any of these features will be included on any laserdisc or DVD is determined by the studio or program supplier, or in certain instances, licensees such as the Company.
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Pricing. Laserdiscs have been priced for the sell-through market as opposed to the rental market. Most laserdisc titles sell for between $29.99 and $39.99 and are generally discounted up to 20% by the retailer or mail order provider. Currently, most DVD's have been priced for the sell-through market between $24.99 and $29.99, and generally discounted up to 20%. PolyGram has announced that it will release the first DVD title priced for the rental market. The Company does not know if other program suppliers will follow PolyGram's rental pricing or if PolyGram will price other titles for the rental market.
Manufacturing and Production Cost. Although the cost of DVD replication is generally half that of laserdisc replication, DVD's 5-inch format and on-screen random access requires costly and time-consuming compression and authoring techniques which laserdisc does not. The Company believes that the cost and technical challenges presented by DVD compression and authoring may limit the number of titles made available. In comparison, the production cost involved in the creation of a laserdisc master is relatively inexpensive.
Channels of Distribution. Laserdisc hardware and software is not supported by mass-market retailers and, as a result, the laserdisc market has become a niche market relative to the videocassette market. DVD is currently being supported by certain mass-merchants and national hardware and software chain stores, as well as the regional music/video chain stores, electronics specialty hardware retailers and independent retailers which support laserdisc. The Company believes that if the market for DVD does not grow large enough to justify continued mass-market support DVD will most likely be a niche market relative to the videocassette market.
THE IMPACT OF DVD ON THE COMPANY'S LASERDISC BUSINESS. Although it is too ----------------------------------------------------- early to assess the ultimate effect of DVD on the laserdisc business, the Company's laserdisc sales have already been negatively affected by the more cautious purchasing patterns of laserdisc retailers. Although pre-orders for new hit titles are down, supplemental ordering to fill demand immediately prior to street date suggests that a continuing demand at the consumer-level exists for new release laserdisc titles. Orders for laserdisc catalogue titles are also down as a result of the decline in laserdisc hardware sales and availability, and reduction in the purchasing habits of laserdisc consumers as they wait to assess the success of the new DVD format. The Company, however, believes that another significant factor currently contributing to reduced laserdisc sales is the distressed financial condition of several of the Company's major customers, primarily music chain stores and distributors. See --- Item 7. "Results of Operations" and "Summary and Outlook -- Distressed Condition of the Retail Entertainment Software Market."
The Company believes that DVD's performance during the 1997 holiday selling season will be a strong indicator of DVD's future sales growth, market penetration and consumer acceptance. DVD's success is also dependent on the participation and extent of the participation by all of the major studios which will dictate the number and breadth of titles that are available on the DVD format. DVD program suppliers must also be willing to at least sustain the video and audio quality and variety of software features currently available on DVD releases while maintaining or lowering pricing. The current technical challenges presented by the DVD format may make it difficult to produce large numbers of titles quickly and economically while preserving the variety of features and audio and video quality consumers of DVD expect.
The Company believes that both the laserdisc format and the DVD format can co-exist for several years because, initially, participating program suppliers are expected to concentrate on the release of new and certain of the more popular catalogue titles on DVD. Laserdisc is supported of all of the major motion picture studios. There are currently over 10,000 titles available on laserdisc. The Company alone releases an average of 50 new titles per month under its exclusive laserdisc agreements. Given the current low level of studio support for DVD, the current high cost of DVD authoring and compression, the present level of DVD authoring skills and uncertain consumer demand, the Company believes that the number of DVD titles will not rival laserdisc for several years. Although new titles will continue to be released on DVD, the Company believes that at least for the near future not all new releases, which would be available on laserdisc and videocassette, would be available on DVD, and that most likely only popular-demand catalog titles will be available in the new DVD format as compared to the large existing library of laserdisc catalogue titles. See Item 1. "Risk Factors." - ---
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The Company further believes that sales of the Pioneer LD/DVD/CD combination player may contribute to sales of the Company's laserdisc catalogue titles because some LD/DVD/CD combination player consumers will be new to both the DVD and laserdisc formats and may purchase laserdisc titles not yet available on DVD. The Company believes that the LD/DVD/CD combination players will continue to be a popular choice for consumers in the foreseeable future, assuming Pioneer's continued commitment to the LD/DVD/CD combination player, because they afford the consumer the widest variety of title choices. Further, the Company believes that a significant percentage of consumers are presently under the impression that DVD versions of all titles will soon be available from all studios and other program providers. In reality, most of the major studios have not affirmatively committed to the new format, and it is unclear if or when DVD versions of all titles will be available.
Notwithstanding the impact of DVD's introduction on the Company's laserdisc business, the Company believes that it is well-positioned to take advantage of the opportunities presented by the new and rapidly changing DVD market. The Company is therefore dedicated to continuing its efforts to secure additional DVD license and distribution opportunities to remain competitive and diversify its core business.
FOR INFORMATION CONCERNING THE IMPACT OF DVD ON SALES AND PROSPECTS OF THE COMPANY'S LASERDISC BUSINESS SEE ITEM 1. "THE NEW DIGITAL VIDEO DISC (DVD) FORMAT" AND "RISK FACTORS." SEE ALSO ITEM 7. "RESULTS OF OPERATIONS" AND --- ---- "SUMMARY AND OUTLOOK -- DVD OUTLOOK."
SUBSIDIARY ACTIVITIES
The Company's only active subsidiary, U.S. Laser Video Distributors, Inc. ("U.S. Laser"), is a New Jersey-based nonexclusive distributor of optical disc programming. U.S. Laser is also the owner-operator of a retail concept store in New Jersey which offers a large selection of entertainment software, including laserdiscs, DVDs and CD-ROMs, for sale and rental, as well as a wide-variety of "home theater" system hardware. The store features an in-store "Internet cafe," where patrons can socialize and access the Internet in a leisurely coffee-house setting. In addition, U.S. Laser publishes LASERVIEWS, a consumer periodical focusing on product announcements, software reviews and articles of general interest to the optical disc consumer.
TRADEMARKS
The Company has received Federal registration of the trademark "IMAGE" in the United States Patent and Trademark Office. The Company also uses the trademarks "Vocal Images," "The Music Disc" and "The Finest in Laserdiscs" and the service marks "Image Post" and "Image Creative Group."
EMPLOYEES
At June 1, 1997, the Company and its subsidiary U.S. Laser together had 116 full-time and 5 part-time employees.
RISK FACTORS
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on the beliefs of Company's management as well as assumptions made by and information currently available to the Company's management. When used in this document, the words "anticipate," "believe," "may," "estimate," "expect" and similar expressions, variations of such terms or the negative of such terms as they relate to the Company or its management are intended to identify such forward- looking statements. Such statements are based on management's current expectations and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, the
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Company's actual results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements.
The Company has made forward-looking statements in this Annual Report concerning, among other things, (i) the viability of the laserdisc format for several years despite the introduction of DVD; (ii) Pioneer's continued commitment to the LD/DVD/CD combination player, and the success of the LD/DVD/CD combination player in growing the laserdisc and DVD formats and attracting new customers to laserdisc; (iii) the strengthening of the retail entertainment software market over the long term; (iv) management's ability to successfully implement sufficient elements of its "Action Plan" (as defined in Item 7. "Liquidity and Capital Resources -- Management's Action Plan"); (v) monetizing all or a portion of the delinquent receivables of two of the Company's largest customers;(vi) closing escrow on the sale of 8.8 acres of the Company's Las Vegas, Nevada property; (vii) ultimate construction of the Las Vegas, Nevada warehouse and distribution facility; (viii) ability to continue restructuring payment terms with the Company's licensors, product suppliers and other vendors; (ix) receiving waivers from the Company's lenders on future noncompliance of loan covenants; and (x) seeking investment opportunities in growth-oriented companies and securing necessary acquisition financing. The inclusion of such forward-looking information should not be regarded as a representation by the Company, its management or any other person that the future events, plans or expectations contemplated by the Company will be achieved. The Company undertakes no obligation to release publically any updates or revisions to any such forward-looking statements that may reflect events or circumstances occurring after the date of this Annual Report. Factors that could cause or contribute to such material differences include, but are not limited to, those discussed below.
FACTORS AFFECTING THE COMPANY'S OVERALL BUSINESS. ------------------------------------------------
Financial Condition of Key Customers. The entertainment software retail sector is experiencing a period of declining sales growth and deteriorating profitability. A number of retailers have recently reported worsening financial results, store closing programs, violations of bank financing covenants and constrained cash positions. The financial difficulties experienced by several of the Company's largest customers has had an adverse effect on the Company's sales to such customers and the Company's net revenues, net income and cash flow. The Company expects the distressed condition of the retail entertainment software market and the financial difficulties of several of its largest customers to continue to adversely impact the Company's laserdisc business and operations. See Item 7. "Summary and Outlook -- Distressed --- Condition of the Retail Entertainment Software Market." Although the Company believes that the negative factors contributing to the prevailing economic environment in the entertainment software retail sector will be mitigated in the long-term, there can be no assurances that any such economic recovery would occur before the present economic slump causes additional customers of the Company to experience financial difficulties that would further adversely impact the Company's business and operations. The distressed financial condition of the entertainment software retail sector may also begin to similarly adversely affect the Company's new DVD business and operations if one or more of its DVD customers constrain their purchasing or otherwise experience financial difficulties.
Competition. The Company believes that it is the largest laserdisc licensee and distributor in the United States; however, the Company also faces competition from Pioneer Entertainment (USA), L.P., which also licenses and distributes laserdiscs; laserdisc subdistributors; and Columbia/TriStar, Universal and Warner, who sell their own programming directly to retailers, as well as to the Company and other distributors. The laserdisc and DVD formats also face competition from other forms of home video entertainment, e.g., videocassettes, network, syndicated, pay/cable television and home satellite systems. See Item 1. "Risk Factors -- Factors Specifically Affecting the Company's DVD Business" for a discussion regarding the Company's competition in licensing and distribution in the DVD market. New and emerging technologies in the entertainment industry (such as entertainment programming on the Internet, video-on-demand, high-definition television, digital videotape and optical discs with greater storage capacity) may also offer alternate forms of leisure-time entertainment or alter the way in which existing forms are delivered, thereby increasing competition for both the Company's laserdisc and DVD business.
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Ability to Sustain Laserdisc Business. Although the Company believes that if the DVD market becomes a niche market the Company could occupy a role similar to its role in the niche laserdisc market, there can be no assurances that the Company will be able to sustain its core laserdisc business until a transition can be made to DVD, if ever; or whether current laserdisc program suppliers and laserdisc hardware manufacturers will continue to support the laserdisc format during the transition period. Further, if the Company can maintain its laserdisc business during such a transition period there can be no assurances that it will be able to license and distribute DVD programming with the same success it has experienced in the laserdisc market, either generally or relative to the breadth of programming it is now able to offer customers and at the margins it currently enjoys.
Seasonality and Variability. The Company has generally experienced higher sales of laserdiscs in the quarters ended December 31 and March 31 due to increased consumer spending associated with the year-end holidays and because most sales of a title occur in the first few months after its release. In addition to seasonality issues, other factors have contributed to variability in the Company's laserdisc net sales on a quarterly basis. These factors include: (i) the popularity of titles in release during the quarter; (ii) the Company's marketing and promotional activities; (iii) the Company's rights and distribution activities; (iv) the extension, termination or non-renewal of existing license and distribution rights; and (v) general economic changes affecting consumer demand for laserdisc hardware and software and affecting the buying habits of the Company's customers. Although it is too early to tell, the Company expects that its DVD sales patterns and net sales on a quarterly basis will be similarly affected.
Delays of Releases. The Company currently expects that all new laserdisc and DVD titles with expected release dates in fiscal 1998 will be released during that year. In the past, however, the Company's laserdisc licensors, for various reasons, have from time-to-time delayed releasing certain titles to the laserdisc and videocassette markets. There can be no assurances that delays of this type will not occur in the future. Although it is too early to tell, the Company believes that its experience relative to delayed releases for certain laserdisc titles will be the same for certain DVD titles.
Nature of the Entertainment Industry. Audience acceptance of the Company's products represents a response not only to the artistic components of the products, but also to the level of advertising and promotion by Company, the studios and distributors, the availability of alternative forms of entertainment and leisure time activities, changes in public taste, and other intangible factors, all of which change rapidly and cannot be predicted. This situation presents a number of risks, including the risk that some of the Company's laserdisc and DVD titles may not be commercially successful, that costs will not be recouped or that anticipated profits justifying the Company's commitments will not be realized.
Acquisition Opportunities. The Company has explored, and continues to explore, acquisition opportunities in various businesses complementary to those of the Company. To date, however, other than the 1995 acquisition of U.S. Laser (see Item 7. "1995 Acquisition") no acquisition agreement has been reached. --- Furthermore, there can be no assurances that the Company will enter into any acquisition agreement, nor can the Company currently predict how such an agreement would impact its results. Any material acquisition would require the Company to obtain financing. There can be no assurances that the Company will obtain such financing on terms and conditions which are reasonable or acceptable to the Company.
Dependence on Key Personnel. The success of the Company depends to a significant degree on the efforts of the Company's executive management, especially its President and Chief Executive Officer, its Chief Financial Officer, its Chief Administrative Officer and its Senior Vice President of Sales, Marketing and Operations. The Company's operations may be adversely affected if one or more members of executive management cease to be active in the Company. The Company, however, has designed its compensation structure and employee benefit programs to encourage long-term employment of all executive officers.
FACTORS SPECIFICALLY AFFECTING THE COMPANY'S DVD BUSINESS. The Company --------------------------------------------------------- only recently began licensing and distributing programming in the new DVD format. All of the same factors which have affected, and in the future
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could affect, the Company's core laserdisc business can also affect the Company's new DVD business. Additionally the following important factors, among others, have affected, and in the future could affect, the actual business, operating results and financial condition of the Company's new DVD business and could cause them to differ materially from those expressed or implied in any forward-looking statements made herein.
Growth of the DVD Market. The Company currently believes that the technical complexities, high-cost and time-consuming process of DVD authoring and compression, the present non-participation of several major motion picture studios (viz., Disney, Fox, Universal and Paramount), and the large number of titles currently available on laserdisc may impede the growth and acceptance of DVD. There can be no assurances that advances in DVD technology will not reduce production time, lower cost and afford more sophisticated features than laserdisc or the current generation of DVDs, or that DVD will not enjoy the support of all of the major motion picture studios at the same, or higher level, as such major motion picture studios currently support laserdisc.
The Company's Ability to License and Release Exclusive DVD Titles. The Company currently expects that it will be able to utilize outside vendors to author, compress and replicate marketable DVD titles for release under its exclusive DVD license agreements. There can be no assurances that the Company's vendors will be able to continue to provide such services at the same or higher level of quality and quantity, or if the Company will be able to access or afford alternative vendors for such services. Further, there can be no assurances that the Company will be able to continue to secure license rights on terms acceptable to the Company.
Availability of DVD Titles for Wholesale Distribution. The Company currently expects that it will be able to purchase on a wholesale basis DVD titles from all participating program suppliers for sale to the Company's laserdisc customers and participating Thomson dealers. There can be no assurances that the Company will be able to continue to purchase and distribute such programming in the event DVD program suppliers elect to sell direct, increase the number of entities distributing their programming or limit the Company's access to programming.
ITEM 2.
ITEM 2. PROPERTIES. ----------
The lease for the Company's office space (30,080 square feet) in Chatsworth, California provides for monthly rent of approximately $14,000 (subject to annual adjustment based upon increases in the consumer price index) and will expire on March 31, 2000.
The lease for the Company's warehouse space (48,300 square feet) in Chatsworth, California provides for monthly rent of approximately $23,000 (subject to annual adjustment based upon increases in the consumer price index) and will expire on March 31, 2000.
The Company owns approximately 17.2 acres of unimproved real property in Las Vegas, Nevada purchased for approximately $4.3 million. The Company purchased the Las Vegas, Nevada property with the intent of constructing a new automated, highly efficient warehouse and distribution facility on the back 8.4 acres and selling the front 8.8 acres. The back 8.4 acres can accommodate the planned 76,000 square foot warehouse and distribution facility, with room to expand the warehouse and distribution facility an additional 74,000 square feet. See Item 1. "Recent Developments." The Company is currently in escrow to sell - --- the 8.8 front acres. See Item 7. "Liquidity and Capital Resources -- --- Management's Action Plan -- Seek Additional Sources of Working Capital." Due to current financial constraints, the Company has deferred the commencement of construction on the warehouse and distribution facility. See Item 7. "Liquidity --- and Capital Resources -- Management's Action Plan -- Reduction of Fiscal 1998 Working Capital Requirements from Fiscal 1997 Levels."
The Company's leased Chatsworth warehouse is currently operating at maximum capacity. To accommodate inventory overflow, on April 1, 1997, the Company entered into a short-term lease (ending March 31, 1998) at approximately $6,000 per month for a 11,060 square foot warehouse located nearby. The Company believes, at least
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for the near-term, that it will be able to either negotiate a renewal of the nearby warehouse lease on the same or similar terms or lease another comparable warehouse under the same or similar terms. The Company believes that the Chatsworth warehouse and the additional warehouse (or a similar additional warehouse) will provide adequate capacity to meet its needs in the foreseeable future but will not efficiently accommodate growth in the Company's business. At such time as the Las Vegas, Nevada warehouse and distribution facility is completed and operational, the Company would attempt to sublease the Chatsworth warehouse. The Company believes it can sublease the Chatsworth warehouse at a rate that will not result in a material expense to the Company; however, there can be no assurances that the Company will sublease the space or not incur a material expense in connection with subleasing the space.
U.S. Laser leases approximately 8,000 square feet of combined office and retail space in Whippany, New Jersey. The lease provides for monthly rent of approximately $8,000 (subject to annual increases) and will expire on September 15, 2001.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS. -----------------
In the normal course of business, the Company and its subsidiary are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to employment and tax matters. While it is not possible to predict the outcome of these matters, it is the opinion of management, based on consultations with legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on the Company's financial position, results of operations or liquidity.
On June 18, 1997, the Company filed a complaint in the Superior Court of the State of California, County of Los Angeles (Case No. BC173084), against LEI Partners, L.P. ("LEI") and a number of related entities and individuals, which relates to a dispute concerning, among other things, LEI's payment obligations under two promissory notes. Item 8. "Note 6. Default of Notes Receivable" is incorporated herein by reference. The Company has alleged, inter alia, breach ----- ---- of contract, intentional misrepresentation, negligent misrepresentation, conspiracy to defraud, interference with economic relationship, conspiracy to interfere with economic relationship, and conversion. The complaint seeks compensatory damages of not less than $5 million plus accrued interest, attorney's fees and punitive damages in an amount to be proven at trial. The defendants have not yet responded to the complaint. The Company cannot make a prediction regarding the outcome of the litigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ---------------------------------------------------
None.
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THE COMPANY'S EXECUTIVE OFFICERS
Executive officers serve at the pleasure of the Company's board of directors (the "Board"). There is no family relationship between any executive officer or director. The following information sets forth the position and age of the Company's executive officers at June 1, 1997 and their business experience for at least the prior five years:
Executive Officer Age Position & Background - --------------------------------------------------------------------------------
Martin W. Greenwald 55 Chairman of the Board, Chief Executive Officer and President since April 1981, and Treasurer since January 1988. Since July 1990, Mr. Greenwald has been a Board Member of the Permanent Charities Committee of the Entertainment Industries, an umbrella organization which coordinates charitable contributions from the entertainment industries. Since 1995, Mr. Greenwald has been the Chairperson of the Optical Video Disc Association (OVDA) (formerly, the Laserdisc Association of America).
Cheryl L. Lee 38 Chief Administrative Officer since April 1993 and General Counsel since April 1992; Vice President of Business Affairs from February 1989 to March 1992; prior thereto, Counsel, Theatrical Distribution & Acquisition, Twentieth Century Fox Film Corporation. Ms. Lee received her A.B. degree from Stanford University in 1980 and her J.D. degree from New York University Law School in 1984. Ms. Lee is a member of the California Bar.
Jeff M. Framer 36 Chief Financial Officer since April 1993; Controller from September 1990 to March 1993; Senior Manager, KPMG Peat Marwick LLP, from July 1989 to September 1990; and, Manager, KPMG Peat Marwick LLP, from July 1988 to June 1989. Mr. Framer received his B.S. degree in Business Administration and Accounting Theory and Practice from California State University at Northridge in 1984. Mr. Framer is a certified public accountant.
David A. Borshell 32 Senior Vice President, Sales, Marketing and Operations from December 1994; Senior Vice President, Operations, from April 1993 to December 1994; Vice President, Operations, from January 1991 to March 1993; Director of Operations from July 1990 to December 1990; Director of Sales from November 1988 to June 1990; and, Account Executive from February 1986 to November 1988.
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PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. ---------------------------------------------------------------------
The Company's common stock trades on The Nasdaq Stock Market under the symbol "DISK." The Company's common stock has been included on the Nasdaq National Market since February 19, 1991. The table below presents the quarterly high and low closing prices on the NASDAQ/NMS during the past two fiscal years.
As of June 2, 1997 there were 1,768 holders of record of the Company's common stock. The closing price on that date was $4.1875.
The Company has never paid a cash dividend on its common stock and presently intends to retain any future earnings for business development. In addition, the Company is party to a loan agreement which imposes restrictions on its payment of dividends.
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ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA. -----------------------
The selected financial data presented below was derived from the consolidated financial statements of the Company and should be read in conjunction with such financial statements, the notes thereto and the other financial information included therein.
_________________
* Other expense - nonrecurring charge composed primarily of legal and accounting fees associated with the termination of acquisition negotiations.
** Extraordinary item - costs associated with early retirement of debt, net of related taxes of $56,000, $34,000, and $10,000 for fiscal 1997, 1995 and 1994, respectively.
*** Includes a nonrecurring pre-tax charge of $10,366,000 equal to $.88 per share (pre-tax), related to the Company's restructuring of its operations.
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ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS. ---------------------
Forward-looking statements, within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, are made throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations. Such statements are based on the beliefs of the Company's management as well as assumptions made by and information currently available to the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "may," "expect" and similar expressions, variations of such terms or the negative of such terms as they relate to the Company or its management are intended to identify such forward-looking statements. Such statements are based on management's current expectations and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, the Company's actual results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements. For a more detailed description of risks and uncertainties that may affect forward-looking statements see Item 1. "Risk Factors."
1995 ACQUISITION
Effective June 8, 1995, Image NewCo., Inc. ("NewCo"), a newly created wholly-owned subsidiary, acquired and assumed substantially all of the assets and liabilities, respectively, of V.T. Laser, Inc., a privately-held New Jersey based corporation doing business as "U.S. Laser Video Distributors," for a purchase price of $3.1 million in cash. NewCo's name was subsequently changed to U.S. Laser Video Distributors, Inc. ("U.S. Laser"). Effective April 1, 1997, the Company consolidated substantially all of U.S. Laser's distribution activities. U.S. Laser continues to maintain distribution control of certain smaller-volume customers, owns and operates a retail concept store "Digitainment" in Whippany, New Jersey which offers a large selection of optical disc software for sale and rental as well as "Home Theatre" hardware systems for sale, and is the publisher of LASERVIEWS, a consumer periodical focusing on product announcements, software reviews and articles of general interest to the optical disc entertainment software consumer. U.S. Laser has been in the optical disc distribution business since 1985.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the acquired assets and assumed liabilities were recorded at their fair market value on the acquisition date. The operating results of U.S. Laser are included in the accompanying consolidated statements of operations for the years ended March 31, 1997 and 1996 (from the acquisition date). The Company has classified the amount of purchase price in excess of the fair market value of the net assets acquired as goodwill. At March 31, 1997 and 1996, goodwill, net of accumulated amortization, was $173,000 and $183,000, respectively, and is included as a component of prepaid expenses and other assets in the accompanying consolidated balance sheets at March 31, 1997 and 1996.
RESULTS OF OPERATIONS
Operating income for fiscal 1997 decreased 72.4% to $2,251,000 from $8,160,000 for fiscal 1996. Operating income for fiscal 1996 increased 5.4% from $7,740,000 for fiscal 1995. Inclusive of the nonrecurring charges and charges relating to doubtful accounts receivable and slow-moving laserdisc inventory described below, net income for fiscal 1997 decreased 88.9% to $845,000, or $.06 per share, from $7,599,000, or $.49 per share, for fiscal 1996. Net income for fiscal 1996 increased 20.4% from $6,311,000, or $.44 per share, for fiscal 1995.
Earnings before interest, income taxes, depreciation and amortization ("EBITDA") for fiscal 1997 decreased 65.0% to $3,291,000 (excluding a write-off of acquisition expenses of $662,000) from $9,393,000 for fiscal 1996. EBITDA for fiscal 1996 increased 4.7% from $8,971,000 (excluding a net gain on a insurance settlement of $742,000) for fiscal 1995.
During fiscal 1997, the Company recorded nonrecurring charges totaling $585,000, net of taxes, or $.04 per share, relating to the write-off of acquisition expenses and costs associated with the early retirement of debt in the accompanying consolidated statement of operations. Also during fiscal 1997, the Company significantly increased its
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provision for doubtful accounts for the August 1996 Chapter 11 bankruptcy filing of Camelot Music, the February 1997 suspension by Musicland of $2.7 million in payments owing to the Company, and the overall distressed condition of the retail entertainment software market. See Item 7. "Summary and Outlook -- --- Distressed Condition of the Retail Entertainment Software Market." The provision for doubtful accounts, net of taxes, was $1,345,000, or $.10 per share, for fiscal 1997 versus $95,000 and $77,000, or $.01 and $.00 per share, for fiscal 1996 and 1995, respectively, and is included in general and administrative expenses in the accompanying consolidated statements of operations. Further, the Company increased its provision for slow-moving laserdisc inventory to $1,358,000, net of taxes, or $.10 per share, for fiscal 1997 versus $232,000 and $283,000, or $.01 and $.02 per share, for fiscal 1996 and 1995, respectively, in response to the continued uncertainty in the laserdisc market caused by the pending introduction of DVD as well as the distressed condition of the retail entertainment software market. These charges are included in cost of optical disc sales in the accompanying consolidated statements of operations.
FISCAL YEAR ENDED MARCH 31, 1997 COMPARED TO FISCAL YEAR ENDED MARCH 31, 1996
Net sales for fiscal 1997 decreased 9.9% to $85,650,000 from $95,086,000 for fiscal 1996. For fiscal 1997, the Company experienced weaker net sales of catalogue titles (previously released laserdisc titles) and, to a lesser extent, weaker net sales of new releases compared to fiscal 1996. Management believes this to be primarily a result of the distressed condition of the retail entertainment software market and uncertainty in the laserdisc market place caused by the introduction of the DVD format.
Specifically, management believes that the financial difficulties experienced by several of the Company's largest customers have negatively impacted the volume and breadth of their purchases of new release and catalogue laserdisc titles from the Company. See Item 7. "Summary and Outlook -- --- Distressed Condition of the Retail Entertainment Software Market."
Management also believes that laserdisc retailer and consumer speculation, anticipation and uncertainty preceding the launch of the DVD format has adversely impacted laserdisc hardware sales which management believes directly impacts the Company's sales of catalogue titles. See Item 1. "Laserdisc --- Basics," "The New Digital Video Disc (DVD) Format -- The Introduction of DVD," "-- The Impact of DVD on the Company's Laserdisc Business" and "-- DVD as a Source of Competition for Laserdisc." See also Item 7. "Summary and Outlook -- --- ---- DVD Outlook." The Company's net sales of DVD titles, all on a nonexclusive basis, from DVD's March 24, 1997 introduction date through the fiscal year ended March 31, 1997 totaled $742,000. See Item 1. "The New Digital Video Disc (DVD) --- Format -- The Company's Market Strategy" and "-- The Company's DVD Agreements and Arrangements."
In the future, the Company expects that net sales will continue to be affected by the popularity of new laserdisc and DVD releases, the level of laserdisc and DVD hardware sales, the extent of the Company's distribution of the DVD format, DVD's market penetration, the financial condition of the retail entertainment software market and the prevailing economic environment.
Cost of optical disc sales (laserdiscs and DVDs collectively) for fiscal 1997 decreased to $68,427,000 from $74,387,000 for fiscal 1996. As a percentage of net sales, cost of optical disc sales for fiscal 1997 increased to 79.9% from 78.2% for fiscal 1996. The fiscal 1997 increase in cost of optical disc sales as a percentage of net sales is primarily attributable to an increased provision for slow-moving laserdisc inventory and a shift in sales mix toward lower-margin nonexclusive wholesale distribution product. The Company increased its provision for slow-moving laserdisc inventory to $1,964,000 in fiscal 1997 versus $254,000 in fiscal 1996. The increase in cost of optical disc sales, as a percentage of net sales, for fiscal 1997 was offset, in part, by manufacturing cost savings, realized on laserdiscs manufactured in Japan, resulting from the comparative strength of the U.S. Dollar against the Japanese Yen. In the future, the strength of the U.S. Dollar versus the Japanese Yen will continue to affect the Company's cost of optical disc sales as a percentage of net sales.
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 23
The sales mix of higher-margin exclusive product and lower-margin nonexclusive product and the margins within each category vary with the availability and popularity of titles and the Company's marketing emphasis. Lower-margin nonexclusive product sales, including lower-margin U.S. Laser sales (U.S. Laser has substantially lower margins because it is solely a nonexclusive distributor), accounted for 22.3% of net sales in fiscal 1997 compared to 18.8% of net sales in fiscal 1996. Beginning with the June 1996 quarter, one of the Company's largest exclusive product customers began buying substantially all of their nonexclusive laserdisc product from the Company, contributing to the percentage increase in nonexclusive product sales.
Selling expenses increased 4.9% to $4,752,000 for fiscal 1997 from $4,531,000 for fiscal 1996. As a percentage of net sales, selling expenses for fiscal 1997 increased to 5.5% from 4.8% for fiscal 1996. This increase resulted primarily from increased trade and media advertising of exclusive titles. The increase in selling expenses for fiscal 1997 was offset, in part, by reduced selling expenses for U.S. Laser for the twelve months of fiscal 1997 versus the ten months in fiscal 1996. The Company expects to increase promotional expenses in fiscal 1998 versus 1997 relating to the promotion of the laserdisc and DVD formats.
General and administrative expenses for fiscal 1997 increased 38.7% to $7,108,000 from $5,124,000 for fiscal 1996. As a percentage of net sales, general and administrative expenses increased to 8.3% for fiscal 1997 from 5.4% for fiscal 1996. This increase resulted primarily from a significant increase in the provision for doubtful accounts. The provision for doubtful accounts was $1,946,000 for fiscal 1997 versus $104,000 for fiscal 1996. Additionally, contributing to increased general and administrative expenses for fiscal 1997 were a full twelve months of U.S. Laser's general and administrative expenses in fiscal 1997 versus ten months in fiscal 1996, expenses related to U.S. Laser's new retail concept store "Digitainment," which opened in October 1996 and higher insurance costs for increased coverage, all of which were offset, in part, by significantly reduced performance-based executive bonuses. See Item 7. "Summary --- and Outlook -- Distressed Condition of the Retail Entertainment Software Market."
Amortization of production costs for fiscal 1997 increased 7.9% to $3,112,000 from $2,884,000 for fiscal 1996. As a percentage of net sales, amortization of production costs for fiscal 1997 increased to 3.6% from 3.0% for fiscal 1996. The increase results from more exclusive titles being placed into production and the higher overhead in the Company's creative services and production departments necessary to produce the higher volume of exclusive titles. The Company expects amortization of production costs to continue to be a function of the timing and number of exclusive titles placed into production.
Interest expense for fiscal 1997 increased 167.7% to $415,000 from $155,000 for fiscal 1996 due to higher average borrowings outstanding during fiscal 1997. Interest income for fiscal 1997 decreased 31.4% to $231,000 from $337,000 for fiscal 1996 due to lower average cash balances during fiscal 1997. The Company used available cash and borrowings under its revolving credit facility to purchase 17.2 acres of unimproved property in Las Vegas, Nevada, pay advance royalties and certain inventory purchase and license fee obligations under new exclusive laserdisc output license and distribution agreements, and repurchase common stock under the Company's stock repurchase program.
Other expense consists of a nonrecurring charge of $662,000 composed primarily of legal and accounting fees relating to a proposed acquisition of Essex Entertainment, Inc., a privately-held independent music company headquartered in New Jersey. Negotiations to acquire Essex Entertainment, Inc. terminated in December 1996. See Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. -------------------------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTSPAGE
- -------------------------------------------------------------------------------- 34 Image Entertainment, Inc.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders Image Entertainment, Inc.:
We have audited the accompanying consolidated financial statements of Image Entertainment, Inc. and subsidiary as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule, as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Image Entertainment, Inc. and subsidiary as of March 31, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California June 6, 1997
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 35
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1997 AND 1996
================================================================================
ASSETS
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- 36 Image Entertainment, Inc.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1997 AND 1996
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 37
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
================================================================================
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- 38 Image Entertainment, Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (NOTES 12 AND 13)
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
================================================================================
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 39
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995 ================================================================================
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- 40 Image Entertainment, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995 ================================================================================
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 41
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995 ================================================================================
SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:
In January 1997, the Company purchased an additional approximately .7 acres of unimproved real property in Las Vegas, Nevada adjacent to the November 1996 real property acquisition for $331,000. The Company issued a note payable for $285,000.
In June 1995, the Company acquired certain assets and assumed certain liabilities of V.T. Laser, Inc. for $3,066,000. See "Note 2. 1995 Acquisition": ---
Fully amortized production costs removed from production costs totaled $3,221,000 and $2,767,000 at March 31, 1997 and 1996, respectively.
See accompanying notes to consolidated financial statements. - -------------------------------------------------------------------------------- 42 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND BUSINESS.
Image Entertainment, Inc. (the "Company") was incorporated in Colorado on April 1, 1975. In November 1989, the Company reincorporated in California. The Company's primary business is the distribution of programming on optical disc under exclusive and nonexclusive license and wholesale distribution agreements.
NOTE 2. 1995 ACQUISITION.
Effective June 8, 1995, Image NewCo., Inc. ("NewCo"), a newly created wholly- owned subsidiary, acquired and assumed substantially all of the assets and liabilities, respectively, of V.T. Laser, Inc., a privately-held New Jersey based corporation doing business as "U.S. Laser Video Distributors," for a purchase price of $3.1 million in cash. NewCo's name was subsequently changed to U.S. Laser Video Distributors, Inc. ("U.S. Laser"). Effective April 1, 1997, the Company consolidated substantially all of U.S. Laser's distribution activities. U.S. Laser continues to maintain distribution control of certain smaller-volume customers, owns and operates a retail concept store "Digitainment" in Whippany, New Jersey which offers a large selection of optical disc software for sale and rental as well as "Home Theatre" hardware systems for sale, and is the publisher of LASERVIEWS, a consumer periodical focusing on product announcements, software reviews and articles of general interest to the optical disc entertainment software consumer.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the acquired assets and assumed liabilities were recorded at their fair market value on the acquisition date. The operating results of U.S. Laser are included in the accompanying consolidated statements of operations for the years ended March 31, 1997 and 1996 (from the acquisition date). The Company has classified the amount of purchase price in excess of the fair market value of the net assets acquired as goodwill. At March 31, 1997 and 1996, goodwill, net of accumulated amortization, was $173,000 and $183,000, respectively, and is included as a component of prepaid expenses and other assets in the accompanying consolidated balance sheets at March 31, 1997 and 1996. Goodwill is being amortized on a straight-line method over 20 years. Amortization charged to operations for the years ended March 31, 1997 and 1996 were immaterial. The acquisition of U.S. Laser does not qualify as a significant subsidiary as defined under generally accepted accounting principles and, accordingly, pro- forma information is not presented.
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
Consolidation - -------------
The consolidated financial statements include those of the Company and its wholly-owned subsidiary, U.S. Laser (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents - -------------------------
The Company considers all highly liquid investments purchased with maturities of three months or less to be cash equivalents.
Accounts Receivable - -------------------
At March 31, 1997 and 1996, the allowance for doubtful accounts was $1,629,000 and $333,000, respectively, and the allowance for sales returns was $3,180,000 and $2,850,000, respectively.
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
Amortization of Production Costs - --------------------------------
The Company amortizes capitalized production costs in accordance with the provisions of Statement of Financial Accounting Standards No. 53 ("SFAS No. 53"). Pursuant to the income forecast method, a percentage of the production costs is charged to expense each month based upon (i) a projected revenue stream resulting from distribution of new and previously released optical disc programming related to the production costs and (ii) management's estimate of the ultimate net realizable value of the production costs. Estimates of future revenues are reviewed periodically and amortization of production costs is adjusted accordingly. If estimated future revenues are not sufficient to recover the unamortized balance of production costs, such costs are reduced to the estimated net realizable value.
Revenue Recognition - -------------------
Revenue is recognized upon shipment. The Company's return policy allows customers to return a percentage of optical discs purchased on a quarterly basis. Generally, this allowance is noncumulative, is generally based on the customer's prior quarter purchases and is limited on an individual-title basis. On occasion, greater return allowances are given to major customers. The Company provides for estimated returns when product is shipped to customers.
Major Customers - ---------------
Customers which individually accounted for more than 10% of fiscal year net sales approximated 31.8% of 1997 net sales (Musicland 11.2%, Alliance Entertainment 10.4% and Ken Crane's Home Entertainment 10.2%) and 10.9% of 1996 net sales (Musicland 10.9%). No customers individually accounted for 10% or more of fiscal 1995 net sales.
Royalty and Distribution Fee Advances - -------------------------------------
Royalty and distribution fee advances represent fixed minimum payments made to licensors for optical disc programming distribution rights. A licensor's share of program distribution revenues is retained by the Company until the share equals the advance(s) paid to the licensor. Thereafter, any excess is paid to the licensor. In the event of an excess, the Company records, as a cost of optical disc sales, an amount equal to the licensor's share of the distribution revenues. Royalty and distribution fee advances are charged to operations as revenues are earned and are stated at the lower of unamortized cost or estimated net realizable value on an individual-title or license-agreement basis.
Depreciation and Amortization of Property, Equipment and Improvements - ---------------------------------------------------------------------
Depreciation of property and equipment is provided for using the straight-line method over the estimated useful lives of the related assets, generally five years (excluding the building which is not yet constructed). See "Note 7. --- Purchase of Nevada Real Property." Leasehold improvements are amortized over the shorter of the estimated useful life of the improvements, generally five years, or the remaining lease term. The cost of repairs and maintenance is charged to operations when incurred.
Goodwill - --------
The excess of purchase price over the value of the net assets acquired is included in prepaid expenses and other assets and is amortized on a straight- line basis over a 20-year period. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining useful life can be recovered through undiscounted future operating cash flows from the acquired operation. - -------------------------------------------------------------------------------- 44 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
Income Taxes - ------------
The Company accounts for income taxes pursuant to the provisions of Financial Accounting Standards Board Statement No. 109 ("SFAS No. 109"). Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and the future tax benefits derived from operating loss and tax credit carryforwards.
Stock Option Plan - -----------------
Prior to April 1, 1996, the Company accounted for its stock option plan in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On April 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," which permits entities to recognize, as expense over the vesting period, the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro-forma net income disclosures for employee stock option grants made in 1996 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro-forma disclosure provisions of SFAS No. 123. Accordingly, the adoption of SFAS No. 123 did not have a material effect on the Company's consolidated financial statements. See "Note --- 13. Stock Options and Warrants."
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of - -----------------------------------------------------------------------
The Company adopted the provision of Statement of Financial Accounting Standards No. 121 ("SFAS No. 121"), "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of," on April 1, 1996. The statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. Adoption of SFAS No. 121 did not have a material impact on the Company's consolidated financial statements.
Fair Value of Financial Instruments - -----------------------------------
The carrying amounts of cash and cash equivalents and revolving credit facility approximates fair value due to the short-term maturity of these instruments.
Use of Estimates - ----------------
The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. The more significant areas requiring the use of management estimates related to allowances for slow-moving inventory, doubtful accounts receivables and sales returns. Actual results could differ from those estimates. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
Reclassifications - -----------------
Certain fiscal 1996 and 1995 balances have been reclassified to conform with the fiscal 1997 presentation.
NOTE 4. NET INCOME PER SHARE.
Net income per share is based on the weighted average number of common shares and common share equivalents (e.g., options and warrants), if dilutive, outstanding for each of the years presented. The amount of dilution to be reflected in net income per share is computed by application of the treasury stock method. In periods where the amount of common stock issuable if all options and warrants are deemed exercised exceeds 20% of the total shares outstanding at the end of the period, the treasury stock method is modified, as required by Accounting Principles Board Opinion No. 15, to adequately reflect the dilutive effect of options and warrants on net income per share.
Under the modified treasury stock method, net income per share data were computed as if all outstanding options and warrants were exercised at the beginning of the period (or on the issuance date, if issued during the period) and as if the funds obtained thereby were applied as follows: first to repurchase up to 20% of the outstanding shares at the average market price during the period, then to reduce any outstanding long-term debt and, if any proceeds remain thereafter, such proceeds are applied to invest in U.S. government securities. If the result of the foregoing application of proceeds has an aggregate dilutive effect on net income per share, the net income per share calculation must reflect the shares issuable upon the assumed exercise of options and warrants, net of the assumed repurchase of shares, and adjustments to net income resulting from the assumed application of proceeds. If, on the other hand, the aggregate effect is anti-dilutive, common share equivalents and adjustments to net income resulting from the assumed application of proceeds are excluded from the calculation of net income per share.
The treasury stock method was applied in determining net income per share for the year ended March 31, 1997, whereas the modified treasury stock method was applied in determining the net income per share for the years ended March 31, 1996 and 1995.
Fully diluted net income per share was not presented since the amounts did not differ significantly from the primary net income per share. - -------------------------------------------------------------------------------- 46 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
The following table sets forth the calculation of net income per share for the years ended March 31, 1997, 1996 and 1995:
NOTE 5. INVENTORIES.
Inventories at March 31, 1997 and 1996 are summarized as follows:
Optical disc inventory consists of finished optical discs (laserdiscs and DVDs) for sale and is stated at the lower of average cost or market and is net of reserves for slow-moving laserdisc inventory of $3,070,000 and $1,219,000 at March 31, 1997 and 1996, respectively. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
The costs to produce licensed optical disc programming include the cost of converting film prints or tapes into the optical disc format, packaging artwork costs and the overhead of the Company's creative services/computer graphics and production departments. As discussed in Note 3 to the consolidated financial statements, the Company amortizes its production costs in accordance with SFAS No. 53. Production costs are net of accumulated amortization of $5,011,000 and $4,942,000 at March 31, 1997 and 1996, respectively. The Company expects to amortize substantially all of the March 31, 1997 production costs by March 31, 2000.
NOTE 6. DEFAULT OF NOTES RECEIVABLE.
On December 31, 1990, the Company entered into a Purchase and Sale Agreement with LEI Partners, L.P., a California Limited Partnership ("LEI"), pursuant to which the Company sold all of the assets of its adult laserdisc licensing and distribution business for $3,829,000 (the "LEI Agreement"). The purchase price consisted of $300,000 cash, a $1,329,000 note ("Note A") and a $2.2 million note ("Note B").
On December 31, 1995, LEI defaulted on a $582,000 principal payment due under Note A and breached the LEI Agreement. As a result of the default, the unpaid balances of Notes A and B became immediately due and payable.
On February 1, 1996, the Company and LEI entered into a Settlement and Forbearance Agreement ("Settlement Agreement") to resolve the dispute between the Company and LEI related to LEI's default and breach. Under the Settlement Agreement, LEI was able to satisfy obligations otherwise owing under Note A by making the payments specified in the Settlement Agreement. Contingent upon and subsequent to LEI's full performance of all of its obligations under the Settlement Agreement, the remaining principal balance due under Note B would be discharged in full.
In the event of default (as defined in the Settlement Agreement), including but not limited to LEI's failure to make all or any one of the scheduled payments when due, all of the terms and conditions of the Settlement Agreement would be automatically revoked, the terms and conditions of the LEI Agreement and Notes A and B would be automatically and immediately reinstated, and the unpaid balances of Notes A and B would be immediately due and payable.
Since November 1996, LEI defaulted on scheduled monthly principal payments due under the Settlement Agreement causing automatic reinstatement of the LEI Agreement and Notes A and B.
At March 31, 1997, principal and interest due under Note A was $852,000 and $36,000, respectively, and under Note B was $1,791,000 and $1,759,000, respectively. At March 31, 1997, the Company's receivable from LEI was fully reserved.
In June 1997, the Company commenced a legal action against LEI and certain other parties in the Superior Court of the State of California in the county of Los Angeles alleging, among other things, breach of the LEI Agreement, breach of Notes A and B, default under the security agreement, intentional misrepresentation, conversion and fraud. The complaint seeks compensatory damages of not less than $5 million plus accrued interest, attorney's fees and punitive damages in an amount to be proven at trial.
NOTE 7. PURCHASE OF NEVADA REAL PROPERTY.
In November 1996, the Company purchased approximately 16.5 acres of unimproved real property adjacent to McCarran International Airport in Las Vegas, Nevada for $4 million cash. In January 1997, the Company purchased an additional approximately .7 acres of unimproved real property adjacent to the November 1996 real property purchase for $331,000. The purchase price for the .7 acres consisted of cash and a $285,000 note payable. The note payable bears interest at 9% per annum, requires quarterly principal and interest payments, is secured by a trust deed on the - -------------------------------------------------------------------------------- 48 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
underlying property and matures on January 30, 1998. The property was subdivided with the intent of selling the front 8.8 acres and building an approximately 76,000 square foot automated distribution facility on the back 8.4 acres. The carrying value of the 8.4 acres, on which the Company intends to build a warehouse and distribution facility, is reflected as a component of property, equipment and improvements in the accompanying consolidated balance sheet at March 31, 1997. The carrying value of the front 8.8 acres, which management intends for sale, is reflected as land held for sale within property, equipment and improvements in the accompanying consolidated balance sheet at March 31, 1997. See "Note 8. Property, Equipment and Improvements." Upon closing the sale --- of the 8.8 acres, proceeds will be used to reduce the carrying value of the land. No gain or loss will be recognized.
A total of $858,000 of costs incurred to date relating to the design, engineering and planning of the construction of the Nevada warehouse and distribution facility is reflected as a component of property, equipment and improvements in the accompanying consolidated balance sheet at March 31, 1997.
The Company has deferred the commencement of construction of a warehouse and distribution facility in Las Vegas, Nevada. See "Note 16. Liquidity." ---
NOTE 8. PROPERTY, EQUIPMENT AND IMPROVEMENTS.
Property, equipment and improvements, stated at cost, at March 31, 1997 and 1996 are summarized as follows:
Depreciation and amortization of property, equipment and improvements was $846,000, $792,000 and $796,000 for fiscal 1997, 1996, and 1995, respectively.
NOTE 9. REVOLVING CREDIT FACILITY.
In December 1996, the Company entered into a Loan Agreement (the "Agreement") with Union Bank of California, N.A. ("Union Bank"). The Agreement provides for revolving advances and the issuance of standby letters of credit under a two- year, $20 million revolving credit facility. Borrowings under the Agreement are at the bank's prime rate plus .25% (8.75% at March 31, 1997). The Agreement provides the Company the option of borrowing for fixed periods at the London Interbank Offered Rate ("LIBOR") plus 2.5% (7.94% at March 31, 1997).
Borrowings under the Agreement are secured by substantially all of the Company's assets located in California and New Jersey. Funds available for borrowing may not exceed the borrowing base specified in the Agreement. At March - -------------------------------------------------------------------------------- Image Entertainment, Inc. 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
31, 1997, $8,709,000 was outstanding under the Agreement, of which $7 million was borrowed under a one-month LIBOR option, and $1.3 million, net of amounts utilized for outstanding letters of credit, was available for borrowing. The Agreement requires the Company to comply with certain financial and operational covenants. At March 31, 1997, the Company was in compliance with financial and operating covenants or received waivers of noncompliance from Union Bank. The Agreement requires that compliance with defined covenants be measured at each quarter-end. At June 30, and September 30, 1997, management believes that the Company may violate a covenant requirement that net income be maintained at $500,000 measured on a two-quarter consecutive average ("Net Income Covenant") as well as a covenant which requires the Company to maintain minimum tangible net worth of $18 million ("Tangible Net Worth Covenant"). Management believes that Union Bank will grant waivers of noncompliance for such technical defaults, similar to the waivers which the Company received at March 31, 1997. Management believes that, based on the Company's expectation of seasonally stronger third and fourth fiscal quarters, the Company will be in compliance with the Net Income Covenant and Tangible Net Worth Covenant for the last two quarters of fiscal 1998. Should the Company fall into technical noncompliance with the Net Income Covenant or Tangible Net Worth Covenant during the third and fourth quarters, management believes that Union Bank will grant waivers of noncompliance at that time.
Concurrent with the signing of the Agreement, the Company terminated its three- year $15 million Loan and Security Agreement with Foothill Capital Corporation which bore interest at prime plus 1.5% and was due to expire on November 15, 1997. The accelerated amortization of deferred financing costs and penalty resulting from the early retirement of debt totaled $183,000 of which $40,000 represented a noncash charge. The extraordinary charge is recorded net of taxes of $56,000 for the year ended March 31, 1997.
NOTE 10. CONSTRUCTION CREDIT FACILITY.
In March 1997, the Company entered into a Business Loan Agreement (the "Loan Agreement") with Bank of America National Trust and Savings Association in Nevada. The Loan Agreement provides for a construction line of credit (the "Construction Line") through January 31, 1998. The maximum available under the line ( the "Maximum Commitment") is $3,434,000 which shall be reduced quarterly beginning December 31, 1997 by $43,000. The Construction Line converts to a revolving line of credit (the "Revolving Line") on January 31, 1998. Under the Revolving Line, the Company may repay and reborrow principal amounts provided the Revolving Line does not exceed the Maximum Commitment. The Revolving Line is available from February 1, 1998 through its maturity date of January 31, 2008.
Borrowings under the Loan Agreement are secured by a deed of trust on the approximate 8.4 acres of land in Las Vegas, Nevada on which the Company intends to construct a new warehouse and distribution facility as well as any of the Company's assets located in Nevada, excluding inventory held for sale. Interest under the Construction Line and the Revolving Line is at the bank's prime rate plus 1.25% (9.75% at March 31, 1997). The Loan Agreement provides the Company the option, under the Revolving Line, of borrowing for fixed periods of time at LIBOR plus either 2.25% or 2.65% depending on level of the Company's debt service coverage ratio, as defined. At March 31, 1997, there were no borrowings outstanding under the Loan Agreement.
The Loan Agreement requires the Company to comply with certain quarterly financial and operational covenants which were met as of March 31, 1997. There are financial covenants within the Loan Agreement which, if violated, may restrict the Company's ability to borrow on this facility in the future.
NOTE 11. WAREHOUSE AND DISTRIBUTION EQUIPMENT LEASE FACILITY.
In March 1997, the Company entered into a Lease Intended As Security Agreement (the "Lease") with BankAmerica Leasing & Capital Corporation. The Lease provides the Company the ability to lease a substantial portion of the warehouse and distribution system equipment to be constructed and utilized in the Company's proposed warehouse - -------------------------------------------------------------------------------- 50 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
and distribution facility in Las Vegas, Nevada. The maximum amount available under the Lease is $2.5 million. The aggregate amount of installation, transportation, any applicable taxes, any software costs or licensing fees with respect to the aggregate borrowings under the lease may not exceed 20%. The Lease provides for advances for the purchase of equipment prior to its delivery date (the "Advance Rent Period") which cannot extend past January 31, 1998. Subsequent to the delivery and installation of the equipment and on the date the equipment is accepted by the Company (the "Base Date"), the base rent period ("Base Rent Period") begins.
During the Advance Rent Period, the advances bear interest at the three-month LIBOR plus 2.5% per annum. During the Base Rent Period, the outstanding borrowings on each equipment schedule will be amortized over 24 consecutive quarterly installments, to a $1 purchase option, with the first such installment due one quarter after the Base Date. The variable implicit interest for each leased unit is the three-month LIBOR plus 2.719%. Under the Lease, during the Base Rent Period, the Company may convert to a fixed implicit interest rate. The fixed implicit interest rate will be the bond-equivalent yield per annum for U.S. Treasury obligations with a maturity most closely matching to the nearest month of the remaining average life of each equipment schedule plus a spread of 3.137%.
Borrowings under the Lease are secured by the underlying equipment leased. The Lease contains certain quarterly financial and operating covenants which were met as of March 31, 1997. There are financial covenants within the Lease which, if violated, may restrict the Company's ability to borrow on this facility in the future. The Lease also contains early termination charges and a $1.5 million minimum utilization requirement. At March 31, 1997, there were no borrowings under the Lease.
NOTE 12. OTHER ITEMS -- STATEMENTS OF OPERATIONS.
Fourth Quarter Adjustments - --------------------------
During the fourth quarter of fiscal 1997, the Company recorded provisions for slow-moving laserdisc inventory and doubtful accounts receivable of $1,214,000 and $792,000, respectively.
During the fourth quarter of fiscal 1995, the Company recorded a net gain on insurance settlement of claims of business interruption related to the January 17, 1994 Northridge earthquake of $742,000.
Acquisition Expenses - --------------------
In December 1996, negotiations to acquire Essex Entertainment, Inc., a privately-held independent music company headquartered in New Jersey were terminated. As a result, the Company recorded a nonrecurring charge of $662,000 consisting primarily of legal and accounting fees. This nonrecurring charge is reflected as other expense in the accompanying consolidated statements of operations for the year ended March 31, 1997.
Amortization of Warrants Associated with Program Acquisition Agreements - -----------------------------------------------------------------------
The value of warrants issued in connection with program acquisition agreements entered into during fiscal years 1992 and 1993 and their respective issuance costs are amortized ratably over the term of the related agreements. Amortization totaled $160,000 for the year ended March 31, 1997, and $349,000 for each of the years ended March 31, 1996 and 1995, and were recorded as cost of optical disc sales in the accompanying consolidated statements of operations. The unamortized balance of stock warrants at March 31, 1997 totaled $73,000. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 13. STOCK OPTIONS AND WARRANTS.
The Company has three employee stock option plans. Incentive stock options may be granted under one plan, and incentive stock options and nonstatutory options under the other two. Under the plans, the exercise price of an incentive stock option may not be less than the fair market value of the common stock on the date of grant. The exercise price of a nonstatutory option generally may not be less than 85% of the fair market value on the date of grant. The term of an option may be no more than 10 years from the date of grant. The Company also has a directors' stock option plan providing for an initial and annual award of an option to purchase 15,000 shares of common stock to each director eligible to participate under the plan. Only nonstatutory options may be granted under the directors' plan. The directors' plan also provides for an exercise price of $0.25 over the fair market value of the common stock on the date of grant, fixed vesting, and a ten-year term. In addition to options under the three employee plans and the directors plan, the Company has granted options (including the antidilution rights described below and warrants in connection with program acquisition agreements described in Note 12 to the consolidated financial statements) to officers, shareholders, creditors and others for various business purposes.
Stock option transactions for the three years ended March 31, 1997 are as follows:
Of the options reflected as outstanding on March 31, 1997 and 1996, options to purchase 2,243,159 and 5,833,689 shares of common stock were exercisable, respectively.
A December 29, 1987 stock purchase agreement (the "Agreement") provides for the grant of antidilution rights (the "Rights") to various persons (the "Investors"). Each Investor is entitled to Rights in connection with certain issuances of common stock.
Upon the exercise of certain options outstanding as of December 29, 1987 (the "Management Options"), each Investor will be granted Rights to purchase shares of common stock pursuant to a formula based in part on the percentage of the outstanding shares of common stock owned by the Investor on December 29, 1987. Rights to purchase an aggregate of 522,135 shares of common stock may be granted to the Investors if all the Management Options are exercised. As of March 31, 1997, Rights to purchase 452,391 shares had been granted, Rights to purchase 329,322 shares had been - -------------------------------------------------------------------------------- 52 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
exercised (as to 22,039 shares in fiscal 1997, 84,168 shares in fiscal 1996, and 12,299 shares in fiscal 1995, at per-share exercise prices ranging from $.74 to $1.07) and Rights to purchase 123,069 shares were outstanding. The above table includes as outstanding on March 31, 1997 additional Rights to purchase 69,744 shares, which Rights would be granted only upon subsequent exercises of Management Options.
Rights granted in connection with the exercise of a Management Option are exercisable for two years from the date of grant and have a per-share exercise price equal to the greater of (a) $.74 or (b) the exercise price of the Management Option.
Upon certain issuances of shares of common stock other than pursuant to the exercise of Management Options, each Investor will be granted a Right (the "Other Right") so that the equity interest represented by the Agreement shares held by the Investor (excluding the shares purchased upon the exercise of Rights issued in connection with the exercise of Management Options) will not be diluted. As of March 31, 1997, Other Rights to purchase 851,616 shares of common stock had been exercised (as to 433 shares in fiscal 1997, 2,720 shares in fiscal 1996, and 87,771 shares in fiscal 1995, at per-share exercise prices ranging from $.59 to $9.29).
The Company applies APB Opinion No. 25 in accounting for its stock option plans, and accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's consolidated net income and net income per share would have been decreased to the pro-forma amounts indicated below:
The weighted-average fair value of options granted during fiscal 1997 and 1996 was $7.19 and $6.59, respectively, using the Black-Scholes option-pricing model with the following weighted-average assumptions: Fiscal 1997 and 1996 - expected volatility of 60%, risk-free interest rates of 5.7% - 6.7%, no expected dividends and an expected life of six years.
Pro-forma consolidated net income and net income per share reflects only options granted in fiscal 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro-forma consolidated net income and net income per share amounts presented above because compensation cost is reflected over the option vesting periods of up to four years and compensation cost for options granted prior to April 1, 1995 are not considered. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 14. INCOME TAXES.
Income taxes for the three years ended March 31, 1997, all current, are summarized as follows:
The tax effects of temporary differences that give rise to a significant portion of the deferred tax assets at March 31, 1997 and 1996 are presented below:
At March 31, 1997, the Company has fully utilized its net operating loss carryforwards for Federal income tax purposes as well as its Alternative Minimum Tax credit carryforwards.
Expected income tax expense based on Federal statutory rates for the three years ended March 31, 1997 differed from actual tax expense as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 15. COMMITMENTS AND CONTINGENCIES.
The lease for the Company's corporate office space provides for monthly rent of $14,000 (subject to annual adjustment based upon increases in the consumer price index). The lease for the Company's warehouse space provides for monthly rent of $23,000 (subject to annual adjustment based upon increases in the consumer price index). Both leases expire on March 31, 2000. The lease for the Company's New Jersey combined office and retail space provides for monthly rent of $8,000 increasing annually to a monthly rent of $10,000 in the final fifth year of the lease term and expires on September 15, 2001. The Company also has leased additional warehouse space in Chatsworth, California through March 31, 1998 with monthly rent of $6,000.
Future minimum annual rental payments at March 31, 1997 are approximately as follows:
Rent expense was $538,000, $476,000 and $459,000 for fiscal 1997, 1996, and 1995, respectively.
At March 31, 1997, the Company had $2.5 million of outstanding letters of credit which expire on November 15, 1997. These letters of credit secure balances due to program suppliers.
At March 31, 1997, the Company's future obligations for royalty advances and minimum guarantees and exclusive distribution fee guarantees under the terms of existing licenses and an exclusive distribution agreement, respectively, are as follows:
At such time as the Las Vegas, Nevada warehouse and distribution facility is completed and operational, the Company intends to sublease its existing 48,000 square foot warehouse and distribution facility in Chatsworth, California (See --- "Note 7. Purchase of Nevada Real Property"). Management believes it can sublease the Chatsworth warehouse at a rate that will not result in a material expense to the Company.
In the normal course of business, the Company and its subsidiary are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to employment and tax matters. While it is not possible to predict the outcome of these matters, it is the opinion of management, based on consultations with legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on the Company's financial position, results of operations or liquidity. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 16. LIQUIDITY.
Working capital has historically been provided by cash flows from operations, private sales of common stock, notes representing long-term debt and bank borrowings. For fiscal 1997, operating activities used cash and cash equivalents of $2,571,000, investing activities used cash and cash equivalents of $6,234,000 and financing activities provided cash and cash equivalents of $5,229,000. During fiscal 1997, borrowings on the Company's existing credit facilities were necessary to supplement operating cash flows in order to meet working capital requirements which included certain discretionary activities such as entering into new exclusive license agreements and the acquisition of land for a new warehouse and distribution facility in Las Vegas, Nevada. See --- "Note 9. Revolving Credit Facility." Certain significant recent developments have caused management to grow concerned that the Company's current sources of working capital may be insufficient to fund working capital requirements in fiscal 1998, unless certain discretionary licensing and capital investment programs are curtailed and additional sources of working capital are secured. These significant recent developments are as follows:
. Suspension of $2.7 Million in Musicland Accounts Receivable. In ----------------------------------------------------------- February 1997, the Company's largest customer, Musicland, suspended payment indefinitely on $2.7 million of outstanding accounts receivable. In May 1997, the suspended receivable aged past Union Bank's borrowing eligibility requirement and accordingly, the Company's available borrowings under its revolving line of credit with Union Bank were reduced by approximately $2.2 million.
. The April 1997 Cancellation of a Prior Escrow to Sell a Portion of ------------------------------------------------------------------ Nevada Land (Note 7). In June 1997, the Company entered into another -------------------- escrow to sell the front 8.8 acres of its land in Las Vegas, Nevada. There can be no assurance that escrow will close.
. The March 1997 Introduction of DVD and its Impact on the Company's ------------------------------------------------------------------ Results of Operations. The introduction of DVD in March 1997 has, --------------------- in the opinion of management, negatively affected the Company's sales and cash flows due to generally declining sales levels of laserdisc software and hardware.
In response to the aforementioned significant recent developments and the related concerns these events raise regarding the Company's liquidity during fiscal 1998, management has developed a fiscal 1998 action plan ("Action Plan"). The Action Plan principally involves:
. Reducing or suspending certain discretionary expenditures such as suspending the Company's stock buy-back program, reducing or eliminating, when possible, up-front payments for advance royalties, distribution fees and contractual inventory purchases on potential new exclusive license and distribution agreements, increasing levels of trade vendor support and deferring the commencement of construction of a proposed warehouse and distribution facility in Las Vegas, Nevada; and
. Seeking additional working capital through sources such as obtaining debt and/or equity financing, monetizing a portion of the delinquent Musicland and Camelot receivables, selling the front 8.8 acres of its Nevada land and generating revenues from exclusive DVD distribution.
Management believes that the Company, through successful implementation of sufficient elements of its Action Plan, will be able to meet its cash requirements for fiscal 1998. - -------------------------------------------------------------------------------- 56 Image Entertainment, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
NOTE 17. RELATED PARTY TRANSACTIONS.
Two individuals, who may be deemed to beneficially own more than 5% of the Company's common stock as the sole shareholders of Image Investors Co., may be deemed to indirectly control Orion Pictures Corporation ("OPC"). OPC's wholly- owned subsidiary Orion Home Video Corporation ("OHVC") licenses programs to the Company in the ordinary course of its business. The Company believes that the terms of its license agreements with OHVC are comparable to the terms of similar agreements between the Company and unaffiliated parties. During the period commencing on April 1, 1996 and ending on March 31, 1997, the Company paid OHVC royalties of approximately $850,000.
In June 1996, the Company's Board of Directors approved the Company's purchase of 138,000 shares of the Company's common stock from the Company's President and Chief Executive Officer at $5.8125 per share. The closing price of the common stock on the date of purchase was $6.125.
NOTE 18. QUARTERLY FINANCIAL DATA. (UNAUDITED)
Summarized quarterly financial data for fiscal 1997 and 1996 is as follows:
- --------------------
(1) Includes nonrecurring charges totaling $662,000 relating to the write-off of acquisition expenses.
(2) Net of extraordinary charge, net of taxes, related to early retirement of debt of $127,000. - -------------------------------------------------------------------------------- Image Entertainment, Inc. 57
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE. --------------------
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ---------------------------------------------------
The information required by this item is incorporated by reference from the information contained under the caption entitled "Election of Directors" in the Company's definitive proxy statement to be filed with the Commission in connection with the Company's 1997 Annual Meeting of Shareholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION. ----------------------
The information required by this item is incorporated by reference from the information contained under the caption entitled "Executive Compensation" in the Company's definitive proxy statement to be filed with the Commission in connection with the Company's 1997 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. --------------------------------------------------------------
The information required by this item is incorporated by reference from the information contained under the caption entitled "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive proxy statement to be filed with the Commission in connection with the Company's 1997 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ----------------------------------------------
The information required by this item is incorporated by reference from the information contained under the caption entitled "Certain Relationships and Related Transactions" in the Company's definitive proxy statement to be filed with the Commission in connection with the Company's 1997 Annual Meeting of Shareholders. - -------------------------------------------------------------------------------- 58 Image Entertainment, Inc.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. ---------------------------------------------------------------
(a) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT.
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SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS -- FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
* Includes $177,000 representing the allowance for doubtful accounts of U.S. Laser as of its June 1995 acquisition date. See Item 7. "Acquisition." ---
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
IMAGE ENTERTAINMENT, INC., a California corporation
Dated: June 30, 1997 By: /s/ Martin W. Greenwald ------------------------------------ MARTIN W. GREENWALD, Chairman of the Board, Chief Executive Officer, President & Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Martin W. Greenwald ------------------------------------ Dated: June 30, 1997 MARTIN W. GREENWALD, Chairman of the Board, Chief Executive Officer, President & Treasurer
/s/ Jeff M. Framer ------------------------------------ Dated: June 30, 1997 JEFF M. FRAMER, Chief Financial Officer (Principal Financial and Accounting Officer)
/s/ Stuart Segall ------------------------------------ Dated: June 30, 1997 STUART SEGALL, Vice President & Director
/s/ Ira Epstein ------------------------------------ Dated: June 30, 1997 IRA EPSTEIN, Director
/s/ Russell Harris ------------------------------------ Dated: June 30, 1997 RUSSELL HARRIS, Director
- -------------------------------------------------------------------------------- Image Entertainment, Inc. 61
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ----------- -----------
3.1 Restated Articles of Incorporation. Filed as Exhibit 3.1 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
3.2 Bylaws. Filed as Exhibit 3.2 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.1 /+/ The Company's Restated 1989 Incentive Stock Option Plan, as amended. Filed as Exhibit 10.1 of the Company's Form 10-K for the year ended March 31, 1992, and incorporated by reference herein.
10.2 /+/ The Company's 1990 Stock Option Plan. Filed as Exhibit A of the Company's Proxy Statement dated December 27, 1990, and incorporated by reference herein.
10.3 /+/ The Company's Restated 1992 Stock Option Plan. Filed as Exhibit A of the Company's Proxy Statement dated September 9, 1994, and incorporated by reference herein.
10.4 The Company's 1994 Eligible Directors Stock Option Plan and Form of Eligible Director Non-Qualified Stock Option Agreement. Filed as Exhibit 10.4 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.5 /+/ Form of Option Agreement dated October 15, 1991 between the Company and Martin W. Greenwald. Filed as Exhibit 10.3 of the Company's 10-Q for the quarter ended September 30, 1991, and incorporated by reference herein.
10.6 /+/ Option granted August 13, 1992 by the Company to Cheryl Lee. Filed as Exhibit 10.12 of the Company's Form 10-K for the year ended March 31, 1994, and incorporated by reference herein.
10.7 /+/ Form of Option granted May 19, 1994 to Jeff Framer, Cheryl Lee and David Borshell. Filed as Exhibit 10.24 to the Company's Form 10-K for the year ended March 31, 1994, and incorporated by reference herein.
10.8 /+/ Employment Agreement of Martin W. Greenwald dated July 1, 1994. Filed as Exhibit 10.8 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.8.A /+/ Amendment No. 1 dated and effective as of July 1, 1995 to Employment Agreement of Martin W. Greenwald dated July 1, 1994. Filed as Exhibit 10.1 of the Company's 10-Q for the quarter ended June 30, 1995, and incorporated herein by reference herein.
10.8.B. /+/ Amendment No. 2 dated and effective as of July 1, 1996 to Employment Agreement of Martin W. Greenwald dated July 1, 1994. Filed as Exhibit 10.3 of the Company's 10-Q for the quarter ended September 30, 1996, and incorporated herein by reference herein.
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10.9 /+/ Employment Agreement of Cheryl Lee dated July 1, 1994. Filed as Exhibit 10.9 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.9.A /+/ Amendment No. 1 dated and effective as of July 1, 1995 to Employment Agreement of Cheryl Lee dated July 1, 1994. Filed as Exhibit 10.2 of the Company's 10-Q for the quarter ended June 30, 1995, and incorporated herein by reference herein.
10.10 /+/ Employment Agreement of Jeff Framer dated July 1, 1994. Filed as Exhibit 10.10 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.10.A /+/ Amendment No. 1 dated and effective as of July 1, 1995 to Employment Agreement of Jeff Framer dated July 1, 1994. Filed as Exhibit 10.3 of the Company's 10-Q for the quarter ended June 30, 1995, and incorporated herein by reference herein.
10.11 /+/ Employment Agreement of David Borshell dated July 1, 1994. Filed as Exhibit 10.11 of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.11.A /+/ Amendment No. 1 dated and effective as of September 1, 1994 to Employment Agreement of David Borshell dated July 1, 1994. Filed as Exhibit 10.11.A of the Company's Form 10-K for the year ended March 31, 1995, and incorporated by reference herein.
10.12 /+/ Form of Indemnity Agreement between the Company and its directors and officers. Filed as Exhibit F of the Company's Proxy Statement dated September 5, 1989, and incorporated by reference herein.
10.13 Stock Purchase Agreement among the Company, Directors of the Company and various Buyers dated December 29, 1987. Filed as Exhibit 4.3 of the Company's Form 8-K dated December 29, 1987, and incorporated by reference herein.
10.13.A Form of First Amendment dated July 7, 1992 to the Stock Purchase Agreement referenced in Exhibit 10.19 above. Filed as Exhibit 10.5 of the Company's Form 10-Q for the quarter ended September 30, 1992, and incorporated by reference herein.
10.14 Stock Purchase Agreement among the Company, Directors of the Company and Image Investors Co. dated June 27, 1990. Filed as Exhibit 10.53 of the Company's Form 10-K for the year ended March 31, 1990. The Company and Image Investors Co. are parties to Stock Purchase Agreements dated July 14, 1988, November 30, 1988, January 11, 1989, February 14, 1989, May 10, 1989 and June 20, 1990, which are virtually identical to this Exhibit except for the number of shares of Common Stock purchased, and incorporated by reference herein.
10.15 Stock Purchase Agreement between the Company and Image Investors Co. dated December 30, 1992, including Warrant. Filed as Exhibit 10.6 of the Company's Form 10-Q for the quarter ended December 31, 1992, and incorporated by reference herein.
10.16 Purchase and Sale Agreement between the Company and LEI Partners, L.P. dated December 31, 1990. Filed as Exhibit 10.1 of the Company's Form 10-Q for the quarter ended December 31, 1990, and incorporated by reference herein. - -------------------------------------------------------------------------------- ii Image Entertainment, Inc.
10.17 Standard Industrial Lease for 9333 Oso Avenue, Chatsworth, California, dated December 1, 1993 and effective April 1, 1994, between the Company and P&R Investment Company. Filed as Exhibit 10.1 of the Company's Form 10-Q for the quarter ended December 31, 1993.
10.18 Standard Industrial Lease for 20350 Prairie Street, Chatsworth, California, dated December 1, 1993 and effective April 1, 1994, between the Company and P&R Investment Company. Filed as Exhibit 10.2 of the Company's Form 10-Q for the quarter ended December 31, 1993, and incorporated by reference herein.
10.19 Agreement for Purchase and Sale dated June 5, 1996, between Airport Center Partnership and the Company. Filed as Exhibit 10.19 of the Company's Form 10-K for the year end March 31, 1996
10.20/*/ Loan Agreement between the Company and Union Bank of California, N.A. dated as of December 17, 1996.
10.20.A/*/ Amendment No. 1 dated as of February 5, 1997 to Loan Agreement dated as of December 17, 1996 by and between the Company and Union Bank of California, N.A.
10.20.B/*/ Amendment No. 2 dated as of February 25, 1997 to Loan Agreement dated as of December 17, 1996 by and between the Company and Union Bank of California, N.A.
10.21 Stock Purchase Agreement between the Company and Stuart Segall dated as of July 12, 1995. Filed as Exhibit 10.1 of the Company's Form 10-Q for the quarter ended September 30, 1996, and incorporated by reference herein.
10.22 Stock Purchase Agreement between the Company and Martin W. Greenwald dated as of June 27, 1996. Filed as Exhibit 10.2 of the Company's Form 10-Q for the quarter ended September 30, 1996, and incorporated by reference herein.
10.23/*/ Construction Agreement between the Company and Carson Construction Management, Inc. dated as of November 25, 1996.
21/*/ Subsidiaries of the Registrant.
23/*/ Consent Letter of KPMG Peat Marwick LLP, Independent Certified Public Accountant.
27/*/ Financial Data Schedule.
* EXHIBIT(S) NOT PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. + MANAGEMENT CONTRACTS, COMPENSATORY PLANS OR ARRANGEMENTS.
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