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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-25308
OVERSEAS FILMGROUP, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 13-3751702
(State or other (I.R.S. Employer
jurisdiction of incorporation or organization) Identification No.)
8800 SUNSET BLVD., THIRD FLOOR, LOS ANGELES, CA 90069
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (310) 855-1199
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(title of class)
Warrants to Purchase Common Stock
(title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
(Cover page of Form 10-K continued on next page)
Indicate by check mark if disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of
the Registrant (assuming for these purposes, but without conceding, that all
executive officers and directors are "affiliates" of the Registrant) as of
March 31, 1999, (based on the closing sale price on such date as reported on the
OTC Bulletin Board) was $6,181,537.
The number of shares of Common Stock outstanding as of March 31, 1999 was
5,732,778.
DOCUMENTS INCORPORATED BY REFERENCE
NO DOCUMENTS ARE INCORPORATED BY REFERENCE INTO PARTS I, II OR III
PART I
THIS ANNUAL REPORT ON FORM 10-K (INCLUDING, WITHOUT LIMITATION, PARTS I, II AND
III) CONTAINS "FORWARD-LOOKING STATEMENTS", INCLUDING THOSE WITHIN THE MEANING
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS MAY
CONSIST OF ANY STATEMENT OTHER THAN A RECITATION OF HISTORICAL FACT AND CAN BE
IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "EXPECT,"
"ANTICIPATE," "ESTIMATE," "INTEND" OR "CONTINUE" OR THE NEGATIVE THEREOF OR
OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. THE READER IS CAUTIONED
THAT ALL FORWARD-LOOKING STATEMENTS ARE NECESSARILY SPECULATIVE AND THERE ARE
CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL EVENTS OR RESULTS TO
DIFFER MATERIALLY FROM THOSE REFERRED TO IN SUCH FORWARD-LOOKING STATEMENTS.
THESE RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, THE HIGHLY
SPECULATIVE AND INHERENTLY RISKY AND COMPETITIVE NATURE OF THE MOTION PICTURE
INDUSTRY. THERE CAN BE NO ASSURANCE OF THE ECONOMIC SUCCESS OF ANY MOTION
PICTURE SINCE THE REVENUES DERIVED FROM THE PRODUCTION AND DISTRIBUTION OF A
MOTION PICTURE (WHICH DO NOT NECESSARILY BEAR A DIRECT CORRELATION TO THE
PRODUCTION OR DISTRIBUTION COSTS INCURRED) DEPEND PRIMARILY UPON ITS ACCEPTANCE
BY THE PUBLIC, WHICH CANNOT BE PREDICTED. THE COMMERCIAL SUCCESS OF A MOTION
PICTURE ALSO DEPENDS UPON THE QUALITY AND ACCEPTANCE OF OTHER COMPETING FILMS
RELEASED INTO THE MARKETPLACE AT OR NEAR THE SAME TIME, THE AVAILABILITY OF
ALTERNATIVE FORMS OF ENTERTAINMENT AND LEISURE TIME ACTIVITIES, GENERAL ECONOMIC
CONDITIONS AND OTHER TANGIBLE AND INTANGIBLE FACTORS, ALL OF WHICH CAN CHANGE
AND CANNOT BE PREDICTED WITH CERTAINTY. THEREFORE, THERE IS A SUBSTANTIAL RISK
THAT SOME OR ALL OF THE MOTION PICTURES RELEASED, DISTRIBUTED, FINANCED OR
PRODUCED BY THE REGISTRANT WILL NOT BE COMMERCIALLY SUCCESSFUL, RESULTING IN
COSTS NOT BEING RECOUPED OR ANTICIPATED PROFITS NOT BEING REALIZED. THE
REGISTRANT'S RESULTS OF OPERATIONS FOR THE PERIOD ENDED DECEMBER 31, 1998 ARE
NOT NECESSARILY INDICATIVE OF THE RESULTS THAT MAY BE EXPECTED IN FUTURE
PERIODS. DUE TO QUARTERLY FLUCTUATIONS IN THE NUMBER OF MOTION PICTURES IN
WHICH THE REGISTRANT CONTROLS THE DISTRIBUTION RIGHTS AND WHICH BECOME AVAILABLE
FOR DISTRIBUTION (AND THUS, FOR WHICH REVENUE CAN FIRST BE RECOGNIZED) AND THE
NUMBER OF MOTION PICTURES DISTRIBUTED BY THE REGISTRANT, AS WELL AS THE
UNPREDICTABLE NATURE OF AUDIENCE AND SUBDISTRIBUTOR RESPONSE TO MOTION PICTURES
DISTRIBUTED BY THE REGISTRANT, THE REGISTRANT'S REVENUES, EXPENSES AND EARNINGS
FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER AND FROM YEAR TO YEAR. IN
ADDITION, FOR SEVERAL REASONS, INCLUDING (i) THE LIKELIHOOD OF CONTINUED
INDUSTRY-WIDE INCREASES IN ACQUISITION, PRODUCTION AND MARKETING COSTS AND (ii)
THE REGISTRANT'S INTENT, BASED UPON ITS ONGOING STRATEGY, TO ACQUIRE RIGHTS TO
OR PRODUCE FILMS WHICH HAVE GREATER PRODUCTION VALUES (OFTEN AS A RESULT OF
LARGER BUDGETS), THE REGISTRANT'S COSTS AND EXPENSES, AND THUS THE CAPITAL
REQUIRED BY THE REGISTRANT IN ITS OPERATIONS AND THE ASSOCIATED RISKS FACED BY
THE REGISTRANT MAY INCREASE IN THE FUTURE. ADDITIONAL RISKS AND UNCERTAINTIES
ARE DISCUSSED ELSEWHERE IN APPROPRIATE SECTIONS OF THIS REPORT AND IN OTHER
FILINGS MADE BY THE REGISTRANT WITH THE SECURITIES AND EXCHANGE COMMISSION. THE
RISKS HIGHLIGHTED ABOVE AND ELSEWHERE IN THIS REPORT SHOULD NOT BE ASSUMED TO BE
THE ONLY THINGS THAT COULD AFFECT FUTURE PERFORMANCE OF THE REGISTRANT. THE
REGISTRANT DOES NOT HAVE A POLICY OF UPDATING OR REVISING FORWARD-LOOKING
STATEMENTS AND THUS IT SHOULD NOT BE ASSUMED THAT SILENCE BY MANAGEMENT OF THE
REGISTRANT OVER TIME MEANS THAT ACTUAL EVENTS ARE BEARING OUT AS ESTIMATED IN
SUCH FORWARD-LOOKING STATEMENTS.
ITEM 1. BUSINESS
Overseas Filmgroup, Inc., a Delaware corporation, (the "Company") is an
independent film company which specializes in the acquisition and worldwide
license, sale or distribution of distribution rights to independently produced
feature films in a wide variety of genres (including action, "art-house,"
comedy, drama, foreign language, science fiction and thrillers). The Company's
executive offices are located at 8800 Sunset Boulevard, Third Floor, Los
Angeles, California 90069, and its telephone number is (310) 855-1199.
The Company was incorporated in December 1993 under the name
"Entertainment/Media Acquisition Corporation" as a Specified Purpose Acquisition
Company* in order to acquire an operating business in the entertainment and
media industry by merger or other similar type of transaction. From inception
until the October 1996 merger hereafter described, its operations were limited
to organizational activities, completion of an initial public offering in
February 1995, and the evaluation and negotiation of possible business
combinations. On October 31, 1996, pursuant to an Agreement of Merger dated as
of July 2, 1996, as amended as of September 20, 1996, among the Company,
Overseas Filmgroup, Inc. - a privately-held Delaware corporation ("Pre-Merger
Overseas"), and Ellen
- -------------------
* "Specified Purpose Acquisition Company" is a registered servicemark of GKN
Securities Corp.
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Dinerman Little and Robert B. Little (as amended, the "Merger Agreement"), the
Company merged with Pre-Merger Overseas (the "Merger"), with the Company as the
surviving corporation in the Merger. Upon consummation of the Merger, the
Company changed its name to "Overseas Filmgroup, Inc.", and succeeded to the
business and operations of Pre-Merger Overseas which had been established in
1980. Unless otherwise specifically indicated or the context otherwise
requires, the term "Company," refers to the Registrant, Overseas Filmgroup,
Inc., and its wholly owned subsidiaries and references to the operations of the
Company are to the operations of Pre-Merger Overseas through the date of the
Merger and to the combined company following the Merger. In addition, the term
"EMAC" is sometimes used herein to refer to the Registrant during the period
from its inception as "Entertainment/Media Acquisition Corporation" until the
Merger.
RECENT DEVELOPMENTS
On April 9, 1999 the Company and the lenders providing the Company's
credit facility agreed to amend the credit facility to extend the expiration
of the credit facility and the maturity date of the outstanding borrowings
thereunder, until April 9, 2000, subject to certain additional reporting
obligations and restrictions. In light of the inability of the Company to
borrow additional amounts under the credit facility, the Company is actively
seeking an equity infusion and the refinancing of the credit facility. See
"Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations Liquidity and Capital Resources" for additional
information regarding the credit facility and the Company's capital needs.
STRATEGIC OBJECTIVES
The Company has accumulated a library of distribution rights (including
sales agency rights) in various media and markets to approximately 220 feature
films. See "The Company's Film Library of Distribution Rights" below. Most of
such motion pictures have had direct negative costs between $1,000,000 and
$6,000,000. This is substantially below the average direct negative cost of
films produced by the major studios, which was approximately $52.7 million in
1998. The Company's primary focus has been the licensing of distribution rights
(such as theatrical, video, pay television, free television, satellite and other
rights) to foreign sub-distributors in the major international territories or
regions. These activities accounted for approximately 70% of the Company's
total revenues in 1998. In recent years, the Company has been increasingly
active in acquiring domestic distribution rights. The Company has engaged
directly in domestic theatrical distribution (booking motion pictures with
theatrical exhibitors, arranging for the manufacture of release prints from the
film negative, and promoting such motion pictures with advertising and publicity
campaigns) through the Company's domestic theatrical releasing division, First
Look Pictures. First Look Pictures has released such films as MRS. DALLOWAY
(starring Vanessa Redgrave, Rupert Graves, and Natascha McElhone), ANTONIA'S
LINE (winner of the 1996 Academy Award for Best Foreign Language Film), THE
DESIGNATED MOURNER (starring Mike Nichols, Miranda Richardson and David De
Keyser), INFINITY (directed by Matthew Broderick, starring Matthew Broderick and
Patricia Arquette), THE SECRET OF ROAN INISH (the critically acclaimed film by
the noted director, John Sayles), THE SCENT OF GREEN PAPAYA (which was nominated
for the 1994 Academy Award for Best Foreign Language Film) and PARTY GIRL (which
the Company believes was the first theatrical motion picture broadcast over the
Internet).
The Company began its operations by acting primarily as a foreign sales
agent, licensing distribution rights in markets outside the United States to
independently produced films which were fully financed and continued to be owned
by others, in exchange for a sales agency fee. In addition, sometimes the
Company acquires from independent producers the distribution rights in a film
for a specified term in one or more territories and media and receives a
distribution fee in connection with its licensing activities. At times the
Company commits to pay an independent producer a minimum guaranteed payment (a
"minimum guarantee") at or after delivery of the completed film to the Company,
ranging from approximately $100,000 to $5,000,000 or more and representing
varying portions, including at times all or substantially all of a film's
production costs. These minimum guarantees may enable the independent producer
to obtain financing for its project and often results in the Company controlling
more of the distribution rights in the film and receiving more favorable
distribution terms. The Company has also selectively produced certain of the
2
motion pictures distributed by it, generally acquiring fully developed projects
ready for pre-production and contracting out pre-production and production
activities.
Certain films distributed and/or licensed by the Company in 1998
performed well, especially Waking Ned Devine (released by Fox Searchlight in
the U.S. where the film has generated approximately $25,000,000 at the box
office, however, at this time the Company does not estimate amounts will be
payable by Fox Searchlight to the Company as a result of such performance in
excess of the $5,000,000 advance paid to the Company in 1998). Additionally,
although the Company has operated under the constraints of having little or
no available debt financing from its current lender, the Company has acquired
the sales or distribution rights to approximately seven films (representing
an estimated $12,000,000 of aggregate production costs) which were first
available for distribution in 1998 and an additional approximately nine films
(representing an estimated $53,000,000 in aggregate production costs) which
are expected to be first made available for distribution in 1999, including
TITUS, the directorial debut of the much acclaimed stage director Julie
Taymor (THE LION KING on Broadway) starring Anthony Hopkins and Jessica
Lange. However, the continued debt level of the Company and the related
interest costs as well as the restrictions imposed by the Company's lenders
have significantly impacted the cash flow and operations of the Company.
Additionally, the Company continues to be impacted by (i) changes in the
marketplace for independent films including the reduced demand by retail
video stores and video subdistributors worldwide for films which have not had
significant (or any) theatrical release (in 1998, the Company released two
films theatrically in the United States through First Look Pictures, MRS.
DALLOWAY and A MERRY WAR and had one film, WAKING NED DEVINE, released by
another party, Fox Searchlight); and (ii) the weakened demand for film rights
in Asia due to the region's recent economic downturn. Additionally, the
marketplace for independent films has been impacted by an overabundance of
lower budget independent film product made available in part due to the
availability of financing sources for such films including "gap financing"
and insurance backed financing structures. In order to seek to improve the
Company's cash flow and address the changes in the marketplace identified
above, as well as in response to the operating limitations imposed by the
lenders under the Company's credit facility, the Company in 1998 made certain
changes in its operational strategy, and is actively investigating and
pursuing potential equity infusions, and is seeking to refinance its debt.
See Management's Discussion and Analysis of Financial Condition and Results
of Operations. There can be no assurance, however, that the Company will be
able to conclude any such equity infusion and/or refinance the Company's
credit facility. Currently, the Company's primary strategies are to:
- - SEEK TO LIMIT RISK BY LIMITING ITS INVESTMENT IN ACQUISITION COSTS AND FILM
PRODUCTION, AND CONTINUING TO USE METHODS FOR ACQUIRING SALES AND
DISTRIBUTION RIGHTS WHICH DRAW UPON THE COMPANY'S EXPERTISE IN SALES AND
ABILITY TO ARRANGE EQUITY AND OTHER FINANCING FOR THE PRODUCTION OF FILMS,
INCLUDING PRE-SALES. In early 1998, the Company began to alter the
frequency in which it engages in various acquisition, distribution and
financing arrangements. The Company presently intends to:
- Continue to act in many instances as sales agent or engage in
"straight distribution" (i.e., licensing distribution rights to a film
from the rights owner for exploitation by the Company for a given term
in a given territory or territories and media without a minimum
guarantee commitment) whereby the related film is produced with funds
provided by other parties and not by the Company.
- Continue to act on behalf of producers to locate and arrange equity
sources (including investors, producers, distributors in various
territories, various international governmental programs designed to
incentivize film production and other equity providers), co-production
and co-financing sources, pre-sales, "gap financing" (arrangements
where a lender lends a portion of the acquisition or production funds
based upon the Company's estimated value of unsold distribution
rights), insurance backed financing arrangements (arrangements where
an insurance company insures a lender or other financier against loss
from the sales of unsold rights) and other resources available for
production of motion pictures in exchange for the sales and/or
distribution rights to the related films and/or fees.
- Limit the instances in which the Company itself produces motion
picture projects. The Company does not presently have plans to
produce any motion picture projects itself in 1999.
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- Limit the number of films for which the Company provides minimum
guarantees.
- Limit the situations in which the Company participates in co-financing
arrangements, whereby the Company, in combination with other equity
providers, commits to fund a portion of a particular film's production
costs.
- Reduce the number of films First Look Pictures releases annually. In
1998, First Look Pictures released two motion pictures. First Look
Pictures may release one film in 1999, assuming the availability of
funding for print and advertising costs associated with such release.
The Company currently anticipates that, in most circumstances, it
will not proceed with a First Look Pictures release unless outside
sources of funds for print and advertising costs are available to
the Company in connection with such release.
- - ACQUIRE FILMS WHICH THE COMPANY BELIEVES ARE LIKELY TO MERIT A THEATRICAL
RELEASE OR ARE SUITABLE FOR INITIAL RELEASE ON TELEVISION
(INCLUDING PAY TELEVISION). The Company currently intends to:
- Acquire films with recognizable cast, directors and producers and
greater production values (often through offering greater creative
opportunity to talent than major studios offer or as a result of
larger budgets) and which may accordingly have broader appeal in the
competitive theatrical market while attempting to limit the Company's
exposure with respect to acquisition and/or production costs through
pre-sales, "gap financing," insurance backed production structures and
other third party equity sources.
- Acquire films which are oriented to television (including pay
television) programming needs including, at times, films with lower
budgets and in specifically oriented genres, such as action films.
- Further develop relationships with major studios and expand the
Company's executive producing role in connection with motion pictures
produced and distributed by other companies.
- - MAINTAIN A COST CONSCIOUSNESS IN ITS ACQUISITION, FINANCING AND
DISTRIBUTION ACTIVITIES. The Company currently intends to:
- Consider possible additional reductions in overhead.
- Seek to develop relationships with emerging and established talent and
to maintain relationships with independent producers with reputations
for producing high quality films while also controlling costs.
- - EXPLORE OBTAINING ADDITIONAL SOURCES OF CAPITAL. The Company is currently
exploring obtaining additional sources of capital (including equity and
debt financing) and the refinancing of its credit facility. There can be
no assurance, however, that such additional capital (and including the
refinancing of its credit facility) will be available or available on
terms advantageous to the Company.
For additional information on these operational strategies, See "Motion
Picture Distribution by the Company," and "Acquisition of Rights by the Company,
Production and Financing" below and "Item 7 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations." No assurances can
be given that any or all of such strategies will be fully or partially realized,
as their successful implementation depends upon, among other things, the ability
of management of the Company to implement such strategies and the availability
of sufficient capital.
THE MOTION PICTURE INDUSTRY
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The motion picture industry consists of two principal activities which are
described in greater detail below: production, which involves the development,
financing and production of motion pictures; and distribution, which involves
the promotion and exploitation of feature-length motion pictures in a variety of
media, including theatrical exhibition, home video, television and other
ancillary markets, both domestically and internationally. The United States
motion picture industry is dominated by the "major studios," including The Walt
Disney Company, Paramount Pictures Corporation, Warner Brothers Inc., Universal
Pictures, Twentieth Century Fox, Sony Pictures Entertainment, and MGM/UA. The
major studios, which have historically produced and distributed the vast
majority of high grossing theatrical motion pictures released annually in the
United States, are typically large diversified corporations that have strong
relationships with creative talent, television broadcasters and channels,
theatrical exhibitors and others involved in the entertainment industry. The
major studios also typically have extensive national or worldwide distribution
organizations and own extensive motion picture libraries. Motion picture
libraries, consisting of motion picture copyrights and distribution rights owned
or controlled by a film company, can be valuable assets capable of generating
revenues from worldwide commercial exploitation in existing media and markets,
and potentially in future media and markets resulting from new technologies and
applications. The major studios also may own or are affiliated with companies
that own other entertainment related assets such as music and merchandising
operations and theme parks. The major studios' motion picture libraries and
other entertainment assets may provide a stable source of earnings which can
offset the variations in the financial performance of their new motion picture
releases and other aspects of their motion picture operations.
During the past 15 years, "independent" production and distribution
companies (many with financial and other ties to the major studios) have played
an important role in the production and distribution of motion pictures for the
worldwide feature film market, including Miramax Films Corporation (PULP
FICTION, IL POSTINO (the Postman) and LIKE WATER FOR CHOCOLATE), now affiliated
with The Walt Disney Company; New Line Cinema Corporation/Fine Line Features
(THE MASK, TEENAGE MUTANT NINJA TURTLES and the NIGHTMARE ON ELM STREET series),
now affiliated with Time Warner Entertainment Company, L.P.; October Films
(SECRETS & LIES, BREAKING THE WAVES) now affiliated with Universal Pictures; and
Orion Pictures (THE SILENCE OF THE LAMBS), now affiliated with MGM/UA. Artisan
Entertainment Inc. (PERMANENT MIDNIGHT, RINGMASTER); and Lion's Gate Films (GODS
AND MONSTERS, AFFLICTION). As a result of consolidation in the domestic motion
picture industry, a number of previously independent producers and distributors
have been acquired or are otherwise affiliated with major studios. However,
there are also a large number of other production and distribution companies
that produce or distribute motion pictures which have not been acquired or
become affiliated with the major studios. In contrast to the major studios, the
independent production and distribution companies generally produce or
distribute fewer motion pictures and do not own production studios, national or
worldwide distribution organizations, or associated businesses or extensive film
libraries which can generate gross revenues sufficient to offset overhead,
service debt or generate significant cash flow.
The motion picture industry is a world-wide industry. In addition to the
production and distribution of motion pictures in the United States, motion
picture distributors generate substantial revenues from the exploitation of
motion pictures internationally. In recent years, there has been a substantial
increase in the amount of filmed entertainment revenue generated by U.S. motion
picture distributors from foreign sources. From 1989 to 1998, international
revenues of motion picture distributors from filmed entertainment grew from
approximately $4.7 billion in 1989 to approximately $10.3 billion in 1998. This
growth has been due to a number of factors, including, among other things, the
general worldwide acceptance of and demand for motion pictures produced in the
United States, the privatization of many foreign television industries, growth
in the number of foreign households with videocassette players, and growth in
the number of foreign theater screens.
Many countries and territories, such as Australia, Canada, China, France,
Germany, Hong Kong, India, Italy, Russia, Japan, Spain, and the United Kingdom
have substantial indigenous film industries. In a number of these countries, as
in the United States, the film (and in some cases the entertainment) industry is
dominated by a small number of companies, often large, diversified companies
with production and distribution operations. However, like in the United
States, in most of such countries there are also smaller, independent, motion
picture production and distribution companies. Foreign distribution companies
not only distribute motion pictures produced in their countries
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or regions but also films licensed or sub-licensed from United States production
companies and distributors. In addition, film companies in many foreign
countries produce films not only for local distribution, but also for export to
other countries, including the United States. While some foreign language
films, such as LIKE WATER FOR CHOCOLATE, IL POSTINO (the Postman) and ANTONIA'S
LINE, and foreign English-language films, such as HILLARY AND JACKIE, WAKING NED
DEVINE, WINGS OF THE DOVE, THE ENGLISH PATIENT, SHINE, FOUR WEDDINGS AND A
FUNERAL, THE CRYING GAME and CROCODILE DUNDEE appeal to a wide U.S. audience,
most foreign language films distributed in the United States are released on a
limited basis as such films draw a specialized audience for which the appeal of
such films has decreased substantially in recent years.
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MOTION PICTURE PRODUCTION
The production of a motion picture begins with the screenplay adaptation of
a popular novel or other literary work acquired by the producer or the
development of an original screenplay having its genesis in a story line or
scenario conceived by a writer and acquired by the producer. In the development
phase, the producer typically seeks production financing and tentative
commitments from a director, the principal cast members and other creative
personnel. A proposed production schedule and budget are also prepared during
this phase. Upon completing the screenplay and arranging financing commitments,
pre-production of the motion picture begins. In this phase, the producer
engages creative personnel to the extent not previously committed; finalizes the
filming schedule and production budget; obtains insurance and secures completion
guaranties, if necessary; establishes filming locations and secures any
necessary studio facilities and stages; and prepares for the start of actual
filming. Principal photography (the actual filming of the screenplay) generally
extends from eight to sixteen weeks for a film produced by a major studio and
often for a significantly shorter period (sometimes as little as four to eight
weeks) for low budget films and films produced by independent production
companies, depending in each case upon such factors as budget, location, weather
and complications inherent in the screenplay. Following completion of principal
photography (the post-production phase), the motion picture is edited, opticals,
dialogue, music and any special effects are added, and voice, effects and music
sound tracks and pictures are synchronized. This results in the production of a
negative from which release prints of the motion picture are made.
Production costs consist primarily of acquiring or developing the
screenplay, compensation of creative and other production personnel, film studio
and location rentals, equipment rentals, film stock and other costs incurred in
principal photography, and post-production costs, including the creation of
special effects and music. Distribution expenses, which consist primarily of
the costs of advertising and preparing release prints, are not included in
direct production costs. The major studios generally fund production costs from
cash flow generated by motion pictures and related activities or, in some cases,
from unrelated businesses or through off-balance sheet methods. Substantial
overhead costs, consisting largely of salaries and related costs of the
production staff and physical facilities maintained by the major studios, also
must be funded. Independent production companies generally avoid incurring
overhead costs as substantial as those incurred by the major studios by hiring
creative and other production personnel and retaining the other elements
required for pre-production, principal photography and post-production
activities on a picture-by-picture basis. As a result, these companies do not
own sound stages and related production facilities, and, accordingly, do not
have the fixed payroll, general administrative and other expenses resulting from
ownership and operation of a studio. Independent production companies also may
finance their production activities on a picture-by-picture basis. Sources of
funds for independent production companies include bank loans, "pre-licensing"
of distribution rights, foreign government subsidies, equity offerings and joint
ventures. Independent production companies generally attempt to obtain all or a
substantial portion of their financing of a motion picture prior to commencement
of principal photography, at which point substantial production costs begin to
be incurred and require payment.
As part of obtaining financing for its films, the independent production
company is often required by its lenders and distributors who advance production
funds to obtain a completion bond or production completion insurance from an
acceptable completion guarantor which names the lenders and applicable
distributors as beneficiaries. The guarantor assures the completion of the
particular motion picture on a certain date, and if the motion picture cannot be
completed for the agreed upon budgeted cost, the completion guarantor is
obligated to pay the additional costs necessary to complete the picture by the
agreed upon delivery date. If the completion guarantor fails to timely complete
and deliver such motion picture on or before the agreed upon delivery date, the
completion guarantor is required to pay the lenders and distributor, if
applicable, an amount equal to the aggregate amount the lenders and distributor
have loaned or advanced to the independent producer.
In connection with the production and distribution of a motion picture,
major studios and independent production companies generally grant contractual
rights to actors, directors, screenwriters, owners of rights and other creative
and financial contributors to share in net revenues from a particular motion
picture. Except for the most sought-after talent, these third-party
participations are generally payable after all distribution fees, marketing
expenses, direct production costs and financing costs are recouped in full.
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Major studios and independent film companies in the United States typically
incur obligations to pay residuals to various guilds and unions including the
Screen Actors Guild, the Directors Guild of America and the Writers Guild of
America. Residuals are payments required to be made by the motion picture
producer to the various guilds and unions (on a picture-by-picture basis)
arising from the exploitation of a motion picture in markets other than the
primary intended market for such picture. Residuals are calculated as a
percentage of the gross revenues derived from the exploitation of the picture in
these ancillary markets. The guilds and unions typically obtain a security
interest in all rights of the producer in the motion picture being exploited to
ensure satisfaction of the residuals obligation. This security interest is
usually subordinate to the security interest of the lenders financing the
production cost of the motion picture and the completion bond company
guaranteeing completion of the motion picture. Under a producer's agreement
with the guilds and unions, the producer of a motion picture may transfer the
obligation to pay the residuals to a distributor if the distributor assumes the
obligation to make the residual payment. If the distributor does not assume
those obligations, the producer is obligated to pay those residuals.
MOTION PICTURE DISTRIBUTION
GENERAL. Distribution of a motion picture involves domestic and
international licensing of the picture for (a) theatrical exhibition, (b)
videocassettes, laser discs and digital video discs (DVD), (c) presentation
on television, including pay-per-view, basic and premium cable, network,
syndication, or satellite, (d) marketing of the other rights in the picture
and underlying literary property, which may include books, CD-ROM,
merchandising and soundtracks, and (e) non-theatrical exhibition, which
includes airlines, hotels and armed forces facilities. Although releases by
the major studios typically are licensed and fully exploited in all of the
foregoing media, often films produced or distributed by independent film
companies are not exploited in all such media. For example, certain films may
not receive theatrical exhibition in the United States or various other
territories and may instead go straight to home video release or instead first
"premiere" or otherwise be exploited on a pay television service (in certain
limited circumstances followed by a theatrical release).
Production companies with distribution divisions, such as the major
studios, typically distribute their motion pictures themselves. Production
companies without distribution divisions may retain the services of sales agents
or distributors to exploit the motion pictures produced by them in various media
and territories, or in all media and territories. Distribution companies may
directly exploit distribution rights licensed to, or otherwise acquired by them,
for example, by booking motion pictures with theatrical exhibitors or selling
videocassettes to video retailers. Alternatively, they may grant sub-licenses
to domestic or foreign sub-distributors to exploit completed motion pictures.
ACQUISITION OF DISTRIBUTION RIGHTS. A sales agent does not generally
acquire distribution rights from the producer or other owner of rights in the
motion picture, but instead acts as an agent on behalf of the producer or rights
owner to license distribution rights to such motion picture to distributors on
behalf of the producer or rights owner in exchange for a sales agency fee,
typically computed as a percentage of gross revenues from licenses obtained by
the sales agent. A distributor generally licenses and takes a grant of
distribution rights from the producer or other rights owner of the motion
picture for a specified term in a particular territory or territories and media,
generally in exchange for a distribution fee calculated as a percentage of gross
revenues generated by exploitation of the motion picture by the distributor.
The distributor often agrees to pay the producer of the motion picture a certain
advance or minimum guarantee upon the delivery of the completed motion picture,
which amount is to be recouped by the distributor out of revenues generated from
the exploitation of the motion picture in particular media or territories. In
general, after receiving its ongoing distribution fee and recouping the advance
or minimum guarantee plus its distribution costs, the distributor pays the
remainder of revenues in excess of an ongoing distribution fee to the producer
of such motion picture. Obtaining license agreements with a distributor or
distributors prior to completion of a motion picture and which provide for
payment of a minimum guarantee (often referred to as the "pre-licensing" or
"pre-selling" of film rights), may enable the producer to obtain financing for
its project by using the contractual commitment of the distributor to pay the
advance or minimum guarantee as collateral to borrow production funding. In the
past pre-selling of film rights had provided a means for financing film
production; however, the ability to pre-sell film rights in various territories
and media, the amount of pre-sales that can be obtained in certain territories
and media and thus the percentage of a film's budget that can be covered with
pre-sales fluctuates. In recent years, independent film companies have not
generally been able to pre-sell as great a percentage of a film's budget as they
have in past
8
years. The producer may also at times be able to acquire additional production
funds through "gap financing", whereby a lender loans a portion of the
production funds based on a distributor's estimate of the value of world
distribution rights. Although "gap financing" is currently being made available
by multiple lenders, there can be no assurance such lenders will continue to
make funds available on this basis. The Company believes that certain gap
financiers may be reducing the frequency of providing such funds as well as
reducing the amount of funds generally provided. In some circumstances, the
distributor is entitled to recoup any unrecouped costs and advances from a film
licensed to such distributor from the revenues from another film or films also
licensed to the distributor, commonly known as "cross collateralizing."
In addition to obtaining distribution rights in a motion picture for a
limited duration, a distributor may also acquire all or a portion of the
copyright in such motion picture or license certain distribution rights in
perpetuity. Both major studios and independent film companies often acquire
motion pictures for distribution through a customary industry arrangement known
as a "negative pickup," under which the studio or independent film company
agrees to pay a specified minimum guaranteed amount to a production company in
exchange for all rights to the film upon completion of production and delivery
of the film. The production company normally finances production of the motion
picture pursuant to financing arrangements with banks and other lenders in which
the lender receives an assignment of the production company's right to payment
of the minimum guarantee and is granted a security interest in the film and in
the production company's rights under its arrangement with the studio or
independent film company. When the major studio or independent film company
"picks up" the completed motion picture, it pays the minimum guarantee or
assumes the production financing indebtedness incurred by the production company
in connection with the film. In addition, the production company is paid a
production fee and generally is granted a participation in net revenues from
distribution of the motion picture.
THE DISTRIBUTION CYCLE. Concurrently with their release in the United
States, motion pictures generally are released in Canada and may also be
released in one or more other international markets. As a general matter, a
motion picture which is released theatrically is typically available for
distribution in other media during its initial distribution cycle as follows:
MARKETPLACE (MEDIA) NUMBER OF MONTHS FOLLOWING INITIAL DOMESTIC
THEATRICAL RELEASE
Domestic theatrical --
International theatrical --
Domestic home video (initial release) 4-6 months
Domestic pay-per-view 6-9 months
International home video (initial release) 6-12 months
Domestic pay television 9-10 months
International television (pay or free) 18-24 months
Domestic free television (*) 30-33 months
Films often remain in distribution for varying periods of time. For
example, motion pictures which are released theatrically can play in theaters
for several weeks following their initial release (for major studios) or, at
times, including for instance in the case of certain successful "art-house"
films which are released on a limited basis, for
- --------------------
(*) Includes network, barter syndication, syndiation and basic cable.
9
several months. Unsuccessful films, on the other hand, may play in theaters for
only a short period of time. Once released on videocassette, a motion picture
may remain available on videocassette for many years. Similarly a motion
picture can be licensed to various forms of television for many years after its
first release. The release periods set forth above represent standard "holdback
periods". A holdback period with respect to a certain media in which the motion
picture is being released represents a stipulated period of time during which
release of the motion picture in other media is prevented to allow the motion
picture to maximize its value in the media in which it is currently being
released. Holdback periods are often specifically negotiated with various
distributors on a media-by-media basis; however the periods set forth above
represent the Company's estimate of typical current holdback periods in the
motion picture industry.
In general, if a film is not released theatrically in the United States and
instead is released straight to domestic home video, television exploitation
generally does not commence until four to eight months after such video release.
Thereafter, the same general release patterns indicated in the table above
typically apply. If a film "premieres" on United States pay television (which
generally means that no other distribution of the film in the United States has
occurred), the pay television service typically is licensed a four to six week
exclusive airing period. The license will generally provide for limited airings
(defined as five to eight "exhibition days" with multiple airings permitted on
each "exhibition day"). The provisions of such license also usually provide for
the pay television service to receive subsequent airing periods following a
period in which the film can be released on video (or sometimes even
theatrically) and a period when the film may be broadcast on free television.
A substantial portion of a film's ultimate revenues are generated in a
film's initial distribution cycle (generally the first five years after the
film's initial domestic release), which typically includes theatrical, video,
and pay and free television. Commercially successful motion pictures, however,
may continue to generate revenues after the film's initial distribution cycle
from the relicensing of distribution rights in certain media, including
television and home video, and from the licensing of distribution rights with
respect to new media and technologies and in emerging markets. Although there
has been a substantial increase over the past fifteen years in the revenues
generated from the licensing of rights in ancillary (other than domestic
theatrical) media, such as home video, cable and pay-per-view, the theatrical
success of a motion picture remains a significant factor in generating revenues
in foreign markets and in other media such as television and videocassettes.
For example, retail video stores have been increasingly purchasing fewer copies
of videocassettes of motion pictures which have not been theatrically released,
and purchasing more copies of major studio theatrical hits.
THEATRICAL. The theatrical distribution of a motion picture, whether in
the United States or internationally, involves the licensing and booking of the
motion picture to theatrical exhibitors (movie theatres), the promotion of the
picture through advertising and publicity campaigns and the manufacture of
release prints from the film negative. Expenditures on these activities,
particularly on promotion and advertising, are often substantial and may have a
significant impact on the ultimate success of the film's theatrical release. In
addition, such expenditures can vary significantly, depending upon the markets
and regions where the film is distributed, the media used to promote the film
(newspaper, television and radio), the number of screens on which the motion
picture is to be exhibited and the ability to exhibit motion pictures during
peak exhibition seasons. With a release by a major studio, the vast majority of
these costs (primarily advertising costs) are incurred prior to the first
weekend of the film's domestic theatrical release, so there is not necessarily a
correlation between these costs and the film's ultimate box office performance.
In addition, the ability to distribute a picture during peak exhibition seasons,
including the summer months and the Christmas holidays, and in the most popular
theaters may affect the theatrical success of a picture. Films distributed
theatrically by an independent film company are sometimes released on a more
limited basis which in some circumstances allows the distributor to defer
certain marketing costs until it is able to assess the initial public acceptance
of the film.
While arrangements for the exhibition of a film vary greatly, there are
certain economic relationships generally applicable to theatrical distribution.
Theater owners (the "exhibitors") retain a portion of the admissions paid at the
box office ("gross box office receipts"). The share of the gross box office
receipts retained by an exhibitor generally includes a fixed amount per week (in
part to cover overhead), plus a percentage of receipts that generally escalates
over time. Although these percentages vary widely, in the Company's general
experience, an exhibitor's share of a particular film's revenues will generally
be approximately 60% to 65% of gross box office receipts. The balance
10
("gross film rentals") is remitted to the distributor. The distributor then
retains a distribution fee (typically 30-35%) from the gross film rentals and
recoups the costs incurred in distributing the film, which consist primarily of
the cost of marketing and advertising and the cost of release prints for
exhibition. The balance of gross film rentals, after deducting distribution
fees and distribution costs recouped by the distributors ("net film rentals"),
is then applied against the recoupment of any advance paid for the distribution
rights (with interest thereon) and the balance is remitted to the producer or
other rights owner of the film.
HOME VIDEO. A motion picture released theatrically typically becomes
available for videocassette distribution within four to six months after its
initial domestic theatrical release. As indicated above, certain films are not
initially released theatrically but may instead be initially released to home
video. Given the increasing preference of retail video stores for successful
theatrical releases, it has become increasingly difficult to secure the initial
release of a film directly to home video, and the economic opportunity for such
films where such a release is obtained has greatly diminished.
Home video distribution consists of the promotion and sale of
videocassettes to local, regional and national video retailers which rent or
sell videocassettes to consumers primarily for home viewing. Most films are
initially made available in videocassette form at a wholesale price of
approximately $50 to $75 per videocassette and are sold at that price primarily
to wholesalers who then sell to video rental stores at a price of approximately
$75 to $105 per videocassette, which rent the cassettes to consumers. Following
the initial marketing period, selected films may be remarketed at a wholesale
price of $10 to $15 or less for sale to consumers. These "sell-through"
arrangements are used most often with films that will appeal to a broad
marketplace or to children. A few major releases with broad appeal may be
initially offered by a film company at a price designed for sell-through rather
than rental when it is believed that the ownership demand by consumers will
result in a sufficient level of sales to justify the reduced margin on each
cassette sold. In the past owners of films did not share in rental income;
however, recently, video distributors are beginning to enter into revenue
sharing arrangements with certain retail stores. Under such arrangements,
videocassettes are sold at a reduced price to video rental stores (usually $8 to
$10 per videocassette) and a percentage of the rental revenue is then shared
with the owners (or licensors) of the films. Home video arrangements in
international territories are similar to those in domestic territories except
that the wholesale prices may differ.
TELEVISION. Television rights for films initially released theatrically
are, if such films have broad appeal, generally licensed first to pay-per-view
for an exhibition period within six to nine months following initial domestic
theatrical release, then to pay television approximately 12 to 15 months after
initial domestic theatrical release, thereafter in certain cases to network
television for an exhibition period, and then to pay television again. These
films are then syndicated to either independent stations or basic cable outlets.
Pay-per-view allows subscribers to pay for individual programs. Pay television
allows cable television subscribers to view such services as HBO/Cinemax,
Showtime/The Movie Channel, Encore Media Services or others offered by their
cable system operators for a monthly subscription fee. Pay-per-view and pay
television is now delivered not only by cable, but also by satellite
transmission, and films are generally licensed in both such media. Certain
films which are not initially released in the domestic theatrical market may
"premiere" instead on pay television followed in some limited circumstances by
theatrical release. Groups of motion pictures are often packaged and licensed
as a group for exhibition on television over a period of time and, therefore,
revenues from these television licensing "packages" may be received over a
period that extends beyond five years from the initial domestic theatrical
release of a particular film. Motion pictures are also licensed and "packaged"
by producers and distributors for television broadcast in international markets
by government owned or privately owned television studios and networks. Pay
television is less developed outside the United States, but is experiencing
significant international growth. The prominent foreign pay television services
include Canal+, Premiere, STAR TV, British Sky Broadcasting and the
international operations of several U.S. cable services including HBO, the
Disney Channel and Turner Broadcasting.
NON-THEATRICAL AND OTHER RIGHTS. Films may be licensed for use by
airlines, schools, public libraries, community groups, the military,
correctional facilities, ships at sea and others. Music contained in a film may
be licensed for sound recording, public performance and sheet music publication.
Rights in motion pictures may be licensed to merchandisers for the manufacture
of products such as toys, T-shirts, posters and other merchandise.
11
Rights may also be licensed to create novels from a screenplay and to generate
other related book publications, as well as interactive games on such platforms
as CD-ROM, CD-I or other proprietary platforms.
MOTION PICTURE DISTRIBUTION BY THE COMPANY
INTERNATIONAL DISTRIBUTION. Management of the Company has considerable
expertise in international distribution. Ellen Dinerman Little and Robert B.
Little, the senior executive officers of the Company and founders of its
operations, have substantial experience in the business of licensing motion
pictures for distribution outside the United States and have been active in
international motion picture sales since 1975. Over the past 24 years, they
have developed, through their foreign sales activities, relationships with
distributors in most significant territories. In addition, the Company is a
founding member of the American Film Marketing Association which sponsors the
American Film Market, one of the three major annual international film markets
attended by significant international and regional distributors. The Company
generally participates annually with a sales office at all three major film
markets (the American Film Market, the Cannes Film Festival and MIFED), as well
as the major television (NATPE, MIP, MIPCOM) and video (VSDA) markets. The
Company, may also, from time to time, engage independent representatives to
assist the Company in acquiring and/or licensing motion picture rights.
With respect to international territories, the Company licenses
distribution rights in various media (such as theatrical, video, pay television,
free television, satellite and other rights) to foreign sub-distributors on
either an individual rights basis or grouped in various combinations of rights
(which sometimes includes rights in all media). These rights are licensed by
the Company to numerous sub-distributors in international territories or regions
either on a picture-by-picture basis or, in certain circumstances, with respect
to a number of motion pictures pursuant to output arrangements. Currently, the
most important international territories for the Company are Australia, the
Benelux countries, Canada, France, Germany, Italy, Scandinavia, Spain and the
United Kingdom. Japan and South Korea have also been important territories to
the Company in the past; however, the economic downturn in Asia in recent years
has resulted in significantly decreased demand in Japan and Korea (as well as
other Southeast Asian territories) resulting in fewer sales and licensing
transactions with respect to those territories than in prior years and,
significantly less advantageous terms to the Company when deals are concluded,
compared to prior years. As a result the Company is generally unable to depend
on such Southeast Asian territories (especially South Korea) for any significant
pre-sales (or other collateral value) for use in arranging financing for
production of motion pictures. In addition certain contracts the Company had
with subdistributors for these territories have been renegotiated or cancelled.
See Note 11 of Notes to the Company's Consolidated Financial Statements for
certain geographic information regarding the Company's foreign distribution
activities.
The terms of the Company's license agreements with foreign sub-distributors
vary depending upon the territory and media involved and whether the agreement
relates to a single motion picture or multiple motion pictures. Most of the
Company's license agreements provide that the Company will receive a minimum
guarantee from the foreign sub-distributor with all or a majority of such
minimum guarantee paid prior to, or upon delivery of, the film to the
sub-distributor for release in the particular territory. The remainder of any
unpaid minimum guarantee is generally payable at specified intervals after
delivery of the film to the sub-distributor. The minimum guarantee is recouped
by the sub-distributor out of the revenues generated from exploitation of the
picture in such territory. The foreign sub-distributor retains a negotiated
distribution fee (generally measured as a percentage of the gross revenues
generated from its distribution of the motion picture), recoups its distribution
expenses and the minimum guarantee and ultimately (after recoupment of the
distribution expenses) remits to the Company the remainder of any receipts in
excess of the distributor's ongoing distribution fee. The Company must rely on
the foreign sub-distributor's ability to successfully exploit the film in order
to receive any proceeds in excess of the minimum guarantee.
In certain situations, the Company does not receive a minimum guarantee
from the foreign sub-distributor and instead negotiates terms which usually
result, in effect, in an allocation of gross revenues between the
sub-distributor and the Company. Typically the terms of such an arrangement
provide for the sub-distributor to retain an ongoing distribution fee
(calculated as a percentage of gross receipts of the sub-distributor in the
territory), recoup its expenses and pay remaining receipts in excess of the
ongoing distribution fee to the Company. Alternatively, such as often with
respect to video rights, the terms may provide for a royalty to be paid to the
Company calculated as a percentage of the
12
gross receipts of the sub-distributor from exploitation of the video rights
(without deduction for the sub-distributor's distribution expenses).
At times, the Company enters into output arrangements with local foreign
distributors whereby the foreign sub-distributor receives the right, typically
for a specified period and/or specified number of motion pictures, to distribute
in a particular territory, in designated media, motion pictures released by the
Company. In some circumstances, a minimum guarantee is paid by the foreign
sub-distributor to the Company; generally on a picture-by-picture basis with
each minimum guarantee having been either pre-negotiated or computed as a
stipulated percentage of the production cost or acquisition cost of each
picture. The Company is currently a party to an output arrangement with
Polygram Pictures Limited. Under such arrangement, Polygram Pictures Limited
receives the right to distribute the Company's motion pictures in all media in
Australia and New Zealand for a term ending December 20, 2000 and, in certain
circumstances, is obligated to pay a minimum guarantee for a particular picture.
See also "Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations - Exchange Rate Considerations" for certain additional
considerations regarding the Company's international distribution activities.
DOMESTIC DISTRIBUTION. In addition to obtaining foreign distribution
rights, the Company has in recent years been increasingly active in acquiring
domestic distribution rights. During 1998, various distribution rights to
approximately eleven films, including various domestic distribution rights in
five films, became available for the first time to the Company for licensing or
distribution. The Company exploits its domestic distribution rights in a
variety of ways. In 1993, the Company's domestic theatrical releasing
operation, First Look Pictures, was established. Not all of the films
distributed by the Company, however, receive domestic theatrical release by
First Look Pictures or otherwise. Some films are licensed by the Company to
domestic sub-distributors for release initially on video or, in certain
circumstances, the Company licenses initially to the pay television services for
"premiere" on pay television (cable and/or satellite). The Company does not
anticipate that First Look Pictures will release any of the five films which
first became available to the Company in 1998 for licensing or distribution and
in which the Company controls various domestic distribution rights. Of the five
films which first became available to the Company in 1998 for licensing or
distribution in the domestic market, two were licensed to third party domestic
distributors for theatrical and other exploitation and three were (or are
intended to be) released straight to video.
The Company also has determined to have the First Look Pictures
operation broaden its role in order to maximize the value of the Company's
growing film library of over 220 titles. First Look Pictures will also seek
to acquire and distribute films from third party providers. The Company is
currently licensing domestic video rights to films on a film-by-film basis or
in small groupings of films to various subdistributors, including BMG Video,
Fox-Lorber Associates and Unapix Entertainment, Inc. The Company intends to
continue such practices, however, additionally, the Company currently has
plans, on a limited basis, to release certain films on video itself.
The Company licenses distribution rights directly to pay television
services including HBO, Showtime and Encore, as well as smaller services,
pay-per-view services and basic cable services, including Lifetime. Although
the Company has not engaged in significant licensing or syndication of domestic
free television rights except as part of a license of rights in multiple media,
it controls these rights to a significant portion of the films in its library
and has licensed these rights in certain films to third parties.
In some cases, the Company will license the right to distribute a film
domestically in multiple media to a major studio, a division of a major studio,
or an independent distributor. Although the terms of such licenses vary,
typically the Company will be paid a minimum guarantee. The sub-distributor
then retains a distribution fee (measured as a percentage of the gross receipts
received by the sub-distributor from exploitation of the film), recoups its
distribution costs and the advance paid to the Company, and ultimately remits to
the Company the remainder of any receipts in excess of an ongoing distribution
fee.
The Company does not always receive a minimum guarantee from the licensing
of distribution rights to foreign and domestic sub-distributors, thus increasing
the Company's reliance on the actual financial performance of the film being
distributed. In some circumstances, whether the Company receives a minimum
guarantee depends upon the media. For example, the Company is increasingly
(particularly with respect to motion pictures which have not been theatrically
released) entering into video distribution arrangements with sub-distributors
where no minimum guarantee is paid to the Company or where the minimum guarantee
paid to the Company is significantly smaller than those paid to the Company for
similar films in the past. In addition, even if the Company does obtain minimum
guarantees from
13
its sub-distributors, such minimum guarantees do not assure the profitability of
the Company's motion pictures or the Company's operations. Additional revenues
may be necessary from distribution of a motion picture in order to enable the
Company to recoup any investment in such motion picture in excess of the
aggregate minimum guarantees obtained from such sub-distributors, pay for
distribution costs, pay for ongoing acquisition and development of other motion
pictures by the Company and cover general overhead. While the pre-licensing of
distribution rights to sub-distributors in exchange for minimum guarantees may
reduce some of the risk to the Company from unsuccessful films, it may also
result in the Company receiving lower revenues with respect to highly successful
films than if such licensing of distribution rights were made upon different
terms that, for example, might have provided lower minimum guarantees to the
Company but also provided a lower distribution fee (i.e., a lower percentage of
gross revenues) to the sub-distributor.
FIRST LOOK PICTURES. The Company, from its Los Angeles offices, has
directly distributed some of the motion pictures for which it controls domestic
rights to theaters throughout the United States under the name First Look
Pictures. Through March 31, 1999, nineteen films have been released through
First Look Pictures (including two in 1998). Although some of First Look
Pictures' future releases may appeal to a wide audience, many of the nineteen
First Look Pictures releases to date have been specialized motion pictures
generally characterized by underlying literary and artistic elements intended to
appeal primarily to sophisticated audiences including foreign language films and
so called "art-house" films.
Management of the Company believes that the Company can benefit in several
ways by theatrically distributing films in the United States directly through
First Look Pictures. The domestic theatrical success of a motion picture can be
a significant factor in generating revenues from distribution of the motion
picture in ancillary media and foreign markets. For example, retail video
stores purchase few copies of videocassettes of motion pictures that have not
been theatrically released. In addition, the Company believes it is generally
able to obtain more favorable distribution terms in its agreements with foreign
sub-distributors and domestic sub-distributors in other media (for example, pay
television) with respect to motion pictures that have been theatrically released
in the United States. Management of the Company also believes that, in some
cases, its First Look Pictures operations enable the Company to achieve domestic
theatrical release for films that might not otherwise be released in U.S.
theaters. In addition, management of the Company believes that its ability to
release a film theatrically in the U.S. enables the Company to attract more
recognizable talent, higher profile producers and more promising motion picture
projects to the Company generally (for both domestic and foreign distribution)
and that by theatrically releasing films itself in the United States, the
Company can retain a significantly greater share of the revenue from domestic
media in the event of a highly successful theatrical release.
Despite the significant potential advantages to distributing motion
pictures directly in the domestic theatrical market, given the disappointing
results of the six 1997 First Look Pictures releases (none of which generated
more than $211,000 in domestic box office receipts) increased industry-wide
cost of prints and advertising, the restrictions imposed by the recent
changes to the Company's credit facility (which do not permit borrowing under
the credit facility for prints and advertising costs and which require the
consent of the Company's lenders before print and advertising commitments can
be made), and the desire of the Company to improve cash flows, in 1998 the
Company reduced the number of First Look Pictures films released as part of
changes in its operational strategies. The Company currently anticipates
that in most circumstances it will not proceed with a First Look Pictures
release unless outside sources of funds for print and advertising costs are
available to the Company in connection with such release. Assuming such
funds become available to the Company, the Company presently anticipates one
1999 First Look Picture release compared to two in 1998. As described in
Item 13, "Certain Relationships and Related Transactions," the funds for
print and advertising costs of First Look Pictures' 1998 release of "MRS.
DALLOWAY" were provided by pre-selling United States video rights and a loan
from the Company's principal shareholders, Ellen Dinerman Little and Robert
B. Little. The funds for print and advertising costs of First Look Pictures'
other 1998 release, "A MERRY WAR", were provided by a unaffiliated third
party investor and such funds are to be repaid from revenues generated by the
film in the U.S. market and are secured by such revenues. The Company is
currently in discussions with various third parties to obtain other possible
sources of funds for print and advertising expenses, however, there can be no
assurance that any such sources will be available to the Company.
14
Films distributed theatrically in the United States by First Look Pictures
have been typically released on a limited basis (initially less than 100
screens) and in selected cities, expanding to new cities or regions based upon
the performance of the film. In some circumstances, films are released in new
cities as prints become available from cities where the engagement has closed,
reducing the number of prints needed and the aggregate cost of such prints. In
select circumstances, the Company may release appropriate films with more mass
market appeal on a wide release basis either through First Look Pictures or,
more likely, by licensing such film to a domestic distributor with more
significant financial and distribution resources.
The cost to First Look Pictures to distribute a specialized motion picture
or "art-house" film on a limited-release basis has in the past typically ranged
from approximately $100,000 to $2,000,000, although in the future these costs
may exceed such range. Expenditures for prints, marketing and advertising
represent a substantial portion of the costs of releasing a film. Costs for
prints, marketing and advertising for the two films initially released by First
Look Pictures during 1998 were approximately $980,000 and $164,000,
respectively. In connection with the acquisition of domestic theatrical rights
to a film, the Company sometimes commits to spend no less than a specified
minimum amount for prints and advertising costs. These costs are in addition to
the direct production or acquisition costs and other distribution expenses of
such films. Generally, in addition to receiving a distribution fee, the Company
is entitled to recoup its prints and advertising expenditures. Although First
Look Pictures may at times utilize standard broadcast television advertising,
First Look Pictures typically supports its limited releases with local newspaper
and, in certain instances, some cable television advertising. First Look
Pictures also relies on local and national publicity, such as reviews or
articles in local and national publications and appearances of the film's
principal artists on radio and television talk shows. In contrast, distributors
of national, wide release films must rely primarily on national advertising
campaigns, including substantial television advertising, to attract
theatergoers.
The success of a domestic theatrical release by First Look Pictures can be
affected by a number of factors outside of its control, including audience and
critical acceptance, availability of motion picture screens and the success of
competing films in release (see "Competition" below), awards won by First Look
Pictures' releases or that of its competition, inclement weather, and competing
televised events (such as sporting and news events). As a result of the
foregoing, and depending upon audience acceptance of the films distributed
through First Look Pictures, the Company expects that, in many cases, it will
not recoup all of its distribution expenses or derive any profit solely from
domestic theatrical distribution of First Look Pictures' releases. In addition,
there can be no assurance that total revenues from any First Look Pictures'
release, including revenues derived from such film in ancillary media and
international markets, will be sufficient to allow the Company to recoup all of
its costs or to realize a profit on such film.
From January 1, 1998 through March 31, 1999, First Look Pictures released
the two motion pictures listed in the following chart. First Look Pictures
currently has plans to release one film in 1999 (as set forth below under
"Anticipated Releases") assuming the availability of funding for the print and
advertising costs associated therewith.
15
RELEASED
RELEASE DATE AND
DOMESTIC BOX OFFICE
TITLE MAJOR CREATIVE ELEMENTS STORYLINE RECEIPTS
MRS. DALLOWAY Director: Marleen Gorris (ANTONIA'S On one summer's day in London, in 1923, Released on February 20,
LINE) Clarissa Dalloway remembers that summer 1998 with domestic box
Cast: Vanessa Redgrave (MISSION in the country, in 1890, when she was office receipts of
IMPOSSIBLE, SMILLA'S SENSE OF SNOW), young and beautiful and very much approximately $2,273,753.
Rupert Graves (THE MADNESS OF KING courted.
GEORGE, A ROOM WITH A VIEW), Natascha
McElhone (THE DEVIL'S OWN, SURVIVING
PICASSO).
A MERRY WAR F/K/A Director: Bob Bierman (VAMPIRE'S KISS) In this touching romantic comedy, the Released on August 20,
KEEP THE ASPIDISTRA Cast: Helena Bonham Carter (WINGS OF beautiful and charming Rosemary tries 1998 with domestic box
FLYING THE DOVE), Richard E. Grant (TWELFTH desperately to maintain appearances and office receipts of
NIGHT, MIGHTY APHRODITE, PORTAIT OF A avoid scandal, but she is constantly approximately $277,747
LADY, THE AGE OF INNOCENCE). frustrated by her eccentric and through March 31, 1999.
rebellious boyfriend Gordon, who
flaunts his outrageous behavior in the
face of stuffy British middle-class
hypocrisy.
16
ANTICIPATED RELEASES
ANTICIPATED
TITLE MAJOR CREATIVE ELEMENTS STORYLINE RELEASE DATE
MARCELLO Director: Anna Maria Tato A documentary about Marcello Summer 1999
MASTROIANNI: I Mastroianni's memories, joy of living,
REMEMBER and love of cinema recorded by his
companion during the shooting of his
last movie VOYAGE AU DEBUT DU MONDE.
There can be no assurance that the motion picture scheduled for release by First
Look Pictures in 1999 or any motion pictures thereafter will actually be
released or released in accordance with the anticipated schedule set forth
above. The motion picture business is subject to numerous uncertainties,
including financing requirements, personnel availability and the release
schedule of competing films. As indicated above, the Company currently
anticipates releasing films through First Look Pictures, in most situations,
only if outside sources of funds are available for print and advertising
expenses.
ACQUISITION OF RIGHTS BY THE COMPANY, PRODUCTION AND FINANCING
The Company acquires sales and/or distribution rights from a large variety
of independent production companies and producers. The Company generally
acquires such sales and/or distribution rights to single films, as compared to
acquiring films pursuant to multi-picture acquisition agreements with
independent film companies or producers. The Company commits to acquire rights
to motion pictures at various stages in the completion of a film, from films
completed and ready for release to developed (or undeveloped) film projects for
which the Company may arrange financing and/or production services to complete.
In acquiring rights, the Company generally seeks to obtain rights to
commercially appealing motion pictures with substantially lower direct negative
costs than motion pictures released by the major studios.
In order to fund the acquisition costs of the films for which it
acquires rights, the Company, in the past, has relied primarily on: (i) the
film facilities provided under the Company's credit facility with Coutts &
Co. and Berliner Bank A.G.; (ii) other lenders willing to finance the
contractual minimum guarantee obligations of the Company to the films'
producers or rights owners; (iii) working capital; (iv) pre-sales (minimum
guarantees obtained from subdistributors who have licensed rights to the film
from the Company); (v) "gap financing" (where a lender is willing to finance
the production and/or acquisition costs of the motion picture based on the
Company's estimate of the value of unsold distribution rights to the motion
picture); (vi) insurance backed financing structures (arrangements where an
insurance company insures a lender or other financier against loss from the
sales of unsold rights); and (vii) other third party equity sources such as
private investors. The lenders under the credit facility have the right to
approve each acquisition by the Company. In addition, the film facilities
portion of the credit facility (a significant primary source of funds for
acquisition of distribution rights by the Company prior to 1998) is, since
April 14, 1998, no longer a revolving credit line and sums repaid by the
Company cannot be re-borrowed (provided, however, that one pending film
facility with respect to the motion picture ILLUMINATA will still be funded
by the lenders). These provisions have necessitated the Company's seeking out
and utilizing alternate resources and structures to carry on its acquisition
activities. The Company has been able to acquire the sales or distribution
rights to approximately seven films, representing an estimated $12,000,000 of
aggregate production costs, which were first available for distribution in
1998 and an additional approximately nine films, representing an estimated
$53,000,000 in aggregate production costs, which are expected to be first
made available for distribution in 1999 - including TITUS, the directorial
debut of the much acclaimed stage director Julie Taymor (THE
17
LION KING on Broadway) starring Anthony Hopkins and Jessica Lange, there is
no assurance that the alternate sources of financing and equity, including
"gap financing", pre-sales and/or other sources of capital, currently being
utilized by the Company will continue to be available to the extent necessary
to fund the Company's planned acquisition and distribution goals. As
described below, the Company has, as part of the changes in its operational
strategy, altered the frequency in which it engages in various acquisition
and distribution arrangements. The Company is also exploring obtaining
additional sources of capital, although there can be no assurance that such
additional capital will be available or available on terms advantageous to
the Company.
The films distributed by the Company have generally had direct negative
costs ranging from $1,000,000 to $6,000,000. However, from time to time, the
Company may acquire rights to, finance or produce, motion pictures with direct
negative costs (as well as marketing costs) below or substantially in excess of
the average direct negative costs (as well as marketing costs) of the films
historically distributed by the Company. For instance, an upcoming film
expected to be distributed by the Company is anticipated to have a direct
negative cost of between $15,000,000 and $20,000,000 (the production funds for
which are currently being provided by a third party equity provider and
pre-sales). In addition, as part of the Company's overall business strategy it
intends to emphasize films with more recognizable cast, directors and producers
and greater production values and which may accordingly have broader appeal in
the competitive theatrical market while attempting to limit the Company's
exposure with respect to production and acquisition costs through gap financing,
insurance backed financing structures and accessing equity sources such as
private investors.
In certain circumstances, the Company acquires limited distribution or
sales rights and, in other circumstances, acquires worldwide rights (sometimes
including the copyright) to such films. Generally, this depends upon whether
the Company agrees to pay the producer or other owner of rights in the film (the
"rights owner") a substantial minimum guarantee. As part of its acquisition of
theatrical, video and/or television distribution rights, the Company may obtain
rights to exploit ancillary rights, such as music or sound track rights,
merchandising rights, or rights to produce CD-ROMs or other interactive media
products. Although the Company may license such rights to sub-distributors,
historically the Company has not derived any significant revenues from these
ancillary rights.
The Company is sometimes appointed as the sales agent for a particular
motion picture to license, on behalf of the rights owner, distribution rights in
the film to various distributors for exploitation on a territory-by-territory
basis. This often occurs in many gap financing arrangements, where a lender
lends a portion of the production and/or acquisition funds based upon the
Company's estimated value of unsold distribution rights. When the Company acts
as a sales agent, in exchange for its services as sales agent, the Company is
generally entitled to a sales agency fee which typically ranges from
approximately 10% to 20% of the gross revenues from resulting licenses or sales.
In such circumstances, the Company generally advances limited funds toward the
marketing and distribution of the film (generally ranging from approximately
$50,000 to $150,000). In gap financing arrangements a portion, or sometimes
all, of the sales agency fee (and some or all of the distribution expenses) may
be deferred as part of the sales agency arrangement until a specified level of
revenues from sale and/or licensing of the particular distribution rights is
achieved.
In some circumstances, the Company acts in much the same manner as a sales
agent but, rather than licensing or selling the distribution rights of a
particular film to a third party on behalf of the rights owner, the Company
itself licenses the distribution rights in the film from the rights owner for
exploitation by the Company for a given term in a given territory (or
territories) and media. The remainder of this arrangement (the fee structure
and funds provided for marketing and distribution) remains similar to that of a
sales agency. As part of the changes in its operational strategy implemented in
1998, the Company has acted in this manner, or as a sales agent, more frequently
since April 1998 than in prior years.
In both a sales agency arrangement and the distribution arrangement
described above, the amounts payable by the Company to the rights owner depend
upon the success of the Company in distributing the film and the financial
performance of the film itself. In acquiring distribution rights to a completed
or incomplete film, however, the Company will sometimes agree to pay the rights
owner a minimum guarantee that is independent of the financial performance of
the film. Historically, these minimum guarantees paid by the Company have
ranged from approximately $100,000 to $5,000,000, although in some circumstances
they may exceed such amounts. A minimum
18
guarantee may be payable in full at the time of delivery of the completed film
to the Company, as in a typical negative pickup arrangement, or in installments
following complete delivery of the film to the Company, depending upon the
particular arrangement. The rights owner may also receive additional payments
as a result of the Company's exploitation of the distribution rights to the
film. After receiving a distribution fee (generally a percentage of gross
receipts from exploitation of the distribution rights) and recovering its
distribution expenses and minimum guarantee, the Company pays the remainder of
revenues in excess of an ongoing distribution fee to the rights owner. The
Company typically receives a larger share of gross receipts from the
distribution of motion pictures for which it has provided a minimum guarantee
than when it does not. In addition, at times the minimum guarantee paid by the
Company may represent, in amount, all or a substantial portion of the film's
production costs. In those circumstances, such as a typical negative pickup
entered into by the Company, the Company generally receives worldwide
distribution rights in all media and generally will also obtain ownership of the
copyright to the film, with the production company from which the Company
acquired the rights receiving a production fee and generally a participation in
net revenues from distribution of the motion picture. As part of the changes in
its operational strategy implemented in 1998, the Company since early 1998 has
not provided any minimum guarantees which represented the majority of the final
production costs of a film or for which the Company otherwise financed all or
substantially all of the films' production costs. Additionally, the Company
currently intends to limit the number of films for which the Company provides
minimum guarantees.
The Company's commitment to pay a minimum guarantee with respect to films
that have not begun production often enables the production company or producer
to obtain financing for its project, if needed. In some cases, the Company's
contractual commitment to pay a minimum guarantee upon delivery of a film serves
as sufficient collateral for a bank to lend production funds. The bank will
typically insure delivery of the film to the Company by requiring the producer
to purchase a completion guaranty. In order to enable the production company or
producer to borrow production funding, or to borrow at preferential bank fees
and interest rates, it may also be necessary for the Company to secure its
purchase or acquisition commitment, which, in the past, it has generally done by
obtaining the issuance of a letter of credit from the Company's primary lenders,
Coutts & Co., a subsidiary of National Westminster Bank plc., and Berliner Bank
A.G. However, as part of the 1998 changes to the Company's credit facility,
such lenders are no longer making such letters of credit available, which has
limited the ability of the Company acting in this capacity and may limit this
practice in the future unless the Company can locate other lenders willing to
provide such letters of credit. See "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." In certain situations, the production company or producer
of a film may initially obtain certain funds from other distribution companies
which obtain distribution rights in certain media or territories (for example,
the domestic distribution rights or distribution rights in Japan), from
accessing foreign governmental film industry incentive programs (such as
programs offered in the past by England, Canada, Australia and New Zealand) or
by using its own resources or other resources available to it, and then
subsequently approach the Company to supply the remaining funds necessary to
complete or co-finance the film in exchange for the Company's obtaining the
remaining distribution rights to the motion picture. As part of the changes in
the Company's operational strategy, the Company presently intends to limit the
situations in which the Company participates in co-financing arrangements. In
those situations where the Company participates in a co-financing arrangement,
the Company, in combination with other equity providers (including producers,
distributors in various territories, various international governmental programs
designed to incentivize film production and other equity providers) commit to
fund a portion of a particular film's production costs. By comparison, ALEGRIA
and ILLUMINATA, two films first made available for distribution by the Company
in 1998, were co-production arrangements of The Cirque de Soleil, Mainstream
S.A. and Egmond Film & Television BV; and of Victor Company of Japan (JVC),
Sogepaq S.A., and Compagnia Distribuzione Internazionale SRL respectively. In
addition, the Company also intends to seek to further develop relationships with
major studios and expand the Company's executive producing role in connection
with motion pictures produced and distributed by other companies.
The Company did not produce any of the 11 completed films which first
became available to the Company for distribution in 1998, and the Company does
not presently have plans to produce motion pictures itself in 1999; however, it
may do so from time to time in the future. In those circumstances where the
Company has produced a film, the Company's production subsidiaries have
typically obtained production financing by obtaining production loans using the
Company's minimum guarantee commitment as collateral, at times secured by a
letter of credit issued under
19
the Company's credit facility. The Company attempts to minimize the risks
associated with any development and production activities that it conducts, in a
variety of ways. The Company does not maintain a substantial staff of creative
or technical personnel. The Company also does not own or operate sound stage
and related production facilities generally referred to as a "studio" and does
not have the fixed payroll, general and administrative and other expenses
resulting from ownership of a studio. In addition, in those circumstances where
the Company produces a film, the Company generally attempts to acquire fully
developed projects ready for pre-production with, when feasible, completed
scripts and directors and/or cast members who are committed to or are interested
in the project. Many projects also have a producer involved or committed.
However, if at the time of acquisition by the Company of rights in a project, a
producer is not formally or informally committed to a project, the Company also
may engage a production services company or a producer to supervise and arrange
all pre-production, production and post-production activities in exchange for a
production fee and a participation in net revenues from the film.
The following chart provides certain information regarding completed motion
pictures first made available to the Company for distribution during 1998. For
purposes of the chart, "Sales Agency" refers to those situations where the
Company licenses distribution rights to third parties on behalf of the rights
owner; "Straight Distribution" refers to those situations where the Company
itself licenses distribution rights to a film from the rights owner for
exploitation by the Company for a given term in a given territory (or
territories) and media; "Minimum Guarantee" refers to those situations where the
Company acquires rights to a film in exchange for an agreement by the Company to
pay a minimum guaranteed amount upon (or after) delivery of the film to the
Company for exploitation; and "Gap Financing" refers to those situations where a
lender has lent a portion of the production funds based upon the Company's
estimated value of unsold distribution rights. The chart includes acquisitions
of rights from unaffiliated production companies or other rights owners, as well
as from production companies owned or controlled by the Company.
MOTION PICTURE TYPE OF TERRITORIES
TITLE GENRE ACQUISITION ACQUIRED SELECTED CAST
ALEGRIA Drama Minimum Guarantee Universe Frank Langella (LOLITA,
EDDIE), Julie Cox (FRANZ
KAFKA'S WHAT A WONDERFUL
WORLD)
A,B,C.., Drama Straight Distribution Universe excluding Lucy Knight, Erin Norris,
MANHATTAN the United States Sara Paul
and Canada
ILLUMINATA Romantic Comedy Minimum Guarantee Universe John Turturro (BIG LEBOWSKI,
ROUNDERS), Christopher
Walken (PULP FICTION, MOUSE
HUNT), Susan Sarandon (DEAD
MAN WALKING, STEPMOM)
THE OTHER SIDE OF Drama Straight Distribution United States and Marie Theisen, Bjorn
SUNDAY Canada Sundquist
PERFECT PREY Action Sales Agency/Gap Universe, excluding Kelly McGillis (TOP GUN, THE
(a.k.a PERFECT Financing the United States ACCUSED), David Keith (AN
LADY) and homevideo in OFFICER AND A GENTLEMAN,
Canada MAJOR LEAGUE II), Bruce Dern
(THAT CHAMPIONSHIP SEASON,
LAST MAN STANDING)
20
MOTION PICTURE TYPE OF TERRITORIES
TITLE GENRE ACQUISITION ACQUIRED SELECTED CAST
SILENT CRADLE Drama Straight Distribution United States and Lorraine Bracco (GOODFELLAS,
various foreign MEDICINE MAN), Jason Gedrick
territories (BACKDRAFT), Margot Kidder
(SUPERMAN)
SOCCER DOG Family Straight Distribution Various foreign Olivia D'Abo (POINT OF NO
territories RETURN), James Marshall (A
FEW GOOD MEN)
SWEET JANE Drama Straight Distribution Universe, excluding Samantha Mathis (LITTLE
the United States WOMEN, BROKEN ARROW), Joseph
and Canada Gordon-Levitt (HALLOWEEN
H2O)
WAKING NED DEVINE Comedy Straight Distribution Universe, excluding Ian Bannen (GANDHI, GORKY
the United Kingdom PARK, HOPE AND GLORY), David
Kelly (INTO THE WEST, THE
MATCHMAKER)
WHATEVER IT TAKES Action Straight Distribution Universe, excluding Don "the Dragon" Wilson
the United States (BLOODFIST, DELTA FORCE 2),
and English-speaking Andrew Dice Clay (FORD
Canada FAIRLANE)
WHO KILLED PIXOTE Drama Straight Distribution Universe, excluding Cassiano Carneiro (SEE THIS
Brazil, Canada and SONG), Luciana Riueira (FICA
the United States COMIDA)
THE COMPANY'S FILM LIBRARY OF DISTRIBUTION RIGHTS
The Company's film library consists of rights to a broad range of films,
most of which were produced since 1980. As of March 31, 1999, the Company had
various distribution rights to approximately 220 motion pictures (including
approximately 77 motion pictures in which the Company owns an interest in the
copyright and approximately 58 motion pictures for which the Company acts as
sales agent on behalf of the producer or other owner of rights in the film).
The Company's distribution rights generally range from 12 to 25 years or more
from the date of acquisition, and typically extend to many, if not all, media of
exhibition worldwide or in specified territories.
21
In addition to exploitation of distribution rights to motion pictures in
its library in the major media (theatrical, video and television), in certain
situations the Company is able to exploit various ancillary rights in such
films. The Company has arranged for the music in several motion pictures it has
distributed to be released as soundtrack recordings (including KEEP THE
ASPIDISTRA FLYING, MRS. DALLOWAY, THE SECRET OF ROAN INISH, PARTY GIRL, THE BIG
SQUEEZE, and INFINITY). Although exploitation of these soundtracks and other
ancillary rights has not generated significant revenues for the Company to date,
the Company's ownership or control of ancillary rights to motion pictures in its
library (including interactive rights, remake rights and merchandising rights,
among others) may provide future sources of additional revenues.
MAJOR CUSTOMERS
Since January 1, 1996, only four customers have accounted for more than 10%
of the Company's revenues (including for this purpose revenues of Pre-Merger
Overseas) in any full fiscal year: one in 1998 (Fox Searchlight with $5,000,000
or 20.3%), none in 1997, and three in 1996 (BMG Video with $3,068,000 or 10.7%,
Helkon Media Filmvertrieb gmbH with $3,490,000 or 12.2% and Columbia TriStar and
its affiliates with $2,940,000 or 10.3%).
EMPLOYEES
At March 31, 1999, the Company employed a total of 24 full-time employees.
Certain subsidiaries of the Company are, for certain films, subject to the terms
in effect from time to time of various industry-wide collective bargaining
agreements, including the Writers Guild of America, the Directors Guild of
America, the Screen Actors Guild and the International Alliance of Theatrical
Stage Employees. In certain circumstances, the Company assumes a production
company's obligation to pay residuals to these various entertainment guilds and
unions. A strike, job action or labor disturbance by the members of any of these
entertainment guilds and unions could have a material adverse effect on the
production of a motion picture within the United States, and, consequently, on
the business, operations and results of operations of the Company. These
organizations have all engaged in strikes and similar activities. The Company
believes that its current relationship with its employees is satisfactory.
COMPETITION
Motion picture distribution, finance and production are highly competitive
businesses. The competition comes both from companies within the same business
and from companies in other entertainment media which create alternative forms
of leisure entertainment. The Company competes with major film studios
(including The Walt Disney Company, Paramount Pictures Corporation, Universal
Pictures, Sony Pictures Entertainment, Twentieth Century Fox, Warner Brothers
Inc. and MGM/UA) and their affiliates (including such previously independent
companies as Miramax, October, and New Line Cinema) which are dominant in the
motion picture industry. The Company also competes with numerous independent
motion picture production and distribution companies, as well as numerous
foreign motion picture production and distribution companies. Many of the
organizations with which the Company competes have significantly greater
financial and other resources than does the Company. The Company's ability to
compete successfully depends upon the continued availability of independently
produced, domestic and foreign motion pictures and the Company's ability to
identify and acquire distribution rights and to distribute motion pictures
successfully. A number of formerly independent motion picture companies have
been acquired in recent years by major entertainment companies. These
transactions have significantly increased competition for the acquisition of
distribution rights to independently produced motion pictures by eliminating
some available sources of independently produced films and providing greater
financial resources to other previously independent companies engaged in the
business of acquiring distribution rights to independently produced films and
distributing such films.
Films distributed or financed by the Company also compete for audience
acceptance and exhibition outlets with motion pictures distributed and produced
by other companies. As a result, the success of any of the films distributed or
financed by the Company is dependent not only on the quality and acceptance of
that particular film, but also on the quality and acceptance of other competing
films released into the marketplace at or near the same time. With respect to
the Company's domestic theatrical releasing operations, a substantial majority
of the motion picture screens in the
22
United States are typically committed at any one time to films distributed
nationally by the major film studios, which generally buy large amounts of
advertising on television and radio and in newspapers and can command greater
access to available screens. Although some exhibitors specialize in the
exhibition of independent, specialized motion pictures and "art-house" films,
there is intense competition for screen availability for these films as well.
Given the substantial number of motion pictures released theatrically in the
United States each year, competition for exhibition outlets and audiences is
intense. In addition, there have also been rapid technological changes over the
past fifteen years. Although technological developments have resulted in the
creation of additional revenue sources from the licensing of rights with respect
to such new media, such developments have also resulted in the popularity and
availability of alternative and competing forms of leisure time entertainment,
including pay/cable programming, and home entertainment equipment such as
videocassettes, interactive games and computers.
REGULATION
In 1994, the United States was unable to reach agreement with its major
international trading partners to include audio-visual works, such as television
programs and motion pictures, under the terms of the General Agreement on Trade
and Tariffs Treaty ("GATT"). The failure to include audiovisual works under
GATT allows many countries (including members of the European Union, which
consists of Belgium, Denmark, Germany, Greece, Spain, France, Ireland, Italy,
Luxembourg, The Netherlands, Portugal and the United Kingdom) to continue
enforcing quotas that restrict the amount of United States produced television
programming which may be aired on television in such countries. The Council of
Europe has adopted a directive requiring all member states of the European Union
to enact laws specifying that broadcasters must reserve a majority of their
transmission time (exclusive of news, sports, game shows and advertising) for
European works. The directive does not itself constitute law, but must be
implemented by appropriate legislation in each member country. In addition,
France requires that original French programming constitute a required portion
of all programming aired on French television. These quotas generally apply
only to television programming and not to theatrical exhibition of motion
pictures, but quotas on the theatrical exhibition of motion pictures could also
be enacted in the future. There can be no assurance that additional or more
restrictive theatrical or television quotas will not be enacted or that
countries with existing quotas will not more strictly enforce such quotas.
Additional or more restrictive quotas or more stringent enforcement of existing
quotas could materially and adversely affect the business of the Company by
limiting the ability of the Company to exploit fully its rights in motion
pictures internationally and, consequently, to assist or participate in the
financing of such motion pictures.
Distribution rights to motion pictures are granted legal protection under
the copyright laws of the United States and most foreign countries, which laws
provide substantial civil and criminal sanctions for unauthorized duplication
and exhibition of motion pictures. Motion pictures, musical works, sound
recordings, art work, still photography and motion picture properties are
separate works subject to copyright under most copyright laws, including the
United States Copyright Act of 1976, as amended. Management of the Company is
aware of reports of extensive unauthorized misappropriation of videocassette
rights to motion pictures, which may include motion pictures distributed by the
Company. Motion picture piracy is an industry-wide problem. The Motion Picture
Association of America ("MPAA"), an industry trade association, operates a
piracy hotline and investigates all reports of such piracy. Depending upon the
results of such investigations, appropriate legal action may be brought by the
owner of the rights. Depending upon the extent of the piracy, the Federal
Bureau of Investigation may assist in these investigations and related criminal
prosecutions.
Motion picture piracy is an international as well as a domestic problem.
Motion picture piracy is extensive in many parts of the world, including South
America, Asia (including Korea, China and Taiwan), the countries of the former
Soviet Union and other former Eastern bloc countries. In addition to the MPAA,
the Motion Picture Export Association, the American Film Marketing Association
and the American Film Export Association monitor the progress and efforts made
by various countries to limit or prevent piracy. In the past, these various
trade associations have enacted voluntary embargoes of motion picture exports to
certain countries in order to pressure the governments of those countries to
become more aggressive in preventing motion picture piracy. In addition, the
United States government has publicly considered trade sanctions against
specific countries which do not prevent copyright infringement of United States
produced motion pictures. There can be no assurance that voluntary industry
embargoes
23
or United States government trade sanctions will be enacted. If enacted, such
actions could impact the amount of revenue that the Company realizes from the
international exploitation of motion pictures depending upon the countries
subject to such action and the duration of such action. If not enacted or if
other measures are not taken, the motion picture industry (including the
Company) may continue to lose an indeterminate amount of revenues as a result of
motion picture piracy.
The Code and Ratings Administration of the MPAA assigns ratings indicating
age-group suitability for theatrical distribution of motion pictures. The
Company sometimes, although not always, submits its motion pictures for such
ratings. In certain circumstances, motion pictures that the Company does not
submit for rating to the Code and Ratings Administration of the MPAA might have
received restrictive ratings had such motion pictures been submitted for rating,
including, in some circumstances, the most restrictive rating, which prohibits
theatrical attendance by persons below the age of seventeen. Unrated motion
pictures (or motion pictures receiving the most restrictive rating) may not be
exhibited by certain theatrical exhibitors or in certain locales, thereby
potentially reducing the total revenues generated by such films. United States
television stations and networks, as well as foreign governments, impose
additional restrictions on the content of motion pictures which may restrict in
whole or in part theatrical or television exhibition in particular territories.
In 1997, the major broadcast networks and the major television production
companies (which consist primarily of the "major" films studios referred to in
"Competition" above) implemented a system to rate television programs. At this
time such television rating system has not had a material adverse effect on the
motion pictures distributed by the Company. However, the possibility exists
that the sale of theatrical motion pictures for broadcast on domestic free
television may become more difficult because of potential advertiser
unwillingness to purchase advertising time on television programs that are rated
for limited audiences. There can be no assurance that current and future
restrictions on the content of motion pictures may not limit or adversely affect
the Company's ability to exploit certain motion pictures in certain territories
and media.
ITEM 2. PROPERTIES.
The Company's principal executive offices are located at 8800 Sunset
Boulevard, Third Floor, Los Angeles, California 90069 and consist of
approximately 10,000 square feet leased by the Company, the lease for which
expires on September 30, 2002. Currently the monthly lease rate is $2.00 per
square foot. Under the terms of the lease, the Company will also pay a
percentage of operating costs, above a base year calculation, beginning in
October 1999. The Company does not maintain any studio facilities or own any
real estate, and its lease is with an unaffiliated party.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not, as of March 31, 1999, a party to any litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's 1998 Annual Meeting of Shareholders held on October 14,
1998, Ellen Dinerman Little and Scot K. Vorse were re-elected to serve as
directors of the Company until the Company's 2001 Annual Meeting of Stockholders
and until their successors are elected and have qualified, in each case by a
vote of 5,297,600 votes in favor of such person's re-election, 500 votes against
such person's reelection and no votes withheld.
At the 1998 Annual Meeting of Stockholders, the Company's stockholders also
approved a proposal to ratify the Company's selection of PricewaterhouseCoopers
LLP as the Company's independent auditors for the fiscal year ended December 31,
1998. The number of votes cast with respect to such proposal were 5,297,100
votes in favor of such proposal and 500 votes against such proposal, with 500
abstentions and no broker non-votes.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
24
MARKET PRICE
The Company's Common Stock is quoted on the OTC Bulletin Board under the
symbol "OSFG." The Company's 4,500,000 Warrants to Purchase Common Stock (each
warrant entitling the registered holder to purchase one share of Common Stock at
an exercise price of $5.00 per share, subject to adjustment, until 5:00 p.m. New
York City time on February 16, 2002) (the "Warrants") are also quoted on the OTC
Bulletin Board under the Symbol "OSFGW." The following table sets forth the
high and low closing bid quotations for the periods indicated. The quotations
represent prices between dealers and do not include retail markups or markdowns
or commissions. They may not necessarily represent actual transactions.
COMMON STOCK WARRANTS
FISCAL 1997 HIGH LOW HIGH LOW
First Quarter 4-5/8 3-1/2 1 19/64
Second Quarter 3-9/32 1-3/8 1/2 1/8
Third Quarter 2-13/16 1-13/16 3/8 1/4
Fourth Quarter 2-3/8 2 3/8 1/4
FISCAL 1998
First Quarter 2-1/2 1-13/16 5/16 1/8
Second Quarter 2-1/8 1-21/32 3/16 3/16
Third Quarter 2-13/16 2 15/32 1/8
Fourth Quarter 2-3/8 1-1/2 7/16 1/16
FISCAL 1999
First Quarter 3-1/8 2-1/16 1/2 1/4
Second Quarter 2-15/16 2-11/16 1/4 3/16
(through April 13, 1999)
HOLDERS
As of March 31, 1999, there were approximately 17 holders of record of the
Company's Common Stock, and there were 5,732,778 shares of Common Stock issued
and outstanding of the 25,000,000 shares authorized. As of March 31, 1999,
there were approximately 8 holders of record of the Company's Warrants. See
note 8 of the notes to the Company's Consolidated Financial Statements for
information regarding certain additional securities which have been issued by
the Company.
DIVIDENDS
The Company has not paid cash dividends on its Common Stock (other than S
Corporation distributions made by Pre-Merger Overseas to its stockholders) and
the Company presently intends to retain future earnings to finance the expansion
and development of its business and not pay dividends on its Common Stock. Any
determination to pay cash dividends in the future would be at the discretion of
the Company's Board of Directors and would be dependent upon the Company's
results of operations, financial condition, contractual restrictions and other
factors deemed relevant at that time by the Company's Board of Directors. In
addition, certain covenants in the Company's credit facility substantially
restrict payment of cash dividends.
25
ITEM 6. SELECTED FINANCIAL DATA.
The following tables set forth selected financial data for the Company
which has been derived from the Company's financial statements as of and for
each of the five years ended December 31, 1998 which have been audited by
PricewaterhouseCoopers LLP, independent accountants. The selected financial
data set forth below should be read in conjunction with the Consolidated
Financial Statements of the Company, together with the related notes thereto
included elsewhere herein, and "Item 7 - Management's Discussion and Analysis of
Financial Condition And Results Of Operations."
YEAR ENDED DECEMBER 31,
-----------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues $20,734,094 $21,672,510 $28,677,571 $22,494,256 $25,585,476
Film costs 16,395,902 16,320,694 23,058,000 19,152,847 21,014,728
Selling, general and administrative 2,151,214 2,721,745 3,595,660 3,509,122 2,960,383
Income (loss) from operations 2,186,978 2,630,071 2,023,910 (167,713) 1,610,365
Income (loss) before income taxes 2,441,960 2,894,066 1,665,269 (837,277) 112,472
Income taxes(1) 296,487 432,905 3,131,367 (293,357) 53,000
Net income (loss) 2,145,473 2,461,161 (1,466,098) (543,920) 59,472