UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________
FORM 10-Q
(Mark One)
þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended December 31, 2013
¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from to
Commission file number 001-33468
Point.360
(Exact Name of Registrant as Specified in Its Charter)
California | 01-0893376 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
incorporation or organization) | |
2701 Media Center Drive, Los Angeles, CA | 90065 |
(Address of principal executive offices) | (Zip Code) |
(818) 565-1400
(Registrant’s Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer ¨ |
Non-accelerated filer ¨ | Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes þ No
As of December 31, 2013, there were 10,536,906 shares of the registrant’s common stock outstanding.
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Point.360
Consolidated Balance Sheets
(in thousands)
June 30, | Dec. 31, | ||||||
2013 | 2013 | ||||||
(Unaudited) | |||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 1,696 | $ | 1,256 | |||
Accounts receivable, net of allowances for doubtful accounts of $327 and $215, respectively | 4,709 | 3,587 | |||||
Inventories, net | 315 | 226 | |||||
Prepaid expenses and other current assets | 253 | 446 | |||||
Prepaid income taxes | - | 5 | |||||
Total current assets | 6,973 | 5,520 | |||||
Property and equipment, net | 15,993 | 15,318 | |||||
Other assets, net | 686 | 788 | |||||
Total assets | $ | 23,652 | $ | 21,626 | |||
Liabilities and Shareholders’ Equity | |||||||
Current liabilities: | |||||||
Current portion of notes payable | $ | 344 | $ | 8,201 | |||
Current portion of capital lease obligations | 146 | 419 | |||||
Accounts payable | 1,302 | 1,367 | |||||
Accrued wages and benefits | 1,317 | 1,030 | |||||
Other accrued expenses | 44 | 45 | |||||
Current portion of deferred gain on sale of real estate | 178 | 178 | |||||
Current portion of deferred lease incentive | 209 | 209 | |||||
Other current liabilities | 13 | 9 | |||||
Total current liabilities | 3,553 | 11,458 | |||||
Notes payable, less current portion | 8,029 | - | |||||
Capital lease obligations, less current portion | 238 | - | |||||
Deferred gain on sale of real estate, less current portion | 1,204 | 1,115 | |||||
Deferred lease incentive, less current portion | 1,409 | 1,304 | |||||
Total long-term liabilities | 10,880 | 2,419 | |||||
Total liabilities | 14,433 | 13,877 | |||||
Commitments and contingencies (Note 4) | - | - | |||||
Shareholders’ equity: | |||||||
Preferred stock – no par value; 5,000,000 shares authorized; none outstanding | - | - | |||||
Common stock – no par value; 50,000,000 shares authorized; 10,513,166 and 10,536,906shares issued and outstanding on June 30 and December 31, 2013, respectively | 21,695 | 21,715 | |||||
Additional paid-in capital | 10,641 | 10,781 | |||||
Accumulated deficit | (23,117) | (24,747) | |||||
Total shareholders’ equity | 9,219 | 7,749 | |||||
Total liabilities and shareholders’ equity | $ | 23,652 | $ | 21,626 |
See accompanying notes to condensed consolidated financial statements.
2 | ||
POINT.360
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
2012 | 2013 | 2012 | 2013 | ||||||||||
Revenues | $ | 7,745,000 | $ | 6,286,000 | $ | 15,406,000 | $ | 13,058,000 | |||||
Cost of services sold | (5,221,000) | (4,095,000) | (10,174,000) | (8,834,000) | |||||||||
Gross profit | 2,524,000 | 2,191,000 | 5,232,000 | 4,224,000 | |||||||||
Selling, general and administrative expense | (2,910,000) | (2,819,000) | (5,843,000) | (5,864,000) | |||||||||
Operating loss | (386,000) | (628,000) | (611,000) | (1,640,000) | |||||||||
Interest expense | (80,000) | (71,000) | (248,000) | (145,000) | |||||||||
Other income | 76,000 | 76,000 | 364,000 | 155,000 | |||||||||
Loss before income taxes | (390,000) | (623,000) | (495,000) | (1,630,000) | |||||||||
Provision for income taxes | - | - | - | - | |||||||||
Net loss | $ | (390,000) | $ | (623,000) | $ | (495,000) | $ | (1,630,000) | |||||
Loss per share: | |||||||||||||
Basic: | |||||||||||||
Net loss | $ | (0.04) | $ | (0.06) | $ | (0.05) | $ | (0.15) | |||||
Weighted average number of shares | 10,513,166 | 10,536,906 | 10,513,166 | 10,528,909 | |||||||||
Diluted: | |||||||||||||
Net loss | $ | (0.04) | $ | (0.06) | $ | (0.05) | $ | (0.15) | |||||
Weighted average number of shares including the dilutive effect of stock options | 10,513,166 | 10,536,906 | 10,513,166 | 10,528,909 |
See accompanying notes to condensed consolidated financial statements.
3 | ||
POINT.360
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended December 31, | |||||||
(in thousands) | |||||||
2012 | 2013 | ||||||
Cash flows from operating activities: | |||||||
Net loss | $ | (495) | $ | (1,630) | |||
Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
Depreciation and amortization | 1,238 | 993 | |||||
Amortization of deferred gain on real estate | (89) | (89) | |||||
Amortization of deferred lease credit | (104) | (105) | |||||
Provision for (recovery of) doubtful accounts | 14 | (112) | |||||
Stock compensation expense | 102 | 140 | |||||
Stock option exercises | - | 20 | |||||
Changes in operating assets and liabilities: | |||||||
Decrease in accounts receivable | 933 | 1,234 | |||||
(Increase) decrease in inventories | (42) | 89 | |||||
(Increase) in prepaid expenses and other current assets | (207) | (198) | |||||
(Increase) in other assets | (12) | (102) | |||||
Increase in accounts payable | 85 | 65 | |||||
(Decrease) in accrued wages and benefits | (189) | (287) | |||||
Increase (decrease) in other accrued expenses | (102) | 1 | |||||
(Decrease) in other current liabilities | (4) | (4) | |||||
Net cash provided by operating activities | 1,128 | 15 | |||||
Cash flows from investing activities: | |||||||
Capital expenditures | (212) | (202) | |||||
Net cash used in investing activities | (212) | (202) | |||||
Cash flows from financing activities: | |||||||
Borrowings of notes payable | 8,602 | - | |||||
Repayment of notes payable | (9,370) | (172) | |||||
Payment of capital lease obligations | (82) | (81) | |||||
Net cash used in financing activities | (850) | (253) | |||||
Net Increase (decrease) in cash and cash equivalents | 66 | (440) | |||||
Cash and cash equivalents at beginning of period | 1,219 | 1,696 | |||||
Cash and cash equivalents at end of period | $ | 1,285 | $ | 1,256 |
Selected cash payments and non-cash activities were as follows (in thousands):
Six Months Ended | |||||||
December 31, | |||||||
2012 | 2013 | ||||||
Cash payments for income taxes (net of refunds) | $ | - | $ | 5 | |||
Cash payments for interest | $ | 291 | $ | 146 | |||
Assets acquired under capital lease | $ | 308 | $ | 116 |
See accompanying notes to condensed consolidated financial statements.
4 | ||
Point.360
Notes to Condensed Consolidated Financial Statements (unaudited)
December 31, 2013
Note 1 – THE COMPANY
Point.360 (the “Company” or “we”) provides high definition and standard definition digital mastering, data conversion, video and film asset management, distribution and other services to owners, producers and distributors of entertainment and advertising content. The Company provides the services necessary to edit, master, reformat, convert, archive and ultimately distribute its clients’ film and video content, including television programming feature films and movie trailers. The Company’s interconnected facilities provide service coverage to all major U.S. media centers. Clients include major motion picture studios and independent producers. The Company also rents and sells DVDs directly to consumers through its Movie>Q retail stores.
The Company operates in two business segments from three post production and three Movie>Q locations. Each post production location is electronically tied to the others and serves the same customer base. Depending on the location size, the production equipment consists of tape duplication, editing, encoding, standards conversion, and other machinery. Each location employs personnel with the skills required to efficiently run the equipment and handle customer requirements. While all locations are not exactly the same, an order received at one location may be fulfilled at one or more “sister” facilities to use resources in the most efficient manner.
Typically, a feature film or television show or related material will be submitted to a facility by a motion picture studio, independent producer, advertising agency, or corporation for processing and distribution. A common sales force markets the Company’s capability for all facilities. Once an order is received, the local customer service representative determines the most cost-effective way to perform the services considering geographical logistics and facility capabilities.
In fiscal 2010, the Company purchased assets and intellectual property for a research and development project to address the viability of the DVD rental business being abandoned by the closure of Movie Gallery/Hollywood Video and Blockbuster stores. The DVD rental market consists principally of online services (Netflix), vending machines (Redbox) and other video stores.
As of December 31, 2013, the Company had opened three Movie>Q stores in Southern California employing an automated inventory management (“AIM”) system in a 1,200-1,600 square foot facility. By saving space and personnel costs which caused the big box stores to be uncompetitive with lower priced online and vending machine rental alternatives, Movie>Q can offer up to 10,000 unit selections to a customer at competitive rental rates. Movie>Q provides online reservations, an in-store destination experience, first run movie titles and a large unit selection (as opposed to 400-700 for a Redbox vending machine).
Based on the success of the stores, the Company may seek to expand the number of Movie>Q stores while further streamlining the design and production of the AIM system. Movie>Q provides the Company with a content distribution capability complimentary to the Company’s post production business.
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts and transactions of the Company, including those of the Company’s subsidiaries. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America and by the Securities and Exchange Commission’s rules and regulations for reporting interim financial statements and footnotes. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. All intercompany balances and transactions have been eliminated in the Condensed Consolidated Financial Statements. Operating results for the three and six month periods ended December 31, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2014. These financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s Form 10-K for the period ended June 30, 2013.
5 | ||
Pro Forma Earnings (Loss) Per Share A reconciliation of the denominator of the basic earnings per share (“EPS”) computation to the denominator of the diluted EPS computation is as follows (in thousands):
Three Months | Three Months | Six Months | Six Months | ||||||
Ended December 31, | Ended December 31, | Ended December 31, | Ended December 31, | ||||||
2012 | 2013 | 2012 | 2013 | ||||||
Pro forma weighted average of number of shares | |||||||||
Weighted average number of common shares outstanding used in computation of basic EPS | 10,513 | 10,537 | 10,513 | 10,529 | |||||
Dilutive effect of outstanding stock options | - | - | - | - | |||||
Weighted average number of common and potential Common shares outstanding used in computation of Diluted EPS | 10,513 | 10,537 | 10,513 | 10,529 | |||||
Effect of dilutive options excluded in the computation of diluted EPS due to net loss | - | 1 | - | 120 |
The weighted average number of common shares outstanding were the same amount for both basic and diluted income per share in the three month period ended December 31, 2012 and 2013 and the six-month periods ended December 31, 2012 and 2013. The effect of potentially dilutive securities for those periods were excluded from the computation of diluted earnings per share because their effect would be anti-dilutive (i.e., including such securities would result in a higher earnings per share, or lower loss per share, respectively). There were 1,587,294 and 951,335 potentially dilutive shares at December 31, 2012 and 2013, respectively.
Fair Value Measurements
The Company follows a framework for consistently measuring fair value under generally accepted accounting principles, and the disclosures of fair value measurements. The framework provides a fair value hierarchy to classify the source of the information.
The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value and include the following:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Cash, the only Level 1 input applicable to the Company (there are no Level 2 or 3 inputs), is stated on the Condensed Consolidated Balance Sheets at fair value.
As of December 31, 2013 the carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other current liabilities approximates fair value due to the short-term nature of such instruments. The carrying value of capital lease obligations, notes payable and other long-term liabilities approximates fair value as the related interest rates approximate rates currently available to the Company.
Recent Accounting Pronouncements
Changes to accounting principles are established by the Financial Accounting Standards Board (FASB) in the form of accounting standards updates (ASU’s) to the FASB’s Accounting Standards Codification. We consider the applicability and impact of all ASU’s. ASU’s not listed below were assessed and determined to be not applicable to our financial position or results of operations.
In July 2013, the FASB issued Accounting Standards Update (“ASU”) 2013-11, Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, an amendment to FASB ASC Topic 740, Income Taxes, (“FASB ASU 2013-11”). This update clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In situations where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. Retrospective application is permitted. We are currently evaluating the impact, if any, that the adoption of this pronouncement may have on our financial position, results of operations, cash flows, or presentation thereof.
6 | ||
NOTE 2 - LONG TERM DEBT AND NOTES PAYABLE
In August and September of 2012 (subsequently modified on December 18, 2013), the Company entered into revolving credit, equipment financing and two mortgage agreements with a bank, as follows:
Revolving Credit Facility. The revolving credit facility provides up to $5 million of credit based on 80% of eligible accounts receivable, as defined. The agreement provides for interest at the lower of (i) Libor plus 2.75% (2.92% as of December 31, 2013) or (ii) the bank’s alternative base rate plus 1.75% (5.00% as of December 31, 2013), plus 0.25% per annum assessed on the unused portion of the credit commitment. The maturity date is August 31, 2014 and is renewable for an additional year on each anniversary date upon mutual agreement of the parties.
Equipment Financing Facility. The equipment financing facility provides up to $1.25 million of financing for the cost of new and already-owned or leased equipment. The agreement provides for interest at the bank’s cost of funds plus 3% (3.89% as of December 31, 2013). The maturity date for each “schedule” of equipment is up to four years from the borrowing date. Amounts may be borrowed under the facility until August 14, 2014.
Hollywood Way and Vine Street Mortgages. In September 2012, the Company entered into two real estate term loan agreements with respect to its Hollywood Way and Vine Street locations for $5.5 million and $3.1 million, respectively. The loans provide for interest at Libor plus 3% (3.17% as of December 31, 2013). Repayment is based on monthly payments with a 25-year amortization, with all principal due in 10 years. The real estate loans are secured by first trust deeds on the properties.
General Terms. All amounts due under the revolving credit facility, equipment financing facility and term mortgage facilities are secured by all personal property and real estate of the Company. While amounts are outstanding under the credit arrangements, the Company will be subject to financial covenants as follows:
1. | Minimum tangible net worth (TNW) of $8.5 million (the Company’s actual TNW was $7.7 million as of December 31, 2013). |
2. | Minimum quarterly EBITDA (as defined) of $750,000, provided that EBITDA may be a minimum of $500,000 in any one quarter within four consecutive quarters (the Company’s EBITDA was $0.0 million for the quarter ended December 31, 2013). |
3. | Minimum quarterly fixed charge ratio (as defined) of 1.25 (the Company’s fixed charge ratio was 0.06 for the quarter ended December 31, 2013). |
4. | Minimum trailing 12 month (TTM) fixed charge ratio (as defined) of 1.25 measured quarterly (the Company’s TTM fixed charge ratio was 0.32 for the TTM ended December 31, 2013). |
All obligations to the bank are cross collateralized. The agreements contain certain other terms and conditions common with such arrangements.
As of December 31, 2013 the Company did not meet the TNW, the minimum quarterly EBITDA, and the minimum quarterly and TTM fixed charge ratio covenants, and obtained a forbearance from the bank. The forbearance acknowledged that a default condition exists, and that availability under the revolving credit and equipment financing facilities will be suspended until the Company demonstrates adequate fixed charge coverage capability and other positive operating developments as determined by the bank. The bank also added an additional financial covenant based on trailing twelve month fixed charge coverage beginning with the quarter ended December 31, 2013 (see 4. above). The bank also limited borrowings under the revolving credit facility to the lesser of (1) 80% of eligible accounts receivable less $600,000 or (2) $1,000,000. Although the bank did not elect to accelerate the Company’s obligations under the agreement, the balance owed for the mortgage debt and capital leases has been classified as a current liability in the balance sheet as of December 31, 2013.
Amounts Borrowed. As of December 31, 2013, the Company had no outstanding borrowings under the revolving credit facility and $0.4 million borrowed under the equipment financing facility.
7 | ||
In connection with the termination of a prior credit agreement, the Company paid a $30,000 break-up fee, which was reflected in other income/expense in the six months ended December 31, 2012.
NOTE 3- PROPERTY AND EQUIPMENT
In March 2006, the Company entered into a sale and leaseback transaction with respect to its Media Center real estate. The real estate was sold for approximately $14.0 million resulting in a $1.3 million after tax gain. In accordance with the Accounting Standards Codification (ASC) 840-40, the gain will be amortized over the initial 15-year lease term as reduced rent. Net proceeds at the closing of the sale were used to pay off the mortgage and other outstanding debt. A $250,000 security deposit related to the lease has been recorded as a deposit in “other assets, net” in the Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2013.
The lease is treated as an operating lease for financial reporting purposes. After the initial lease term, the Company has four five-year options to extend the lease. Minimum annual rent payments for the initial five years of the lease were $1,111,000, increasing annually thereafter based on the Consumer Price Index change from year to year.
In June 2011, the Company entered into a lease amendment with respect to the Company’s Media Center facility. The amendment provided that the landlord would reimburse the Company up to $2 million for the leasehold improvements to be made by the Company to the premises. The leasehold improvements would be recorded as a fixed asset and amortized over the remaining term of the lease (until March 2021). Pursuant to the lease amendment, the Company’s monthly lease costs increased by approximately $14,000 on July 1, 2011, and by an additional $13,000 to approximately $27,000 on April 1, 2012. The Company incurred $2.1 million of costs for construction, of which $2.0 million was reimbursed by the landlord. A deferred lease incentive has been recorded for the total amount reimbursed by the landlord in accordance with ASC 840-20. The lease incentive is being amortized over the remaining lease term as an offset to rent.
Property and equipment consist of the following as ofDecember 31, 2013:
Land | $ | 3,985,000 | ||
Buildings | 9,317,000 | |||
Machinery and equipment | 38,002,000 | |||
Leasehold improvements | 9,084,000 | |||
Computer equipment | 7,937,000 | |||
Equipment under capital lease | 1,111,000 | |||
Office equipment, CIP | 607,000 | |||
Subtotal | 70,043,000 | |||
Less accumulated depreciation and amortization | (54,725,000) | |||
Property and equipment, net | $ | 15,318,000 |
NOTE 4- COMMITMENTS AND CONTINGENCIES
From time to time, the Company may become a party to legal actions and complaints arising in the ordinary course of business, although it is not currently involved in any such legal proceedings.
NOTE 5- INCOME TAXES
The Company reviewed its Accounting Standards Codification (“ASC”) 740-10 documentation for the periods through December 31, 2013 to ascertain if any changes should be made with respect to tax positions previously taken. In addition, the Company reviewed its income tax reporting through December 31, 2013. Based on Company’s review of its tax positions as of December 31, 2013, no new uncertain tax positions have been identified; nor has new information become available that would change management’s judgment with respect to tax positions previously taken.
As of December 31, 2013, the Company had no net deferred tax assets. No tax benefit was recorded during thethree month period ended December 31, 2013 because future realizability of such benefit was not considered to be more likely than not.
The ASC prescribes a recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition.
The Company files income tax returns in the U.S. federal jurisdiction, and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal state or local income tax examinations by tax authorities for years before 2008.
8 | ||
NOTE 6- STOCK OPTION PLAN, STOCK-BASED COMPENSATION
In May 2007, the Board of Directors approved the 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan provides for the award of options to purchase up to 2,000,000 shares of common stock, appreciation rights and restricted stock awards.
In November 2010, the shareholders approved the 2010 Incentive Plan (the “2010 Plan”). The 2010 Plan provides for the award of options to purchase up to 4,000,000 shares of common stock, appreciation rights and restricted stock and performance awards.
Under the 2007 and 2010 Plans, the stock option price per share for options granted is determined by the Board of Directors and is based on the market price of the Company’s common stock on the date of grant, and each option is exercisable within the period and in the increments as determined by the Board, except that no option can be exercised later than ten years from the grant date. The stock options generally vest in one to five years.
The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. We also estimate the fair value of the award that is ultimately expected to vest to be recognized as expense over the requisite service periods in the Condensed Consolidated Statements of Operations.
We estimate the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Condensed Consolidated Statements of Operations. Stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the three and six month periods ended December 31, 2013 included compensation expense for the share-based payment awards based on the grant date fair value. For stock-based awards issued to employees and directors, stock-based compensation is attributed to expense using the straight-line single option method. As stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the periods reported in this Form 10-Q is based on awards expected to vest, forfeitures are also estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For the period being reported in this Form 10-Q, expected forfeitures are immaterial. The Company will re-assess the impact of forfeitures if actual forfeitures increase in future quarters. Stock-based compensation expense related to employee or director stock options recognized for the three and six month periods ended December 31, 2012 and 2013 was as follows:
Three months ended December 31, 2012 | $ | 60,000 | ||
Three months ended December 31, 2013 | 77,000 | |||
Six months ended December 31, 2012 | 102,000 | |||
Six months ended December 31, 2013 | 140,000 |
The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant uses the Black-Scholes model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected term of the awards, and actual and projected employee stock options exercise behaviors. The Company estimates expected volatility using historical data. The expected term is estimated using the “safe harbor” provisions provided by the SEC.
During each of the three and six month periods ended December 31, 2012 and 2013, the Company granted awards of stock options as follows:
2007 Plan | 2010 Plan | ||||||||||||
Options | Exercise | Options | Exercise | ||||||||||
Granted | Price per Share | Granted | Price per Share | ||||||||||
Three months ended December 31, 2012 | 30,000 | $ | 0.80 | - | - | ||||||||
Three months ended December 31, 2013 | 22,500 | $ | 0.74 | - | - | ||||||||
Three months ended December 31, 2013 | 15,000 | $ | 0.64 | - | - | ||||||||
Six months ended December 31, 2012 | 30,000 | $ | 0.80 | - | - | ||||||||
Six months ended December 31, 2013 | 22,500 | $ | 0.74 | - | - | ||||||||
Six months ended December 31, 2013 | 15,000 | $ | 0.64 | - | - |
The following table summarizes the status of the 2007 and 2010 Plans as of December 31, 2013:
2007 Plan | 2010 Plan | Total | ||||||||
Options originally available | 2,000,000 | 4,000,000 | 6,000,000 | |||||||
Stock options outstanding | 1,835,110 | 529,500 | 2,364,610 | |||||||
Options available for grant | 132,725 | 3,466,925 | 3,599,650 |
9 | ||
Transactions involving stock options are summarized as follows:
Number of Shares | Weighted Average Exercise Price | Weighted Average Grant Date Fair Value | ||||||||
Balance at June 30, 2013 | 2,413,525 | $ | 0.95 | $ | 0.53 | |||||
Granted | - | $ | - | $ | - | |||||
Exercised | (23,740) | $ | 1.00 | $ | 0.52 | |||||
Cancelled | (31,200) | $ | 1.15 | $ | 0.56 | |||||
Balance at September 30, 2013 | 2,358,585 | $ | 0.95 | $ | 0.53 | |||||
Granted | 37,500 | $ | 0.70 | $ | 0.57 | |||||
Exercised | (3,000) | $ | 0.86 | $ | 0.49 | |||||
Cancelled | (28,475) | $ | 1.25 | $ | 0.56 | |||||
Balance at December 31, 2013 | 2,364,610 | $ | 0.94 | $ | 0.53 |
As of December 31, 2013, the total compensation costs related to non-vested awards yet to be expensed was approximately $0.5 million to be amortized over the next four years.
The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of December 31, 2013 were as follows:
Number of Shares | Weighted Average Exercise Price ($) | Weighted Average Remaining Contractual Life (Years) | Intrinsic Value ($) | ||||||||||
Employees – Outstanding | 2,222,110 | $ | 0.94 | 2.63 | - | ||||||||
Employees – Expected to Vest | 1,999,899 | $ | 0.94 | 2.63 | - | ||||||||
Employees – Exercisable | 827,585 | $ | 1.08 | 1.33 | - | ||||||||
Non-Employees-Outstanding | 142,500 | $ | 0.96 | 2.96 | - | ||||||||
Non-Employees- Expected to Vest | 142,500 | $ | 0.96 | 2.96 | - | ||||||||
Non-Employees-Exercisable | 123,750 | $ | 0.99 | 2.77 | - |
The aggregate intrinsic value in the table above is the sum of the amounts by which the quoted market price of the Company’s common stock exceeded the exercise price of the options at December 31, 2013, for those options for which the quoted market price was in excess of the exercise price.
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Additional information with respect to outstanding options as of December 31, 2013 is as follows:
Options Outstanding | Options Exercisable | ||||||||||||||||
Options Exercise Price Range | Number of Shares | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Number of Shares | Weighted Average Remaining Contractual Life | ||||||||||||
$ | 1.29 | 301,450 | 1.1 years | $ | 1.29 | 226,800 | 1.1 years | ||||||||||
$ | 1.27 | 15,000 | 1.7 years | $ | 1.27 | 11,250 | 1.7 years | ||||||||||
$ | 1.20 | 246,675 | 0.1 years | $ | 1.20 | 246,675 | 0.1 years | ||||||||||
$ | 1.15 | 22,500 | 1.9 years | $ | 1.15 | 22,500 | 1.9 years | ||||||||||
$ | 1.07 | 22,500 | 2.9 years | $ | 1.07 | 22,500 | 2.9 years | ||||||||||
$ | 1.05 | 22,500 | 0.9 years | $ | 1.05 | 22,500 | 0.9 years | ||||||||||
$ | 0.95 | 242,800 | 3.2 years | $ | 0.95 | 60,325 | 3.2 years | ||||||||||
$ | 0.86 | 526,185 | 2.1 years | $ | 0.86 | 256,285 | 2.1 years | ||||||||||
$ | 0.81 | 830,000 | 4.1 years | $ | 0.81 | - | 4.1 years | ||||||||||
$ | 0.80 | 22,500 | 3.9 years | $ | 0.80 | 22,500 | 3.9 years | ||||||||||
$ | 0.75 | 75,000 | 2.4 years | $ | 0.75 | 37,500 | 2.4 years | ||||||||||
$ | 0.74 | 22,500 | 4.9 years | $ | 0.74 | 22,500 | 4.9 years | ||||||||||
$ | 0.64 | 15,000 | 4.9 years | $ | 0.64 | - | 4.9 years |
In addition to the above 2007 Plan, the Company issued 10,000 shares of restricted stock during fiscal year ended June 30, 2010 with a weighted average fair value of $0.58 per share.
We use the detailed method provided in ASC 718 for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and the Condensed Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of ASC 718.
NOTE 7- STOCK RIGHTS PLAN
In July 2007, the Company implemented a stock rights program. Pursuant to the program, stockholders of record on August 7, 2007, received a dividend of one right to purchase for $10 one one-hundredth of a share of a newly created Series A Junior Participating Preferred Stock. The rights are attached to the Company’s Common Stock and will also become attached to shares issued subsequent to August 7, 2007. The rights will not be traded separately and will not become exercisable until the occurrence of a triggering event, defined as an accumulation by a single person or group of 20% or more of the Company’s Common Stock. The rights will expire on August 6, 2017 and are redeemable at $0.0001 per right.
After a triggering event, the rights will detach from the Common Stock. If the Company is then merged into, or is acquired by, another corporation, the Company has the opportunity to either (i) redeem the rights or (ii) permit the rights holder to receive in the merger stock of the Company or the acquiring company equal to two times the exercise price of the right (i.e., $20). In the latter instance, the rights attached to the acquirer’s stock become null and void. The effect of the rights program is to make a potential acquisition of the Company more expensive for the acquirer if, in the opinion of the Company’s Board of Directors, the offer is inadequate.
No triggering events occurred in the six months ended December 31, 2013.
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NOTE 8- SHAREHOLDER’S EQUITY
The following table analyzes the components of shareholders’ equity from June 30, 2013 to December 31, 2013 (in thousands):
Common Stock | Paid-in Capital | Accumulated (Deficit) | Shareholders’ Equity | ||||||||||
Balance, June 30, 2013 | $ | 21,695 | $ | 10,641 | $ | (23,117) | $ | 9,219 | |||||
Exercise of stock options | 17 | 17 | |||||||||||
Stock-based compensation expense | 63 | 63 | |||||||||||
Net loss | (1,007) | (1,007) | |||||||||||
Balance, September 30, 2013 | 21,712 | 10,704 | (24,124) | 8,292 | |||||||||
Stock-based compensation expense | 77 | 77 | |||||||||||
Exercise of stock options | 3 | 3 | |||||||||||
Net loss | (623) | (623) | |||||||||||
Balance, December 31, 2013 | $ | 21,715 | $ | 10,781 | $ | ( 24,747) | $ | 7,749 |
NOTE 9- STOCK REPURCHASE PLAN
In February 2008, the Company’s Board of Directors authorized a stock repurchase program. Under the stock repurchase program, the Company may purchase outstanding shares of its common stock on the open market at such times and prices determined in the sole discretion of management. No shares were acquired pursuant to the repurchase program during the three months ended December 31, 2013.
NOTE 10- SEGMENT INFORMATION:
In its operation of the business, management reviews certain financial information, including segmented internal profit and loss statements prepared on a basis consistent with U.S. generally accepted accounting principles. Our two segments are Point.360 and Movie>Q. The two segments discussed in this analysis are presented in the way we internally managed and monitored performance for the three and six month periods ended December 31, 2012 and 2013. Allocations for internal resources were made for the periods. The Movie>Q segment tracks certain assets separately, and all others are recorded in the Point.360 segment for internal reporting presentations. Cash was not segregated between the two segments but retained in the Point.360 segment.
The types of services provided by each segment are summarized below:
Point.360 –The Point.360 segment provides high definition and standard definition digital mastering, data conversion, video and film asset management, distribution and other services to owners, producers and distributors of entertainment and advertising content. Point.360 provides the services necessary to edit, master, reformat, convert, archive and ultimately distribute its clients’ film and video content, including television programming feature films and movie trailers. The segment’s interconnected facilities provide service coverage to all major U.S. media centers. Clients include major motion picture studios and independent producers.
Movie>Q –The Movie>Q segment rents and sells DVDs directly to consumers though its retail stores. The stores employ an automated inventory management (“AIM”) system in a 1,200-1,600 square foot facility. By saving space and personnel costs which caused the big box stores to be uncompetitive with lower priced online and vending machine rental alternatives, Movie>Q can offer up to 10,000 unit selections to a customer at competitive rental rates. Movie>Q provides online reservations, an in-store destination experience, first run movie and game titles and a large unit selection.
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Segment revenues, operating loss and total assets were as follows (in thousands):
Revenue | Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||
2012 | 2013 | 2012 | 2013 | ||||||||||
Point.360 | $ | 7,619 | $ | 6,160 | $ | 15,163 | $ | 12,822 | |||||
Movie>Q | 126 | 126 | 243 | 236 | |||||||||
Consolidated revenue | $ | 7,745 | $ | 6,286 | $ | 15,406 | $ | 13,058 |
Operating loss | Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||
2012 | 2013 | 2012 | 2013 | ||||||||||
Point.360 | $ | (190) | $ | (487) | $ | (228) | $ | (1,355) | |||||
Movie>Q | (196) | (141) | (384) | (285) | |||||||||
Operating loss | $ | (386) | $ | (628) | $ | (612) | $ | (1,640) |
Total Assets | June 30, | December 31, | |||||
2013 | 2013 | ||||||
Point.360 | $ | 22,588 | $ | 20,661 | |||
Movie>Q | 1,064 | 965 | |||||
Consolidated assets | $ | 23,652 | $ | 21,626 |
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Except for the historical information contained herein, certain statements in this quarterly report are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995, which involve certain risks and uncertainties, which could cause actual results to differ materially from those discussed herein, including but not limited to competition, customer and industry concentration, depending on technological developments, risks related to expansion, dependence on key personnel, fluctuating results and seasonality and control by management. See the relevant portions of the Company's documents filed with the Securities and Exchange Commission, including the Risk Factors section of the Company’s most recent annual report on Form 10-K, and Risk Factors in Item 1A of Part II of this Form 10-Q, for a further discussion of these and other risks and uncertainties applicable to the Company's business.
Overview
Point.360 provides video and film asset management services to owners, producers and distributors of entertainment content. We provide the services necessary to edit, master, reformat, distribute and archive our clients’ film and video content, including television programming, feature films and movie trailers using electronic and physical means. Clients include major motion picture studios and independent producers. The Company also rents and sells DVDs directly to consumers through its Movie>Q retail stores.
We operate in a highly competitive environment in which customers desire a broad range of services at a reasonable price. There are many competitors offering some or all of the services provided by us. Additionally, some of our customers are large studios, which also have in-house capabilities that may influence the amount of work outsourced to companies like Point.360. We attract and retain customers by maintaining a high service level at reasonable prices.
The market for our services is primarily dependent on our customers’ desire and ability to monetize their entertainment content. The major studios derive revenues from re-releases and/or syndication of motion pictures and television content. While the size of this market is not quantifiable, we believe studios will continue to repurpose library content to augment uncertain revenues from new releases. The current uncertain economic environment has negatively impacted the ability and willingness of independent producers to create new content.
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The demand for entertainment content should continue to expand through web-based applications. We believe long and short form content will be sought by users of personal computers, hand-held devices and home entertainment technology. Additionally, changing formats from standard definition, to high definition, to Blu-Ray and perhaps to 3D will continue to give us the opportunity to provide new services with respect to library content.
To meet these needs, we must be prepared to invest in technology and equipment, and attract the talent needed to serve our client needs. Labor, facility and depreciation expenses constituted approximately 91% of our revenues in the six months ended December 31, 2013. Our goals include maximizing facility and labor usage, and maintaining sufficient cash flow for capital expenditures and acquisitions of complementary businesses to enhance our service offerings.
We have an opportunity to expand our business by establishing closer relationships with our customers through excellent service at a competitive price and adding to our service offering. Our success is also dependent on attracting and maintaining employees capable of maintaining such relationships. Also, growth can be achieved by acquiring similar businesses that can increase revenues by adding new customers, or expanding current services to existing customers. Additionally, we are looking to capitalize on the Movie>Q retail opportunity.
Our business generally involves the immediate servicing needs of our customers. Most orders are fulfilled within several days, with occasional larger orders spanning weeks or months. At any particular time, we have little firm backlog.
We believe that our interconnected facilities provide the ability to better service customers than single-location competitors. We will look to expand both our service offering and geographical presence through acquisition of other businesses or opening additional facilities.
Three Months EndedDecember 31, 2013 Compared to Three Months EndedDecember 31, 2012
Revenues. Revenues were $6.3 million for the three months ended December 31, 2013, compared to $7.7 million for the same period last year. Revenues declined due to lower orders for distribution of older programming and the timing of orders received with respect to seasonal television programming. One customer reduced its outsourced requirement by $0.8 million when compared to the prior year period, which orders vary from period to period. Sales declined $0.5 million due to our decision to terminate our computer graphics business due to uncertain revenues and the need to retain costly talent. Increased sales were experienced with one other larger customer. Larger project-based orders can also affect revenues depending on the size of the order and the length of time needed to perform the required services We continue to have excellent relations with our major customers.
Cost of Services. Costs of services consist principally of wages and benefits, facility costs and depreciation of physical assets. During the three months ended December 31, 2013, total costs of services declined $1.1 million, and were 65% of sales compared to 67% in the prior year. The majority of the decrease was associated with wages and benefits, totaling $0.6 million. Also, in the current period, outside servicing costs and depreciation decreased by $0.3 million.
Gross Profit. In the three months ended December 31, 2013, gross margin was 35% of sales, compared to 33% for the same period last year. The increase in gross profit percentage is due to the factors cited above. From time to time, we will increase or decrease staff capabilities to satisfy potential customer service demand. We expect gross margins to fluctuate in the future as the sales mix changes.
Selling, General and Administrative Expense. SG&A expense was $2.8 million (45% of sales) in the three months ended December 31, 2013 as compared to $2.9 million (38% of sales) in the same period last year.
Operating Loss.Operating loss was $0.6 million in the three months ended December 31, 2013 period compared to a $0.4 million loss in the same period last year.
Interest Expense. Net interest expense was $0.1 million in the three months ended December 31, 2013 compared to $0.1 million in the prior year.
Other Income. Other income in both periods includes sublease income.
Net Loss.Net loss in the three months ended December 31, 2013 was $0.6 million, compared to a $0.4 million loss in the prior year period.
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Six Months EndedDecember 31, 2013 Compared to Six Months EndedDecember 31, 2012
Revenues. Revenues were $13.1 million for the six months ended December 31, 2013, compared to $15.4 million for the same period last year. Revenues declined due to lower orders for distribution of older programming and the timing of orders received with respect to seasonal television programming. One customer reduced its outsourced requirement by $1.7 million when compared to the prior year period, which orders vary from period to period. Sales declined $0.5 million due to our decision to terminate our computer graphics business due to uncertain revenues and the need to retain costly talent. Increased sales were experienced with one other larger customer. Larger project-based orders can also affect revenues depending on the size of the order and the length of time needed to perform the required services We continue to have excellent relations with our major customers.
Cost of Services. Costs of services consist principally of wages and benefits, facility costs and depreciation of physical assets. During the six months ended December 31, 2013, total costs of services declined $1.3 million, and were 68% of sales compared to 66% in the prior year. The majority of the decrease was associated with wages and benefits, totaling $0.8 million. Also, in the current period, outside servicing costs and depreciation decreased by $0.4 million.
Gross Profit. In the six months ended December 31, 2013, gross margin was 32% of sales, compared to 34% for the same period last year. The decrease in gross profit percentage is due to the factors cited above. From time to time, we will increase or decrease staff capabilities to satisfy potential customer service demand. We expect gross margins to fluctuate in the future as the sales mix changes.
Selling, General and Administrative Expense. SG&A expense was $5.9 million (45% of sales) in the six months ended December 31, 2013 as compared to $5.8 million (38% of sales) in the same period last year.
Operating Loss.Operating loss was $1.6 million in the six months ended December 31, 2013 period compared to a $0.6 million loss in the same period last year.
Interest Expense. Net interest expense was $0.1 million in the six months ended December 31, 2013 compared to $0.2 million in the prior year. Interest expense declined during the fiscal 2014 period due to a refinancing of our revolving debt and term loans during the quarter ended September 30, 2012 at lower interest rates. Interest expense for our two term loan mortgages declined by approximately $0.1 million in the six months ended December 31, 2013 when compared to the prior year period.
Other Income. Other income in both periods includes sublease income. In the six month period ended December 31, 2012, other income also included a $0.3 million discount on debt repayment, the write off of $0.1 million deferred financing and other costs associated with the termination of a line of credit and one mortgage loan, and $0.1 million of income associated with the change in accounting estimate for a customer rebate program.
Net Loss.Net loss in the six months ended December 31, 2013 was $1.6 million, compared to a $0.5 million loss in the prior year period.
LIQUIDITY AND CAPITAL RESOURCES
This discussion should be read in conjunction with the notes to the consolidated financial statements and the corresponding information more fully described elsewhere in this Form 10-Q.
In July 2008, the Company entered into a Promissory Note with a bank (the “note”) in order to purchase land and a building that had been occupied by the Company since 1998 (the total purchase price was approximately $8.1 million). Pursuant to the note, the Company borrowed $6,000,000. The mortgage was paid off in September 2012 and replaced by a new mortgage (see below). The Company received a $332,000 discount in connection with the payoff and wrote off approximately $90,000 of deferred financing costs related to the note, both of which were recorded as other income (expense) in the quarter ended September 30, 2012.
In June 2009, the Company entered into a $3,562,500 Purchase Money Promissory Note secured by a Deed of Trust for the purchase of land and a building. The note was repaid in September 2012 and replaced by a new mortgage (see below).
In August and September of 2012, the Company entered into revolving credit, equipment financing and two mortgage agreements with a bank, as follows:
Revolving Credit Facility. The revolving credit facility provides up to $5 million of credit based on 80% of eligible accounts receivable, as defined. The agreement provides for interest at the lower of (i) Libor plus 2.75% (2.92% as of December 31, 2013) or (ii) the bank’s alternative base rate plus 1.75% (5.00% as of December 31, 2013), plus 0.25% per annum assessed on the unused portion of the credit commitment. The maturity date is August 31, 2014 and is renewable for an additional year on each anniversary date upon mutual agreement of the parties.
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Equipment Financing Facility. The equipment financing facility provides up to $1.25 million of financing for the cost of new and already-owned or leased equipment. The agreement provides for interest at the bank’s cost of funds plus 3% (3.89% as of December 31, 2013). The maturity date for each “schedule” of equipment is up to four years from the borrowing date. Amounts may be borrowed under the facility until August 14, 2014.
Hollywood Way and Vine Street Mortgages. In September 2012, the Company entered into two real estate term loan agreements with respect to its Hollywood Way and Vine Street locations for $5.5 million and $3.1 million, respectively. The loans provide for interest at Libor plus 3% (3.17% as of December 31, 2013). Repayment is based on monthly payments with a 25-year amortization, with all principal due in 10 years. The real estate loans are secured by first trust deeds on the properties.
General Terms. All amounts due under the revolving credit facility, equipment financing facility and mortgage facilities are secured by all personal property and real estate of the Company. While amounts are outstanding under the credit arrangements, the Company will be subject to financial covenants as follows:
1. | Minimum tangible net worth (TNW) of $8.5 million (the Company’s actual TNW was $7.7 million as of December 31, 2013). | |
2. | Minimum quarterly EBITDA (as defined) of $750,000, provided that EBITDA may be a minimum of $500,000 in any one quarter within four consecutive quarters (the Company’s EBITDA was $0.0 million for the quarter ended December 31, 2013). | |
3. | Minimum quarterly fixed charge ratio (as defined) of 1.25 (the Company’s fixed charge ratio was 0.06 for the quarter ended December 31, 2013). | |
4. | Minimum trailing 12 month (TTM) fixed charge ratio (as defined) of 1.25 measured quarterly (the Company’s fixed charge ratio was 0.32 for the TTM ended December 31, 2013). |
Amounts Borrowed. As of December 31, 2013, the Company had no outstanding borrowings under the revolving credit facility and $0.4 million borrowed under the equipment financing facility.
In connection with the termination of the prior credit agreement, the Company paid a $30,000 break-up fee, which was reflected in other income/expense in the three months ended September 30, 2012.
In connection with the September 2012 financing of the Hollywood Way mortgage, the Company received $126,000 (the difference between the new $5,526,000 loan and the $5,400,000 payoff amount of the old loan). The Company used cash of $491,000 (the difference between $3,566,000 payoff of the old loan and $3,075,000 provided by the new loan) in the Vine refinancing. The cash used for both transactions was $365,000, net of transaction costs.
As of December 31, 2013 the Company did not meet the TNW, the minimum quarterly EBITDA, and the minimum quarterly and TTM fixed charge ratio covenants, and obtained a forbearance from the bank. The forbearance acknowledged that a default condition exists, and that availability under the revolving credit and equipment financing facilities will be suspended until the Company demonstrates adequate fixed charge coverage capability and other positive operating developments as determined by the bank. The bank also added an additional financial covenant based on trailing twelve month fixed charge coverage beginning with the quarter ended December 31, 2013 (see 4. above). The bank also limited borrowings under the revolving credit facility to the lesser of (1) 80% of eligible accounts receivable less $600,000 or (2) $1,000,000. Although the bank did not elect to accelerate the Company’s obligations under the agreement, the balance owed for the mortgage debt and capital leases has been classified as a current liability in the balance sheet as of December 31, 2013. If the Company does not achieve compliance in the future, all amounts outstanding under the credit arrangements may become due at the election of the bank.
Monthly and annual principal and interest payments due under the capital leases and mortgages are approximately $68,000 and $0.8 million, respectively, assuming no change in interest rates.
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The following table summarizes the December 31, 2013 amounts outstanding under our line of credit, capital lease obligations and mortgage loans:
Line of credit | $ | - |
Current portion of notes payable, capital leases and mortgages | 8,620,000 | |
Long-term portion of notes payable, capital leases and mortgages | - | |
Total | $ | 8,620,000 |
The Company’s cash balance decreased from $1,696,000 on July 1, 2013 to $1,256,000 on December 31, 2013, due to the following:
Balance July 1, 2013 | $ | 1,696,000 | ||
Decrease in accounts receivable | 1,234,000 | |||
Decrease in accrued expenses & other liabilities | (287,000) | |||
Decrease in notes payable & other liabilities | (253,000) | |||
Capital expenditures for property and equipment | (202,000) | |||
Changes in other assets and liabilities | (932,000) | |||
Balance December 31, 2013 | $ | 1,256,000 |
Cash generated by operating activities is directly dependent upon sales levels and gross margins achieved. We generally receive payments from customers in 60-120 days after services are performed. The larger payroll and facilities components of our cost structure must be paid currently. Payment terms of other liabilities vary by vendor and type. Fluctuations in sales levels will generally affect cash flow negatively or positively in early periods of growth or contraction, respectively, because of operating cash receipt/payment timing. Other investing and financing cash flows also affect cash availability.
In fiscal 2013 and 2014, the underlying drivers of operating cash flows (sales, receivable collections, the timing of vendor payments, facility costs and employment levels) have been consistent. Sales outstanding in accounts receivable have decreased from approximately 64 days to 55 days within the last 12 months. We do not expect days sales outstanding to materially fluctuate in the future.
In June 2011, the Company entered into a lease amendment with respect to the Company’s Media Center facility. The amendment provided that the landlord would reimburse the Company for up to $2 million of improvements to be made to the premises. The amendment also provided that the Company’s monthly rent cost would increase approximately $14,000 on July 1, 2011, and an additional $13,000 to approximately $27,000 on April 1, 2012.
The Company incurred $2.1 million of costs for the Media Center construction, of which $2.0 million was reimbursed by the landlord. The Company completed the project and vacated one of its Burbank facilities on the February 28, 2012 expiration of the related lease and move to the Media Center space. Total annual savings, which began in April 2012, are approximately $1.2 million.
The following table summarizes contractual obligations as of December 31, 2013 due in the future:
Payment due by Period | ||||||||||||||||
Contractual Obligations | Total | Less than 1 Year | Years 2 and 3 | Years 4 and 5 | Thereafter | |||||||||||
Term Debt Principal Obligations | $ | 8,201,000 | $ | 8,201,000 | $ | - | $ | - | $ | |||||||
Term Debt Interest Obligations(1) | 265,000 | 265,000 | - | - | ||||||||||||
Capital Lease Obligations | 419,000 | 419,000 | - | - | ||||||||||||
Capital Lease Interest Obligations | 13,000 | 13,000 | - | - | ||||||||||||
Operating Lease Obligations | 13,591,000 | 1,997,000 | 3,999,000 | 3,844,000 | 3,751,000 | |||||||||||
Line of Credit Obligations | - | - | - | - | - | |||||||||||
Total | $ | 22,489,000 | $ | 10,895,000 | $ | 3,999,000 | $ | 3,844,000 | $ | 3,751,000 |
(1) Interest on variable rate debt has been computed using the rate on the latest balance sheet date.
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As described elsewhere in this Form 10-Q, the Company began a research and development project in Fiscal 2010 to create “proof of concept” stores to distribute digital video discs (DVDs) to consumers. The Company initially issued stock (valued at $500,000) and cash for assets and intellectual property, and spent $4.7 million in Fiscal 2010 and 2011 to test the concept. The plan was to open test stores, three of which were completed at a cost of approximately $200,000 per store for the physical build-out and inventory. Over the last 12 months, the quarterly negative cash flow (defined as earnings before interest, taxes, depreciation and amortization) for each of the three stores operating during that period has averaged $17,000 on revenues of $39,000, including rent for the two previously vacant locations. We estimate that cash flow break even can be achieved on revenues of $56,000per quarter per store, which level may be lower if administrative costs were spread over a larger number of stores. Further expansion of Movie>Q will depend on the performance of the stores and the availability of additional funding.
During the past year, the Company had generated sufficient cash flow to meet operating, capital expenditure and debt service needs and its other obligations. When preparing estimates of future cash flows, we consider historical performance, technological changes, market factors, industry trends and other criteria. In our opinion, the Company will continue to be able to fund its needs for the foreseeable future, unless its bank elects to declare all obligations due and payable as a result of the current covenant default condition.
We will continue to consider the acquisition of businesses which compliment our current operations and possible real estate transactions. Consummation of any acquisition, real estate or other expansion transaction by the Company may be subject to the Company securing additional financing, perhaps at a cost higher than our existing line of credit and term loans. In the current economic climate, additional financing may not be available. Future earnings and cash flow may be negatively impacted to the extent that any acquired entities do not generate sufficient earnings and cash flow to offset the increased financing costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to allowance for doubtful accounts, valuation of long-lived assets, and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Critical accounting policies are those that are important to the portrayal of the Company’s financial condition and results, and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We have made critical estimates in the following areas:
Revenues. We perform a multitude of services for our clients, including film-to-tape transfer, video and audio editing, standards conversions, duplication, distribution, etc. A customer orders one or more of these services with respect to an element (movie, trailer, electronic press kit, etc.). The sum total of services performed on a particular element (a “package”) becomes the deliverable (i.e., the customer will pay for the services ordered in total when the entire job is completed). Occasionally, a major studio will request that package services be performed on multiple elements. Each element creates a separate revenue stream which is recognized only when all requested services have been performed on that element. At the end of an accounting period, revenue is accrued for un-invoiced but shipped work.
Certain jobs specify that many discrete tasks must be performed which require up to four months to complete. In such cases, we use the proportional performance method for recognizing revenue. Under the proportional performance method, revenue is recognized based on the value of each stand-alone service completed.
In some instances, a client will request that we store (or “vault”) an element for a period ranging from a day to indefinitely. The Company attempts to bill customers a nominal amount for storage, but some customers, especially major movie studios, will not pay for this service. In the latter instance, storage is an accommodation to foster additional business with respect to the related element. It is impossible to estimate (i) the length of time we may house the element, or (ii) the amount of additional services we may be called upon to perform on an element. We do not treat vaulting as a separate deliverable in those instances in which the customer does not pay.
The Company records all revenues when all of the following criteria are met: (i) there is persuasive evidence that an arrangement exists; (ii) delivery has occurred or the services have been rendered; (iii) the Company’s price to the customer is fixed or determinable; and (iv) collectability is reasonably assured. Additionally, in instances where package services are performed on multiple elements or where the proportional performance method is applied, revenue is recognized based on the value of each stand-alone service completed.
Allowance for doubtful accounts. We are required to make judgments, based on historical experience and future expectations, as to the collectability of accounts receivable. The allowances for doubtful accounts and sales returns represent allowances for customer trade accounts receivable that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their net realizable value. The Company records these allowances as a charge to selling, general and administrative expenses based on estimates related to the following factors: (i) customer specific allowance; (ii) amounts based upon an aging schedule and (iii) an estimated amount, based on the Company’s historical experience, for issues not yet identified.
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Valuation of long-lived assets. Long-lived assets, consisting primarily of property, plant and equipment comprise a significant portion of the Company’s total assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances have indicated that their carrying amounts may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to its fair value in a current transaction between willing parties, other than in a forced liquidation sale.
Factors we consider important which could trigger an impairment review include the following:
· | Significant underperformance relative to expected historical or projected future operating results; | |
· | Significant changes in the manner of our use of the acquired assets or the strategy of our overall business; | |
· | Significant negative industry or economic trends; | |
· | Significant decline in our stock price for a sustained period; and | |
· | Our market capitalization relative to net book value. |
When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on comparing the carrying amount of the asset to its fair value in a current transaction between willing parties or, in the absence of such measurement, on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Any amount of impairment so determined would be written off as a charge to the statement of operations, together with an equal reduction of the related asset. Net long-lived assets amounted to approximately $15.3 million as of December 31, 2013.
Research and Development. Research and development costs include expenditures for planned search and investigation aimed at discovery of new knowledge to be used to develop new services or processes or significantly enhance existing processes. Research and development costs also include the implementation of the new knowledge through design, testing of service alternatives, or construction of prototypes. The cost of materials and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses are capitalized as tangible assets when acquired or constructed. All other research and development costs are expensed as incurred.
Accounting for income taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.
At December 31, 2013, the Company has no uncertain tax positions. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The deferred tax assets are fully reserved at December 31, 2013.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk. The Company had borrowings of $8.6 million on December 31, 2013 under note payable and mortgage agreements. Our line of credit, equipment financing and two mortgage loans are subject to variable interest rates. The weighted average interest rate paid during the three months ended December 31, 2013 was 3.3%. For variable rate debt outstanding at December 31, 2013, a .25% increase in interest rates will increase annual interest expense by approximately $22,000. Amounts outstanding or that may become outstanding under our credit facilities provide for interest primarily at the LIBOR plus 2.5-3.0% (2.67% to 3.17% as of December 31, 2013). The Company’s market risk exposure with respect to financial instruments is to changes in LIBOR.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2013.
Changes in Internal Control over Financial Reporting
The Chief Executive Officer and President and the Chief Financial Officer conducted an evaluation of our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) to determine whether any changes in internal control over financial reporting occurred during the quarter ended December 31, 2013 that have materially affected or which are reasonably likely to materially affect internal control over financial reporting. Based on the evaluation, no such change occurred during such period.
Internal control over financial reporting refers to a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
· | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; | |
· | Provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and members of our board of directors; and | |
· | Provide reasonable assurance regarding the prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements. |
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company may become a party to legal actions and complaints against the Company arising in the ordinary course of business, although it is not currently involved in any such legal proceedings.
ITEM 1A. RISK FACTORS
In our capacity as Company management, we may from time to time make written or oral forward-looking statements with respect to our long-term objectives or expectations which may be included in our filings with the Securities and Exchange Commission (the “SEC”), reports to stockholders and information provided on our web site.
The words or phrases “will likely,” “are expected to,” “is anticipated,” “is predicted,” “forecast,” “estimate,” “project,” “plans to continue,” “believes,” or similar expressions identify “forward-looking statements.” Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. We wish to caution you not to place undue reliance on any such forward-looking statements, which speak only as of the date made. We are calling to your attention important factors that could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The following list of important factors may not be all-inclusive, and we specifically decline to undertake an obligation to publicly revise any forward-looking statements that have been made to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Among the factors that could have an impact on our ability to achieve expected operating results and growth plan goals and/or affect the market price of our stock are:
· | Recent history of losses. | |
· | Changes in credit agreements and breaches of related covenants and ongoing liquidity. | |
· | Our highly competitive marketplace. |
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· | The risks associated with dependence upon significant customers. | |
· | Our ability to execute our expansion strategy. | |
· | The uncertain ability to manage in a changing environment. | |
· | Our dependence upon and our ability to adapt to technological developments. | |
· | Dependence on key personnel. | |
· | Our ability to maintain and improve service quality. | |
· | Fluctuation in quarterly operating results and seasonality in certain of our markets. | |
· | Possible significant influence over corporate affairs by significant shareholders. | |
· | Our ability to operate effectively as a stand-alone, publicly traded company. | |
· | The consequences of failing to implement effective internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. | |
· | Possibility of the Company’s stock being delisted from the Nasdaq Capital Market. |
Other factors not identified above, including the risk factors described in the “Risk Factors” section of the Company’s June 30, 2013, Form 10-K filed with the Securities and Exchange Commission, may also cause actual results to differ materially from those projected by our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these areas of risk in connection with considering any forward-looking statements that may be made in this Form 10-Q and elsewhere by us and our business generally. Except to the extent of any obligation to disclose material information under the federal securities laws or the rules of the NASDAQ Capital Market, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events.
ITEM 6. EXHIBITS
(a) | Exhibits |
31.1 | Certification of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101 | The following unaudited financial information from our Quarterly Report on Form 10-Q for the quarter and six months ended December 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (1) Consolidated Balance Sheets as of December 31, 2013 and June 30, 2013; (2) Consolidated Condensed Statements of Operations for the three and six months ended December 31, 2012 and 2013; (3) Consolidated Condensed Statements of Cash Flows for the six months ended December 31, 2012 and 2013; and (4) Notes to Condensed Consolidated Financial Statements. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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DATE: February 10, 2014 | BY: | /s/ Alan R. Steel |
Alan R. Steel | ||
Executive Vice President, | ||
Finance and Administration | ||
(duly authorized officer and principal financial officer) |
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