UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark one)

For the quarterly period ended March 31, 2018.

For the transition period from ________ to ________.

Commission File Number 001-35675

 

RLJ ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

 

 

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):

 

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 May 3, 2018:  15,138,250

 

 

 

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RLJ ENTERTAINMENT, INC.

INDEX TO FORM 10-Q

 

 

 

 

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2018, 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:

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 16, 2018. You are cautioned not to place undue reliance on such forward-looking statements.

 

 

 

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PART I - FINANCIAL INFORMATION

RLJ ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

March 31, 2018 (unaudited) and December 31, 2017

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

Three Months Ended March 31, 2018 and 2017

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

Three Months Ended March 31, 2018 and 2017

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

Three Months Ended March 31, 2018

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Three Months Ended March 31, 2018 and 2017

 

 

See accompanying notes to consolidated financial statements.

 

 

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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) 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 United Kingdom (or 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 are a premium digital channel company serving distinct audiences through our proprietary subscription-based video on demand (or SVOD) digital channels (or Digital Channels segment), Acorn TV and UMC or Urban Movie Channel. Acorn TV features high-quality British and International mysteries and dramas. UMC showcases superior black television programs and films including original series, drama, romance, comedy, thrillers, stage plays, documentaries and other exclusive content for African-American and urban audiences.

We also exclusively control, co-produce, and own a large library of content primarily consisting of British mysteries and dramas, independent feature films and urban content. In addition to supporting our Digital Channels segment, we monetize our library through intellectual property (or IP) rights that we own, produce, and then exploit worldwide (our IP Licensing segment) and through distribution operations across all available wholesale windows of exploitation (our Wholesale Distribution segment). Our IP Licensing segment consists of our investment in ACL and owned intellectual property that is either owned or created by us and licensed for exploitation worldwide. Our Wholesale Distribution segment consists of worldwide exploitation of exclusive content in various formats through third party media and retail outlets in the United States of America (or U.S.), Canada, U.K. and Australia. 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.

Basis of Presentation

Unaudited Interim Financial Statements

The consolidated financial information presented in the accompanying unaudited interim consolidated financial statements as of March 31, 2018 and for the three months ended March 31, 2018 and 2017 has been prepared in accordance with accounting principles generally accepted in the United States (or US GAAP) and with the Securities and Exchange Commission’s (or SEC) instructions for interim financial reporting 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 US 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 16, 2018 (or 2017 Form 10-K). Note 2, Summary of Significant Accounting Policies, of our audited consolidated financial statements included in our 2017 Form 10-K contains a summary of our significant accounting policies. As of March 31, 2018, we have made no material changes to our significant accounting policies disclosed in our 2017 Form 10-K, except for the adoption of the new revenue recognition standard.

Recently Adopted Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (or FASB) issued Accounting Standard Update (ASU) No. 2014-09, Revenue from Contracts with Customers, as a new Topic, Accounting Standards Codification (ASC) Topic 606. 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. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. We adopted Topic 606 as of January 1, 2018 using the modified retrospective method. See Note 2, Revenues, for further details.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases. This ASU establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required by lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of the pending adoption of this new standard on our financial statements and we have yet to determine the overall impact this ASU is expected to have. The likely impact will be one of presentation only on our consolidated balance sheets. Our leases currently consist of operating leases with varying expiration dates through 2022 and our future minimum lease commitments before sub-lease income total $4.3 million as of March 31, 2018.

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.

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. Our recurring fair value measurements of stock warrants and other derivative liabilities and our non-recurring fair value measurements of investments in content are disclosed in Note 11, Fair Value Measurements.

Earnings (Loss) per Common Share

Basic earnings (loss) per common share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is 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 March 31, 2018, our cash balance was $4.2 million. For the three months ended March 31, 2018, we recognized a net loss of $6.5 million and we used $1.1 million of cash for operating activities. At March 31, 2018, we had $53.7 million of term debt outstanding (see Note 8, 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 past-due vendor payables. These past-due payables are largely a result of 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.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Growth of our Digital Channels segment has the potential to improve our liquidity. We continue to realize significant growth in our Digital Channels segment. Our Digital Channels segment revenues increased 45.4% to $8.7 million during the three months ended March 31, 2018 as compared to the same period in 2017 (see Note 3, Segment Information).

We believe that our current cash at March 31, 2018, and cash generated from operations will be sufficient to meet our forecasted requirements for operating liquidity, capital expenditure and debt repayments (none until 2020) 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. We define 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, restructuring 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.

NOTE 2. REVENUES

Adoption of ASC Topic 606, "Revenue from Contracts with Customers"

On January 1, 2018, we adopted Topic 606 using the modified retrospective method applied to all contracts as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

We recorded a net increase to opening accumulated deficit of $0.7 million as of January 1, 2018 due to the cumulative impact to revenues and cost of sales of adopting Topic 606, with the impact primarily related to renewals for licensing agreements within our Wholesale Distribution segment. Under the new standard, renewals are a separate deliverable for which revenue should generally be deferred and recognized when the renewal period begins. Under the prior standards, renewals were generally recognized as revenue when entering into an amendment.

The cumulative effect of the changes made to our consolidated January 1, 2018 balance sheet for the adoption of Topic 606, Revenue — Revenue from Contracts with Customers were as follows:

 

 

The impact of adoption on our current period statement of operations was as follows:

 

 

Within our Wholesale Distribution segment, we estimate certain non-physical revenues each reporting period and we adjust our estimate when additional information becomes available, which includes the receipt of actual statements from our wholesalers. For the three months ended March 31, 2018 and 2017, we recognized an increase in revenues of $0.2 million and $0.1 million, respectively, as actual information received exceeded our prior period estimates.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Digital Channels segment revenues are recognized over time as subscription services are delivered. Wholesale Distribution segment revenues are generally recognized at a point in time when a sales transaction is completed. As of March 31, 2018, our deferred revenue of $3.3 million comprised of prepaid subscriptions within our Digital Channels segment of $2.8 million, payments received within our Wholesale Distribution segment of $0.1 million for content not yet delivered or available due to certain restrictions, and $0.4 million for the license of our tradenames. Deferred revenue will be recognized over time as revenue upon delivery of subscription services or content, or upon the removal of restrictions whereby the wholesaler will be free to exploit the delivered content. Deferred revenue associated with the tradename license will be recognized in equal monthly amounts over the license term beginning in April 2018 through March 2020. We estimate that all deferred revenue amounts that are not associated with the tradename license will be recognized as revenue within the next 12 months.

Upon adoption of the new revenue standards, we also made certain other reclassifications within our consolidated balance sheet, which pertained to sales of DVD and Blu-rays that are within our Wholesale Distribution segment, as follows:

Included in our accounts payable and other accrued liabilities are accruals for both sales returns and market development funds that total $3.8 million and $6.8 million as of March 31, 2018 and December 31, 2017, respectively. These accruals require the exercise of judgement and affect the reported revenues and net earnings. In determining these accruals, we analyze historical returns, pricing and other credit data; current economic trends; and changes in customer demand and acceptance of our products, including reorder activity. Based on this information, we determine our best estimates, which we believe is fair value, and accrue a percentage of each dollar of product sales where the customer has the right to either return the product and receive a credit or reduce their purchase price. Actual returns and reductions could differ from our estimates.

 

NOTE 3. 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 operations. 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 includes the subscription-based sale of film and television content directly and through third-party distribution to consumers through our digital channels, Acorn TV and UMC. Our IP Licensing segment includes intellectual property (or content) that we own, produce and then license for exploitation worldwide. The IP Licensing segment also includes our investment in ACL. Our Wholesale Distribution segment consists of the acquisition and worldwide exploitation of exclusive content in various formats, including digital (download-to-rent and electronic sell-through, or EST), television video on demand (VOD) through cable and satellite, broadcast, streaming, and DVD and Blu-ray through third party media and retail outlets. 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 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 our 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.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Operating costs and expenses exclude costs related to depreciation and amortization which are separately presented in the tables below.

The tables below summarize the segment contribution for the three months ended March 31, 2018 and 2017.

 

 

 

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

 

 

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 are as follows:

 

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 4. 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.

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

 

 

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 5. 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.

 

 

Wholesale Distribution receivables are partially billed and collected by our U.S. distribution facilitation partner, 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 March 31, 2018, SPHE owed us $0.8 million for receivables settled at quarter end. As of December 31, 2017, we owed SPHE $4.1 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.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

As of March 31, 2018, the net Wholesale Distribution payables with SPHE were $0.5 million, which is included in accounts payable and accrued liabilities. As of December 31, 2017, the net Wholesale Distribution receivables with SPHE were $4.3 million, which is included in accounts receivable.

 

 

NOTE 6. INVENTORIES

Inventories are summarized as follows:

 

 

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 $9.5 million as of March 31, 2018 and $10.2 million as of December 31, 2017. We reduce our inventories with adjustments for lower of cost or market valuation, shrinkage, excess quantities and obsolescence. During the three months ended March 31, 2018, we recorded no impairment charges. During the three months ended March 31, 2017, we recorded impairment charges of $0.4 million. These charges are included in cost of sales as manufacturing and fulfillment cost.

 

 

NOTE 7. INVESTMENTS IN CONTENT

 

 

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. Impairment charges for the three months ended March 31, 2018 and 2017, were $0.3 million in each period. Impairment charges are included in cost of sales as part of content amortization and royalties.

In determining the fair value of content for impairments (Note 11, Fair Value Measurements), 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 type of content.

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 8. DEBT

Debt consists of the following:

 

 

Future minimum principal payments, exclusive of debt discount, as of March 31, 2018 are as follows:

 

 

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.

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 was payable quarterly whereby 4.0% was payable in cash and the balance was 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. This amendment also changed certain debt covenant ratios to reflect the extended maturity date and the increase of the Tranche A Loan balance.

On January 2, 2018, we issued AMC 418,255 shares of common stock in payment of $1.3 million of interest on the principal outstanding under the AMC Credit Agreement.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Concurrent with the June 2017 amendment, RLJ SPAC Acquisition, LLC (a related party) converted all of its preferred stock holdings into shares of common stock (see Note 9, Redeemable Convertible Preferred Stock and Equity) and AMC exercised a portion of their warrants (see Note 10, Stock Warrants) that resulted in the Tranche B Loan principal reduction of $5.0 million.

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 (see Note 10, 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:

 

 

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 $3.5 million for all years beginning after 2017. As of March 31, 2018, we were in compliance with all covenants as set forth in the amended 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 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.

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 9. 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.

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:

We are adjusting the carrying balance of our preferred stock 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 three months ended March 31, 2018 and 2017, we recognized accretion of $0.2 million and $0.4 million, respectively. Accretion includes cumulative preferred dividends. As of March 31, 2018, the accumulated unpaid dividends on preferred stock were $2.8 million. During the three months ended March 31, 2018 there was no change in accumulated dividends. During the three months ended March 31, 2017 accumulated dividends increased by $0.7 million (or $22.60 per share of preferred stock). During the three months ended March 31, 2018, we made cash dividend payments of $0.4 million.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

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 10, 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. The restricted stock-based awards are fair valued 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 awards may be subject to further forfeitures if the employee or director terminates his or her service during the vesting period. All shares of restricted stock participate in dividends, if declared prior to their vesting date.

The option grants in 2017 include an option to purchase 0.7 million shares of common stock with an exercise price of $2.66 per share cliff vesting in two years and an option to purchase 0.7 million shares of common stock with an exercise price of $3.00 per share cliff vesting in four years.

Total share-based compensation expense for the three months ended March 31, 2018 and 2017 is detailed below.

 

As of March 31, 2018, unrecognized share-based compensation expense relating to restricted stock-based service awards of $1.5 million is expected to be expensed ratably over the remaining weighted-average vesting period of 1.4 years. Unrecognized compensation expense relating to restricted stock-based performance awards of $1.1 million is expected to be expensed ratably over the remaining weighted-average vesting period of 1.8 years. Unrecognized compensation expense relating to unvested stock options of $1.7 million is expected to be expensed ratably over the remaining weighted-average vesting period of 2.0 years. Expense associated with our performance award is contingent upon achieving specified financial criteria and upon certification by the Compensation Committee of the satisfaction of the 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 130% (or 0.7 million shares). However, the possible range of vesting is between zero and 1.0 million shares.

Assuming 100% vesting for all service awards and 130% vesting of all performance awards, we expect to recognize $2.2 million of compensation expense over the next 12 months.

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

A summary of our restricted stock unit activity during the three months ended March 31, 2018 is presented below:

 

 

During the three months ended March 31, 2018, we issued 75,000 shares of common stock for restricted stock units that vested on December 31, 2017. On April 2, 2018, we issued 158,000 shares of common stock for restricted units that vested on March 31, 2018.

A summary of our restricted stock award activity during three months ended March 31, 2018 is presented below.

 

 

A summary of our stock option activity during three months ended March 31, 2018 is presented below.

 

 

 

NOTE 10. STOCK WARRANTS

We have the following unregistered warrants outstanding:

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

Concurrent with entering into the AMC Credit Agreement, we issued 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 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 the 2015 Warrants to our preferred stock holders to acquire 3.1 million shares of our common stock. The 2015 Warrants have a 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 2015 Warrants to 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 2015 Warrants to shareholders’ equity.

 

 

NOTE 11. FAIR VALUE MEASUREMENTS

Warrant Liability

Stock Warrant and Other Derivative Liabilities

We account for our AMC Tranche C Warrant to acquire 5.0 million shares of common stock as a derivative liability, which requires us to carry it on our consolidated balance sheet at its fair value.

We determined the fair value of the AMC Tranche C warrant using a lattice model, which is classified as Level 3 within 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 $16.7 million as of March 31, 2018 and $13.7 million as of December 31, 2017. During the current year, the AMC Tranche C warrant increased in value as a result of an increase in our common stock price.

The following table represents the carrying amount, valuation and a roll-forward of activity for our warrant classified within Level 3 of the fair-value hierarchy:

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

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:

 

 

During the three months ended March 31, 2018 and 2017, the investments in content were impaired by $0.3 million in each period. In determining the fair value of our investments in content, we employ a 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 12. NET LOSS PER COMMON SHARE

We had outstanding warrants to acquire 21.3 million and 30.1 million shares of common stock as of March 31, 2018 and 2017, 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 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 March 31, 2018 and 2017, we have weighted average unvested shares of 2.7 million and 0.6 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 months ended March 31, 2018 and 2017, we excluded 5.9 million and 11.7 million shares of common stock that are acquirable upon conversion of the preferred stock as they were anti-dilutive.

 

 

NOTE 13. STATEMENTS OF CASH FLOWS

Supplemental Disclosures

 

 

 

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RLJ Entertainment, Inc.

 

Notes To Consolidated Financial Statements

(Unaudited)

 

NOTE 14. 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 15. RELATED PARTY TRANSACTIONS

Equity Investment in Affiliate

During the three months ended March 31, 2017, we paid ACL $0.1 million, 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 three months ended March 31, 2018 and 2017, we recognized content amortization and royalty expense of $44,000 and $0.1 million, respectively. This amortization is included in our cost of sales as content amortization and royalties. As of March 31, 2018, our remaining unamortized content advance is $1.5 million.

ACL paid dividends to RLJE Ltd. of $0.4 million during the three months ended March 31, 2018. No dividends were received during the three months ended March 31, 2017. Dividends received were recorded 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 AME and RLJE Australia. As of March 31, 2018, Acorn Media had lent its U.K. subsidiaries approximately $5.1 million and its Australian subsidiary approximately $3.4 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 British Pound Sterling 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 March 31, 2018, we recognized foreign currency losses of $7,000. During the three months ended March 31, 2017, we recognized foreign currency gains of $0.3 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 March 31, 2018, we made payments totaling $0.5 million to The RLJ Companies, which reduced our remaining obligation to $2.0 million.

Debt, Preferred Stock and Warrants

On January 2, 2018, we made a dividend payment of $0.4 million to our preferred shareholders, which includes AMC. Since AMC holds more than 10% of the outstanding shares of our common stock, they are considered a related party.

On January 2, 2018, we issued AMC 418,255 shares of common stock in payment of $1.3 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement.

 

 

NOTE 16. SUBSEQUENT EVENTS

On April 2, 2018, we made a dividend payment of $0.4 million to our preferred shareholders.

On April 2, 2018, we issued AMC 409,162 shares of common stock in payment of $1.2 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement.

 

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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 16, 2018.

OVERVIEW

General

RLJ Entertainment, Inc. (RLJE or the Company) 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 United Kingdom (or 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 are a premium digital channel company serving distinct audiences through our proprietary subscription-based video on demand (or SVOD) digital channels (or Digital Channels segment), Acorn TV and UMC or Urban Movie Channel. Acorn TV features high-quality British and International mysteries and dramas. UMC showcases superior black television programs and films including original series, drama, romance, comedy, thrillers, stage plays, documentaries and other exclusive content for African-American and urban audiences.

We also exclusively control, co-produce, and own a large library of content primarily consisting of British mysteries and dramas, independent feature films and urban content. In addition to supporting our Digital Channels segment, we monetize our library through intellectual property (or IP) rights that we own, produce, and then exploit worldwide (our IP Licensing segment) and through distribution operations across all available wholesale windows of exploitation (our Wholesale Distribution segment). Our IP Licensing segment consists of our investment in ACL and owned intellectual property that is either owned or created by us and licensed for exploitation worldwide. Our Wholesale Distribution segment consists of worldwide exploitation of exclusive content in various formats through third party media and retail outlets in the United States of America (or U.S.), Canada, U.K. and Australia. 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.

HIGHLIGHTS

Highlights and significant events for the three months ended March 31, 2018 and 2017 are as follows:

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The highlights above and the discussion below are intended to identify some of our more significant results and transactions during the three months ended March 31, 2018 and should be read in conjunction with our consolidated financial statements and related discussions within this Quarterly Report. Adjusted EBITDA is defined and reconciled to net loss 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 months ended March 31, 2018 and 2017, as disclosed in our consolidated financial statements in Item 1, Financial Statements, is as follows:

 

 

Revenues

A summary of revenues by segment for the three months ended March 31, 2018 and 2017 is as follows:

 

 

Revenues increased $4.7 million for the three months ended March 31, 2018 compared to the same period in 2017. The increase in revenues is primarily driven by our Digital Channels segment, which increased by $2.7 million, and our Wholesale Distribution segment, which increased by $2.0 million. The increase in revenues from our Digital Channels segment was driven by a 44.2% growth in paying subscribers. We increased our marketing efforts beginning in the third quarter of 2017 to support 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 March 31, 2018 account for 46.7% of our total revenues as compared to 43.0% for the three months ended March 31, 2017.

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Our Wholesale Distribution segment’s revenue increase is primarily attributable to increases in U.S. revenues of $1.7 million. The Wholesale Distribution segment’s U.S. revenue increase is primarily attributable to increased digital sales and demand for content being released during the current period.

Cost of Sales (“COS”) and Gross Margins

A summary of COS by segment and overall gross margins for the three months ended March 31, 2018 and 2017 is as follows:

 

 

COS increased by $0.7 million to $9.8 million for the three months ended March 31, 2018 compared to the same period in 2017. The increase in COS is primarily attributable to an increase in royalty expenses within our Digital Channels segment. This increase is due to the release of new content on the channels. Impairment charges recorded for content investments and inventories total $0.3 million and $0.7 million for the three months ended March 31, 2018 and 2017, respectively. Impairment charges decreased due to improved performance of our released content relative to our estimation of future revenues. Our step-up amortization was $0.5 million and $0.9 million for the three months ended March 31, 2018 and 2017, respectively. The decrease in step-up amortization is attributable to lower revenues from titles that were acquired prior to our Business Combination. As time passes, we expect that step-up amortization will continue to decrease.

As a percentage of revenues, our gross margin improved to 47.4% for the three months ended March 31, 2018 as compared to 34.3% for the same period last year. The improvement is primarily attributable to lower impairments and step-up amortization within our Wholesale Distribution segment, as well as, revenue growth of our proprietary digital channels, which generates a higher gross margin than our other business segments.

Operating Expenses (“SG&A”)

A summary of the components of SG&A for the three months ended March 31, 2018 and 2017 is as follows:

 

 

For the three months ended March 31, 2018, SG&A increased by $2.8 million compared to the same period last year. The increase is attributable to targeted marketing expenses that increased $2.0 million during the quarter, primarily due to increased marketing related to our Digital Channels segment. General and administrative expenses increased $0.8 million primarily due to increased incentive compensation costs including increased expenses associated with share-based compensation for executives and employees.

Equity Earnings of Affiliate

Equity earnings of affiliate (which is ACL) increased $0.2 million for the three months ended March 31, 2018 when compared to the same periods in 2017. For the first quarter of 2018, ACL’s gross profit and its income from operations are higher when compared to the same period in 2017 due to higher publishing revenues, as a percent of its total revenues, which generate higher margins when compared to its other operations.

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Interest Expense, Net

Interest expense increased $0.4 million for the three months ended March 31, 2018 as compared to the same period in 2017. The increase is primarily a result of higher average outstanding debt balances during the three months ended March 31, 2018 as compared to the same period in 2017.

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 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 March 31, 2018 and 2017, we recognized expense of $3.0 million and $2.9 million, respectively, due to changes in the fair value of our stock warrants and other derivative liabilities.

Other (Expense) Income

Other (expense) income mostly 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 British Pound Sterling (or 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 Dollar, we recognize other expense. During the three months ended March 31, 2018, we recognized a foreign currency loss of $7,000 on intercompany loans with our foreign subsidiaries. During the three months ended March 31, 2017, we recognized foreign currency gains of $0.3 million.

During the three months ended March 31, 2018, other expenses also included foreign currency transaction costs of $0.1 million related to transactions in Canadian dollars and $0.1 million of transaction costs incurred to respond to AMC’s offer to purchase RLJE’s common stock.

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 $0.2 million for each of the periods ending March 31, 2018 and 2017. Our tax provision consists primarily of a deferred tax provision for certain deferred tax liabilities and a current tax provision for our U.K. operations. We are recording a deferred tax provision and liability for our equity earnings of affiliate (ACL). These earnings will be taxable in the U.K., when and if we dispose of our investment. We are providing current income tax expense on pre-tax income from our consolidated U.K. subsidiaries at an effective tax rate of approximately 19%. We are not providing a current tax provision (benefit) on our U.S. operations, other than for certain state minimum taxes, which are not material.

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, restructuring 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 US 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.

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

 

For the three months ended March 31, 2018, our Adjusted EBITDA improved by $1.4 million compared to the same period 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 Wholesale Distribution segment during the three months ended March 31, 2018 as compared to the same period in 2017. The 2018 restructuring adjustment primarily consists of certain non-recurring transaction costs totaling $0.2 million. The 2017 restructuring adjustment primarily includes our net gain on extinguishment of debt and certain non-recurring transaction costs totaling $0.3 million.

BALANCE SHEET ANALYSIS

Assets

Total assets at March 31, 2018 and December 31, 2017, were $147.8 million and $151.8 million, respectively. The decrease of $4.0 million in assets is primarily attributed to decreases in cash of $2.0 million, accounts receivable of $8.7 million, and other intangible assets of $0.3 million; offset by increases in investments in content of $6.1 million and equity investment in ACL of $1.1 million. The decrease in cash is primarily due to increased investments in content, the use of cash for incentive compensation payments and to reduce vendor payables, offset by net cash received from the collection of accounts receivable and cash dividends received from ACL of $0.4 million. Our equity investment in ACL primarily increased due to improved operating performance at ACL. Our accounts receivable decreased due to the seasonal nature of our Wholesale Distribution business and follows the decline in our Wholesale Distribution segment revenues.

A summary of assets by segment is as follows:

 

 

Liabilities and Equity

The decrease of liabilities and equity of $4.0 million to $147.8 million is primarily due to a decrease in our account payable and accrued liabilities of $5.0 million, primarily resulting from payments to vendors and incentive compensation payments; and a decrease in retained earnings of $7.3 million primarily attributable to our net loss during the quarter. These decreases were offset by increases in the fair value of our stock warrants of $3.0 million, accrued royalties of $1.1 million, the accretion of debt discount of $1.1 million, additional paid-in capital of $1.7 million, primarily from the issuance of common stock for interest, and the reduction of accumulated other comprehensive loss of $1.0 million from foreign currency gains.

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LIQUIDITY AND CAPITAL RESOURCES

Liquidity

A summary of our cash flow activities is as follows:

 

 

During the three months ended March 31, 2018, our cash position was impacted by the following:

Growth of our Digital Channels segment has the potential to improve our liquidity. We continue to realize significant growth in our Digital Channels segment. Our Digital Channels segment revenues increased 45.4% to $8.7 million during the three months ended March 31, 2018 as compared to the same period in 2017. After cost of sales and operating expenses, our Digital Channels segment contributed $2.4 million of income from operations during the three months ended March 31, 2018 compared to $2.6 million last year. Our expectation is that our Digital Channels segment will continue to grow, however there is no assurance that this will occur.

We believe that our current cash at March 31, 2018, and cash to be generated from operations will be sufficient to meet our forecasted requirements for operating liquidity, capital expenditures and debt repayments (none due until 2020) for at least one year from the date of issuance of this Quarterly Report. 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 March 31, 2018 we had cash of $4.2 million, as compared to $6.2 million as of December 31, 2017.

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.

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 was payable quarterly whereby 4.0% was payable in cash and the balance was 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.

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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. 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 2017 amendment, RLJ SPAC Acquisition, LLC (a related party) converted all of its preferred stock holdings into shares of common stock and AMC exercised a portion of their warrants that resulted in the Tranche B Loan principal reduction of $5.0 million.

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.

Financial covenants include the following:

 

 

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 $3.5 million for all years beginning after 2017. As of March 31, 2018, we were in compliance with all covenants as stipulated in the amended 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.

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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.

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.

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:

We are adjusting the carrying balance of our preferred stock 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 three months ended March 31, 2018 and 2017, we recognized accretion of $0.2 million and $0.4 million, respectively. Accretion includes cumulative preferred dividends. As of March 31, 2018, the accumulated unpaid dividends on preferred stock were $2.8 million. During the three months ended March 31, 2018 there was no change in accumulated dividends. During the three months ended March 31, 2017 accumulated dividends increased by $0.7 million (or $22.60 per share of preferred stock). During the three months ended March 31, 2018, we made cash dividend payments of $0.4 million.

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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 15, 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 March 31, 2018, we had entered into licensing and distribution agreements for which we are obligated to pay $6.0 million once the related content has been delivered.

Critical Accounting Policies and Procedures

There have been no significant changes in the critical accounting policies disclosed in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K filed on March 16, 2018.

 

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

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.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2018 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

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.

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 16, 2018. 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 March 31, 2018, there have been no material changes to the risk factors set forth in that Form 10-K.

As reported in Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, the AMC Credit Agreement requires us to settle all interest payments with shares of common stock. The shares are issuable at $3.00 per share. During the quarter ended March 31, 2018, we issued AMC 418,255 shares of common stock in payment of $1.3 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 5.OTHER INFORMATION

On February 26, 2018, we received a letter from AMC (the Proposal Letter) pursuant to which AMC proposed to acquire the outstanding shares of our common stock not currently owned by AMC and its affiliates or Mr. Robert L. Johnson, The RLJ Companies, LLC and RLJ SPAC Acquisition, LLC for a cash purchase price of $4.25 per share. Through this offer AMC intends that the Company would become a privately-owned subsidiary of AMC, with a minority stake held by Mr. Johnson or his affiliates. AMC stated in the Proposal Letter that it is only interested in acquiring the shares of the Company (and outstanding rights to acquire shares of the Company) not owned by AMC or Mr. Johnson and his affiliates and has no interest in disposing of its stake in the Company or participating in any other process. Our Board of Directors formed a special committee of independent directors composed of directors Andor (Andy) Laszlo and Scott R. Royster and authorized the committee to evaluate and respond to the Proposal Letter. The special committee has engaged an independent legal advisor and an independent financial advisor and is in the process of reviewing the Proposal Letter.

 

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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.

 

 

 

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