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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 March 31, 1997
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-22558
IWERKS ENTERTAINMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 95-4439361
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)
4540 West Valerio Street
Burbank, California 91505-1046
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(818) 841-7766
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 and 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
----- ----
As of May 7, 1997, the Registrant had 12,152,009 shares of Common Stock,
$.001 par value, issued and outstanding.
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IWERKS ENTERTAINMENT, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
- -----------------------------
Condensed Consolidated Balance Sheets as of March 31, 1997
and June 30, 1996 2
Condensed Consolidated Statements of Operations for the Three
and Nine Months Ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended March 31, 1997 and 1996 5
Notes to the Condensed Consolidated Financial Statements 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9
---------------------------------------------
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 12
- --------------------------
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 12
- -----------------------------------------
Signatures 13
1
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(in thousands)
March 31, 1997 June 30, 1996
--------------- -------------
(unaudited)
Current assets:
Cash and cash equivalents $ 6,500 $12,674
Short-term investments 13,461 6,782
Trade accounts receivable, net of allowance
for doubtful accounts 5,715 4,872
Costs and estimated earnings in excess of
billings on uncompleted contracts 7,028 5,583
Inventories and other current assets 6,016 3,166
------- -------
Total current assets 38,720 33,077
Investment in debt securities, excluding
current portion - 5,826
Properties, net:
Portable simulation theaters at cost, net of
accumulated depreciation 8,079 9,084
Property and equipment at cost, net of
accumulated depreciation and amortization 3,303 3,519
Film inventory at cost, net of amortization 3,169 3,372
Goodwill and patents, net of amortization 19,673 17,700
Investment in joint ventures and other assets 1,951 348
------- -------
Total assets $74,895 $72,926
======= =======
See accompanying notes.
2
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
LIABILITIES AND STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
March 31, 1997 June 30, 1996
--------------- --------------
(unaudited)
Current liabilities:
Accounts payable $ 2,501 $ 2,634
Accrued expenses 7,645 7,667
Notes payable to related parties, current portion - 875
Notes payable, current portion 211 571
Billings in excess of costs and estimated
earnings on uncompleted contracts 2,737 1,106
Deferred revenue 322 61
Capital leases, current portion 720 615
-------- --------
Total current liabilities 14,136 13,529
Notes payable, excluding current portion - 81
Capital lease obligations, excluding current portion 2,020 2,651
Stockholders' equity:
Preferred stock $.001 par value, 1,000,000 authorized,
none issued and outstanding - -
Common stock, $.001 par value, 20,000,000 shares
authorized; issued and outstanding 12,147,592
and 11,588,048, respectively 57 56
Additional paid-in-capital 78,026 76,340
Accumulated deficit (19,344) (19,731)
-------- --------
Total stockholders' equity 58,739 56,665
-------- --------
Total liabilities and stockholders' equity $ 74,895 $ 72,926
======== ========
See accompanying notes.
3
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share amounts)
For the Three Months Ended For the Nine Months Ended
March 31, March 31,
1997 1996 1997 1996
-------------- ------------- ------------- -------------
Revenue $11,042 $13,825 $30,660 $37,128
Cost of sales 7,335 7,642 20,527 21,601
------------- ----------- ------------ ------------
Gross profit 3,707 6,183 10,133 15,527
Selling, general, and administrative
expenses 3,451 4,921 9,870 13,742
Research and development 131 110 415 269
------------- ----------- ---------- ------------
Income (loss) from operations 125 1,152 (152) 1,516
Interest income 235 299 845 892
Interest expense 90 73 306 285
------------- ----------- ----------- ------------
Net income $270 $1,378 $387 $2,123
============= =========== =========== ============
Net income per common share $0.02 $0.12 $0.03 $0.18
============= =========== =========== ============
Weighted average shares outstanding 12,173,896 11,893,415 12,281,248 11,611,526
============= =========== =========== ============
See accompanying notes.
4
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the Nine Months Ended
March 31,
1997 1996
-------- --------
OPERATING ACTIVITIES
Net income $ 387 $ 2,123
Depreciation and amortization 4,204 4,856
Changes in operating assets and liabilities (4,413) (2,071)
-------- --------
Net cash provided by operating activities 178 4,908
INVESTING ACTIVITIES
Investment in joint ventures (897) -
Investment in portable simulation theaters (108) (140)
Purchases of property and equipment (702) (363)
Additions to film inventory (1,349) (350)
Purchase of short-term investments and
investment in debt securities, net (853) (1,243)
Purchase of Pioneer and acquisition of related patent,
net of cash acquired and stock issued (see note 7) (1,088) -
--------- --------
Net cash used in investing activities (4,997) (2,096)
FINANCING ACTIVITIES
Repayment of notes payable (1,315) (1,714)
Payments on capital leases (526) (93)
Exercise of stock options 486 235
Exercise of warrants - 226
Retirement of Stock - (250)
Other - 263
--------- ---------
Net cash used in financing activities (1,355) (1,333)
--------- ---------
Net (decrease) increase in cash (6,174) 1,479
Cash and cash equivalents at beginning of period 12,674 5,731
--------- ---------
Cash and cash equivalents at end of period $ 6,500 $ 7,210
========= =========
See accompanying notes.
5
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Supplemental disclosures of cash flow information:
Cash paid during the nine months ended March 31, 1997 and 1996 for interest
was $327,000 and $322,000, respectively.
Cash paid during the nine months ended March 31, 1997 and 1996 for income
taxes was immaterial.
Supplemental disclosures of non-cash activities:
Accrued expenses decreased by $1.6 million and stockholders' equity increased
by corresponding amounts due to the class action litigation settlement agreement
completed during the nine months ended March 31, 1996.
In March 1997, the Company purchased patents, other assets and all the
outstanding common stock of Pioneer related entities for cash and Iwerks common
stock. The common stock issued was valued at $1.2 million (see note 7).
See accompanying notes.
6
IWERKS ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Introduction
- ---------------------
The accompanying condensed consolidated financial statements of Iwerks
Entertainment, Inc. (the "Company") have been prepared without audit pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures made are adequate to make information
presented not misleading. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of March 31, 1997 and the results of its
operations for the three and nine months ended March 31, 1997 and 1996 and the
cash flows for the nine months ended March 31, 1997 and 1996 have been included.
Certain reclassifications have been made to the previously reported financial
information in order to conform with March 31, 1997 presentation. The results
of operations for interim periods are not necessarily indicative of the results
which may be realized for the full year. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's latest Annual Report on Form 10-K as filed with the SEC.
Note 2 - Cash and cash equivalents, Short-term investments and Debt securities
- ------------------------------------------------------------------------------
The Company has classified "Investment in debt securities" as investments
held with maturity dates greater than one year, and "Short-term investments" as
investments held with maturity dates between 90 days and one year. The Company's
investments (primarily U.S. Treasury Securities), with original maturity dates
less than 90 days are classified as cash equivalents.
Note 3 - Income Taxes
- ---------------------
At June 30, 1996, the Company had available federal and state tax net
operating loss carryforwards of $17,963,000 and $7,372,000, respectively
expiring through 2011. As a result of these net operating losses, the Company's
effective tax rate was negligible and consequently no income tax provision was
recorded in either the quarter or nine month periods presented.
Note 4 - Depreciation and Amortization
- --------------------------------------
Depreciation and amortization expense is computed using the straight-line
method over the estimated useful lives of the assets and consists of the
following:
For the Three Months Ended For the Nine Months Ended
March 31 March 31
1997 1996 1997 1996
----------- ---------- ---------- ----------
Depreciation and amortization on fixed assets $ 307,000 $ 311,000 $ 881,000 $1,270,000
Depreciation on touring equipment 373,000 365,000 1,113,000 1,066,000
Amortization of film 469,000 419,000 1,502,000 1,789,000
Amortization of goodwill, patents and other 245,000 243,000 708,000 731,000
---------- ---------- ---------- ----------
Total depreciation and amortization $1,394,000 $1,338,000 $4,204,000 $4,856,000
========== ========== ========== ==========
Depreciation and amortization included in cost of sales was $853,000 and
$793,000 for the quarter ended March 31, 1997 and 1996, respectively, and
$2,653,000 and $2,893,000 for the nine months ended March 31, 1997 and 1996,
respectively.
7
Note 5 - Net Income Per Common Share
- ------------------------------------
The net income per share for the three and nine month periods ended March
31, 1997 and 1996 are based on the weighted average number of common and common
equivalent shares outstanding during the period. Common equivalent shares
consisting of outstanding stock options and warrants have been included in the
calculation to the extent they are dilutive. Fully diluted amounts for the
three and nine months ended March 31, 1997 and 1996 do not materially differ
from the amounts presented herein.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, Earnings Per Share, which is effective for annual and interim
financial statements issued for periods ending after December 15, 1997 and early
adoption is not permitted. When adopted, the statement will require restatement
of prior years' earnings per share ("EPS"). SFAS No. 128 was issued to simplify
the standards for calculating EPS previously found in APB No. 15, Earnings Per
Share. SFAS 128 replaces the presentation of primary EPS with a presentation of
basic EPS. The new rules also require dual presentation of basic and diluted
EPS on the face of the statement of operations for companies with a complex
capital structure. For the Company, basic EPS will exclude the dilutive effects
of stock options and warrants. Diluted EPS for the Company will reflect all
potential dilutive securities. Under the provisions of FAS 128, basic EPS would
have been $.02 and $.13 for the three months ended March 31, 1997 and 1996,
respectively and $.03 and $.20 for the nine months ended March 31, 1997 and
1996, respectively. Diluted EPS would have been the same as the reported
amounts.
Note 6 - Litigation
- -------------------
Fred Hollingsworth III, a former director of Iwerks Entertainment, Inc. and
former chief executive officer and founder of Omni Films International, Inc.,
filed suit in April, 1996 against the Company and seven of its current or former
officers and directors. The complaint seeks unspecified damages arising from
misconduct, including alleged misstatements and omissions, in connection with
the acquisition by Iwerks of Omni Films International, Inc. in May 1994. In
February 1997, the Company and Mr. Hollingsworth reached an out-of-court
settlement. The Company made a cash payment to Mr. Hollingsworth which the
Company believes will be covered by insurance and, as such, has included the
amount as a receivable from the insurance carrier at March 31, 1997.
Note 7 - Acquisition of Pioneer and Related Companies
- -----------------------------------------------------
On March 4, 1997 two newly formed wholly-owned subsidiaries of the Company
acquired the stock of Pioneer Marketing Corporation and a related company
(collectively referred to as "Pioneer") in exchange for 299,101 shares of Iwerks
common stock. On the same date in a related transaction, the Company purchased
a patent from a partnership related to Pioneer for approximately $1,144,000 in
cash. These transactions were accounted for as a purchase by Iwerks of Pioneer
resulting in an aggregate purchase price of approximately $2,784,000 including
acquisition costs. The aggregate purchase price of Pioneer in excess of the
fair value of the identifiable assets of Pioneer at the date of acquisition was
$1,536,000 which has been allocated to goodwill. The operations of Pioneer have
been consolidated with the operations of the Company from March 4, 1997.
Unaudited pro forma combined statements of operations for the nine months
ended March 31, 1997 and 1996, which would combine the results of operations of
the Company and Pioneer are not present herein as such information is not
material to the combined results of operations.
Pioneer is in the business of designing and manufacturing motion picture
projectors.
Note 8 - Other
- --------------
The Company announced in October, 1996, that the Board of Directors has
approved a stock repurchase program by which up to 300,000 shares of its common
stock may be acquired in the open market. This program will terminate on
October 20, 1997 unless extended by the Board of Directors. As of the date of
this report, the Company has not repurchased any of its common stock pursuant to
this program.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- ------- -----------------------------------------------------------------------
OF OPERATIONS
-------------
Results of Operations
- ---------------------
For the nine months ended March 31, 1997 Iwerks Entertainment, Inc. (the
"Company") recorded revenue of $30,660,000 compared to $37,128,000 for the same
period last year. Net income for the nine months ended March 31, 1997 was
$387,000 or $.03 per share compared to $2,123,000 or $.18 per share for the
same period last year.
For the three months ended March 31, 1997 the Company recorded revenue of
$11,042,000 compared to $13,825,000 for the same period last year. The Company
recorded net income for the three months ended March 31, 1997 of $270,000 or
$.02 per share compared to $1,378,000 or $.12 per share for the same period last
year.
Comparison of the three and nine month periods ended March 31, 1997 and 1996:
- -----------------------------------------------------------------------------
REVENUE
- -------
The Company's revenue is derived from the manufacture and sale of specialty
theater systems (hardware), the licensing of film software to the installed base
of these systems, the participation in joint ventures, as well as the ownership
and operation ("O & O") of both fixed and mobile specialty theater entertainment
venues. The following table presents summary information regarding these
revenues (amounts in thousands):
For the Three Months Ended For the Nine Months Ended
March 31 March 31
1997 1996 1997 1996
-------- -------- -------- --------
Hardware Sales & Service $ 8,002 $ 7,634 $20,631 $20,887
Owned and Operated 1,277 4,405 5,824 11,232
Film Licensing 1,693 1,302 3,928 3,563
Film Production and Other 70 484 277 1,446
------- ------- ------- -------
Total $11,042 $13,825 $30,660 $37,128
======= ======= ======= =======
Hardware Sales and Service includes the sale of hardware contracts, recorded
on a percentage of completion basis, and includes revenue generated from the
service of these attractions. The sales of hardware contracts for Turbo-Ride and
Giant Screen attractions declined four percent from the previous year's nine
month period, and increased four percent in the current quarter as compared with
the previous year's third quarter.
Owned and Operated ("O&O") revenue includes sponsorship, contract and
admission revenue from the Company's fleet of 17 Reactors (portable motion
simulation theaters) along with revenue derived from joint ventures. The
decrease in O & O revenue for the nine month and three month periods as compared
to last year was primarily due to a one time cancellation settlement from the
Tokyo Expo recorded in the third quarter of the prior year, along with the loss
of a significant sponsor in the first quarter of fiscal 1997. Increased market
efforts, as well as an upturn in the cyclical nature of the Reactor business,
should improve revenues and operating results from this portion of the business
in the fourth quarter of fiscal 1997 as compared the second and third fiscal
1997 quarters. The Company is also actively seeking additional sponsors and
evaluating other alternatives regarding the touring operations.
9
Film Licensing revenue for the nine months ended March 31, 1997 increased as
compared to the nine months ended March 31, 1996 due primarily to the Company's
increasing base of simulation theaters. Film License revenue for the three
months ended March 31, 1997 increased as compared to the three months ended
March 31, 1996 as a result of the timing of certain license renewals.
Film Production and Other decreased for the nine month period as compared to
the prior year nine month period due to the Company recognizing revenue in the
prior year from an exclusive distribution agreement. The exclusive period was
for a three-year term which ended December 1995. The decrease for the three
month period was primarily due to the cancellation of a sales commitment from a
customer which resulted in additional revenue to the Company in the third
quarter of the prior year.
COST OF SALES AND GROSS PROFIT MARGINS
- --------------------------------------
Cost of sales consist principally of the costs of theater systems sold,
expenses associated with the operation of portable and fixed-base theaters (O &
O), and costs associated with film licensing, primarily the amortization of
film production costs and royalty fees.
The overall gross profit margin percentage for the nine months ended March
31, 1997 and 1996 was 33% and 42%, respectively, and the overall gross profit
margin percentage of the three months ended March 1997 and 1996 was 34% and 45%,
respectively. The change in overall profit margin percentage resulted primarily
from the one time cancellation at the Tokyo Expo and aforementioned cancellation
of a customer commitment which generated revenue with no corresponding cost of
sales in the prior year. Factoring out this revenue, the prior year's gross
margin for the nine months and three months would have been 36% and 30%
respectively.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
- --------------------------------------------
Selling, general and administrative expenses ("SG&A") include, among other
things, personnel costs, trade shows and other promotional expenses, sales
commissions, public relation costs, travel expenses, outside consulting and
professional fees, depreciation of fixed assets, amortization of goodwill and
departmental administrative costs.
SG&A costs for the nine months ended March 31, 1997 and 1996 were $9,870,000
and $13,742,000, respectively. SG&A costs for the quarter ended March 31, 1997
and 1996 were $3,451,000 and $4,921,000, respectively. These decreases, 28% for
the nine months and 30% year to date, are due primarily to a reduction in
salaries and wages, reduction in legal expenses and lower depreciation compared
to the comparable periods of last year. The prior year reflected higher legal
fees in association with the settlement of a class action lawsuit against the
Company.
10
INTEREST INCOME AND EXPENSE
- ---------------------------
Interest income for the nine months ended March 31, 1997 and 1996 was
$845,000 and $892,000, respectively. Interest income for the three months ended
March 31, 1997 and 1996 was $235,000 and $299,000, respectively. Interest
income is principally derived from the Company's investments, primarily in U.S.
Treasury Notes. The decrease in interest income for the nine and three month
period was directly related to the Company's investment portfolio.
Interest expense for the nine months ended March 31, 1997 and 1996 was
$306,000 and $285,000, respectively. Interest expense for the three months ended
March 31, 1997 and 1996 was $90,000 and $73,000, respectively. Interest
expense is primarily financing costs on portable simulation theaters.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's operating activities for the nine months ended March 31, 1997
generated a positive cash flow of $178,000. Investing activities for the nine
months ended March 31, 1997 consisted primarily of the purchase of Pioneer,
along with the normal investing in joint ventures, additions to film inventory
and fluctuations of short-term investments. The Company's portfolio of
investments reflects more securities which have maturity dates greater than 90
days. Consequently, the Company's cash and cash equivalents have decreased and
short-term investments have increased.
The Company maintains a bank line of credit in the amount of $5 million.
At March 31, 1997, and during the nine month periods ending March 31, 1997 and
1996, there were no amounts outstanding on the line of credit. Together with
existing cash balances and short-term investments in debt securities, the
Company believes that it has adequate liquidity to meet its cash requirements
for at least the next twelve months, after which time it may be required to
raise additional cash through the sale of equity or debt securities. In
addition, to the extent the Company experiences growth in the future, or its
cash flow from operations is less than anticipated, the Company may be required
to obtain additional sources of cash.
The Company does not anticipate the need to retire its debt security
investments before maturity to meet cash requirements. At March 31, 1997, the
investment in debt securities are classified as available-for-sale and are
stated at fair market value.
OUTLOOK AND RISK FACTORS
- ------------------------
With the exception of the historical information, the matters discussed
above include forward-looking statements that involve risks and uncertainties.
Among the important factors that could cause actual results to differ from those
indicated in the forward-looking statements are revenue, costs of sales and the
ability of the Company to maintain pricing at a level to maintain gross profit
margins, the level of selling, general and administrative costs, the performance
by the Company under its existing purchase contracts and the ability to obtain
new contracts, the success of the Company's owned and operating strategy, the
ability of the Company to find additional sponsors for its Reactors or
alternative sources of revenue, the ability of the Company to identify and
successfully negotiate arrangements with joint venture and other strategic
partners, the success of the Company's film software, the effects of
competition, general economic conditions and acts of God and other events
outside the control of the Company.
11
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- -------------------------
Fred Hollingsworth III, a former director of Iwerks Entertainment, Inc. and
former chief executive officer and founder of Omni Films International, Inc.,
filed suit in April, 1996 against the Company and seven of its current or former
officers and directors. The complaint seeks unspecified damages arising from
misconduct, including alleged misstatements and omissions, in connection with
the acquisition by Iwerks of Omni Films International, Inc. in May 1994. In
February 1997, the Company and Mr. Hollingsworth reached an out-of-court
settlement. The Company made a cash payment to Mr. Hollingsworth which the
Company believes will be covered by insurance and, as such, has included the
amount as a receivable from the insurance carrier at March 31, 1997.
The Company is also a party to various other actions arising in the
ordinary course of business which, in the opinion of management, will not have a
material adverse impact on the Company's financial condition; however, there can
be no assurance that the Company will not become a party to other lawsuits in
the future, and such lawsuits could potentially have a material adverse effect
on the Company's financial condition and results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Exhibits:
11.1 Earnings per share
15.1 Letter regarding unaudited Interim Financial Information
27.1 Schedule of financial data
99.1 Independent Accountants' Review Report
(b) Reports on Form 8-K filed during the quarter ended March 31, 1997:
i) A Form 8-K was filed on March 5, 1997, which included the press release
of the same date announcing the acquisition of Pioneer and related
entities.
ii) A Form 8-K was filed on March 27, 1997, which included the press
release announcing the resignation of a board member.
12
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the city of Burbank,
State of California on the 13th day of May, 1997.
IWERKS ENTERTAINMENT, INC.
(Registrant)
By: /s/ Bruce C. Hinckley
---------------------
Executive Vice President
Chief Financial Officer
(Principal Finance Officer)
By: /s/ Jeffrey M. Dahl
-------------------
Vice President / Controller
(Principal Accounting Officer)
13