SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
- Exchange Act of 1934.
For the quarterly period ended March 31, 2003 or
__ Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934.
For the transition period from to
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Commission file number 0-21917
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Point.360
(Exact Name of Registrant as Specified in its Charter)
California
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95-4272619
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification
Number)
California 95-4272619
(State of or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7083 Hollywood Boulevard, Suite 200, Hollywood, CA 90028
(Address of principal executive offices) (Zip Code)
(323) 957-7990
(Registrant's Telephone Number, Including Area Code)
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
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As of April 20, 2003, there were 9,035,482 shares of the registrant's common
stock outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POINT.360
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31, March 31,
2002 2003
---- ----
Current assets:
Current assets:
Cash and cash equivalents $ 5,372,000 $ 6,680,000
Accounts receivable, net of allowances for doubtful
accounts of $801,000 and $862,000, respectively 12,218,000 11,549,000
Income tax receivable 398,000 631,000
Inventories 903,000 816,000
Prepaid expenses and other current assets 857,000 1,031,000
Deferred income taxes 1,383,000 1,463,000
-------------- -------------
Total current assets 21,131,000 22,170,000
Property and equipment, net 19,965,000 19,162,000
Other assets, net 843,000 604,000
Goodwill and other intangibles, net 27,212,000 27,200,000
Investment in acquisitions 929,000 1,206,000
-------------- -------------
Total assets $ 70,080,000 $ 70,342,000
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,974,000 $ 4,329,000
Accrued expenses 3,885,000 4,055,000
Current portion of notes payable 5,000,000 5,250,000
Current portion of capital lease obligations 87,000 88,000
-------------- -------------
Total current liabilities 12,946,000 13,722,000
-------------- -------------
Deferred income taxes 3,857,000 4,091,000
Notes payable, less current portion 18,000,000 16,499,000
Capital lease obligations, less current portion 65,000 45,000
Derivative valuation liability 701,000 531,000
Shareholders' equity
Preferred stock - no par value; 5,000,000 authorized;
none outstanding - -
Common stock - no par value; 50,000,000 authorized; 9,014,232
and 9,035,482 shares issued and outstanding, respectively 17,359,000 17,385,000
Additional paid-in capital 1,272,000 1,182,000
Accumulated other comprehensive income (90,000) (75,000)
Retained earnings 15,970,000 16,962,000
-------------- -------------
Total shareholders' equity 34,511,000 35,454,000
-------------- -------------
Total liabilities and shareholders' equity $ 70,080,000 $ 70,342,000
============== =============
See accompanying notes to consolidated financial statements.
2
POINT.360
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
March 31,
---------
2002 2003
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Revenues $ 16,846,000 $ 17,293,000
Cost of goods sold (10,594,000) (10,854,000)
------------- --------------
Gross profit 6,252,000 6,439,000
Selling, general and administrative expense (4,607,000) (4,382,000)
------------- --------------
Operating income 1,645,000 2,057,000
Interest expense, net (678,000) (521,000)
Derivative fair value change 176,000 145,000
------------- --------------
Income before income taxes 1,143,000 1,681,000
Provision for income taxes (492,000) (689,000)
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Net income $ 651,000 $ 992,000
============= ==============
Other comprehensive income:
Derivative fair value change $ (15,000) $ (15,000)
------------- --------------
Comprehensive income $ 636,000 $ 977,000
============= ===============
Earnings per share:
Basic
Net income $ 0.07 $ 0.11
Weighted average number of shares 9,011,324 9,023,440
============= ==============
Diluted
Net income $ 0.07 $ 0.11
Weighted average number of shares including
the dilutive effect of stock options 9,069,172 9,289,476
============= ==============
See accompanying notes to consolidated financial statements.
3
POINT.360
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
---------
2002 2003
---- ----
Cash flows from operating activities:
Net income (loss) $ 651,000 $ 992,000
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 1,507,000 1,286,000
Provision for doubtful accounts 169,000 92,000
Deferred income taxes 235,000 154,000
Other non cash item (187,000) (41,000)
Write-off of note receivable 148,000 -
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (711,000) 577,000
(Increase) decrease in inventories (13,000) 87,000
(Increase) in prepaid expenses and other current assets (177,000) (174,000)
Decrease (increase) in other assets 29,000 (95,000)
(Decrease) increase in accounts payable (1,010,000) 355,000
Increase in accrued expenses 775,000 390,000
Increase (decrease) in income taxes 267,000 (233,000)
------------- ------------
Net cash provided by operating activities 1,683,000 3,390,000
------------- ------------
Cash used in investing activities:
Capital expenditures (287,000) (466,000)
Proceeds from sale of equipment 27,000 -
Net cash paid for acquisitions (5,000) (282,000)
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Net cash used in investing activities (265,000) (748,000)
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Cash flows used in financing activities:
Repurchase of common stock - -
Exercise of stock options - 26,000
Repayment of notes payable - (1,251,000)
Repayment of capital lease obligations (15,000) (19,000)
Contract settlement - (90,000)
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Net cash used in financing activities (15,000) (1,334,000)
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Net increase in cash 1,403,000 1,308,000
Cash and cash equivalents at beginning of period 3,758,000 5,372,000
------------- ------------
Cash and cash equivalents at end of period 5,161,000 6,680,000
============= ============
Supplemental disclosure of cash flow information -
Cash paid for:
Interest 663,000 512,000
============= ============
Income tax $ - $ 917,000
============= ============
See accompanying notes to consolidated financial statements.
4
POINT.360
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003
NOTE 1 - THE COMPANY
Point.360 ("Point.360" or the "Company") provides video and film asset
management services to owners, producers and distributors of entertainment and
advertising content. The Company provides the services necessary to edit,
master, reformat, archive and distribute its clients' video content, including
television programming, spot advertising and movie trailers. The Company
provides worldwide electronic distribution, using fiber optics and satellites.
The Company delivers commercials, movie trailers, electronic press kits,
infomercials and syndicated programming, by both physical and electronic means,
to thousands of broadcast outlets worldwide. The Company operates in one
reportable segment.
The Company seeks to capitalize on growth in demand for the services
related to the distribution of entertainment content, without assuming the
production or ownership risk of any specific television program, feature film or
other form of content. The primary users of the Company's services are
entertainment studios and advertising agencies that generally choose to
outsource such services due to the sporadic demand of any single customer for
such services and the fixed costs of maintaining a high-volume physical plant.
Since January 1, 1997, the Company has successfully completed eight
acquisitions of companies providing similar services. The Company will continue
to evaluate acquisition opportunities to enhance its operations and
profitability. As a result of these acquisitions, the Company believes it is one
of the largest and most diversified providers of technical and distribution
services to the entertainment and advertising industries, and is therefore able
to offer its customers a single source for such services at prices that reflect
the Company's scale economies.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles and the Securities and
Exchange Commission's rules and regulations for reporting interim financial
statements and footnotes. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the three month period
ended March 31, 2003 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003. These financial statements
should be read in conjunction with the financial statements and related notes
contained in the Company's Form 10-K for the year ended December 31, 2002.
NOTE 2 - ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES" (SFAS No. 133). The standard, as amended, requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in other
income.
In June 2001, the Financial Accounting Standards Board issued SFAS Nos.
141 and 142, "BUSINESS COMBINATIONS" and "GOODWILL AND OTHER INTANGIBLE ASSETS,"
respectively. SFAS No. 141 replaces Accounting Principles Board ("APB") Opinion
No. 16. It also provides guidance on purchase accounting related to the
recognition of intangible assets and accounting for negative goodwill. SFAS No.
142 changes the accounting for goodwill and other intangible assets with
indefinite useful lives ("goodwill") from an amortization method to an
impairment-only approach. Under SFAS No. 142, goodwill will be tested annually
and whenever events or circumstances occur indicating that goodwill might be
impaired. SFAS No. 141 and SFAS No. 142 are effective for all business
combinations completed after June 30, 2001. Upon adoption of SFAS No. 142,
amortization of goodwill recorded for business combinations consummated prior to
July 1, 2001 ceases, and intangible assets acquired prior to July 1, 2001 that
do not meet the criteria for recognition under SFAS No. 141 will be reclassified
to goodwill. The Company implemented SFAS No. 142 in the first quarter of fiscal
2002 which required no goodwill impairment. The Company also tested goodwill as
of September 30, 2002 with no impairment indicated.
5
We ceased amortization of approximately $26.3 million of goodwill
beginning in 2002. We had recorded approximately $2.0 million of amortization on
these amounts during the year ended December 31, 2001.
In August 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS," which requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which the
obligation is incurred. When the liability is initially recorded, the entity
capitalizes the cost by increasing the carrying amount of the related long-lived
asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.
The Company does not have asset retirement obligations and, therefore, believes
there will be no impact upon adoption of SFAS No. 143.
In October 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which is applicable to financial
statements issued for fiscal years beginning after December 15, 2001. The FASB's
new rules on asset impairment supersede SFAS No. 121, "ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,"
and portions of APB Opinion No. 30, "REPORTING THE RESULTS OF OPERATIONS." SFAS
No. 144 provides a single accounting model for long-lived assets to be disposed
of and significantly changes the criteria that would have to be met to classify
an asset as held-for-sale. Classification as held-for-sale is an important
distinction since such assets are not depreciated and are stated at the lower of
fair value and carrying amount. SFAS No. 144 also requires expected future
operating losses from discontinued operations to be displayed in the period(s)
in which the losses are incurred, rather than as of the measurement date as
presently required. SFAS No. 144 has had no impact on the Company.
In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB
STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL
CORRECTIONS." SFAS No. 145 updates, clarifies, and simplifies existing
accounting pronouncements. This statement rescinds SFAS No. 4, which required
all gains and losses from extinguishment of debt to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
As a result, the criteria in APB No. 30 will now be used to classify those gains
and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS
No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer
necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-lease transactions. This statement
also makes technical corrections to existing pronouncements. While those
corrections are not substantive in nature, in some instances, they may change
accounting practice. The Company does not expect adoption of SFAS No. 145 to
have a material impact, if any, on its financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES." This statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue 94-3, a
liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No.146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, "ACQUISITIONS OF CERTAIN
FINANCIAL INSTITUTIONS." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," to include certain financial
institution-related intangible assets. This statement is not applicable to the
Company.
6
In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR
STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE," an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. SFAS No. 148 will not have any impact on the Company's
financial statements as management does not have any intention to change to the
fair value method.
NOTE 3 - LONG TERM DEBT AND NOTES PAYABLE
In November 1998, the Company borrowed $29,000,000 on a term loan with a
bank. The term loan was repaid in 2000 with the proceeds of a new borrowing
arrangement with a group of banks.
In September 2000, the Company entered into a credit agreement
("Agreement") with a group of banks providing a revolving credit facility of up
to $45,000,000. The purpose of the facility was to repay previously outstanding
amounts under a prior agreement with a bank, fund working capital and capital
expenditures and for general corporate purposes including up to $5,000,000 of
stock repurchases under the Company's repurchase program. Loans made under the
Agreement are collateralized by substantially all of the Company's assets. The
borrowing base under the Agreement was limited to 90% of eligible accounts
receivable, 50% of inventory and 100% of operating machinery and equipment. The
Agreement provided that the aggregate commitment will decline by $5,000,000 on
each December 31 beginning in 2002 until expiration of the entire commitment on
December 31, 2005.
The Agreement also contained covenants requiring certain levels of
annual earnings before interest, taxes, depreciation and amortization (EBITDA)
and net worth, and limited the amount of capital expenditures. By December 31,
2000, the Company had borrowed $31,024,000 under the Agreement and was not in
compliance with certain financial covenants due to adjustments recorded to prior
years' and 2000 results. The bank waived compliance with the covenants and
amended the Agreement in April 2001. In connection with the amendment, the
Company paid the banks a restructuring fee of $225,000 which was expensed in the
second quarter of 2001.
As of April 30, May 31 and June 30, 2001, outstanding amounts under the
line of credit exceeded the borrowing base. On June 11 and July 20, 2001, the
Company entered into amendment and forbearance agreements with the banks which
required the Company to repay the amount of excess borrowings and amended the
Agreement to reduce the aggregate commitment from $45,000,000 to $30,050,000
until the expiration of the commitment on December 31, 2005. In August 2001, the
Company did not make required debt payments which created a breach of the
amendment and forbearance agreements. As a consequence of the breach, the amount
outstanding under the credit facility became immediately due and payable.
In May 2002, the Company and the banks entered into a restructured loan
agreement changing the revolving credit facility to a term loan, with all
existing defaults being waived. The term loan has a maturity date of December
31, 2004. Pursuant to the agreement, the Company made a $2 million principal
payment and will make additional principal payments of $3.5 million, $5.0
million and $18.5 million in 2002, 2003 and 2004, respectively. The agreement
provides for interest at the banks' reference rate plus 1.25% and requires the
Company to maintain certain financial covenant ratios. The term loan is secured
by substantially all of the Company's assets. In connection with the
restructuring, the Company wrote off $265,000 of deferred financing costs
related to the original Agreement in the second quarter of 2002. Certain legal
and other costs associated with the new term loan were capitalized and will be
amortized over the life of the loan.
In October 2002, the company paid the banks $20,000 and made an
additional principal payment of $500,000 in connection with a waiver received
from the banks to allow the company's former President and Chief Executive
Officer to reduce his percentage ownership in the Company to below 14%.
7
NOTE 4 - ISSUANCE OF WARRANT AND POSSIBLE ACQUISITION
In July 2002, the Company acquired an option to purchase three
subsidiaries (the "Subsidiaries") of Alliance Atlantis Communications Inc.
("Alliance") engaged in businesses directly related to those of the Company. In
consideration for the option, the Company issued to Alliance a warrant to
acquire 500,000 shares of the Company's common stock at $2.00 per share. The
warrant expires five years from the closing date of the transaction, or July 3,
2005 if the Company does not purchase the Subsidiaries. In connection therewith,
the Company capitalized the fair value of the warrant ($619,000 determined by
using the Black-Scholes valuation model) and the deposit as other assets on the
balance sheet.
In December 2002, the option was extended to March 10, 2003. In
connection with the extension, the Company made a $300,000 deposit toward the
purchase price of the Subsidiaries, which deposit is nonrefundable except in
very limited circumstances. The deposit was capitalized as an other asset.
Additionally, the Company capitalized approximately $411,000 of due diligence
and other expenses associated with the proposed acquisition and related
financing during the quarter ended March 31, 2003.
The Company did not exercise its option to purchase the Subsidiaries by
the March 10, 2003 termination date. Alliance has agreed to continue
negotiations with the Company to complete the transaction. If the Company does
not purchase the Subsidiaries, the capitalized values or costs of the warrant,
deposit and financing will be written off.
In order to complete the acquisition, the Company must refinance its
existing bank debt and raise additional funds to pay the cash portion of the
purchase price. A provision in the Company's current term loan agreement
prohibits acquisitions unless approved by the banks, which permission has been
denied.
In connection with the possible acquisition and financing, the Company
will incur additional legal, accounting and other costs subsequent to March 31,
2003. If the acquisition and/or financing transactions are not consummated, such
costs will be expensed. If the acquisition and financing is completed, these
amounts will be capitalized as costs of the acquisition or deferred financing
costs, respectively.
NOTE 5 - DERIVATIVE AND HEDGING ACTIVITIES
In November 2000, the Company entered into an interest rate swap
contract to economically hedge its floating debt rate. Under the terms of the
contract, the notional amount is $15,000,000, whereby the Company receives LIBOR
and pays a fixed 6.5% rate of interest for three years. FAS 133 requires that
the swap contract be recorded at fair value upon adoption of FAS 133 and
quarterly by recording (i) a cumulative-effect type adjustment at January 1,
2001 equal to the fair value of the swap contract on that date, (ii) amortizing
the cumulative-effect type adjustment quarterly over the life of the derivative
contract, and (iii) a charge or credit to income in the amount of the difference
between the fair value of the swap contract at the beginning and end of such
8
quarter. The following adjustments were recorded to reflect changes during the
quarters ended March 31, 2002 and 2003:
Increase (Decrease) Income
---------------------------------------------------------------------
Derivative Fair (Provision for) Benefit Net Derivative
Value Change from Income Taxes Fair Value Change
------------ ----------------- -----------------
For the quarter ended March 31, 2002:
- ------------------------------------
Amortization of cumulative-effect type
adjustment $ (26,000) $ 11,000 $ ( 15,000)
Difference in the derivative fair value
between the beginning and end of the year 202,000 (87,000) 115,000
------------ ----------- -----------
$ 176,000 $ (76,000) $ 100,000
============ =========== ===========
For the quarter ended March 31, 2003:
- ------------------------------------
Amortization of cumulative-effect type
adjustment $ (26,000) $ 11,000 $ (15,000)
Difference in the derivative fair value
between the beginning and end of the period 171,000 (70,000) 101,000
----------- ----------- -----------
$ 145,000 $ (59,000) $ 86,000
=========== =========== ===========
NOTE 6 - SETTLEMENT AGREEMENT
In the quarter ended March 31, 2003, the Company entered into a Final
Settlement agreement with its former Chief Executive Officer. The agreement
resulted in a $90,000 reduction of the amount previously credited to Additional
Paid-in Capital in connection with the October 2002 resignation of the Chief
Executive Officer.
9
POINT.360
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Three Months Ended March 31, 2003 Compared To Three Months Ended March 31, 2002.
REVENUES. Revenues increased by $0.5 million to $17.3 million for the
three-month period ended March 31, 2003, compared to $16.8 million for the
three-month period ended March 31, 2002.
GROSS PROFIT. Gross profit increased $0.2 million or 3% to $6.4 million
for the three-month period ended March 31, 2003, compared to $6.2 million for
the three-month period ended March 31, 2002. As a percent of revenues, gross
profit was 37%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and
administrative ("SG&A") expense decreased $0.2 million, or 5% to $4.4 million
for the three-month period ended March 31, 2003, compared to $4.6 million for
the three-month period ended March 31, 2002. As a percentage of revenues, SG&A
decreased to 25% for the three-month period ended March 31, 2003, compared to
27% for the three-month period ended March 31, 2002.
OPERATING INCOME. Operating income increased $0.5 million to $2.1
million for the three-month period ended March 31, 2003, compared to a $1.6
million for the three-month period ended March 31, 2002.
INTEREST EXPENSE. Interest expense for the three-month period ended
March 31, 2003 was $0.5 million, a decrease of $0.1 million from the three-month
period ended March 31, 2002 because of lower debt levels due to principal
payments made during the last twelve months.
DERIVATIVE FAIR VALUE CHANGE. The Company adopted SFAS 133 on January 1,
2001. During the quarters ended March 31, 2003 and 2002, the Company recorded
the difference between the derivative fair value of the Company's interest rate
hedge contract at the beginning and end of the periods, or $171,000 ($101,000
net of tax provision) and $202,000 ($115,000 net of tax provision) in 2003 and
2002, respectively, and amortization of the cumulative-effect adjustment.
INCOME TAXES. The Company's effective tax rate was 41% for the first
quarter of 2003 and 43% for the first quarter of 2002. The decrease in effective
tax rate is the result of the Company's periodic assessment of the relationship
of book/tax timing differences to total expected annual pre-tax results and the
elimination of goodwill expense for financial statement purposes. The effective
tax rate percentage may change from period to period depending on the difference
in the timing of the recognition of revenues and expenses for book and tax
purposes.
NET INCOME. The net income for the three-month period ended March 31,
2003 was $1.0 million, an increase of $0.4 million compared to net income of
$0.6 million for the three-month period ended March 31, 2002.
LIQUIDITY AND CAPITAL RESOURCES
This discussion should be read in conjunction with the notes to the
financial statements and the corresponding information more fully described in
the Company's Form 10-K for the year ended December 31, 2002.
On March 31, 2003, the Company's cash and cash equivalents aggregated
$6.7 million. The Company's operating activities provided cash of $3.4 million
for the three months ended March 31, 2003.
The Company's investing activities used cash of $0.7 million in the
three months ended March 31, 2003. The Company spent approximately $0.5 million
for the addition and replacement of capital equipment and management information
systems which we believe is a reasonable capital expenditure level given the
current revenue volume. In the prior year, the Company's capital expenditures
were $0.3 million. The Company's business is equipment intensive, requiring
periodic expenditures of cash or the incurrence of additional debt to acquire
additional fixed assets in order to increase capacity or replace existing
equipment. We estimate that capital expenditures will be $3.5 to $4.5 million in
2003.
10
In September 2000, the Company signed a $45 million revolving credit
facility agented by Union Bank of California. The amount of the commitment was
reduced to $30 million in July 2001. The facility provided the Company with
funding for capital expenditures, working capital needs and support for its
acquisition strategies.
Due to lower sales levels in the second and third quarters of Fiscal
2001, the borrowing base (eligible accounts receivable, inventory and machinery
and equipment) securing the Company's bank line of credit was less than the
amount borrowed under the line. Consequently, the Company was in breach of
certain covenants. On June 11 and on July 20, 2001, the Company entered into
amendment and forbearance agreements with the banks and agreed to repay the
overdraft amount in weekly increments. In August 2001, the Company failed to
meet the repayment schedule and again entered discussions with the banks.
In May 2002, the Company and the banks entered into a restructured loan
agreement changing the revolving credit facility to a term loan, with all
existing defaults being waived. The term loan has a maturity date of December
31, 2004. Pursuant to the agreement, the Company made $5.5 million in scheduled
principal payments in 2002 and will make additional principal payments of $5.0
million and $18.0 million in 2003 and 2004, respectively. The agreement provides
for interest at the banks' reference rate plus 1.25% and requires the Company to
maintain certain financial covenant ratios. The term loan is secured by
substantially all of the Company's assets.
In July 2002, we entered into an arrangement regarding earn-out payments
related to the July 1997 acquisition of MultiMedia Services, Inc. The original
acquisition agreement would have required payments of approximately $1.5 million
during the next two years assuming minimum earnings levels are met, which levels
have been achieved in the past. In exchange for a one-time $1.1 million payment
made in July 2002, we were relieved of all future earn-out obligations under the
purchase agreement.
In October 2002, the company paid the banks $20,000 and made an
additional principal payment of $500,000 in connection with a waiver received
from the banks to allow the company's former President and Chief Executive
Officer to reduce his percentage ownership in the Company to below the 14%
required in the restructured loan agreement.
During the past year, the Company has generated sufficient cash to meet
operating, capital expenditure and debt service needs and obligations, as well
as to provide sufficient cash reserves to address contingencies. When preparing
estimates of future cash flows, we consider historical performance,
technological changes, market factors, industry trends and other criteria. In
our opinion, the Company will continue to be able to fund its needs for the
foreseeable future.
The Company, from time to time, considers the acquisition of businesses
complementary to its current operations. Consummation of any such acquisition or
other expansion of the business conducted by the Company may be subject to the
Company securing additional financing. For example, the Company is currently
negotiating to acquire three subsidiaries of Alliance Atlantis Communications
Inc. ("Alliance"). If we acquire the entities, we will have to finance a large
portion of the purchase price and refinance our existing $22 million term loan.
The cost of new financing is expected to be higher than our existing term loan.
Future earnings and cash flow may be negatively impacted to the extent the
acquired entities do not generate sufficient earnings and cash flow to offset
the increased costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates and judgments,
including those related to allowance for doubtful accounts, valuation of
long-lived assets, and accounting for income taxes. We base our estimates on
11
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following
critical accounting policies affect our more significant judgments and estimates
used in the preparation of our consolidated financial statements.
Critical accounting policies are those that are important to the
portrayal of the Company's financial condition and results, and which require
management to make difficult, subjective and/or complex judgements. Critical
accounting policies cover accounting matters that are inherently uncertain
because the future resolution of such matters is unknown. We have made critical
estimates in the following areas:
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We are required to make judgments,
based on historical experience and future expectations, as to the collectibility
of accounts receivable. The allowances for doubtful accounts and sales returns
represent allowances for customer trade accounts receivable that are estimated
to be partially or entirely uncollectible. These allowances are used to reduce
gross trade receivables to their net realizable value. The Company records these
allowances based on estimates related to the following factors: i) customer
specific allowances; ii) amounts based upon an aging schedule and iii) an
estimated amount, based on the Company's historical experience, for issues not
yet identified.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS. Long-lived assets,
consisting primarily of property, plant and equipment and intangibles comprise a
significant portion of the Company's total assets. Long-lived assets, including
goodwill and intangibles are reviewed for impairment whenever events or changes
in circumstances have indicated that their carrying amounts may not be
recoverable. Recoverability of assets is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
that asset. The cash flow projections are based on historical experience,
management's view of growth rates within the industry and the anticipated future
economic environment.
Factors we consider important which could trigger an impairment review
include the following:
o significant underperformance relative to expected historical or
projected future operating results;
o significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
o significant negative industry or economic trends;
o significant decline in our stock price for a sustained period; and
o our market capitalization relative to net book value.
When we determine that the carrying value of intangibles, long-lived
assets and related goodwill and enterprise level goodwill may not be recoverable
based upon the existence of one or more of the above indicators of impairment,
we measure any impairment based on a projected discounted cash flow method using
a discount rate determined by our management to be commensurate with the risk
inherent in our current business model. Net intangible assets, long-lived
assets, and goodwill amounted to $47.6 million as of March 31, 2003.
We ceased amortization of approximately $26.3 million of goodwill
beginning in 2002. We had recorded approximately $2.0 million of amortization on
these amounts during the year ended December 31, 2001.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves us
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within our consolidated balance
sheet. We must then assess the likelihood that our deferred tax assets will be
recovered from future taxable income and to the extent we believe that recovery
is not likely, we must establish a valuation allowance. To the extent we
establish a valuation allowance or increase this allowance in a period, we must
include an expense within the tax provision in the statement of operations.
12
Significant management judgment is required in determining our provision
for income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. The net deferred tax
liability as of March 31, 2003 was $2.6 million. The Company did not record a
valuation allowance against its deferred tax assets as of March 31, 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2001, the Company adopted SFAS No. 133. The
standard, as amended, requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in other income.
In June 2001, the Financial Accounting Standards Board issued SFAS Nos.
141 and 142, "BUSINESS COMBINATIONS" and "GOODWILL AND OTHER INTANGIBLE ASSETS,"
respectively. SFAS No. 141 replaces Accounting Principles Board ("APB") Opinion
No. 16. It also provides guidance on purchase accounting related to the
recognition of intangible assets and accounting for negative goodwill. SFAS No.
142 changes the accounting for goodwill and other intangible assets with
indefinite useful lives ("goodwill") from an amortization method to an
impairment-only approach. Under SFAS No. 142, goodwill will be tested annually
and whenever events or circumstances occur indicating that goodwill might be
impaired. SFAS No. 141 and SFAS No. 142 are effective for all business
combinations completed after June 30, 2001. Upon adoption of SFAS No. 142,
amortization of goodwill recorded for business combinations consummated prior to
July 1, 2001 ceases, and intangible assets acquired prior to July 1, 2001 that
do not meet the criteria for recognition under SFAS No. 141 will be reclassified
to goodwill. The Company implemented SFAS No. 142 in the first quarter of fiscal
2002 which required no goodwill impairment. The Company also tested goodwill as
of September 30, 2002 with no impairment indicated.
We ceased amortization of approximately $26.3 million of goodwill
beginning in 2002. We had recorded approximately $2.0 million of amortization on
these amounts during the year ended December 31, 2001.
In August 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS," which requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which the
obligation is incurred. When the liability is initially recorded, the entity
capitalizes the cost by increasing the carrying amount of the related long-lived
asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.
The Company does not have asset retirement obligations and, therefore, believes
there will be no impact upon adoption of SFAS No. 143.
In October 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," which is applicable to financial
statements issued for fiscal years beginning after December 15, 2001. The FASB's
new rules on asset impairment supersede SFAS No. 121, "ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,"
and portions of APB Opinion No. 30, "REPORTING THE RESULTS OF OPERATIONS." SFAS
No. 144 provides a single accounting model for long-lived assets to be disposed
of and significantly changes the criteria that would have to be met to classify
an asset as held-for-sale. Classification as held-for-sale is an important
distinction since such assets are not depreciated and are stated at the lower of
fair value and carrying amount. SFAS No. 144 also requires expected future
operating losses from discontinued operations to be displayed in the period(s)
in which the losses are incurred, rather than as of the measurement date as
presently required. SFAS No. 144 has had no impact on the Company.
In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB
STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL
CORRECTIONS." SFAS No. 145 updates, clarifies, and simplifies existing
accounting pronouncements. This statement rescinds SFAS No. 4, which required
all gains and losses from extinguishment of debt to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
As a result, the criteria in APB No. 30 will now be used to classify those gains
and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS
No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer
necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-lease transactions. This statement
also makes technical corrections to existing pronouncements. While those
corrections are not substantive in nature, in some instances, they may change
accounting practice. The Company does not expect adoption of SFAS No. 145 to
have a material impact, if any, on its financial position or results of
operations.
13
In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES." This statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue 94-3, a
liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No.146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, "ACQUISITIONS OF CERTAIN
FINANCIAL INSTITUTIONS." SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, "BUSINESS COMBINATIONS," and SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE
ASSETS." In addition, this statement amends SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," to include certain financial
institution-related intangible assets. This statement is not applicable to the
Company.
In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR
STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE," an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. SFAS No. 148 will not have any impact on the Company's
financial statements as management does not have any intention to change to the
fair value method.
CAUTIONARY STATEMENTS AND RISK FACTORS
In our capacity as Company management, we may from time to time make
written or oral forward-looking statements with respect to our long-term
objectives or expectations which may be included in our filings with the
Securities and Exchange Commission, reports to stockholders and information
provided in our web site.
The words or phrases "will likely," "are expected to," "is anticipated,"
"is predicted," "forecast," "estimate," "project," "plans to continue,"
"believes," or similar expressions identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical earnings and
those presently anticipated or projected. We wish to caution you not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. In connection with the "Safe Harbor" provisions of the Private
Securities Litigation Reform Act of 1995, we are calling to your attention
important factors that could affect our financial performance and could cause
actual results for future periods to differ materially from any opinions or
statements expressed with respect to future periods in any current statements.
The following list of important factors may not be all-inclusive, and we
specifically decline to undertake an obligation to publicly revise any
forward-looking statements that have been made to reflect events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events. Among the factors that could have an impact
on our ability to achieve expected operating results and growth plan goals
and/or affect the market price of our stock are:
14
o Recent history of losses
o Prior breach of credit agreement covenants and new principal payment
requirements.
o Our highly competitive marketplace.
o The risks associated with dependence upon significant customers.
o Our ability to execute our expansion strategy.
o The uncertain ability to manage growth.
o Our dependence upon and our ability to adapt to technological
developments.
o Dependence on key personnel.
o Our ability to maintain and improve service quality.
o Fluctuation in quarterly operating results and seasonality in certain of
our markets.
o Possible significant influence over corporate affairs by significant
shareholders.
These risk factors are discussed further below.
RECENT HISTORY OF LOSSES. The Company has reported losses for each of the five
fiscal quarters ended December 31, 2001 due, in part, to lower gross margins and
lower sales levels and a number of unusual charges. Although we achieved
profitability in Fiscal 2000 and prior years, as well as in the five fiscal
quarters ended March 31, 2003, there can be no assurance as to future
profitability on a quarterly or annual basis.
PRIOR BREACH OF CREDIT AGREEMENT COVENANTS AND NEW PRINCIPAL PAYMENT
REQUIREMENTS. Due to lower operating cash amounts resulting from reduced sales
levels in 2001 and the consequential net losses, the Company breached certain
covenants of its credit facility. The breaches were temporarily cured based on
amendments and forbearance agreements among the Company and the banks which
called for, among other provisions, scheduled payments to reduce amounts owed to
the banks to the permitted borrowing base. In August 2001, the Company failed to
meet the principal repayment schedule and was once again in breach of the credit
facility. The banks ended their formal commitment to the Company in December
2001.
In May 2002, we entered into an agreement with the banks to restructure the
credit facility to a term loan maturing on December 31, 2004. As part of this
restructuring, the banks waived all existing defaults and the Company made
principal payments of $5.5 million in 2002, and will make principal payments of
$5.0 million and $18.5 million in 2003, and 2004, respectively. Based upon the
Company's financial forecast, the Company will have to refinance the facility by
2004 to satisfy the final payment requirement.
COMPETITION. Our broadcast video post production, duplication and distribution
industry is a highly competitive, service-oriented business. In general, we do
not have long-term or exclusive service agreements with our customers. Business
is acquired on a purchase order basis and is based primarily on customer
satisfaction with reliability, timeliness, quality and price.
We compete with a variety of post production, duplication and distribution
firms, some of which have a national presence, and to a lesser extent, the
in-house post production and distribution operations of our major motion picture
studio and advertising agency customers. Some of these firms, and all of the
studios, have greater financial, distribution and marketing resources and have
achieved a higher level of brand recognition than the Company. In the future, we
may not be able to compete effectively against these competitors merely on the
basis of reliability, timeliness, quality and price or otherwise.
We may also face competition from companies in related markets which could offer
similar or superior services to those offered by the Company. We believe that an
increasingly competitive environment and the possibility that customers may
utilize in-house capabilities to a greater extent could lead to a loss of market
share or price reductions, which could have a material adverse effect on our
financial condition, results of operations and prospects.
15
CUSTOMER AND INDUSTRY CONCENTRATION. Although we have an active client list of
over 2,500 customers, seven motion picture studios accounted for approximately
34% of the Company's revenues during the year ended December 31, 2002. If one or
more of these companies were to stop using our services, our business could be
adversely affected. Because we derive substantially all of our revenue from
clients in the entertainment and advertising industries, the financial
condition, results of operations and prospects of the Company could also be
adversely affected by an adverse change in conditions which impact those
industries.
EXPANSION STRATEGY. Our growth strategy involves both internal development and
expansion through acquisitions. We currently have no agreements or commitments
to acquire any company or business other than an option to acquire three
facilities from Alliance Atlantis Communications Inc. Even though we have
completed eight acquisitions in the last five fiscal years, we cannot be sure
additional acceptable acquisitions will be available or that we will be able to
reach mutually agreeable terms to purchase acquisition targets, or that we will
be able to profitably manage additional businesses or successfully integrate
such additional businesses into the Company without substantial costs, delays or
other problems. Certain of the businesses previously acquired by the Company
reported net losses for their most recent fiscal years prior to being acquired,
and our future financial performance will be in part dependent on our ability to
implement operational improvements in, or exploit potential synergies with,
these acquired businesses.
Acquisitions may involve a number of special risks including: adverse effects on
our reported operating results (including the amortization of acquired
intangible assets), diversion of management's attention and unanticipated
problems or legal liabilities. In addition, we may require additional funding to
finance future acquisitions. We cannot be sure that we will be able to secure
acquisition financing on acceptable terms or at all. We may also use working
capital or equity, or raise financing through equity offerings or the incurrence
of debt, in connection with the funding of any acquisition. Some or all of these
risks could negatively affect our financial condition, results of operations and
prospects or could result in dilution to the Company's shareholders. In
addition, to the extent that consolidation becomes more prevalent in the
industry, the prices for attractive acquisition candidates could increase
substantially. We may not be able to effect any such transactions. Additionally,
if we are able to complete such transactions they may prove to be unprofitable.
The geographic expansion of the Company's customers may result in increased
demand for services in certain regions where it currently does not have post
production, duplication and distribution facilities. To meet this demand, we may
subcontract. However, we have not entered into any formal negotiations or
definitive agreements for this purpose. Furthermore, we cannot assure you that
we will be able to effect such transactions or that any such transactions will
prove to be profitable.
In July 2002, the Company issued a warrant to purchase 500,000 shares of the
Company's common stock to Alliance Atlantis Communications, Inc. ("Alliance") in
consideration of an option to purchase three post-production facilities (the
"Subsidiaries") owned by Alliance. In connection therewith, the Company
capitalized the fair value of the warrant ($619,000, determined by using the
Black-Scholes valuation model). In December 2002, the option was extended by
mutual agreement and we deposited $300,000 toward the ultimate purchase price,
which was negotiated downward. Additionally, the Company capitalized $278,000 of
due diligence costs associated with the proposed acquisition and $141,000 of
costs associated with a new financing arrangement. The Company did not exercise
its option to purchase the Subsidiaries by the March 10, 2003 termination date.
Alliance has agreed to continue negotiations with the Company to complete the
transaction. In the event the Company does not exercise its option to purchase
the Alliance subsidiaries, or does not complete the financing, these amounts
will be written off. Although such a write-off would represent a non cash charge
to income, we cannot predict the effect of such a charge on the market price of
our common stock, if any.
If we acquire the entities, we will have to finance a large portion of the
anticipated purchase price and refinance our existing $22 million term loan. The
cost of new financing is expected to be higher than our existing term loan.
Future earnings and cash flow may be negatively impacted to the extent the
acquired entities do not generate sufficient earnings and cash flow to offset
the increased costs.
16
MANAGEMENT OF GROWTH. During the three years ended December 31, 1999, we
experienced rapid growth that resulted in new and increased responsibilities for
management personnel and placed and continues to place increased demands on our
management, operational and financial systems and resources. To accommodate this
growth, compete effectively and manage future growth, we will be required to
continue to implement and improve our operational, financial and management
information systems, and to expand, train, motivate and manage our work force.
We cannot be sure that the Company's personnel, systems, procedures and controls
will be adequate to support our future operations. Any failure to do so could
have a material adverse effect on our financial condition, results of operations
and prospects.
DEPENDENCE ON TECHNOLOGICAL DEVELOPMENTS. Although we intend to utilize the most
efficient and cost-effective technologies available for telecine, high
definition formatting, editing, coloration and delivery of video content,
including digital satellite transmission, as they develop, we cannot be sure
that we will be able to adapt to such standards in a timely fashion or at all.
We believe our future growth will depend in part, on our ability to add to these
services and to add customers in a timely and cost-effective manner. We cannot
be sure we will be successful in offering such services to existing customers or
in obtaining new customers for these services, including the Company's
significant investment in high definition technology in 2000 and 2001. We intend
to rely on third party vendors for the development of these technologies and
there is no assurance that such vendors will be able to develop such
technologies in a manner that meets the needs of the Company and its customers.
Any material interruption in the supply of such services could materially and
adversely affect the Company's financial condition, results of operations and
prospects.
DEPENDENCE ON KEY PERSONNEL. The Company is dependent on the efforts and
abilities of certain of its senior management, particularly those of Haig S.
Bagerdjian, Chairman, President and Chief Executive Officer. The loss or
interruption of the services of key members of management could have a material
adverse effect on our financial condition, results of operations and prospects
if a suitable replacement is not promptly obtained. Mr. Bagerdjian beneficially
owns approximately 25% of the Company's outstanding stock, but does not have an
employment contract. Although we have employment agreements with certain of our
other key executives, we cannot be sure that either Mr. Bagerdjian or other
executives will remain with the Company. In addition, our success depends to a
significant degree upon the continuing contributions of, and on our ability to
attract and retain, qualified management, sales, operations, marketing and
technical personnel. The competition for qualified personnel is intense and the
loss of any such persons, as well as the failure to recruit additional key
personnel in a timely manner, could have a material adverse effect on our
financial condition, results of operations and prospects. There is no assurance
that we will be able to continue to attract and retain qualified management and
other personnel for the development of our business.
ABILITY TO MAINTAIN AND IMPROVE SERVICE QUALITY. Our business is dependent on
our ability to meet the current and future demands of our customers, which
demands include reliability, timeliness, quality and price. Any failure to do
so, whether or not caused by factors within our control could result in losses
to such clients. Although we disclaim any liability for such losses, there is no
assurance that claims would not be asserted or that dissatisfied customers would
refuse to make further deliveries through the Company in the event of a
significant occurrence of lost deliveries, either of which could have a material
adverse effect on our financial condition, results of operations and prospects.
Although we maintain insurance against business interruption, such insurance may
not be adequate to protect the Company from significant loss in these
circumstances and there is no assurance that a major catastrophe (such as an
earthquake or other natural disaster) would not result in a prolonged
interruption of our business. In addition, our ability to make deliveries within
the time periods requested by customers depends on a number of factors, some of
which are outside of our control, including equipment failure, work stoppages by
package delivery vendors or interruption in services by telephone or satellite
service providers.
FLUCTUATING RESULTS, SEASONALITY. Our operating results have varied in the past,
and may vary in the future, depending on factors such as the volume of
advertising in response to seasonal buying patterns, the timing of new product
and service introductions, the timing of revenue recognition upon the completion
of longer term projects, increased competition, timing of acquisitions, general
economic factors and other factors. As a result, we believe that
period-to-period comparisons of our results of operations are not necessarily
meaningful and should not be relied upon as an indication of future performance.
17
For example, our operating results have historically been significantly
influenced by the volume of business from the motion picture industry, which is
an industry that is subject to seasonal and cyclical downturns, and,
occasionally, work stoppages by actors, writers and others. In addition, as our
business from advertising agencies tends to be seasonal, our operating results
may be subject to increased seasonality as the percentage of business from
advertising agencies increases. In any period our revenues are subject to
variation based on changes in the volume and mix of services performed during
the period. It is possible that in some future quarter the Company's operating
results will be below the expectations of equity research analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected. Fluctuations in sales due to seasonality may
become more pronounced if the growth rate of the Company's sales slows.
CONTROL BY PRINCIPAL SHAREHOLDER; POTENTIAL ISSUANCE OF PREFERRED STOCK;
ANTI-TAKEOVER PROVISIONS. The Company's Chairman, President and Chief Executive
Officer, Haig S. Bagerdjian, beneficially owned approximately 25% of the
outstanding common stock as of March 31, 2003. The ex-spouse of R. Luke
Stefanko, the Company's former President and Chief Executive Officer, owned
approximately 25% of the common stock on that date. Together, they owned
approximately 50%. By virtue of their stock ownership, Ms. Stefanko and Mr.
Bagerdjian individually or together may be able to significantly influence the
outcome of matters required to be submitted to a vote of shareholders, including
(i) the election of the board of directors, (ii) amendments to the Company's
Restated Articles of Incorporation and (iii) approval of mergers and other
significant corporate transactions. The foregoing may have the effect of
discouraging, delaying or preventing certain types of transactions involving an
actual or potential change of control of the Company, including transactions in
which the holders of common stock might otherwise receive a premium for their
shares over current market prices. Our Board of Directors also has the authority
to issue up to 5,000,000 shares of preferred stock without par value (the
"Preferred Stock") and to determine the price, rights, preferences, privileges
and restrictions thereof, including voting rights, without any further vote or
action by the Company's shareholders. Although we have no current plans to issue
any shares of Preferred Stock, the rights of the holders of common stock would
be subject to, and may be adversely affected by, the rights of the holders of
any Preferred Stock that may be issued in the future. Issuance of Preferred
Stock could have the effect of discouraging, delaying, or preventing a change in
control of the Company. Furthermore, certain provisions of the Company's
Restated Articles of Incorporation and By-Laws and of California law also could
have the effect of discouraging, delaying or preventing a change in control of
the Company.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK. The Company had borrowings of $22,000,000 at March 31,
2003 under a credit agreement. Amounts outstanding under the credit agreement
now bear interest at the bank's reference rate plus 1.25%.
The Company's market risk exposure with respect to financial instruments
is to changes in the London Interbank Offering Rate ("LIBOR"). In November 2000,
the Company entered into an interest rate swap contract to economically hedge
its floating debt rate. Under the terms of the contract, the notional amount is
$15,000,000, whereby the Company receives LIBOR and pays a 6.50% rate of
interest for the three years.
On June 15, 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities. The standard, as amended by Statement of
Financial Accounting Standards No. 137, Accounting for Derivative Instruments
and Hedging Activities Deferral of the Effective Date of FASB Statement No. 133,
an amendment of FASB Statement No. 133, and Statement of Financial Accounting
Standards No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities, an amendment of FASB Statement No. 133 (referred to
hereafter as "FAS 133"), is effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000 (January 1, 2001 for the Company). FAS 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or in other comprehensive income, depending on
whether a derivative is designated as part of a hedging relationship and, if it
is, depending on the type of hedging relationship. During 2001, the Company
recorded a cumulative effect type adjustment of $247,000 (net of $62,000 tax
benefit) as a charge to Accumulated Other Comprehensive Income, a component of
Shareholders' Equity, and an expense of $700,000 ($560,000 net of tax benefit)
for the derivative fair value change of an interest rate swap contract and
amortization of the cumulative effect adjustment. During the twelve month period
ended December 31, 2002, the Company recorded income of $82,000 ($48,000 net of
tax provision), for the derivative fair value change and amortization of the
cumulative effect type adjustment. During the quarter ended March 31, 2003, the
Company recorded income of $171,000 ($101,000 net of tax provision), for the
derivative fair value change and amortization of the cumulative effect-type
adjustment.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing date of this report, an
evaluation was conducted under the supervision and with the participation of the
Company's management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures, as such term is defined in Rules 13a-14(c)
and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act").
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in bringing to their attention on a timely basis material information
relating to the Company that is required to be disclosed in the Company's
reports that are filed under the Exchange Act. Subsequent to the date that the
Chief Executive Officer and Chief Financial Officer completed their evaluation,
there have not been any significant changes in the Company's internal controls
or in other factors that could significantly affect such internal controls.
19
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Amended and Restated Option Agreement dated December 30, 2002 between
the Company and Alliance Atlantis Communications Inc. (1)
99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.ss.1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.ss.1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Notes:
(1) Filed as an exhibit to Form 8-K with the Commission on January 8,
2003.
(b) Reports On Form 8-K
The Company filed a Form 8-K dated January 8, 2003 related to an
extension of the period in which the Company could exercise an option to
purchase three entities.
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.
POINT.360
DATE: May 14, 2003 BY: /s/ Alan Steel
-----------------------------
Alan Steel
Executive Vice President,
Finance and Administration
(duly authorized officer and
principal financial officer)
20
CERTIFICATIONS
I, Haig S. Bagerdjian, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Point.360;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: May 14, 2003 /s/ Haig S. Bagerdjian
-----------------------------------
Haig S. Bagerdjian
Chairman of the Board of Directors,
President and Chief Executive Officer
21
I, Alan R. Steel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Point.360;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors:
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: May 14, 2003 /s/ Alan R. Steel
----------------------------------
Alan R. Steel
Executive Vice President
Finance and Administration and
Chief Financial Officer
22
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. ss. 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Point.360 ( the "Company") on Form
10-Q for the period ended March 31, 2003, as filed with the Securities and
Exchange Commission (the "Report"), I, Haig S. Bagerdjian, Chief Executive
Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my
knowledge:
(1) The Report fully complies with the requirements of Section 13 (a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
/s/ Haig S. Bagerdjian
- ---------------------------
Haig S. Bagerdjian
Chief Executive Officer
May 14, 2003
23
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. ss. 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Point.360 ( the "Company") on Form
10-Q for the period ended March 31, 2003, as filed with the Securities and
Exchange Commission (the "Report"), I, Alan R. Steel, Chief Financial Officer of
the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:
(1) The Report fully complies with the requirements of Section 13 (a) or 15
(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
/s/ Alan R. Steel
- ---------------------------
Alan R. Steel
Chief Financial Officer
May 14, 2003
24