ITEM 1. BUSINESS.
GENERAL
Iwerks Entertainment, Inc. and its subsidiaries ("Iwerks" or "the Company") designs, engineers, manufactures, markets and services high-tech entertainment attractions which employ a variety of projection, show control, ride simulation and software technologies. The Company: (a) sells and installs ride simulation attractions in specialty theatres, (b) sells and installs large format 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) sells and installs specialty theatres which include special "4D" effects, (d) licenses and distributes the films in its library to ride simulation and large format theatres and specialty "3D/4D" theater attractions, (e) produces and/or distributes films in the 5/70, 8/70 and 15/70 film format for third parties, (f) invests in joint ventures by contributing its ride simulation technology, design and equipment and participating in the theatre profits, and (g) leases camera equipment and renting of post production facilities.
The primary markets for the Company's attractions are theme parks, museums, movie theatres, various types of location-based entertainment centers, destination centers and special events. The popularity of entertainment attractions of the type sold by the Company has led to their increasing use as the featured attraction in these locations. The sale of large format theatres into existing commercial exhibitor theatre sites is a new market the Company has targeted. In addition, high-profile retail sites and casinos are expanding their entertainment offerings to broaden appeal, extend the visitors stay and stimulate repeat visits.
The Company offers attractions that are well suited to meet this demand. In addition to their drawing power, the attractions require relatively little space and can be easily refreshed by changing the film or other software.
The Company has installed more than 250 fixed-base theatres and touring attractions in 37 countries. Of these, 111 were ride simulation theatres, which the Company supports with a library of 45 ride simulation films, the industry's largest premium ride simulation film library. The Company is one of the world's premier distributors of Simulation Ride Films to theatres worldwide including Premier Park's Six Flags and Paramount Parks. The Company is proud to be the exclusive distributor of such dynamic films as the award winning "Dino Island" and "Dino Island II -3D". Both films utilize state of the art computer graphics to create action packed adventures that bring you face to face with dinosaurs such as
T-Rex, Pteranodon and a herd of Apatosaurs. "Meteor Attack", another film released exclusively by Iwerks, blasts you into the future as you join a do-or-die mission to save the planet. The Company also enjoys relationships with several independent production companies and distributes additional films on a non-exclusive basis including most of nWave's film library and films from Casting Office, Ex-Machina, Landmark's "James Bond: 007 License To Thrill", Deepwork's space adventure "Star Warriors" and Discovery's "Wings" an educational aviation adventure. In fiscal 2001, Iwerks and Stan Lee Media have announced an agreement to develop, create and distribute a 3D Simulation Ride film based on the "7th Portal," Lee's team of Super Heroes for the 21st century created for the Internet. Stan Lee, who attained icon status as the founder of Marvel Comics, including Spiderman, the Fantastic Four, X-Men and other super heroes, has three generations of fans, devoted to his well-known creations. Additionally, the Company continues to cultivate relationships within the creative community to further increase its extensive library. The Company has the largest installed base of ride simulation theaters and the largest library of ride simulation films in the world.
The Company is a Delaware corporation with principal executive offices located at 4520 West Valerio Street, Burbank, California 91505, telephone number (818) 841-7766. In addition to its principal executive offices, Iwerks has sales offices in Sarasota, Florida and London, England. A sales representative maintains offices in Hong Kong and Shanghai.
BUSINESS STRATEGY
The Company's goal is to capitalize on its position as a leader in the ride simulation attraction business and become the leading full-service provider in the ride simulation, large format and specialty venue 4D attractions by offering a full range of support services and film-based software.
The Company's current strategies to achieve its objectives include the following:
FULL SERVICE PROVIDER OF COMPLETE ENTERTAINMENT BUSINESS SOLUTIONS. The Company intends to expand its market penetration by offering its customers a complete line of services and products to support the design, development and operation of specialty format theater attractions. The Company has installed over 250-specialty format theater attractions and currently licenses film software to over 68 installed simulation theaters. The Company believes that its track record of successes positions it as a leader in terms of industry experience and operating expertise in the specialty format theater market. By focusing its services and products on solutions designed to assist its customers in building their businesses, the Company believes that it will continue to expand its own business opportunities in the future.
EXTEND THE COMPANY'S PRODUCT LINE THROUGH INNOVATIVE USE OF ITS CURRENT TECHNOLOGIES. Management believes that the Company has the opportunity to increase its product offerings without incurring significant additional research and development costs. An example of this is the introduction of a turnkey specialty theatre which utilizes "4D" effects, the first which opened in Shenzhen, China in February 2000. These effects include a water mist, wind and a seat drop among other visceral effects. Management believes there are opportunities to leverage the Company's existing technology to provide new, innovative products designed to meet current market requirements and opportunities, including adding 4D effects to its ride simulation systems.
EXPAND INTO NEW MARKETS. The Company is exploring potential new markets for its attractions, products and services. The Company continues its expansion efforts in Europe and South America. In addition, the Company is pursuing market opportunities for its large format theaters in commercial locations, such as movie theater multiplexes, where it made its first sales in fiscal year 1999, and its ride simulation theaters in untapped commercial settings including casinos and retail businesses.
IDENTIFY NEW STRATEGIC PARTNERS. Management believes that the Company can optimize its market position and performance through the formation of strategic alliances with companies who have complementary technologies, manufacturing or distribution. For example, an alliance with Media Technology Source, the world's largest cinema equipment dealer, provides benefits especially in the large format market.
BRANDED PRODUCTS. The Company has launched the Extreme Screen(TM) brand in an effort to establish a recognizable and significant global market presence for the Company's large format theater installations. In fiscal 2000 six theaters opened with the Extreme Screen(TM) brand and five additional theaters are scheduled to open in fiscal 2001.
IWERKS PRODUCTS
FIXED-BASE RIDE SIMULATION THEATRES. The Company's line of fixed-base ride simulators are marketed under the brands IWERKS TURBORIDE(TM) and EXPLORATION IN MOTION(TM), and combine high-resolution projector film or video software, digital surround sound and moving seats to fully involve the audience in a realistic, simulated experience. The Company is also beginning to incorporate digital projection technology into some of its installations. Software currently available includes a variety of live action and fantasy experiences such as taking a ride through the center of the earth, being chased by dinosaurs, flying at supersonic speeds, racing with Indy cars, riding a roller coaster, white-water rafting and space and underwater adventures. The Company's ride simulation theatre product line is the broadest in the industry, enabling the Company to offer its customers seat, and platform-based simulators in a variety of configurations and at multiple price points. The Company's ride simulators are designed to operate in theatres which typically seat 8 to 100 people, and feature screens up to 52 feet high, with six-channel digital surround sound. In these rides, guests watch a high-resolution film with a fast action point-of-view perspective while sitting in seats that move in synchronization with the action on the screen. Films for the Company's ride simulation theatres typically range between three and five minutes. Ride simulation theatres can be reprogrammed to create new adventures.
LARGE FORMAT THEATRES. The Company's large format theatres are marketed under the name IWERKS EXTREME SCREEN(TM), and feature screens which are much larger than standard movie screens and projection systems that deliver a sharper, brighter image than conventional movies. The result is a high-impact, immersive, sensory experience for the audience. These theatres can seat up to 600 people, have steeply raked seating and exhibit films typically lasting between 15 and 40 minutes. The Company offers 15/70 (15 perforations, 70 millimeter film), 8/70 (8 perforations, 70 millimeter film) and 5/70 (5 perforations, 70 millimeter film) format systems including its exclusive patented Academy Award winning Linear Loop projectors.
The Company's large format theatres are available in a variety of configurations. Its flat screen theatres use screens as large as 65 feet high by 85 feet wide, more than five times the size of most movie theatre screens. The Company's domed screen theatres use a dome-shaped screen up to 85 feet in diameter which wraps around and above the audience filling the audience's field of vision. The Company also offers 3D systems which use dual projectors to create a 3D image.
CUSTOM AND OTHER THEATRES. The Company offers a wide range of custom film and video-based theatre systems utilizing 70 millimeter and 35 millimeter film formats. Among its offerings is the Iwerks' 4D Specialty Theatre, a theatre that includes in-theatre physical effects of fog, rain, wind, speed and more. The Company's custom projects range from the sale of individual projectors to complete theatre systems.
FILM SOFTWARE. The Company produces film and video software for the Company's attractions with a production strategy that is similar to that of a movie studio, where a small core of executives hire supplemental production talent and specialists on a project-by-project basis. This structure allows the Company to maintain creative control of projects without incurring substantial, continuing overhead expenses. In addition, the Company has acquired distribution rights for ride simulation films purchased or licensed from others.
The Company has a film library which includes, as of June 30, 2000, the distribution rights to 45 simulation films of which 7 are available in 3D, 6 large format films of which 2 are available in 3D and 5 3D-attraction films. The Company's library of ride simulation films is the largest in the industry. In addition to the Iwerks' film library, owners of Iwerks' large format theatres have access to an additional library of over 100 films. The Company believes that the quality and size of its film library is an additional significant competitive advantage in the markets in which it competes, particularly in the ride
simulation market. Growth in the installed base of theatres provides the Company an opportunity to increase film licensing revenue.
The Company's film distribution efforts are focused in three primary market sectors: Simulation films, 3D/4D Attraction films and Large Format films. The Company's recent ride simulation films include METEOR ATTACK, a 23rd century training flight; JAMES BOND: LICENSE TO THRILL, a truly live-action experience; STAR WARRIORS, the ultimate starfighter experience; WINGS, an educational aviation adventure made in association with Discovery Channel; JOURNEY THROUGH THE CENTER OF THE EARTH, a 3D ride to the center of the earth; ESCAPE FROM DINO ISLAND, a 3D sequel to its highly successful film DINO ISLAND; SUPERSTITION, a haunted scream park adventure hosted by Elvira - Mistress of the Dark; MAD RACERS, Iwerks' first ride simulation 3D film; SECRETS OF THE LOST TEMPLE, based on an explorer's adventure through a Mayan temple; ALIEN RIDE AT THE SPEED OF FRIGHT, based on the futuristic movie thriller of the same name; DINO ISLAND, a fantasy ride through a dinosaur-inhabited island; MOON RAID ALPHA, a space chase adventure fantasy; a film for Six Flags theme parks called THE RIGHT STUFF; a film for Paramount theme parks based on the motion picture DAYS OF THUNDER and a film based on the motion picture ROBOCOP. Fiscal 2001 releases are scheduled to include a simulation ride film based on Stan Lee's the "7th Portal." The Company continues to look at additional projects which may increase the number of films released in fiscal 2001. Many of the Company's ride simulation and other productions have received industry recognition. In November, 1998 DINO ISLAND II won 1st place at the prestigious London Effects and Animation Festival. Other awards for the Company were the prestigious Marketing Award for Best Brand Pricing at the 1998 International Association of Amusement Parks and Attractions (IAAPA) convention. The Company intends to continue to seek opportunities for deriving additional revenue from its library of simulation films in fiscal year 2001.
The Company also produces and distributes large format and specialty films to theme parks. In fiscal 1999, the Company released "ENCOUNTER IN THE THIRD DIMENSION" a large format 3D film based on the history and technology of 3D effects. In fiscal 2000 the Company released "Adventure Planet." These films are available in 15/70 and 8/70 formats. A shortened version of this film is also available for "3D/4D" specialty theater exhibition.
MULTI-FORMAT FILM PRODUCTION STRATEGY
Given the Company's presence in three unique market places, Iwerks can select film properties and exploit them across the three separate film markets. In the case of the Company's investment in the large format film "ENCOUNTER IN THE THIRD DIMENSION," Iwerks was able to derive three different film products from the single investment. This strategy greatly reduces the risk of the film investment and facilitates entry into new markets to increase revenue potential at a greatly reduced cost. This strategy was duplicated with the release of "ALIEN ADVENTURE IN 3D" which also derived four 3D simulation films including "MAGIC CARPET RIDE IN 3D," "KID COASTER 3D," "AQUA RIDE 3D" and "GLACIER RUN 3D" as well as a 12 minute 3D/4D specialty film.
FILM PRODUCTION
The Company's internal executive production capability develops and oversees production of films for the Company's film productions as well as for third party custom film projects. In fiscal 2000 the production group developed and oversaw production of two custom films for Volkswagen ("The Secret of Safety" a 360 film and "PanoramaTour" a simulation film) and a custom 360 film for Sony entitled "Berlin Symphony." For 2001, Iwerks has secured a custom film contract for a concert film "*NSYNC BIGGER THAN LIVE" showcasing the chart-topping band *NSYNC.
OWNED AND OPERATED (O&O)
The Company has entered into numerous Joint Venture arrangements with Location Based Entertainment ("LBE") operators, specifically Dave & Busters and Pier 39. Typically the arrangement consists of Iwerks contributing the hardware and the operator contributing the site and improvements. The agreements generally call for a film lease payment and gross profit split.
CAMERAS AND OTHER PRODUCTION SERVICES
The Company contracts with third parties to lease its 8/70 large format cameras and related equipment, including a 3D rig, lenses and accessories, generally from several days to several months.
The Company has developed and manufactured one 15/70 large format camera and is in the process of completing two additional 15/70 cameras. The Company also provides technical and post-production services to third party producers for a fee and maintains a 15/70 projection room at its Burbank facilities for rent to large format filmmakers for use in the post-production process.
PORTABLE RIDE SIMULATION THEATRES
In September 1999, the Company decided to sell the assets relating to the portable ride simulation theater ("Touring Division"). These assets are described as the portable ride simulation theaters and are reflected at their estimated fair value less cost to sell. The Company is actively seeking buyers for the portable ride simulation theaters.
MARKETING AND CUSTOMERS
The Company distributes its theatre systems, software and services through multiple distribution channels including a direct sales and marketing force as well as independent sales representatives in selected areas. The sales and marketing staff consists of 8 employees. A sales representative maintains foreign sales offices in Hong Kong and Shanghai which provide support to the Company's Asian marketing programs and assist in customer service. A sales office was established in London, England to create a stronger sales effort in the European market. In addition, the Company has sales professionals located in Burbank, California and Sarasota, Florida.
The Company markets its attractions, including theatre systems and film software, mainly to theme parks, museums, movie theaters, destination centers, casinos, location-based entertainment centers and special event venues. The Company's theatre systems include projection and audio equipment, show control systems and film handling equipment. The Company also provides ride simulation systems which include motion bases, film projection and audio equipment, show control and other effects as well as 4D specialty systems which include other sensory effects. The customer supplies its own theatre space and other necessary site improvements to operate the theatre. The Company provides installation, training, design, marketing, maintenance and other support services.
A primary market for the Company's 2D, 3D and 4D theatres has been the worldwide amusement and theme park industry. The Company expects that continuing sales will come from existing parks looking for new attractions, parks under development looking for an array of attractions and the expanding location-based entertainment industry. Substantial new park development is occurring outside of the United States and management believes that international operators will continue as important customers for this product. The Company has also developed customers in the family entertainment center, movie theater, institutional and casino markets as well as tourist, vacation, destination shopping and convention locations for its ride simulation theatres. The Company sells its ride simulation theatres at prices which are separately negotiated, depending upon the product, the number of motion bases, the configuration of the theatre space, optional components selected and the level of design service provided. The Company licenses its ride simulation films for a range of prices depending on the film, license term and site of theater.
The primary markets for the Company's large format 2D and 3D theatres have been museums, visitor destination centers, and other institutional exhibition facilities frequented by large numbers of visitors. Increasingly, commercial movie theatre operators are also viewing large format theatres as a new entertainment option for their guests. The Company sells its large format theatres at prices which are separately negotiated.
No single customer accounted for more than 10% of revenues in fiscal 1998, 1999 or 2000.
The Company's sales typically are made pursuant to written contracts, and are denominated in United States dollars. International sales are generally backed by letters of credit. Consequently, the Company's operations historically have not been subject to risks related to currency fluctuations. The Company's sales contracts typically provide for progress payments that are timed to match related expenditures by the Company. The customer generally has the right to terminate the contract before completion by paying Iwerks its non-recoverable costs plus a termination fee. The Company offers a warranty on sales of its products, generally for a period of 12 months. The Company believes that its material contract terms are consistent with industry practices.
ENABLING TECHNOLOGIES
With limited exceptions, the underlying technologies employed by the Company are in the public domain and generally available in the marketplace. However, the Company possesses substantial expertise in the design, modification and engineering of projection, film handling, and camera and audio technologies which it believes to be an important competitive factor.
IMAGING SYSTEMS. The Company offers a variety of technologically advanced imaging systems.
The Company's 8/70 is an eight perforation, 70-millimeter film system that operates at 24 or 30 frames per second. By comparison, most motion picture theatres use four perforation, 35-millimeter film that runs at 24 frames per second and standard 70-millimeter film is five perforation which also runs at 24 frames per second. The larger frame size and faster speed gives the Company's 8/70 a brighter and sharper image without the flicker and stroboscopic effects common with conventional 35 and 70-millimeter film systems. The Company's 8/70 is used in the Company's array of ride simulation systems and large format theatres common to museums, movie theatres and other venues where screen sizes up to 60' high and 80' wide or dome screens of 75' or less in diameter are suitable.
The Company owns the proprietary patented Linear-Loop Projection ("LLP") Technology which offers the expanding large format market a genuine alternative to existing projection techniques. The LLP gently pushes film through the projector on a column of air unlike most projection systems that use gear mechanisms to pull film through. The LLP is designed to produce an image that is brighter and more stable than other projectors available. In 2000, the inventor of the patented Linear Loop technology, L. Ron Schmidt, was recognized by the Academy of Motion Picture Arts and Sciences as the recipient of an Academy Scientific and Achievement Award for the Linear Loop's superior concept, design and engineering.
The Company's 15/70 is a fifteen perforation, 70-millimeter rolling loop projection system that handles the largest commercially available film size. This system projects an image area more than nine times that of conventional 35-millimeter film and 300% larger than standard 70-millimeter film. The Company's 15/70 is capable of achieving screen sizes up to 65' high and 85' wide and dome screens up to 85' in diameter that are generally found in high capacity theatres at world expositions and larger museums and visitor centers. Iwerks, 8/70 and 15/70 are used in the Iwerks Dome and Large Format Theatres.
The Company offers high-resolution digital video imaging systems that utilize a laser disc source and produce a high quality video image. This imaging system is ideal for small ride simulation theatre systems.
MOTION BASES. The Company's ride simulation theatres utilize either two seat or eight seat motion platforms. The two seat hydraulic base is a compact and highly responsive three-axis system, allowing a multitude of combinations of pitch (tilt from front to rear), vertical (move up and down) and roll (tilt from side to side) movements, which keep passengers in constant motion with the image. The Company introduced a new eight seat electro-mechanical base, which has six-axis of motion capable of producing the most realistic ride simulation available. The six-axis systems permit pitch, roll, vertical, sway, yaw (a turning motion), and surge (forward and back), all the motions available within a given motion envelope. Each motion base is a self-contained system, requiring only electronic communications and electrical power connections.
MANUFACTURING
The Company manufactures and assembles its theatre systems at its facilities in Burbank, California. A majority of the components for these theatre systems are purchased from outside vendors. The Company's manufacturing operations consist of assembly, testing, quality control and system integration of its theatre system components, subassemblies and final assemblies, including modifications and the programming of the show-control and motion-control components, and installation of the completed theatre systems.
The Company's manufacturing operations utilize a wide variety of electrical and mechanical components, raw materials and other supplies and services. The Company has developed multiple commercial sources for most components and materials, but it does use single sources for a limited number of standard and custom components. While delays in delivery of such single source components could cause delay in shipments of certain products by Iwerks, at this time, the Company has no reason to believe that any of the single-source vendors present a serious risk. Consistent with industry practice, the Company generally purchases components of its theatre systems upon receipt of an order. Certain components used by Iwerks, including lenses, hydraulic power sources and motion bases must be ordered up to four months in advance to assure timely delivery. The Company maintains an inventory of these items as it deems appropriate to service forecasted demand. Research and development costs are incurred in the design, construction and testing of prototype systems and are charged to expense as incurred. The research and development expenses were $766,000, $565,000 and $404,000 for the years ended June 30, 1998, 1999 and 2000, respectively. Of the expenses, 66%, 91% and 53% in 1998, 1999 and 2000, respectively, were for improvements to existing products and the remainder was for development of new products.
In fiscal 1997, the Company acquired the technology and patents to produce the Linear Loop Projector. The Company utilizes LLP not only in its Large Format Theatres, but also as its projector of choice in larger ride simulation installations. Since the acquisition of this technology, the Company has continued to make modifications and enhancements to the LLP. The LLP is not an upgrade or rework of existing vendored products. The technology is unique, patented and has a distinct advantage compared to "geneva" driven models that preceded it.
The Company acquires certain other projectors from third party suppliers and makes modifications to the projectors to fit the Company's use. Lenses and lamphouses incorporated in the projection systems are supplied to the Company by third parties.
The Company and Eaton-Vickers Incorporated, a manufacturer of hydraulic components, jointly developed the hydraulically actuated seats which are used in the two-seat motion base-ride simulation theatre. Under the agreement pursuant to which the hydraulically actuated seats were developed, the Company owns all rights in and to the seats. Eaton-Vickers continues as the sole manufacturer of these motion bases on behalf of the Company; however, the Company has the right under its agreement with Eaton-Vickers to secure alternate sources of manufacturing at any time. The Company also purchases other products from Eaton-Vickers.
The Company also has developed an electro-mechanical 8-seat base in conjunction with MOOG, Inc. The base actuates 6 degrees of movement and uses standard 110 volt electrical power as its source. In the development of the 8-seat simulator, a manufacturer was secured to execute the fiberglass seat as a finished product requiring no additional assembly or finishing by the Company. The finished product will be shipped directly to the installation site for installation.
PATENTS AND TRADEMARKS
With the exception of certain features of Iwerks' motion base and motion control system used in its motion simulation theaters and certain features of its LLP, for which Iwerks owns United States patents, Iwerks does not have United States or foreign patent protection on its existing technology underlying its products. Iwerks intends to seek patent protection for any patentable technology developed in the future. Iwerks has registered certain marks under United States and international trademark laws.
Iwerks intends to take all steps necessary to cause these trademarks to have a perpetual existence, although Iwerks does not believe that its business is dependent on any of these marks.
EMPLOYEES
At September 15, 2000, the Company employed 89 persons, of whom 22 were employed in management, finance and administration, 8 were employed in sales and marketing, and 59 were employed in operations (including 4 employees working on a temporary basis refurbishing the Company's portable ride simulation theaters that are being sold). None of the Company's employees are represented by a collective bargaining agreement. The Company believes that its relations with its employees are satisfactory.
ITEM 2.
ITEM 2. PROPERTIES.
The Company maintains its principal facility in Burbank, California where it leases space under three separate leases on adjacent facilities consisting of 36,000, 23,460 and 7,596 square feet each, expiring September 30, 2001. The Company leases the space for an aggregate lease payment of approximately $42,400 per month. In June 2000, in an effort to reduce operating costs, the Company consolidated its operations into two of the existing buildings. The Company currently is seeking to sublease the third building (23,460 square feet).
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is a party to various actions arising in the ordinary course of business which, in the opinion of management, based in part on the advice of legal counsel, will not have a material adverse effect on the Company's financial condition or results of operations; 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 or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the last quarter of the Registrant's fiscal year ended June 30, 2000, no matter was submitted to a vote of the security holders of the Registrant.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed for quotation on The Nasdaq Small Capital Market. The table below sets forth, for the calendar quarters indicated, the high and low closing sales prices per share as reported on The Nasdaq Small Capital Market for the Iwerks Common Stock.
As of September 15, 2000, Iwerks had approximately 804 holders of record. No dividends have been declared or paid since incorporation. Iwerks currently intends to retain earnings for use in its business and does not anticipate paying any cash dividends on its common stock in the foreseeable future.
On July 28, 2000, the Company was notified by Nasdaq that the Company did not meet the continued listing requirements of The Nasdaq National Market. Accordingly, effective August 1, 2000 the Company was listed on the Nasdaq Small Capital Market pursuant to an exemption and the trading symbol of the Company's securities was changed from IWRK to IWRKC. The Company was granted a temporary exception from the continued listing requirements of the Nasdaq Small Capital Market and must satisfy these requirements, which it currently does not, on or before October 30, 2000. In the event the Company fails to comply, the Company's securities will be delisted from The Nasdaq Stock Market and the Company anticipates that its shares of common stock would begin trading on The Over The Counter Bulletin Board.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company designs, engineers, manufactures, markets and services high-tech entertainment attractions which employ a variety of projection, show control, ride simulation and software technologies.
The Company currently: (a) sells and installs ride simulation attractions in specialty theatres, (b) sells and installs large format 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) sells and installs specialty theatres which include special "4D" effects, (d) licenses and distributes the films in its library to ride simulation, large format theatres and specialty 3D/4D attraction theaters, (e) produces films in the 5/70, 8/70 and 15/70 film format for its film library and for third parties, (f) invests in joint ventures by contributing its ride simulation technology, design and equipment and participating in the theatre profits, and (g) leases camera equipment and rents post production facilities.
The Company's operating results in fiscal 2000 have decreased from fiscal 1999. This was primarily due to decreased hardware sales in North America, reduced film licensing revenue, film inventory write-downs and several large non-cash one-time adjustments. In the third quarter of fiscal 2000, the Company recorded a one-time non-cash write-down to goodwill associated with the acquisition of Omni Film International (Omni) in 1994 ($11.7 million). In the fourth quarter of fiscal 2000, the Company recorded impairment write-downs totaling $2.2 million (certain camera equipment-$1.58 million, portable ride simulation theaters -$594,000). In addition, the Company recorded a charge of $202,000 relating to the adoption of SOP 00-2, "Accounting by Producers or Distributors of Films." In the fourth quarter of fiscal 1999, results were adversely impacted by approximately $1.0 million due to the termination of one contract for a one-time research and development specialty project.
REVENUES FOR THE FISCAL YEARS ENDED JUNE 30, 1998, 1999 AND 2000 ARE ANALYZED IN THE FOLLOWING TABLE (IN THOUSANDS):
The Company derives its revenues primarily from four sources: sales of hardware systems, licensing of films, owned and operated (portable ride simulation theatres and joint venture arrangements), and the production of films for third parties, rental of facilities and camera equipment.
Revenues for the fiscal years ended June 30, 1998, 1999 and 2000 are analyzed in the following table (in thousands):
Revenues on sales of theatre systems are recognized on the percentage-of-completion method, measured by the ratio of percentage of labor hours incurred to-date to estimated total labor hours for each fixed-price contract, over the life of the contract. Accordingly, the timing of shipment and installation schedules as dictated by the customer can result in variability of quarterly revenues and earnings. Likewise, the cash received and used for the contract can vary from quarter-to-quarter with the revenue and cost recognition on the contract. The gross margin for each contract varies based upon pricing strategies, competitive conditions and product mix.
Film Licensing revenues and related expenses are recognized at the beginning of the license period at which time the customer is billed the license fee and the film is delivered to the customer.
Revenues from O&O consist of portable ride simulation theatres, revenues 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. In September 1999, the Company curtailed the Touring Division and
decided to sell the assets. These assets are described as the portable ride simulation theaters and are reflected at their estimated fair value less cost to sell.
Revenue from film production and other is generated primarily through the production of films for third parties, rental of camera equipment and the rental of postproduction facilities. The Company recognizes revenues and costs associated with the production of custom films on the percentage of completion method. The Company typically realizes a smaller margin from the sale of custom films in comparison to its theatre system sales.
A significant portion of the Company's sales are made to customers located outside of the United States, primarily in Asia, South America, Europe, the Middle East and Canada. Sales from customers outside of the United States continue to increase as a percentage of total revenues. Sales from Asia, Europe and the Middle East account for 65% of the Company's total sales in fiscal 2000. Revenues for the fiscal years ended June 30, 1998, 1999 and 2000 attributable to sales to these areas are summarized in the following table (in thousands):
A sales representative maintains offices in Hong Kong and Shanghai to support sales to Asia. The Company also maintains an office in London, England to support its European sales. South American sales are supported out of the Sarasota, Florida office. International operations and sales may be subject to political and economic risks, including political instability, currency fluctuations, changes in import/export regulations, tariff and freight rates. In addition, various forms of protectionist trade legislation have been proposed in the United States and in certain other countries. Any resulting change in current tariff structures or other trade and monetary policies could adversely affect Iwerks' international operations. Political and economic factors have been identified by the Company with respect to certain markets in which it competes. There can be no assurance that these factors will not result in customers of the Company defaulting on payments owed to Iwerks, or in the reduction of potential purchases of the Company's products. For example, turmoil in the economies of the countries in Asia has historically had a material adverse effect on the Company's revenues and results of operations. Revenues attributable to sales in Asia declined from $13.7 million for fiscal 1997 (representing 34.6% of the Company's revenues) to $5.7 million in fiscal 1998 (representing 22.6% of the Company's revenues). Fiscal 1999 sales to Asia increased to $10.4 million (representing 29.9% of the Company revenues). During fiscal 2000, sales to Asia remained strong at $9.8 million (representing 34.7% of the Company's revenue). The Company is not able to predict to what extent, or for what period, economic trends may adversely affect the sales of its products. Typically, sales outside the United States are denominated in United States dollars and are backed by bank letters of credit, which reduce the risks related to international sales.
COMPARISON OF YEAR ENDED JUNE 30, 2000 TO YEAR ENDED JUNE 30, 1999
REVENUES
Revenue for the fiscal year ended June 30, 2000 decreased $6.6 million or 19% from the fiscal year ended June 30, 1999 due to the factors described below.
Hardware sales and service decreased by $3.0 million or 16% from the prior fiscal year. Hardware sales in North America decreased by $5.7 million or 68%. Due to the lead-time involved in completing our contracts, bookings in one fiscal year are typically recognized as revenue in the following
fiscal years. The reduction in North American revenues in fiscal 2000 primarily is due to the Company concentrating it's large format sales efforts on the commercial exhibitor market in fiscal 1999. Commercial exhibitors have been experiencing financial difficulties. Consequently, these exhibitors have not purchased large format product to the extent we expected. We also believe that fiscal 2000 sales were adversely effected by changes in the Company's sales team in fiscal 1999. Hardware sales in the Asia region increased from the prior year by $1.5 million or 30%, South American hardware sales increased by $473,000 or 164% and European and Middle Eastern hardware sales increased by $418,000.
Film licensing revenues for fiscal 2000 decreased approximately $1.7 million or 24% compared to the comparable prior year period. This was primarily due to certain theaters that signed multiple year contracts in fiscal 1999. The Company recognized the revenue in the prior year, consequently no revenue was recognized in the current year for these licenses. In addition, the Company experienced a decline in new hardware installations as compared to last year.
O&O revenue for fiscal 2000 decreased by approximately $2.8 million or 55% as compared to the same period last year, primarily due to a decrease of approximately $2.4 million in the Touring Division and a decrease in revenue from the fixed site joint ventures of approximately $450,000. The decline in sales and related expenses in the Touring Division is due to the Company's decision to curtail the division in September 1999 and actively pursue the sale of the portable ride simulation theaters. The decrease in joint venture revenue is the result of reduced attendance levels at our joint venture sites.
Film production and other revenue for fiscal 2000 increased by approximately $940,000 or 28% compared to the comparable prior year period. This was primarily due to three film production deals in fiscal 2000 compared to one in fiscal 1999.
COST OF SALES
Cost of sales primarily includes costs of theatre systems sold, expenses associated with operating portable ride simulation theatres and costs associated with film production and distribution. The cost of theatre systems includes the cost of components, customization, engineering, project management, assembly, system integration, installation and estimated warranty expenses. Also included in cost of sales are royalties payable to a former joint venture partner which will expire in January 2001. The costs associated with film distribution primarily reflect amortization of film production costs and royalties paid to third parties. The cost of sales associated with operating portable ride simulation theatres includes costs for personnel, depreciation, event fees, fuel, insurance and maintenance.
Cost of sales as a percentage of sales was 92% for fiscal 2000 as compared to 78% for fiscal 1999. One contributing factor to the increase is an increase in hardware cost of sales due to unexpected cost overruns during the installation phase of certain projects. In addition, the Company recorded write-downs on certain films in the final two quarters of fiscal 2000. Additionally, the Company experienced an increase in film production, which typically have a higher cost of sales. Finally, in the fourth quarter of fiscal 2000, the Company increased its reserve for inventory obsolescence.
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 of fixed assets, amortization of goodwill, departmental administrative costs and research and development costs.
Selling, general and administrative expenses were $12.6 million and $11.1 million, for fiscal 1999 and 2000, respectively. The reduction is primarily due to reduced marketing expenses, professional services, insurance costs and research and development expenses, partially offset by an additional expense to settle a claim with a former employee.
IMPAIRMENT OF LONG-LIVED ASSETS
In the third quarter of fiscal 2000, the Company recognized a one-time non-cash write-down of goodwill of $11.7 million associated with the acquisition of Omni in 1994. Although the Company continues to service Omni related products, the Company decided to discontinue the sale of these products in the third quarter of fiscal 2000. The Company determined that the Omni product offerings were more costly to produce and can be replaced with newer, more reliable and more cost effective technology, which the Company owns. Thus, the goodwill related to the Omni acquisition was determined to be impaired.
In the fourth quarter of fiscal 2000, the Company recorded a non-cash write-down for impaired assets totaling $2.2 million. This write-down relates to certain camera equipment and the portable ride simulation theaters that are for sale.
INTEREST INCOME & EXPENSE
Interest income for fiscal 1999 and 2000 was approximately $366,000 and $144,000, respectively. The decrease from 1999 to 2000 resulted primarily from a reduction in the invested cash balances during the 2000 fiscal year.
Interest expense for fiscal 1999 and 2000 was $156,000 and $253,000, respectively. This increase is due to having an outstanding notes payable balance for a full year in fiscal 2000.
INCOME TAXES
The provision for income taxes or (benefit) was $2,000 and ($222,000) for the years ended June 30, 1999 and 2000, respectively. As the Company has significant net losses, the income tax provisions are primarily for foreign taxes and minimum state taxes. The fiscal 2000 tax benefit is the result of a $234,000 federal tax refund relating to a prior year.
NET LOSS
The Company recorded a net loss of $4,778,000 in 1999, compared to a net loss of $22,507,000 in 2000 due to the aforementioned reasons.
COMPARISON OF YEAR ENDED JUNE 30, 1999 TO YEAR ENDED JUNE 30, 1998
REVENUES
Revenue for the fiscal year ended June 30, 1999 increased $9.8 million or 39% from the fiscal year ended June 30, 1998 revenue due to the factors described below.
Hardware sales and service increased by $7.2 million or 59% from the prior fiscal year. Hardware sales in the Asian region increased by $2.7 million, North American hardware sales increased by $2.6 million and hardware sales in Europe increased by $3.5 million. The only decline in hardware sales was in the South American region where sales declined by approximately $1.0 million.
Film licensing revenues increased by approximately $2.3 million or 42% compared to the same period last year. These results are due to new film venues in fiscal 1999 from new hardware sales, as well as new theme park attractions, several of which have signed multiple year license agreements. Many of these new venues are a direct result of new films that the Company released this year.
O&O revenue decreased by approximately $1.8 million as compared to the same period last year, primarily due to declining sales of approximately $2.0 million in the Touring Division, partially offset by an increase in revenue from the fixed site joint ventures of approximately $279,000. The decline in sales, and related expenses, in the Touring Division is due to the Company's decision to participate in fewer
events than the prior year, focusing on the more profitable events. The increase in joint venture revenue is the result of three additional joint venture sites opened during the second quarter of fiscal year 1999.
Film Production and other revenue increased by approximately $2.0 million. This was primarily due to the Company securing one major film production deal in fiscal 1999 compared to none in fiscal 1998.
COST OF SALES
Cost of sales primarily includes costs of theatre systems sold, expenses associated with operating portable ride simulation theatres and costs associated with film production and distribution. The cost of theatre systems includes the cost of components, customization, engineering, project management, assembly, system integration, installation and estimated warranty expenses. Also included in cost of sales are royalties payable to a former joint venture partner. The costs associated with film distribution primarily reflect amortization of film production costs over the lives of certain films and royalties paid to third parties. The cost of sales associated with operating portable ride simulation theatres includes costs for personnel, depreciation and amortization, event fees, fuel, insurance and maintenance.
Cost of sales as a percentage of sales was 78% for both fiscal years ended June 30, 1998 and 1999. Included in the cost of sales in 1999 is a charge of approximately $1.0 million due to the termination of one contract relating to a one-time research and development specialty project.
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 were approximately $16.0 million and approximately $12.6 million, for the years ended June 30, 1998 and 1999, respectively. This decrease was primarily due to a reduction of $2.2 million in employee related expenses from the prior year. Of those expenses, approximately $1.6 million was related to severance costs that were made to fifteen employees including the former CEO and two other officers whose employment terminated in the third quarter of fiscal 1998. In addition, bad debt expense was approximately $0.8 million larger in the prior year than fiscal 1999 due to the economic problems affecting the Asian region in the prior year. Other savings included a reduction in building leases and business insurance partially offset by an increase in sales commissions and an increase in sales and marketing expenses due to the Company's new corporate brand initiative launched in the 1999 fiscal year as well as a more comprehensive marketing program to support clients' efforts to build their Iwerks attractions.
MERGER RELATED EXPENSES
The Company incurred approximately $1.8 million of non-recurring expenses related to the proposed merger with Showscan that did not receive the required shareholder vote in March 1998. These costs were primarily professional legal, accounting and investment banking fees of which approximately $1.6 million was expensed in fiscal 1998. Approximately $0.2 million was expensed in fiscal 1997.
INTEREST INCOME & EXPENSE
Interest income for fiscal 1998 and 1999 was approximately $0.8 million and $0.4 million, respectively. The decrease from 1998 to 1999 resulted primarily from a reduction in the invested cash balances during the 1999 fiscal year.
Interest expense for fiscal 1998 and 1999 was $247,000 and $156,000, respectively. This decrease resulted primarily from the scheduled maturity of capital lease obligations in fiscal 1999.
INCOME TAXES
The provisions for income taxes were $23,000 and $2,000 for the years ended June 30, 1998 and 1999, respectively. As the Company has significant net losses, the income tax provisions are primarily for foreign taxes and minimum state taxes.
NET LOSS
The Company recorded net loss of $11,560,000 in 1998, compared to a net loss of $4,778,000 in 1999 due aforementioned reasons.
COMPANY'S SEASONALITY AND FLUCTUATING QUARTERLY RESULTS
The following tables set forth unaudited data regarding operations for each quarter of fiscal 1999 and 2000 and the percentage of the Company's revenue and expenses represented by each item of the respective quarter. This quarterly information has been prepared on the same basis as the annual consolidated financial statements and, in management's opinion, contains all adjustments necessary to fairly state the information set forth herein. The operating results for any quarter are not necessarily indicative of results for any future period.
The Company's operating results fluctuate from quarter to quarter as a result of the timing of theatre system shipments, the mix of theatre system contracts, the completion of custom film contracts and the amount of revenues from portable simulation theatre and film licensing agreements. Hardware sales will likely continue to experience quarterly fluctuations which cannot be reasonably predicted, as they are substantially dependent on the customers' varying delivery and installation requirements.
Significant portions of the Company's operating expenses are relatively fixed, and planned expenditures are primarily based upon revenue forecasts. The sales cycle for the sale of a single attraction by the Company typically ranges between six and eighteen months. The Company has little control over the timing of customer purchases.
The seasonal fluctuations in earnings also may cause volatility in the stock prices of the Company. While a significant portion of the Company's expense levels are relatively fixed, the timing of increases in expense levels is based in large part on the Company's 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 the Company's inability to adjust spending quickly enough to compensate for the sales shortfall. The Company may also choose to reduce prices or increase spending in response to market conditions, which may have a material adverse effect on the Company's results of operations.
LIQUIDITY AND CAPITAL RESOURCES
In fiscal 2000, approximately $2.0 million in cash was used in operating activities and $0.4 million was used in financing activities, offset by $0.8 million provided by investing activities. Investing activities primarily consisted of additions to film inventory ($0.6 million) and the purchase of property and equipment ($0.8 million) offset by the maturity of investments ($2.5 million). Financing activities consisted primarily of payments on capital leases ($0.6 million) offset by the issuance of common stock warrants ($0.3 million).
At June 30, 2000 the Company had cash and short-term investments of approximately $2.7 million, $1.2 million of which is restricted. The Company's cash and short-term investment balances have continued to decline since June 30, 2000 and the Company expects to experience further declining balances during the remainder of fiscal 2001. Because of the substantial reductions in the Company's cash balances over the last twelve months, and contractual restrictions on the use of some of its cash balances, the Company may not be able to continue operations at its current levels. The Company is dependent upon current cash collections to meet its operating needs and pay its current liabilities. The Company has experienced significant difficulty in accurately projecting its cash balances historically. The Company's cash flow is dependent on the timing of delivery of hardware systems, collections and the signing of new contracts, all of which are difficult to predict with accuracy. Further complicating its ability to project cash balances is that the timing of progress payments of the hardware projects are dependent upon achieving certain performance milestones under its hardware sales agreements. In addition, progress payments on some of the Company's hardware sales agreements are not sufficient to provide for the cost of assembly and delivery of the systems, requiring the Company to fund the cash cost of performing on the agreements.
The Company determined to sell its portable ride simulation theaters, which when sold, will generate cash and is considering a number of other options to improve the financial condition of the Company. Subsequent to year end one portable ride simulation theater was sold. There can be no assurance that any additional ride simulation theaters will be sold. The Company also is aggressively seeking additional debt or equity financing and other strategic alternatives. However, recent operating losses, the Company's declining cash balances, the Company's historical stock performance, the recent decline in revenue, and a general decrease in investor interest in the Company's industry, may make it difficult for the Company to attract equity investments or debt financing or strategic partners on terms that are deemed to be favorable to the Company. In addition, the transfer from The Nasdaq National Market to The Nasdaq Small Capital Market together with the Company's trading status under an exemption from the continued listing requirements may make it more difficult for the Company to attract financing. The Company has been aggressively seeking additional equity or debt financing for more than the last twelve months and to date has been unsuccessful in attracting new financing. If the Company's financial condition continues to worsen and it is unable to successfully attract equity or debt financing or other strategic transactions, the Company could be forced to consider steps that would protect its assets against its creditors. The Company's independent auditors' report contains an emphasis paragraph indicating there is substantial doubt about the Company's ability to continue as a going concern.
In order to preserve cash, the Company has been required to reduce expenditures for capital projects (including new films), research and development, and in its corporate infrastructure, any of which may have a material adverse affect on the Company's future operations. Further reductions in its cash balances could require the Company to make more significant cuts in its operations, which would have a material adverse impact on its future operations. There can be no assurance that the Company can achieve these reductions over a short enough period of time in order to allow it to continue as a going concern.
RISK FACTORS
WE HAVE A HISTORY OF LOSSES AND THERE CAN BE NO ASSURANCE THAT WE WILL BE ABLE TO ACHIEVE PROFITABLE OPERATIONS IN FISCAL 2001.
We have not been profitable in five of the last six years and have an aggregate net loss for the last six years of $59.2 million. During fiscal 2000, we incurred a net loss of $22.5 million. Because substantial portions of our expenses are fixed and our gross margin is relatively low, achieving profitability depends upon our ability to generate and sustain substantially higher revenues. Although we have implemented plans to increase revenues and operating margin, we can not assure you that we will be able to do so and consequently we may experience additional losses in fiscal 2001. We expect that our cash on hand, together with cash generated by operations, cannot sufficiently fund future operating losses and capital requirements, and we have attempted to raise additional capital. To date, we have not been able to obtain additional financing in amounts or on terms acceptable to us.
WE ARE TRADING ON THE NASDAQ SMALL CAPITAL MARKET UNDER AN EXEMPTION AND MAY BE DELISTED IF WE DO NOT MEET THE CONTINUED LISTING REQUIREMENTS ON OR BEFORE OCTOBER 30, 2000.
On July 28, 2000, we were notified by The Nasdaq Stock Market that we did not meet the continued listing requirements of the Nasdaq National Market. Accordingly, effective August 1, 2000, our common stock was removed from trading on the Nasdaq National Market and listed on The Nasdaq Small Capital Market. Our common stock currently is trading under an exemption from the continued listing requirements of The Nasdaq Small Capital Market. If we do not meet these requirements on or before October 30, 2000, we may be delisted from The Nasdaq Small Capital Market, in which case we anticipate that we would apply for our common stock to trade on the Over The Counter Bulletin Board. If we are delisted from The Nasdaq Small Capital Market, it may be more difficult to raise additional debt or equity financing.
WE DEPEND ON SINGLE OR LIMITED SUPPLIERS FOR CERTAIN OF OUR COMPONENTS AND IF THESE SUPPLIERS ARE UNABLE TO PROVIDE THESE COMPONENTS, WE MAY EXPERIENCE DELAYS IN PRODUCT SHIPMENT AND ADDITIONAL COSTS.
We currently use only one or a limited number of suppliers for certain of the components that we use in our theater systems. If our suppliers are unable to deliver these components to us we may be unable to locate an alternate source of these components, which would result in a material adverse effect on our revenues, results of operations, liquidity and financial position. Our reliance on a limited number of vendors involves many risks including:
o Shortages of certain key components;
o Delays in product shipment;
o Product performance shortfalls;
o Additional costs associated with the purchase of the components from alternative suppliers; and
o Reduced control over delivery schedules, manufacturing capabilities, quality and costs;
If any of our suppliers suffers business disruptions, financial difficulties, or if there is any significant change in condition of our relationship with the supplier, our costs of goods sold may increase or we may be unable to obtain these key components for our products. In any event, our revenues, results of operations, liquidity and financial condition would be adversely affected. While we believe that we can obtain most of the components necessary for our products from other manufacturers, any unanticipated change in the source of our supplies, or unanticipated supply limitations, could adversely affect our ability to meet our product orders.
IT IS POSSIBLE THAT OUR CURRENT FILM SOFTWARE MAY NOT SUSTAIN ITS POPULARITY AND OUR NEW FILM SOFTWARE MAY NOT BECOME POPULAR.
A substantial portion of our revenue is dependent upon the production and distribution of entertainment film software for exhibition on our theatre systems. Each production is an individual artistic work. We try to develop and produce film software that will achieve high market acceptance. However, market acceptance depends upon many factors beyond our control, including:
o audience reaction;
o competing programming;
o other forms of entertainment;
o perceived quality of programming.
We cannot assure you that our film software will obtain market acceptance. If our film software becomes less popular, we will most likely derive less revenue from the license of our film library and from new hardware sales.
OUR COMPETITIVE POSITION IS DEPENDENT ON CONTINUING TO INVEST IN NEW FILM PRODUCTIONS. IF WE ARE UNABLE TO DO SO, IT COULD HAVE A NEGATIVE IMPACT ON OUR REVENUES.
We believe that our extensive library of popular films is a competitive advantage and that we must continue to add to this library if we are to be successful. Film production is expensive. We generally spend $100,000 - $2,000,000 to produce a film. Although we try to reduce the financial impact of a new film by entering into licensing, participation or other financing arrangements with third parties, prior to release we typically do not recoup our costs until 2-3 years later. Even if we are able to reduce the costs of production, we cannot assure you that the films we produce and acquire will be popular. In addition, because our cash balances have continued to decline, we have had to decrease the level of our investment in film software and this may have an adverse impact on our revenues in future periods.
OUR PRINCIPAL COMPETITORS DEVOTE GREATER FINANCIAL, PERSONNEL AND MARKETING RESOURCES TO THE DEVELOPMENT AND EXPANSION OF COMPETITIVE PRODUCTS.
We face significant competition in each of the markets in which we operate. Our principal direct competition for customers comes from manufacturers of competing movie-based attractions, and in the case of amusement and theme parks, manufacturers of traditional amusement park attractions. In addition, there is also competition from systems integrators and some amusement and theme parks developing and constructing their own attractions. We have significantly fewer financial, technical, manufacturing, marketing and other resources than certain of our competitors and these limited resources may harm our business in many ways. Our competitors may leverage their greater resources to:
o develop, manufacture and market products that are less expensive or technologically superior to our products;
o reach a wider array of potential customers through increased marketing and sales activities;
o attend more trade shows and spend more on advertising and marketing;
o operate at lower margins for longer periods;
o respond more quickly to new or changing technologies, customer requirements and standards; or
o reduce prices in order to preserve or gain market share.
In addition, the out-of-home entertainment industry in general is undergoing significant changes, primarily due to technological developments as well as changing consumer tastes. Many companies are developing and are expected to develop new entertainment products or concepts in response to these developments that may be directly competitive with our products.
We believe these competitive pressures are likely to continue. We cannot guarantee that our resources will be sufficient to address this competition or that we will manage costs and adopt strategies capable of effectively utilizing our resources. If we are unable to respond to competitive pressures successfully, our prices and profit margins may fall and our market share may decrease.
OUR FUTURE SUCCESS WILL DEPEND IN PART UPON OUR ABILITY TO ANTICIPATE CHANGES IN TECHNOLOGY AND DEVELOP NEW AND ENHANCED PRODUCTS ON A TIMELY AND COST-EFFECTIVE BASIS.
We operate in a technology-driven segment of the entertainment industry. Consequently, it is important for us to develop new and enhanced products in response to technological changes. Risks inherent in the development and introduction of new products include:
o difficulty in forecasting customer demand accurately;
o our inability to expand capacity fast enough to meet customer demand;
o the possibility that new products may cannibalize current products;
o delays or interruptions in the manufacture and installation of new products;
o competitors' responses to our introduction of new products;
o the desire by customers to evaluate new products for longer periods of time before making a purchase decision; and
o the possibility the market may reject certain new technology and products.
If we are unable, for technological or other reasons, to develop products in a timely manner or the products or product enhancements that we develop do not achieve market acceptance, our business could be harmed.
A SIGNIFICANT PORTION OF OUR SALES AND CUSTOMERS ARE LOCATED OUTSIDE THE UNITED STATES. CURRENCY FLUCTUATIONS AND THE INCREASED COSTS ASSOCIATED WITH INTERNATIONAL SALES, COULD MAKE OUR PRODUCTS UNAFFORDABLE IN FOREIGN MARKETS, WHICH COULD REDUCE OUR PROFITABILITY.
Sales to customers outside the United States accounted for approximately 46%, 56% and 70% of our revenues in fiscal 1998, 1999 and 2000, respectively. We believe that international sales will continue to represent a significant portion of our total sales. Our foreign sales subject us to a number of risks including:
o although we denominate our international sales in U.S. dollars, currency fluctuations could make our products unaffordable to foreign purchasers or more expensive compared to those of foreign manufacturers;
o greater difficulty of administering business overseas may increase the costs of foreign sales and support;
o foreign governments may impose tariffs, quotas and taxes on our products;
o longer payment cycles typically associated with international sales and potential difficulties in collecting accounts receivable may reduce the profitability of foreign sales;
o political and economic instability may reduce demand for our products or our ability to market our products;
o restrictions on the export or import of technology may reduce or eliminate our ability to sell in certain markets; and
o although we have met certain international manufacturing standards, our lack of ISO 9000 certification, a widely accepted method of establishing and certifying the technical characteristics and quality of our products, may hinder our foreign sales.
These risks may increase our costs of doing business internationally and reduce our sales or profitability.
WE ARE DEPENDENT ON THE STRENGTH OF THE NATIONAL AND INTERNATIONAL ECONOMIES. RECESSIONARY OR DEFLATIONARY CONDITIONS IN ANY OF OUR PRINCIPAL MARKETS COULD REDUCE OUR SALES AND PROFITABILITY.
Our revenues and profitability are dependent on the strength of the national and international economies. In a recessionary or deflationary environment, sales of our products may be adversely affected.
Theme parks and other out-of-home entertainment venues may also experience a downturn in sales which could reduce the funds available for capital improvements and film licensing, resulting in price and other concessions and discounts by us in order to maintain sales activity.
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE DIFFICULT TO FORECAST. IF REVENUES AND OPERATING RESULTS FLUCTUATE UNEXPECTEDLY FROM QUARTER TO QUARTER, OUR STOCK PRICES MAY FLUCTUATE.
Our quarterly revenues and operating results are difficult to forecast. As a result, we believe that the period-to-period comparisons for operating results are not necessarily reliable indicators of our future performance. A variety of factors may affect our operating results, including factors which are outside our control. These factors include the following:
o the size and timing of customer orders;
o the timing, introduction or enhancement of products by us or our competitors;
o the timing and level of our operating expenses.
Any unanticipated change in operating results may cause our stock prices to fluctuate since such changes reflect new information for investors and analysts. New information causes investors and analysts to revalue our stock and this in the aggregate could cause our stock price to fluctuate.
OUR CUSTOMERS HAVE THE RIGHT TO TERMINATE THEIR CONTRACTS WITH US IN CERTAIN CIRCUMSTANCES WHICH CAN HAVE AN ADVERSE EFFECT ON OUR CASH FLOW.
Our hardware sales contracts typically provide that the customer may terminate our contract prior to delivery. However, a customer canceling its contract is obligated to pay to us a cancellation fee equal to the costs committed or incurred plus 20%. Customers typically pay a deposit upon execution of a contract. If a customer cancels a contract and the amount of the deposit exceeds the cancellation fee, we are contractually obligated to refund the excess to the customer. In the event of a large refund, we could experience a negative impact on cash flow.
IF WE ARE SUED ON A PRODUCT LIABILITY CLAIM, OUR INSURANCE POLICIES MAY NOT BE SUFFICIENT.
Although we maintain general liability insurance and product liability insurance, our insurance may not cover all potential types of product liability claims to which manufacturers are exposed or may
not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS ADEQUATELY, THE ADVANTAGES OF OUR RESEARCH, MANUFACTURING AND DISTRIBUTION SYSTEMS MAY BE REDUCED AS COMPETITORS ADOPT SOME OR ALL OF THESE TECHNIQUES.
Since our business depends in part on intellectual property rights, our ability to compete effectively depends in part on our ability to develop and maintain proprietary aspects of our technology in creative works. We currently hold several patents on the design elements of our products and also rely on a combination of trademark, trade secret, copyright and other intellectual property laws to protect our proprietary rights. Such rights, however, may not preclude competitors from developing products that are essentially equivalent or superior to ours. In addition, many aspects of our product are not subject to intellectual property protection and therefore may be reproduced by our competitors.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US COULD BE TIME CONSUMING AND EXPENSIVE TO DEFEND AND MAY HARM OUR BUSINESS.
In recent years there has been significant litigation in the United States involving patents and other intellectual property rights. While we currently are not engaged in any material intellectual property litigation or proceedings, we may become involved in the future. An adverse outcome of litigation could force us to do one or more of the following:
o stop selling, incorporating or using our products for services that use the challenged intellectual property;
o subject us to significant liabilities to third parties;
o obtain from the owners of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms or at all; or
o redesign those products and services that use such technology, which redesign may be either economically or technologically infeasible.
Whether or not an intellectual property litigation claim is valid, the cost of responding to it, in terms of legal fees and expenses and the diversion of management resources, could harm our business.
THE ABILITY OF OUR BOARD OF DIRECTORS TO ISSUE PREFERRED STOCK AND OUR STOCKHOLDER RIGHTS PLAN MAY MAKE TAKEOVER ATTEMPTS DIFFICULT OR IMPOSSIBLE.
Our Board of Directors has the authority, without any action of the shareholders, to issue up to one million shares of Preferred Stock and to fix the rights and preferences of those shares. In addition, we have in place a Stockholder Rights Plan. The ability of our Board to issue Preferred Stock and the existence of the Stockholder Rights Plan may have the effect of delaying, deferring or preventing a change of control, may discourage bids for our common stock at a premium over its market price and may adversely affect the market price, and the voting and rights of the holders of our Common Stock.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors Iwerks Entertainment, Inc.
We have audited the accompanying consolidated balance sheets of Iwerks Entertainment, Inc. as of June 30, 1999 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Iwerks Entertainment, Inc. at June 30, 1999 and 2000 and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that Iwerks Entertainment, Inc. will continue as a going concern. As more fully described in Note 1, the Company has incurred significant operating losses in the current year, has a large accumulated deficit and working capital deficiency at June 30, 2000 and has been unable to meet all of its obligations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Los Angeles, California Ernst & Young LLP September 26, 2000
IWERKS ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
IWERKS ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
See accompanying notes.
IWERKS ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See accompanying notes.
IWERKS ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
See accompanying notes.
IWERKS ENTERTAINMENT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
SUPPLEMENTAL INFORMATION TO CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental disclosures of non-cash investing and financing activities:
In 1999, the Company issued a note payable for approximately $1.5 million in connection with the termination of a customer contract (see Note 15).
See accompanying notes.
IWERKS ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GOING CONCERN MATTERS
The accompanying financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has experienced significant operating losses in the current and prior years. In addition, the Company has been unable to pay all of its trade creditors and certain other obligations in accordance with their terms and some of the Company's creditors have refused to provide further product or services except on a C.O.D. basis. Management intends to improve liquidity in various ways such as (a) the completion of equity or debt financing or other strategic transactions; (b) the continued monitoring and reduction of manufacturing, facility and administrative costs including reduction of personnel; and (c) the sale of its portable ride simulation units. However, there is no assurance that the Company will succeed in accomplishing any or all of these initiatives. The fiscal 2000 consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
2. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation and Basis of Presentation - Iwerks is a Delaware corporation. Iwerks designs, manufactures, installs and services high resolution, proprietary motion picture theatre attractions. Iwerks' attractions are built around a variety of theatre systems, including fixed and portable simulators, large format theatres, 3D theatres, 4D specialty theatres and the licensing of the related software.
Iwerks operates in one business segment, the manufacture, distribution and operation of entertainment hardware and software.
The financial statements consolidate the accounts of Iwerks and its wholly owned subsidiaries. All significant intercompany amounts and transactions have been eliminated in consolidation.
Revenue and Cost Recognition - Revenue from fixed-price-contracts are recognized on the percentage-of-completion method, measured by the ratio of percentage of labor hours incurred to date to estimated total labor hours for each contract. Management considers expended labor hours to be the best available measure of progress on such contracts. A contract is considered substantially complete upon delivery and acceptance of the product by the customer. These contracts average six to eighteen months in duration.
Contract costs include direct materials, direct labor cost and indirect costs related to contract performance, such as indirect labor, supplies and tools. Costs and estimated earnings in excess of billings on uncompleted contracts represents costs incurred and gross profit recognized in excess of amounts billed. Billings in excess of costs and estimated earnings on uncompleted contracts represents billings in excess of costs incurred and gross profit recognized. Billings to customers are in accordance with the terms of the contract and generally follow a payment schedule.
Iwerks performs a quarterly review of uncompleted contracts. Changes in estimates are reflected in the period of the change. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.
Iwerks provides a warranty for contracts generally for a period of twelve months. Such warranty costs are included in cost of sales. The warranty accrual as of June 30, 1999 and 2000 was $1,028,000,
and $963,000 respectively, and is included in accrued expenses in the accompanying consolidated balance sheets.
Iwerks also earns revenues for the production of films for outside parties. Iwerks recognizes such producer fee revenue as the services are rendered.
Iwerks generally licenses films at agreed-upon minimum amounts. Revenues from film licenses are recognized when the license period begins and the programming is available pursuant to the terms of the license agreement.
Trade Accounts Receivable primarily consists of amounts due on contracts and film licenses. Allowance for doubtful accounts was $1,823,000 at June 30, 1999 and $933,000 at June 30, 2000.
Inventories consist primarily of simulation system equipment components and are stated at the lower of cost or market on an average cost basis.
Change in Accounting Principle--In June 2000, Statement of Position 00-2 "Accounting by Producers or Distributors of Films" (SOP 00-2), was issued. SOP 00-2 establishes new financial accounting and reporting standards for producers and distributors of films, including changes in measuring impairment of film costs. The Company has adopted the provisions of SOP 00-2 as of July 1, 1999.
SOP 00-2 requires the use of a fair value approach when measuring impairment of film costs. The Company utilizes discounted cash flows to determine fair value, which differs from the net realizable value approach utilized by the Company pursuant to the previous accounting model and under which cash flows were not discounted. In connection with the adoption of SOP 00-2, the Company has recorded a non-cash charge of approximately $202,000 to reduce the carrying value of its film inventory. Such charge is included in cost of sales in the accompanying consolidated statement of operations.
Film Inventory consists of production costs and is stated at the lower of cost or fair value. The individual film forecast method is used to amortize film inventory. Costs of a film are amortized in the proportion that gross revenues in the period bear to management's estimate of the total current and future gross revenues to be received. Estimated liabilities for participation and royalties are accrued and expensed in the same manner as film inventory is amortized.
Revenue estimates on a film-by-film basis are reviewed periodically by management and are revised, if warranted, based upon management's appraisal of current market conditions. Unamortized individual film costs are written down to estimated fair value based on this estimate, where applicable. When estimates of total revenue indicate that a film will ultimately realize a loss, the entire loss is recognized in the current period.
Film inventory is comprised of the following (in thousands):
While the Company has ceased production of new films, it is actively engaged as an exclusive distributor of films produced by third parties. In such instances, the Company is entitled to recoupment of its distribution expenses as well as a distribution fee.
Management estimates that 45% of the costs of its unamortized films will be amortized during fiscal 2001 and that 93% of such costs will be amortized within three years.
Depreciation and Amortization of Property and Equipment is computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years. Leasehold improvements are amortized over five years or the remaining term of the lease, whichever is shorter.
Goodwill (excess purchase price and liabilities assumed over the fair market value of assets acquired) relates to the acquisition of Pioneer Marketing Corporation and a related company (collectively referred to as "Pioneer") and prior acquisitions and is being amortized over 16 to 25 years. Goodwill is reviewed periodically to determine if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based upon discounted cash flows of the acquired business over the remaining amortization period, then the carrying value of the related goodwill will be reduced by the estimated shortfalls of cash flows (see Note 4). Accumulated amortization was $4,047,000 at June 30, 1999 and $16,209,000 at June 30, 2000.
Other Assets - Patents are stated at cost, and are being amortized using the straight-line method over 10 to 25 years. Iwerks acquired a patent in fiscal 1997 in connection with the Pioneer acquisition in the amount of $1,094,000, and a covenant not to compete in the amount of $50,000. Accumulated amortization was $377,000 at June 30, 1999 and $487,000 at June 30, 2000. The Company has entered into joint venture arrangements whereby the Company contributes ride simulation theatre equipment and the joint venture partner contributes site improvements. The Company retains title to the assets it contributes to certain joint ventures, and therefore its investment in joint ventures is carried at historical cost and depreciated over 5 years. The Company receives film licensing fees and cash flow income is split between the joint venture partners.
Long-Lived Assets used in operations or held for sale are reviewed periodically to determine that the carrying values are not impaired and if indicators of impairment are present or if long-lived assets are expected to be disposed of at a loss, impairment losses are recorded (see Note 4).
Accrued Expenses - The Company provides for commission and applicable royalties on revenue recognized in connection with certain agreements. The commission accrual as of June 30, 1999 and 2000 was $820,000 and $595,000 respectively, and the royalty accrual as of June 30, 1999 and 2000 was $2,425,000 and $2,646,000 respectively. These amounts are included in accrued expenses in the accompanying consolidated balance sheets.
The Company had legal accruals as of June 30, 1999 and 2000 in the amounts of $298,000 and $138,000 respectively. This amount is included in accrued expenses in the accompanying consolidated balance sheets.
Deferred Revenue represents advance payments received for theatre service contracts and is recognized as revenue over the life of the respective agreements.
Research and Development Costs are incurred in the design, construction and testing of prototype systems and are charged to expense as incurred. Research and development expenses amounted to $766,000, $565,000 and $404,000 for the years ended June 30, 1998, 1999 and 2000, respectively and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Income Taxes - The Company has applied Statement of Financial Accounting Standards No. 109, (Accounting for Income Taxes), which utilizes the liability method. Deferred income taxes under the liability method arise primarily from the difference between the timing of recognition of certain revenue and expense items for financial reporting and income tax purposes.
Advertising costs are expensed as incurred. Advertising expense amounted to approximately $271,000, $251,000 and $199,000 in the years ended June 30, 1998, 1999 and 2000, respectively, and is
included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Concentration of Credit Risk - The Company conducts credit evaluations of customers and believes the credit risk from its customers to be minimal. The Company generally requires significant foreign sales be supported by irrevocable letters of credit established with the Company as beneficiary.
Qualified 401k Plan - The Company has a Defined Contribution 401k Plan ("Plan") for all of its eligible employees. Under the Plan, each employee who has attained the age of eighteen and who has completed three months of service with the Company is eligible to become a participant. Each participant is permitted to make tax deferred voluntary contributions of an amount not to exceed the lesser of 15% of his or her respective compensation and the applicable statutory limitation. Effective July 1997, the Company began making matching contributions not to exceed 3% of participants salaries to the Plan, and has consequently recorded an expense of approximately $109,000, $96,000 and $73,000 in fiscal 1998, 1999 and 2000, respectively.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Fair Value of Financial Instruments - The Company's financial instruments, other than cash, accounts receivable and accounts payable, consist primarily of investments in debt securities. The fair value of investments in debt securities is based on quoted market prices.
3. RESTRICTED CASH
Included in the June 30, 2000 cash and cash equivalents balance is $1,176,000 of cash received from two customers, which is restricted as to its use. This restriction will remain in effect until the Company reaches a certain milestone related to the completion of a project for each of the two customers. The milestone for one customer project was reached in the first quarter of fiscal 2001 and $136,000 of restricted cash became available for Company use. Management expects to reach the required milestone for the other customer's project in the second quarter of fiscal 2001, at which time $1,040,000 is expected to become available for Company use.
4. IMPAIRMENT OF LONG-LIVED ASSETS
The following non-cash charges are included in impairment of long-lived assets for the year ended June 30, 2000 (in thousands):
Omni Film International goodwill $ 11,657 Camera equipment 1,581 Portable ride simulation theatres 594 ---------- $ 13,832 ==========
In the third quarter of fiscal 2000, the Company recorded a one-time non-cash write-down to goodwill of approximately $11,657,000. The goodwill was associated with the acquisition of Omni Film International (Omni) in 1994. Although the Company continues to service Omni related products, the Company decided to discontinue the sale of these products during the third quarter of fiscal 2000. In connection with the decision, the Company determined that the Omni product offerings were more costly to produce and can be replaced with newer, more reliable and more cost effective technology, which the Company owns. Thus, the entire amount of goodwill related to the Omni acquisition was determined to be impaired.
The Company completed manufacturing of camera equipment for rental use during the current year and is manufacturing additional camera equipment. The Company first rented the camera equipment in July 2000. Based on actual rental revenues received, and considering costs to complete the remaining camera equipment, the Company determined that an impairment analysis was required at June 30, 2000. Upon comparing the carrying value and future costs to complete the camera equipment to the estimated discounted net cash inflows from rentals of such camera equipment, the Company recorded a non-cash charge of approximately $1,581,000 in the fourth quarter of fiscal 2000.
As described in Note 5, in September 1999 the Company decided to sell the portable ride simulation theaters of the Touring Division. Since that time, the Company sold one portable ride simulation theater (in August 2000). Based on the terms of this sale and the current discussions regarding potential sales, the Company determined that the carrying value of the remaining theaters was impaired. Accordingly, a non-cash charge of approximately $594,000 was recorded in the fourth quarter of fiscal 2000 to write the portable motion theatres down to their estimated fair value less cost to sell.
5. ASSETS HELD FOR SALE
In September 1999 the Company decided to sell the assets relating to the Touring Division. These assets are described as the portable ride simulation theaters and are reflected at management's estimate of their fair value less cost to sell. Management has discontinued depreciating these assets and will continue to periodically assess the net fair value of these assets. Fiscal 2000 revenues and expenses of the Touring Division were $1,192,000 and $2,184,000 respectively.
6. ISSUANCE OF WARRANTS
On September 8, 1999 the Company appointed two new outside members to its Board of Directors. The two new members purchased warrants to purchase an aggregate 442,857 shares of Iwerks common stock. The warrants were issued in four tranches of equal amounts ranging in a per share price of $5.01 to $10.50. Certain restrictions apply to the exercise of these warrants, which have a life of five years. These two board members resigned on January 18, 2000. The warrants remain outstanding with the same terms described above.
7. DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense of property and equipment, 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.
Depreciation and amortization included in cost of sales was $2,678 and $3,461 for 1999 and 2000, respectively.
8. SHORT TERM INVESTMENTS
The carrying amounts of the Company's investments in debt securities is $2.5 million and $0 at June 30, 1999 and 2000, respectively. The principal amount, cost and fair value are not materially different than the carrying amount as shown above. There were no sales of available for sale securities for fiscal year 2000. Realized gains or losses from debt securities sold or matured during the year ended June 30, 1999 and 2000 were not material. The basis on which cost was determined on calculating gains and losses was the specific identification method.
9. BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Billings in excess of costs and estimated earnings on uncompleted contracts at June 30, 1999 and 2000 consist of the following (in thousands):
Such costs are included in the accompanying balance sheets at June 30, 1999 and 2000 under the following captions (in thousands):
10. NET LOSS PER COMMON SHARE
Basic and diluted loss per share is calculated using the weighted average number of common shares outstanding during the period. Options and warrants to purchase 31,189, 8,029 and 2,882 shares of common stock were not included in the computation of diluted loss per common share for the years ended June 30, 1998, 1999 and 2000, respectively, as the effect would be antidulitive.
During fiscal 2000 1,059 shares of common stock were issued as a result of exercises of stock options.
On January 13, 2000, the Company's stockholders approved an amendment to the Company's certificate of incorporation to effect a one for three and one-half reverse stock split with no change in par values, effective for stockholders of record on November 12, 1999. The reverse stock split was effective January 18, 2000. All references to per share amounts and shares outstanding included herein have been retroactively restated to reflect the stock split.
11. PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and is comprised of the following at June 30, 1999, and 2000 (in thousands):
Certain equipment aggregating $3,711,000 at June 30, 1999 was recorded under capital lease agreements. Accumulated depreciation on this equipment was $1,594,967 at June 30, 1999. At June 30, 2000, such equipment is classified as assets held for sale in the accompanying consolidated balance sheets.
Depreciation expense was $1,797,000, $1,946,000 and $1,814,000 for the years ended June 30, 1998, 1999 and 2000, respectively, including amounts related to assets under capital leases.
12. RELATED PARTY TRANSACTIONS
During 1993, Itochu Corporation ("Itochu"), a former stockholder, agreed to pay the Company $5 million primarily for the right to become the Company's exclusive distributor for a three year term in Asia. In addition, Itochu became a nonexclusive agent for Iwerks' other products for seven years. Itochu earned sales commissions on collections from customers on any theatre systems and related software sold in Asia. During the years ended June 30, 1998, 1999 and 2000, $291,000, $145,000, and $23,000 respectively, were paid to Itochu in connection with this arrangement. This arrangement ended in December 1999.
13. INCOME TAXES
Significant components of income tax expense (benefit) are as follows (in thousands):
The reconciliation of income tax computed at the U.S. federal statutory tax rates to income tax expense is: ,
The deferred tax asset at June 30 consists of (in thousands):
At June 30, 2000, Iwerks had available federal and state tax net operating loss carryforwards of approximately $36,200,000 and $13,100,000, respectively, expiring through 2019.
14. STOCK OPTIONS AND WARRANTS
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of Iwerks' employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
The Company has four stock incentive plans adopted in 1987, 1993, 1994 and the 1999 non-employee directors stock option plan (collectively the "Plans"). In aggregate, 1,000,000 shares of Iwerks Common Stock are reserved for issuance under the Plans. The Company has granted other options to purchase 28,571 shares of Iwerks Common Stock to certain officers outside of these plans. Options generally vest over a four-year period and expire in ten years.
Terminated employees have 90 days to exercise options, however certain officers, having separation agreements, have as long as 36 months to exercise options. At June 30, 2000, there were 219,348 vested options outstanding relating to two terminated officers which expire at varying dates until July 2001.
Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for fiscal year 1998, 1999 and 2000, respectively: risk-free interest rates of 5.55%, 4.84% and 6.50%, weighted-average expected life of the option of 4.75 years, 5.00 years and 4.93 years; zero dividend yields; and a volatility factor of the expected market price of Iwerks' Common Stock of 57%, 86% and 100%
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Given this method of amortization, the initial impact of applying FAS 123 on pro forma net loss and pro forma loss per share is not representative of the potential impact on pro forma amounts in future years when the effect of amortization from multiple awards would be reflected. The Company's pro forma information follows (in thousands except for per share information):
A summary of the Company's stock option activities and related information for the years ended June 30 are as follows:
The weighted-average fair value of options granted was $1.91 in fiscal year 1998, $2.14 in fiscal year 1999, and $5.08 in fiscal year 2000.
The following table summarizes information about stock options outstanding at June 30, 2000:
As of June 30, 1998, 1999 and 2000 the Company had 6,600, 164,318 and 126,041 shares available for future grants under the Plans. As of June 30, 2000 Iwerks has reserved 686,943 shares of unissued Iwerks Common Stock for issuance upon exercise of options granted under the Plans and outside the Plans.
At June 30, 2000 the Company had 2,286 warrants exercisable at $25.55 per share expiring April 2003.
15. NOTES PAYABLE
Notes payable consists of the following:
In the fourth quarter of fiscal 1999, one customer contract relating to a research and development specialty project was terminated. In connection with the termination, the Company agreed to refund payments previously received from the customer and established a note payable ("Customer Note") for approximately $1.5 million. The Customer Note accrues interest at a rate of 7.752 % per annum. The Company is currently in default regarding the Customer Note and therefore the entire balance is classified as a current liability in the accompanying consolidated balance sheets.
On June 6, 2000 a settlement agreement for severance pay was reached with a former executive of the Company. The agreement established a note payable ("Settlement Note") for approximately $363,000 that is secured by certain assets of the Company. The Settlement Note does not accrue interest and is payable in equal installments over twelve months.
On June 22, 2000, the Company renegotiated its capital lease and in connection therewith established a $485,000 note payable ("Equipment Note") to purchase certain equipment (see Note 16). The Equipment Note has an 18-month term beginning January 1, 2001 and accrues interest at the rate of 12.5% per annum. Approximately $152,000 and $333,000 in principal payments under the Equipment Note are due in fiscal year 2001 and 2002, respectively.
16. COMMITMENTS AND CONTINGENCIES
The Company leases facilities under operating leases that expire through 2001. Leases that expire are expected to be renewed or replaced. Rental expense for the years ended June 30, 1998, 1999 and 2000 was approximately $641,000, $506,000 and $538,000, respectively.
Future minimum lease payments under capital and operating leases at June 30, 2000 are as follows (in thousands):
The Company's capital lease was renegotiated in June 2000. Pursuant to the revised terms, the capital lease expires in December 2000 at which time the Company shall purchase the equipment currently being leased for a total purchase price of $485,000 plus sales tax. Provided that the Company is not in default of its obligations under the lease, the lessor has agreed to finance the purchase of the equipment. The Company anticipates that they will utilize the financing offered by the lessor and has established a note payable at June 30, 2000 pursuant to the terms agreed upon with the lessor (see Note 15).
The Company has, from time to time, provided standby letters of credit to customers as performance bonds. The customers may draw on the letters of credit should Iwerks fail to perform under the terms of the contracts. There were two standby letters of credit outstanding as of June 30, 2000. (See Note 3).
There are no material legal proceedings to which the Company is a party other than ordinary routine litigation in the course of business. In the opinion of management, based in part on the advice of counsel, resolution of these matters will not have a material adverse impact on the Company's consolidated financial position or results of operations.
17. SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION
The Company operates in one business segment - the manufacture, distribution and operation of entertainment hardware and software.
Geographic segment information is as follows (in thousands):
Nearly all of the Company's identifiable assets are located in the United States. In fiscal 1998, 1999 and 2000, the Company had no customers who accounted for more than 10% of consolidated revenues.
18. STOCKHOLDER RIGHTS PLAN
The Company has adopted a Stockholder Rights Plan (the "Agreement"). Pursuant to the Agreement each outstanding share of Iwerks' Common Stock has received one right entitling the holder to purchase 1/100th of a share of Series A Preferred Stock of Iwerks for each share of Iwerks Common Stock then held by such holder. Each right becomes exercisable upon certain triggering events related to an unsolicited takeover attempt of Iwerks.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.
Information regarding directors and executive officers of the Company will appear in the Proxy Statement for the 2000 Annual Meeting of Stockholders, and is incorporated herein by this reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation will appear in the Proxy Statement for the 2000 Annual Meeting of Stockholders, and is incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and management of the Company will appear in the Proxy Statement for the 2000 Annual Meeting of Stockholders, and is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions will appear in the Proxy Statement for the 2000 Annual Meeting of Stockholders, and is incorporated herein by this reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements: PAGE NUMBER
Report of Independent Auditors 25
Consolidated Balance Sheets June 30, 1999 and 2000 26
Consolidated Statements of Operations Years Ended June 30, 1998, 1999 and 2000 28
Consolidated Statements of Stockholders' Equity Years Ended June 30, 1998, 1999 and 2000 29
Consolidated Statements of Cash Flows Years Ended June 30, 1998, 1999 and 2000 30
Notes to Consolidated Financial Statements 32
Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts for the years ended June 30, 1998, 1999 and 2000.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(b) Exhibits: See Exhibit List attached to this Annual Report on Form 10-K.
(c) Reports on Form 8-K: none
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
IWERKS ENTERTAINMENT, INC. (Registrant)
By: /S/ JEFFREY M. DAHL ------------------------ Jeffrey M. Dahl Senior Vice President & Chief Financial Officer
Date: September 26, 2000
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Don Iwerks and Jeffrey Dahl, or any one of them, his attorney-in-fact and agent, with full power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact, or their substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
3.1 Certificate of Amendment of Certificate of Incorporation dated August 1, 1997. Incorporated by reference from Registrant's annual Report on Form 10-K for the year ended June 30, 1996.
3.2 Bylaws of Iwerks. Incorporated by reference from Registrant's annual Report on Form 10-K for the year ended June 30, 1995.
4.1 Specimen Certificate evidencing Common Stock of Iwerks. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
4.2 Warrant Agreement, dated April 30, 1993, by and between Iwerks and Richard King International. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
4.3 Warrant to purchase 339,063 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Guber Family Trust dated October 20, 1978. Incorporated by reference from Registrant's Report on Form 8-K filed on September 23, 1999.
4.4 Warrant to purchase 339,063 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Guber Family Trust dated October 20, 1978. Incorporated by reference from Registrant's Report on Form 8-K filed on September 23, 1999.
4.5 Warrant to purchase 339,062 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Guber Family Trust dated October 20, 1978. Incorporated by reference from Registrant's Report on Form 8-K filed on September 23, 1999.
4.6 Warrant to purchase 339,062 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Guber Family Trust dated October 20, 1978. Incorporated by reference from Registrant's Report on Form 8-K filed on September 23, 1999.
4.7 Warrant to purchase 48,438 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Paul and Judy Schaeffer Living Trust dated February 28, 1992. Incorporated by reference from Registrant's Current Report on Form 8-K filed on September 23, 1999.
4.8 Warrant to purchase 48,438 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Paul and Judy Schaeffer Living Trust dated February 28, 1992. Incorporated by reference from Registrant's Current Report on Form 8-K filed on September 23, 1999.
4.9 Warrant to purchase 48,437 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Paul and Judy Schaeffer Living Trust dated February 28, 1992. Incorporated by reference from Registrant's Current Report on Form 8-K filed on September 23, 1999.
4.10 Warrant to purchase 48,437 shares of common stock of the Registrant, dated September 8, 1999, by the Registrant to the Paul and Judy Schaeffer Living Trust dated February 28, 1992. Incorporated by reference from Registrant's Current Report on Form 8-K filed on September 23, 1999.
10.1 Form of Indemnification Agreement and schedule of indemnified parties. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.2 Purchase Agreement dated January 23, 1991, by and between Iwerks and Ride and Show Engineering, Inc. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.3 Amended and Restated 1987 Stock Option, Purchase and Appreciation Rights Plan of Iwerks. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.6 1993 Stock Incentive Plan of Iwerks. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.7 Lease for 4540 W. Valerio Street, Burbank, California 91505, dated May 15, 1990, by and between Iwerks as lessee and Sheldon Plutsky as lessor. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.8 Lease for 4520Valerio Street, Burbank, California 91505, dated September 1, 1992, and the Amendment thereto, dated September 22, 1992, by and between Iwerks as lessee and James E. McGraw as lessor. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.9 Lease for 4535 W. Valerio Street, Burbank, California 91505, dated September 11, 1991, by and between Iwerks as lessee and R.C. Associates as lessor. Incorporated by reference from Iwerks' Registration Statement on Form S-1, SEC Rule No. 68022 declared effective on October 19, 1993.
10.10 Intentionally left blank.
10.12 1994 Stock Incentive Plan of Iwerks Entertainment, Inc. Incorporated by reference from Registrant's annual Report on Form 10-K for the year ended June 30, 1995
10.15 Lease Agreement - Matrix Funding Corporation. Incorporated by reference from Registrant's annual Report on Form 10-K for the year ended June 30, 1996.
10.16 Separation Agreement dated October 31, 1997 between the Company and Roy A. Wright. Incorporated by reference from Registrants Quarterly Report on Form 10-Q for the quarter and six months ended December 31, 1997.
10.17 Separation Agreement dated October 31, 1997 between the Company and Bruce Hinckley. Incorporated by reference from Registrant's Quarterly Report on Form 10-Q for the quarter and six months ended December 31, 1997.
10.18 Separation Agreement dated October 31, 1997 between the Company and William J. Battison III. Incorporated by reference from Registrant's Quarterly Report on Form 10-Q for the quarter and six months ended December 31, 1997.
10.22 Employment Agreement dated February 21, 1998 between the Company and Charles Goldwater Incorporated by reference from Registrant's Registration Statement on Form S-4 filed on March 4, 1998.
10.23 Employment Agreement dated March 2, 1998 between the Company and Dan Griesmer. Incorporated by reference from Registrant's Quarterly Report on Form 10-Q for the quarter and nine months ended March 31, 1998.
10.24 Employment Agreement dated August 3, 1998 between the Company and Jack Shishido. Incorporated by reference from Registrant's Quarterly Report on Form 10-Q for the quarter and three months ended September 30, 1998.
10.25 1998 Non-Employee Directors Stock Option Plan. Incorporated by reference from Registrant's Proxy Statement on Form 14-A file October 28, 1998.
10.26 Rights Agreement Amendment dated as of July 16, 1999, between Iwerks Entertainment, Inc. and U.S. Stock Transfer Corporation. Incorporated by reference from Registrant's Current Report on Form 8-K filed on July 23, 1999.
10.27 Consulting Agreement as of February 15, 2000, between Iwerks Entertainment, Inc. and Donald W. Iwerks, as amended.
10.28 Consulting Agreement as of February 15, 2000, between Iwerks Entertainment, Inc. and Gary J. Matus, as amended.
10.29 Agreement as of March 22, 2000, between Iwerks Entertainment, Inc. and Jeffrey M. Dahl. Incorporated by reference from Registrant's Current Report on Form 10-K filed on September 28, 2000.
10.30 First Amendment to Schedule as of June 22, 2000, by and between Matrix Funding corporation and Iwerks Entertainment, Inc.
21.1 Subsidiary List.
23.1 Consent of Independent Auditors - Ernst & Young LLP
27.1 Financial Data Schedule