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EX-32.1 - EX-32.1 - RLJ ENTERTAINMENT, INC.rlje-ex321_6.htm
EX-31.2 - EX-31.2 - RLJ ENTERTAINMENT, INC.rlje-ex312_8.htm
EX-31.1 - EX-31.1 - RLJ ENTERTAINMENT, INC.rlje-ex311_7.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark one)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017.

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________.

Commission File Number 001-35675

 

RLJ ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

 

Nevada

 

45-4950432

(State or other jurisdiction of incorporation)

 

(IRS Employer Identification Number)

 

 

 

8515 Georgia Avenue, Suite 650
Silver Spring, Maryland

 

20910

(Address of principal executive offices)

 

(Zip Code)

 

(301) 608-2115

(Registrant’s telephone number, including area code)

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES      NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES     NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

 

Accelerated filer  

Non-accelerated filer  

(Do not check if a smaller reporting company)

 

Smaller reporting company

 

 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No

Number of shares outstanding of the issuer’s common stock on November 2, 2017:  14,071,423

 

 


RLJ ENTERTAINMENT, INC.

INDEX TO FORM 10-Q

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements  (Unaudited)

4

 

 

 

 

 

 

 

(a)

Consolidated Balance Sheets — September 30, 2017 and December 31, 2016 (audited)

4

 

 

 

 

 

 

 

(b)

Consolidated Statements of Operations — Three and Nine Months Ended September 30, 2017 and 2016

5

 

 

 

 

 

 

 

(c)

Consolidated Statements of Comprehensive Loss — Three and Nine Months Ended September 30, 2017 and 2016  

6

 

 

 

 

 

 

 

(d)

Consolidated Statement of Changes in Shareholders’ Equity — Nine Months Ended September 30, 2017

7

 

 

 

 

 

 

 

(e)

Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2017 and 2016 

8

 

 

 

 

 

 

 

(f)

Notes to Consolidated Financial Statements

9

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

27

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

38

 

 

 

 

Item 4.

 

Controls and Procedures

38

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

39

 

 

 

 

Item 1A.

 

Risk Factors

39

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

39

 

 

 

 

Item 6.

 

Exhibits

39

 

 

 

 

SIGNATURES

40

 

 

 

2


FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2017, includes forward-looking statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Other than statements of historical fact, all statements made in this Quarterly Report are forward-looking, including, but not limited to, statements regarding industry prospects, future results of operations or financial position, and statements of our intent, belief and current expectations about our strategic direction, prospective and future results and condition. In some cases, forward-looking statements may be identified by words such as “will,” “should,” “could,” “may,” “might,” “expect,” “plan,” “possible,” “potential,” “predict,” “anticipate,” “believe,” “estimate,” “continue,” “future,” “intend,” “project” or similar words.

Forward-looking statements involve risks and uncertainties that are inherently difficult to predict, which could cause actual outcomes and results to differ materially from our expectations, forecasts and assumptions. Factors that might cause such differences include, but are not limited to:

 

Our financial performance, including our ability to achieve improved results from operations and improved Adjusted EBITDA;

 

Our ability to continue to increase the revenues and financial performance of our digital channels having a positive effect on our liquidity, cash flows and operating results;

 

The effects of limited cash liquidity on operational performance;

 

Our obligations under the credit agreement;

 

Our ability to satisfy financial ratios;

 

Our ability to generate sufficient cash flows from operating activities;

 

Our ability to fund planned capital expenditures and development efforts;

 

Our inability to gauge and predict the commercial success of our programming;

 

Our selection of the modified retrospective method when adopting the new revenue recognition standard in 2018 and, upon adoption, our election to apply the new standard to all customer contracts;

 

Our ability to maintain relationships with customers, employees and suppliers, including our ability to enter into revised payment plans, when necessary, with our vendors that are acceptable to all parties;

 

Our ability to realize anticipated synergies and other efficiencies in connection with the AMC transaction;

 

Delays in the release of new titles or other content;

 

The effects of disruptions in our supply chain;

 

The loss of key personnel;

 

Our public securities’ limited liquidity and trading; or

 

Our ability to meet the NASDAQ Capital Market continuing listing standards and maintain our listing.

All forward-looking statements should be evaluated with the understanding of inherent uncertainty. The inclusion of such forward-looking statements should not be regarded as a representation that contemplated future events, plans or expectations will be achieved. Unless otherwise required by law, we undertake no obligation to release publicly any updates or revisions to any such forward-looking statements that may reflect events or circumstances occurring after the date of this Quarterly Report. Important factors that could cause or contribute to such material differences include those discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K filed on March 23, 2017. You are cautioned not to place undue reliance on such forward-looking statements.

 

 

 

3


PART I - FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

RLJ ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

September 30, 2017 (unaudited) and December 31, 2016

 

 

 

September 30,

 

 

December 31,

 

(In thousands, except share data)

 

2017

 

 

2016

 

ASSETS

 

 

 

 

 

 

 

 

Cash

 

$

6,587

 

 

$

7,834

 

Accounts receivable, net

 

 

13,263

 

 

 

19,569

 

Inventories, net

 

 

5,368

 

 

 

6,215

 

Investments in content, net

 

 

75,314

 

 

 

60,737

 

Prepaid expenses and other assets

 

 

789

 

 

 

798

 

Property, equipment and improvements, net

 

 

1,178

 

 

 

1,336

 

Equity investment in affiliate

 

 

19,884

 

 

 

16,491

 

Other intangible assets, net

 

 

8,063

 

 

 

9,309

 

Goodwill

 

 

13,958

 

 

 

13,691

 

Total assets

 

$

144,404

 

 

$

135,980

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

12,316

 

 

$

11,995

 

Accrued royalties and distribution fees

 

 

52,834

 

 

 

55,614

 

Deferred revenue

 

 

2,549

 

 

 

2,152

 

Debt, net of discounts and debt issuance costs

 

 

51,599

 

 

 

42,053

 

Deferred tax liability

 

 

1,857

 

 

 

1,715

 

Stock warrant and other derivative liabilities

 

 

13,410

 

 

 

9,763

 

Total liabilities

 

 

134,565

 

 

 

123,292

 

Commitments and contingencies (see Note 13)

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

Redeemable convertible preferred stock, $0.001 par value, 1,000,000 shares

   authorized; 31,046 shares issued; 15,198 shares outstanding at September 30,

   2017 and 30,198 shares outstanding at December 31, 2016; liquidation

   preference of $17,997 at September 30, 2017 and $34,366 at December 31, 2016

 

 

19,725

 

 

 

38,708

 

Common stock, $0.001 par value, 250,000,000 shares authorized, 13,644,076

   shares issued and outstanding at September 30, 2017; and 5,240,085

   shares issued and outstanding at December 31, 2016

 

 

14

 

 

 

5

 

Additional paid-in capital

 

 

130,585

 

 

 

106,059

 

Accumulated deficit

 

 

(137,331

)

 

 

(127,388

)

Accumulated other comprehensive loss

 

 

(3,154

)

 

 

(4,696

)

Total shareholders' equity

 

 

9,839

 

 

 

12,688

 

Total liabilities and shareholders' equity

 

$

144,404

 

 

$

135,980

 

 

See accompanying notes to consolidated financial statements.

 

 

4


RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

Three and Nine Months Ended September 30, 2017 and 2016

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands, except share data)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

$

20,900

 

 

$

18,351

 

 

$

53,620

 

 

$

51,882

 

Cost of sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Content amortization and royalties

 

 

9,538

 

 

 

7,887

 

 

 

21,867

 

 

 

22,957

 

Manufacturing and fulfillment

 

 

3,174

 

 

 

3,425

 

 

 

9,055

 

 

 

12,031

 

Total cost of sales

 

 

12,712

 

 

 

11,312

 

 

 

30,922

 

 

 

34,988

 

Gross profit

 

 

8,188

 

 

 

7,039

 

 

 

22,698

 

 

 

16,894

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling expenses

 

 

3,972

 

 

 

2,536

 

 

 

9,131

 

 

 

6,882

 

General and administrative expenses

 

 

4,926

 

 

 

4,068

 

 

 

14,165

 

 

 

13,563

 

Depreciation and amortization

 

 

974

 

 

 

831

 

 

 

2,751

 

 

 

2,100

 

Total operating expenses

 

 

9,872

 

 

 

7,435

 

 

 

26,047

 

 

 

22,545

 

LOSS FROM CONTINUING OPERATIONS

 

 

(1,684

)

 

 

(396

)

 

 

(3,349

)

 

 

(5,651

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity earnings of affiliate

 

 

1,723

 

 

 

990

 

 

 

3,143

 

 

 

2,198

 

Interest expense, net

 

 

(2,288

)

 

 

(2,222

)

 

 

(6,326

)

 

 

(6,617

)

Change in fair value of stock warrants and other derivatives

 

 

(264

)

 

 

(1,222

)

 

 

(3,647

)

 

 

(3,406

)

Gain on extinguishment of debt

 

 

 

 

 

 

 

 

470

 

 

 

 

Other income (expense), net

 

 

169

 

 

 

(42

)

 

 

614

 

 

 

(772

)

LOSS FROM CONTINUING OPERATIONS

   BEFORE PROVISION FOR INCOME TAXES

 

 

(2,344

)

 

 

(2,892

)

 

 

(9,095

)

 

 

(14,248

)

Provision for income taxes

 

 

(372

)

 

 

(151

)

 

 

(848

)

 

 

(192

)

LOSS FROM CONTINUING OPERATIONS,

   NET OF INCOME TAXES

 

 

(2,716

)

 

 

(3,043

)

 

 

(9,943

)

 

 

(14,440

)

LOSS FROM DISCONTINUED OPERATIONS,

   NET OF INCOME TAXES

 

 

 

 

 

(917

)

 

 

 

 

 

(3,169

)

NET LOSS

 

 

(2,716

)

 

 

(3,960

)

 

 

(9,943

)

 

 

(17,609

)

Accretion on preferred stock

 

 

(203

)

 

 

(1,473

)

 

 

(959

)

 

 

(3,763

)

NET LOSS ATTRIBUTABLE TO COMMON

   SHAREHOLDERS

 

$

(2,919

)

 

$

(5,433

)

 

$

(10,902

)

 

$

(21,372

)

Net loss per common share attributable to common shareholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.22

)

 

$

(0.97

)

 

$

(1.31

)

 

$

(4.08

)

Discontinued operations

 

 

 

 

 

(0.20

)

 

 

 

 

 

(0.71

)

Basic and diluted net loss per common share attributable

   to common shareholders

 

$

(0.22

)

 

$

(1.17

)

 

$

(1.31

)

 

$

(4.79

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

13,463

 

 

 

4,640

 

 

 

8,329

 

 

 

4,463

 

 

See accompanying notes to consolidated financial statements.

 

 

5


RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

Three and Nine Months Ended September 30, 2017 and 2016

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net loss

 

$

(2,716

)

 

$

(3,960

)

 

$

(9,943

)

 

$

(17,609

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss)

 

 

708

 

 

 

(409

)

 

 

1,542

 

 

 

(2,368

)

Total comprehensive loss

 

$

(2,008

)

 

$

(4,369

)

 

$

(8,401

)

 

$

(19,977

)

 

See accompanying notes to consolidated financial statements.

 

 

6


RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

Nine months ended September 30, 2017

 

 

 

 

 

 

 

Common Stock

 

 

Additional

 

 

 

 

 

 

Accumulated

Other

 

 

 

 

 

(In thousands)

 

Preferred

Stock

 

 

Shares

 

 

Par

Value

 

 

Paid-in

Capital

 

 

Accumulated

Deficit

 

 

Comprehensive

Loss

 

 

Total

Equity

 

Balance at January 1, 2017

 

$

38,708

 

 

 

5,240

 

 

$

5

 

 

$

106,059

 

 

$

(127,388

)

 

$

(4,696

)

 

$

12,688

 

Issuance of restricted common stock for

   services

 

 

 

 

 

117

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock to AMC for interest

 

 

 

 

 

609

 

 

 

1

 

 

 

1,688

 

 

 

 

 

 

 

 

 

1,689

 

Exercise of warrants for common stock

 

 

 

 

 

1,773

 

 

 

2

 

 

 

3,003

 

 

 

 

 

 

 

 

 

3,005

 

Conversion of preferred stock

 

 

(19,592

)

 

 

5,906

 

 

 

6

 

 

 

19,586

 

 

 

 

 

 

 

 

 

 

Accretion on preferred stock

 

 

959

 

 

 

 

 

 

 

 

 

(959

)

 

 

 

 

 

 

 

 

 

Preferred stock dividends paid

 

 

(350

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(350

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

1,208

 

 

 

 

 

 

 

 

 

1,208

 

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,542

 

 

 

1,542

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,943

)

 

 

 

 

 

(9,943

)

Balance at September 30, 2017

 

$

19,725

 

 

 

13,645

 

 

$

14

 

 

$

130,585

 

 

$

(137,331

)

 

$

(3,154

)

 

$

9,839

 

 

See accompanying notes to consolidated financial statements.

 

 

7


RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Nine Months Ended September 30, 2017 and 2016

 

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

Net loss

 

$

(9,943

)

 

$

(17,609

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

 

 

 

 

 

 

 

 

Equity earnings of affiliate

 

 

(3,143

)

 

 

(2,198

)

Content amortization and royalties

 

 

21,867

 

 

 

23,152

 

Depreciation and amortization

 

 

2,751

 

 

 

3,167

 

Foreign currency exchange (gain) loss

 

 

(640

)

 

 

900

 

Fair value adjustment of stock warrant and other derivative liabilities

 

 

3,647

 

 

 

3,406

 

Non-cash interest expense

 

 

5,446

 

 

 

1,512

 

Gain on extinguishment of debt

 

 

(470

)

 

 

 

Stock-based compensation expense

 

 

1,208

 

 

 

922

 

Loss on disposal of fixed assets

 

 

 

 

 

187

 

Dividends received from affiliate

 

 

1,243

 

 

 

1,701

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

6,547

 

 

 

13,205

 

Inventories, net

 

 

1,001

 

 

 

4,034

 

Investments in content, net

 

 

(38,997

)

 

 

(24,779

)

Prepaid expenses and other assets

 

 

24

 

 

 

695

 

Accounts payable and accrued liabilities

 

 

(460

)

 

 

(8,010

)

Deferred revenue

 

 

397

 

 

 

(36

)

Net cash (used in) provided by operating activities

 

 

(9,522

)

 

 

249

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(1,199

)

 

 

(1,006

)

Net cash used in investing activities

 

 

(1,199

)

 

 

(1,006

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

Proceeds received from AMC to amend debt

 

 

18,000

 

 

 

 

Proceeds from exercise of warrants

 

 

159

 

 

 

 

Dividend payments to preferred stockholders

 

 

(350

)

 

 

 

Repayment of debt

 

 

(8,618

)

 

 

(2,100

)

Payment of debt modification costs

 

 

(101

)

 

 

 

Net cash provided by (used in) financing activities

 

 

9,090

 

 

 

(2,100

)

Effect of exchange rate changes on cash

 

 

384

 

 

 

(199

)

NET DECREASE IN CASH:

 

 

(1,247

)

 

 

(3,056

)

Cash at beginning of period

 

 

7,834

 

 

 

4,530

 

Cash at end of period

 

$

6,587

 

 

$

1,474

 

 

See accompanying notes to consolidated financial statements.

 

 

8


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

RLJ Entertainment, Inc. (RLJE or the Company) is a premium digital channel company serving distinct audiences through its proprietary subscription-based digital channels, Acorn TV and UMC or Urban Movie Channel, and a direct presence in North America, the United Kingdom (or U.K.) and Australia with strategic sublicense and distribution relationships covering Europe, Asia and Latin America. RLJE was incorporated in Nevada in April 2012. On October 3, 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media), which is referred to herein as the “Business Combination.” Acorn Media includes its U.K. subsidiaries RLJ Entertainment Ltd (or RLJE Ltd.), Acorn Media Enterprises Limited (or AME), and RLJE International Ltd (collectively, RLJE UK), as well as RLJ Entertainment Australia Pty Ltd (or RLJE Australia). In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL). References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC. “We,” “our” or “us” refers to RLJE and its subsidiaries unless otherwise noted. Our principal executive offices are located in Silver Spring, Maryland, with an additional location in Woodland Hills, California. We also have international offices in London, England and Sydney, Australia.

We acquire content rights in various categories including, British mysteries and dramas, content targeting urban audiences and full-length independent motion pictures. We acquire content in three ways:  

 

through long-term exclusive licensing agreements where we secure multiple rights to third-party programs;

 

through development, production and ownership of original drama television programming through our wholly-owned subsidiary, AME, and our 64%-owned equity method investee, ACL; and

 

through both acquired and original programming licensed and produced for our proprietary UMC subscription streaming service.

We market our products through a multi-channel strategy encompassing (1) direct relations with consumers via proprietary subscription-based video on demand (or SVOD) digital channels (our Digital Channels segment); (2) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, AME, and our majority-owned equity method investee, ACL, (our Intellectual Property, or IP, Licensing segment); and (3) exploitation through partners covering broadcast/cable, digital, mobile, ecommerce and brick and mortar outlets (our Wholesale Distribution segment).

Our Digital Channels segment includes the subscription-based sale of video content directly and through third-party distribution to consumers through our digital channels, such as Acorn TV and UMC.

Our IP Licensing segment includes intellectual property (or content) owned or created by us, other than certain fitness related content, that is sublicensed for exploitation worldwide. The IP Licensing segment also includes our investment in ACL.

Our Wholesale Distribution segment consists of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including broadcast (which includes cable and satellite), DVD, Blu-ray, digital, video-on-demand (or VOD), SVOD, downloading and sublicensing. The Wholesale Distribution segment exploits content through third-party vendors, which we also refer to as wholesale partners. Our wholesale partners are broadcasters, digital outlets and major retailers in the United States of America (or U.S.), Canada, U.K. and Australia, including, among others, Amazon, Barnes & Noble, DirecTV, Hulu, iTunes, Netflix, PBS, Showtime, Starz, Target and Walmart.

On June 24, 2016, we entered into a licensing agreement with Universal Screen Arts (or USA) whereby USA took over our Acorn U.S. catalog/ecommerce business becoming the official, exclusive, direct-to-consumer seller of Acorn product in the U.S. through catalogs and ecommerce. As such, USA received the rights to the Acorn catalog and related website for an 18-month period. In May 2017, we amended the agreement and extended the licensing term through March 31, 2020. To facilitate the transfer of the catalog to USA, we granted USA access to the catalog’s customer list and the Acorn brand. Going forward, we will also endeavor to provide USA with an exclusivity period for new Acorn releases. USA is responsible for all costs associated with their efforts. On an annual basis, USA will purchase from us a minimum of $1.2 million of inventory (Acorn video content) at pricing that is consistent with wholesale pricing. We also agreed to a one-time transfer of certain existing inventory to USA at cost. Further, we have been given meaningful consultation rights regarding sales prices of Acorn content listed in the catalog.

9


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

In addition to purchasing inventory from us, USA makes royalty payments to us for the various rights we have licensed. Further, all customer and marketing data obtained during the license period is jointly owned by both companies. During the nine months ended September 30, 2017 and 2016, our Wholesale Distribution segment recognized revenues of $1.6 million and $0.2 million, respectively, from its sale of inventory to USA.

RLJE’s management evaluates business performance based on these three distinctive reporting segments: (1) Digital Channels, (2) IP Licensing and (3) Wholesale Distribution. Operations and net assets that are not associated with any of these stated segments are reported as “Corporate” when disclosing and discussing segment information.

Basis of Presentation

Unaudited Interim Financial Statements

The consolidated financial information presented in the accompanying unaudited interim consolidated financial statements as of September 30, 2017 and for the three and nine months ended September 30, 2017 and 2016 has been prepared in accordance with accounting principles generally accepted in the United States (or U.S. GAAP) and with the Securities and Exchange Commission’s (or SEC) instructions for interim financial reporting instructions for the Form 10-Q and Article 10 of Regulation S‑X of the SEC. Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete financial statements.

In management’s opinion, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Due to the seasonal nature of our business, with a disproportionate amount of sales occurring in the fourth quarter and other factors, including our content release schedule, interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The accompanying unaudited financial information should, therefore, be read in conjunction with the consolidated financial statements and the notes thereto in our Annual Report on Form 10-K filed on March 23, 2017 (or 2016 Form 10-K). Note 2, Summary of Significant Accounting Policies, of our audited consolidated financial statements included in our 2016 Form 10-K contains a summary of our significant accounting policies. As of September 30, 2017, we have made no material changes to our significant accounting policies disclosed in our 2016 Form 10-K.

Fair Value of Financial Instruments

The carrying amount of our financial instruments, which principally include cash, trade receivables, accounts payable and accrued expenses, approximates fair value due to the relative short maturity of such instruments. The carrying amount of our debt under our senior credit agreement approximates its fair value as it bears interest at market rates of interest after taking into consideration its debt discount.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (or FASB) issued an accounting standard update relating to the recognition of revenue from contracts with customers, which will supersede most current U.S. GAAP revenue recognition guidance, including industry-specific guidance. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Based on the current guidance, the new framework will become effective for us on either a full or modified retrospective basis on January 1, 2018. We will be electing the modified retrospective method; and as such, we will not be restating our revenues for 2017. Upon adoption, we will also be applying the new standard to all customer contracts.

Subsequent to the issuance of the May 2014 guidance, several clarifications and updates have been issued by the FASB on this topic, the most recent of which was issued in December 2016. Many of these clarifications and updates to the guidance, as well as a number of interpretive issues, apply to companies in the media and entertainment industry.

We are currently evaluating the impact of the new standard. While there may be additional areas impacted by the new standard, we have identified certain areas that may be impacted as follows:

Renewals of Licenses of Intellectual Property — Under the current guidance, when the term of an existing license agreement is extended, without any other changes to the provisions of the license, revenue for the renewal period is recognized when the agreement is renewed or extended. Under the new guidance, revenue associated with renewals or extensions of existing license agreements will be recognized as revenue when the license content becomes available under the renewal or extension. This change will impact the timing of revenue recognition as compared with current revenue recognition guidance. While revenues from renewals do occur, they

10


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

are not a significant portion of our revenues. Based on renewals through September 30, 2017, we have renewal revenue of approximately $0.5 million that would require adjustment.

Licenses of Symbolic Intellectual Property — Certain intellectual property, such as brands, tradenames and logos, is categorized in the new guidance as symbolic. Under the new guidance, a licensee’s ability to derive benefit from a license of symbolic intellectual property is assumed to depend on the licensor continuing to support or maintain the intellectual property throughout the license term. Accordingly, under the new guidance, revenue from licenses of symbolic intellectual property is generally recognized over the corresponding license term. Therefore, the new guidance will impact the timing of revenue recognition as compared to current guidance. Our revenues from the licensing of symbolic intellectual property is limited. As of September 30, 2017, we have one symbolic license for approximately $0.4 million that would require adjustment.

Cross Collateralization — Under the current guidance, customer advances for content that is cross collateralized must be deferred when received and later recognized as revenue as the customer recoups their advance. Under the new guidance, the customer advance is allocated to the cross collateralized content and recognized as revenue once the content has been delivered and the customer is free to exploit. Therefore, the new guidance will impact the timing of revenue recognition as compared to the current guidance. Very few of our licensing agreements contain cross collateralized content. As of September 30, 2017, we have less than $0.3 million of deferred revenue related to cross collateralized content. This balance will likely decrease during the fourth quarter of 2017 as the customers recoup their advances. Any remaining advance not yet recognized as revenue as of January 1, 2018, will give rise to an adjustment upon adoption of the new revenue standard.

Principles of Consolidation

The operations of ACL are subject to oversight by ACL’s Board of Directors. The investment in ACL is accounted for using the equity method of accounting given the voting control of the Board of Directors by the minority shareholder. We have included our share of ACL’s operating results as a separate line item in our consolidated financial statements.

Our consolidated financial statements include the accounts of all majority-owned subsidiary companies, except for ACL. We carry our investment in ACL as a separate asset on our consolidated balance sheet at cost adjusted for our share of the equity in undistributed earnings. Except for dividends and changes in ownership interest, we report changes in equity in undistributed earnings of ACL as “Equity earnings of affiliate” in our consolidated statements of operations. All intercompany transactions and balances have been eliminated.

Earnings (Loss) per Common Share

Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share are computed using the combination of dilutive common share equivalents and the weighted-average shares outstanding during the period. For the periods reporting a net loss, diluted loss per share is equivalent to basic loss per share, as inclusion of common share equivalents would be anti-dilutive.

Liquidity

At September 30, 2017, our cash balance was $6.6 million. For the nine months ended September 30, 2017, we recognized a net loss of $9.9 million and we used $9.5 million of cash for operating activities. At September 30, 2017, we had $51.6 million of term debt outstanding (see Note 7, Debt). We continue to experience liquidity constraints as we have several competing demands on our available cash and cash that may be generated from operations. We continue to have significant past-due vendor payables. These past-due payables are largely a result of significant past-due vendor payables acquired in 2012 when purchasing Image. As we work to catch up on the acquired past-due payables, we have fallen behind on other payables. We continue to work with our vendors to make payment arrangements that are agreeable with them and that give us flexibility in terms of when payments will be made. Additionally, we must maintain a certain level of expenditures for marketing to support subscriber growth and for the acquisition of new content that allows us to generate revenues and margins sufficient to meet our obligations.

11


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Growth of our Digital Channels segment has the potential impact of improving our liquidity. We continue to realize significant growth in our Digital Channels segment. Our Digital Channels segment revenues increased 75.1% to $19.4 million during the nine months ended September 30, 2017 as compared to the same period in 2016 (see Note 2, Segment Information). After cost of sales and operating expenses, our Digital Channels segment contributed $6.3 million of income from continuing operations during the first nine months of 2017 compared to $4.1 million last year. Our expectation is that our digital channels will continue to grow, although there is no assurance that this will occur.

On October 14, 2016, we refinanced our senior debt (see Note 7, Debt). In January 2017, to repay our subordinated notes payable, we amended our senior debt and borrowed an additional $8.0 million. In June 2017, we expanded our senior debt and borrowed an additional $10.0 million. The proceeds received are available for working capital purposes, including the acquisition of content. In addition to providing us liquidity, the amended senior loan facility helps us address our liquidity constraints going forward in three ways: (1) it eliminates cash interest payments, which were 12% prior to October 14, 2016 and 4% through March 31, 2017, (2) there are no required principal payments until 2020, and (3) the financial covenants have been reset to less restrictive levels that provide us the necessary flexibility to invest in our operations.

In 2016, we also took actions to improve our operating results and Adjusted EBITDA (as defined in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Adjusted EBITDA) by exiting certain non-core operations that have been generating losses. During the first half of 2016, we closed our Acacia catalog operations. Further, on June 24, 2016, we entered into a licensing agreement to outsource the U.S. Acorn catalog/ecommerce business to USA (see our Discontinued Operations disclosure below). During 2016, our U.S. catalog/ecommerce business was fully transitioned to USA and we do not anticipate future losses from this line of business.

We believe that our current cash at September 30, 2017, will be sufficient to meet our forecasted requirements for operating liquidity, capital expenditure and debt repayments for at least one year from the date of issuance of these consolidated financial statements. However, there can be no assurances that we will be successful in realizing improved results from operations including improved Adjusted EBITDA, generating sufficient cash flows from operations or agreeing with vendors on revised payment terms.

Discontinued Operations

During December 2015, we committed to a plan to stop circulating our Acacia catalogs and to liquidate the catalog’s inventory. The last Acacia print catalogs were circulated in January 2016 and electronic email distribution continued through May 2016. On June 24, 2016, we entered into a licensing agreement to outsource our U.S. Acorn catalog and ecommerce business to USA. USA began selling Acorn video content during the third quarter of 2016.

We consider the outsourcing of the U.S. Acorn catalog to be a major strategic shift in our business. Future revenues and gross margins from our outsourced operations will decrease. However, operating profits will increase as we have historically incurred significant selling expenses that will be eliminated. Upon circulating the last Acacia catalog and entering into the licensing agreement with USA during the quarter ended June 30, 2016, we classified the U.S. catalog/ecommerce business (Acacia and U.S. Acorn catalogs) as discontinued operations.

12


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Major classes of line items constituting loss from discontinued operations, net of income taxes are:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

$

 

 

$

626

 

 

$

 

 

$

7,769

 

Cost of Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Royalty expense

 

 

 

 

 

(40

)

 

 

 

 

 

(195

)

Manufacturing and fulfillment

 

 

 

 

 

(532

)

 

 

 

 

 

(6,223

)

Selling expenses

 

 

 

 

 

(129

)

 

 

 

 

 

(2,280

)

General and administrative expenses

 

 

 

 

 

(561

)

 

 

 

 

 

(986

)

Depreciation and amortization

 

 

 

 

 

(94

)

 

 

 

 

 

(1,067

)

Loss on disposal of fixed assets

 

 

 

 

 

(187

)

 

 

 

 

 

(187

)

Loss before provision for income taxes

 

 

 

 

 

(917

)

 

 

 

 

 

(3,169

)

Provision for income taxes

 

 

 

 

 

 

 

 

 

 

 

 

Loss from discontinued operations, net of

   income taxes

 

$

 

 

$

(917

)

 

$

 

 

$

(3,169

)

 

There are no income taxes allocable to the discontinued operations as the discontinued operations reside in the U.S. for which there is no tax provision as a result of the overall U.S. operating loss for tax purposes.

Operating and investing cash flows of the discontinued operations are as follows:

 

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

Net loss from discontinued operations

 

$

 

 

$

(3,169

)

Adjustments to reconcile net loss to net cash used in operating

   activities of discontinued operations:

 

 

 

 

 

 

 

 

Royalty expense

 

 

 

 

 

195

 

Depreciation and amortization

 

 

 

 

 

1,067

 

Loss on disposal of assets

 

 

 

 

 

 

187

 

Stock-based compensation expense

 

 

 

 

 

35

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

 

 

 

937

 

Inventories, net

 

 

 

 

 

2,417

 

Investments in content, net

 

 

 

 

 

(195

)

Prepaid expenses and other assets

 

 

 

 

 

1,011

 

Accounts payable and accrued liabilities

 

 

 

 

 

(5,635

)

Deferred revenue

 

 

 

 

 

(697

)

Net cash used in operating activities of

   discontinued operations

 

$

 

 

$

(3,847

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

Capital expenditures

 

$

 

 

$

(5

)

Net cash used in investing activities of

   discontinued operations

 

$

 

 

$

(5

)

 

 

13


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 2. SEGMENT INFORMATION

In accordance with the requirements of ASC 280 “Segment Reporting,” selected financial information regarding our reportable business segments, Digital Channels, IP Licensing and Wholesale Distribution, is presented below. Our reportable segments are determined based on the distinct nature of their operation. Each segment is a strategic business unit that is managed separately and either exploits our content over a different business model (subscription based vs. transactional) or acquires content differently. Our Digital Channels segment consists of our proprietary digital streaming channels. Our IP Licensing segment includes intellectual property (or content) owned or created by us that is sublicensed for exploitation worldwide. The IP Licensing segment also includes our investment in ACL. Our Wholesale Distribution segment consists of the acquisition, enhancement and worldwide exploitation through our wholesale partners of exclusive content in various formats, including DVD, Blu-ray, digital, broadcast (including cable and satellite), VOD, streaming video, downloading and sublicensing. Our Wholesale Distribution segment also includes our U.K. mail-order catalog and ecommerce businesses.

Management currently evaluates segment performance based primarily on revenues and operating income (loss), including earnings from ACL. Operating costs and expenses exclude costs related to depreciation and amortization. Operating costs and expenses attributable to our Corporate segment include only those expenses incurred by us at the parent corporate level, which are not allocated to our reporting segments and include costs associated with RLJE’s corporate functions such as finance and accounting, human resources, legal and information technology departments. Interest expense, change in the fair value of stock warrants and other derivatives, other income (expense) and provision for income taxes are evaluated by management on a consolidated basis and are not allocated to our reportable segments.

The segment results exclude our discontinued operations. During 2016, we reclassified our U.K. mail-order catalog and ecommerce businesses into our Wholesale Distribution segment. As a result, for the three months ended September 30, 2016, we reclassified revenues of $0.4 million and operating costs and expenses of $0.4 million. For the nine months ended September 30, 2016, we reclassified revenues of $1.3 million, operating costs and expenses of $1.6 million and depreciation and amortization of $36,000.

The tables below summarize the segment contribution for the three months ended September 30, 2017 and 2016.

 

 

 

Three Months Ended September 30, 2017

 

(In thousands)

 

Digital

Channels

 

 

IP Licensing

 

 

Wholesale

Distribution

 

 

Corporate

 

 

Total

 

Revenues

 

$

6,954

 

 

$

41

 

 

$

13,905

 

 

$

 

 

$

20,900

 

Operating costs and expenses

 

 

(5,263

)

 

 

(113

)

 

 

(12,904

)

 

 

(3,330

)

 

 

(21,610

)

Depreciation and amortization

 

 

(272

)

 

 

(33

)

 

 

(495

)

 

 

(174

)

 

 

(974

)

Share in ACL earnings

 

 

 

 

 

1,723

 

 

 

 

 

 

 

 

 

1,723

 

Segment contribution income (loss)

 

$

1,419

 

 

$

1,618

 

 

$

506

 

 

$

(3,504

)

 

$

39

 

 

 

 

Three Months Ended September 30, 2016

 

(In thousands)

 

Digital

Channels

 

 

IP Licensing

 

 

Wholesale

Distribution

 

 

Corporate

 

 

Total

 

Revenues

 

$

4,384

 

 

$

17

 

 

$

13,950

 

 

$

 

 

$

18,351

 

Operating costs and expenses

 

 

(2,406

)

 

 

11

 

 

 

(13,076

)

 

 

(2,445

)

 

 

(17,916

)

Depreciation and amortization

 

 

(174

)

 

 

(33

)

 

 

(506

)

 

 

(118

)

 

 

(831

)

Share in ACL earnings

 

 

 

 

 

990

 

 

 

 

 

 

 

 

 

990

 

Segment contribution income (loss)

 

$

1,804

 

 

$

985

 

 

$

368

 

 

$

(2,563

)

 

$

594

 

 

14


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

The following tables summarize the segment contribution for the nine months ended September 30, 2017 and 2016:

 

 

 

Nine Months Ended September 30, 2017

 

(In thousands)

 

Digital

Channels

 

 

IP Licensing

 

 

Wholesale

Distribution

 

 

Corporate

 

 

Total

 

Revenues

 

$

19,358

 

 

$

45

 

 

$

34,217

 

 

$

 

 

$

53,620

 

Operating costs and expenses

 

 

(12,342

)

 

 

(342

)

 

 

(32,316

)

 

 

(9,218

)

 

 

(54,218

)

Depreciation and amortization

 

 

(702

)

 

 

(96

)

 

 

(1,486

)

 

 

(467

)

 

 

(2,751

)

Share in ACL earnings

 

 

 

 

 

3,143

 

 

 

 

 

 

 

 

 

3,143

 

Segment contribution income (loss)

 

$

6,314

 

 

$

2,750

 

 

$

415

 

 

$

(9,685

)

 

$

(206

)

 

 

 

Nine Months Ended September 30, 2016

 

(In thousands)

 

Digital

Channels

 

 

IP Licensing

 

 

Wholesale

Distribution

 

 

Corporate

 

 

Total

 

Revenues

 

$

11,053

 

 

$

43

 

 

$

40,786

 

 

$

 

 

$

51,882

 

Operating costs and expenses

 

 

(6,555

)

 

 

(225

)

 

 

(40,481

)

 

 

(8,172

)

 

 

(55,433

)

Depreciation and amortization

 

 

(442

)

 

 

(103

)

 

 

(1,199

)

 

 

(356

)

 

 

(2,100

)

Share in ACL earnings

 

 

 

 

 

2,198

 

 

 

 

 

 

 

 

 

2,198

 

Segment contribution income (loss)

 

$

4,056

 

 

$

1,913

 

 

$

(894

)

 

$

(8,528

)

 

$

(3,453

)

 

A reconciliation of total segment contribution income (loss) to loss from continuing operations before provision for income taxes is as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Segment contribution income (loss)

 

$

39

 

 

$

594

 

 

$

(206

)

 

$

(3,453

)

Interest expense, net

 

 

(2,288

)

 

 

(2,222

)

 

 

(6,326

)

 

 

(6,617

)

Change in fair value of stock warrants and other

   derivatives

 

 

(264

)

 

 

(1,222

)

 

 

(3,647

)

 

 

(3,406

)

Gain on extinguishment of debt

 

 

 

 

 

 

 

 

470

 

 

 

 

Other income (expense), net

 

 

169

 

 

 

(42

)

 

 

614

 

 

 

(772

)

Loss from continuing operations before

   provision for income taxes

 

$

(2,344

)

 

$

(2,892

)

 

$

(9,095

)

 

$

(14,248

)

 

Total assets for each segment primarily include accounts receivable, inventory and investments in content. The Corporate segment primarily includes assets not fully allocated to any other segment including consolidated cash accounts, certain prepaid assets and fixed assets used across all segments.

Total assets by segment, excluding assets of discontinued operations, are as follows:

 

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

2017

 

 

2016

 

Digital Channels

 

$

7,806

 

 

$

5,941

 

IP Licensing

 

 

21,717

 

 

 

18,648

 

Wholesale Distribution

 

 

107,068

 

 

 

102,748

 

Corporate

 

 

7,813

 

 

 

8,643

 

 

 

$

144,404

 

 

$

135,980

 

 

 

15


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 3. EQUITY EARNINGS OF AFFILIATE

In February 2012, Acorn Media acquired a 64% interest in ACL for total purchase consideration of £13.7 million or approximately $21.9 million excluding direct transaction costs. The acquisition gave Acorn Media a majority ownership of ACL’s extensive works including a variety of short story collections, more than 80 novels, 19 plays and a film library of over 100 made-for-television films.

We account for our investment in ACL using the equity method of accounting because (1) Acorn Media is only entitled to appoint one-half of ACL’s board members and (2) in the event the board is deadlocked, the chairman of the board, who is appointed by the directors elected by the minority shareholders, casts a deciding vote.

As of the Business Combination, our 64% share of the difference between ACL’s fair value and the amount of underlying equity in ACL’s net assets was approximately $18.7 million. This step-up basis difference is primarily attributable to the fair value of ACL’s copyrights, which expire in 2046. We are amortizing the basis difference through 2046 using the straight-line method. Basis difference amortization is recorded against our share of ACL’s net income in our consolidated statements of operations; however, this amortization is not included within ACL’s financial statements presented below.

The following summarized financial information is derived from the unaudited financial statements of ACL:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

$

5,016

 

 

$

3,506

 

 

$

11,970

 

 

$

14,357

 

Film cost amortization

 

 

(260

)

 

 

(431

)

 

 

(2,175

)

 

 

(6,056

)

General, administrative and other expenses

 

 

(1,096

)

 

 

(961

)

 

 

(2,926

)

 

 

(3,131

)

Income from operations

 

$

3,660

 

 

$

2,114

 

 

$

6,869

 

 

$

5,170

 

Net income

 

$

2,922

 

 

$

1,693

 

 

$

5,483

 

 

$

4,142

 

 

ACL's functional currency is the British Pound Sterling (the Pound). Amounts have been translated from the Pound to U.S. dollar using the average exchange rate for the periods presented.

 

 

NOTE 4. ACCOUNTS RECEIVABLE

Accounts receivable for our Digital Channels segment are primarily derived from subscription revenues, which are processed by merchant banks or our channel partners such as Amazon, that have not cleared our bank as of period end. Accounts receivable for our Wholesale Distribution segment are primarily derived from (1) video content we license to broadcast, cable/satellite providers and digital subscription platforms like Netflix, and (2) the sale of physical content to retailers and wholesale distributors and U.K. ecommerce and catalog sales. Our accounts receivable typically trends with retail seasonality.

 

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

2017

 

 

2016

 

Digital Channels

 

$

2,508

 

 

$

2,200

 

Wholesale Distribution

 

 

13,436

 

 

 

22,231

 

Accounts receivable before allowances and reserves

 

 

15,944

 

 

 

24,431

 

Less: reserve for returns

 

 

(2,610

)

 

 

(4,817

)

Less: allowance for doubtful accounts

 

 

(71

)

 

 

(45

)

Accounts receivable, net

 

$

13,263

 

 

$

19,569

 

 

Wholesale Distribution receivables are partially billed and collected by our U.S. distribution facilitation partner, Sony Pictures Home Entertainment (or SPHE). Each quarter, SPHE preliminarily settles their portion of our wholesale receivables assuming a timing lag on collections and an average-return rate. When actual returns differ from the amounts previously assumed, adjustments are made that give rise to payables and receivables between us and SPHE. Amounts vary and tend to be seasonal following our sales activity. As of September 30, 2017, we owed SPHE $5.2 million for receivables settled at quarter end. As of December 31, 2016, we owed SPHE $5.6 million for receivables settled as of year‑end. The Wholesale Distribution receivables are reported net of amounts owed to SPHE as these amounts are offset against each other when settling.

16


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

As of September 30, 2017, the net Wholesale Distribution payables due to SPHE were $2.2 million, which is included in accounts payable and accrued liabilities. As of December 31, 2016, the net Wholesale Distribution receivables with SPHE were $4.3 million, which is included in accounts receivable.

 

 

NOTE 5. INVENTORIES

Inventories are summarized as follows:

 

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

2017

 

 

2016

 

Packaged discs

 

$

4,745

 

 

$

5,601

 

Packaging materials

 

 

440

 

 

 

452

 

Other merchandise

 

 

183

 

 

 

162

 

Inventories, net

 

$

5,368

 

 

$

6,215

 

 

For each reporting period, we review the value of inventories on hand to estimate the recoverability through future sales. Values in excess of anticipated future sales are booked as obsolescence reserve. Our obsolescence reserve was $9.9 million as of September 30, 2017 and $10.0 million as of December 31, 2016. We reduce our inventories with adjustments for lower of cost or market valuation, shrinkage, excess quantities and obsolescence. During the nine months ended September 30, 2017 and 2016, we recorded impairment charges of $1.0 million and $1.8 million, respectively. During the three months ended September 30, 2017 and 2016, we recorded impairment charges of $0.5 million and $0.6 million, respectively. These charges are included in cost of sales as manufacturing and fulfillment cost.

 

 

NOTE 6. INVESTMENTS IN CONTENT

 

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

2017

 

 

2016

 

Released

 

$

65,292

 

 

$

48,593

 

Completed, not released

 

 

5,365

 

 

 

8,453

 

In-production

 

 

4,657

 

 

 

3,691

 

Investments in content, net

 

$

75,314

 

 

$

60,737

 

 

Investments in content are stated at the lower of unamortized cost or estimated fair value. The valuation of investments in content is reviewed on a title-by-title basis when an event or change in circumstances indicates that the fair value of content is less than its unamortized cost. For the three months ended September 30, 2017 and 2016, impairment charges were $0.5 million and $0.3 million, respectively. For the nine months ended September 30, 2017 and 2016, impairment charges were $1.1 million and $2.1 million, respectively. These charges are included in cost of sales as part of content amortization and royalties.

In determining the fair value of content for impairments (Note 10, Fair Value Measurements), we employ a discounted cash flow (or DCF) methodology. Key inputs employed in the DCF methodology include estimates of ultimate revenue and costs as well as a discount rate. The discount rate utilized in the DCF analysis is based on a market participant's weighted average cost of capital plus a risk premium representing the risk associated with producing a particular type of content.

 

 

17


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 7. DEBT

Debt consists of the following:

 

 

 

Maturity

 

Interest

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

Date

 

Rate

 

 

2017

 

 

2016

 

Senior secured term notes

   with AMC:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tranche A Loan

 

Beginning June 30, 2020

 

 

7.0%

 

 

$

23,000

 

 

$

5,000

 

Tranche B Loan

 

Beginning October 14, 2021

 

 

6.0%

 

 

 

54,999

 

 

 

60,000

 

Less: debt discount

 

 

 

 

 

 

 

 

(26,400

)

 

 

(31,565

)

Total senior-term notes, net of

   discount

 

 

 

 

 

 

 

 

51,599

 

 

 

33,435

 

Subordinated notes payable to prior

   Image Shareholders

 

Repaid January 31, 2017

 

1.5% through 2016 then 12%

 

 

 

 

 

 

8,618

 

Debt, net of discount

 

 

 

 

 

 

 

$

51,599

 

 

$

42,053

 

 

Future minimum principal payments, exclusive of debt discount, as of September 30, 2017 are as follows:

 

(In thousands)

 

Senior Notes

 

Remainder of 2017

 

$

 

2018

 

 

 

2019

 

 

 

2020

 

 

13,000

 

2021

 

 

25,000

 

2022

 

 

30,000

 

2023

 

 

9,999

 

 

 

$

77,999

 

 

Senior Term Notes

On October 14, 2016, we entered into a $65.0 million Credit and Guaranty Agreement (the AMC Credit Agreement) with Digital Entertainment Holdings LLC, a wholly owned subsidiary of AMC Networks Inc. (or AMC). Concurrent with entering into the AMC Credit Agreement, we also issued AMC three warrants (the AMC Warrants) to acquire a total of 20.0 million shares of our common stock at $3.00 per share. The entering of the AMC Credit Agreement, the issuance of the AMC Warrants and the associated transactions are referred to as the AMC Transaction.

The proceeds received from the AMC Credit Agreement were used to repay our prior senior secured term notes of $55.1 million, including accrued interest, and transaction expenses of approximately $1.7 million, which includes a prepayment penalty of $0.8 million. Initially, the AMC Credit Agreement consisted of (i) a term loan tranche in the principal amount of $5.0 million (or Tranche A Loan), which was due on October 14, 2017, and (ii) a term loan tranche in the principal amount of $60.0 million (or Tranche B Loan) of which 25% is due after five years, 50% is due after six years and the remaining 25% is due after seven years. The Tranche A Loan bears interest at a rate of 7.0% per annum and the Tranche B Loan bears interest at a rate of 6.0% per annum. Interest is payable quarterly whereby 4.0% was payable in cash and the balance is payable in shares of common stock determined using a per-share value of $3.00. The loan is secured by a lien on substantially all of our consolidated assets.

On January 30, 2017, to repay prior debt obligations under the subordinated notes payable we amended the AMC Credit Agreement and borrowed an additional $8.0 million, thereby increasing our Tranche A Loan from $5.0 million to $13.0 million. We also extended the maturity date for our Tranche A Loan from October 14, 2017 to June 30, 2019. When doing so, we did not incur a prepayment penalty.

On June 16, 2017, to fuel the growth of our business we expanded the AMC Credit Agreement and borrowed an additional $10.0 million, thereby increasing our Tranche A Loan from $13.0 million to $23.0 million. Further, we extended the maturity date for

18


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

our Tranche A Loan from June 30, 2019 to beginning on June 30, 2020. We also amended the payment provisions regarding interest whereby all interest is now settled with shares of common stock at $3.00 per share beginning as of April 1, 2017. The additional $10.0 million borrowed is available for working capital purposes, including the acquisition of content. This amendment also changed certain debt covenant ratios to reflect the extended maturity date and the increase of the Tranche A Loan balance.

Concurrent with the June amendment, RLJ SPAC Acquisition, LLC converted all of its preferred stock holdings into shares of common stock (see Note 8, Redeemable Convertible Preferred Stock and Equity) and AMC exercised a portion of their warrants (see Note 9, Stock Warrants) that resulted in the Tranche B Loan principal reduction of $5.0 million. This reduction in principal did not result in a prepayment penalty.

Subject to certain customary exceptions, the AMC Credit Agreement requires mandatory prepayments if we were to receive proceeds from asset sales, insurance, debt issuance or the exercise of the warrants (see Note 9, Stock Warrants). We may also make voluntary prepayments. Prepayments of the Tranche B Loan (either voluntary or mandatory) are subject to a prepayment premium of 3.0% if principal is repaid on or before October 14, 2018, and 1.5% if principal is repaid after October 14, 2018 but on or before October 14, 2019. No prepayment premium is due for amounts prepaid after October 14, 2019, and for mandatory prepayments made from proceeds received from the exercise of warrants. The Tranche A Loan is not subject to prepayment penalties.

The AMC Credit Agreement contains certain financial and non-financial covenants. Financial covenants are assessed annually and are based on Consolidated Adjusted EBITDA, as defined in the AMC Credit Agreement. Financial covenants vary by fiscal year and generally become more restrictive over time.

Financial covenants include the following:

 

 

 

Fiscal Year Ended December 31, 2016

 

Fiscal Year Ending December 31, 2017

 

Fiscal Year Ending December 31, 2018

 

Thereafter

Leverage Ratios:

 

 

 

 

 

 

 

 

Senior debt-to-Adjusted EBITDA

 

6.00 : 1.00

 

5.75 : 1.00

 

4.00 : 1.00

 

Ranges from 3.75 : 1.00 to 2.50 : 1.00

Total debt-to-Adjusted EBITDA

 

6.75 : 1.00

 

6.00 : 1.00

 

5.00 : 1.00

 

4.00 : 1.00

Fixed charge coverage ratio

 

1.00 : 1.00

 

1.00 : 1.00

 

2.00 : 1.00

 

2.00 : 1.00

 

The AMC Credit Agreement contains events of default that include, among others, non-payment of principal, interest or fees; violation of covenants; inaccuracy of representations and warranties; bankruptcy and insolvency events; material judgments; cross defaults to certain other contracts (including, for example, business arrangements with our U.S. distribution facilitation partner and other material contracts); and indebtedness and events constituting a change of control or a material adverse effect in any of our results of operations or conditions (financial or otherwise). The occurrence of an event of default would increase the applicable rate of interest and could result in the acceleration of our obligations under the AMC Credit Agreement.

The AMC Credit Agreement imposes restrictions on such items as encumbrances and liens, payments of dividends to common stockholders, other indebtedness, stock repurchases, capital expenditures and entering into new lease obligations. Additional covenants restrict our ability to make certain investments, such as loans and equity investments, or investments in content that are not in the ordinary course of business. Pursuant to the AMC Credit Agreement, we must maintain at all times a cash balance of $1.0 million for 2016, $2.0 million in cash for 2017 and $3.5 million in cash for all years thereafter. As of September 30, 2017, we were in compliance with all covenants as stipulated in the AMC Credit Agreement.

Concurrent with entering into the AMC Transaction, we issued the AMC Warrants to acquire shares of our common stock. The first warrant is for 5.0 million shares of common stock, of which 1.7 million shares were exercised in June 2017, and expires on October 14, 2021. The second warrant is for 10.0 million shares of common stock and expires on October 14, 2022. The third warrant is for 5.0 million shares of common stock, subject to adjustment, and expires on October 14, 2023. The AMC Warrants are subject to certain standard anti-dilution provisions, and may be exercised on a non-cash basis at AMC’s discretion.

The third warrant (the AMC Tranche C Warrant) contains a provision that may increase the number of shares acquirable upon exercising, for no additional consideration payable by AMC, such that the number of shares acquirable upon exercise is equal to the sum of (i) at least 50.1% of our then outstanding shares of common stock, determined on a fully diluted basis, less (ii) the sum of 15.0 million shares and the equity interest shares issued in connection with the AMC Credit Agreement. This provision provides AMC

19


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

the ability to acquire at least 50.1% of our common stock for $60.0 million, provided that all warrants are exercised and AMC elects not to exercise on a non-cash basis. The third warrant with this guarantee provision is being accounted for as a derivative liability.

Subordinated Notes Payable

On January 31, 2017, we repaid the outstanding principal and interest on our unsecured subordinated promissory notes. The subordinated notes were issued in 2012 in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image (or Subordinated Note Holders). In 2015, and in connection with the sale of preferred stock and warrants, the Subordinated Note Holders exchanged approximately $8.5 million of subordinated notes for 8,546 shares of preferred stock and warrants to acquire approximately 855,000 shares of common stock.

 

 

NOTE 8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND EQUITY

Redeemable Convertible Preferred Stock and 2015 Warrants

On May 20, 2015, we closed a transaction in which we sold 31,046 shares of preferred stock and warrants to acquire 3.1 million shares of common stock (the 2015 Warrants) for $22.5 million in cash and the exchange of $8.5 million in subordinated notes. Of the preferred shares and warrants sold, 16,500 shares of preferred stock and warrants to acquire 1.7 million shares of common stock were sold to certain board members or their affiliated companies. We used $10.0 million of the cash proceeds from this sale to make partial payment on our senior notes payable and approximately $1.9 million for prepayment penalties, legal and accounting fees, which include fees associated with our registration statement filed in July 2015 and other expenses associated with the transaction. The balance of the net cash proceeds was used for content investment and working capital purposes. Of the fees incurred, $0.9 million was recorded against the proceeds received, $0.5 million was recorded as additional debt discounts, $0.2 million was included as interest expense and the balance was included in other expense.

On October 14, 2016 and concurrent with the close of our AMC Credit Agreement, we amended our preferred stock such that we were able to classify our preferred stock and its embedded conversion feature within our shareholders’ equity. Prior to the amendment, our preferred stock and its embedded conversion feature were recorded on our consolidated balance sheet outside of shareholders’ equity. The amended terms are disclosed below.

The preferred stock has the following rights and preferences:

 

Rank – the preferred stock ranks higher than other company issued equity securities in terms of distributions, dividends and other payments upon liquidation.

 

Dividends – the preferred stockholders are entitled to cumulative dividends at a rate of 8% per annum of a preferred share’s stated value ($1,000 per share plus any unpaid dividends). The first dividend payment was made on July 1, 2017 and payments will be made quarterly thereafter. At our discretion, dividend payments are payable in either cash, or if we satisfy certain equity issuance conditions, in shares of common stock. Pursuant to the October 14, 2016 amended terms, if we don’t satisfy equity issuance conditions, then we may elect to accrue the value of the dividend and add it to the preferred share’s stated value.

 

Conversion – at the preferred stockholder’s discretion, each share of preferred stock is convertible into 333.3 shares of our common stock, subject to adjustment for any unpaid dividends. Prior to the October 14, 2016 amendment, the conversion rate was subject to anti-dilution protection for offerings consummated at a per-share price of less than $3.00 per common share. This down-round provision was removed as part of the October 14, 2016 amendment.

 

Mandatory Redemption – unless previously converted, on May 20, 2020, at our option we will either redeem the preferred stock with (a) cash equal to $1,000 per share plus any unpaid dividends (Redemption Value), or (b) shares of common stock determined by dividing the Redemption Value by a conversion rate equal to the lower of (i) the conversion rate then in effect (which is currently $3.00) or (ii) 85% of the then trading price, as defined, of our common stock. As part of the October 14, 2016 amendment, a floor was established for all but 16,500 shares of preferred stock such that the redemption ratio cannot be below $0.50 per common share. For the 16,500 shares of preferred stock, a floor of $2.49 was already in place and remained unchanged. If we were to redeem with shares of common stock, the actual number of shares that would be issued upon redemption is not determinable as the number is contingent upon the then trading price of our common stock. Generally, if we were to redeem with shares, the number of common shares needed for redemption increases as our common stock price decreases. Because of the October 14, 2016 amendment, the maximum number of

20


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

 

common shares issuable upon redemption is determinable given the redemption conversion floors. If we elect to redeem with shares of common stock, and we fail to meet certain conditions with respect to the issuance of equity, then we would be subject to a 20% penalty of the maturity redemption price, payable in either cash or shares of common stock. This penalty is subject to, and therefore possibly limited by, a $0.50 per share floor.

 

Voting – except for certain matters that require the approval of the preferred stockholders, such as changes to the rights and preferences of the preferred stock, the preferred stock does not have voting rights. However, the holders of the preferred stock are entitled to appoint two board members and, under certain circumstances, appoint a third member.

We are increasing (or accreting) the carrying balance of our preferred stock up to its Redemption Value using the effective interest-rate method over a period of time beginning from the issuance date of May 20, 2015 to the required redemption date of May 20, 2020. During the nine months ended September 30, 2017 and 2016, we recognized accretion of $1.0 million and $3.8 million, respectively. Accretion includes cumulative preferred dividends. As of September 30, 2017, the accumulated unpaid dividends on preferred stock were $2.8 million. During the nine months ended September 30, 2017 and 2016 accumulated dividends increased by $1.4 million (or $46.16 per share of preferred stock) and $2.0 million (or $64.80 per share of preferred stock), respectively. On July 1, 2017, we made the first cash dividend payment of $0.4 million.

During 2016, two preferred shareholders converted a total of 849 shares of preferred stock and $0.1 million of accumulated dividends into 0.3 million shares of common stock. During June 2017, the largest preferred shareholder (RLJ SPAC Acquisition, LLC) converted a total of 15,000 shares of preferred stock and $2.7 million of accumulated dividends into 5.9 million shares of common stock.

In 2015, we filed a registration statement with the Securities and Exchange Commission to register the shares issuable upon conversion of the preferred stock and exercise of the 2015 Warrants (see Note 9, Stock Warrants). The registration statement was declared effective in July 2015 and amended in 2016. If we are in default of the registration rights agreement, and as long as the event of default is not cured, then we are required to pay, in cash, partial liquidation damages, which in total are not to exceed 6% of the aggregated subscription amount of $31.0 million. We will use our best efforts to keep the registration statement effective.

Share-Based Compensation

Our share-based compensation consists of awards of restricted stock, restricted stock units, performance stock units and stock options. During the nine months ended September 30, 2017, 1.1 million shares of restricted stock-based awards were granted, 1.4 million options were granted to an executive officer, 0.2 million shares vested and 3,668 shares were forfeited due to employee terminations. Of the shares granted, we issued 0.9 million shares of restricted stock-based awards to executive officers and directors and 0.2 million shares of restricted stock units to employees. The restricted stock-based awards were fair valued on the date of grant using the closing price of the common stock on the grant date. The restricted stock-based awards generally vest over a three to four-year period for executive officers and a one-year period for directors. The restricted stock units generally vest over a three-year period for employees. The vesting of restricted stock awards and restricted stock units is subject to certain service criteria.

The option grants in 2017 include an option to purchase 700,000 shares of common stock with an exercise price of $2.66 per share vesting in two years and an option to purchase 700,000 shares of common stock with an exercise price of $3.00 per share vesting in four years. The options were fair valued at $1.90 per share using the Black Scholes model. Inputs into the model included the stock price of $2.66 at the time of grant, the exercise price, the risk-free interest rate of 1.97%, expected volatility of 75% and the expected terms, which were 7.0 years and 8.4 years. The expected term for the option with an exercise price of $2.66 was estimated as the average of its vesting term of two years and its contractual term of 10 years. The expected term of the other option was estimated by using a lattice model that took into consideration the vesting term, the contractual term of 10 years, post-vesting exercise behavior and the award’s exercise price relative to the current fair value of a share of common stock.

Compensation expense relating to our share-based grants for the three months ended September 30, 2017 and 2016 was $0.7 million and $0.3 million, respectively. Compensation expense relating to our share-based grants for the nine months ended September 30, 2017 and 2016 was $1.2 million and $0.9 million, respectively. Compensation expense related to share-based grants is included in general and administrative expenses. As of September 30, 2017, unrecognized share-based compensation expense relating to the service awards of $4.4 million is expected to be expensed ratably over the remaining vesting period 1.4 years. Unrecognized compensation expense relating to the performance awards of $1.7 million is expected to be expensed ratably over the remaining weighted-average vesting period of 1.8 years. Expense associated with our performance award is contingent upon achieving specified

21


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

financial criteria and upon certification by the Compensation Committee of the satisfaction of such performance criteria based upon our audited financial statements for 2017, 2018, 2019 and 2020. The above unrecognized stock-based compensation expense assumes that the performance awards will vest at 100% (or 0.5 million shares). However, the possible range of vesting is between zero and 1.0 million shares.

Assuming 100% vesting for all awards, we expect to recognize $2.8 million of compensation expense in the next 12 months.

During the nine months ended September 30, 2016, 418,805 shares of restricted stock-based awards were granted, 192,501 shares vested and 6,231 shares were forfeited based upon the failure to achieve the 2015 performance criteria. Of the shares granted, we issued 216,982 shares of restricted stock awards to executive officers and directors and 201,823 shares of restricted stock units to employees. A summary of the restricted stock-based award activity since December 31, 2016 is as follows:

 

(In thousands, except per share data)

 

Service Shares

 

 

Performance Shares

 

Restricted Stock-Based Compensation Award Activity

 

Shares

 

 

Weighted-

Average Grant

Date Fair Value

 

 

Shares

 

 

Weighted-

Average Grant

Date Fair Value

 

Non-vested shares at December 31, 2016

 

 

409

 

 

$

1.92

 

 

 

 

 

$

 

Granted

 

 

634

 

 

$

3.22

 

 

 

500

 

 

$

2.40

 

Vested

 

 

(204

)

 

$

2.01

 

 

 

 

 

$

 

Forfeited

 

 

(4

)

 

$

1.92

 

 

 

 

 

$

 

Non-vested shares at September 30, 2017

 

 

835

 

 

$

2.90

 

 

 

500

 

 

$

2.40

 

 

 

NOTE 9. STOCK WARRANTS

As of September 30, 2017, outstanding warrants to purchase shares of common stock are as follows:

 

 

 

September 30, 2017

(In thousands, except per share data)

 

Shares

 

 

Weighted-

Average

Exercise Price

 

 

Weighted-

Average

Remaining Life

AMC Unregistered warrants

 

 

18,333

 

 

$

3.00

 

 

5.1 years

2015 Unregistered warrants

 

 

2,999

 

 

$

2.29

 

 

2.6 years

2012 Warrants:

 

 

 

 

 

 

 

 

 

 

Registered warrants

 

 

5,125

 

 

$

36.00

 

 

Sponsor warrants

 

 

1,272

 

 

$

36.00

 

 

Unregistered warrants

 

 

617

 

 

$

36.00

 

 

 

 

 

28,346

 

 

 

 

 

 

 

 

Concurrent with entering into the AMC Credit Agreement, we issued AMC three warrants (the AMC Warrants) to acquire shares of our common stock at $3.00 per share. The first warrant is for 5.0 million shares of common stock, of which 1.7 million shares were exercised in June 2017, and expires on October 14, 2021. The second warrant is for 10.0 million shares of common stock and expires on October 14, 2022. The third warrant is for 5.0 million shares of common stock, subject to adjustment, and expires on October 14, 2023. The AMC Warrants are subject to certain standard anti-dilution provisions, and may be exercised on a non-cash basis at AMC’s discretion.

The third warrant (the AMC Tranche C Warrant) contains a provision that may increase the number of shares acquirable upon exercising, for no additional consideration payable by AMC, such that the number of shares acquirable upon exercise is equal to the sum of (i) at least 50.1% of our then outstanding shares of common stock, determined on a fully diluted basis, less (ii) the sum of 15.0 million shares and the equity interest shares issued in connection with the AMC Credit Agreement. This provision provides AMC the ability to acquire at least 50.1% of our common stock for $60.0 million, provided that all warrants are exercised and AMC elects not to exercise on a non-cash basis. The third warrant with this guarantee provision is being accounted for as a derivative liability.

On May 20, 2015 and concurrent with our preferred stock placement, we issued warrants to our preferred stock holders to acquire 3.1 million shares of our common stock (the 2015 Warrants). The warrants have term of five years. On October 14, 2016 and in connection with the AMC Credit Agreement, we amended the anti-dilution and redemption provisions of the warrants to

22


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

conform to the terms of the amended preferred stock. Because of the AMC transaction and the then-existing terms of the 2015 Warrants, the warrant exercise price was reduced from $4.50 to $3.00; however, the exercise price was further reduced down to $1.50 for warrants to acquire 1.5 million shares of common stock, and down to $2.37 for warrants to acquire 150,000 shares of common stock. Because of the October 14, 2016 amendment, we began accounting for the 2015 Warrants as equity awards and reclassified the carrying balance of the warrants to shareholders’ equity.

During the nine months ended September 30, 2017, warrant holders exercised warrants for approximately 106,000 shares with an exercise price of $1.50. We received cash proceeds of $0.2 million.

On October 3, 2012, we issued warrants with a term of five years that provide the warrant holder the right to acquire one share of our common stock for $36.00 per share (the 2012 Warrants). The warrants expired on October 3, 2017.

 

 

NOTE 10. FAIR VALUE MEASUREMENTS

Stock Warrant and Other Derivative Liabilities

Certain warrants are accounted for as derivative liabilities, which require us to carry them on our consolidated balance sheet at their fair value. Our derivative liability warrants consist of the AMC Tranche C Warrant to acquire 5.0 million shares of common stock and our 2012 Warrants to acquire 7.0 million shares of common stock. Prior to the amendment on October 14, 2016, our 2015 Warrants to purchase 3.1 million shares of our common stock and the preferred stock’s embedded conversion feature were being accounted for as derivative liabilities as well.

We determined the fair value of the AMC Tranche C warrant using a lattice model, which is classified as Level 3 within in the fair-value hierarchy. Inputs to the model include our publicly-traded stock price, our stock volatility, the risk-free interest rate and contractual terms of the warrant (which are remaining life of the warrant, exercise price and assumptions pertaining to increasing the number of acquirable shares of common stock to achieve 50.1% ownership). We use the closing stock price of our common stock to compute stock volatility. To quantify and value the possibility of increasing the number of acquirable shares, management took into consideration its current capital structure, the impact of the 20% penalty if we were to fail to meet certain equity issuance conditions, and management’s best estimates of the likelihood of being subject to the 20% penalty. The AMC Tranche C warrant was valued at $13.4 million as of September 30, 2017 and $9.8 million as of December 31, 2016. During the current year, the AMC Tranche C warrant increased in value as a result of an increase in our common stock price.

We determined the fair value of our 2012 Warrants using a Monte Carlo simulation model. Because the warrants are so far out-of-the-money (exercise price is $36.00 per share) and as they approach their expiration date (which is October 2017) their fair value is effectively zero as of December 31, 2016 and September 30, 2017.

Prior to the October 14, 2016 amendment, we were using a lattice model to value the 2015 Warrants, which was classified as Level 3 within the fair-value hierarchy. Inputs to the model were stock volatility, contractual warrant terms (which were remaining life of the warrant and the exercise price), the risk-free interest rate and management’s assessment of the likelihood of doing a down-round transaction.

Prior to the October 14, 2016 amendment, we were using the lattice model to value the preferred stock’s embedded conversion feature, which was classified as Level 3 within the fair-value hierarchy. Inputs to the model were stock volatility, contractual terms (which were remaining life of the conversion option and the conversion rate), the risk-free interest rate and management’s assessment of the likelihood of doing a down-round transaction.

The following tables represent the valuation of our warrant and other derivative liabilities within the fair-value hierarchy:

 

 

 

September 30, 2017

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Stock warrants

 

$

 

 

$

 

 

$

13,410

 

 

$

13,410

 

 

 

 

December 31, 2016

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Stock warrants

 

$

 

 

$

 

 

$

9,763

 

 

$

9,763

 

23


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

 

The following tables include a roll-forward of our warrant and other derivative liabilities classified within Level 3 of the fair-value hierarchy:

 

 

 

Nine Months Ended September 30, 2017

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Stock warrants at December 31, 2016

 

$

 

 

$

 

 

$

9,763

 

 

$

9,763

 

Change in fair value

 

 

 

 

 

 

 

 

3,647

 

 

 

3,647

 

Stock warrants at September 30, 2017

 

$

 

 

$

 

 

$

13,410

 

 

$

13,410

 

 

 

 

 

Nine Months Ended September 30, 2016

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Stock warrants at December 31, 2015

 

$

 

 

$

 

 

$

2,252

 

 

$

2,252

 

Change in fair value

 

 

 

 

 

 

 

 

1,011

 

 

 

1,011

 

Stock warrants at September 30, 2016

 

$

 

 

$

 

 

$

3,263

 

 

$

3,263

 

 

 

 

Nine Months Ended September 30, 2016

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Embedded conversion feature at December 31, 2015

 

$

 

 

$

 

 

$

8,426

 

 

$

8,426

 

Change in fair value

 

 

 

 

 

 

 

 

2,395

 

 

 

2,395

 

Amount reclassified to equity upon conversion

 

 

 

 

 

 

 

 

(296

)

 

 

(296

)

Embedded conversion feature at September 30, 2016

 

$

 

 

$

 

 

$

10,525

 

 

$

10,525

 

 

Investments in Content

When events and circumstances indicate that investments in content are impaired, we determine the fair value of the investment; and if the fair value is less than the carrying amount, we recognize additional amortization expense equal to the excess. The following fair value hierarchy tables present information about our assets and liabilities measured at fair value on a non-recurring basis.

 

 

 

Nine Months Ended September 30, 2017

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

Loss

 

Investments in content

 

$

 

 

$

 

 

$

1,702

 

 

$

1,702

 

 

$

1,057

 

 

 

 

Nine Months Ended September 30, 2016

 

(In thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

Loss

 

Investments in content

 

$

 

 

$

 

 

$

598

 

 

$

598

 

 

$

2,062

 

 

During the nine months ended September 30, 2017 and 2016, the investments in content were impaired by $1.1 million and $2.1 million, respectively. In determining the fair value of our investments in content, we employ a discounted cash flow (or DCF) methodology. Key inputs employed in the DCF methodology include estimates of a film's ultimate revenue and costs as well as a discount rate. The discount rate utilized in the DCF analysis is based on our weighted average cost of capital plus a risk premium representing the risk associated with producing a particular film or television program. As the primary determination of fair value is determined using a DCF model, the resulting fair value is considered a Level 3 measurement.

 

 

NOTE 11. NET INCOME (LOSS) PER COMMON SHARE

We have outstanding warrants to acquire 28.3 million and 10.1 million shares of common stock as of September 30, 2017 and 2016, respectively, which are not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.

During periods of reported net losses from continuing operations after adjusting for accretion on preferred stock, all reported net losses are allocated to our unrestricted common stock. This has the effect of excluding our outstanding restricted common stock from the computation of our net loss per common share. For the three months ended September 30, 2017 and 2016, we have weighted average unvested shares of 2.7 million and 0.5 million, respectively, of compensatory stock options and restricted share-based awards

24


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

that were not included in the computation of diluted net loss per common share as the effect would be anti-dilutive. For the nine months ended September 30, 2017 and 2016, we had weighted average unvested shares of 1.5 million and 0.4 million respectively, of compensatory stock options and restricted share-based awards that were not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.

When dilutive, we include in our computation of diluted loss per share the number of shares of common stock that is acquirable upon conversion of the preferred stock by applying the as-converted method per ASC 260, Earnings per Share. For the three and nine months ended September 30, 2017 and 2016, we excluded 5.9 million and 11.2 million shares of common stock that are acquirable upon conversion of the preferred stock as they were anti-dilutive.

 

 

NOTE 12. STATEMENTS OF CASH FLOWS

Supplemental Disclosures

 

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

Cash paid during the period for:

 

 

 

 

 

 

 

 

Interest

 

$

1,592

 

 

$

4,911

 

Income taxes

 

$

30

 

 

$

35

 

Reclassification of deferred financing costs from prepaid

   expenses and other assets to debt, net of discounts

 

$

 

 

$

832

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Accretion on preferred stock

 

$

959

 

 

$

3,763

 

Preferred stock and derivative liability converted

   into common stock

 

$

 

 

$

1,232

 

Common stock issued to AMC as payment for

   prior year interest expense

 

$

158

 

 

$

 

Conversion of preferred stock into shares of common

 

$

19,592

 

 

$

 

Exercise of AMC warrant and reduction of senior debt

 

$

2,847

 

 

$

 

Interest payable on subordinated notes converted to

   principal

 

$

 

 

$

72

 

Capital expenditures accrued for in accounts payable and

   accrued liabilities

 

$

369

 

 

$

357

 

 

 

NOTE 13. COMMITMENTS AND CONTINGENCIES

In the normal course of business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to content ownership, copyright and employment matters. While it is not possible to predict the outcome of these matters, it is the opinion of management, based on consultations with legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on our financial position, results of operations or liquidity. Accordingly, we record a charge to earnings based on the probability of settlement and determination of an estimated amount. These charges were not material to our results.

 

 

NOTE 14. RELATED PARTY TRANSACTIONS

Equity Investment in Affiliate

During the nine months ended September 30, 2017 and 2016, we paid ACL $0.1 million and $3.2 million, respectively, for distribution rights for three titles, two of which were released as of December 31, 2016 and one which was released in 2017. As we recognize revenues from these titles, and all other titles, we amortize our content advances resulting in the recognition of content amortization and royalty expense. For the nine months ended September 30, 2017, we recognized content amortization and royalty expense of $0.2 million and none during the three months ended September 30, 2017. For the three and nine months ended

25


RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

September 30, 2016, we recognized content amortization and royalty expense of $0.1 million and $0.4 million, respectively. This amortization is included in our cost of sales as content amortization and royalties. As of September 30, 2017, our remaining unamortized content advance is $1.6 million.

ACL paid dividends to RLJE Ltd. of $1.2 million during the nine months ended September 30, 2017 and $1.7 million during the nine months ended September 30, 2016. No dividends were received during the three months ended September 30, 2017 and 2016. We record dividends received as a reduction to the ACL investment account.

Foreign Currency

We recognize foreign currency gains and losses, as a component of other expense, on amounts lent by Acorn Media to RLJE Ltd. and RLJE Australia. As of September 30, 2017, Acorn Media had lent its U.K. subsidiaries approximately $3.9 million and its Australian subsidiary approximately $3.3 million. Amounts lent will be repaid in U.S. dollars based on available cash. Movement in exchange rates between the U.S. dollar and the functional currencies (which are the Pound and the Australian dollar) of those subsidiaries that were lent the monies will result in foreign currency gains and losses. During the three months ended September 30, 2017, we recognized foreign currency gains of $0.2 million and during the three months ended September 30, 2016 we recognized foreign currency losses of $0.1 million. During the nine months ended September 30, 2017, we recognized foreign currency gains of $0.6 million and during the nine months ended September 30, 2016, we recognized foreign currency losses of $0.9 million.

The RLJ Companies, LLC

In June 2013, The RLJ Companies, LLC (whose sole manager and voting member is the chairman of our board of directors) purchased from one of our vendors $3.5 million of contract obligations that we owed to the vendor. These purchased liabilities, which are now owed to The RLJ Companies, are included in accrued royalties and distribution fees in the accompanying consolidated balance sheets. During the three months ended September 30, 2017, we made a $0.5 million payment to The RLJ Companies which reduced our remaining obligation to $3.0 million.

Preferred Stock and Warrants

In May 2015, certain present and former board members and their affiliate companies, including RLJ SPAC Acquisition, LLC, which is owned by the chairman of our board of directors, purchased 16,500 shares of preferred stock and warrants to acquire 1.7 million shares of common stock from us for $16.5 million.

In June 2017, RLJ SPAC Acquisition, LLC converted its 15,000 shares of preferred stock and accumulated dividends and received 5.9 million shares of common stock.

On July 1, 2017, we made a $0.4 million cash dividend payment to preferred stockholders.

 

 

NOTE 15. SUBSEQUENT EVENT

On October 2, 2017, we made a dividend payment of $0.4 million to our preferred shareholders.

On October 2, 2017, we issued AMC 427,347 shares of common stock in payment of $1.3 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement. At September 30, 2017, this accrued interest was included in accounts payable and accrued liabilities.

 

 

26


 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. As described at the beginning of this Quarterly Report under the heading “Forward-Looking Statements,” our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could contribute to such differences include those discussed elsewhere in this Quarterly Report under the heading “Forward-Looking Statements.” You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report. Except as may be required under federal law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur.

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related footnotes included in Item 1 of this Quarterly Report and with our audited consolidated financial statements and notes thereto, and with the information under the headings entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in our Annual Report on Form 10-K filed on March 23, 2017.

OVERVIEW

General

RLJ Entertainment, Inc. (RLJE or the Company) is a premium digital channel company serving distinct audiences through its proprietary subscription-based digital channels, Acorn TV and Urban Movie Channel (or UMC), and a direct presence in North America, the United Kingdom (or U.K.) and Australia with strategic sublicense and distribution relationships covering Europe, Asia and Latin America. RLJE was incorporated in Nevada in April 2012. On October 3, 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media), which is referred to herein as the “Business Combination.” Acorn Media includes its U.K. subsidiaries RLJ Entertainment Ltd, Acorn Media Enterprises Limited (or AME), and RLJE International Ltd (collectively, RLJE UK), as well as RLJ Entertainment Australia Pty Ltd (or RLJE Australia). In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL).  References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC. “We,” “our” or “us” refers to RLJE and its subsidiaries unless otherwise noted. Our principal executive offices are located in Silver Spring, Maryland, with an additional location in Woodland Hills, California. We also have international offices in London, England and Sydney, Australia.

We strive to be a preferred source and destination for entertainment for a variety of distinct audiences with particular and special programming interests. We acquire, develop and exploit television, film and other media content across all platforms of distribution. We actively manage all windows of exploitation to optimize the reach of our promotional efforts and maximize the value of our releases.

We acquire content rights in various categories, with particular focus on British mysteries and dramas, urban programming and full-length independent motion pictures. We also develop, produce and own original programming primarily through our wholly-owned subsidiary, AME, our 64%-owned equity method investee, ACL and UMC. We control an extensive program library in genres such as British mysteries and dramas, urban/African-American, action/thriller and horror, fitness/lifestyle and long-form documentaries.

We market our products through a multi-channel strategy encompassing (1) direct relations with consumers via proprietary subscription-based digital channels (Digital Channels segment); (2) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, AME, and our 64%-owned equity method investee, ACL, (IP Licensing segment); and (3) wholesale exploitation through partners covering broadcast and cable, digital, online and retail outlets (Wholesale Distribution segment). As a result, we view our operations based on these three distinctive reporting segments. Operations and net assets that are not associated with any of these stated segments are reported as “Corporate” when disclosing and discussing segment information. Our Digital Channels segment consists of our subscription-based digital streaming channels. The IP Licensing segment includes intellectual property rights that we own or create and then sublicense for exploitation worldwide. Our Wholesale Distribution segment consist of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including broadcast, DVD and Blu-ray and digital (which include VOD, SVOD, streaming and downloading). We also sublicense certain distribution rights to others to cover territories outside the U.S., the U.K. and Australia. Our Wholesale Distribution segment also includes our U.K. mail-order catalog and ecommerce businesses.

27


 

AME manages and develops our intellectual property rights on British drama and mysteries. Our owned content includes 28 Foyle’s War made-for-TV films; multiple instructional Acacia titles; and through our 64% ownership interest of ACL, the vast majority of the Agatha Christie library. ACL is home to some of the world’s greatest works of mystery fiction, including Murder on the Orient Express and Death on the Nile and includes all development rights to iconic sleuths such as Hercule Poirot and Miss Marple. The Agatha Christie library includes a variety of short story collections, more than 80 novels, 19 plays and a film library of over 100 made-for-television films. In 2014, ACL published its first book since the death of Agatha Christie, The Monogram Murders. In September 2016, ACL released another new book, Closed Casket.

The IP Licensing and Wholesale Distribution segments exploit content primarily through third-party vendors. Our wholesale partners are broadcasters, digital outlets and major retailers in the U.S., Canada, United Kingdom and Australia, including, among others: Amazon, Barnes & Noble, Comcast, DirecTV, Hulu, iTunes, Netflix, PBS, Showtime, Starz, Target and Walmart. We work closely with our wholesale partners to outline and implement release and promotional campaigns customized to the different audiences we serve and the program genres we exploit. We have a catalog of owned and long-term licensed content that is segmented into brands such as Acorn (British drama/mystery, including content produced by ACL), RLJE Films (independent feature films, action/thriller horror), UMC (urban), Acacia (fitness), and Athena (documentaries).

On June 24, 2016, we entered into a licensing agreement with Universal Screen Arts (or USA) whereby USA took over our Acorn U.S. catalog/ecommerce business becoming the official, exclusive, direct-to-consumer seller of Acorn product in the U.S. During the quarter ended June 30, 2016, we also electronically distributed our last Acacia catalogs. As a result of these actions, we have classified the U.S. catalog/ecommerce business as discontinued operations. For the majority of 2016, these businesses were included in our Digital Channels segment. In the fourth quarter of 2016, we reclassified our remaining U.K. catalog/ecommerce business from our Digital Channels segment to our Wholesale Distribution segment to reflect adjustments we made internally in terms of how we are viewing and managing our operations after the disposal of our U.S. ecommerce/catalog business. The reclassification for both our U.S. and U.K. catalog and ecommerce businesses were made retroactively for all periods presented.

HIGHLIGHTS

Highlights and significant events for the three months ended September 30, 2017 and 2016 are as follows:

 

Digital Channels paying subscribers increased over 50% from the third quarter of 2016 to over 620,000.

 

Digital Channels segment revenues increased 58.6% to $7.0 million from $4.4 million in the third quarter of 2016.

 

Total net revenues increased 13.9% year-over-year to $20.9 million, primarily driven by a 58.6% increase in Digital Channels revenue. Our Wholesale Distribution segment revenues remained flat compared to the third quarter of 2016.

 

Gross profit increased 16% to $8.2 million from the third quarter of 2016 as higher revenues from the Digital Channels segment offset the increased investment in content.

 

Equity Earnings from ACL increased by 74.0% to $1.7 million from the third quarter of 2016 as ACL continued to improve its film, TV distribution and publishing business segments.

 

Net loss was $2.7 million, an improvement of $1.2 million from third quarter of 2016.

 

Adjusted EBITDA grew 3.4% to $2.9 million from the third quarter of 2016 as a result of continued growth of the higher-margin Digital Channels segment and higher equity earnings from ACL.

Highlights and significant events for the nine months ended September 30, 2017 and 2016 are as follows:

 

Digital Channels segment revenues grew by 75.1% to $19.4 million as a result of continued subscriber growth.

 

Revenues increased $1.7 million to $53.6 million. The growth in revenues from our Digital Channels segment was partially offset by a $6.6 million decline in the revenues from our Wholesale Distribution segment primarily due to the release of less content during the first half of 2017. As a result, revenues increased 3.3% to $53.6 million compared to the same period in 2016.

 

Our Digital Channels segment contribution to income from continuing operations increased 55.7% to $6.3 million from $4.1 million during the nine months ended September 30, 2016.

 

Gross margin increased to 42.3% from 32.6% for the nine months ended September 30, 2016, primarily attributable to (i) the Digital Channels segment, a higher proportion of higher-margin proprietary Digital Channels revenue mix and expanding gross margin as fixed costs are leveraged through subscriber and revenue growth and (ii) in the Wholesale

28


 

 

Distribution segment, which had a few higher than normal-margin licensing deals and lower content impairment charges during the second quarter of 2017.

 

Net loss was $9.9 million compared to $17.6 million during the nine months ended September 30, 2016. The variance is primarily improved gross profit of $5.8 million and the elimination of the $3.2 million loss from discontinued operations in 2016.

 

Adjusted EBITDA improved by $4.9 million to positive $6.9 million from the nine months ended September 30, 2016. This improvement is primarily attributable to the continued growth of the Digital Channels segment, which delivers a higher profit margin, stronger Wholesale Distribution segment performance and higher equity earnings from ACL.

 

On June 20, 2017, we broadened our strategic partnership with AMC Networks, Inc. (or AMC) to accelerate our content investments and other strategic initiatives, expanded the AMC Tranche A Loan from $13.0 million to $23.0 million and converting the form of interest payments entirely into common stock at a fixed conversion price of $3.00 per share on both the Tranche A Loan and Tranche B Loan. AMC also exercised $5.0 million of its Tranche A Warrants into RLJE common stock at $3.00 per common share. Additionally, dividend payments on the preferred stock, held by the chairman of the board of directors, were eliminated through 100% conversion of his preferred stock to common stock at $3.00 per share.

The highlights above and the discussion below are intended to identify some of our more significant results and transactions during the three and nine months ended September 30, 2017 and should be read in conjunction with our consolidated financial statements and related discussions within this Quarterly Report. Adjusted EBITDA is defined below in this Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Adjusted EBITDA.

RESULTS OF OPERATIONS

A summary of our results of operations for the three and nine months ended September 30, 2017 and 2016, as disclosed in our consolidated financial statements in Item 1, Financial Statements, is as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

$

20,900

 

 

$

18,351

 

 

$

53,620

 

 

$

51,882

 

Costs of sales

 

 

12,712

 

 

 

11,312

 

 

 

30,922

 

 

 

34,988

 

Gross profit

 

 

8,188

 

 

 

7,039

 

 

 

22,698

 

 

 

16,894

 

Operating expenses

 

 

9,872

 

 

 

7,435

 

 

 

26,047

 

 

 

22,545

 

Loss from continuing operations

 

 

(1,684

)

 

 

(396

)

 

 

(3,349

)

 

 

(5,651

)

Equity in earnings of affiliate

 

 

1,723

 

 

 

990

 

 

 

3,143

 

 

 

2,198

 

Interest expense, net

 

 

(2,288

)

 

 

(2,222

)

 

 

(6,326

)

 

 

(6,617

)

Change in fair value of stock warrants and other derivatives

 

 

(264

)

 

 

(1,222

)

 

 

(3,647

)

 

 

(3,406

)

Gain on extinguishment of debt

 

 

 

 

 

 

 

 

470

 

 

 

 

Other income (expense), net

 

 

169

 

 

 

(42

)

 

 

614

 

 

 

(772

)

Provision for income taxes

 

 

(372

)

 

 

(151

)

 

 

(848

)

 

 

(192

)

Loss from continuing operations, net of income taxes

 

 

(2,716

)

 

 

(3,043

)

 

 

(9,943

)

 

 

(14,440

)

Loss from discontinued operations, net of income taxes

 

 

 

 

 

(917

)

 

 

 

 

 

(3,169

)

Net loss

 

$

(2,716

)

 

$

(3,960

)

 

$

(9,943

)

 

$

(17,609

)

 

29


 

Revenues

A summary of net revenues by segment for the three and nine months ended September 30, 2017 and 2016 is as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Digital Channels

 

$

6,954

 

 

$

4,384

 

 

$

19,358

 

 

$

11,053

 

IP Licensing

 

 

41

 

 

 

17

 

 

 

45

 

 

 

43

 

Wholesale Distribution:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

 

11,297

 

 

 

11,440

 

 

 

25,326

 

 

 

32,787

 

International

 

 

2,608

 

 

 

2,510

 

 

 

8,891

 

 

 

7,999

 

Total Wholesale Distribution

 

 

13,905

 

 

 

13,950

 

 

 

34,217

 

 

 

40,786

 

Total Revenues

 

$

20,900

 

 

$

18,351

 

 

$

53,620

 

 

$

51,882

 

 

Revenues increased $2.5 million for the three months ended September 30, 2017 compared to the same period in 2016. The increase in revenues is primarily driven by our Digital Channels segment, which increased by $2.6 million. The increase in revenues from our Digital Channels segment primarily results from over 50% growth in paying subscribers. We increased our marketing efforts during the quarter to enhance subscriber growth. In addition, we are continually featuring new content on our digital channels, which we believe is a key factor in attracting new subscribers for all of our channels. Revenues from our Digital Channels segment continues to represent a growing and more meaningful portion of our consolidated revenues. Revenues from these channels for the three months ended September 30, 2017 account for 33.3% of our total revenues as compared to 23.9% for the three months ended September 30, 2016.

Revenues increased $1.7 million for the nine months ended September 30, 2017 compared to the same period in 2016. The increase in revenues is primarily driven by our Digital Channels segment which increased by $8.3 million offset by revenues from our Wholesale Distribution segment, which decreased by $6.6 million during the first nine months of 2017. The increase in revenues from our Digital Channels segment primarily results from over 50% growth in paying subscribers. Our Wholesale Distribution segment’s revenue decline is attributable to decreases in the U.S. revenues of $7.5 million and an increase in international revenues of $0.9 million. The Wholesale Distribution segment’s U.S. revenue decrease is primarily attributable to less content being released in the first half of 2017 compared to the same period last year as well as a decline in demand for DVDs and Blu-ray product as more digital programming becomes available. International Wholesale Distribution revenues increased due to the strong performance of two new releases during the year.

Cost of Sales (“COS”) and Gross Profit

A summary of COS by segment and overall gross margins for the three and nine months ended September 30, 2017 and 2016 is as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Digital Channels

 

$

2,291

 

 

$

1,202

 

 

$

5,496

 

 

$

3,358

 

IP Licensing

 

 

 

 

 

(106

)

 

 

 

 

 

(102

)

Wholesale Distribution

 

 

10,421

 

 

 

10,216

 

 

 

25,426

 

 

 

31,732

 

Total COS

 

$

12,712

 

 

$

11,312

 

 

$

30,922

 

 

$

34,988

 

Gross Profit

 

$

8,188

 

 

$

7,039

 

 

$

22,698

 

 

$

16,894

 

Gross Margin %

 

 

39.2

%

 

 

38.4

%

 

 

42.3

%

 

 

32.6

%

 

COS increased by $1.4 million to $12.7 million for the three months ended September 30, 2017 compared to the same period in 2016. The increase in COS is primarily attributed our Digital Channels segment which increased by $1.1 million due to increased content amortization and royalty expense resulting from additional programming added to the channels. Impairment charges recorded for content investments and inventories total $1.0 million and $0.9 million for the three months ended September 30, 2017 and 2016, respectively. Our step-up amortization was $0.7 million and $1.0 million for the three months ended September 30, 2017 and 2016, respectively. The decrease step-up amortization is primarily attributable to lower revenues for content that was released as of the Business Combination date relative to our estimations of future revenues.

As a percentage of revenues, our gross margin improved to 39.2% for the three months ended September 30, 2017 as compared to 38.4% for the same period last year. The improvement is primarily attributable to a revenue growth from our proprietary digital

30


 

channels. Revenues from these channels for the three months ended September 30, 2017 account for 33.3% of our total revenues as compared to 23.9% for the three months ended September 30, 2016. This business generates a higher gross margin than our other businesses especially as its revenues increase.

COS decreased by $4.1 million to $30.9 million for the nine months ended September 30, 2017 compared to the same period in 2016. The decrease in COS is attributed to lower sales of physical content and lower impairment charges in our Wholesale Distribution segment. Impairment charges recorded for content investments and inventories total $2.1 million and $3.9 million for the nine months ended September 30, 2017 and 2016, respectively. Our step-up amortization was $2.0 million for each of the nine months ended September 30, 2017 and 2016. Impairment charges decreased due to improved performance of our released content relative to our estimation of future revenues.

As a percentage of revenues, our gross margin improved to 42.3% for the nine months ended September 30, 2017 as compared to 32.6% for the same period last year. The improvement is primarily attributable to lower impairments and to revenue growth of our proprietary digital channels. Revenues from these channels for the nine months ended September 30, 2017 account for 36.1% of our total revenues as compared to 21.3% for the nine months ended September 30, 2016. This business generates a higher gross margin than our other businesses especially as its revenues increase. The Wholesale Distribution segment margins also increased due to the positive impact of a few one-time sales and licensing renewal transactions during the second quarter which had very little associated cost.

Selling, General and Administrative Expenses (“SG&A”)

A summary of SG&A expenses for the three and nine months ended September 30, 2017 and 2016 is as follows:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Selling expenses

 

$

3,972

 

 

$

2,536

 

 

$

9,131

 

 

$

6,882

 

General and administrative expenses

 

 

4,926

 

 

 

4,068

 

 

 

14,165

 

 

 

13,563

 

Depreciation and amortization

 

 

974

 

 

 

831

 

 

 

2,751

 

 

 

2,100

 

Total selling, general and administrative expenses

 

$

9,872

 

 

$

7,435

 

 

$

26,047

 

 

$

22,545

 

 

For the three and nine months ended September 30, 2017, SG&A increased by $2.4 million and $3.5 million, respectively, compared to the same periods in 2016. The increase in both periods is primarily attributable to targeted marketing expenses which increased $1.4 million during the quarter and $2.2 million during the nine-month period primarily due to increased marketing related to our Digital Channel segment. General and administrative expenses increased primarily due to increased incentive compensation costs including increased expenses associated with stock-based compensation for executives and employees. For the three and nine months ended September 30, 2017, depreciation and amortization expenses increased by $0.1 million and $0.7 million, respectively, which is primarily attributable to continued investment in our digital platforms to support the growth of our Digital Channels segment.

Equity Earnings of Affiliate

Equity earnings of affiliate (which is ACL) increased by $0.7 million and $0.9 million in each of the three- and nine-month periods ended September 30, 2017, when compared to the same periods in 2016. During 2017, ACL’s gross profit margin and its income from operations are higher when compared to 2016 due to higher publishing and licensing revenues, as a percent of its total revenues, which generate higher margins when compared to its other operations. In addition, ACL’s results were impacted by the receipt of additional licensing revenues from one title.

Interest Expense, Net

Interest expense increased by $0.1 million for the three-month period ended September 30, 2017 compared to the same period in 2016 which is primarily a result of higher average outstanding debt balances partially offset by reduced interest rates on our senior debt. Interest expense decreased by $0.3 million for the nine-month period ended September 30, 2017 as compared to the same period in 2016 primarily due to reduced interest rates on our senior debt partially offset by higher average outstanding debt balances during 2017 as compared to 2016.

Change in Fair Value of Stock Warrants and Other Derivatives

The change in the fair value of our warrant and other derivative liabilities impacts the statement of operations. A decrease in the fair value of the liabilities results in the recognition of income, while an increase in the fair value of the liabilities results in the

31


 

recognition of expense. Changes in fair value are primarily driven by changes in our common stock price and its volatility. For the three months ended September 30, 2017 and 2016, we recognized expense of $0.3 million and $1.2 million, respectively, due to changes in the fair value of our stock warrants and other derivative liabilities. For the nine months ended September 30, 2017 and 2016, we recognized expense of $3.6 million and $3.4 million, respectively, due to changes in the fair value of our stock warrants and other derivative liabilities.

Other Income (Expense)

Other income (expense) primarily consists of foreign currency gains and losses resulting from advances and loans by our U.S. subsidiaries to our foreign subsidiaries that have not yet been repaid. Our foreign currency gains and losses are primarily impacted by changes in the exchange rate of the Pound relative to the U.S. dollar. As the Pound strengthens relative to the U.S. dollar, we recognize other income; and as the Pound weakens relative to the U.S. dollar, we recognize other expense. During the three months ended September 30, 2017, we recognized foreign currency gains of $0.2 million compared to foreign currency losses of $0.1 million during the same period in 2016. During the nine months ended September 30, 2017, we recognized foreign currency gains of $0.6 million compared to foreign currency losses of $0.9 million during the same period in 2016.

Income Taxes

We have fully reserved our net U.S. deferred tax assets, and such tax assets may be available to reduce future income taxes payable should we have U.S. taxable income in the future. To the extent such deferred tax assets relate to net operating losses (or NOL) carryforwards, the ability to use our NOL carryforwards against future earnings will be subject to applicable carryforward periods and limitations subsequent to a change in ownership.

We recorded income tax expense of $0.4 million and $0.2 million for the three-month periods ended September 30, 2017 and 2016, respectively. We recorded income tax expense of $0.8 million and $0.2 million for the nine-month periods ended September 30, 2017 and 2016, respectively. Our tax provision in 2017 primarily relates to our U.K. operations. We provide income tax provisions on our U.K. earnings, which includes our share of ACL earnings, at an effective tax rate of approximately 20%. During 2016, our income tax provision was provided primarily during the third quarter based on the pre-tax earnings of our U.K. operations.

Loss from Discontinued Operations, Net of Income Taxes

Our loss from discontinued operations is attributable to the wind down of our U.S. catalog/ecommerce business which occurred during 2016 and was effectively complete as of September 30, 2016. For the three and nine months ended September 30, 2016, our losses were $0.9 million and $3.2 million, respectively.

ADJUSTED EBITDA

Management defines Adjusted EBITDA as earnings before income tax, depreciation and amortization, non-cash royalty expense, interest expense, non-cash exchange gains and losses on intercompany accounts, goodwill impairments, severance costs, change in fair value of stock warrants and other derivatives, stock-based compensation, basis-difference amortization in equity earnings of affiliate and dividends received from affiliate in excess of equity earnings of affiliate.

Management believes Adjusted EBITDA to be a meaningful indicator of our performance that provides useful information to investors regarding our financial condition and results of operations because it removes material non-cash items that allows investors to analyze the operating performance of the business using the same metric management uses. The exclusion of non-cash items better reflects our ability to make investments in the business and meet obligations. Presentation of Adjusted EBITDA is a non-GAAP financial measure commonly used in the entertainment industry and by financial analysts and others who follow the industry to measure operating performance. Management uses this measure to assess operating results and performance of our business, perform analytical comparisons, identify strategies to improve performance and allocate resources to our business segments. While management considers Adjusted EBITDA to be an important measure of comparative operating performance, it should be considered in addition to, but not as a substitute for, net income and other measures of financial performance reported in accordance with U.S. GAAP. Not all companies calculate Adjusted EBITDA in the same manner and the measure, as presented, may not be comparable to similarly-titled measures presented by other companies.

32


 

The following table includes the reconciliation of our consolidated U.S. GAAP net loss to our consolidated Adjusted EBITDA:

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net loss

 

$

(2,716

)

 

$

(3,960

)

 

$

(9,943

)

 

$

(17,609

)

Interest expense

 

 

2,288

 

 

 

2,222

 

 

 

6,326

 

 

 

6,617

 

Provision for income tax

 

 

372

 

 

 

151

 

 

 

848

 

 

 

192

 

Depreciation and amortization

 

 

974

 

 

 

831

 

 

 

2,751

 

 

 

2,100

 

Basis-difference amortization in equity earnings of

   affiliate

 

 

117

 

 

 

117

 

 

 

342

 

 

 

373

 

Change in fair value of stock warrants and other

   derivatives

 

 

264

 

 

 

1,222

 

 

 

3,647

 

 

 

3,406

 

Stock-based compensation

 

 

696

 

 

 

277

 

 

 

1,208

 

 

 

887

 

Restructuring

 

 

200

 

 

 

 

 

 

8

 

 

 

 

Loss from discontinued operations

 

 

 

 

 

917

 

 

 

 

 

 

3,169

 

Foreign currency exchange gain on intercompany

   accounts

 

 

(165

)

 

 

76

 

 

 

(640

)

 

 

900

 

Non-cash royalty expense

 

 

881

 

 

 

963

 

 

 

2,397

 

 

 

2,001

 

Adjusted EBITDA

 

$

2,911

 

 

$

2,816

 

 

$

6,944

 

 

$

2,036

 

 

During 2016, we changed how we are computing our Adjusted EBITDA. Previously, we were adding back content amortization and royalty expense and deducting cash invested in content to arrive at an Adjusted EBITDA. We have now aligned our adjusted EBITDA definition to our peers in our industry and to the amended definition in our credit agreement.  The revised Adjusted EBITDA adds back our non-cash royalty expense, which consists of step-up amortization and impairments on content that was acquired as of the Business Combination.

For the three- and nine-month periods ended September 30, 2017, our Adjusted EBITDA improved by $0.1 million and $4.9 million, respectively, compared to the same periods last year. The increase reflects our improved operating results from continuing operations after adjusting for the above non-cash expenses. The improved performance primarily results from the growth of our Digital Channels segment which is becoming a larger portion of our business and is contributing a higher profit margin. Adjusted EBITDA also improved due to the improved performance of our investment in ACL during the nine months ended September 30, 2017 as compared to the same period in 2016. The restructuring adjustment for the nine months ended September 30, 2017, primarily includes our net gain on extinguishment of debt, certain non-recurring transaction costs totaling $0.3 million and a legal settlement of $0.2 million during the third quarter.

BALANCE SHEET ANALYSIS

Assets

Total assets at September 30, 2017 and December 31, 2016, were $144.4 million and $136.0 million, respectively. The increase of $8.4 million in assets is primarily attributed to increases in investments in content of $14.6 million and equity investment in ACL of $3.4 million offset by decreases in accounts receivable of $6.3 million, other intangible assets of $1.2 million and cash of $1.2 million. The decrease in cash is primarily due to increased investments in content and increased royalty payments offset by the expansion of our debt, which generated about $9.3 million of cash, and cash dividends received from ACL of $1.2 million. Our equity investment in ACL increased due to improved operating performance and the strengthening Pound. Our accounts receivable decreased because of the seasonal nature of our Wholesale Distribution segment business and follows the decline in Wholesale Distribution segment revenues.

A summary of assets by segment is as follows:

 

 

 

September 30,

 

 

December 31,

 

(In thousands)

 

2017

 

 

2016

 

Digital Channels

 

$

7,806

 

 

$

5,941

 

IP Licensing

 

 

21,717

 

 

 

18,648

 

Wholesale Distribution

 

 

107,068

 

 

 

102,748

 

Corporate

 

 

7,813

 

 

 

8,643

 

 

 

$

144,404

 

 

$

135,980

 

33


 

 

Liabilities and Equity

The increase in our liabilities and equity of $8.4 million to $144.4 million is primarily due to an $8.6 million increase in our debt balance.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

A summary of our cash flow activity is as follows:

 

 

 

Nine Months Ended September 30,

 

(In thousands)

 

2017

 

 

2016

 

Net cash (used in) provided by operating activities

 

$

(9,522

)

 

$

249

 

Net cash used in investing activities

 

 

(1,199

)

 

 

(1,006

)

Net cash provided by (used in) financing activities

 

 

9,090

 

 

 

(2,100

)

Effect of exchange rate changes on cash

 

 

384

 

 

 

(199

)

Net decrease in cash

 

 

(1,247

)

 

 

(3,056

)

Cash at beginning of period

 

 

7,834

 

 

 

4,530

 

Cash at end of period

 

$

6,587

 

 

$

1,474

 

 

At September 30, 2017 and December 31, 2016, our cash and cash equivalents was $6.6 million and $7.8 million, respectively. During the nine months ended September 30, 2017, our cash position was impacted by the following:

 

We used cash for operating activities of $9.5 million compared to us generating cash from operating activities of $0.2 million for the first nine months of last year. We used more cash for operating activities in 2017 due to increasing our investments in content to expand our program library and to reducing our royalty liabilities. We continue to have significant short-term vendor debts, that are past due and which we are in the process of paying off by making increased cash payments or modifying payment terms in the short term. Bringing our vendor trade payables current continues to constrain our liquidity.

 

Our quarterly results are typically affected by: (a) the timing and release dates of key productions, (b) the seasonality of our Wholesale Distribution business which is 32% to 35% weighted to the fourth quarter and (c) the increased investment in content during the first half of the year, yet investments at times may be impacted by liquidity constraints.

 

Our reported cash flow activities include the impacts of our discontinued operations. During the nine months ended September 30, 2016, our discontinued operations required a net use of cash from operating activities of $3.8 million.

 

During the first nine months of 2017, we received $9.1 million from financing activities compared to using $2.1 million for the same period last year. During 2017, we increased our senior debt by $18.0 million and used $8.6 million to repay our subordinated debt. Last year our net cash used in financing activities consisted of normal debt servicing payments. Under our current senior loan, we have no required debt servicing payments until 2020.

Growth of our Digital Channels segment has the potential impact of improving our liquidity. We continue to realize significant growth in our Digital Channels segment. Our Digital Channels segment revenues increased 75.1% to $19.4 million during the nine months ended September 30, 2017 as compared to the same period in 2016. After cost of sales and operating expenses, our Digital Channels segment contributed $6.3 million of income from continuing operations during the nine months ended September 30, 2017 compared to $4.1 million last year. Our expectation is that our digital channels will continue to grow, although there is no assurance that this will occur.

In October 2016, we refinanced our senior debt. In January 2017, to repay our subordinated notes payable, we amended our senior debt and borrowed an additional $8.0 million. In June 2017, we expanded our senior debt and borrowed an additional $10.0 million. The proceeds received are available for working capital purposes, including the acquisition of content In addition to providing us liquidity, the amended senior loan facility helps us address our liquidity constraints going forward in three ways: (1) it eliminates cash interest payments, which were 12% prior to October 14, 2016 and 4% through March 31, 2017, (2) there are no required principal payments until 2020, and (3) the financial covenants have been reset to less restrictive levels that provide us the necessary flexibility to invest in our operations.

34


 

In 2016, we also took actions to improve our operating results and Adjusted EBITDA by exiting certain non-core operations that have been generating losses. During the first half of 2016, we closed our Acacia catalog operations. Further, on June 24, 2016, we entered into a licensing agreement to outsource the U.S. Acorn catalog/ecommerce business to USA. During 2016, our U.S. catalog/ecommerce business was fully transitioned to USA and we do not anticipate future losses from this line of business.

We believe that our current cash at September 30, 2017, will be sufficient to meet our forecasted requirements for operating liquidity, capital expenditure and debt repayments, which are none until 2020, for at least the next one year from the date of issuance of these financial statements. However, there can be no assurances that we will be successful in realizing improved results from operations including improved Adjusted EBITDA, generating sufficient cash flows from operations or agreeing with vendors on revised payment terms.

Capital Resources

Cash

As of September 30, 2017 and December 31, 2016, we had cash of $6.6 million and $7.8 million, respectively.

Senior Term Notes

On October 14, 2016, we entered into a $65.0 million Credit and Guaranty Agreement (the AMC Credit Agreement) with Digital Entertainment Holdings LLC, a wholly owned subsidiary of AMC Networks Inc. (or AMC). The proceeds received from the AMC Credit Agreement were used to repay our prior senior secured term notes of $55.1 million, including accrued interest, and transaction expenses of approximately $1.7 million, which includes a prepayment penalty of $0.8 million. Initially, the AMC Credit Agreement consisted of (i) a term loan tranche in the principal amount of $5.0 million (or Tranche A Loan), which was due October 14, 2017, and (ii) a term loan tranche in the principal amount of $60.0 million (or Tranche B Loan) of which 25% is due after five years, 50% is due after six years and the remaining 25% is due after seven years. The Tranche A Loan bears interest at a rate of 7.0% per annum and the Tranche B Loan bears interest at a rate of 6.0% per annum. Interest is payable quarterly whereby 4.0% was payable in cash and the balance is payable in shares of common stock determined using a per-share value of $3.00. The loan is secured by a lien on substantially all of our consolidated assets.

On January 30, 2017, to repay prior debt obligations under the subordinated notes payable we amended the AMC Credit Agreement and borrowed an additional $8.0 million, thereby increasing our Tranche A Loan from $5.0 million to $13.0 million. We also extended the maturity date for our Tranche A Loan from October 14, 2017 to June 30, 2019. When doing so, we did not incur a prepayment penalty.

On June 16, 2017, to fuel the growth of our business we expanded the AMC Credit Agreement and borrowed an additional $10.0 million, thereby increasing our Tranche A Loan from $13.0 million to $23.0 million. Further, we extended the maturity date for our Tranche A Loan from June 30, 2019 to beginning on June 30, 2020. We also amended the payment provisions regarding interest whereby all interest is now settled with shares of common stock at $3.00 per share beginning as of April 1, 2017. The additional $10.0 million borrowed is available for working capital purposes, including the acquisition of content. This amendment also changed certain debt covenant ratios to reflect the extended maturity date and the increase of the Tranche A Loan balance.

Concurrent with the June amendment, RLJ SPAC Acquisition, LLC converted all of its preferred stock holdings into shares of common stock and AMC exercised a portion of their warrants that resulted in a Tranche B Loan principal reduction of $5.0 million. This reduction in principal did not result in a prepayment penalty.

Subject to certain customary exceptions, the AMC Credit Agreement requires mandatory prepayments if we were to receive proceeds from asset sales, insurance, debt issuance or the exercise of warrants. We may also make voluntary prepayments. Prepayments of the Tranche B Loan (either voluntary or mandatory) are subject to a prepayment premium of 3.0% if principal is repaid on or before October 14, 2018, and 1.5% if principal is repaid after October 14, 2018 but on or before October 14, 2019. No prepayment premium is due for amounts prepaid after October 14, 2019, and for mandatory prepayments made from proceeds received from the exercise of warrants. The Tranche A Loan is not subject to prepayment penalties.

The AMC Credit Agreement contains certain financial and non-financial covenants. Financial covenants are assessed annually and are based on Consolidated Adjusted EBITDA, as defined in the AMC Credit Agreement. Financial covenants vary by fiscal year and generally become more restrictive over time.

35


 

Financial covenants include the following:

 

 

 

Fiscal Year Ended December 31, 2016

 

Fiscal Year Ending December 31, 2017

 

Fiscal Year Ending December 31, 2018

 

Thereafter

Leverage Ratios:

 

 

 

 

 

 

 

 

Senior debt-to-Adjusted EBITDA

 

6.00 : 1.00

 

5.75 : 1.00

 

4.00 : 1.00

 

Ranges from 3.75 : 1.00 to 2.50 : 1.00

Total debt-to-Adjusted EBITDA

 

6.75 : 1.00

 

6.00 : 1.00

 

5.00 : 1.00

 

4.00 : 1.00

Fixed charge coverage ratio

 

1.00 : 1.00

 

1.00 : 1.00

 

2.00 : 1.00

 

2.00 : 1.00

 

The AMC Credit Agreement contains events of default that include, among others, non-payment of principal, interest or fees; violation of covenants; inaccuracy of representations and warranties; bankruptcy and insolvency events; material judgments; cross defaults to certain other contracts (including, for example, business arrangements with our U.S. distribution facilitation partner and other material contracts); and indebtedness and events constituting a change of control or a material adverse effect in any of our results of operations or conditions (financial or otherwise). The occurrence of an event of default would increase the applicable rate of interest and could result in the acceleration of our obligations under the AMC Credit Agreement.

The AMC Credit Agreement imposes restrictions on such items as encumbrances and liens, payments of dividends to common stockholders, other indebtedness, stock repurchases, capital expenditures and entering into new lease obligations. Additional covenants restrict our ability to make certain investments, such as loans and equity investments, or investments in content that are not in the ordinary course of business. Pursuant to the AMC Credit Agreement, we must maintain at all times a cash balance of $1.0 million for 2016, $2.0 million in cash for 2017 and $3.5 million in cash for all years thereafter. As of September 30, 2017, we were in compliance with all covenants as stipulated in the amended AMC Credit Agreement.

Subordinated Notes Payable

On January 31, 2017, we repaid the outstanding principal and interest on our unsecured subordinated promissory notes. The subordinated notes were issued in 2012 in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image (or Subordinated Note Holders). In 2015, and in connection with the sale of preferred stock and warrants, the Subordinated Note Holders exchanged approximately $8.5 million of subordinated notes for 8,546 shares of preferred stock and warrants to acquire approximately 855,000 shares of common stock.

Preferred Stock

On May 20, 2015, we closed a transaction in which we sold 31,046 shares of preferred stock and warrants to acquire 3.1 million shares of common stock (the 2015 Warrants) for $22.5 million in cash and the exchange of $8.5 million in subordinated notes. Of the preferred shares and warrants sold, 16,500 shares of preferred stock and warrants to acquire 1.7 million shares of common stock were sold to certain board members or their affiliated companies. We used $10.0 million of the cash proceeds from this sale to make partial payment on our senior notes payable and approximately $1.9 million for prepayment penalties, legal and accounting fees, which include fees associated with our registration statement filed in July 2015 and other expenses associated with the transaction. The balance of the net cash proceeds was used for content investment and working capital purposes. Of the fees incurred, $0.9 million was recorded against the proceeds received, $0.5 million was recorded as additional debt discounts, $0.2 million was included as interest expense and the balance was included in other expense.

On October 14, 2016 and concurrent with the close of the AMC Credit Agreement, we amended our preferred stock such that we were able to classify our preferred stock and its embedded conversion feature within our shareholders’ equity. Prior to the amendment, our preferred stock and its embedded conversion feature were recorded on our consolidated balance sheet outside of shareholders’ equity. The amended terms are disclosed below.

The preferred stock has the following rights and preferences:

 

Rank – the preferred stock ranks higher than other company issued equity securities in terms of distributions, dividends and other payments upon liquidation.

 

Dividends – the preferred stockholders are entitled to cumulative dividends at a rate of 8% per annum of a preferred share’s stated value ($1,000 per share plus any unpaid dividends). The first dividend payment was made on July 1, 2017 and payments will be made quarterly thereafter. At our discretion, dividend payments are payable in either cash, or if we satisfy certain equity issuance conditions, in shares of common stock. Pursuant to the October 14, 2016 amended terms, if we don’t satisfy equity issuance conditions, then we may elect to accrue the value of the dividend and add it to the preferred share’s stated value.

36


 

 

Conversion – at the preferred stockholder’s discretion, each share of preferred stock is convertible into 333.3 shares of our common stock, subject to adjustment for any unpaid dividends. Prior to the October 14, 2016 amendment, the conversion rate was subject to anti-dilution protection for offerings consummated at a per-share price of less than $3.00 per common share. This down-round provision was removed as part of the October 14, 2016 amendment.

 

Mandatory Redemption – unless previously converted, on May 20, 2020, at our option we will either redeem the preferred stock with (a) cash equal to $1,000 per share plus any unpaid dividends (Redemption Value), or (b) shares of common stock determined by dividing the Redemption Value by a conversion rate equal to the lower of (i) the conversion rate then in effect (which is currently $3.00) or (ii) 85% of the then trading price, as defined, of our common stock. As part of the October 14, 2016 amendment, a floor was established for all but 16,500 shares of preferred stock such that the redemption ratio cannot be below $0.50 per common share. For the 16,500 shares of preferred stock, a floor of $2.49 was already in place and remained unchanged. If we were to redeem with shares of common stock, the actual number of shares that would be issued upon redemption is not determinable as the number is contingent upon the then trading price of our common stock. Generally, if we were to redeem with shares, the number of common shares needed for redemption increases as our common stock price decreases. Because of the October 14, 2016 amendment, the maximum number of common shares issuable upon redemption is determinable given the redemption conversion floors. If we elect to redeem with shares of common stock, and we fail to meet certain conditions with respect to the issuance of equity, then we would be subject to a 20% penalty of the maturity redemption price, payable in either cash or shares of common stock. This penalty is subject to, and therefore possibly limited by, a $0.50 per share floor.

 

Voting – except for certain matters that require the approval of the preferred stockholders, such as changes to the rights and preferences of the preferred stock, the preferred stock does not have voting rights. However, the holders of the preferred stock are entitled to appoint two board members and, under certain circumstances, appoint a third member.

We are increasing (or accreting) the carrying balance of our preferred stock up to its redemption value using the effective interest-rate method over a period of time beginning from the issuance date of May 20, 2015 to the required redemption date of May 20, 2020. During the nine months ended September 30, 2017 and 2016, we recognized accretion of $1.0 million and $3.8 million, respectively. Accretion includes cumulative preferred dividends. As of September 30, 2017, the accumulated unpaid dividends on preferred stock were $2.8 million. During the nine months ended September 30, 2017 and 2016 accumulated dividends increased by $1.4 million (or $46.16 per share of preferred stock) and $2.0 million (or $64.80 per share of preferred stock), respectively. On July 1, 2017, we made the first cash dividend payment of $0.4 million.

During 2016, two preferred shareholders converted a total of 849 shares of preferred stock and $0.1 million of accumulated dividends into 0.3 million shares of common stock. During June 2017, the largest preferred shareholder (RLJ SPAC Acquisition, LLC) converted a total of 15,000 shares of preferred stock and $2.7 million of accumulated dividends into 5.9 million shares of common stock.

In 2015, we filed a registration statement with the Securities and Exchange Commission to register the shares issuable upon conversion of the preferred stock and exercise of the 2015 Warrants. The registration statement was declared effective in July 2015 and amended in 2016. If we are in default of the registration rights agreement, and as long as the event of default is not cured, then we are required to pay, in cash, partial liquidation damages, which in total are not to exceed 6% of the aggregated subscription amount of $31.0 million. We will use our best efforts to keep the registration statement effective.

RELATED PARTY TRANSACTIONS

In the ordinary course of business we enter into transactions with related parties, primarily our equity method investee and entities owned and controlled by the Chairman of our Board of Directors. Information regarding transactions and amounts with related parties is discussed in Note 14, Related Party Transactions of our consolidated financial statements in Item 1, Financial Statements.

OTHER ITEMS

Off-Balance Sheet Arrangements

We typically acquire content via separately executed licensing or distribution agreements with content suppliers. These contracts generally require that we make advance payments before the content is available for exploitation. Advance payments are generally due prior to and upon delivery of the related content. To the extent payment is not due until delivery has occurred, we do not recognize our payment obligations under our licensing and distribution agreements prior to the content being delivered. As of September 30, 2017, we had entered into licensing and distribution agreements for which we are obligated to pay $8.0 million once the related content has been delivered.

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Critical Accounting Policies and Procedures

There have been no significant changes in the critical accounting policies disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K filed on March 23, 2017.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Item 3, Quantitative and Qualitative Disclosures about Market Risk is not required for smaller reporting companies.

ITEM 4.

CONTROLS AND PROCEDURES

 

(a)

Evaluation of Disclosure Controls and Procedures

The term “disclosure controls and procedures” is defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Exchange Act. Disclosure controls and procedures refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

We have evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.

 

(b)

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

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PART II - OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

In the normal course of business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to employment and tax matters. While it is not possible to predict the outcome of these matters, it is the opinion of management, based on consultations with legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on our financial position, results of operations or liquidity.

ITEM 1A.

RISK FACTORS

Our results of operations and financial condition are subject to numerous risks and uncertainties described in our Annual Report on Form 10-K filed on March 23, 2017. You should carefully consider these risk factors in conjunction with the other information contained in this Quarterly Report. Should any of these risks materialize, our business, financial condition and future prospects could be negatively impacted. As of September 30, 2017, there have been no material changes to the risk factors set forth in that Form 10-K.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

As reported in Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, the AMC Credit Agreement initially provided for the payment of interest partially in cash and partially in shares of common stock. In June 2017, we amended the payment provisions regarding interest whereby all interest is now settled with shares of common stock beginning as of April 1, 2017. The shares are issuable at $3.00 per share. For the quarter ended March 31, 2017, we issued AMC 224,807 shares of common stock in payment for $0.7 million of interest, including 102,501 shares issued January 3, 2017 in payment of $0.3 million of interest on the outstanding principal of $65.0 million for the quarter ended December 31, 2016, and 122,306 shares issued March 31, 2017 in payment of $0.4 million of interest on the outstanding principal of $73.0 million for the quarter ended March 31, 2017. For the quarter ended June 30, 2017, we issued AMC 384,084 shares of common stock in payment of $1.2 million of interest on the outstanding principal of $78.0 million. The issuance of the shares was exempt from registration pursuant to Securities Act Section 4(a)(2) as a transaction not involving a public offering.

ITEM 6.

EXHIBITS

 

 

 

31.1

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

 

 

31.2

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

 

 

32.1

Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

 

 

101.INS

XBRL Instance Document

 

 

101.SCH

XBRL Taxonomy Extension Schema Document

 

 

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document

 

 

101.LAB

XBRL Taxonomy Extension Label Linkbase Document

 

 

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

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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.

 

 

RLJ ENTERTAINMENT, INC.

 

 

 

 

Date:

November 9, 2017

By:

/S/ MIGUEL PENELLA

 

 

 

Miguel Penella

 

 

 

Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

Date:

November 9, 2017

By:

/S/ NAZIR ROSTOM

 

 

 

Nazir Rostom

 

 

 

Chief Financial Officer

 

 

 

(Principal Financial and Accounting Officer)

 

 

40