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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-22558
IWERKS ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4439361
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
4540 West Valerio Street
Burbank, California 91505-1046
(Address of principal executive offices and zip code)
(818) 841-7766
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities and Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that
the Registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes X No
--- ---
As of February 9, 1999, the Registrant had 12,388,902 shares of Common
Stock, $.001 par value, issued and outstanding.
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IWERKS ENTERTAINMENT, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
- -----------------------------
Condensed Consolidated Balance Sheets as of December 31, 1998
and June 30, 1998 2
Condensed Consolidated Statements of Operations for the Three and Six
Months ended December 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended December 31, 1998 and 1997 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 19
Item 4 - Submission of Matters to a vote of Security Holders 19
Item 6 - Exhibits and Reports on Form 8-K 19
Signatures 20
1
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
(in thousands)
December 31, June 30,
1998 1998
------------ -------------
(unaudited) (audited)
Current assets:
Cash and cash equivalents $ 9,323 $ 7,542
Short-term investments - 2,922
Trade accounts receivable, net of
allowance for doubtful accounts 4,525 3,521
Costs and estimated earnings in excess of
billings on uncompleted contracts 1,044 1,574
Inventories and other current assets 4,995 4,072
------- -------
Total current assets 19,887 19,631
Portable simulation theaters at cost, net of
accumulated depreciation 3,093 3,413
Property and equipment at cost, net of
accumulated depreciation 4,883 4,329
Film inventory at cost, net of amortization 5,564 5,308
Goodwill, net of amortization 14,428 14,742
Investment in joint ventures and other assets 3,575 3,380
------- -------
Total assets $51,430 $50,803
======= =======
See accompanying notes.
2
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
December 31, June 30,
1998 1998
------------ ------------
(unaudited) (audited)
Current liabilities:
Accounts payable $ 2,903 $ 1,982
Accrued expenses 6,176 6,823
Billings in excess of costs and
estimated earnings on uncompleted contracts 5,714 2,971
Deferred revenue 32 308
Capital leases, current portion 796 803
-------- --------
Total current liabilities 15,621 12,887
Capital lease obligations, excluding 698 1,082
current portion
Stockholders' equity:
Preferred stock, $.001 par value,
1,000,000 authorized, none issued and outstanding - -
Common stock, $.001 par value,
50,000,000 authorized; issued and outstanding
12,384,557 and 12,344,807, respectively 57 57
Additional paid-in capital 78,112 78,024
Accumulated deficit (43,058) (41,247)
-------- --------
Total stockholders' equity 35,111 36,834
-------- --------
Total liabilities and stockholders' equity $ 51,430 $ 50,803
======== ========
See accompanying notes.
3
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
For the Three Months Ended For the Six Months Ended
December 31, December 31,
1998 1997 1998 1997
--------- --------- --------- ----------
Revenue $ 8,649 $ 5,989 $16,022 $14,041
Cost of sales 6,146 5,168 11,524 9,957
--------- --------- --------- ----------
Gross profit 2,503 821 4,498 4,084
Selling, general, and administrative
expenses 3,388 4,311 6,438 7,916
Merger related expenses - 218 - 531
--------- --------- --------- ----------
Loss from operations (885) (3,708) (1,940) (4,363)
Interest income 105 272 216 491
Interest expense (41) (64) (87) (134)
--------- --------- --------- ----------
Net loss $ (821) $(3,500) $(1,811) $(4,006)
========= ========= ========= ==========
Basic and diluted loss per
common share (note 4) $(0.07) $(0.29) $(0.15) $(0.33)
========= ========= ========= ==========
Weighted average shares outstanding
-basic and diluted 12,365 12,161 12,356 12,160
========= ========= ========= ==========
See accompanying notes
4
IWERKS ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the six months ended
December 31,
----------------------------
1998 1997
--------- ----------
Operating Activities
Net loss $(1,811) $(4,006)
Depreciation and amortization 2,136 2,259
Changes in operating assets and liabilities 1,344 4,673
--------- ----------
Net cash provided by operating activities 1,669 2,926
--------- ----------
Investing Activities
Investment in joint ventures (701) (208)
Purchases of property and equipment (1,107) (1,444)
Additions to film inventory (982) (2,518)
Investment in debt securities 2,922 1,741
--------- ----------
Net cash provided by (used in)
investing activities 132 (2,429)
Financing Activities
Repayment of notes payable - (81)
Payments on capital leases (391) (362)
Exercise of stock options 88 -
Other 283 -
--------- ----------
Net cash used in financing activities (20) (443)
--------- ----------
Net increase in cash 1,781 54
Cash and cash equivalents at beginning of 7,542 3,608
period
--------- ----------
Cash and cash equivalents at end of period $ 9,323 $ 3,662
========= ==========
Supplemental disclosures of cash flow
information:
Cash paid during the period for interest $ 90 $ 131
========= ==========
Cash paid during the period for income
taxes $ 13 $ 8
========= ==========
See accompanying notes.
5
IWERKS ENTERTAINMENT, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1 - Introduction
- ---------------------
The accompanying condensed consolidated financial statements of Iwerks
Entertainment, Inc. (the "Company") have been prepared without audit pursuant to
the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures made are adequate to make information
presented not misleading. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
financial position of the Company as of December 31, 1998 and the results of its
operations for the three and six months ended December 31, 1998 and 1997 and the
cash flows for the six months ended December 31, 1998 and 1997 have been
included. The results of operations for interim periods are not necessarily
indicative of the results which may be realized for the full year. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's latest Annual Report on Form 10-K as filed
with the SEC.
Note 2 - Income Taxes
- ---------------------
At June 30, 1998, the Company had available federal and state tax net
operating loss carryforwards of approximately $30,400,000 and $14,400,000,
respectively. The federal net operating loss carryforwards expire, in varying
amounts, from the year 2009 through 2013. The state net operating loss
carryforwards expire, in varying amounts, from the year 1999 through 2003. As a
result of these net operating loss carryforwards and current period losses, the
Company's effective tax rate was negligible and consequently no income tax
provision or benefit was recorded in the periods presented.
6
Note 3 - Depreciation and Amortization
- --------------------------------------
Depreciation expense and amortization expense for goodwill and other is
computed using the straight line method over the estimated useful lives of the
assets. Film costs are amortized using the individual film forecast method.
Three Months Ended Six Months Ended
December 31, December 31,
--------------------------------- --------------------------------
1998 1997 1998 1997
----------- ------------- ---------- ----------
Depreciation on fixed assets $ 416,000 $ 276,000 $ 728,000 $ 560,000
Depreciation on touring equipment 160,000 184,000 320,000 352,000
Amortization of film 284,000 367,000 726,000 985,000
Amortization of goodwill and other 181,000 181,000 362,000 362,000
---------- ---------- ---------- ----------
Total depreciation and amortization $1,041,000 $1,008,000 $2,136,000 $2,259,000
========== =========== ========== ==========
Depreciation and amortization included in cost of sales was $451,000 and
$561,000 for the quarter ended December 31, 1998 and 1997, respectively, and
$1,060,000 and $1,356,000 for the six months ended December 31, 1998 and 1997,
respectively.
Note 4 - Net Loss Per Common Share
- ----------------------------------
For the six months ended December 31, 1998 and 1997, the basic and diluted
per share data is based on the weighted average number of common shares
outstanding during the period. Common equivalent shares, consisting of
outstanding stock options and warrants, are not included in the diluted loss per
share calculation since they are antidilutive.
During the six months ended December 31, 1998, 39,750 shares of common
stock were issued as a result of exercises of stock options.
Note 5 - Litigation
- -------------------
The proceedings to which the Company is a defendant consist of ordinary
routine litigation in the course of business. In the opinion of management,
resolution of these matters will not have a material adverse impact on the
Company's financial position or results of operations.
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Information
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe," and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this filing and include statements regarding the intent,
belief or current expectations of Iwerks, its Directors or Officers with respect
to, among other things (a) trends affecting the financial condition or results
of operations of Iwerks and (b) the business and growth strategies of Iwerks.
The stockholders of Iwerks are cautioned not to put undue reliance on such
forward-looking statements. Such forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in this Report, for the reasons, among
others, discussed in "Future Operating Results" below and under the caption,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Risk Factors" in the Company's Annual Report on Form 10-K for
Fiscal 1998, filed with the Securities and Exchange Commission. Iwerks
undertakes no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers
should carefully review the risk factors referred to above and the other
documents the Company files from time to time with the Securities and Exchange
Commission, including the Company's Annual Report on Form 10-K for the fiscal
year 1998, the quarterly reports on Form 10-Q filed by the Company during the
remainder of fiscal 1999, and any current reports on Form 8-K filed by the
Company.
General
- -------
The Company is engaged in the business of designing, engineering,
manufacturing, marketing and servicing high-tech entertainment attractions which
employ a variety of projection, show control, ride simulation and software
technologies. The Company is currently in the business of: (a) selling and
installing ride simulation attractions in specialty theatres, (b) selling and
installing giant screen theatres (generally such theatres require projection
technology which utilize film sizes ranging between five perforations per frame
by 70 millimeters (5/70) and fifteen perforations per frame by 70 millimeter
(15/70)), (c) licensing and distributing the films in its library to ride
simulation theatres previously sold by the Company, as well as to large format
theatres, (d) producing films in the 5/70, 8/70 and 15/70 film format for its
film library as well as producing films in these formats for third parties, (e)
investing in joint ventures by contributing its ride simulation technology,
design and equipment and participating in the theatre profits, (f) operating a
fleet of 16 mobile ride simulation attractions and (g) leasing camera equipment
and the rental of post production facilities.
8
Results of Operations
- ---------------------
Hardware Sales and Service
Revenues on sales of theatre systems are recognized on the percentage-of-
completion method over the life of the contract. The gross margin for each
contract varies based upon pricing strategies, competitive conditions and
product mix.
Owned and Operated
Revenues from owned and operated (O&O) consist of portable ride simulation
theatre revenues (touring) derived primarily from corporate sponsorship or
ticket sales at state fairs, air shows, and similar events; as well as revenues
derived from fixed site joint venture revenues which includes Iwerks'
contractual share of the sites' revenues or profits as applicable. Admission
revenues from the portable ride simulation theatres are subject to variability
due to the seasonal nature of these events which are higher during the summer
months. Sponsorship and contract revenues for the portable theatres are
recognized ratably over the term of the contract.
Film Licensing
The Company typically licenses its film software under one year film
license agreements. Revenues and related expenses are recognized at the
beginning of the license period at which time the customer is billed the license
fee and film is delivered to the customer.
Film Production and Other
Revenue from film production and other is generated primarily through the
leasing of camera equipment, the rental of post production facilities, and the
production of films for third parties.
The following table presents summary information regarding revenues
(amounts in thousands):
Periods Ended December 31,
Three Months Six Months
------------------------------------ -----------------------------
1998 1997 1998 1997
------------------ --------------- ------------- -------------
Hardware Sales & Service $6,174 $3,620 $ 9,432 $ 7,092
Owned and Operated 908 860 3,101 4,039
Film Licensing 1,392 1,415 3,105 2,759
Film Production and Other 175 94 384 151
------ ------ ------- -------
Total $8,649 $5,989 $16,022 $14,041
====== ====== ======= =======
9
Comparison of the Three Months Ended December 31, 1998 to Three Months Ended
- ----------------------------------------------------------------------------
December 31, 1997
- -----------------
For the three months ended December 31, 1998 the Company recorded revenues
of $8,649,000 compared to $5,989,000 for the same period last year. For the
three months ended December 31, 1998, the Company recorded a net loss of
$821,000 or $.07 per share compared to a net loss of $3,500,000 or $.29 per
share for the same period last year.
Revenues
Hardware Sales and Service revenues increased by approximately $2.6 million
as compared to the same period last year. Sales recognized from Asian customers
increased by approximately $2.5 million as compared to the prior year. The
Company has experienced an increase in the signing of new sales contracts in
Asia during fiscal 1999. Decreased sales from Asian customers were adversely
impacted in the second quarter of fiscal 1998 as a result of economic problems
in that region. Typically, sales outside the United States are denominated in
U.S. dollars and are backed by letters of credit, which reduces the risks
related to international sales.
Owned and Operated revenue increased by approximately $48,000, as compared
to the same period last year, primarily due to increases resulting from three
additional joint venture sites opening during the current fiscal year which were
partially offset by a decrease in touring revenue. The Company expects the lower
touring revenue trend to continue to adversely affect results for the remainder
of fiscal 1999 and may continue into future periods. The Company is actively
seeking additional sponsors and other revenue sources.
Film Licensing revenues were relatively consistent with the prior year.
Film Production and Other revenue increased by approximately $81,000
primarily due to additional post production activities.
Cost of Sales and Gross Profit Margin
The overall gross profit margin percentages for the three months ended
December 31, 1998 and 1997 were 28.9% and 13.7%, respectively. The increase in
gross profit margin in the 1998 quarter compared to the same quarter last year
is primarily related to the touring division. While the touring division's
revenue decreased by approximately $64,000, cost of sales decreased by
approximately $435,000. The decreased cost of sales is primarily the result of
to the Company's efforts to reduce costs in this division.
10
Selling, general and administrative expenses
Selling, general and administrative expenses include, among other things,
personnel costs, trade shows and other promotional expenses, sales commissions,
travel expenses, public relation costs, outside consulting and professional
fees, depreciation on fixed assets, amortization of goodwill, departmental
administrative costs and research and development costs.
Selling, general and administrative expenses decreased for the three months
ended December 31, 1998 by $923,000 over the same period in the prior year. This
decrease was primarily due to a reduction of approximately $340,000 in employee-
related expenses due to lower staffing levels and lower recruiting costs, an
approximately $239,000 in research and development costs and a reduction of
approximately $358,000 in bad debt expense. Bad debt expense in the prior fiscal
quarter was higher due primarily to certain Asian customers.
Merger related expenses
- -----------------------
During the three months ended December 31, 1997 the Company incurred
$218,000 of transaction expenses associated with the proposed merger with
Showscan Entertainment, Inc. which did not receive the required shareholder vote
in March 1998. There were no such expenses in the second quarter of fiscal
1999.
Interest income
Interest income for the three months ended December 31, 1998 and 1997 was
$105,000 and $272,000, respectively, and is derived from the Company's
investments. The decrease in interest income resulted primarily from the
decrease in the invested balances during the comparable periods.
Comparison of Six Months Ended December 31, 1998 to Six Months Ended December
- -----------------------------------------------------------------------------
31, 1997
- --------
For the six months ended December 31, 1998 the Company recorded revenues of
$16,022,000 compared to $14,041,000 for the same period last year. For the six
months ended December 31, 1998, the Company recorded a net loss of $1,811,000
or $.15 per share compared to a net loss of $4,006,000 or $.33 per share for the
same period last year.
11
Revenues
Hardware Sales and Service revenues increased by approximately $2.3 million
as compared to the same period last year. The increase is primarily due to an
approximate $2.1 million increase in sales to Asian customers. The Company has
experienced an increase in the signing of new sales contracts in Asia in the
current fiscal year, whereas sales from Asian customers were adversely impacted
in the second quarter of fiscal 1998. Typically, sales outside the United States
are denominated in U.S. dollars and are backed by letters of credit, which
reduce the risks related to international sales.
Owned and Operated revenue decreased by approximately $938,000 as compared
to the same period last year. This decrease was primarily due to lower sales in
the touring division partially offset by an increase in fixed site joint venture
revenues. Both corporate sponsorship and general admission touring revenues were
substantially lower as compared to the same period in the prior year.
Film Licensing revenue increased by approximately $346,000 as a result of
the increasing base of installed theatres that license the Company's film
software. Furthermore, one customer signed a five-year license agreement
relating to a specific film for which all of the related revenues and expenses
were recognized in the first quarter of fiscal 1999.
Film Production and other revenue increased by approximately $233,000
primarily due to additional post production activities.
Cost of Sales and Gross Profit Margin
The total gross profit margin percentages for the six months ended December
31, 1998 and 1997 were 28.1% and 29.1%, respectively. The decrease in gross
profit margin was primarily due to lower margins in the touring division, mostly
in the first quarter, when costs did not decrease in proportion to the decrease
in touring sales. Also, to a lesser extent, hardware sales margins have
decreased due to a change in the mix of hardware sales from simulator (with
higher margins) to other specialty theatres (with lower margins).
Selling, general and administrative expenses
Selling, general and administrative expenses decreased for the six months
ended December 31, 1998 by approximately $1.5 million over the same period in
the prior year. This decrease was primarily due to a reduction of an
approximately $817,000 in employee-related expenses due to lower staffing levels
and lower recruiting costs, approximately $349,000 in research and development
costs, lower trade show marketing expenses of approximately $300,000 and a
reduction of an approximately $88,000 in bad debt expense.
12
Interest Income
Interest income for the six months ended December 31, 1998 and 1997 was
$216,000 and $491,000, respectively, and is derived from the Company's
investments. The decrease in interest income resulted primarily from the
decrease in the invested balances during the comparable periods.
Merger related expenses
During the six months ended December 31, 1997 the Company incurred $531,000
of transaction expenses associated with the proposed merger with Showscan
Entertainment, Inc. which did not receive the required shareholder vote in March
1998. There were no such expenses during the six months ended December 31,
1998.
Impact of Year 2000
General Description of the Year 2000 Issue and the Nature and Effects of the
Year 2000 on Information Technology (IT) and Non-IT Systems
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.
Based on extensive assessments, the Company determined that it will be
required to modify or replace significant portions of its software and certain
hardware so that those systems will properly utilize dates beyond December 31,
1999. The Company presently believes that with modifications or replacements of
existing software and certain hardware, the Year 2000 Issue can be mitigated.
However, if such modifications and replacements are not made, or are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of the Company.
The Company's plan to resolve the Year 2000 Issue involves the following
five phases: (1) inventorying Year 2000 items; (2) assessing the Year 2000
compliance of items determined to be material to the Company; (3) repairing or
replacing material items that are determined not to be Year 2000 compliant; (4)
testing material items; and (5) implementation. To date, the Company has
completed the inventorying of Year 2000 items phase, the assessing the Year 2000
compliance of items determined to be material to the Company phase, and the
repairing or replacing material items that are determined not to be Year 2000
compliant phase. The completed assessment indicated that most of the
13
Company's significant information technology systems could be affected,
particularly the general ledger, billing and inventory systems. The non-IT
systems were assessed and are not material to the Company's operations. For
example, the Company's engineers have reviewed the Company's significant
products and do not believe there is any date sensitive software included in
products sold by the Company since 1994. Some products sold by Omni
Entertainment, a company acquired in 1994, may have date-sensitive chips which
may result in incorrect date displays. The Company is in the process of
notifying these customers of this concern and is providing the necessary tools
to test their equipment. The Company does not expect to incur a material cost to
test or correct products initially sold by the Company.
Status of Progress in Becoming Year 2000 Compliant, Including Timetable for
Completion of Each Remaining Phase
For its information technology exposures, the Company has completed the
inventorying phase, assessment phase and replacement phase. The Company is
currently in the testing and implementation phase. Completion of the testing
phase for all significant systems is expected by March 31, 1999 with complete
implementation targeted for May 31, 1999.
Nature and Level of Importance of Third Parties and their Exposure to the Year
2000
The Company does not interface directly with third party vendors with
regard to shared information systems. The Company has queried its significant
suppliers and subcontractors that do not share information systems with the
Company (external agents). To date, the Company is not aware of any external
agent with a Year 2000 issue that would materially impact the Company's results
of operations, liquidity, or capital resources. However, the Company has no
means of ensuring that external agents will be Year 2000 ready. The inability
of external agents to complete their Year 2000 resolution process in a timely
fashion could materially impact the Company. The effect of non-compliance by
external agents is not determinable.
Costs
The Company will utilize both internal and external resources to replace,
test, and implement the software and certain hardware for Year 2000
modifications. The total cost of the Year 2000 project is estimated at $500,000
and will be funded through operating cash flows or leasing of hardware and
software. To date, the Company has incurred approximately $233,000 related to
all phases of the Year 2000 project. Of the total remaining project costs,
approximately $172,000 is attributable to the purchase of new software and
hardware, which will be capitalized. The remaining $95,000 relates to internal
systems development and will be expensed as incurred.
14
Risks
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. In the event
that the Company does not complete any additional phases, the Company may be
unable to take customer orders, manufacture and ship products, invoice customers
or collect payments. In addition, disruptions in the economy generally
resulting from Year 2000 issues could also materially adversely affect the
Company. The Company could be subject to litigation for computer systems
product failure, for example, equipment shutdown or failure to properly date
business records. The amount of potential liability and lost revenue cannot be
reasonably estimated at this time.
Contingency Plan
The Company currently has no contingency plans in place in the event it
does not complete all phases of the Year 2000 program. The Company plans to
evaluate the status of completion in the third quarter of fiscal 1999 and
determine whether such a plan is necessary.
Readers are cautioned that forward-looking statements contained in this
Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Special Note on Forward-looking Statements,"
beginning on page 8 above. Readers should understand that the dates on which
the Company believes the Year 2000 project will be completed are based upon
Management's best estimates, which were derived utilizing numerous assumptions
of future events, including the availability of certain resources, third-party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, or that there will not be a delay in, or
increased costs associated with, the implementation of the Company's Year 2000
Compliance Project. Specific factors that might cause differences between the
estimates and actual results include, but are not limited to, the availability
and cost of personnel trained in these areas, the ability to locate and correct
all relevant computer code, timely responses to and corrections by third parties
and suppliers, the ability to implement interfaces between the new systems and
the systems not being replaced, and other similar uncertainties. Due to the
general uncertainty inherent in the Year 2000 problem, resulting in part from
the uncertainty of the Year 2000 readiness of third parties and the inter-
connection of national and international businesses, the Company cannot ensure
its ability to timely and cost-effectively resolve problems associated with the
Year 2000 issue which may affect its business operations, or expose it to third
party liability.
15
Future Operating Results
The market for the Company's products is intensely competitive and is
undergoing significant changes, primarily due to technological developments as
well as changing consumer tastes. Numerous companies are developing and are
expected to develop new entertainment products or concepts for the out-of-home
entertainment industry. There is competition for financial, creative and
technological resources in the industry and there can be no assurance that
existing products will continue to compete effectively or that products under
development will ever be competitive.
The Company and its principal competitor in the large screen market, Imax
Corporation, are aggressively competing, particularly in the United States
market, for new 15 perforation, 70 millimeter format (15/70) theatre
installations. The Company primarily competes in this market based upon the
price and terms of its projection technology. Imax, the dominant competitor in
the market, competes primarily on the basis of its brand identity and its larger
base of installed theatres. These factors, and Imax's access to greater
financial and other resources, are expected to continue to place the Company at
a competitive disadvantage in this market and could have a negative impact on
the Company's gross margins in this market. However, the Company believes there
is potential and is pursuing the 8 perforation, 70 millimeter (8/70) format
theatre market in addition to it's 15/70 sales efforts. Imax does not offer an
8/70 product.
In addition to competition in the large screen market, the Company faces
competition in the simulation industry from Showscan Entertainment and a large
number of other competitors. The Company competes in this market based upon the
breadth of its product offerings and the size and quality of its film library.
Few of its competitors in this market have sufficient financial resources to
effectively compete with the Company based on these criteria. The Company's
competitive position in this market segment could be materially affected if any
of its existing competitors or a new entrant were to assemble the financial,
technical and creative resources required to effectively compete with the
Company's range of product offerings and film library. The Company recognizes
these competitive issues and is in the process of creating new products, such as
developing a new generation of smaller ride simulation configurations that can
accommodate the potential opportunity in the mass retail environment and movie
theatres.
Revenues from the Company's owned and operated attractions (primarily
portable simulation theatres) have been declining since the first quarter of
fiscal 1997 when the Company lost its principal sponsorship contract. The
Company has been aggressively pursuing and has signed other sponsorship
contracts since that time. However, it has not been successful in fully
replacing this revenue source and expects the lower sponsorship sales trends to
continue to adversely affect results for at least the next two quarters.
Because this segment of the Company's business has a significant level of fixed
costs regardless of fluctuations in revenues, the Company's gross margins are
expected to continue to be adversely impacted unless it is able to secure
alternate sources of revenue
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or disposes of all or a portion of this business segment or otherwise eliminates
a portion of the fixed costs associated with its operation.
Iwerks has experienced quarterly fluctuations in operating results and
anticipates that these fluctuations will continue in future periods. Operating
results and cash flow can fluctuate substantially from quarter to quarter and
periodically as a result of the timing of theatre system deliveries, contract
signing, sponsorships, the mix of theatre systems shipped, the completion of
custom film contracts, the existence of world expos, the amount of revenues from
portable simulation theatre and film licensing agreements, the timing of sales
of ride simulation attractions, the timing of delivery and installation of such
sales (pursuant to percentage of completion accounting) and any delays therein
caused by permitting or construction delays at the customer's site, the size,
type and configuration of the attractions sold, the timing of film rental
payments from existing attractions and the performance of those attractions that
pay film rental based on a percentage of box office and the timing of sales and
marketing efforts and related expenditures. In particular, fluctuations in
theater system sales and deliveries from quarter to quarter can materially
affect quarterly and periodic operating results, and theatre system contract
signing can materially affect quarterly or periodic cash flow. Accordingly,
Iwerks' revenues and earnings in any particular period may not be indicative of
the results for any future period.
The seasonal fluctuations in earnings also may cause volatility in the
stock price of Iwerks. While a significant portion of Iwerks' expense levels
are relatively fixed, the timing of increases in expense levels is based in
large part on Iwerks' forecasts of future sales. If net sales are below
expectations in any given period, the adverse impact on results of operations
may be magnified by Iwerks' inability to adjust spending quickly enough to
compensate for the sales shortfall. Iwerks may also choose to reduce prices or
increase spending in response to market conditions, which may have a material
adverse effect on Iwerks' results of operations.
Additionally, the Company plans to continue to evaluate and, when
appropriate, make acquisitions of complementary technologies, products or
businesses. The Company will continue to evaluate the changing value of its
assets, and when necessary, make adjustments thereto. While the Company cannot
predict what effect these various factors may have on its financial results, the
aggregate effect of these and other factors could result in significant
volatility in the Company's future performance and stock price.
Liquidity and capital resources
- -------------------------------
Net cash provided by operating activities for the six months ended December
31, 1998 was approximately $1.7 million. This was primarily attributable to the
net loss of approximately $1.8 million offset by non-cash charges of
approximately $2.1 million for depreciation and amortization along with positive
changes in operating assets and liabilities of approximately $1.3 million.
Investing activities for the six months ended December 31, 1998 consisted
primarily of maturities of debt securities partially offset by investments in
17
film inventory, purchases of property and equipment and investments in joint
ventures. Cash used in financing activities consisted primarily of payments on
capital leases.
At December 31, 1998, the Company had cash and cash equivalents of
approximately $9.3 million. The Company believes that its existing cash balances
and cash equivalents on hand at December 31, 1998, combined with anticipated
cash flow from operations, are adequate to meet its cash requirements for at
least the next twelve months, after which time it may be required to raise
additional cash through the sale of equity or debt securities. The Company's
operations are expected to generate cash over the next twelve months, however
this positive cash flow is expected to be offset by cash usages for changes in
operating assets and liabilities, planned additions to film inventory, Year 2000
expenditures and other assets. Consequently, the Company expects its cash
balance to continue to decline during the next twelve months.
If the Company is unable to achieve its projected cash flow from
operations, the Company may experience significantly reduced cash and short-term
investments, which could result in the Company not being able to meet its
operating needs. Recent operating losses, the Company's declining cash
balances, the ongoing financial turmoil in Asia (historically the Company's
largest market and a significant source of operating revenues), the Company's
historical stock performance, and a general decrease in investor interest in the
Company's industry, may make it difficult for the Company to attract equity
investments on terms that are deemed to be favorable to the Company. In
addition, the losses in fiscal 1997, fiscal 1998 and the first six months of
fiscal 1999 make it more difficult for the Company to attract significant debt
financing. Although the Company anticipates that its cash balances will
decrease during fiscal 1999, management is in the process of implementing a plan
which it believes will facilitate a return to profitability and increased cash
flow beyond fiscal 1999. This plan includes, among other things, changes to
sales management, developing and marketing new products, seeking new markets for
the Company's simulation and film capabilities, the establishment of new
strategic vendor and customer partnerships and aggressively reducing expenses.
In the event that cash flow from operation is less than that anticipated, in
order to preserve cash, the Company would be required to reduce expenditures for
capital projects (including new films) and research and development, or effect
further reductions in its corporate infrastructure, any of which could have a
material adverse affect on the Company's future operations. At December 31,
1998 the Company was committed to approximately $2.2 million of capital
expenditures to be made in the remainder of fiscal 1999.
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PART II - OTHER INFORMATION
Item 1. Legal proceedings
- -------------------------
The Company is a party to various actions arising in the ordinary course of
business which, in the opinion of management and in part on the advise of
counsel, will not have a material adverse impact on the Company's financial
condition; however, there can be no assurance that the Company will not become a
party to other lawsuits in the future, and such lawsuits could potentially have
a material adverse effect on the Company's financial condition and results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
On December 17, 1998 the Company held its annual shareholders meeting. The
following two items were voted on:
1. To elect two Class II Directors to hold office for three years and
until their respective successors have been elected. Votes cast for Mr.
Dag Tellefsen totaled 6,790,753; votes withheld totaled 734,191. Votes
cast for Mr. Peter Hanelt totaled 6,880,403; votes withheld totaled
644,541.
2. To approve the Company's 1998 Non-Employee Directors Stock Option Plan.
Votes cast for totaled 6,619,616; votes cast against totaled 857,864;
votes abstained totaled 47,464.
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits:
11.1 Schedule of earnings per share
27.1 Schedule of financial data
(b) Reports on Form 8-K filed during the quarter ended December 31, 1998:
i) A Form 8-K was filed on November 3, 1998, Item 5, regarding a
press release dated October 28, 1998.
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SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the city of Burbank,
State of California on the 11th day of February, 1999.
Iwerks Entertainment, Inc.
(Registrant)
By: /s/ Jeffrey M. Dahl
------------------------------
Senior Vice President
Chief Financial Officer
(Principal Finance Officer)
By: /s/ Bruce E. Palmore
------------------------------
Vice President / Controller
(Principal Accounting Officer)
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