UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
----------
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
DATE OF REPORT COMMISSION FILE NUMBER
SEPTEMBER 18, 1998 0-21943
(Date of earliest event reported)
- - - - - - - - - - - - - - - - - - -
FOUR MEDIA COMPANY
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 95-4599440
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2813 WEST ALAMEDA AVENUE
BURBANK, CALIFORNIA 91505
(Address of principal executive offices) (Zip code)
Registrant's telephone number including area code: 818-840-7000
Not applicable
(Former name and former address, if changed since last report)
ITEM 7. Financial Statements, Pro Forma Financial Information and
Exhibits. The following documents are included as part of this report:
(a) Financial Statements of Business Acquired: PAGE NO.
--------
MSCL, Inc.
Financial Statements for the ten months ended July 31, 1998
Report of Independent Accountants................................................. A-1
Consolidated Balance Sheet........................................................ A-2
Consolidated Statement of Income................................................. A-3
Consolidated Statement of Cash Flows.............................................. A-4
Consolidated Statement of Shareholders' Equity.................................... A-5
Notes to Consolidated Financial Statements........................................ A-6
MSCL, Inc.
Financial Statements for the year ended September 30, 1997
Report of Independent Accountants................................................. A-20
Consolidated Balance Sheet........................................................ A-21
Consolidated Statement of Income................................................. A-22
Consolidated Statement of Cash Flows.............................................. A-23
Consolidated Statement of Shareholders' Equity.................................... A-24
Notes to Consolidated Financial Statements........................................ A-25
MSCL, Inc.
Financial Statements for the year ended September 30, 1996
Report of Independent Accountants................................................. A-40
Consolidated Balance Sheet........................................................ A-41
Consolidated Statement of Income................................................. A-42
Consolidated Statement of Cash Flows.............................................. A-43
Consolidated Statement of Shareholders' Equity.................................... A-44
Notes to Consolidated Financial Statements........................................ A-45
(b) Pro Forma Financial Information
Pro Forma Information............................................................. B-1
Pro Forma Condensed Consolidated Balance Sheet
as of August 2, 1998............................................................ B-2
Pro Forma Condensed Consolidated Statement of Operations
For the year ended August 2, 1998............................................. B-3
Notes to Pro Forma Condensed Consolidated Financial
Statements.................................................................... B-4
REPORT OF INDEPENDENT ACCOUNTANTS
__________
Board of Directors
MSCL, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, cash flows and shareholders' equity present
fairly, in all material respects, the financial position of MSCL, Inc. (the
"Company") as of July 31, 1998, and the results of its operations and its cash
flows for the ten months then ended, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
September 10, 1998, except for the information
presented in Note 13, as to which the date
is September 18, 1998.
A-1
MSCL, INC.
CONSOLIDATED BALANCE SHEET
July 31, 1998
__________
A S S E T S:
Current assets:
Cash and cash equivalents $ 1,022,595
Accounts receivable, less allowance for doubtful accounts of $200,354 5,138,143
Inventories 232,679
Prepaid expenses and other current assets 420,969
Deferred income taxes 37,784
-----------
Total current assets 6,852,170
Property and equipment, net 26,618,826
Due from shareholders 97,960
Other assets 424,927
Deferred income taxes 352,216
-----------
Total assets $34,346,099
===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Notes payable to bank $ 965,000
Current maturities of long-term debt 6,733,049
Accounts payable 2,217,810
Accrued expenses and other current liabilities 1,245,020
Unearned revenue 124,714
-----------
Total current liabilities 11,285,593
Long-term debt 12,260,035
-----------
Total liabilities 23,545,628
Minority interests 435,999
Commitments and contingencies (Note 11)
Shareholders' equity:
Common stock, $3.33 par value; authorized 10,000 shares, issued and
outstanding 900 shares 2,997
Retained earnings 10,361,475
-----------
Total shareholders' equity 10,364,472
-----------
Total liabilities and shareholders' equity $34,346,099
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-2
MSCL, INC.
CONSOLIDATED STATEMENT OF INCOME
For The Ten Months Ended July 31, 1998
__________
Revenues $41,067,412
Cost of revenue 27,005,822
-----------
Gross profit 14,061,590
Selling, general and administrative expenses 12,340,494
-----------
Income from operations 1,721,096
Other income (expense):
Interest expense (1,577,081)
Gain on sale of assets 63,918
Interest income 42,367
Other income 90,437
Expense related to settlement with former shareholder (801,836)
-----------
Total other expense (2,182,195)
Loss before benefit for income taxes and minority interests (461,099)
Benefit for income taxes (4,131)
-----------
Loss before minority interests (456,968)
Minority interests (323,591)
-----------
Net loss ($780,559)
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-3
MSCL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For The Ten Months Ended July 31, 1998
__________
Cash flows from operating activities:
Net loss ($780,559)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 6,618,914
Bad debt expense 160,412
Net gain on disposal of property and equipment (63,000)
Deferred income taxes (17,620)
Compensation on stock options 98,210
Changes in operating assets and liabilities, net of effects from acquisition
of businesses:
Decrease in accounts receivable 4,009,310
Decrease in inventories 67,215
Decrease in prepaid expenses and other current assets 696,385
Increase in due from officers/shareholders (59,234)
Decrease in other assets 121,078
Decrease in accounts payable (237,056)
Decrease in accrued expenses and other current liabilities (238,355)
Decrease in unearned revenue (235,650)
Increase in minority interests 146,702
-----------
Net cash provided by operating activities 10,286,752
Cash flows from investing activities:
Capital expenditures (6,946,470)
Proceeds from the sale of property and equipment 63,000
-----------
Net cash used in investing activities (6,883,470)
Cash flows from financing activities:
Borrowings under credit agreement 921,810
Proceeds from long-term debt 7,082,758
Principal payments on long-term debt (9,654,631)
Distributions to shareholders, inclusive of minority interests (396,969)
Repurchased shares (1,228,405)
Additional paid-in capital related to common stock repurchase (162,262)
-----------
Net cash used in financing activities (3,437,699)
Net decrease in cash and cash equivalents (34,417)
Cash and cash equivalents, beginning of period 1,057,012
-----------
Cash and cash equivalents, end of period $ 1,022,595
===========
Cash paid for:
Interest $ 1,343,469
===========
Income taxes $ -
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-4
MSCL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For The Ten Months Ended July 31, 1998
__________
Additional
Paid-In Retained
Common Stock Capital Earnings Total
------------------- ----------- ------------ ------------
Shares Amount
------ ------
Balance, September 30, 1997 1,000 $3,330 $ 365,713 $13,237,009 $13,606,052
Net loss (780,559) (780,559)
Legal costs related to common
stock repurchase (162,262) (162,262)
Stock options 98,210 98,210
Dividends (396,969) (396,969)
Acquisition and retirement of
shares (100) (333) (301,661) (1,698,006) (2,000,000)
Balance, July 31, 1998 900 $2,997 $ - $10,361,475 $10,364,472
The accompanying notes are an integral part of these consolidated financial
statements.
A-5
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Ten Months Ended July 31, 1998
__________
1. Company Organization And Basis Of Consolidation:
The consolidated financial statements include the divisions of MSCL, Inc.
("MSCL") dba Encore Hollywood, Encore Santa Monica, Encore Non Linear,
FilmCore Editorial Los Angeles (for the three months ended December 31,
1997), FilmCore Distribution Los Angeles, FilmCore Distribution San
Francisco, and FilmCore Editorial San Francisco LLC, FilmCore Editorial Los
Angeles LLC (for the period January 1, 1998 through July 31, 1998), and
the Virtual Office Inc., dba "Virtuosity," collectively known as the
"Company." FilmCore Editorial Los Angeles LLC, San Francisco LLC, and
Virtuosity are majority-owned subsidiaries of MSCL. In January 1998, MSCL
entered into an operating agreement for the formation of FilmCore Editorial
Los Angeles LLC and contributed certain assets for a 75%-interest in net
profits. MSCL contributed certain assets in October 1996 to FilmCore
Editorial San Francisco LLC for a 75%-interest in net profits and in
November 1995 to Virtuosity for a 66-2/3% interest.
MSCL and the FilmCore Editorial LLC's are engaged in providing post-
production services and facilities to advertising agencies, production
companies, motion picture and television studios related to the production
of television programs and commercials produced primarily in California.
The Company also leases video post-production equipment to customers under
short-term cancellable operating leases. Virtuosity provides telephone
voice mail and various other services to individuals and businesses for an
access charge.
In December 1997, the Company changed its fiscal year-end from September
30th to December 31st.
2. Summary Of Significant Accounting Policies:
Revenue Recognition
-------------------
Revenue is recognized when services are rendered. Revenue is recognized on
incomplete visual effects and editing jobs using the percentage-of-
completion method. Losses on jobs are recognized in their entirety when
identified. Unearned revenue represents billings on incomplete editing
jobs in excess of costs incurred.
Use Of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates.
A-6
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
2. Summary Of Significant Accounting Policies, Continued:
Cash And Cash Equivalents
-------------------------
The Company considers all highly liquid debt instruments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
include money market funds.
Concentration Of Credit Risk
----------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of trade accounts
receivable and uninsured cash balances. Concentrations of credit risk with
respect to trade accounts receivable are limited due to the number of
customers comprising the Company's customer base. The Company requires no
collateral from its customers and performs ongoing credit evaluations of
its customers' financial condition.
The Company places its cash deposits with high-credit, quality financial
institutions. At times, balances in the Company's cash accounts may exceed
the Federal Deposit Insurance Corporation limit of $100,000.
Inventories
-----------
Inventories are stated at the lower of cost or market, cost generally being
determined on a first-in, first-out basis.
Property And Equipment
----------------------
Property and equipment are stated at cost. Depreciation is provided for on
the straight-line method over the estimated useful lives of the assets.
The estimated useful lives of the assets are as follows:
Editing equipment 5 - 10 years
Video equipment 5 - 7 years
Office furniture and equipment 5 - 7 years
Vehicles 5 years
Video equipment held for lease 5 years
Video and editing equipment held under capital leases 5 - 7 years
Leasehold improvements are amortized on the straight-line method over the
term of the lease or estimated useful life, whichever is shorter.
A-7
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
2. Summary Of Significant Accounting Policies, Continued:
Property And Equipment, Continued
----------------------
Expenditures for maintenance and repairs are charged to operations as
incurred, while renewals and betterments are capitalized.
Other Assets
------------
Goodwill represents the excess of the acquisition costs of acquired
subsidiaries over the fair value of the net assets, and is being amortized
on the straight-line method over periods of 5 to 40 years.
The cost of patents and trademarks acquired are being amortized on the
straight-line method over 17 and 20 years, respectively, or the estimated
useful life, whichever is shorter.
Capital Lease Obligations
-------------------------
The Company has capitalized certain property and equipment under lease
obligations which, by their terms, are equivalent to installment purchases.
Advertising Costs
-----------------
The Company expenses advertising costs as incurred. Advertising costs
charged to operations were $676,067 for the ten months ended July 31,
1998.
Income Taxes
------------
The Company has elected to be taxed as an S Corporation, whereby the entire
Federal and California taxable income or loss of the Company is reportable
by the shareholders. The Company will not be responsible for Federal
income tax or California franchise tax in excess of the minimum tax, but
will incur a 1.5% California surtax.
Income taxes are provided for the tax effects of transactions reported in
the financial statements and consist of taxes currently due plus deferred
taxes.
A-8
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
2. Summary Of Significant Accounting Policies, Continued:
Income Taxes, Continued
------------
Deferred income taxes are provided for temporary differences with respect
to balance sheet items that result from different reporting practices for
financial statement and income tax purposes. Deferred tax assets and
liabilities represent the future tax return consequences of those
differences which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred taxes are also recognized
for tax credits that are available to offset future California surtax.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
The principal sources of temporary differences result from differing
methods used for property and equipment depreciation and the recognition of
Los Angeles Revitalization Zone credit carryforwards.
Deferred taxes are classified as current or noncurrent, depending on the
classification of the assets and liabilities to which they relate.
Deferred taxes arising from temporary differences that are not related to
an asset or liability are classified as current or noncurrent depending on
the periods in which the temporary differences are expected to reverse.
3. Due From Shareholders:
Loans receivable from shareholders are unsecured, due on demand, and bear
interest at 7% per annum.
A-9
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
4. Property And Equipment:
Property and equipment consist of the following:
Editing and video equipment $ 31,390,521
Office furniture and equipment 7,773,807
Vehicles 151,356
Video equipment held for lease 4,741,712
Video and editing equipment held under capital leases 6,823,917
Leasehold improvements 9,245,246
Construction-in-progress 346,443
------------
60,473,002
Less: Accumulated depreciation, including $3,319,933 for video
equipment held for lease and $6,490,772 for equipment held under
capital leases (33,854,176)
------------
$ 26,618,826
============
5. Other Assets:
Other assets consist of the following:
Goodwill, net of accumulated amortization of $62,927 $155,449
Patents and trademarks, net of accumulated amortization of $104,821 201,984
Other 67,494
--------
$424,927
========
A-10
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
6. Notes Payable To Bank:
Under the terms of a credit agreement expiring May 31, 1999, the Company
may borrow up to $3,000,000 under a revolving credit facility. Interest is
payable monthly at either 2% per annum in excess of the LIBOR rate, if
requested by the Company in accordance with the terms of the agreement, or
.25% per annum above the reference rate. At July 31, 1998, the rate was
8.75% and $965,000 was outstanding under this facility.
The credit agreement contains various financial covenants and is
collateralized by the personal guarantees of certain officers/shareholders
of the Company, and their related trusts and by collateralized interests in
substantially all of the assets of the Company, to the extent that these
assets are not leased or financed by other unrelated parties. The Company
was not in compliance with certain of its financial covenants at July 31,
1998, which is a breach of the credit agreement. The noncompliance has
been subsequently cured as part of the sale of the Company. The most
restrictive financial covenants require the Company to maintain 1) a ratio
of current assets to current liabilities of at least 1.00:1.00 at each
quarter-end; 2) a ratio of total liabilities to tangible net worth of not
greater than 2.25:1.00 at each quarter-end; and 3) a fixed charge coverage
ratio of not less than 1.25:1.00 at each year-end, as defined.
The Company entered into a construction line of credit on March 1, 1998
for $700,000, which will become a term note on September 31, 1998 and will
be due in sixty equal payments with the final payment due on September 30,
2003. Interest will be payable monthly at 2.25% per annum in excess of
U.S. Treasuries or 0.25% per annum greater than the LIBOR rate. At July
31, 1998, no amount was outstanding under this facility.
7. Long-Term Debt:
Notes payable, due in aggregate monthly installments of $252,598 through
March 2003, including interest ranging from 8.05% to 8.82% per annum,
collateralized by security interests in the related equipment. $7,108,744
Notes payable, due in aggregate monthly installments of $74,780 through
August 2001, plus and including interest of 8.70% per annum,
collateralized by security interests in the related equipment and any
proceeds it generates. The note is guaranteed by the
officers/shareholders of the Company. 2,419,174
A-11
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
7. Long-Term Debt, Continued:
Notes payable, due in aggregate monthly installments of $144,067
through October 2001, including interest ranging from 7.74% to
9.12% per annum, collateralized by security interests in the $ 4,208,055
related equipment.
Notes payable, due in aggregate monthly installments of $44,055
through November 2000, including interest ranging from 9.31% to
10.15% per annum, collateralized by security interests in the 746,557
related equipment.
Capital lease obligations, due in aggregate monthly installments of
$80,867 through September 2000, including interest ranging from
7.00% to 9.25% per annum. 714,349
Notes payable to bank, due in aggregate monthly installments of
$61,666 through January 2003, plus interest at .75% per annum
above the reference rate and at 8.65% and 10.34% per annum. The
interest rate on the variable rate note was 8.75% at July 31, 2,398,333
1998.
Officers'/shareholders' unsecured loans, due in monthly
installments of $1,719 through May 2003, including interest at 80,857
9.40% per annum.
Notes payable, former stockholder due in aggregate monthly
installments of $47,645 through March 2003, including interest at
10.00% per annum. 1,317,015
-----------
18,993,084
Less: Current maturities, including $550,596 for capital lease 6,733,049
obligations -----------
$12,260,035
===========
A-12
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
7. Long-Term Debt, Continued:
The following is a schedule of future aggregate maturities of long-term
debt:
Years Ending
December 31,
--------------
1998 $ 3,084,767
1999 6,530,439
2000 5,270,454
2001 3,078,550
2002 931,928
Thereafter 96,946
-----------
$18,993,084
===========
8. Retirement Plan:
The Company has a qualified 401(k) retirement plan in effect for eligible
employees. The plan provides for pretax employee contributions, fifty
percent of which will be matched by the Company, pursuant to the plan
agreement. Additional annual contributions may be made by the Company at
its discretion. Total contributions are not to exceed annual amounts
deductible under Internal Revenue Service regulations. Retirement plan
expense charged to operations was $234,424 for the ten months ended July
31, 1998.
9. Shareholders' Equity:
The Company incurred legal expenses related to certain litigation, as
discussed in these financial statements, for the repurchase of shares from
a minority shareholder. These legal expenses were incurred for both the
litigation and the acquisition of the shares of stock. The Company
classified the portion of the expenses directly related to the acquisition
of shares into additional paid-in capital and the balance was expensed in
the consolidated statement of income.
A-13
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
10. Stock Option:
The Company entered into a stock option agreement on February 1, 1997 with
an employee of the Company. The agreement provides for a grant of options
to purchase up to 1% of the issued and outstanding common stock of the
Company for each full year of service of the agreement not to exceed 5% of
the total outstanding stock. The exercise price for each 1% of the
outstanding common stock is $20. As of July 31, 1998, the employee has
vested and may exercise 1% of the outstanding shares of the Company.
Any stock purchased pursuant to the agreement will be subject to a
restriction which requires the sale of the stock by the employee to the
Company at the exercise price in the event the employee's employment is
terminated, either voluntarily or involuntarily.
The Company recognized $57,770 of earned compensation expense related to
this stock option agreement for the ten months ended July 31, 1998.
Compensation cost was estimated by management using a market approach and
applying multiples derived from comparable sale transactions of similar
companies with a discount for the restrictions placed on the stock.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," and will use the intrinsic
value-based method of accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." However, at July 31, 1998,
compensation cost for the existing employee stock option agreement measured
under the intrinsic value-based method approximates compensation cost
measured under the fair value-based method.
11. Commitments And Contingencies:
Employment Agreements
---------------------
The Company has employment agreements with certain key employees. In
addition to base salaries, some of the agreements provide for bonuses based
on total employee billings or net income after tax, and severance payments.
In addition, one of the agreements also provides for 5% of distributed
income for one of the divisions, as defined, starting September 30, 2002
and thereafter, and 5% of the net sales proceeds attributable to one of the
divisions upon the sale of the division or Company, providing the employee
remains employed or if the sale occurs one year after the employee's
termination.
A-14
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
11. Commitments And Contingencies, Continued:
Leases
------
The Company leases its facilities and property and equipment under
noncancellable operating and capital leases, respectively, expiring in
various years through 2012 and is committed to future minimum rental
payments (exclusive of real estate taxes, maintenance, etc.) as follows:
Operating Leases
Years Ending ---------------- Capital
December 31, Affiliates Other Leases
- ------------ ----------- ---------- --------
1998 $ 665,325 $ 138,500 $326,604
1999 1,588,380 309,858 336,078
2000 1,588,380 244,032 99,974
2001 1,588,380 245,832 -
2002 1,547,160 206,332 -
Thereafter 8,683,199 63,944 -
Total minimum lease
payments $15,660,824 $1,208,498 762,656
========== =========
Less: Amount representing interest (25,044)
--------
Present value of net minimum
lease payments $737,612
========
The Company leases six of its Southern California facilities from certain
officers/shareholders of the Company. Rent on three of the facilities is
to be adjusted annually based on increases in the Consumer Price Index or
5% of the previous year's rent, whichever is greater. The 5% annual
adjustment is included in minimum rental payments. Rent on six facilities
is to be adjusted annually based on increases in the Consumer Price Index
up to a maximum of 5%. Minimum rental payments for these leases do not
include any anticipated rental increases. One of these leases also
provides for a ten-year renewal option. Rent under the option will be
redetermined at the time the option is exercised. Each lease requires
payment of certain additional expenses including utilities, property taxes
and other operating expenses.
A-15
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
11. Commitments And Contingencies, Continued:
Leases, Continued
------
The Company leases two facilities in Northern California. One of these
leases includes a determinable escalation clause and rent expense is
recognized on the straight-line method over the term of the lease. The
difference between rent expense recognized and rent payable under the
escalation clause is reflected in accrued expenses. The lease also
provides for a five-year renewal option. Rent under the option will be the
fair market rental for the premises, but not less than the monthly rental
for the last month of the initial lease term. The second lease includes an
escalation clause which will be determined at future dates based on the
Consumer Price Index. The lease also provides for a ten-year renewal
option. The leases require payment of certain additional expenses,
including utilities, property taxes and other operating expenses.
The Company also leases two facilities in Southern California from
unrelated parties. One of the leases includes an escalation clause based
on the Consumer Price Index. The leases provide for renewal options of
five and two years.
In addition, the Company has subleased a portion of one of its West Los
Angeles facilities under a five-year noncancellable operating lease for
$6,363 per month, including $1,786 for reimbursement of leasehold
improvements. Rent commenced on November 1, 1996.
Rent expense charged to operations was $1,064,611 for the ten months ended
July 31, 1998.
Guarantees
----------
The Company has guaranteed notes payable of $3,250,000 and a standby letter
of credit for $812,240 on behalf of certain officers/shareholders of the
Company. The letter of credit is subject to the terms and conditions as
indicated in these financial statements. These obligations were made in
connection with the construction and refinancing of post-production
facilities currently leased by the Company. The amount of borrowings
outstanding at July 31, 1998 was $2,756,466. The letter of credit has not
been drawn upon. The Company requires no collateral with respect to these
guarantees.
Conditional Grant
-----------------
The Company received a conditional grant of $99,306 during the year ended
September 30, 1993 from a governmental agency for leasehold improvements
on facilities leased from certain officers/shareholders of the Company.
A-16
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
11. Commitments And Contingencies, Continued:
Conditional Grant, Continued
-----------------
Should the Company remain in compliance with the terms of the conditional
grant agreement, the debt will be forgiven at the rate of 10% per year for
10 years; otherwise, the remaining balance becomes due and payable. The
grant is collateralized by the assignment of the Company's leasehold
interest in the leased premises.
The grant has been deducted from the carrying value of leasehold
improvements and, therefore, is recognized in the consolidated statement of
income by way of a reduced depreciation charge.
Stock Repurchase Agreement
--------------------------
Under the terms of a shareholders' agreement, upon the death, withdrawal or
termination of a shareholder, the Company is required to purchase all of
the shares owned by the shareholder, provided such sale and purchase may be
lawfully made. The value of shares owned by a deceased, withdrawn or
terminated shareholder shall be determined by appraisal. The Company
maintains life insurance on each shareholder to fund the stock purchase
upon the death of a shareholder, should it become necessary to do so.
Litigation
----------
During October 1995, a shareholder owning 10% of the stock of the Company
withdrew. The Company entered into a legal settlement on April 16, 1998
with the former shareholder. The Company agreed to pay the former
shareholder $2,000,000 for his 10% ownership interest in the Company. The
Company also agreed to pay $450,000 in interest accrued on the appraised
value of the stock from the date of termination of the former shareholder
to the date of the legal settlement. In addition, the Company agreed to
forgive the note receivable from the former shareholder in the amount of
$101,836 and entered into a note payable for $250,000 in satisfaction of
all other outstanding claims.
A-17
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
11. Commitments And Contingencies, Continued:
Litigation, Continued
----------
At the date of settlement, the Company had recorded two long-term notes
payable in the amounts of $1,221,595 and $250,000, with the balance of
$1,228,405 accrued in a short-term payable to be paid in a lump-sum payment
on or before May 16, 1998. Until such time the lump-sum payment is made,
the shares to be repurchased were held in an escrow account. On May 16,
1998, the Company made the lump-sum payment of $1,228,405 to the former
shareholder and received from escrow his shares of stock for 10% of the
Company, which was immediately retired. At July 31, 1998, the balance on
each of the two above-mentioned long-term notes payable to the former
shareholder was $1,082,185 and $234,831, respectively.
12. Income Taxes:
Income tax (benefit) consists of the following:
Current taxes $ 13,489
Deferred taxes (136,014)
Valuation allowance 118,394
---------
Total benefit for income taxes ($4,131)
Income taxes for the period October 1, 1997 through July 31, 1998 differ
from the expense that would result from applying the 1.5% S Corporation
California surtax to income before income taxes due to the benefits of the
Los Angeles Revitalization Zone credits and permanent differences that are
not tax deductible.
Deferred tax assets recognized for deductible temporary differences and Los
Angeles Revitalization Zone credit carryforwards were $429,094, net of a
valuation allowance of $118,394, and deferred tax liabilities recognized
for taxable temporary differences were ($39,094) at July 31, 1998.
The Company has Los Angeles Revitalization Zone credit carryforwards of
approximately $545,000 which may be used to offset future S Corporation
California surtax from within the zone through 2010.
A-18
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Ten Months Ended July 31, 1998
__________
13. Subsequent Event:
On September 18, 1998, the shareholders of the Company sold 100% of the
outstanding shares in MSCL, certain real estate and the two minority
shareholders' 25% profit interests in the FilmCore Editorial LLCs for
approximately $68,600,000.
A-19
REPORT OF INDEPENDENT ACCOUNTANTS
__________
To the Board of Directors of
MSCL, Inc.
We have audited the accompanying consolidated balance sheet of MSCL, Inc. (the
"Company") as of September 30, 1997, and the related consolidated statements of
income, cash flows and shareholders' equity for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MSCL, Inc. as of
September 30, 1997, and the results of its operations and its cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
Coopers & Lybrand LLP
Los Angeles, California
February 6, 1998
A-20
MSCL, INC.
CONSOLIDATED BALANCE SHEET
September 30, 1997
__________
A S S E T S:
Current assets:
Cash and cash equivalents $ 1,057,012
Accounts receivable, less allowance for doubtful accounts of $117,957 9,307,865
Inventories 299,894
Prepaid expenses and other current assets 1,117,354
Deferred income taxes 24,348
Due from shareholder 100,075
-----------
Total current assets 11,906,548
Property and equipment, net 26,291,270
Other assets 546,005
Deferred income taxes 348,032
-----------
Total assets $39,091,855
===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Notes payable to bank $ 500,000
Current maturities of long-term debt 6,266,583
Accounts payable 2,454,866
Accrued expenses and other current liabilities 1,483,375
Unearned revenue 360,364
-----------
Total current liabilities 11,065,188
Long-term debt 14,069,969
Due to officers/shareholders 61,349
-----------
Total liabilities 25,196,506
Minority interests 289,297
Commitments and contingencies (Note 12)
Shareholders' equity:
Common stock, $3.33 par value; authorized 10,000 shares, issued and
outstanding 1,000 shares 3,330
Additional paid-in capital 365,713
Retained earnings 13,237,009
-----------
Total shareholders' equity 13,606,052
-----------
Total liabilities and shareholders' equity $39,091,855
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-21
MSCL, INC.
CONSOLIDATED STATEMENT OF INCOME
For The Year Ended September 30, 1997
__________
Revenues $47,388,143
Cost of revenue 29,397,546
-----------
Gross profit 17,990,597
Selling, general and administrative expenses 14,586,979
-----------
Income from operations 3,403,618
Other income (expense):
Interest expense (1,614,553)
Gain on disposition of property and equipment 401,757
Interest income 82,256
Other expense (451,825)
-----------
Total other income (expense) (1,582,365)
-----------
Income before benefit for income taxes and minority interests 1,821,253
Benefit for income taxes (79,572)
-----------
Income before minority interests 1,900,825
Minority interests (271,661)
-----------
Net income $ 1,629,164
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-22
MSCL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For The Year Ended September 30, 1997
__________
Cash flows from operating activities:
Net income $ 1,629,164
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 7,117,424
Amortization 31,838
Bad debt expense 73,949
Net gain on disposal of property, plant and equipment (401,757)
Deferred income taxes (80,372)
Changes in operating assets and liabilities, net of effects from acquisition
of businesses:
Increase in accounts receivable (1,500,133)
Increase in inventories (221,044)
Increase in prepaid expenses and other current assets (670,738)
Decrease in due from shareholder 175,011
Decrease in other assets 275,398
Decrease in accounts payable (1,261,414)
Increase in accrued liabilities 664,748
Increase in unearned revenue 218,174
Decrease in due to officers/shareholders (64,119)
Increase in minority interests 271,661
-----------
Net cash provided by operating activities 6,257,790
-----------
Cash flows from investing activities:
Capital expenditures (5,597,983)
Proceeds from the sale of property, plant and equipment 265,124
-----------
Net cash used in investing activities (5,332,859)
Cash flows from financing activities:
Borrowings under credit agreement 500,000
Proceeds from long-term debt 4,645,956
Principal payments on long-term debt (5,331,257)
Distributions to shareholders (852,000)
Additional paid-in capital related to common stock repurchase (153,955)
-----------
Net cash used in financing activities (1,191,256)
Net decrease in cash and cash equivalents (266,325)
Cash and cash equivalents, beginning of year 1,323,337
-----------
Cash and cash equivalents, end of year $ 1,057,012
===========
Acquisition of property, plant and equipment through debt financing $ 4,306,089
===========
Cash paid for:
Interest $ 1,646,284
===========
Income taxes $ 2,500
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-23
MSCL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For The Year Ended September 30, 1997
__________
Common Stock Additional
-------------------- Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ----------- -------- -----
Balance, September 30, 1996 1,000 $3,330 $ 519,668 $12,459,845 $12,982,843
Net income 1,629,164 1,629,164
Legal costs related to common
stock repurchase (153,955) (153,955)
Dividends (852,000) (852,000)
Balance, September 30, 1997 1,000 $3,330 $ 365,713 $13,237,009 $13,606,052
The accompanying notes are an integral part of these consolidated financial
statements.
A-24
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Year Ended September 30, 1997
__________
1. Company Organization And Basis Of Consolidation:
The consolidated financial statements include the accounts of MSCL, Inc.
dba Encore and Filmcore ("MSCL"), a California corporation, Filmcore
Editorial San Francisco, L.L.C. ("Filmcore Editorial") and the Virtual
Office, Inc., dba Virtuosity ("Virtuosity"), collectively known as the
"Company." Filmcore Editorial and Virtuosity are majority-owned
subsidiaries of MSCL. In October 1996, MSCL entered into an operating
agreement for the formation of Filmcore Editorial and contributed certain
assets for a 75% interest in net profits. MSCL contributed certain assets
for a 66-2/3% interest in Virtuosity in November 1995. In fiscal year
1997, the Company adopted early the provisions of EITF 96-16, "Investors
Accounting for an Investee When the Investor Has a Majority of the Voting
Interest but the Minority Shareholder or Shareholders Have Certain Approval
or Veto Rights," and changed the method of recording the investment in
Virtuosity from the equity method to consolidation. The impact of the
Company adopting EITF 96-16 did not have a material effect on the financial
statements. All significant intercompany transactions have been eliminated
in consolidation.
MSCL and Filmcore Editorial are engaged in providing post-production
services and facilities to advertising agencies, production companies and
motion picture and television studios, television programs and commercials
produced primarily in Southern California. The Company also leases video
equipment to customers under short-term cancellable operating leases.
Virtuosity provides telephone voice mail and various other services to
individuals and businesses for an access charge.
2. Summary Of Significant Accounting Policies:
Revenue Recognition
-------------------
Revenue is recognized when services are rendered. Revenue is recognized on
incomplete visual effects and editing jobs using the percentage-of-
completion method. Losses on jobs are recognized in their entirety when
identified. Unearned revenue represents billings on incomplete editing
jobs in excess of costs incurred.
Use Of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates.
A-25
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
2. Summary Of Significant Accounting Policies, Continued:
Cash Equivalents
----------------
The Company considers all highly liquid debt instruments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
include money market funds.
Concentration Of Credit Risk
----------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of trade accounts
receivable and uninsured cash balances. Concentrations of credit risk with
respect to trade accounts receivable are limited due to the number of
customers comprising the Company's customer base. The Company requires no
collateral from its customers and performs ongoing credit evaluations of
its customers' financial condition.
The Company places its cash deposits with high-credit, quality financial
institutions. At times, balances in the Company's cash accounts may exceed
the Federal Deposit Insurance Corporation limit of $100,000.
Inventories
-----------
Inventories are stated at the lower of cost or market, cost generally being
determined on a first-in, first-out basis.
Property And Equipment
----------------------
Property and equipment are stated at cost. Depreciation is provided for on
the straight-line method over the estimated useful lives of the assets.
The estimated useful lives of the assets are as follows:
Editing equipment 5 - 10 years
Video equipment 5 - 7 years
Office furniture and equipment 5 - 7 years
Vehicles 5 years
Video equipment held for lease 5 years
Video and editing equipment held under capital lease 5 - 7 years
A-26
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
2. Summary Of Significant Accounting Policies, Continued:
Property And Equipment, Continued
----------------------
Leasehold improvements are amortized on the straight-line method over the
term of the lease or estimated useful life, whichever is shorter.
Expenditures for maintenance and repairs are charged to operations as
incurred, while renewals and betterments are capitalized.
Other Assets
------------
Goodwill represents the excess of the acquisition costs of acquired
subsidiaries over the fair value of the net assets, and is being amortized
on the straight-line method over periods of 5 to 40 years.
The cost of patents and trademarks acquired are being amortized on the
straight-line method over 17 and 20 years, respectively, or the estimated
useful life, whichever is shorter.
Capital Lease Obligations
-------------------------
The Company has capitalized certain property and equipment under lease
obligations which, by their terms, are equivalent to installment purchases.
Advertising Costs
-----------------
The Company expenses advertising costs as incurred. Advertising costs
charged to operations were $441,964 for the year ended September 30, 1997.
Income Taxes
------------
The Company has elected to be taxed as an S Corporation, whereby the entire
Federal and California taxable income or loss of the Company is reportable
by the shareholders. The Company will not be responsible for Federal
income tax or California franchise tax in excess of the minimum tax, but
will incur a 1.5% California surtax.
Income taxes are provided for the tax effects of transactions reported in
the financial statements and consist of taxes currently due plus deferred
taxes.
A-27
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
2. Summary Of Significant Accounting Policies, Continued:
Income Taxes, Continued
------------
Deferred income taxes are provided for temporary differences with respect
to balance sheet items that result from different reporting practices for
financial statement and income tax purposes. Deferred tax assets and
liabilities represent the future tax return consequences of those
differences which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred taxes are also recognized
for tax credits that are available to offset future California surtax.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
The principal sources of temporary differences result from differing
methods used for property and equipment depreciation and the recognition of
Los Angeles Revitalization Zone credit carryforwards.
Deferred taxes are classified as current or noncurrent, depending on the
classification of the assets and liabilities to which they relate.
Deferred taxes arising from temporary differences that are not related to
an asset or liability are classified as current or noncurrent depending on
the periods in which the temporary differences are expected to reverse.
Reclassifications
-----------------
Certain classifications in the current financial statements may be
different from classifications in the prior year's financial statements.
3. Due From Shareholder:
Loans receivable from officer/shareholder are unsecured, due on demand, and
bear interest at 7% per annum. The loans include $100,075 receivable from
a shareholder who has resigned from the Company.
A-28
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
4. Property And Equipment:
Property and equipment consist of the following:
Editing and video equipment $ 29,410,062
Office furniture and equipment 4,872,204
Vehicles 151,356
Video equipment held for lease 4,746,310
Video and editing equipment held under capital lease 6,823,917
Leasehold improvements 6,890,235
Construction-in-progress 819,952
------------
53,714,036
Less: Accumulated depreciation, including $2,685,166 for video equipment
held for lease and $5,353,452 for equipment held under capital lease
(27,422,766)
------------
$ 26,291,270
============
5. Other Assets:
Other assets consist of the following:
Goodwill, net of accumulated amortization of $44,011 $174,365
Patents and trademarks, net of accumulated amortization of $96,615 182,858
Deposits 111,547
Advances 41,861
Other 35,374
--------
$546,005
========
A-29
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
6. Notes Payable To Bank:
Under the terms of a credit agreement expiring August 31, 1998, the Company
may borrow up to $2,000,000 under a revolving credit facility. Interest is
payable monthly at either 2% per annum in excess of the LIBOR rate, if
requested by the Company in accordance with the terms of the agreement, or
.25% per annum above the reference rate. At September 30, 1997, the rate
was 8.75% and $500,000 was outstanding under this facility.
The credit agreement contains various financial covenants and is
collateralized by the personal guarantees of certain officer/shareholders
of the Company, and their related trusts and by collateralized interests in
substantially all of the assets of the Company, to the extent that these
assets are not leased or financed by other unrelated parties. The Company
was not in compliance with certain of its financial covenants at September
30, 1997, which is a breach of the credit agreement. The bank has waived
these specific requirements of the credit agreement through March 31,
1998, at which time a new credit agreement was finalized. Under the terms
of the new credit agreement expiring May 31, 1999, the Company may borrow
up to $3,000,000 under a revolving line of credit. The most restrictive
financial covenants require the Company to maintain 1) a ratio of current
assets to current liabilities of at least 1.00:1.00 at each quarter end; 2)
a ratio of total liabilities to tangible net worth of not greater than
2.25:1.00 at each quarter end; and 3) a fixed charge coverage ratio of not
less than 1.25:1.00 at each year end, as defined.
The Company entered into a construction line of credit on September 2,
1997 for $1,200,000, which will become a Term Note on February 28, 1998
and will be due in 60 equal payments with the final payment due on January
31, 2003. Interest will be payable monthly at 2% per annum in excess of
the LIBOR rate. At September 30, 1997, no amount was outstanding under
this facility.
7. Long-Term Debt:
Notes payable, due in aggregate monthly installments of $223,704 through
October 2001, including interest ranging from 8.05% to 8.82% per annum,
collateralized by security interests in the related equipment. The
Company was not in compliance with a reporting covenant associated with
this note at September 30, 1997, which is a breach of the terms of the
note. The lender has waived the specific violation of the note terms. $7,451,518
A-30
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
7. Long-Term Debt, Continued:
Notes payable, due in aggregate monthly installments of $74,780 through
September 2001, plus and including interest of 8.7% per annum,
collateralized by security interests in the related equipment and any
proceeds it generates. The note is guaranteed by the
officer/shareholders of the Company. The Company was not in compliance
with a reporting covenant associated with this note at September 30,
1997, which is a breach of the terms of the note. The lender has waived
the specific violation of the note terms. $3,022,638
Notes payable, due in aggregate monthly installments of $144,067 through
October 2001, including interest ranging from 7.74% to 9.12% per annum,
collateralized by security interests in the related equipment. The
Company was not in compliance with a reporting covenant associated with
this note at September 30, 1997, which is a breach of the terms of the
note. The lender has waived the specific violation of the note terms. 5,489,168
Notes payable, due in aggregate monthly installments of $36,450 through
March 2000, including interest ranging from 9.31% to 10.15% per annum,
collateralized by security interests in the related equipment. 898,529
Capital lease obligations, due in aggregate monthly installments of
$104,784 through September 2000, including interest ranging from 7.0% to
9.25% per annum. 1,648,438
A-31
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
7. Long-Term Debt, Continued:
Notes payable to bank, due in aggregate monthly installments of $41,667
through December 2001, plus interest at .75% per annum above the
reference rate and at 8.65% and 10.34% per annum. The interest rate on
the variable rate note was 8.75% at September 30, 1997. These notes are
subject to the terms and conditions as indicated in these financial
statements. $ 1,735,000
Officer/shareholders' unsecured loans, due in monthly installments of
$1,719 through May 2003, including interest at 9.4% per annum. 91,261
-----------
20,336,552
Current maturities, including $1,036,383 for capital lease obligations 6,266,583
-----------
$14,069,969
===========
The following is a schedule of aggregate annual maturities of long-term
debt:
Years Ending
September 30,
-------------
1998 $6,266,583
1999 5,651,058
2000 4,560,456
2001 3,194,590
2002 649,555
Thereafter 14,310
-----------
$20,336,552
===========
8. Due To Officers/Shareholders:
Loans payable to officers/shareholders are unsecured, due on demand, and
bear interest at 7% per annum. The officer/shareholders will not make
demand within the next 12 months.
A-32
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
9. Retirement Plan:
The Company has a qualified 401(k) retirement plan in effect for eligible
employees. The plan provides for pretax employee contributions, fifty
percent of which will be matched by the Company, pursuant to the plan
agreement. Additional annual contributions may be made by the Company at
its discretion. Total contributions are not to exceed annual amounts
deductible under Internal Revenue Service regulations. Retirement plan
expense charged to operations was $196,118 for the year ended September
30, 1997.
10. Shareholders' Equity:
The Company incurred legal expenses related to certain litigation, as
discussed in these financial statements, for the repurchase of stock from a
minority shareholder. These legal expenses were incurred for both the
litigation and the acquisition of the shares of stock. The Company
classified the portion of the expenses directly related to the acquisition
of stock into additional paid-in capital and the balance was expensed in
the consolidated statement of income.
11. Stock Option:
The Company entered into a stock option agreement on February 1, 1997 with
an employee of the Company. The agreement provides for a grant of options
to purchase up to 1% of the issued and outstanding common stock of the
Company for each full year of service of the agreement not to exceed 5% of
the total outstanding stock. The exercise price for each 1% of the
outstanding common stock is $20. As of September 30, 1997, no options are
exercisable under the agreement.
Any stock purchased pursuant to the agreement will be subject to a
restriction which requires the sale of the stock by the employee to the
Company at the exercise price in the event the employee's employment is
terminated, either voluntarily or involuntarily.
The Company recognized $40,440 of earned compensation expense related to
this stock option agreement for the year ended September 30, 1997.
Compensation cost was estimated by management using a market approach and
applying multiples derived from comparable sale transactions of similar
companies with a discount for the restrictions placed on the stock.
A-33
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
11. Stock Option, Continued:
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," and will use the intrinsic
value-based method of accounting prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." However, at September 30,
1997, compensation cost for the existing employee stock option agreement
measured under the intrinsic value-based method approximates compensation
cost measure under the fair value-based method.
12. Commitments And Contingencies:
Employment Agreements
---------------------
The Company has employment agreements with certain key employees. In
addition to base salaries, some of the agreements provide for bonuses based
on total employee billings or net income after tax, and severance payments.
In addition, one of the agreements also provides for 5% of distributed
income for one of the divisions, as defined, starting September 30, 2002
and thereafter, and 5% of the net sales proceeds attributable to one of the
divisions upon the sale of the division or Company, providing the employee
remains employed or if the sale occurs one year after the employee's
termination.
A-34
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
12. Commitments And Contingencies, Continued:
Leases
------
The Company leases its facilities and property and equipment under
noncancellable operating and capital leases, respectively, expiring in
various years through 2012 and is committed to minimum rental payments
(exclusive of real estate taxes, maintenance, etc.) as follows:
Operating Leases
Years Ending ----------------------------- Capital
September 30, Affiliates Other Leases
------------- ----------- ---------- ----------
1998 $ 1,670,973 $ 327,630 $1,129,932
1999 1,654,186 317,372 513,400
2000 1,676,984 242,232 133,298
2001 1,700,922 243,132 -
2002 1,690,985 223,332 -
Thereafter 9,005,937 129,902 -
Total minimum lease
payments $17,399,987 $1,483,600 1,776,630
=========== ==========
Less amount representing interest (128,192)
----------
Present value of net minimum
lease payments $1,648,438
==========
The Company leases six of its Southern California facilities from certain
officer/shareholders of the Company. Rent on three of the facilities is to be
adjusted annually based on increases in the Consumer Price Index or 5% of the
previous year's rent, whichever is greater. The 5% annual adjustment is
included in minimum rental payments. Rent on six facilities is to be adjusted
annually based on increases in the Consumer Price Index up to a maximum of 5%.
Minimum rental payments for this lease do not include any anticipated rental
increases. One of these leases also provides for a ten-year renewal option.
Rent under the option will be redetermined at the time the option is exercised.
Each lease requires payment of certain additional expenses including utilities,
property taxes and other operating expenses.
A-35
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
12. Commitments And Contingencies, Continued:
Leases, Continued
------
The Company leases two facilities in Northern California. One of these
leases includes a determinable escalation clause and rent expense is
recognized on the straight-line method over the term of the lease. The
difference between rent expense recognized and rent payable under the
escalation clauses is reflected in accrued expenses. The lease also
provides for a five-year renewal option. Rent under the option will be the
fair market rental for the premises but not less than the monthly rental
for the last month of the initial lease term. The second lease includes an
escalation clause which will be determined at future dates based on the
Consumer Price Index. The lease also provides for a ten-year renewal
option. The leases require payment of certain additional expenses,
including utilities, property taxes and other operating expenses.
The Company also leases two facilities in Southern California from
unrelated parties. One of the leases includes an escalation clause based
on the Consumer Price Index. The leases provide for renewal options of
five and two years.
In addition, the Company has subleased a portion of one of its Westside
facilities under a five-year noncancellable operating lease for $6,363 per
month, including $1,786 for reimbursement of leasehold improvements. Rent
commenced on November 1, 1996.
Rent expense charged to operations was $1,598,689 for the year ended
September 30, 1997.
Guarantees
----------
The Company has guaranteed notes payable of $3,250,000 and a standby letter
of credit for $812,240 on behalf of certain officer/shareholders of the
Company. The letter of credit is subject to the terms and conditions as
indicated in these financial statements. These obligations were made in
connection with the construction and refinancing of post-production
facilities currently leased by the Company. The amount of borrowings
outstanding at September 30, 1997 was $2,871,351. The letter of credit has
not been drawn upon. The Company requires no collateral with respect to
these guarantees.
Conditional Grant
-----------------
The Company received a conditional grant of $99,306 during the year ended
September 30, 1993 from a governmental agency for leasehold improvements
on facilities leased from certain officer/shareholders of the Company.
A-36
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
12. Commitments And Contingencies, Continued:
Conditional Grant, Continued
-----------------
Should the Company remain in compliance with the terms of the conditional
grant agreement, the debt will be forgiven at the rate of 10% per year for
10 years; otherwise, the remaining balance becomes due and payable. The
grant is collateralized by the assignment of the Company's leasehold
interest in the leased premises.
The grant has been deducted from the carrying value of leasehold
improvements and, therefore, is recognized in the consolidated statement of
income by way of a reduced depreciation charge.
Stock Repurchase Agreement
--------------------------
Under the terms of a shareholders' agreement, upon the death, withdrawal or
termination of a shareholder, the Company is required to purchase all of
the shares owned by the shareholder, provided such sale and purchase may be
lawfully made. The value of shares owned by a deceased, withdrawn or
terminated shareholder shall be determined by appraisal. The Company
maintains life insurance on each shareholder to fund the stock purchase
upon the death of a shareholder, should it become necessary to do so.
During October 1995, a shareholder owning 10% of the stock of the Company
withdrew, which is currently the subject of litigation (see below).
Appraisals to determine the purchase price of the stock are currently
pending. Once the purchase price is determined, it will be reflected in
the Company's balance sheet as a note payable and a reduction in common
stock and additional paid-in capital. Principal and interest at 10% per
annum will be due in equal monthly installments over 5 years if the
principal is greater than $300,000, or 3 years if less.
Litigation
----------
The Company is a defendant in a lawsuit filed by a minority shareholder who
has withdrawn from the Company. Final valuation of the Company's shares
has not yet been determined; the values range from $1,500,000 to
$3,800,000. Subsequent to September 30, 1997, the Company deposited
$579,000 with the court in regard to this matter.
A-37
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
12. Commitments And Contingencies, Continued:
Litigation, Continued
----------
The minority shareholder is also suing for damages for breach of contract,
constructive termination of an alleged employment agreement and various
other issues. The Company believes the suit is without merit and is
vigorously defending its position. Based on the progress of the lawsuit to
date, outside counsel has advised the Company that it has no reason to
believe that the Company will incur a material loss in excess of the
appraised value of the shares, which it will purchase pursuant to the
shareholders' agreement.
The Company was a defendant in a lawsuit filed by an individual to whom the
Company had provided pro bono use of editing systems and storage. The
plaintiff brought various causes of action against the Company resulting
from the loss of film media and asked for damages of $600,000 plus punitive
damages. The lawsuit was settled on or about September 2, 1997 for
$95,000, which the Company paid on that date.
13. Income Taxes:
Income tax (benefit) consists of the following:
Current taxes $ 800
Deferred taxes (80,372)
---------
($79,572)
=========
Income taxes for the year ended September 30, 1997 differ from the expense
that would result from applying the 1.5% California surtax to income before
income taxes due to the benefits of the Los Angeles Revitalization Zone
credits and permanent differences that are not tax-deductible.
Deferred tax assets recognized for deductible temporary differences and Los
Angeles Revitalization Zone credit carryforwards were $434,483 and deferred
tax liabilities recognized for taxable temporary differences were $62,103
at September 30, 1997.
The Company has Los Angeles Revitalization Zone credit carryforwards of
approximately $427,000 which may be used to offset future California surtax
from within the zone through 2010.
14. Nonmonetary Transaction:
During the year ended September 30, 1997, the Company exchanged video
equipment with a net book value of $31,667 and cash of $792,580 for similar
equipment with a fair value of $1,195,780 and a service agreement with a
fair value of $17,676. The new equipment was recorded at its fair value.
A gain on the transaction of $389,209 has been included in the consolidated
statement of income at September 30, 1997.
A-38
MSCL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For The Year Ended September 30, 1997
__________
15. Subsequent Events:
Financing Agreements
--------------------
Subsequent to September 30, 1997, the Company financed the acquisition of
property and equipment for $718,621. The notes are payable in aggregate
monthly installments of $16,971, through November 2002, including interest
ranging from 8.19% to 8.40% per annum.
Investment In LLC
-----------------
Subsequent to September 30, 1997, the Company has reached an agreement for
the formation of a limited liability company, Filmcore Editorial Los
Angeles, LLC (the "LLC") and plans to contribute net assets for a 75%
interest in net profits. The Company has been appointed manager of the LLC
and has agreed to lend amounts that may be necessary for working capital
requirements of the LLC.
A-39
REPORT OF INDEPENDENT ACCOUNTANTS
__________
To the Board of Directors of
MSCL, Inc.
In our opinion, the accompanying balance sheet and the related statements of
income, cash flows and shareholders' equity present fairly, in all material
respects, the financial position of MSCL, Inc. (the "Company") at September 30,
1996, and the results of its operations and its cash flows for the year then
ended, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which requires that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.
As more fully discussed in Note 10 to these financial statements, subsequent to
September 30, 1996, the Company entered into a legal settlement agreement with
a former shareholder for the repurchase of his shares.
PricewaterhouseCoopers LLP
August 6, 1998
A-40
MSCL, INC.
BALANCE SHEET
September 30, 1996
__________
ASSETS
Current assets:
Cash and cash equivalents $1,323,337
Accounts receivable, less allowance for doubtful accounts of $130,000 7,864,044
Inventories 78,850
Prepaid expenses and other current assets 446,616
Deferred income taxes 20,926
-----------
Total current assets 9,733,773
Property and equipment, net 23,367,291
Other assets 699,666
Investment in unconsolidated subsidiary 153,576
Deferred income taxes 271,082
Due from shareholders 275,086
-----------
Total assets $34,500,474
===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Notes payable to bank $ 57,864
Current maturities of long-term debt 4,538,203
Accounts payable 3,716,280
Accrued expenses and other current liabilities 818,626
Unearned revenue 142,190
-----------
Total current liabilities 9,273,163
Long-term debt 12,119,698
Due to shareholders 124,770
-----------
Total liabilities 21,517,631
Commitments and contingencies (Note 10)
Shareholders' equity:
Common stock, $3.33 par value; authorized 10,000 shares, issued and
outstanding 1,000 shares 3,330
Additional paid-in capital 519,668
Retained earnings 12,459,845
-----------
Total shareholders' equity 12,982,843
-----------
Total liabilities and shareholders' equity $34,500,474
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-41
MSCL, INC.
STATEMENT OF INCOME
For The Year Ended September 30, 1996
__________
Revenues $37,088,069
Cost of revenue 22,053,019
-----------
Gross profit 15,035,050
Selling, general and administrative expenses 12,505,600
-----------
Income from operations 2,529,450
Other income (expense):
Interest expense (1,028,091)
Net gain on sale of property and equipment 273,815
Interest income 135,946
Business tax refund 201,628
Equity portion of loss from unconsolidated subsidiary (84,719)
Other expense 15,855
Total other expense (485,566)
-----------
Income before benefit for income taxes (2,043,884)
-----------
Benefit for income taxes (118,270)
-----------
Net income $ 2,162,154
===========
The accompanying notes are an integral part of these consolidated financial
statements.
A-42
MSCL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For The Year Ended September 30, 1996
__________
Cash flows from operating activities:
Net income $ 2,162,154
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 5,489,122
Amortization 88,538
Bad debt expense 74,462
Net gain on disposal of property and equipment (273,815)
Deferred income taxes (111,450)
Equity portion of loss from unconsolidated subsidiary 84,719
Changes in operating assets and liabilities:
Increase in accounts receivable (1,973,006)
Increase in inventories (19,904)
Increase in prepaid expenses and other current assets (44,058)
Increase in due from shareholders (17,997)
Decrease in other assets 466,089
Increase in investment in unconsolidated subsidiary (300,000)
Increase in accounts payable 723,624
Increase in accrued liabilities 173,818
Increase in unearned revenue 59,462
Increase in due to shareholders 7,511
-----------
Net cash provided by operating activities 6,589,269
Cash flows from investing activities:
Capital expenditures (9,486,204)
Proceeds from the sale of property and equipment 22,274
Loans to employees (8,450)
Investment in unconsolidated subsidiary (200,000)
Loan to unconsolidated subsidiary (50,000)
-----------
Net cash used in investing activities (9,722,380)
Cash flows from financing activities:
Borrowing under credit agreement 57,864
Proceeds from long-term debt 6,912,450
Repayment of long-term debt (3,562,469)
-----------
Net cash provided by financing activities 3,407,845
-----------
Net increase in cash and cash equivalents 274,734
Cash and cash equivalents, beginning of year 1,048,603
-----------
Cash and cash equivalents, end of year $ 1,323,337
===========
During 1996, the Company incurred long-term debt of $2,519,628 and accounts payable and accrued expenses of
$1,570,413 to finance the purchase of equipment.
The Company applied advances made in 1995 of $100,000 toward the purchase of shares in an unconsolidated
subsidiary.
The Company also converted $711,293 of short-term borrowings under a credit agreement to long-term debt.
Cash paid for:
Interest $ 1,012,778
Income taxes $ 800
The accompanying notes are an integral part of these consolidated financial
statements.
A-43
MSCL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For The Year Ended September 30, 1996
__________
Common Stock Additional
-------------------- Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ---------- ----------- -----------
Balance, September 30, 1995 1,000 $3,330 $519,668 $10,297,691 $10,820,689
Net income 2,162,154 2,162,154
Balance, September 30, 1996 1,000 $3,330 $519,668 $12,459,845 $12,982,843
The accompanying notes are an integral part of these consolidated financial
statements.
A-44
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS
For the Year Ended September 30, 1996
__________
1. Company Organization:
The Company is engaged in providing post-production services and facilities
to advertising agencies, production companies and freelance artists for
motion pictures, television programs and commercials produced primarily in
Southern California. The Company also leases video equipment to customers
under short-term cancellable operating leases.
2. Summary Of Significant Accounting Policies:
Revenue Recognition
-------------------
Revenue is recognized when services are rendered. Revenue is recognized on
work-in-process visual effects and editing jobs using the percentage-of-
completion method. Losses on jobs are recognized in their entirety when
identified. Unearned revenue represents billings on work-in-process
editing jobs in excess of costs incurred.
Use Of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates.
Cash Equivalents
----------------
The Company considers all highly liquid debt instruments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
include money market funds.
Concentration Of Credit Risk
----------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of trade accounts
receivable and uninsured cash balances. Concentrations of credit risk with
respect to trade accounts receivable are limited due to the number of
customers comprising the Company's customer base. The Company requires no
collateral from its customers and performs ongoing credit evaluations of
its customers' financial condition.
A-45
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
2. Summary Of Significant Accounting Policies, Continued:
Concentration Of Credit Risk, Continued
----------------------------
The Company places its cash deposits with high-credit, quality financial
institutions. At times, balances in the Company's cash accounts may exceed
the Federal Deposit Insurance Corporation limit of $100,000.
Inventories
-----------
Inventories are stated at the lower of cost or market, cost generally being
determined on a first-in, first-out basis.
Property And Equipment
----------------------
Property and equipment are stated at cost. Depreciation is provided for on
the straight-line method over the estimated useful lives of the assets.
The estimated useful lives of the assets are as follows:
Editing equipment 5 - 10 years
Video equipment 5 - 7 years
Office furniture and equipment 5 - 10 years
Vehicles 5 years
Video equipment held for lease 5 - 7 years
Video and editing equipment held under capital lease 5 - 7 years
Leasehold improvements are amortized on the straight-line method over the
term of the lease or estimated useful life, whichever is shorter.
Expenditures for maintenance and repairs are charged to operations as
incurred, while renewals and betterments are capitalized.
Other Assets
------------
Goodwill represents the excess of the acquisition cost of an acquired
subsidiary over the fair value of the net assets, and is being amortized on
the straight-line method over 40 years.
The cost of patents and trademarks acquired are being amortized on the
straight-line method over 17 and 20 years, respectively, or the estimated
useful life, whichever is shorter.
A-46
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
2. Summary Of Significant Accounting Policies, Continued:
Capital Lease Obligations
-------------------------
The Company has capitalized certain property and equipment under lease
obligations which, by their terms, are equivalent to installment purchases.
Advertising Costs
-----------------
The Company expenses advertising costs as incurred. Advertising costs
charged to operations were $409,923 for the year ended September 30, 1996.
Income Taxes
------------
The Company has elected to be taxed as an S Corporation, whereby the entire
Federal and California taxable income or loss of the Company is reportable
by the shareholders. The Company will not be responsible for Federal
income tax or California franchise tax in excess of the minimum tax, but
will incur a 1.5% California surtax.
Income taxes are provided for the tax effects of transactions reported in
the financial statements and consist of taxes currently due plus deferred
taxes.
Deferred income taxes are provided for temporary differences with respect
to balance sheet items that result from different reporting practices for
financial statement and income tax purposes. Deferred tax assets and
liabilities represent the future tax return consequences of those
differences which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred taxes are also recognized
for tax credits that are available to offset future California surtax.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.
The principal sources of temporary differences result from differing
methods used for property and equipment depreciation and the recognition of
Los Angeles Revitalization Zone credit carryforwards.
Deferred taxes are classified as current or noncurrent, depending on the
classification of the assets and liabilities to which they relate.
Deferred taxes arising from temporary differences that are not related to
an asset or liability are classified as current or noncurrent depending on
the periods in which the temporary differences are expected to reverse.
A-47
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
3. Due From Shareholders:
Loans receivable from shareholders are unsecured, due on demand, and bear
interest at 7% per annum. The loans include $93,528 receivable from a
shareholder who has resigned from the Company.
4. Property And Equipment:
Property and equipment consist of the following:
Editing and video equipment $ 23,955,665
Office furniture and equipment 3,444,870
Vehicles 151,356
Video equipment held for lease 3,708,771
Video and editing equipment held under capital lease 6,823,917
Leasehold improvements 6,123,617
------------
44,208,196
Less: Accumulated depreciation, including $1,920,602 for video equipment
held for lease and $4,114,566 for equipment held under capital lease (20,840,905)
$ 23,367,291
============
5. Other Assets:
Other assets consist of the following:
Goodwill, net of accumulated amortization of $21,312 $115,079
Patents and trademarks, net of accumulated amortization of $84,066 156,942
Deposits 377,645
Note receivable from unconsolidated subsidiary 50,000
--------
$699,666
========
A-48
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
5. Other Assets, Continued:
Investment In Unconsolidated Subsidiary
---------------------------------------
On November 1, 1995, the Company acquired a 66.67% interest in The Virtual
Office, Inc., dba Virtuosity, which provides telephone voicemail and
various other services to individuals and businesses for an access charge.
The Company accounts for its investment under the equity method since it
exerts significant influence over Virtuosity's operating and financial
activities, but does not control the majority voting interest due to
limitations provided in the underlying corporate documents. Under the
terms of a related shareholders' agreement, the Company would be required
to sell its stock to the remaining Virtuosity stockholder in the event a
change in ownership, as defined, occurs.
A summary of the financial position and results of operations for
Virtuosity as of and for the twelve months ended September 30, 1996 is as
follows:
Current assets $ 155,330
Property and equipment 485,027
Other assets 19,606
----------
$ 659,963
==========
Current liabilities $ 248,811
Long-term debt 313,243
----------
562,054
Stockholders' equity 97,909
----------
$ 659,963
==========
Net sales $ 543,156
==========
Net loss ($127,072)
Long-term debt includes a $50,000 note payable to the Company.
The investment in Virtuosity exceeded the Company's share of the underlying
net assets by $347,794, which is being amortized on the straight-line
method over 62 months.
A-49
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
5. Other Assets, Continued:
Investment In Unconsolidated Subsidiary, Continued
---------------------------------------
The Company purchased telephone equipment of $55,162 and incurred voicemail
and web design service fees of $29,941 from Virtuosity during the year
ended September 30, 1996. In addition, the Company has guaranteed notes
payable with outstanding balances of $403,928 at September 30, 1996 and
accounts payable for purchases from a specific vendor up to $50,000.
6. Notes Payable To Bank:
Under the terms of a credit agreement expiring April 17, 1997, the Company
may borrow up to $2,000,000 under a revolving credit facility. Interest is
payable monthly at either 2% per annum in excess of the LIBOR rate, if
requested by the Company in accordance with the terms of the agreement, or
.25% per annum above the reference rate. There were no outstanding
balances under this facility at September 30, 1996.
The Company may also borrow up to $300,000 under an additional credit
facility through December 31, 1996. Interest is payable monthly at .25%
per annum above the reference rate. The outstanding balance under this
facility was $57,864 at September 30, 1996. The interest rate at
September 30, 1996 was 8.5%.
On December 31, 1996, the credit facility was fully advanced to $300,000
and was converted to long-term debt, payable in monthly installments of
$5,000 through December 31, 2001, plus interest at .25% per annum above
the reference rate.
The credit agreement contains various financial covenants and is
collateralized by the personal guarantees of certain shareholders of the
Company, and their related trusts and by collateralized interests in
substantially all of the assets of the Company, to the extent that these
assets are not leased or financed by other unrelated parties.
A-50
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
7. Long-Term Debt:
Notes payable, due in aggregate monthly installments of $32,983 through
September 1999, including interest ranging from 8.05% to 8.82% per annum,
collateralized by security interests in the related equipment. $ 870,995
Notes payable, due in aggregate monthly installments of $74,780 through
September 2001, plus and including interest of 8.7% per annum,
collateralized by security interests in the related equipment and any
proceeds it generates. The note is guaranteed by the shareholders of the
Company. 3,605,793
Notes payable, due in aggregate monthly installments of $171,899 through
September 2001, including interest ranging from 7.74% to 9.12% per annum,
collateralized by security interests in the related equipment. 6,472,100
Notes payable, due in aggregate monthly installments of $29,989 through
December 1999, including interest of 9.31% per annum, collateralized by
security interests in the related equipment. 983,666
Capital lease obligations, due in aggregate monthly installments of
$135,371 through September 2000, including interest ranging from 7.0% to
9.25% per annum. 2,688,958
Notes payable to bank, due in aggregate monthly installments of $51,249
through May 2001, plus interest at .75% per annum above the reference
rate and at 8.65% and 10.34% per annum. The interest rate on the
variable rate note was 9.0% at September 30, 1996. These notes are
subject to the terms and conditions as indicated in these financial
statements. 1,934,583
Shareholders' unsecured loans, due in monthly installments of $1,719
through May 2003, including interest at 9.4% per annum. 101,806
-----------
16,657,901
Current maturities, including $1,036,383 for capital lease obligations 4,538,203
-----------
$12,119,698
===========
A-51
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
7. Long-Term Debt, Continued:
The following is a schedule of aggregate annual maturities of long-term
debt:
Years Ending
September 30,
-------------
1997 $ 4,538,203
1998 4,136,902
1999 3,561,113
2000 2,655,050
2001 1,735,076
Thereafter 31,557
-----------
$16,657,901
===========
8. Due To Shareholders:
Loans payable to shareholders of $124,770 at September 30, 1996 are
unsecured, due on demand, and bear interest at 7% per annum. The
shareholders will not make demand within the next 12 months.
9. Retirement Plan:
The Company has a qualified 401(k) retirement plan in effect for eligible
employees. The plan provides for pretax employee contributions, fifty
percent of which will be matched by the Company, pursuant to the plan
agreement. Additional annual contributions may be made by the Company at
its discretion. Total contributions are not to exceed annual amounts
deductible under Internal Revenue Service regulations. Retirement plan
expense charged to operations was $163,817 for the year ended September
30, 1996.
A-52
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
10. Commitments And Contingencies:
Leases
------
The Company leases its facilities and property and equipment under
noncancellable operating and capital leases, respectively, expiring in
various years through 2010 and is committed to minimum rental payments
(exclusive of real estate taxes, maintenance, etc.) as follows:
Years Ending Operating Leases Capital
September 30, Affiliates Other Leases
------------- ----------- -------- ----------
1997 $ 1,301,201 $ 80,150 $1,287,991
1998 1,317,071 85,875 1,086,580
1999 1,301,592 67,627 487,044
2000 1,324,390 - 122,182
2001 1,348,328 - -
Thereafter 8,053,780 - -
Total minimum lease
payments $14,646,362 $233,652 2,983,797
=========== ========
Less: Amount representing interest 294,839
----------
Present value of net minimum $2,688,958
lease payments ==========
The Company leases seven of its Southern California facilities from certain
shareholders of the Company. Rent on five of the facilities is to be
adjusted annually based on increases in the Consumer Price Index or 5% of
the previous year's rent, whichever is greater. The 5% annual adjustment
is included in minimum rental payments. Rent on one facility is to be
adjusted annually based on increases in the Consumer Price Index up to a
maximum of 5%. Minimum rental payments for this lease do not include any
anticipated rental increases. This lease also provides for a ten-year
renewal option. Rent under the option will be redetermined at the time the
option is exercised. Each lease requires payment of certain additional
expenses, including utilities, property taxes and other operating expenses.
A-53
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
10. Commitments And Contingencies, Continued:
Leases, Continued
------
The Company also leases a facility in Northern California. The lease
includes escalation clauses. Rent expense is recognized on the straight-
line method over the term of the lease. The difference between rent
expense recognized and rent payable under the escalation clauses is
reflected in accrued expenses. The lease also provides for a five-year
renewal option. Rent under the option will be the fair market rental for
the premises, but not less than the monthly rental for the last month of
the initial lease term. The lease requires payment of certain additional
expenses, including utilities, property taxes and other operating expenses.
In addition, the Company leases its West Los Angeles facility from certain
shareholders on a month-to-month basis at a minimum monthly rental of
$15,800. The Company has subleased a portion of this facility under a
five-year noncancellable operating lease for $6,634 per month, including
$1,786 for the reimbursement of leasehold improvements. Rent commenced on
November 1, 1996.
Rent expense charged to operations was $1,568,579 for the year ended
September 30, 1996.
Guarantees
----------
The Company has guaranteed notes payable of $3,250,000 and a standby letter
of credit for $989,266 on behalf of certain shareholders of the Company.
The letter of credit is subject to the terms and conditions as indicated in
these financial statements. These obligations were made in connection with
the construction and refinancing of post-production facilities currently
leased by the Company. The amount of borrowings outstanding at September
30, 1996 was $2,997,887. The letter of credit has not been drawn upon.
The Company requires no collateral with respect to these guarantees.
Conditional Grant
-----------------
The Company received a conditional grant of $99,306 during the year ended
September 30, 1993 from a governmental agency for leasehold improvements
on facilities leased from certain shareholders of the Company.
A-54
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
10. Commitments And Contingencies, Continued:
Conditional Grant, Continued
-----------------
Should the Company remain in compliance with the terms of the conditional
grant agreement, the debt will be forgiven at the rate of 10% per year for
10 years; otherwise, the remaining balance becomes due and payable. The
grant is collateralized by the assignment of the Company's leasehold
interest in the leased premises.
The grant has been deducted from the carrying value of leasehold
improvements and, therefore, is recognized in the statement of income by
way of a reduced depreciation charge.
Share Repurchase Agreement
--------------------------
Under the terms of a shareholders' agreement, upon the death, withdrawal or
termination of a shareholder, the Company is required to purchase all of
the shares owned by the shareholder, provided such sale and purchase may be
lawfully made. The value of shares owned by a deceased, withdrawn or
terminated shareholder shall be determined by appraisal. The Company
maintains life insurance on each shareholder to fund the stock purchase
upon the death of a shareholder, should it become necessary to do so.
During October 1995, a shareholder owning 10% of the shares of the Company
withdrew. On April 16, 1998, the parties entered into a settlement
agreement for the purchase of the former shareholder's shares and in
settlement of all outstanding claims. The Company agreed to pay the former
shareholder $2,000,000 for his 10% ownership interest in the Company. The
Company also agreed to pay $450,000 in interest accrued on the appraised
value of the shares from the date of termination of the former shareholder
to the date of the legal settlement. In addition, the Company agreed to
forgive the note receivable from the former shareholder in the amount of
$101,836, value at April 16, 1998, and entered into a note payable for
$250,000 in satisfaction of all other outstanding claims.
As the amount of the settlement was unknown and not estimable at September
30, 1996, it has not been reflected in these financial statements. The
settlement has been recorded in the Company's financial records as of April
1998.
A-55
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
10. Commitments And Contingencies, Continued:
Litigation
----------
The Company was a defendant in a lawsuit filed by an individual to whom the
Company had provided pro bono use of editing systems and storage. The
plaintiff brought various causes of action against the Company resulting
from the loss of film media and asked for damages of $600,000 plus punitive
damages. The lawsuit was settled on or about September 2, 1997 for
$95,000, which the Company paid on that date.
As the amount of the settlement was unknown and not estimable at September
30, 1996, it has not been reflected in these financial statements. The
settlement has been recorded in the Company's financial records as of
September 1997.
11. Income Taxes:
Income tax benefit consists of the following:
Current taxes $ 800
Deferred taxes (111,450)
Other (7,620)
----------
($118,270)
==========
Income taxes for the year ended September 30, 1996 differ from the expense
that would result from applying the 1.5% California surtax to income before
income taxes due to the benefits of the Los Angeles Revitalization Zone
credits and permanent differences that are not tax-deductible.
Deferred tax assets recognized for deductible temporary differences and Los
Angeles Revitalization Zone credit carryforwards were $347,974 and deferred
tax liabilities recognized for taxable temporary differences were $55,966
at September 30, 1996.
The Company has Los Angeles Revitalization Zone credit carryforwards of
approximately $343,000 which may be used to offset future California surtax
from within the zone through 2010.
A-56
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
12. Nonmonetary Transaction:
During the year ended September 30, 1996, the Company exchanged video
equipment with a net book value of $57,560 and cash of $618,324 for similar
equipment with a fair value of $955,025. The new equipment was recorded at
its fair value. A gain on the transaction of $279,141 has been included in
the net income at September 30, 1996.
13. Subsequent Events:
Investment In LLC's
-------------------
On October 1, 1996, the Company entered into an operating agreement for the
formation of a limited liability company, FilmCore Editorial San Francisco,
LLC (the "LLC"), and contributed net assets of $161,500 for a 75% interest.
The Company has been appointed manager of the LLC and has agreed to lend
amounts that may be necessary for working capital requirements of the LLC.
The Company will prepare financial statements as of and for the year ending
September 30, 1997, on a consolidated basis.
On January 1, 1998, the Company reached an agreement for the formation of a
limited liability company, FilmCore Editorial Los Angeles, LLC (the "LLC"),
and contributed net assets for a 75% interest in net profits. The Company
has been appointed manager of the LLC and has agreed to lend amounts that
may be necessary for working capital requirements of the LLC.
Stock Option
------------
The Company entered into a stock option agreement on February 1, 1997 with
an employee of the Company. The agreement provides for a grant of options
to purchase up to 1% of the issued and outstanding common stock of the
Company for each full year of service of the agreement not to exceed 5% of
the total outstanding stock. The exercise price for each 1% of the
outstanding common stock is $20.
Change In Fiscal Year
---------------------
In December 1997, the Company changed its fiscal year-end from September
30th to December 31st.
A-57
MSCL, INC.
NOTES TO FINANCIAL STATEMENTS, Continued
For the Year Ended September 30, 1996
__________
13. Subsequent Events, Continued:
Letter Of Intent
----------------
On May 6, 1998, the shareholders of the Company entered into a nonbinding
letter of intent to sell 100% of the outstanding shares in MSCL and the two
minority shareholders' 25% profits interests in the FilmCore Editorial
LLC's. As part of the proposed transaction, the purchaser would also
purchase certain real estate that is currently owned by the shareholders
and leased to the Company. All the terms of the nonbinding letter of
intent are subject to a nondisclosure and confidentiality provision and
disclosure is made in these financial statements under those provisions.
A-58
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On September 18, 1998, Four Media Company ("4MC") acquired all the
outstanding shares of capital stock of MSCL, Inc. ("Encore") and the real estate
occupied by Encore. The total price of the Encore transaction was approximately
$47.2 million. This amount includes $43.1 million paid in cash to the Encore
shareholders (including $11.2 million for the purchase of real estate), $2.0
million in estimated transaction costs, and the issuance of 486,486 shares of
4MC common stock valued at $4.38 per share.
On May 4, 1998, 4MC through its wholly owned subsidiary VSDD Acquisition
Corp., acquired all of the outstanding ownership interests in Symphonic Video
LLC and Digital Doctors LLC from their parent companies Video Symphony, Inc. and
Digital Doctors, Inc. (collectively "VSI"). In this transaction, 4MC
effectively acquired all of the operations of VSI. The purchase price totaled
approximately $3.1 million paid in 4MC common stock.
On February 2, 1998, 4MC acquired all the outstanding shares of capital
stock of Visualize, a California corporation d/b/a Pacific Ocean Post ("POP").
The purchase price of the shares was $26.4 million of which $23.3 million was
paid in cash, and $3.1 million is represented by promissory notes. Additional
adjustment contingent on and related to the amounts of tax refunds or payments
may become due upon realization.
The unaudited pro forma condensed consolidated balance sheet at August 2,
1998 gives effect to the Encore acquisition as if it had occurred on August 2,
1998. The 4MC historical balance sheet at August 2, 1998 includes the balance
sheets of POP and VSI.
The unaudited pro forma condensed consolidated statements of operations
for the year ended August 2, 1998 give effect to the VSI, POP and Encore
acquisitions as if they had occurred on August 4, 1997. The 4MC historical
statement of operations for the year ended August 2, 1998 includes the results
of POP from the February 2, 1998 acquisition date and the results of VSI from
the May 4, 1998 acquisition date.
The acquisitions were accounted for using the purchase accounting method
and, accordingly, the purchase price of each transaction will be allocated to
the assets acquired and liabilities assumed based on the fair market value of
such assets and liabilities at the date of acquisition. The unaudited condensed
pro forma balance sheet and results of operations are based on available
information and certain assumptions regarding the allocation of purchase price,
which could change significantly based on the realizable value of certain
assets, the potential to incur additional transaction related costs, and other
analyses.
The unaudited pro forma condensed consolidated financial statements may
not be indicative of actual results which would have been obtained if the
acquisitions had been completed and in effect for the periods indicated, nor of
the results that may be obtained in the future.
B-1
FOUR MEDIA COMPANY
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF AUGUST 2, 1998
(in thousands)
4MC ENCORE PRO FORMA 4MC
ASSETS (HISTORICAL) (HISTORICAL) ADJUSTMENTS (PRO FORMA)
Current assets:
Cash......................................... $ 3,301 $ 1,023 $ - $ 4,324
Trade accounts receivable.................... 31,657 5,138 - 36,795
Inventory.................................... 1,263 233 - 1,496
Prepaid expenses............................. 5,624 421 - 6,045
Deferred income taxes........................ - 38 (38)/1/ -
-------- ------- --------- --------
Total current assets........................ 41,845 6,853 (38) 48,660
Property, plant & equipment, net.............. 124,230 26,619 (1,419)/1/ 149,430
Deferred taxes................................ 6,572 352 (352)/1/ 6,572
Long term receivables......................... 3,276 - - 3,276
Goodwill...................................... 37,507 - 39,186 /1/ 76,693
Other assets.................................. 2,914 522 - 3,436
-------- ------- --------- --------
Total assets................................ $216,344 $34,346 $ 37,377 $288,067
======== ======= ========= ========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Current maturities of long term debt and $ 6,184 $ 7,698 $ (6,498)/1/ $ 7,384
capital lease obligations...................
Accounts payable............................. 10,781 2,218 - 12,999
Accrued and other liabilities................ 5,980 1,370 - 7,350
Deferred income taxes........................ 1,615 - - 1,615
-------- ------- --------- --------
Total current liabilities................... 24,560 11,286 (6,498) 29,348
Long term debt and capital lease obligations.. 124,671 12,260 52,544 /1/ 189,475
Minority interests............................ - 436 (436)/1/ -
Commitments and contingencies
Stockholders' equity:
Preferred stock.............................. 2 - - 2
Common stock................................. 99 3 2 /1/ 104
Additional paid-in capital................... 59,577 - 2,126 /1/ 61,703
Foreign currency translation adjustment...... (1,567) - - (1,567)
Retained earnings (deficit).................. 9,002 10,361 (10,361) 9,002
-------- ------- --------- --------
Total stockholders' equity.................. 67,113 10,364 (8,233) 69,244
-------- ------- --------- --------
Total liabilities and stockholders' equity.. $216,344 $34,346 $ 37,377 $288,067
======== ======= ========= ========
The accompanying notes are an integral part of the pro forma condensed
consolidated financial statements.
B-2
FOUR MEDIA COMPANY
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE FISCAL YEAR ENDED AUGUST 2, 1998
(In thousands, except per share amounts)
4MC POP VSI ENCORE
(HISTORICAL) (HISTORICAL) (HISTORICAL) (HISTORICAL)
---------- ---------- ---------- ----------
Revenues................................................ $129,168 $18,617 $3,101 $49,281
Cost of services........................................ 81,144 10,927 1,238 32,408
---------- ---------- ---------- ----------
Gross profit.......................................... 48,024 7,690 1,863 16,873
---------- ---------- ---------- ----------
Operating expenses:
Sales general and administrative...................... 18,504 4,894 479 14,808
Depreciation and amortization......................... 18,191 3,607 9 -
---------- ---------- ---------- ----------
Total operating expenses............................ 36,695 8,501 488 14,808
---------- ---------- ---------- ----------
Income from operations............................ 11,329 (811) 1,375 2,065
Interest expense, net................................... 8,139 912 239 1,893
Other expense......................................... - - - 606
---------- ---------- ---------- ----------
Income before income taxes, minority interest,
and extraordinary item............................... 3,190 (1,723) 1,136 (434)
Income taxes.......................................... - (709) 6 (4)
Minority interest..................................... - 23 - (388)
---------- ---------- ---------- ----------
Income before extraordinary item...................... 3,190 (991) 1,130 (818)
Extraordinary loss on early extinguishment of debt.... (2,449) - - -
---------- ---------- ---------- ----------
Net income.......................................... $ 741 $ (991) $1,130 $ (818)
========== ========== ========== ==========
Earnings per common share - Basic:
Income before extraordinary item...................... $ 0.33
Extraordinary item.................................... (0.25)
----------
Net income per common share........................... $ 0.08
==========
Earnings per common share - Diluted:
Income before extraordinary item...................... $ 0.29
Extraordinary item.................................... (0.22)
----------
Net income per common share........................... $ 0.07
==========
Weighted average number of shares outstanding-basic..... 9,634
==========
Weighted average number of shares outstanding-diluted... 10,898
==========
ACQUISITION ACQUISITION ACQUISITION 4MC
OF POP OF VSI OF ENCORE (PRO FORMA)
----------- ----------- ----------- -----------
Revenues................................................ $ - $ - $ - $200,167
Cost of services........................................ - (667) (7,144)/7/ 117,906
----------- ----------- ----------- -----------
Gross profit.......................................... - 667 7,144 82,261
----------- ----------- ----------- -----------
Operating expenses:
Sales general and administrative...................... - - (798)/7/ 37,887
Depreciation and amortization......................... (2,380)/2/ 278 /5/ 3,204 /7/ 22,909
----------- ----------- ----------- -----------
Total operating expenses............................ (2,380) 278 2,406 60,796
----------- ----------- ----------- -----------
Income from operations............................ 2,380 389 4,738 21,465
Interest expense, net................................... 2,057 /3/ (65)/6/ 3,482 /5/ 16,657
Other expense......................................... - - - 606
----------- ----------- ----------- -----------
Income before income taxes, minority interest,
and extraordinary item............................... 323 454 1,256 4,202
Income taxes.......................................... 709 /4/ (6)/4/ 4 /4/ -
Minority interest..................................... - - 388 /9/ 23
----------- ----------- ----------- -----------
Income before extraordinary item...................... (386) 460 1,640 4,225
Extraordinary loss on early extinguishment of debt.... - - - (2,449)
----------- ----------- ----------- -----------
Net income.......................................... $ (386) $ 460 $ 1,640 $ 1,776
=========== =========== =========== ===========
Earnings per common share - Basic:
Income before extraordinary item...................... $ 0.41
Extraordinary item.................................... (0.24)
-----------
Net income per common share........................... $ 0.17
===========
Earnings per common share - Diluted:
Income before extraordinary item...................... $ 0.36
Extraordinary item.................................... (0.21)
-----------
Net income per common share........................... $ 0.15
===========
Weighted average number of shares outstanding-basic..... 10,363
===========
Weighted average number of shares outstanding-diluted... 11,627
===========
The accompanying notes are an integral part of the pro forma condensed
consolidated financial statements.
B-3
FOUR MEDIA COMPANY
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. The total price of the Encore transaction was approximately $47,200. This
amount includes $43,100 paid in cash to the Encore shareholders (including
$11,200 for the purchase of real estate), $2,000 in estimated transaction
costs, and the issuance of 486,486 shares of 4MC common stock valued at
$4.38 per share. In addition, the Company repaid approximately $19,000 of
Encore's debt and assumed the remaining $1,900 in Encore debt. Property,
plant and equipment was adjusted to an estimated fair market value of
$14,000 and deferred tax assets relating to Los Angeles Revitalization Zone
credit carryforwards were reduced to zero due to the inability of 4MC to
utilize such credits.
2. Adjustments to reflect revised depreciation using fair market value of POP
assets and seven-year useful life, and goodwill acquired amortized over
forty years.
3. Adjustments to reflect new debt at average interest rate of 8.1%, plus
amortization of $3,000 financing costs over 6 1/2 years.
4. Elimination of 100% of net income tax benefit based on taxable income being
reported on a consolidated basis. No income tax is shown on a consolidated
basis because of 4MC's net operating loss carryforwards.
5. Adjustments to reflect revised depreciation using fair market value of VSI
assets and seven year useful life, and goodwill acquired amortized over
forty years. In addition, depreciation expense reported by VSI in cost of
services has been reclassified to operating expenses to conform to the 4MC
presentation.
6. Adjustments to related payoff of VSI debt with borrowings for the Company's
debt facility at average interest rate of 8.1%.
7. Adjustments to reflect revised depreciation using fair market value of
Encore assets and seven year useful life, and goodwill acquired amortized
over forty years. In addition, depreciation expense reported by Encore has
been reclassified to conform to the 4MC presentation.
8. Adjustments related to payoff of Encore debt with borrowings from 4MC's debt
facility at average interest rate of 8.1% and new debt at average interest
rate of 8.1%.
9. Elimination of the minority interest due to acquisition of 100% of the
interest in such entities.
B-4
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.
FOUR MEDIA COMPANY
Date: December 2, 1998 By: /s/ Alan S. Unger
-----------------
Alan S. Unger
Vice President and Chief Financial Officer
B-5