|
Three months ended
September 30
|
Nine months ended
September 30
|
|---|
|
2003 |
2002 |
2003 |
2002 |
|---|
|
|
|
|
|
|---|
Risk-free interest rate |
|
|
| 1.04 |
% |
| 2.87 |
% |
| 1.05 |
% |
| 4.04 |
% |
Expected term (years) | | |
| 5.0 |
|
| 5.0 |
|
| 5.0 |
|
| 5.0 |
|
Volatility | | |
| 76 |
% |
| 114 |
% |
| 76 |
% |
| 114 |
% |
Expected annual dividends | | |
| None |
|
| None |
|
| None |
|
| None |
|
NOTE 7 — SETTLEMENT
AGREEMENT
In
the nine-month period ended September 30, 2003, the Company entered into a Final
Settlement Agreement with its former Chief Executive Officer. The agreement resulted in a
$90,000 reduction of the amount previously credited to Additional Paid-in Capital in
connection with the October 2002 resignation of the Chief Executive Officer.
9
POINT.360
MANAGEMENT’S
DISCUSSION AND ANALYSIS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Three Months Ended
September 30, 2003 Compared To Three Months Ended September 30, 2002.
Revenues. Revenues decreased by $0.3 million to $16.7 million for the three-month
period ended September 30, 2003, compared to $17.0 million for the three-month
period ended September 30, 2002.
Gross Profit. In the third quarter of 2003, gross margin increased by 2% of sales. Gross
margin on sales was 42% in the 2003
third quarter compared to 40% in the prior year’s third quarter due principally to
lower wages and benefits.
Selling, General And
Administrative Expense. Selling, general and administrative (“SG&A”)
expense increased $0.1 million, or 2% to $4.8 million for the three-month period
ended September 30, 2003, compared to $4.7 million for the three-month period
ended September 30, 2002. As a percentage of revenues, SG&A increased to 29%
for the three-month period ended September 30, 2003, compared to 28% for the
three-month period ended September 30, 2002.
Operating
Income.Operating income increased $0.1 million to $2.2 million for the three-month
period ended September 30, 2003, compared to a $2.1 million for the three-month period
ended September 30, 2002.
Interest Expense. Interest expense for the three-month period ended September 30, 2003 was $0.5
million, a decrease of
$0.1 million from the three-month period ended September 30, 2002 because of lower
debt levels due to principal payments made during the last twelve months.
Derivative Fair Value Change. The Company adopted SFAS 133 on January 1, 2001. During the
quarters ended September 30, 2003 and
2002, the Company recorded the difference between the derivative fair value of the
Company’s interest rate hedge contract at the beginning and end of the periods, or
$181,000 income ($106,000 net of tax provision) and $53,000 expense ($30,000 net of tax
benefit) in 2003 and 2002, respectively, and amortization of the cumulative-effect
adjustment.
Income Taxes. The Company's effective tax rate was 42% for the third quarter of 2003 and
43% for the third quarter of 2002.
The decrease in effective tax rate is the result of the Company’s periodic assessment
of the relationship of book/tax timing differences to total expected annual pre-tax
results and the elimination of goodwill expense for financial statement purposes. The
effective tax rate percentage may change from period to period depending on the difference
in the timing of the recognition of revenues and expenses for book and tax purposes.
Net Income. The net income for the three-month period ended September 30, 2003 was $1.1
million, an increase of
$0.3 million compared to net income of $0.8 million for the three-month period ended
September 30, 2002.
Nine Months Ended
September 30, 2003 Compared To Nine Months Ended September 30, 2002.
Revenues. Revenues decreased by $0.7 million to $49.8 million for the nine-month
period ended September 30, 2003, compared to $50.5 million for the nine-month
period ended September 30, 2002.
Gross Profit. Gross profit increased $0.2 million or 1% to $19.3 for the nine-month period
ended September 30, 2003, compared to
$19.1 million for the nine-month period ended September 30, 2002 due principally to lower
wages and benefits. As a percent of revenues, gross profit increased from 38% to 39%.
Selling, General And
Administrative Expense. Selling, general and administrative (“SG&A”) expense decreased $0.6 million, or 5%, to $13.2 million for the nine-month
period ended September 30, 2003, compared to $13.8 million for the nine-month
period ended September 30, 2002. As a percentage of revenues, SG&A decreased
to 26% for the nine-month period ended September 30, 2003, compared to 27% for
the nine-month period ended September 30, 2002.
In
June 2003, the Company wrote off approximately $1.0 million of previously deferred
expenses related to a proposed acquisition and financing package. Amounts expensed related
to $300,000 paid to extend the option to purchase three subsidiaries of Canadian entity,
approximately $400,000 of legal, accounting and other due diligence costs related to the
proposed acquisition, and approximately $300,000 of legal and other costs associated with
the proposed financing.
Operating
Income.Operating income increased $0.8 million to $6.1 million for the nine-month
period ended September 30, 2003, compared to a $5.3 million for the nine-month period
ended September 30, 2002.
Interest Expense. Interest expense for the nine-month period ended September 30, 2003 was $1.6
million, a decrease of
$0.3 million from the nine-month period ended September 30, 2002 because of lower
debt levels due to principal payments made during the last twelve months.
10
Derivative Fair Value Change. The Company adopted SFAS 133 on January 1, 2001. During the
nine-month periods ended September
30, 2003 and 2002, the Company recorded the difference between the derivative fair value
of the Company’s interest rate hedge contract at the beginning and end of the
periods, or $492,000 income ($290,000 net of tax provision) and $35,000 expense ($19,000
net of tax benefit) in 2003 and 2002, respectively, and amortization of the
cumulative-effect adjustment.
Income Taxes. The Company's effective tax rate was 41.5% for the first nine months of
2003 and 43% for the first nine
months of 2002. The decrease in effective tax rate is the result of the Company’s
periodic assessment of the relationship of book/tax timing differences to total expected
annual pre-tax results and the elimination of goodwill expense for financial statement
purposes. The effective tax rate percentage may change from period to period depending on
the difference in the timing of the recognition of revenues and expenses for book and tax
purposes.
Net Income. The net income for the nine-month period ended September 30, 2003 was $2.3
million, an increase of
$0.4 million compared to net income of $1.9 million for the nine-month period ended
September 30, 2002.
LIQUIDITY AND CAPITAL
RESOURCES
This
discussion should be read in conjunction with the notes to the financial statements and
the corresponding information more fully described in the Company’s Form 10-K for the
year ended December 31, 2002.
On
September 30, 2003, the Company’s cash and cash equivalents aggregated $7.5 million.
The Company’s operating activities provided cash of $9.0 million for the nine months
ended September 30, 2003.
The
Company’s investing activities used cash of $1.0 million in the nine months ended
September 30, 2003. The Company spent approximately $1.0 million for the addition and
replacement of capital equipment and management information systems which we believe is a
reasonable capital expenditure level given the current revenue volume. In the prior year,
the Company’s capital expenditures were $0.9 million. The Company’s business is
equipment intensive, requiring periodic expenditures of cash or the incurrence of
additional debt to acquire additional fixed assets in order to increase capacity or
replace existing equipment.
In
September 2000, the Company signed a $45 million revolving credit facility agented by
Union Bank of California. The amount of the commitment was reduced to $30 million in July
2001. The facility provided the Company with funding for capital expenditures, working
capital needs and support for its acquisition strategies.
Due
to lower sales levels in the second and third quarters of Fiscal 2001, the borrowing base
(eligible accounts receivable, inventory and machinery and equipment) securing the
Company’s bank line of credit was less than the amount borrowed under the line.
Consequently, the Company was in breach of certain covenants. On June 11 and on July 20,
2001, the Company entered into amendment and forbearance agreements with the banks and
agreed to repay the overdraft amount in weekly increments. In August 2001, the Company
failed to meet the repayment schedule and again entered discussions with the banks.
In
May 2002, the Company and the banks entered into a restructured loan agreement changing
the revolving credit facility to a term loan, with all existing defaults being waived. The
term loan has a maturity date of December 31, 2004. Pursuant to the agreement, the Company
made $5.5 million in scheduled principal payments in 2002 and will make additional
scheduled principal payments of $5.0 million and $16.0 million in 2003 and 2004,
respectively. The agreement provides for interest at the banks’ reference rate plus
1.25% and requires the Company to maintain certain financial covenant ratios. The term
loan is secured by substantially all of the Company’s assets. In May and June of 2002
and 2003, the Company paid $50,000 and $250,000, respectively, as a restructuring fee with
respect to the new term loan.
In
July 2002, we entered into an arrangement regarding earn-out payments related to the July
1997 acquisition of MultiMedia Services, Inc. The original acquisition agreement would
have required payments of approximately $1.5 million during the next two years assuming
minimum earnings levels are met, which levels have been achieved in the past. In exchange
for a one-time $1.1 million payment made in July 2002, we were relieved of all future
earn-out obligations under the purchase agreement.
In
October 2002, the Company paid the banks $20,000 and made an additional principal payment
of $500,000 in connection with a waiver received from the banks to allow the
company’s former President and Chief Executive Officer to reduce his percentage
ownership in the Company to below the 14% required in the restructured loan agreement.
In
June and September 2003, the Company made an additional principal payments of $1,000,000
each after considering its positive cash position, future cash requirements and the desire
to reduce interest costs.
During
the past year, the Company has generated sufficient cash to meet operating, capital
expenditure and debt service needs and obligations, as well as to provide sufficient cash
reserves to address contingencies. When preparing estimates of future cash flows, we
consider historical performance, technological changes, market factors, industry trends
and other criteria. In our opinion, the Company will continue to be able to fund its needs
for the foreseeable future.
11
The
Company, from time to time, considers the acquisition of businesses complementary to its
current operations. Consummation of any such acquisition or other expansion of the
business conducted by the Company may be subject to the Company securing additional
financing, perhaps at a cost higher than our existing term loan. Future earnings and cash
flow may be negatively impacted to the extent that any acquired entities do not generate
sufficient earnings and cash flow to offset the increased financing costs.
CRITICAL ACCOUNTING
POLICIES AND ESTIMATES
Our
discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our estimates and
judgments, including those related to allowance for doubtful accounts, valuation of
long-lived assets, and accounting for income taxes. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions. We
believe the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements.
Critical
accounting policies are those that are important to the portrayal of the Company’s
financial condition and results, and which require management to make difficult,
subjective and/or complex judgements. Critical accounting policies cover accounting
matters that are inherently uncertain because the future resolution of such matters is
unknown. We have made critical estimates in the following areas:
Allowance
for doubtful accounts. We are required to make judgments, based on historical
experience and future expectations, as to the collectibility of accounts receivable. The
allowances for doubtful accounts and sales returns represent allowances for customer trade
accounts receivable that are estimated to be partially or entirely uncollectible. These
allowances are used to reduce gross trade receivables to their net realizable value. The
Company records these allowances based on estimates related to the following factors: i)
customer specific allowances; ii) amounts based upon an aging schedule and iii) an
estimated amount, based on the Company’s historical experience, for issues not yet
identified.
Valuation
of long-lived and intangible assets. Long-lived assets, consisting primarily of
property, plant and equipment and intangibles comprise a significant portion of the
Company’s total assets. Long-lived assets, including goodwill and intangibles are
reviewed for impairment whenever events or changes in circumstances have indicated that
their carrying amounts may not be recoverable. Recoverability of assets is measured by a
comparison of the carrying amount of an asset to future net cash flows expected to be
generated by that asset. The cash flow projections are based on historical experience,
management’s view of growth rates within the industry and the anticipated future
economic environment.
Factors
we consider important which could trigger an impairment review include the following:
- significant underperformance relative to expected
historical or projected future operating results;
- significant changes in the manner of our use of the
acquired assets or the strategy for our overall business;
- significant negative industry or economic trends;
- significant decline in our stock price for a sustained
period; and
- our market capitalization relative to net book value.
When
we determine that the carrying value of intangibles, long-lived assets and related
goodwill and enterprise level goodwill may not be recoverable based upon the existence of
one or more of the above indicators of impairment, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business model. Net intangible
assets, long-lived assets, and goodwill amounted to $44 million as of September 30,
2003.
We
ceased amortization of approximately $26.3 million of goodwill beginning in 2002. We
had recorded approximately $2.0 million of amortization on these amounts during the
year ended December 31, 2001.
Accounting
for income taxes. As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the jurisdictions in
which we operate. This process involves us estimating our actual current tax exposure
together with assessing temporary differences resulting from differing treatment of items,
such as deferred revenue, for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within our consolidated balance
sheet. We must then assess the likelihood that our deferred tax assets will be recovered
from future taxable income and to the extent we believe that recovery is not likely, we
must establish a valuation allowance. To the extent we establish a valuation allowance or
increase this allowance in a period, we must include an expense within the tax provision
in the statement of operations.
12
Significant
management judgment is required in determining our provision for income taxes, our
deferred tax assets and liabilities and any valuation allowance recorded against our net
deferred tax assets. The net deferred tax liability as of September 30, 2003 was $2.8
million. The Company did not record a valuation allowance against its deferred tax assets
as of September 30, 2003.
RECENT ACCOUNTING
PRONOUNCEMENTS
In
June 2001, the Financial Accounting Standards Board issued SFAS Nos. 141 and 142,
“Business Combinations” and “Goodwill and Other Intangible
Assets,” respectively. SFAS No. 141 replaces Accounting Principles Board
(“APB”) Opinion No. 16. It also provides guidance on purchase accounting related
to the recognition of intangible assets and accounting for negative goodwill.
SFAS No. 142 changes the accounting for goodwill and other intangible assets with
indefinite useful lives (“goodwill”) from an amortization method to an
impairment-only approach. Under SFAS No. 142, goodwill will be tested annually and
whenever events or circumstances occur indicating that goodwill might be impaired. The
Company implemented SFAS No. 142 in the first quarter of fiscal 2002 which required no
goodwill impairment. The Company also tested goodwill as of September 30, 2003 with no
impairment indicated.
In
December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based
Compensation-Transition and Disclosure,” an amendment of SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent
and more frequent disclosures in financial statements about the effects of stock-based
compensation. This statement is effective for financial statements for fiscal years
ending after December 15, 2002. Other than supplemental footnote disclosures, SFAS
No. 148 will not have any impact on the Company’s financial statements as management
does not have any intention to change to the fair value method.
In
April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies
accounting and reporting for derivative instruments and hedging activities under SFAS No.
133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS
No. 149 is effective for derivative instruments and hedging activities entered into or
modified after June 30, 2003, except for certain forward purchase and sale securities. For
these forward purchase and sale securities, SFAS No. 149 is effective for both new and
existing securities after June 30, 2003. Management does not expect adoption of SFAS No.
149 to have a material impact on the Company’s statements of earnings, financial
position, or cash flows.
In
May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150
establishes standards for how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both liabilities
and equity. In accordance with the standard, financial instruments that embody obligations
for the issuer are required to be classified as liabilities. SFAS No. 150 will be
effective for financial instruments entered into or modified after May 31, 2003 and
otherwise will be effective at the beginning of the first interim period beginning after
June 15, 2003. This statement does not affect the Company at this time.
CAUTIONARY STATEMENTS
AND RISK FACTORS
In
our capacity as Company management, we may from time to time make written or oral
forward-looking statements with respect to our long-term objectives or expectations which
may be included in our filings with the Securities and Exchange Commission (the
“SEC”), reports to stockholders and information provided in our web site.
The
words or phrases “will likely,” “are expected to,” “is
anticipated,” “is predicted,” “forecast,” “estimate,”
“project,” “plans to continue,” “believes,” or similar
expressions identify “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking statements are
subject to certain risks and uncertainties that could cause actual results to differ
materially from historical earnings and those presently anticipated or projected. We wish
to caution you not to place undue reliance on any such forward-looking statements, which
speak only as of the date made. In connection with the “Safe Harbor” provisions
of the Private Securities Litigation Reform Act of 1995, we are calling to your attention
important factors that could affect our financial performance and could cause actual
results for future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
The
following list of important factors may not be all-inclusive, and we specifically decline
to undertake an obligation to publicly revise any forward-looking statements that have
been made to reflect events or circumstances after the date of such statements or to
reflect the occurrence of anticipated or unanticipated events. Among the factors that
could have an impact on our ability to achieve expected operating results and growth plan
goals and/or affect the market price of our stock are:
- Recent history of losses
- Prior breach of credit
agreement covenants and new principal payment requirements.
- Our highly competitive marketplace.
13
- The risks associated
with dependence upon significant customers.
- Our ability to execute our expansion strategy.
- The uncertain ability to manage growth.
- Our dependence upon and
our ability to adapt to technological developments.
- Dependence on key personnel.
- Our ability to maintain
and improve service quality.
- Fluctuation in quarterly
operating results and seasonality in certain of our markets.
- Possible significant
influence over corporate affairs by significant shareholders.
These risk factors are discussed
further below.
Recent History of
Losses. The Company has reported losses for each of the five fiscal
quarters ended December 31, 2001 due, in part, to lower gross margins and lower sales
levels and a number of unusual charges. Although we achieved profitability in Fiscal 2000
and prior years, as well as in the seven fiscal quarters ended September 30, 2003, there
can be no assurance as to future profitability on a quarterly or annual basis.
Prior Breach of Credit
Agreement Covenants and New Principal Payment Requirements. Due to lower operating
cash amounts resulting from reduced sales levels in 2001 and the consequential net losses,
the Company breached certain covenants of its credit facility. The breaches were
temporarily cured based on amendments and forbearance agreements among the Company and the
banks which called for, among other provisions, scheduled payments to reduce amounts owed
to the banks to the permitted borrowing base. In August 2001, the Company failed to meet
the principal repayment schedule and was once again in breach of the credit facility. The
banks ended their formal commitment to the Company in December 2001.
In May 2002, we entered into an
agreement with the banks to restructure the credit facility to a term loan maturing on
December 31, 2004. As part of this restructuring, the banks waived all existing defaults
and the Company was required to make principal payments of $5.5 million, $5.0 million and
$18.5 million in 2002, 2003, and 2004, respectively. Based upon the Company’s
financial forecast, the Company will have to refinance the facility by 2004 to satisfy the
final payment requirement.
Competition.
Our post production, duplication and distribution industry is a highly
competitive, service-oriented business. In general, we do not have long-term or
exclusive service agreements with our customers. Business is acquired on a
purchase order basis and is based primarily on customer satisfaction with
reliability, timeliness, quality and price.
We compete with a variety of post
production, duplication and distribution firms, some of which have a national presence,
and to a lesser extent, the in-house post production and distribution operations of our
major motion picture studio and advertising agency customers. Some of these firms, and all
of the studios, have greater financial, distribution and marketing resources and have
achieved a higher level of brand recognition than the Company. In the future, we may not
be able to compete effectively against these competitors merely on the basis of
reliability, timeliness, quality and price or otherwise.
We may also face competition from
companies in related markets which could offer similar or superior services to those
offered by the Company. We believe that an increasingly competitive environment and the
possibility that customers may utilize in-house capabilities to a greater extent could
lead to a loss of market share or price reductions, which could have a material adverse
effect on our financial condition, results of operations and prospects.
Customer and Industry
Concentration. Although we have an active client list of over 2,500
customers, seven motion picture studios accounted for approximately 34% of the
Company’s revenues during the year ended December 31, 2002. If one or more of these
companies were to stop using our services, our business could be adversely affected.
Because we derive substantially all of our revenue from clients in the entertainment and
advertising industries, the financial condition, results of operations and prospects of
the Company could also be adversely affected by an adverse change in conditions which
impact those industries.
Expansion
Strategy. Our growth strategy involves both internal development and
expansion through acquisitions. We currently have no agreements or commitments to acquire
any company or business. Even though we have completed eight acquisitions in the last five
fiscal years, we cannot be sure additional acceptable acquisitions will be available or
that we will be able to reach mutually agreeable terms to purchase acquisition targets, or
that we will be able to profitably manage additional businesses or successfully integrate
such additional businesses into the Company without substantial costs, delays or other
problems.
Certain of the businesses previously
acquired by the Company reported net losses for their most recent fiscal years prior to
being acquired, and our future financial performance will be in part dependent on our
ability to implement operational improvements in, or exploit potential synergies with,
these acquired businesses.
14
Acquisitions may involve a number of
special risks including: adverse effects on our reported operating results (including the
amortization of acquired intangible assets), diversion of management’s attention and
unanticipated problems or legal liabilities. In addition, we may require additional
funding to finance future acquisitions. We cannot be sure that we will be able to secure
acquisition financing on acceptable terms or at all. We may also use working capital or
equity, or raise financing through equity offerings or the incurrence of debt, in
connection with the funding of any acquisition. Some or all of these risks could
negatively affect our financial condition, results of operations and prospects or could
result in dilution to the Company’s shareholders. In addition, to the extent that
consolidation becomes more prevalent in the industry, the prices for attractive
acquisition candidates could increase substantially. We may not be able to effect any such
transactions. Additionally, if we are able to complete such transactions they may prove to
be unprofitable.
The geographic expansion of the
Company’s customers may result in increased demand for services in certain regions
where it currently does not have post production, duplication and distribution facilities.
To meet this demand, we may subcontract. However, we have not entered into any formal
negotiations or definitive agreements for this purpose. Furthermore, we cannot assure you
that we will be able to effect such transactions or that any such transactions will prove
to be profitable.
In July 2002, the Company issued a
warrant to purchase 500,000 shares of the Company’s common stock to Alliance Atlantis
Communications, Inc. (“Alliance”) in consideration of an option to purchase
three post-production facilities (the “Subsidiaries”) owned by Alliance. In
connection therewith, the Company capitalized the fair value of the warrant ($619,000,
determined by using the Black-Scholes valuation model). In December 2002, the option was
extended by mutual agreement and we deposited $300,000 toward the ultimate purchase price,
which was negotiated downward. Additionally, the Company capitalized approximately
$400,000 of due diligence costs associated with the proposed acquisition and approximately
$400,000 of costs associated with a new financing arrangement.
In June 2003, discussions with
Alliance and the new lenders were terminated. As a result, the Company wrote off the
above-mentioned deposit, due diligence costs and costs associated with the proposed new
financing. The $619,000 value of the warrant was charged to Additional Paid-in Capital
because, in management’s opinion, Alliance had breached certain provisions of the
option agreement resulting in a termination event according to the provisions of the
warrant. In July 2003, Alliance filed a complaint seeking a judicial determination that
Alliance has full right of legal ownership to the warrant as well as the $300,000 deposit.
The Company intends to vigorously defend its position. If the Company is not successful in
this defense, the warrant value will have to be expensed. Although such a write-off and
possible expense of the warrant represent non-cash charges to income, we cannot predict
the effect of the charge on the future market price of our common stock, if any.
On July 18, 2003, Alliance filed a
complaint against the Company in the Superior Court of Justice, Ontario, Canada. The
complaint alleges that the Company breached a non-disclosure agreement between Alliance
and the Company by issuing a press release with respect to termination of negotiations to
purchase the Subsidiaries without obtaining the required prior written consent of
Alliance. Alliance maintains that the press release impaired its ability to extract value
from the Subsidiaries and negatively affected its ability to sell the Subsidiaries to a
third party. The complaint seeks breach of contract and punitive damages of approximately
$4.4 million, expenses and a permanent order enjoining further such statements by the
Company. The outcome of the complaint cannot be estimated at this time.
On August 11, 2003, the Company filed
a counterclaim in the United States District Court, Central District of California against
Alliance for, among other things, misrepresentation and breach of contract seeking
cancellation of the warrant and general damages of at least $1.2 million. The outcome of
the counterclaim cannot be estimated at this time.
If we acquire any entities, we may
have to finance a large portion of the anticipated purchase price and refinance our
existing $18.2 million term loan. The cost of any new financing may be higher than our
existing term loan. Future earnings and cash flow may be negatively impacted if any
acquired entity does not generate sufficient earnings and cash flow to offset the
increased costs.
Management of
Growth. In prior years, we experienced rapid growth that resulted in new
and increased responsibilities for management personnel and placed and continues to place
increased demands on our management, operational and financial systems and resources. To
accommodate this growth, compete effectively and manage future growth, we will be required
to continue to implement and improve our operational, financial and management information
systems, and to expand, train, motivate and manage our work force. We cannot be sure that
the Company’s personnel, systems, procedures and controls will be adequate to support
our future operations. Any failure to do so could have a material adverse effect on our
financial condition, results of operations and prospects.
Dependence on Technological
Developments. Although we intend to utilize the most efficient and
cost-effective technologies available for telecine, high definition formatting, editing,
coloration and delivery of video content, including digital satellite transmission, as
they develop, we cannot be sure that we will be able to adapt to such standards in a
timely fashion or at all. We believe our future growth will depend in part, on our ability
to add to these services and to add customers in a timely and cost-effective manner. We
cannot be sure we will be successful in offering such services to existing customers or in
obtaining new customers for these services, including the Company’s significant
investment in high definition technology in 2000 and 2001. We intend to rely on third
party vendors for the development of these technologies and there is no assurance that
such vendors will be able to develop such technologies in a manner that meets the needs of
the Company and its customers. Any material interruption in the supply of such services
could materially and adversely affect the Company’s financial condition, results of
operations and prospects.
15
Dependence on Key
Personnel. The Company is dependent on the efforts and abilities of certain
of its senior management, particularly those of Haig S. Bagerdjian, Chairman, President
and Chief Executive Officer. The loss or interruption of the services of key members of
management could have a material adverse effect on our financial condition, results of
operations and prospects if a suitable replacement is not promptly obtained. Mr.
Bagerdjian beneficially owns approximately 25% of the Company’s outstanding stock.
Although we have employment agreements with certain key executives, we cannot be sure that
either Mr. Bagerdjian or other executives will remain with the Company. In addition, our
success depends to a significant degree upon the continuing contributions of, and on our
ability to attract and retain, qualified management, sales, operations, marketing and
technical personnel. The competition for qualified personnel is intense and the loss of
any such persons, as well as the failure to recruit additional key personnel in a timely
manner, could have a material adverse effect on our financial condition, results of
operations and prospects. There is no assurance that we will be able to continue to
attract and retain qualified management and other personnel for the development of our
business.
Ability to Maintain and Improve
Service Quality. Our business is dependent on our ability to meet the
current and future demands of our customers, which demands include reliability,
timeliness, quality and price. Any failure to do so, whether or not caused by factors
within our control could result in losses to such clients. Although we disclaim any
liability for such losses, there is no assurance that claims would not be asserted or that
dissatisfied customers would refuse to make further deliveries through the Company in the
event of a significant occurrence of lost deliveries, either of which could have a
material adverse effect on our financial condition, results of operations and prospects.
Although we maintain insurance against business interruption, such insurance may not be
adequate to protect the Company from significant loss in these circumstances and there is
no assurance that a major catastrophe (such as an earthquake or other natural disaster)
would not result in a prolonged interruption of our business. In addition, our ability to
make deliveries within the time periods requested by customers depends on a number of
factors, some of which are outside of our control, including equipment failure, work
stoppages by package delivery vendors or interruption in services by telephone or
satellite service providers.
Fluctuating Results,
Seasonality. Our operating results have varied in the past, and may vary in
the future, depending on factors such as the volume of advertising in response to seasonal
buying patterns, the timing of new product and service introductions, the timing of
revenue recognition upon the completion of longer term projects, increased competition,
timing of acquisitions, general economic factors and other factors. As a result, we
believe that period-to-period comparisons of our results of operations are not necessarily
meaningful and should not be relied upon as an indication of future performance. For
example, our operating results have historically been significantly influenced by the
volume of business from the motion picture industry, which is an industry that is subject
to seasonal and cyclical downturns, and, occasionally, work stoppages by actors, writers
and others. In addition, as our business from advertising agencies tends to be seasonal,
our operating results may be subject to increased seasonality as the percentage of
business from advertising agencies increases. In any period our revenues are subject to
variation based on changes in the volume and mix of services performed during the period.
It is possible that in some future quarter the Company’s operating results will be
below the expectations of equity research analysts and investors. In such event, the price
of the Company’s Common Stock would likely be materially adversely affected.
Fluctuations in sales due to seasonality may become more pronounced if the growth rate of
the Company’s sales slows.
Control by Principal
Shareholder; Potential Issuance of Preferred Stock; Anti-Takeover Provisions.
The Company’s Chairman, President and Chief Executive Officer, Haig S.
Bagerdjian, beneficially owned approximately 25% of the outstanding common stock as of
September 30, 2003. The ex-spouse of R. Luke Stefanko, the Company’s former President
and Chief Executive Officer, owned approximately 20% of the common stock on that date.
Together, they owned approximately 45%. By virtue of their stock ownership, Ms. Stefanko
and Mr. Bagerdjian individually or together may be able to significantly influence the
outcome of matters required to be submitted to a vote of shareholders, including (i) the
election of the board of directors, (ii) amendments to the Company’s Restated
Articles of Incorporation and (iii) approval of mergers and other significant corporate
transactions. The foregoing may have the effect of discouraging, delaying or preventing
certain types of transactions involving an actual or potential change of control of the
Company, including transactions in which the holders of common stock might otherwise
receive a premium for their shares over current market prices. Our Board of Directors also
has the authority to issue up to 5,000,000 shares of preferred stock without par value
(the “Preferred Stock”) and to determine the price, rights, preferences,
privileges and restrictions thereof, including voting rights, without any further vote or
action by the Company’s shareholders. Although we have no current plans to issue any
shares of Preferred Stock, the rights of the holders of common stock would be subject to,
and may be adversely affected by, the rights of the holders of any Preferred Stock that
may be issued in the future. Issuance of Preferred Stock could have the effect of
discouraging, delaying, or preventing a change in control of the Company. Furthermore,
certain provisions of the Company’s Restated Articles of Incorporation and By-Laws
and of California law also could have the effect of discouraging, delaying or preventing a
change in control of the Company.
16
ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market
Risk. The Company had borrowings of $17,218,000 at September 30, 2003 under a term
loan agreement. Amounts outstanding under the agreement bear interest at the bank’s
reference rate plus 1.25%.
The
Company’s market risk exposure with respect to financial instruments is to changes in
the London Interbank Offering Rate (“LIBOR”). In November 2000, the Company
entered into an interest rate swap contract to economically hedge its floating debt rate.
Under the terms of the contract, the notional amount is $15,000,000, whereby the Company
receives LIBOR and pays a 6.50% rate of interest for the three years ending in November
2003.
On
June 15, 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and
Hedging Activities.” The standard, as amended by Statement of Financial
Accounting Standards No. 137, “Accounting for Derivative Instruments and Hedging
Activities Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB
Statement No. 133,” and Statement of Financial Accounting Standards No. 138,
“Accounting for Certain Derivative Instruments and Certain Hedging Activities, an
amendment of FASB Statement No. 133” (referred to hereafter as “FAS
133”), is effective for all fiscal quarters of all fiscal years beginning after June
15, 2000 (January 1, 2001 for the Company). FAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or in other
comprehensive income, depending on whether a derivative is designated as part of a hedging
relationship and, if it is, depending on the type of hedging relationship. During 2001,
the Company recorded a cumulative effect type adjustment of $247,000 (net of $62,000 tax
benefit) as a charge to Accumulated Other Comprehensive Income, a component of
Shareholders’ Equity, and an expense of $700,000 ($560,000 net of tax benefit) for
the derivative fair value change of an interest rate swap contract and amortization of the
cumulative effect adjustment. During the twelve month period ended December 31, 2002, the
Company recorded income of $82,000 ($49,000 net of tax provision), for the derivative fair
value change and amortization of the cumulative effect type adjustment. During the three-
and nine-month periods ended September 30, 2003, the Company recorded income of $181,000
($106,000 net of tax provision), and $492,000 ($290,000 net of tax provision),
respectively, for the derivative fair value change and amortization of the cumulative
effect-type adjustment.
ITEM 4. CONTROLS AND
PROCEDURES
Pursuant
to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange
Act”), the Company’s management, with the participation of the Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s
disclosure controls and procedures, as of the end of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures are effective in
ensuring that information required to be disclosed in reports that the Company files or
submits under the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in the SEC’s rules and forms. No change in the Company’s
internal control over financial reporting occurred during the Company’s most recent
fiscal quarter that materially affected, or is reasonably likely to materially affect the
Company’s internal control over financial reporting.
17
PART II – OTHER
INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On
July 7, 2003, Alliance filed a complaint against the Company in the United States District
Court, Central District of California. The complaint seeks a declaration of the court that
Alliance has full right of legal ownership of (i) the warrant issued by the Company in
July 2003 in consideration of an option to purchase the Subsidiaries and (ii) the $300,000
paid to Alliance in December 2002 to extend the option. The complaint alleges that the
Company made false and misleading statements in its press release announcing the
termination of negotiations with Alliance, asking for undetermined damages. The outcome of
the complaint cannot be determined at this time.
On
July 18, 2003, Alliance filed a complaint against the Company in the Superior Court of
Justice, Ontario, Canada. The complaint alleges that the Company breached a non-disclosure
agreement between Alliance and the Company by issuing a press release with respect to
termination of negotiations to purchase the Subsidiaries without obtaining the required
prior written consent of Alliance. Alliance maintains that the press release impaired its
ability to extract value from the Subsidiaries and negatively affected its ability to sell
the Subsidiaries to a third party. The complaint seeks breach of contract and punitive
damages of approximately $4.4 million, expenses and a permanent order enjoining further
such statements by the Company. The outcome of the complaint cannot be determined at this
time.
On
August 11, 2003, the Company filed a counterclaim in the United States District Court,
Central District of California against Alliance for, among other things, misrepresentation
and breach of contract seeking cancellation of the warrant and general damages of at least
$1.2 million. The outcome of the counterclaim cannot be estimated at this time.
18
ITEM 6. EXHIBITS AND
REPORTS ON FORM 8-K
(a) Exhibits
|
10.1 |
|
Amended and
Restated Option Agreement dated December 30, 2002 between the Company and
Alliance Atlantis Communications Inc. (1) |
|
10.2 |
|
Severance
Agreement dated September 30, 2003 between the Company and Haig S. Bagerdjian. |
|
10.3 |
|
Severance
Agreement dated September 30, 2003 between the Company and Alan R. Steel. |
|
31.1 |
|
Certification
of Chief Executive Officer Pursuant to 15 U.S.C. ss. 7241, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. |
|
31.2 |
|
Certification
of Chief Financial Officer Pursuant to 15 U.S.C. ss. 7241, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. |
|
32.1 |
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. ss. 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. |
|
32.2 |
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. ss. 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. |
(1)
Filed as an exhibit to Form 8-K with the SEC on January 8, 2003.
(b)
Reports On Form 8-K
|
The
Company filed a Form 8-K dated August 8, 2003 related to its earnings release for the
quarter ended June 30, 2003. |
|
The
Company filed a Form 8-K dated November 12, 2003 related to its earnings release for the
quarter ended September 30, 2003. |
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
POINT.360 |
|
|
DATE:
November 12, 2003 |
BY: /s/ Alan R.
Steel
Alan R. Steel
Executive Vice President,
Finance and Administration
(duly authorized officer and principal financial officer) |
19