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United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For The Quarterly Period Ended September 30, 2001
OR
[_] 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 0-11071
_______________________
IMAGE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
_______________________
California 84-0685613
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification Number)
9333 Oso Avenue, Chatsworth, California 91311
(Address of principal executive offices, including zip code)
(818) 407-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ( x ) NO ( )
Number of shares outstanding of the registrant's common stock on November 5,
2001: 15,828,253
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PART I - FINANCIAL INFORMATION
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ITEM 1. Financial Statements.
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IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, 2001 and March 31, 2001
________________________________________________________________________________
ASSETS
(In thousands) September 30, 2001 March 31, 2001
------------------ --------------
Cash and cash equivalents $ 1,365 $ 606
Accounts receivable, net of allowances of
$4,617 - September 30, 2001;
$4,470 - March 31, 2001 11,768 14,393
Inventories 18,731 18,622
Royalty and distribution fee advances 17,488 12,879
Prepaid expenses and other assets 2,219 2,442
Deferred tax assets 5,013 4,254
Property, equipment and improvements, net of
accumulated depreciation and amortization of
$8,669 - September 30, 2001;
$7,318 - March 31, 2001 14,554 14,559
Goodwill, net of accumulated amortization of
$1,377 - September 30, 2001;
$1,123 - March 31, 2001 6,251 6,506
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$ 77,389 $ 74,261
================== ==============
See accompanying notes to consolidated financial statements
-1-
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, 2001 and March 31, 2001
________________________________________________________________________________
LIABILITIES AND SHAREHOLDERS' EQUITY
(In thousands, except share data) September 30, 2001 March 31, 2001
------------------ --------------
LIABILITIES:
Accounts payable and accrued liabilities $ 16,403 $ 18,511
Accrued royalties and distribution fees 4,268 4,460
Revolving credit and term loan facilities 8,486 2,603
Revolving loan facility -- disc manufacturer 6,500 6,500
Real estate credit facility 2,918 3,004
Capital lease obligations 1,738 1,061
Equipment line of credit 891 647
Convertible subordinated note payable 5,000 5,000
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Total liabilities 46,204 41,786
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SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, 3,366,000 shares
authorized; none issued and outstanding -- --
Common stock, no par value, 30,000,000 shares authorized;
15,822,000 and 15,849,000 issued and outstanding
at September 30, 2001 and March 31, 2001, respectively 29,824 29,765
Additional paid-in capital 3,320 3,320
Accumulated deficit (1,959) (610)
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Net shareholders' equity 31,185 32,475
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$ 77,389 $ 74,261
================== ==============
See accompanying notes to consolidated financial statements
-2-
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Three Months Ended September 30, 2001 and 2000
________________________________________________________________________________
(In thousands, except per share data) 2001 2000
-------- --------
NET REVENUES $ 21,070 $ 25,580
OPERATING COSTS AND EXPENSES:
Cost of sales 15,127 17,882
Selling expenses 2,237 2,297
General and administrative expenses 3,077 2,323
Amortization of production costs 1,279 1,203
Amortization of goodwill 127 127
-------- --------
21,847 23,832
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EARNINGS (LOSS) FROM OPERATIONS (777) 1,748
OTHER EXPENSES (INCOME):
Interest expense, net 499 419
Other 63 (479)
-------- --------
562 (60)
-------- --------
EARNINGS (LOSS) BEFORE INCOME TAXES (1,339) 1,808
INCOME TAX (BENEFIT) EXPENSE (483) 55
-------- --------
NET EARNINGS (LOSS) $ (856) $ 1,753
======== ========
NET EARNINGS (LOSS) PER SHARE:
Basic $ (.05) $ .11
Diluted $ (.05) $ .10
======== ========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic 15,821 16,479
======== ========
Diluted 15,821 17,876
======== ========
See accompanying notes to consolidated financial statements
-3-
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the Six Months Ended September 30, 2001 and 2000
________________________________________________________________________________
(In thousands, except per share data) 2001 2000
---------- ----------
NET REVENUES $ 41,550 $ 49,547
OPERATING COSTS AND EXPENSES:
Cost of sales 29,761 34,727
Selling expenses 4,285 4,234
General and administrative expenses 5,803 4,582
Amortization of production costs 2,586 2,202
Amortization of goodwill 254 254
---------- ----------
42,689 45,999
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EARNINGS (LOSS) FROM OPERATIONS (1,139) 3,548
OTHER EXPENSES (INCOME):
Interest expense, net 925 849
Other 44 (464)
---------- ----------
969 385
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EARNINGS (LOSS) BEFORE INCOME TAXES (2,108) 3,163
INCOME TAX (BENEFIT) EXPENSE (759) 95
---------- ----------
NET EARNINGS (LOSS) $ (1,349) $ 3,068
========== ==========
NET EARNINGS (LOSS) PER SHARE:
Basic $ (.09) $ .19
Diluted $ (.09) $ .18
========== ==========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic 15,819 16,469
========== ==========
Diluted 15,819 17,860
========== ==========
See accompanying notes to consolidated financial statements
-4-
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Six Months Ended September 30, 2001 and 2000
________________________________________________________________________________
(In thousands) 2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ (1,349) $ 3,068
Adjustments to reconcile net earnings (loss)
to net cash (used in) provided by operating activities:
Amortization of production costs 2,586 2,202
Amortization of goodwill 254 254
Depreciation and other amortization 1,361 981
Deferred income taxes (759) --
Amortization of restricted stock units 98 130
Provision for lower of cost or market inventory writedowns 244 120
Provision for estimated doubtful accounts receivable 150 442
Gain on sale of land -- (499)
Changes in assets and liabilities associated
with operating activities:
Accounts receivable 2,475 (4,777)
Inventories (353) (428)
Royalty and distribution fee advances, net (4,609) (2,245)
Production cost expenditures (2,586) (3,079)
Prepaid expenses and other assets 223 (156)
Accounts payable, accrued royalties and liabilities (2,250) 5,562
---------------- --------------
Net cash (used in) provided by operating activities (4,515) 1,575
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,356) (1,775)
Net proceeds from sale of land -- 1,399
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Net cash used in investing activities (1,356) (376)
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See accompanying notes to consolidated financial statements
-5-
IMAGE ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(unaudited)
For the Six Months Ended September 30, 2001 and 2000
________________________________________________________________________________
(In thousands) 2001 2000
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CASH FLOWS FROM FINANCING ACTIVITIES:
Advances under revolving credit and term loan facility $ 47,761 $ 43,517
Advances under equipment line of credit 244 411
Advances under capital lease obligation 915 --
Repayment of advances under revolving credit and
term loan facility (41,878) (44,767)
Repayment of advances under real estate credit facility (86) (86)
Principal payments under capital lease obligations (213) (182)
Repurchase of common stock (113) (421)
------------------- ----------------
Net cash provided by (used in) financing activities 6,630 (1,528)
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NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS: 759 (329)
Cash and cash equivalents at beginning of period 606 1,532
------------------- ----------------
Cash and cash equivalents at end of period $ 1,365 $ 1,203
=================== ================
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 681 $ 860
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SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
On July 9, 2001 and June 30, 2000, the Company issued 19,884 and 28,674 shares
of common stock, respectively, to officers (net of shares withheld for payment
of related income taxes) in connection with the vesting of restricted stock
units. The Company increased common stock at July 9, 2001 and June 30, 2000 by
approximately $172,000 and $215,000, respectively, such amounts representing the
value of the total vested shares as of the respective grant dates less the value
of shares withheld for payment of related income taxes on the vesting dates.
See accompanying notes to consolidated financial statements
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
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Note 1. Basis of Presentation.
The accompanying consolidated financial statements include the accounts of Image
Entertainment, Inc. ("Image"), its wholly-owned subsidiary DVDPlanet.com, Inc.
(formerly known as Image Newco, Inc., doing business as Ken Crane's
DVD/Laserdisc and DVDPlanet.com, Inc. ("DVDPlanet")), and Image's controlled,
50%-owned joint venture, Aviva International, LLC ("Aviva") (collectively, the
"Company"). All significant inter-company balances and transactions have been
eliminated in consolidation. DVDPlanet was acquired in January 1999 and Aviva
was formed in June 1999.
The accompanying condensed consolidated financial statements are unaudited and
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. They do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. However, except as disclosed herein, there has been no material
change in the information disclosed in the notes to consolidated financial
statements included in the Annual Report on Form 10-K of the Company for the
year ended March 31, 2001. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation have been included. Operating results for the three and six months
ended September 30, 2001, are not necessarily indicative of the results that may
be expected for the fiscal year ending March 31, 2002. The accompanying
consolidated financial information for the three and six months ended September
30, 2001 and 2000 should be read in conjunction with the Financial Statements,
the Notes thereto and Management's Discussion and Analysis of Financial
Condition and Results of Operations in the Company's Annual Report on Form 10-K
for the year ended March 31, 2001.
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 significant areas requiring the use of
management's estimates are related to allowances for lower of cost or market
inventory writedowns, doubtful accounts receivables, unrecouped royalty and
distribution fee advances and sales returns. Although these estimates are based
on management's knowledge of current events and actions management may undertake
in the future, actual results may ultimately differ from management's estimates.
Certain fiscal 2001 balances have been reclassified to conform with the fiscal
2002 presentation.
Note 2. New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires
that the purchase method be used for all business combinations initiated after
June 30, 2001. SFAS No. 142 requires that goodwill no longer be amortized to
earnings, but instead be reviewed for impairment. The amortization of goodwill
ceases upon adoption of SFAS No. 142. SFAS No. 142 must be adopted in fiscal
years beginning after December 15, 2001, as of the beginning of the fiscal year.
The Company is currently evaluating the effects that the adoption of SFAS No.
141 and Statement No. 142 will have on its financial position and results from
operations. The Company does have goodwill recorded and anticipates adopting
Statement No. 142 on April 1, 2002.
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
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Note 3. Inventories.
Inventories at September 30, 2001 and March 31, 2001 are summarized as follows:
September 30, March 31,
(In thousands) 2001 2001
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DVD $ 13,106 $ 13,104
Other 925 1,197
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14,031 14,301
Reserve for lower of cost or market inventory writedowns:
DVD (920) (915)
Other (336) (720)
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(1,256) (1,635)
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12,775 12,666
Production costs, net 5,956 5,956
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$ 18,731 $ 18,622
================== =================
Inventories consist primarily of finished product for sale and are stated at the
lower of average cost or market.
Production costs are reflected net of accumulated amortization of $12,768,000
and $10,607,000 at September 30, 2001 and March 31, 2001, respectively.
Note 4. Debt.
Revolving Credit and Term Loan Facilities. Effective September 30, 2001, the
- -----------------------------------------
Company and Foothill Capital Corporation ("Foothill") amended the Company's Loan
and Security Agreement dated December 28, 1998 (the "Agreement"). The
significant terms amended are as follows: (1) the term of the Agreement was
extended three years to December 29, 2004 (the Agreement still contains an
automatic renewal provision for successive one-year periods thereafter unless
terminated by either the Company or Foothill); (2) certain borrowing base
availability limitations were redefined providing the Company with additional
borrowing availability under the revolving credit facility of approximately
$1,350,000 at September 30, 2001; (3) the minimum interest rate for the
facilities was lowered from 7% to 5.75%; (4) the maximum borrowing limit under
the capital expenditure term loan facility component of the Agreement was raised
from $500,000 to $1,000,000; (5) the tangible net worth financial covenant was
redefined, increasing minimum required levels which the Company must maintain
quarterly; and, (6) a financial covenant was added requiring the Company to
maintain certain minimum levels of quarterly EBITDA (earnings before interest,
taxes, depreciation and amortization).
At September 30, 2001, the Company had $8,147,000 outstanding under its
$15,000,000 revolving credit facility and $339,000 outstanding under its
$1,000,000 capital expenditure term loan facility with Foothill. On such date,
the Company had borrowing availability of $3,702,000 under its revolving credit
facility, net of amounts utilized for an outstanding standby letter of credit,
and $661,000 under its capital expenditure term loan facility. Borrowings under
the revolving credit and term loan facilities bear interest at prime plus 0.75%
(6.75% at September 30, 2001).
At September 30, 2001, the Company had one outstanding standby letter of credit
in the amount of $150,000 issued by Foothill which has been renewed through
November 18, 2002. This standby letter of credit secures trade payables to a
program supplier.
Real Estate Credit Facility. At September 30, 2001, $2,918,000 in borrowings
- ---------------------------
were outstanding under the revolving real estate credit facility with Bank of
America National Trust and Savings Association in Nevada. Borrowings bear
interest at LIBOR plus 2.25% (6.06% at September 30, 2001). The Company may
repay and reborrow principal
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
amounts provided the outstanding borrowings do not exceed the maximum commitment
of $2,918,000 at September 30, 2001, reduced quarterly by $43,000. The credit
facility expires on January 31, 2008.
Capital Lease Obligations. At September 30, 2001, $865,000 in borrowings were
- -------------------------
outstanding under the distribution equipment lease facility with BankAmerica
Leasing and Capital Corporation. Borrowings bear interest at a fixed rate of
7.719% and are repaid quarterly through October 1, 2003.
In July 2001, the Company entered into a capital lease agreement with General
Electric Capital Corporation for the lease of DVD production equipment. The term
of the lease is 48 months through September 2005. Borrowings under the lease
bear interest at 7.58% per annum. Monthly payments, which began September 1,
2001, are approximately $22,000. At September 30, 2001, $873,000 in borrowings
were outstanding under the lease.
Equipment Line of Credit. The Company's June 28, 2000 equipment line of credit
- ------------------------
with Bank of America, N.A. in Nevada was converted into a note payable in the
amount of $891,000 on September 30, 2001. Outstanding borrowings under the note
are to be repaid in 42 equal principal installments plus interest through
maturity on February 28, 2005. The note bears interest at LIBOR plus 2.50%
(6.08% at September 30, 2001).
Convertible Subordinated Note Payable. At September 30, 2001, the Company had
- -------------------------------------
$5,000,000 outstanding under the convertible subordinated note payable to Image
Investors Co., bearing interest at 8.0% and due September 29, 2002.
At September 30, 2001, the Company was in compliance with all financial and
operating covenants under its debt agreements.
Note 5. Revolving Loan Facility -- Disc Manufacturer.
In March 2001, Image entered into an Optical Disc Replication and Loan Agreement
(the "Agreement") with MRT Technology LLC, doing business as Ritek Global Media
("Ritek"). The five-year term of the Agreement commenced August 1, 2001.
Under the terms of the Agreement, Ritek has provided Image with a commitment to
provide title development funding in the form of a series of advances under an
unsecured, non-interest bearing loan. The purpose of Ritek's loan commitment to
Image is to assist Image in funding the acquisition of entertainment programming
for exclusive United States and/or worldwide distribution, whether through a
license or exclusive distribution agreement. Outstanding balances under the loan
are subordinate to all of Image's obligations to BankAmerica Leasing and Capital
Corporation, Bank of America National Trust and Savings Association of Nevada,
Foothill Capital Corporation and Image Investors Co. and all replacements and
refinancings of such debt.
Repayment of the initial loan of $6,500,000 commenced in October 2001 on a per
unit basis of $1.00 for each DVD and $.50 for each CD ordered by the Company
from Ritek. Additional advances will be made by Ritek to Image on September 1 of
each year from 2002 through 2005 based on prior year orders ($1.00 per DVD and
$0.50 per CD) with advances not exceeding $10,000,000 and the final advance in
2005 not exceeding $5,000,000. The agreement contains an option for Ritek to
renegotiate the terms if Image fails to meet certain minimum order levels.
At September 30, 2001, $6,500,000 was outstanding under the loan from Ritek. As
outstanding amounts are non-interest bearing, the Company imputed interest
expense of approximately $102,000 and $232,000 for the three and six months
ended September 30, 2001, respectively, at Image's incremental borrowing rate.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
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Note 6. Net Earnings (Loss) per Share.
The following presents a reconciliation of the numerators and denominators used
in computing basic and diluted net earnings (loss) per share for the three and
six months ended September 30, 2001 and 2000:
Three months Three months Six months Six months
ended ended ended ended
September 30, September 30, September 30, September 30,
(In thousands, except per share data) 2001 2000 2001 2000
---------- ---------- ---------- ----------
Net earnings (loss) (basic numerator) $ (856) $ 1,753 $ (1,349) $ 3,068
========== ========== ========== ==========
Interest, net of taxes, on assumed
conversion of dilutive security -- 97 -- 195
---------- ---------- ---------- ----------
Net earnings (loss) (diluted numerator) $ (856) $ 1,850 $ (1,349) $ 3,263
========== ========== ========== ==========
Weighted average common shares
outstanding(basic denominator) 15,821 16,479 15,819 16,469
========== ========== ========== ==========
Effect of dilutive securities -- 1,397 -- 1,391
---------- ---------- ---------- ----------
Weighted average common shares
outstanding(diluted denominator) 15,821 17,876 15,819 17,860
========== ========== ========== ==========
Net earnings (loss) per share
Basic $ (.05) $ .11 $ (.09) $ .19
Diluted $ (.05) $ .10 $ (.09) $ .18
========== ========== ========== ==========
Diluted net loss per share for the three and six months ended September 30, 2001
is based only on the weighted average number of common shares outstanding for
the periods as inclusion of common stock equivalents (outstanding common stock
options and common stock underlying the convertible subordinated note payable
totaling 1,340,000 and 1,379,000, respectively) would be antidilutive.
Outstanding common stock options not included in the computation of diluted net
income per share totaled 1,140,000 for the three and six months ended September
30, 2000 and were excluded because their exercise prices were greater than the
average market price of the common stock for the periods and the assumed
exercise would be antidilutive.
Note 7. Sale of Land in Fiscal 2001.
In August 2000, the Company closed escrow for the sale (to a real estate
developer) of the remaining approximate 4.7 acres of vacant land adjacent to the
Company's 8.4 acre warehouse and distribution facility site in Las Vegas, Nevada
for net proceeds of approximately $1,399,000. The resulting pretax gain on sale
of $499,000 was recorded as other income in the accompanying consolidated
statements of operations for the three and six months ended September 30, 2000.
Note 8. Segment Information.
Selected financial information regarding the Company's reportable business
segments, program licensing and production/domestic wholesale distribution
("Domestic Wholesale Distribution"), direct-to-consumer retail distribution
(through DVDPlanet) ("Retail Distribution"), and international wholesale
distribution/broadcast rights exploitation (through Aviva) ("International
Wholesale Distribution"), are presented below. The largest business segment is
Domestic Wholesale Distribution of entertainment programming (primarily DVD).
Management currently evaluates segment performance based primarily on net
revenues, operating costs and expenses and earnings (loss) before income
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
taxes. Interest income and expense are evaluated on a consolidated basis and not
allocated to the Company's business segments.
For the Three Months Ended September 30, 2001:
2001
--------------------------------------------------------------------------
Domestic International
Wholesale Retail Wholesale Inter-segment
(In thousands) Distribution Distribution Distribution Eliminations Consolidated
------------- ------------- -------------- ------------ -------------
NET REVENUES $ 16,720 $ 3,923 $ 2,465 $ (2,038) $ 21,070
OPERATING COSTS AND EXPENSES 17,009 4,311 2,619 (2,092) 21,847
------------- ------------- -------------- ------------ -------------
LOSS FROM OPERATIONS (289) (388) (154) 54 (777)
OTHER EXPENSES 499 -- -- 63 562
------------- ------------- -------------- ------------ -------------
LOSS BEFORE INCOME TAXES $ (788) $ (388) $ (154) $ (9) $ (1,339)
============= ============= ============== ============ =============
For the Three Months Ended September 30, 2000:
2000
--------------------------------------------------------------------------
Domestic International
Wholesale Retail Wholesale Inter-segment
(In thousands) Distribution Distribution Distribution Eliminations Consolidated
------------- ------------- -------------- ------------ -------------
NET REVENUES $ 23,587 $ 3,840 $ 1,336 $ (3,183) $ 25,580
OPERATING COSTS AND EXPENSES 21,054 4,566 1,393 (3,181) 23,832
------------- ------------- -------------- ------------ -------------
EARNINGS (LOSS) FROM OPERATIONS 2,533 (726) (57) (2) 1,748
OTHER INCOME (80) -- -- 20 (60)
------------- ------------- -------------- ------------ -------------
EARNINGS (LOSS) BEFORE
INCOME TAXES $ 2,613 $ (726) $ (57) $ (22) $ 1,808
============= ============= ============== ============ =============
For the Six Months Ended September 30, 2001:
2001
--------------------------------------------------------------------------
Domestic International
Wholesale Retail Wholesale Inter-segment
(In thousands) Distribution Distribution Distribution Eliminations Consolidated
------------- ------------- -------------- ------------ -------------
NET REVENUES $ 34,548 $ 7,695 $ 4,356 $ (5,049) $ 41,550
OPERATING COSTS AND EXPENSES 34,399 8,486 4,895 (5,091) 42,689
------------- ------------- -------------- ------------ -------------
EARNINGS (LOSS) FROM OPERATIONS 149 (791) (539) 42 (1,139)
OTHER EXPENSES 925 -- -- 44 969
------------- ------------- -------------- ------------ -------------
LOSS BEFORE INCOME TAXES $ (776) $ (791) $ (539) $ (2) $ (2,108)
============= ============= ============== ============ =============
For the Six Months Ended September 30, 2000:
2000
--------------------------------------------------------------------------
Domestic International
Wholesale Retail Wholesale Inter-segment
(In thousands) Distribution Distribution Distribution Eliminations Consolidated
------------- ------------- -------------- ------------ -------------
NET REVENUES $ 45,625 $ 7,416 $ 2,744 $ (6,238) $ 49,547
OPERATING COSTS AND EXPENSES 40,619 8,898 2,705 (6,223) 45,999
------------- ------------- -------------- ------------ -------------
EARNINGS (LOSS) FROM OPERATIONS 5,006 (1,482) 39 (15) 3,548
OTHER EXPENSES 350 -- -- 35 385
------------- ------------- -------------- ------------ -------------
EARNINGS (LOSS) BEFORE
INCOME TAXES $ 4,656 $ (1,482) $ 39 $ (50) $ 3,163
============= ============= ============== ============ =============
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
As of
-------------------------------
(In thousands) September 30, March 31,
2001 2001
-------------- ------------
Total Assets:
Domestic Wholesale Distribution $ 71,242 $ 67,376
Retail Distribution 8,969 9,785
International Wholesale Distribution 5,559 4,369
Inter-segment eliminations (8,381) (7,269)
-------------- ------------
Consolidated total assets $ 77,389 $ 74,261
============== ============
-12-
ITEM 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations.
---------------------
General
The Company is primarily engaged in the business of licensing and
distributing DVD format entertainment programming in the home video market. The
Company distributes programming exclusively and nonexclusively. In addition to
the DVD format, the Company distributes some of its exclusive titles in the VHS
home video format and the audio portion of certain exclusive programming in the
CD format. The Company also secures and exploits broadcast rights for certain of
its exclusive titles. Broadcast rights may include exploitation via television,
pay-per-view, cable, satellite and radio media. The Company has also begun to
secure Internet streaming and digital downloading rights for certain of its
exclusive titles.
The Company's business strategy is to actively pursue, secure and
exploit exclusive rights to entertainment programming in as many home
entertainment formats and broadcast media as possible, and in as many
territories as possible, for the longest term possible. To this end, the Company
has expanded its business and operations to produce its own entertainment
programming, with an emphasis on music programming. The Company's three
reportable business segments are program licensing and production/domestic
wholesale distribution, direct-to-consumer retail distribution and international
wholesale distribution/broadcast rights exploitation.
Program Licensing & Production/Domestic Wholesale Distribution Segment
----------------------------------------------------------------------
("Domestic Wholesale Distribution"). Operation of the Domestic Wholesale
- -----------------------------------
Distribution segment is conducted by Image. Image distributes entertainment
programming on both an exclusive and nonexclusive basis. The exclusive product
distributed by Image (DVD and other formats) is typically produced, marketed and
sold by Image pursuant to an exclusive grant of rights -- typically a licensing
arrangement but sometimes pursuant to an exclusive distribution agreement. The
nonexclusive product distributed by Image (mainly DVD format product) is
purchased directly from suppliers in final, finished and packaged form.
Direct-to-Consumer Retail Distribution Segment ("Retail
-------------------------------------------------------
Distribution"). The Company's direct-to-consumer retail distribution operations
- --------------
are conducted by DVDPlanet, in conjunction with Image. DVDPlanet specializes in
DVD software retailing through its www.DVDPlanet.com and Kencranes.com web
sites, and via mail order. DVDPlanet also owns and operates a DVD retail store
in Westminster, California. See "Liquidity and Capital Resources --Management's
---
Plan to Improve Fiscal 2002 DVDPlanet Operating Results."
International Wholesale Distribution/Broadcast Rights Exploitation
------------------------------------------------------------------
Segment ("International Wholesale Distribution"). The Company's international
- ------------------------------------------------
wholesale distribution business, and its domestic and international broadcast
rights exploitation activities, are conducted by Aviva, in conjunction with
Image.
Seasonality and Variability.
The Company has generally experienced higher sales in the quarters
ended December 31 and March 31 due to increased consumer spending associated
with the year-end holidays. In addition to seasonality issues, other factors
have contributed to variability in the Company's DVD net revenues on a quarterly
basis. These factors include: (i) wholesale customer and retail consumer demand
for the Company's exclusively distributed programming then in release; (ii) the
Company's licensing and distribution activities relating to new exclusive
programming; (iii) the extension, termination or non-renewal of existing license
and distribution rights; (iv) the Company's marketing and promotional
activities; and (v) general and economic changes affecting the buying habits of
the Company's customers, particularly those changes affecting consumer demand
for DVD hardware and software. Accordingly, the Company's revenues and results
of operations may vary significantly from period to period, and the results of
any one period may not be indicative of the results of any future periods.
-13-
The accompanying consolidated financial information for the three and six
months ended September 30, 2001 should be read in conjunction with the Financial
Statements, the Notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations in the Company's Annual Report on
Form 10-K for the year ended March 31, 2001.
Results of Operations
The Three Months Ended September 30, 2001 Compared to The Three Months Ended
September 30, 2000
The following tables present consolidated net revenues by format and
net revenues by format as a percentage of total consolidated net revenues for
the three months ended September 30, 2001 and 2000. The information in the table
below does not represent segment data, but rather is presented for purposes of
explaining certain trends within net revenues:
Three Months Ended
September 30,
-------------------------------
2001 2000 % Change
------------- -------------- -------------
(in thousands)
Net revenues:
DVD:
Exclusive $ 10,864 $ 16,503 (34.2)%
Nonexclusive 7,315 6,821 7.2
------------- -------------- -------------
Total 18,179 23,324 (22.1)
VHS/CD 1,254 849 47.7
Broadcast/Sublicense 1,048 466 124.9
Other 589 941 (37.4)
------------- -------------- -------------
$ 21,070 $ 25,580 (17.6)%
============= ============== =============
As a percentage of consolidated net revenues:
DVD:
Exclusive 51.6% 64.5% (12.9)%
Nonexclusive 34.7 26.7 8.0
------------- -------------- -------------
Total 86.3 91.2 (4.9)
VHS/CD 5.9 3.3 2.6
Broadcast/Sublicense 5.0 1.8 3.2
Other 2.8 3.7 (0.9)
------------- -------------- -------------
100.0% 100.0% --%
============= ============== =============
The following table presents consolidated net revenues by reportable
business segment for the three months ended September 30, 2001 and 2000:
Three Months Ended
September 30,
-------------------------------
2001 2000 % Change
------------- -------------- -------------
(in thousands)
Net revenues:
Domestic Wholesale Distribution $ 14,682 $ 20,404 (28.0)%
Retail Distribution 3,923 3,840 2.2
International Wholesale Distribution 2,465 1,336 84.5
------------- -------------- ------------
Consolidated $ 21,070 $ 25,580 (17.6)%
============= ============== ============
Consolidated net revenues for all segments for the three months ended
September 30, 2001 decreased 17.6% to $21,070,000 from $25,580,000 for the three
months ended September 30, 2000. Factors that contributed to the decrease in
consolidated net revenues for the three months ended September 30, 2001 as
compared to the three months ended September 30, 2000 are detailed below.
Net revenues for the Company's Domestic Wholesale Distribution segment
for the three months ended September 30, 2001 decreased 28.0% to $14,682,000
from net revenues of $20,404,000 for the three months ended September 30, 2000.
Net revenues for the Domestic Wholesale Distribution segment for the three
months ended
-14-
September 30, 2001 and 2000 are reflected after elimination of $2,038,000 and
$3,183,000, respectively, in inter-segment sales from the Domestic Wholesale
Distribution segment to the Retail Distribution segment. Management believes
this segment's revenue performance was negatively impacted by economic weakness
in the retail sector, as well as the loss of exclusive revenues from the Orion
Home Entertainment Corp. ("Orion") and Universal Studios Home Video, Inc.
("Universal") license agreements which expired at the end of the last fiscal
year. Revenue generated from these two agreements totaled over $5,500,000 for
the September 2000 quarter. Approximately $4,000,000 of this $5,500,000 resulted
from a successful sales re-promotion program of previously released exclusive
Universal DVD titles. Management believes that future revenue growth will be
primarily dependent upon Image's ability to continue to license new exclusive
programming as well as renew existing license agreements upon their expiration.
Management further believes that revenue generated from new and existing
licensing should begin to replace these lost revenue sources for fiscal 2002,
but there can be no assurance. See "Liquidity and Capital Resources -- The ---
Company's Liquidity Position at September 30, 2001 and Management's Assessment
of the Company's Liquidity Position for the Next 12 Months."
Net revenues for DVDPlanet, the Company's Retail Distribution segment,
for the three months ended September 30, 2001 increased 2.2% to $3,923,000 from
net revenues of $3,840,000 for the three months ended September 30, 2000. Net
revenues of DVD programming sold by the Retail Distribution segment were up 3.3%
to $3,487,000 for the three months ended September 30, 2001 from $3,377,000 for
the three months ended September 30, 2000. Net revenues of DVD programming via
Internet/mail order increased 13.3% to $2,720,000 for the three months ended
September 30, 2001 from $2,401,000 for the three months ended September 30,
2000. While management believes DVDPlanet is benefitting from consolidation in
the DVD Internet retailing sector as well as the growing popularity of the DVD
format, revenue growth was less than management expected. Management believes
economic weakness in the retail sector has also affected DVDPlanet's revenues.
In March 2001, DVDPlanet increased its selling prices to customers as well as
shipping fees charged customers as part of management's plan to improve fiscal
2002 operating results. See "Liquidity and Capital Resources -- Management's
Plan to Improve Fiscal 2002 DVDPlanet Operating Results."
Net revenues for the Company's International Wholesale Distribution
segment for the three months ended September 30, 2001 were up 84.5% to
$2,465,000 from net revenues of $1,336,000 for the three months ended September
30, 2000. For the three months ended September 30, 2001 and 2000, revenues of
approximately $2,002,000 and $1,169,000, respectively, were derived from
international wholesale distribution of Image's licensed DVD and VHS
programming, either through international subdistribution or international
sublicensees. For the three months ended September 30, 2001 and 2000, revenues
of approximately $463,000 and $167,000, respectively, were derived from
international and domestic broadcast exploitation of the Image's licensed
programming. Management expects that projected international growth of DVD
player-households should increase the Company's international DVD revenues.
Additionally, in September 2001, Aviva added a dedicated broadcast sales
executive to further take advantage of broadcast revenue opportunities for the
Company's exclusive programming.
-15-
The following tables present consolidated cost of sales by reportable
business segment and as a percentage of related segment net revenues for the the
three months ended September 30, 2001 and 2000:
Three Months Ended
September 30,
---------------------------
2001 2000
---------- ---------
in thousands)
Cost of sales:
Domestic Wholesale Distribution $ 10,133 $ 13,631
Retail Distribution 3,195 3,402
International Wholesale Distribution 1,799 849
---------- --------
Consolidated $ 15,127 $ 17,882
========== ========
As a percentage of segment net revenues: % Change
------------
Domestic Wholesale Distribution 69.0% 66.8% 2.2%
Retail Distribution 81.4 88.6 (7.2)
International Wholesale Distribution 73.0 63.5 9.5
---------- -------- ------------
Consolidated 71.8% 69.9% 1.9%
========== ======== ===========
Consolidated cost of sales for the three months ended September 30,
2001 was $15,127,000, or 71.8% of net revenues, compared to $17,882,000, or
69.9% of net revenues, for the three months ended September 30, 2000.
Accordingly, consolidated gross profit margin declined to 28.2% for the three
months ended September 30, 2001 from 30.1% for the three months ended September
30, 2000.
In general, the Company's cost of sales, as a percentage of net
revenues, can vary period to period depending upon the sales mix of
higher-margin exclusive programming and lower-margin nonexclusive programming.
The sales mix of exclusive and nonexclusive programming and the cost of sales
within each category will vary with the availability of and the demand for new
and catalogue exclusive and nonexclusive programming. The Company's cost of
sales for exclusive programming will vary depending upon specific royalty rates
or distribution fees paid to program suppliers and will vary for nonexclusive
programming depending upon the cost of the programming from the program
suppliers.
Gross margins for the Domestic Wholesale Distribution segment, as a
percentage of segment net revenues, declined 2.2% to 31.0% for the three months
ended September 30, 2001 from 33.2% for the three months ended September 30,
2000. The 2.2% decrease was primarily due to the decrease in higher-margin
exclusive revenues as a percentage of total segment revenues for the September
2001 quarter as compared to the September 2000 quarter. Beginning in the quarter
ending December 31, 2001, and assuming a similar mix of exclusive and
nonexclusive programming sold, management anticipates that its segment gross
margins will improve as a result of expected manufacturing cost savings to be
realized under the Ritek Global Media manufacturing agreement. See "Liquidity
---
and Capital Resources -- New Disc Manufacturing Agreement and Revolving Loan
Commitment." Manufacturing under the agreement began August 1, 2001.
Gross margins for the Retail Distribution segment, as a percentage of
segment net revenues, improved 7.2% to 18.6% for the three months ended
September 30, 2001 from 11.4% for the three months ended September 30, 2000. The
7.2% increase was primarily due to the increase in selling prices to customers
as well as an increase in shipping fees charged to customers as part of
management's plan to improve fiscal 2002 operating results. See "Liquidity and
---
Capital Resources -- Management's Plan to Improve Fiscal 2002 DVDPlanet
Operating Results."
Gross margins for the International Wholesale Distribution segment, as
a percentage of segment net revenues, declined 9.5% to 27.0% for the three
months ended September 30, 2001 from 36.5% for the three months ended September
30, 2000. The decline in the gross margins was primarily due to a higher
percentage of lower-margin sublicense and broadcast revenues recognized during
the September 2001 quarter, as a percentage of overall segment revenues,
compared to the September 2000 quarter. Beginning in the quarter ending December
31, 2001, and assuming a similar mix of subdistribution, sublicense and
broadcast revenues recognized, management anticipates that its segment
-16-
gross margins will benefit from expected lower international disc manufacturing
costs to be realized under the Ritek Global Media manufacturing agreement.
The following tables present consolidated selling expenses by
reportable business segment and as a percentage of related segment net revenues
for the three months ended September 30, 2001 and 2000:
Three Months Ended
September 30,
-------------------------------
2001 2000 % Change
------------- -------------- -------------
(in thousands)
Selling expenses:
Domestic Wholesale Distribution $ 1,379 $ 1,291 6.8%
Retail Distribution 472 661 (28.6)
International Wholesale Distribution 386 345 11.9
------------- -------------- ------------
Consolidated $ 2,237 $ 2,297 (2.6)%
============= ============== ============
As a percentage of segment net revenues:
Domestic Wholesale Distribution 9.4% 6.3% 3.1%
Retail Distribution 12.0 17.2 (5.2)
International Wholesale Distribution 15.7 25.8 (10.1)
------------- -------------- ------------
Consolidated 10.6% 9.0% 1.6%
============= ============== ============
Consolidated selling expenses for the three months ended September 30,
2001 decreased 2.6% to $2,237,000 from $2,297,000 for the three months ended
September 30, 2000. As a percentage of consolidated net revenues, consolidated
selling expenses for the three months ended September 30, 2001 increased to
10.6% from 9.0% for the three months ended September 30, 2000. Factors that led
to the increase in consolidated selling expenses as a percentage of consolidated
net revenues for the three months ended September 30, 2001 as compared to the
three months ended September 30, 2000 are detailed below.
Selling expenses for the Domestic Wholesale Distribution segment were
up 6.8% to $1,379,000 for the three months ended September 30, 2001 from
$1,291,000 for the three months ended September 30, 2000. As a percentage of
segment net revenues, selling expenses for the three months ended September 30,
2001 were 9.4%, up from 6.3% for the three months ended September 30, 2000 due,
in part, to spreading of fixed costs over lower comparative quarterly revenue.
During the September 2001 quarter, Image incurred comparatively higher
advertising and promotional expenditures (higher by $154,000) for specific title
and line of programming promotions in an effort to drive exclusive sales. The
increased advertising and promotional expenditures were offset, in part, by
reduced travel and convention expenditures (lower by $63,000).
Selling expenses for the Retail Distribution segment decreased 28.6% to
$472,000 for the three months ended September 30, 2001 from $661,000 for the
three months ended September 30, 2000. As a percentage of segment net revenues,
selling expenses were down 5.2% to 12.0% for the three months ended September
30, 2001, from 17.2% for the three months ended September 30, 2000. Selling
expenses for this segment decreased as a percentage of segment net revenues for
the September 2001 quarter based upon the staffing reduction, staffing
redeployment and other operational changes instituted in the fourth quarter of
the fiscal year ended March 31, 2001. See "Liquidity and Capital Resources --
---
Management's Plan to Improve Fiscal 2002 DVDPlanet Operating Results."
Selling expenses for the International Wholesale Distribution segment
increased 11.9% to $386,000 for the three months ended September 30, 2001 from
$345,000 for the three months ended September 30, 2000. However, as a percentage
of segment revenues, selling expenses were down 10.1% to 15.7% for the three
months ended September 30, 2001, from 25.8% for the three months ended September
30, 2000. Management has been working with its international subdistributors to
reduce segment advertising and promotion expenses as a percentage of segment net
revenues.
-17-
The following tables present consolidated general and administrative
expenses by reportable business segment and as a percentage of related segment
net revenues for the three months ended September 30, 2001 and 2000:
Three Months Ended
September 30,
------------------
2001 2000 % Change
-------- -------- --------
(in thousands)
General and administrative expenses:
Domestic Wholesale Distribution $ 2,360 $ 1,883 25.3%
Retail Distribution 517 376 37.5
International Wholesale Distribution 200 64 212.5
-------- -------- -------
Consolidated $ 3,077 $ 2,323 32.5%
======== ======== =======
As a percentage of segment net revenues:
Domestic Wholesale Distribution 16.1% 9.2% 6.9%
Retail Distribution 13.2 9.8 3.4
International Wholesale Distribution 8.1 4.8 3.3
-------- -------- -------
Consolidated 14.6% 9.1% 5.5%
======== ======== =======
Consolidated general and administrative expenses for the three months
ended September 30, 2001 increased 32.5% to $3,077,000 from $2,323,000 for the
three months ended September 30, 2000. As a percentage of consolidated net
revenues, consolidated general and administrative expenses for the three months
ended September 30, 2001 were 14.6%, up from 9.1% for the three months ended
September 30, 2000. Factors that led to the increase in consolidated general and
administrative expenses for the three months ended September 30, 2001 as
compared to the three months ended September 30, 2000 are detailed below.
General and administrative expenses for the Domestic Wholesale
Distribution segment for the three months ended September 30, 2001 were up 25.3%
to $2,360,000 from $1,883,000 for the three months ended September 30, 2000. As
a percentage of segment net revenues, general and administrative expenses for
the three months ended September 30, 2001 were 16.1%, up from 9.2% for the three
months ended September 30, 2000. The increase in absolute dollar general and
administrative expenses for the September 2001 quarter results, in part, from a
litigation settlement fee expense accrual (including associated legal fees)
totaling $310,000, higher depreciation and amortization expense (higher by
$158,000) relating to increased capital expenditures in prior periods, higher
personnel costs (higher by $82,000), and higher other legal costs (higher by
$52,000). These increases were partially offset by a comparatively lower
provision for uncollectible accounts receivable (lower by $127,000) during the
September 2001 quarter than for the September 2000 quarter. Additionally,
spreading fixed costs over lower comparative net revenues for the September 2001
quarter contributed to the increase in segment general and administrative
expenses as a percentage of segment net revenues.
General and administrative expenses for the Retail Distribution segment
increased 37.5% to $517,000 for the three months ended September 30, 2001 from
$376,000 for the three months ended September 30, 2000. As a percentage of
segment net revenues, general and administrative expenses for the three months
ended September 30, 2001 were 13.2%, up from 9.8% for the three months ended
September 30, 2000. The increase in general and administrative expenses was
primarily due to higher depreciation and amortization expenses relating to
increased capital expenditures (higher by $53,000), higher management
information systems' related costs (personnel and third-party computer
programmer services - higher by $45,000), and higher rent (higher by $26,000)
for the September 2001 quarter.
General and administrative expenses for the International Wholesale
Distribution segment increased to $200,000 for the three months ended September
30, 2001 from $64,000 for the three months ended September 30, 2000. As a
percentage of segment net revenues, general and administrative expenses were
8.1% for the three months ended September 30, 2001, up from 4.8% for the three
months ended September 30, 2000. The increase in absolute dollar general and
administrative expenses was primarily due to increased personnel costs (higher
by $75,000) and higher foreign currency exchange loss (higher by $30,000).
-18-
Amortization of production costs for the three months ended September
30, 2001 increased 6.3% to $1,279,000, or 6.1% of consolidated net revenues,
from $1,203,000, or 4.7% of consolidated net revenues, for the three months
ended September 30, 2000. This increase resulted primarily from an increase in
exclusive international titles released and amortized during the three months
ended September 30, 2001 compared to the three months ended September 30, 2000.
Amortization of production costs for the three months ended September 30, 2001
and 2000 included $234,000 and $135,000, respectively, attributable to the
International Wholesale Distribution segment. The Company anticipates that
amortization of production costs will decrease as a percentage of net revenues,
beginning in the quarter ending December 31, 2001, as a result of expected
production cost savings to be realized under the Ritek Global Media
manufacturing agreement. See "Liquidity and Capital Resources -- New Disc
Manufacturing Agreement and Revolving Loan Commitment." Production services
under the manufacturing agreement began August 1, 2001.
Interest expense, net of interest income, for the three months ended
September 30, 2001 increased 19.1% to $499,000, or 2.4% of consolidated net
revenues, from $419,000, or 1.6% of consolidated net revenues, for the three
months ended September 30, 2000. The increase is attributable to higher weighted
average outstanding debt levels offset, in part, by lower weighted average
interest rate levels during the three months ended September 30, 2001 as
compared to the three months ended September 30, 2000.
Other expense for the three months ended September 30, 2001 was $63,000
consisting of the minority interest in the net earnings of Aviva. Other income
for the three months ended September 30, 2000 was $479,000 consisting of a gain
on sale of land of $499,000, net of minority interest in the net earnings of
Aviva of $20,000.
The Company recorded an income tax benefit for the September 2001
quarter of $483,000, based on an estimated consolidated effective income tax
rate of approximately 36%. Income tax expense of $55,000 for the September 2000
quarter reflected an estimated consolidated effective tax rate of approximately
3%. The effective tax rate is subject to on-going review and evaluation by
management.
Consolidated net loss for the September 2001 quarter was $856,000, or
$.05 per basic and diluted share, as compared to consolidated net earnings for
the September 2000 quarter of $1,753,000, or $.11 per basic share and $.10 per
diluted share.
The Six Months Ended September 30, 2001 Compared to The Six Months Ended
September 30, 2000
The following tables present consolidated net revenues by format and
net revenues by format as a percentage of total consolidated net revenues for
the six months ended September 30, 2001 and 2000. The information in the table
below does not represent segment data, but rather is presented for purposes of
explaining certain trends within net revenues:
Six Months Ended
September 30,
----------------
2001 2000 % Change
------- ------- ---------
(in thousands)
Net revenues:
DVD:
Exclusive $21,356 $29,556 (27.7)%
Nonexclusive 15,263 14,614 4.4
------- ------- --------
Total 36,619 44,170 (17.1)
VHS/CD 2,335 2,120 10.1
Broadcast/Sublicense 1,690 1,410 19.9
Other 906 1,847 (50.9)
------- ------- --------
$41,550 $49,547 (16.1)%
======= ======= ========
-19-
As a percentage of consolidated net revenues:
DVD:
Exclusive 51.4% 59.7% (8.3)%
Nonexclusive 36.7 29.5 7.2
------- ------- -------
Total 88.1 89.2 (1.1)
VHS/CD 5.6 4.3 1.3
Broadcast/Sublicense 4.1 2.8 1.3
Other 2.2 3.7 (1.5)
------- ------- -------
100.0% 100.0% -- %
======= ======= =======
The following table presents consolidated net revenues by reportable
business segment for the six months ended September 30, 2001 and 2000:
Six Months Ended
September 30,
------------------
2001 2000 % Change
------- ------- --------
(in thousands)
Net revenues:
Domestic Wholesale Distribution $29,499 $39,387 (25.1)%
Retail Distribution 7,695 7,416 3.8
International Wholesale Distribution 4,356 2,744 58.7
------- ------- -------
Consolidated $41,550 $49,547 (16.1)%
======= ======= =======
Consolidated net revenues for all segments for the six months ended
September 30, 2001 decreased 16.1% to $41,550,000 from $49,547,000 for the six
months ended September 30, 2000. Factors that contributed to the decrease in
consolidated net revenues for the six months ended September 30, 2001 as
compared to the six months ended September 30, 2000 are detailed below.
Net revenues for the Company's Domestic Wholesale Distribution segment
for the six months ended September 30, 2001 decreased 25.1% to $29,499,000 from
net revenues of $39,387,000 for the six months ended September 30, 2000. Net
revenues for the Domestic Wholesale Distribution segment for the six months
ended September 30, 2001 and 2000 are reflected after elimination of $5,049,000
and $6,238,000, respectively, in inter-segment sales from the Domestic Wholesale
Distribution segment to the Retail Distribution segment. Management believes
this segment's revenue performance was negatively impacted by economic weakness
in the retail sector, as well as the loss of exclusive revenues from the Orion
and Universal license agreements which expired at the end of the last fiscal
year. Revenue generated from these two agreements totaled over $7,500,000 for
the September 2000 period. Approximately $4,000,000 of this $7,500,000 resulted
from a successful sales re-promotion program of previously released exclusive
Universal DVD titles. Management believes that future revenue growth will be
primarily dependent upon Image's ability to continue to license new exclusive
programming as well as renew existing license agreements upon their expiration.
Management further believes that revenue generated from new and existing
licensing should begin to replace these lost revenue sources for fiscal 2002,
but there can be no assurance. See "Liquidity and Capital Resources -- The ---
Company's Liquidity Position at September 30, 2001 and Management's Assessment
of the Company's Liquidity Position for the Next 12 Months."
Net revenues for DVDPlanet, the Company's Retail Distribution segment,
for the six months ended September 30, 2001 increased 3.8% to $7,695,000 from
net revenues of $7,416,000 for the six months ended September 30, 2000. Net
revenues of DVD programming sold by the Retail Distribution segment were up 7.7%
to $6,953,000 for the September 2001 period from $6,453,000 for the September
2000 period. Net revenues of DVD programming via Internet/mail order increased
18.0% to $5,345,000 for the September 2001 period from $4,529,000 for the
September 2000 period. While management believes DVDPlanet is benefitting from
consolidation in the DVD Internet retailing sector as well as the growing
popularity of the DVD format, revenue growth was less than management expected.
Management believes the slowing economy has also affected DVDPlanet's revenues.
DVDPlanet has increased its selling prices to customers as well as shipping fees
charged customers as part of management's plan to improve fiscal 2002 operating
results. See "Liquidity and Capital Resources -- Management's Plan to Improve
---
Fiscal 2002 DVDPlanet Operating Results."
Net revenues for the Company's International Wholesale Distribution
segment for the six months ended September 30, 2001 were up 58.7% to $4,356,000
from net revenues of $2,744,000 for the six months ended September
-20-
30, 2000. For the six months ended September 30, 2001 and 2000, revenues of
approximately $3,629,000 and $1,999,000, respectively, were derived from
international wholesale distribution of Image's licensed DVD and VHS
programming, either through international subdistribution or international
sublicensees. For the six months ended September 30, 2001 and 2000, revenues of
approximately $727,000 and $745,000, respectively, were derived from
international and domestic broadcast exploitation of the Image's licensed
programming. Management expects that projected international growth of DVD
player-households should increase the Company's international DVD revenues.
The following tables present consolidated cost of sales by reportable
business segment and as a percentage of related segment net revenues for the the
six months ended September 30, 2001 and 2000:
Six Months Ended
September 30,
------------------
2001 2000
-------- --------
(in thousands)
Cost of sales:
Domestic Wholesale Distribution $ 20,289 $ 26,324
Retail Distribution 6,299 6,579
International Wholesale Distribution 3,173 1,824
-------- --------
Consolidated $ 29,761 $ 34,727
======== ========
As a percentage of segment net revenues: % Change
--------
Domestic Wholesale Distribution 68.8% 66.8% 2.0%
Retail Distribution 81.9 88.7 (6.8)
International Wholesale Distribution 72.8 66.5 6.3
-------- -------- --------
Consolidated 71.6% 70.1% 1.5%
======== ======== ========
Consolidated cost of sales for the six months ended September 30, 2001
was $29,761,000, or 71.6% of net revenues, compared to $34,727,000, or 70.1% of
net revenues, for the six months ended September 30, 2000. Accordingly,
consolidated gross profit margin declined to 28.4% for the September 2001 period
from 29.9% for the September 2000 period.
Gross margins for the Domestic Wholesale Distribution segment, as a
percentage of segment net revenues, declined 2.0% to 31.2% for the six months
ended September 30, 2001 from 33.2% for the six months ended September 30, 2000.
The 2.0% decrease was primarily due to the decrease in higher-margin exclusive
revenues as a percentage of total segment revenues for the September 2001 period
as compared to the September 2000 period. Beginning in the quarter ending
December 31, 2001, and assuming a similar mix of exclusive and nonexclusive
programming sold, management anticipates that its segment gross margins will
improve as a result of expected manufacturing cost savings to be realized under
the Ritek Global Media manufacturing agreement. See "Liquidity and Capital
---
Resources -- New Disc Manufacturing Agreement and Revolving Loan Commitment."
Manufacturing under the agreement began August 1, 2001.
Gross margins for the Retail Distribution segment, as a percentage of
segment net revenues, improved 6.8% to 18.1% for the six months ended September
30, 2001 from 11.3% for the six months ended September 30, 2000. The 6.8%
increase was primarily due to the increase in selling prices to customers as
well as an increase in shipping fees charged to customers for the September 2001
period as part of management's plan to improve fiscal 2002 operating results.
See "Liquidity and Capital Resources -- Management's Plan to Improve Fiscal 2002
- ---
DVDPlanet Operating Results."
Gross margins for the International Wholesale Distribution segment, as
a percentage of segment net revenues, declined 6.3% to 27.2% for the six months
ended September 30, 2001 from 33.5% for the six months ended September 30, 2000.
The decline in the gross margins was primarily due to a higher percentage of
lower-margin sublicense revenues recognized during the September 2001 period, as
a percentage of overall segment net revenues, compared to the September 2000
period. Beginning in the quarter ending December 31, 2001, and assuming a
similar mix of subdistribution, sublicense and broadcast revenue recognized,
management anticipates that its segment gross margins
-21-
will benefit from expected lower international disc manufacturing costs to be
realized under the Ritek Global Media manufacturing agreement.
The following tables present consolidated selling expenses by reportable
business segment and as a percentage of related segment net revenues for the six
months ended September 30, 2001 and 2000:
Six Months Ended
September 30,
-------------------------------
2001 2000 % Change
------------- -------------- -------------
(in thousands)
Selling expenses:
Domestic Wholesale Distribution $ 2,508 $ 2,288 9.6%
Retail Distribution 909 1,334 (31.9)
International Wholesale Distribution 868 612 41.8
------------- -------------- -------------
Consolidated $ 4,285 $ 4,234 1.2%
============= ============== =============
As a percentage of segment net revenues:
Domestic Wholesale Distribution 8.5% 5.8% 2.7%
Retail Distribution 11.8 18.0 (6.2)
International Wholesale Distribution 19.9 22.3 (2.4)
------------- -------------- -------------
Consolidated 10.3% 8.5% 1.8%
============= ============== =============
Consolidated selling expenses for the six months ended September 30, 2001
increased 1.2% to $4,285,000 from $4,234,000 for the six months ended September
30, 2000. As a percentage of consolidated net revenues, consolidated selling
expenses for the September 2001 period increased to 10.3% from 8.5% for the
September 2000 period. Factors that led to the increase in consolidated selling
expenses for the six months ended September 30, 2001 as compared to the six
months ended September 30, 2000 are detailed below.
Selling expenses for the Domestic Wholesale Distribution segment were up
9.6% to $2,508,000 for the six months ended September 30, 2001 from $2,288,000
for the six months ended September 30, 2000. As a percentage of segment net
revenues, selling expenses for the September 2001 period were 8.5%, up from 5.8%
for the September 2000 period due, in part, to spreading of fixed costs over
lower comparative six-month revenues. During the September 2001 period, Image
incurred comparatively higher promotional expenditures (higher by $200,000) and
increased personnel costs (higher by $78,000). In an effort to drive exclusive
sales, Image incurred comparatively higher expenditures during the September
2001 period for specific title and line of programming promotions.
Selling expenses for the Retail Distribution segment decreased 31.9% to
$909,000 for the six months ended September 30, 2001 from $1,334,000 for the six
months ended September 30, 2000. As a percentage of segment net revenues,
selling expenses were down 6.2% to 11.8% for the September 2001 period, from
18.0% for the September 2000 period. Selling expenses for this segment decreased
as a percentage of segment net revenues for the September 2001 period based upon
the staffing reduction, staffing redeployment and operational changes initiated
in the fourth quarter of the fiscal year ended March 31, 2001. See "Liquidity
---
and Capital Resources -- Management's Plan to Improve Fiscal 2002 DVDPlanet
Operating Results."
Selling expenses for the International Wholesale Distribution segment
increased 41.8% to $868,000 for the six months ended September 30, 2001 from
$612,000 for the six months ended September 30, 2000. However, as a percentage
of segment revenues, segment selling expenses were down 2.4% to 19.9% for the
September 2001 period from 22.3% for the September 2000 period. The September
2001 period had comparatively higher expenditures for advertising and promotion
(higher by $145,000) and personnel (higher by $79,000). Although not fully
realized during the September 2001 period as a percentage of segment net
revenues, management has been working with its international subdistributors to
reduce segment advertising and promotion expenses as a percentage of segment net
revenues.
-22-
The following tables present consolidated general and administrative
expenses by reportable business segment and as a percentage of related segment
net revenues for the six months ended September 30, 2001 and 2000:
Six Months Ended
September 30,
-------------------------------
2001 2000 % Change
------------- -------------- -------------
(in thousands)
General and administrative expenses:
Domestic Wholesale Distribution $ 4,388 $ 3,717 18.1%
Retail Distribution 1,024 731 40.1
International Wholesale Distribution 391 134 191.8
------------- -------------- -------------
Consolidated $ 5,803 $ 4,582 26.6%
============= ============== =============
As a percentage of segment net revenues:
Domestic Wholesale Distribution 14.9% 9.4% 5.5%
Retail Distribution 13.3 9.9 3.4
International Wholesale Distribution 9.0 4.9 4.1
------------- -------------- -------------
Consolidated 14.0% 9.2% 4.8%
============= ============== =============
Consolidated general and administrative expenses for the six months ended
September 30, 2001 increased 26.6% to $5,803,000 from $4,582,000 for the six
months ended September 30, 2000. As a percentage of consolidated net revenues,
consolidated general and administrative expenses for the September 2001 period
were 14.0%, up from 9.2% for the September 2000 period. Factors that led to the
increase in consolidated general and administrative expenses for the September
2001 period as compared to the September 2000 period are detailed below.
General and administrative expenses for the Domestic Wholesale Distribution
segment for the six months ended September 30, 2001 were up 18.1% to $4,388,000
from $3,717,000 for the six months ended September 30, 2000. As a percentage of
segment net revenues, general and administrative expenses for the September 2001
period were 14.9%, up from 9.4% for the September 2000 period, with the majority
of the increase due to the spreading of fixed costs over lower revenues. The
increase in absolute dollar general and administrative expenses for the
September 2001 period results, in part, from a litigation settlement fee expense
accrual (including associated legal fees) totaling $310,000, higher depreciation
and amortization expense (higher by $296,000) relating to increased capital
expenditures in prior periods, higher other legal costs (higher by $133,000),
and higher personnel costs (higher by $122,000). These increases were partially
offset by a lower provision for uncollectible accounts receivable (lower by
$275,000) for the September 2001 period than that for the September 2000 period.
General and administrative expenses for the Retail Distribution segment
increased 40.1% to $1,024,000 for the six months ended September 30, 2001 from
$731,000 for the six months ended September 30, 2000. As a percentage of segment
net revenues, general and administrative expenses for the September 2001 period
were 13.3%, up from 9.9% for the September 2000 period. The increase in general
and administrative expenses was primarily due to higher management information
systems' related costs (personnel and third-party computer programmer services -
higher by $137,000), higher depreciation and amortization expenses relating to
increased capital expenditures (higher by $79,000), and higher rent (higher by
$62,000) for the September 2001 period.
General and administrative expenses for the International Wholesale
Distribution segment increased to $391,000 for the six months ended September
30, 2001 from $134,000 for the six months ended September 30, 2000. As a
percentage of segment net revenues, general and administrative expenses were
9.0% for the September 2001 period, up from 4.9% for the September 2000 period.
The increase in absolute dollar general and administrative expenses for the
September 2001 period was primarily due to increased personnel costs (higher by
$141,000) and higher foreign currency exchange loss (higher by $61,000).
Amortization of production costs for the six months ended September 30,
2001 increased 17.4% to $2,586,000, or 6.2% of consolidated net revenues, from
$2,202,000, or 4.4% of consolidated net revenues, for the six months ended
September 30, 2000. This increase resulted primarily from an increase in
exclusive international titles released and
-23-
amortized during the six months ended September 30, 2001 compared to the six
months ended September 30, 2000. Amortization of production costs for the
September 2001 period included $463,000 attributable to the International
Wholesale Distribution segment. The Company anticipates that amortization of
production costs will decrease as a percentage of net revenues, beginning in the
quarter ending December 31, 2001, as a result of expected production cost
savings to be realized under the Ritek Global Media manufacturing agreement. See
---
"Liquidity and Capital Resources -- New Disc Manufacturing Agreement and
Revolving Loan Commitment." Production services under the manufacturing
agreement began August 1, 2001.
Interest expense, net of interest income, for the six months ended
September 30, 2001 increased 9.0% to $925,000, or 2.2% of consolidated net
revenues, from $849,000, or 1.7% of consolidated net revenues, for the six
months ended September 30, 2000. The increase is attributable to higher weighted
average outstanding debt levels offset, in part, by lower weighted average
interest rate levels during the September 2001 period as compared to the
September 2000 period.
Other expense for the six months ended September 30, 2001 was $44,000
consisting of the minority interest in the net earnings of Aviva. Other income
for the six months ended September 30, 2000 was $464,000 consisting of a gain on
sale of land of $499,000, net of minority interest in the net earnings of Aviva
of $35,000.
The Company recorded an income tax benefit for the six months ended
September 30, 2001 of $759,000, based on an estimated consolidated effective
income tax rate of approximately 36%. Income tax expense of $95,000 for the
September 2000 period reflected an estimated consolidated effective tax rate of
approximately 3%. The effective tax rate is subject to on-going review and
evaluation by management.
Consolidated net loss for the six months ended September 30, 2001 period
was $1,349,000, or $.09 per basic and diluted share, as compared to consolidated
net earnings for the six months ended September 30, 2000 of $3,068,000, or $.19
per basic share and $.18 per diluted share.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. SFAS
No. 141 requires that the purchase method be used for all business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill no longer be
amortized to earnings, but instead be reviewed for impairment. The amortization
of goodwill ceases upon adoption of SFAS No. 142. SFAS No. 142 must be adopted
in fiscal years beginning after December 15, 2001, as of the beginning of the
year. The Company is currently evaluating the effects that the adoption of SFAS
No. 141 and Statement No. 142 will have on its financial position and results
from operations. The Company does have goodwill recorded and anticipates
adopting Statement No. 142 on April 1, 2002.
Inflation
Management believes that inflation is not a material factor in the
operation of the Company's business at this time.
Liquidity and Capital Resources
The Company's working capital requirements vary primarily with the level of
its licensing, production and distribution activities. The principal recurring
uses of working capital in operations are for program licensing costs (i.e.,
royalty payments, including advances, to program suppliers), distribution fee
advances, manufacturing and production costs, costs of acquiring finished
product for wholesale distribution and selling, general and administrative
expenses. Working capital has historically been provided by cash flows from
operations, private and public sales of common stock, notes representing short-
and long-term debt and bank borrowings.
-24-
Sources and Uses of Working Capital, Six Months Ended September 30, 2001 and
2000.
Net cash used in operating activities for the six months ended September
30, 2001 was $4,515,000 compared to net cash provided by operating activities of
$1,575,000 for the comparable September 2000 period. The major factors
contributing to the reduction of net cash provided by operating activities for
the six months ended September 30, 2001 as compared to the prior year are as
follows: the Company incurred a net loss of $1,349,000 for the six months ended
September 30, 2001 compared to net earnings of $3,068,000 for the September 2000
period and the September 2001 period had significantly higher royalty and
distribution fee advances paid. Additionally, the Company paid down its accounts
payable, accrued liabilities and accrued royalties and distribution fees
balances during the September 2001 period by $2,250,000 compared to increasing
those same account balances by $5,562,000 during the September 2000 period.
Investing activities consisted primarily of capital expenditures. Such
amounts aggregated $1,356,000 and $1,775,000 during the September 2001 and 2000
six-month periods, respectively. The September 2000 period included net proceeds
of $1,399,000 received from the sale of vacant land adjacent to the Company's
distribution facility.
Net cash provided by financing activities for the six months ended
September 30, 2001 was $6,630,000 compared to net cash used in financing
activities for the six months ended September 30, 2000 of $1,528,000. The
increase was primarily due to increased borrowing activity to finance royalty
and distribution fee advances and capital expenditure requirements.
The Company's Liquidity Position at September 30, 2001 and Management's
Assessment of the Company's Liquidity Position for the Next 12 Months.
At March 31, 2001, the Company had cash and cash equivalents of $606,000,
borrowings outstanding of $2,603,000 and borrowing availability of $12,512,000
under its $15 million revolving credit and $500,000 capital expenditures term
loan facilities with Foothill. At September 30, 2001, the Company had cash and
cash equivalents of $1,365,000, borrowings outstanding of $8,486,000 and
borrowing availability of $4,363,000 under its $15 million revolving credit and
$1 million capital expenditures term loan facilities, as amended, with Foothill.
During the six months ended September 30, 2001, the Company's outstanding
borrowings increased with Foothill because operational cash flow was
insufficient to fund the Company's working capital needs. The Company's working
capital needs increased significantly, primarily by reason of the Company's
aggressive acquisition of exclusive rights to entertainment programming for
worldwide distribution. In addition, the Company's borrowing availability with
Foothill decreased due to increased borrowing and a reduction in the Company's
accounts receivable. Management believes the slowing economy and its effect on
our wholesale customers' buying habits as well as retail customers'
discretionary spending habits negatively impacted revenue performance over the
six months ended September 30, 2001. The loss of revenues from the Orion and
Universal expired license agreements further reduced revenues over the six-month
2001 period compared to the prior-year period.
In March 2001, the Company received a $6,500,000 unsecured, non-interest
bearing loan from Ritek Global Media to assist the Company in funding the
acquisition of entertainment programming for exclusive worldwide distribution,
whether through a license or exclusive distribution agreement. Upon funding, the
Company paid down the then-outstanding borrowings from Foothill. Pursuant to the
terms of the loan agreement with Ritek Global Media, repayment of this loan
began October 2001. See "New Disc Manufacturing Agreement and Revolving Loan
---
Commitment."
At September 30, 2001, the Company had one outstanding standby letter of
credit in the amount of $150,000 issued by Foothill which was renewed through
November 18, 2002. This letter of credit secures trade payables due to a program
supplier.
-25-
At September 30, 2001, the Company had future license obligations for
royalty advances, minimum guarantees and other fees of $5,974,000 due during the
remainder of fiscal 2002 and $4,220,000 due during fiscal 2003. These advances
and guarantees are recoupable against royalties and distribution fees earned (in
connection with Company revenues) by the licensors and program suppliers,
respectively. Depending upon the competition for license and exclusive
distribution rights, the Company may have to pay increased advances, guarantees
and/or royalty rates in order to acquire or retain such rights in the future.
Over the past year, the Company has been on an aggressive licensing
campaign to provide a foundation for future exclusive worldwide revenue growth,
as well as to replace the exclusive revenues lost by reason of the expiration of
the Orion and Universal agreements in March 2001. The Company believes it has
developed a specialty niche in exclusive distribution of music related
entertainment programming. Because of this aggressive licensing campaign, the
Company believes it is the DVD marketplace's leading source of music related
programming, with an estimated 26% share of the market (as reported in the June
10 - 16, 2001 edition of Video Store Magazine, a video industry trade magazine).
These license agreements normally require substantial up-front royalty advances
prior to the release of the programming.
Management disclosed in its Form 10-Q for the quarterly period ended June
30, 2001, that based upon then-operating results, borrowing availability and the
state of the economy, it believed it may have over-committed its then-available
working capital to fund then-existing exclusive license agreements. Management
disclosed its concern that the Company's then-sources of working capital might
be insufficient to fund working capital requirements for the next 12 months
unless certain discretionary licensing and capital investment programs were
rescheduled, restructured or curtailed and/or additional sources of working
capital were secured either through the sale of equity or debt securities, the
incurrence of new debt financing or the restructuring of existing obligations.
During the three months ended September 30, 2001, management has taken the
following courses of action to manage its expected cash outflows against cash
inflows and accordingly, fund working capital requirements for the next 12
months:
Suspended Stock Repurchase Plan. In June 2001, management suspended the
repurchase of its common stock under its existing stock repurchase plan until
such time as the Company's projected short-term and long-term operating cash
flow improves and then-current market conditions and other factors may allow.
Amended Revolving Credit and Term Loan Facilities. Effective September 30,
2001, management amended its revolving credit and term loan facilities with
Foothill which extended the term of the facilities and increased borrowing
availability as of September 30, 2001. See "Amendment of Revolving Credit and
---
Term Loan Facilities."
New Lease Agreement with General Electric Capital Corporation. In July
2001, the Company entered into a capital lease agreement with General Electric
Capital Corporation ("GE Capital") for the lease of DVD production equipment
totaling $915,000. The Company had previously paid cash for these assets.
Proceeds received from GE Capital were used to pay down a portion of the
outstanding borrowings from Foothill. Obligations under the lease agreement are
being repaid over 48 months through September 2005 at approximately $22,000 per
month.
Rescheduled Commitments Under Existing License Agreements. Management has
been successful in working with certain licensors to reschedule payment of
certain royalty advance commitments to later in fiscal 2002 and into fiscal 2003
in an attempt to better match such advances paid with the release of the related
licensed content.
New Exclusive License Agreements. When possible and when in the best
interests of the Company, management has continued to attempt to acquire future
rights pursuant to license agreements which provide for reduced or no up-front
payments of advance royalties as well as a larger percentage of advances and/or
guarantees tied to the release of the licensed content.
-26-
Expedited Release of Licensed Programming. Management is endeavoring to
move up the release dates of higher profile licensed programming for both
domestic and international releases in an effort to speed up the cycle of
recoupment of previously funded royalty advances.
Management believes that through continued successful implementation of the
above courses of action and expected improved revenue performance during the
Company's historically strong holiday selling season, its projected cash flows
from operations, borrowing availability under its revolving lines of credit,
cash on hand and trade credit will provide the necessary capital to meet its
projected cash requirements for at least the next 12 months. However, any
projections of future cash needs and cash flows are subject to substantial
uncertainty. If future cash flows to be generated from operations, future
borrowing availability under its revolving lines of credit, its disc
manufacturer revolving credit commitment and future cash on hand are
insufficient to satisfy the Company's continuing licensing and acquisition of
exclusive DVD programming (which require significant advance royalty or
distribution fee payments), the Company will need to seek additional debt and/or
equity financing. Failure to obtain this additional financing could
significantly restrict the Company's growth plans. There can be no assurance
that additional financing would be available in amounts or on terms acceptable
to the Company, if at all.
Amendment of Revolving Credit and Term Loan Facilities.
Effective September 30, 2001, the Company and Foothill amended its Loan and
Security Agreement dated December 28, 1998 (the "Agreement"). The significant
terms amended are as follows: (1) the term of the Agreement was extended three
years to December 29, 2004 (the Agreement contains an automatic renewal
provision for successive one-year periods thereafter unless terminated by either
the Company or Foothill); (2) certain borrowing base availability limitations
were redefined providing the Company with additional borrowing availability
under the revolving credit facility of approximately $1,350,000 at September 30,
2001; (3) the minimum interest rate for the facilities was lowered from 7% to
5.75%; (4) the maximum borrowing limit under the capital expenditure term loan
facility component of the Agreement was raised from $500,000 to $1,000,000; (5)
the tangible net worth financial covenant was redefined, increasing minimum
required levels for the Company to maintain quarterly; and, (6) a financial
covenant requiring the Company to maintain certain minimum levels of quarterly
EBITDA (earnings before interest, taxes, depreciation and amortization) was
added.
New Disc Manufacturing Agreement and Revolving Loan Commitment.
In March 2001, Image entered into an Optical Disc Replication and Loan
Agreement (the "Agreement") with MRT Technology LLC, doing business as Ritek
Global Media ("Ritek"). The five-year term of the Agreement commenced August 1,
2001. Under the Agreement, Ritek has become the exclusive provider of
manufacturing services associated with the Image's DVD, DVD-audio and compact
disc programming as well as Image's programming on all future home entertainment
storage mediums then-serviced by Ritek.
The provisions of the Agreement are expected to reduce Image's current
optical disc manufacturing costs and related production service costs on a
per-disc basis for Image's exclusive domestic and international releases. The
Company expects to see the benefits of these reduced costs in the form of
increased gross profit margins and lower production cost expenditures beginning
in the Company's third quarter ending December 31, 2001.
In addition to the lower pricing, under the terms of the Agreement, Ritek
has provided Image with a commitment to provide title development funding in the
form of a series of advances under an unsecured, non-interest bearing loan. The
purpose of Ritek's loan commitment to Image is to assist Image in funding the
acquisition of entertainment programming for exclusive United States and/or
worldwide distribution, whether through a license or exclusive distribution
agreement. Outstanding balances under the loan are subordinate to all of Image's
obligations to BankAmerica Leasing and Capital Corporation, Bank of America
National Trust and Savings Association of Nevada, Foothill Capital Corporation
and Image Investors Co. and all replacements and refinancings of such debt.
-27-
Repayment of the initial loan of $6,500,000 commenced in October 2001 on a
per unit basis of $1.00 for each DVD and $.50 for each CD ordered by the Company
from Ritek. Additional advances will be made by Ritek to Image on September 1 of
each year from 2002 through 2005 based on prior year orders ($1.00 per DVD and
$0.50 per CD) with advances not exceeding $10,000,000 and the final advance in
2005 not exceeding $5,000,000. The agreement contains an option for Ritek to
renegotiate the terms if Image fails to meet certain minimum order levels.
At September 30, 2001, $6,500,000 was outstanding under the loan from
Ritek. As outstanding amounts are non-interest bearing, the Company imputed
interest expense of approximately $102,000 and $232,000 for the three and six
months ended September 30, 2001, respectively, at Image's incremental borrowing
rate.
Management's Plan to Improve Fiscal 2002 DVDPlanet Operating Results.
In July 1999, the Company began expanding the DVDPlanet employee base in
anticipation of growth in DVD revenues through direct-to-consumer distribution
via the Internet. The majority of the new employees hired were based in Image's
Chatsworth, California corporate headquarters and not at DVDPlanet's retail
store and shipping facility in Westminster, California. From mid-calendar 1999
and throughout calendar 2000, competing Internet retailers offered DVD
programming to consumers at deep discounts, often at or below their actual cost,
in an effort to capture new customers. Management believes that profitability
for these Internet retailers was ultimately sacrificed to obtain rapid revenue
growth during this period. Although DVDPlanet did lower its pricing to consumers
with an additional discount from the suggested retail price, it did not
eliminate its entire gross profit margin to match its competitors' pricing.
Management believes, in large part because of its competitors' pricing policies,
DVDPlanet's revenue growth has been below management's expectations. During the
Company's third quarter ended December 31, 2000, the financial difficulties and
related attrition experienced by certain Internet DVD retailers led to generally
increased pricing to consumers by the remaining Internet DVD retailers.
Management believes this overall pricing increase by DVDPlanet's competitors has
positively impacted DVDPlanet Internet-based revenues since that time, because
the disparity in pricing between DVDPlanet and its competitors narrowed.
With lower than expected revenue growth and a significant increase in
operating expenses, DVDPlanet had sustained upwardly trending quarterly losses.
In response to the negative trend in the operating results of DVDPlanet,
management developed an action plan (the "Action Plan") to improve the operating
results of DVDPlanet with the goal of achieving positive cash flows and
profitability. The Action Plan principally involved (i) initiatives which were
implemented by March 2001 (including (a) fulfilling DVDPlanet's orders out of
the Company's Las Vegas, Nevada warehouse and distribution facility; (b)
increased pricing and shipping charges to customers; (c) reduction in
ineffective customer solicitations; and, (d) reduction in selling and shipping
department payroll expenses and redeployment of certain personnel to the
Domestic Wholesale Distribution segment) and (ii) initiatives which were
implemented during the quarter ended June 30, 2001 (including (a) realignment of
customer service, retail sales and shipping functions and (b) changes in class
of shipping).
Management believes that implementation of the aforementioned Action Plan
has yielded positive operating results for the six months ended September 30,
2001 as compared to the prior year. EBITDA (earnings before interest, taxes,
depreciation and amortization), a measure of cashflow, improved 71.5% to a
negative EBITDA of $308,000 for the six months ended September 30, 2001 from a
negative EBITDA of $1,080,000 for the six months ended September 30, 2000.
Management believes that these Action Plan initiatives, as well as a
continuing review of cost savings opportunities, will continue to improve
DVDPlanet's cash flows and operating results for the remainder of fiscal year
ending March 31, 2002 as compared to the results for the fiscal year ended March
31, 2001. However, there can be no assurance that DVDPlanet's operating results
will continue to improve as a result of these initiatives or that the goal of
achieving positive cash flows and profitability will be reached.
-28-
Other Items.
In October 2001, the Company settled its litigation with Universal Studios
Home Video, Inc. The Company accrued $310,000 in related settlement fee expense
and associated legal expenses as a component of general and administrative
expenses in the accompanying consolidated statements of operations for the three
and six months ended September 30, 2001.
Under Image's reinstated stock repurchase program announced in August 2000,
Image repurchased approximately 696,000 common shares through September 30, 2001
for an aggregate purchase price of approximately $2,413,000 (average price of
approximately $3.47 per share), including brokerage commissions. At September
30, 2001, there were approximately 138,000 common shares remaining for
repurchase under the January 1995 Board of Directors' authorized program to
repurchase up to 2.5 million common shares. Under the program, Image may
purchase shares from time to time in the open market and/or through privately
negotiated transactions based upon current market conditions and other factors.
The Company's stock repurchase program has been suspended. See "The Company's
---
Liquidity Position at September 30, 2001 and Management's Assessment of the
Company's Liquidity Position for the Next 12 Months" above.
Forward-looking Statements
Forward-looking statements, within the meaning of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, are
contained throughout this Form 10-Q. Such statements are based on the belief 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," "plan," "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 and 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. 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. The Company has made forward-looking statements in this Form 10-Q
concerning, among other things: (1) that the Company will be able to
successfully implement the remaining courses of action described above in "The
Company's Liquidity Position at September 30, 2001 and Management's Assessment
of the Company's Liquidity Position for the Next 12 Months" with respect to its
liquidity position, (2) that the Company's revenue performance will improve
during the Company's historically strong holiday selling season, (3) that the
Company's international revenues should grow if DVD player-households grow
internationally, (4) that DVDPlanet revenues will continue to benefit from the
closing of certain Internet retailers, (5) that Image should begin to replace
revenue lost from the expiration of license agreements with Orion and Universal
during fiscal 2002 with revenue from new and existing licensing agreements, (6)
that cost savings under the Ritek manufacturing agreement which began August 1,
2001 should result in a lower cost structure (lower manufacturing and production
costs) and accordingly, both increase gross margins and decrease production cost
amortization as a percentage of net revenues beginning in the quarter ending
December 31, 2001, (7) that implementation of management's Action Plan to
improve fiscal 2002 DVDPlanet operating results, along with a continuing review
of cost savings opportunities, should continue to improve DVDPlanet's cash flows
and operating results for the fiscal year ending March 31, 2002 as compared to
fiscal 2001, and (8) that the Company can continue to work with its
international subdistributors to further reduce future segment advertising and
promotional expenses as a percentage of segment revenues. These statements are
only predictions. Actual events or results may differ materially as a result of
risks facing the Company. These risks include, but are not limited to: (1) that
any projections of future cash needs and cash flows are subject to substantial
uncertainty, (2) that there can be no assurance that the Company will be
successfully able to sell equity or debt securities, incur new debt financing or
reschedule existing obligations, if necessary, to provide additional liquidity,
(3) the failure to continue to successfully implement the courses of action
described in "The Company's Liquidity Position at September 30, 2001 and
Management's Assessment of the Company's
-29-
Liquidity Position for the Next 12 Months" could significantly restrict the
Company's future licensing of exclusive distribution rights and its growth
plans, (4) customer and consumer tastes and preferences for the Company's
domestic and international entertainment programming, (5) the DVDPlanet Action
Plan might ultimately reduce sales volume which, in turn, might reduce the
benefit of certain economies of scale expected to be achieved upon
implementation of the DVDPlanet Action Plan, and (6) certain new Internet DVD
retailers may begin operations offering pricing substantially below DVDPlanet
pricing. Given these uncertainties, prospective investors are cautioned not to
place undue reliance on such forward-looking statements. Unless otherwise
required by law, the Company disclaims any obligation to update any such factors
or to announce publicly the result of any revisions to any of the
forward-looking statements contained in this and other Securities and Exchange
Commission filings of the Company to reflect future events or developments. In
addition to the foregoing risk factors, the risks facing the Company include
those contained in the Company's Annual Report on Form 10-K for the year ended
March 31, 2001. The risk factors described in that report are applicable to all
forward-looking statements wherever they appear in this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
----------------------------------------------------------
Market risk is the potential loss arising from adverse changes in market rates
and prices, such as interest rates and foreign currency exchange rates. Changes
in interest rates and, in the future, changes in foreign currency exchange rates
have and will have an impact on the Company's results of operations.
Interest Rate Fluctuations. At September 30, 2001, approximately $13.2 million
of the Company's outstanding borrowings are subject to changes in interest
rates; however, the Company does not use derivatives to manage this risk. This
exposure is linked to the prime rate and LIBOR. The Company believes that
moderate changes in the prime rate or LIBOR would not materially affect the
operating results or financial condition of the Company. For example, a 1%
change in interest rates would result in an approximate $132,000 annual impact
on pretax income (loss) based upon those outstanding borrowings at September 30,
2001.
Foreign Exchange Rate Fluctuations. At September 30, 2001, approximately
$1,792,000 of the Company's accounts receivables related to international
distribution and denominated in foreign currencies are subject to foreign
exchange rate risk in the future. The Company distributes certain of its
licensed DVD and VHS programming (for which the Company has international
distribution rights) internationally through international subdistributors.
Additionally, the Company exploits international broadcast rights to its
licensed entertainment programming. The Company believes that moderate changes
in foreign exchange rates will not materially affect the operating results or
financial condition of the Company. For example, a 10% change in exchange rates
would result in an approximate $179,000 impact on pretax income (loss) based
upon those outstanding receivables at September 30, 2001. To date, the Company
has not entered into foreign currency exchange contracts.
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REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
The condensed consolidated financial statements as of September 30, 2001
and for the three- and six-month periods ended September 30, 2001 and 2000 in
this Form 10-Q have been reviewed by KPMG LLP, independent certified public
accountants, in accordance with established professional standards and
procedures for such a review.
The report of KPMG LLP commenting upon their review follows.
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INDEPENDENT AUDITORS' REVIEW REPORT
-----------------------------------
The Board of Directors and Shareholders
Image Entertainment, Inc.:
We have reviewed the condensed consolidated balance sheet of Image
Entertainment, Inc. and subsidiary as of September 30, 2001, and the related
condensed consolidated statements of operations and cash flows for the three-
and six-month periods ended September 30, 2001 and 2000. These condensed
consolidated financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Image Entertainment, Inc. and
subsidiary as of March 31, 2001, and the related consolidated statements of
operations, shareholders' equity and cash flows for the year then ended; and in
our report dated June 1, 2001, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of March 31, 2001, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ KPMG LLP
Los Angeles, California
November 2, 2001
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================================================================================
PART II - OTHER INFORMATION
================================================================================
ITEM 1. Legal Proceedings.
-----------------
On November 16, 2000, Universal Studios Home Video, Inc. ("USHV")
filed a Complaint (the "USHV Complaint") against Image in Los Angeles Superior
Court (Case No. BC240429), alleging causes of action for breach of contract and
breach of the covenant of good faith and fair dealing. USHV's claims arose out
of a 3 year license agreement (the "USHV License Agreement") between the parties
pursuant to which USHV licensed to Image the exclusive right to distribute
within the United States and Canada 52 delineated motion picture (the
"Pictures") in the DVD format for the term September 15, 1997 to September 14,
2000. In the USHV Complaint, USHV alleged, inter alia, that, by reducing the
wholesale price and suggested retail price of the Pictures, Image breached the
USHV License Agreement. In the USHV Complaint, USHV prayed for "compensatory
damages according to proof but reasonably believed to be in excess of
$5,000,000," reasonable attorney's fees and costs of suit. On January 10, 2001,
Image filed its Answer to the USHV Complaint, denying all of USHV's material
allegations and asserting numerous affirmative defenses. On or about, and as of
October 3, 2001, Image and USHV entered into an "Agreement of Compromise,
Settlement and Release" (the "Settlement Agreement") pursuant to which, without
any admission of wrongdoing, the parties released each other from all claims
asserted in the lawsuit and all claims pertaining to the USHV License Agreement,
and Image agreed to pay $300,000 to USHV in three installments of $100,000,
payable upon execution of the Settlement Agreement, on April 3, 2002 and on
October 3, 2002. On October 29, 2001, pursuant to the Settlement Agreement, the
court dismissed the USHV Complaint with prejudice.
In the normal course of business, the Company is 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.
ITEM 2. Changes in Securities and Use of Proceeds.
-----------------------------------------
Not Applicable.
ITEM 3. Defaults upon Senior Securities.
--------------------------------
Not Applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------
On September 7, 2001, the Company held its annual meeting of
shareholders. Represented at the meeting in person or by proxy were 14,705,215
shares of common stock (approximately 92.94% of the shares entitled to vote),
constituting a quorum.
At the meeting, Martin W. Greenwald, Ira S. Epstein, M. Trevenen
Huxley and Stuart Segall were elected as directors of the Company to serve until
their respective successors have been elected and qualified. With respect to Mr.
Greenwald's election, there were 14,476,774 votes for and 228,267 votes
withheld. With respect to Mr. Epstein's election there were 14,475,573 votes for
and 228,901 votes withheld. With respect to Mr. Huxley's election, there were
14,476,428 votes for and 228,046 votes withheld. With respect to Mr. Segall's
election, there were 14,462,964 votes for and 242,077 votes withheld.
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At the meeting, the Company's shareholders voted upon and ratified the
appointment of KPMG LLP as the Company's independent auditors for the fiscal
year ending March 31, 2002. With respect to this matter, there were 14,632,249
votes for, 44,100 votes against and 29,607 abstentions.
ITEM 5. Other Information.
-----------------
Not Applicable.
ITEM 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits
See Exhibit Index on page i
(b) Reports on Form 8-K
None
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================================================================================
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.
IMAGE ENTERTAINMENT, INC.
Date: November 13, 2001 By: /s/ MARTIN W. GREENWALD
--------------------------------------
Martin W. Greenwald
Chairman of the Board, Chief Executive
Officer, President and Treasurer
Date: November 13, 2001 By: /s/ JEFF M. FRAMER
--------------------------------------
Jeff M. Framer
Chief Financial Officer
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================================================================================
EXHIBIT INDEX
================================================================================
Exhibit No. Description
- --------------------------------------------------------------------------------
10.1*+ Form of Director Stock Unit Award Agreement, dated as of
October 1, 2001, between Image and each of Ira Epstein, M.
Trevenen Huxley and Stuart Segall.
10.2* Amendment No. 3, dated as of August 28, 2001, to Loan and
Security Agreement, dated as of December 28, 1998, by and
between Image and Foothill Capital Corporation.
10.3* Amendment No. 4, dated as of September 30, 2001, to Loan and
Security Agreement, dated as of December 28, 1998, by and
between Image and Foothill Capital Corporation.
10.4* Master Lease Agreement, dated as of July 25, 2001, by and
between Image and General Electric Capital Corporation.
15* Consent Letter of KPMG LLP, Independent Certified Public
Accountants.
_________________________________
* Exhibit(s) not previously filed with the Securities and
Exchange Commission.
+ Management Contracts, Compensatory Plans or Arrangements.
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