Image Entertainment, Inc. F4Q08 (Qtr End 03/31/08) Earnings Call Transcript

Jun.27.08 | About: Image Entertainment, (DISK)

Image Entertainment, Inc. (OTC:DISK) F4Q08 Earnings Call June 26, 2008 4:30 PM ET

Executives

David Borshell - President

Jeff Framer - Chief Financial Officer

Bill Bromiley - Chief Acquisitions Officer

Rick Eiberg - Executive Vice President of Operation and Chief Technology Officer

Burgess Wilson - Senior Vice president of Digital Operations

Michael Bayer - Associate General Counsel and Vice President of Business and Legal Affairs.

Operator

Good day and welcome ladies and gentlemen to the Fourth Quarter and Fiscal Year End 2008 Results Conference Call (Operator Instructions). I will now ask Michael Bayer, the company’s Associate General Counsel, to read the safe harbor statement.

Michael Bayer

Thank you operator. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 relating to among other things, our goals, plans, and projections regarding our financial position, results of operations, market position, product development, and business strategy. These statements may be identified by the use of words such as, “will”, “may”, “estimate”, “expect”, “intend”, “plan”, “believe”, and other terms of similar meaning in connection with any discussion of future operating or financial performance.

All forward-looking statements are based on management’s current expectations and involve inherent risks and uncertainties, including factors that could delay, divert, or change any of them and could cause actual outcomes and results to differ materially from current expectations. These factors include among other things our inability to raise additional working capital, changes in debt and equity markets, increased competitive pressures, changes in our business plan, and changes in the retail DVD and entertainment industries. For further details and a discussion of these and other risks and uncertainties, please see Forward-Looking Statements and Risk Factors in our most recent annual report on form 10-K and our most recent quarterly report on form 10-Q. Unless otherwise required by law, we undertake no obligation to publicly update any forward-looking statement whether as a result of new information, future events, or otherwise. Thank you, operator.

Operator

I will now turn the conference over to David Borshell, President of Image Entertainment Incorporated. Please go ahead Sir.

David Borshell

Thank you, operator. I would like to thank everyone for joining us this afternoon. Participating with me on today’s call is Jeff Framer, our Chief Financial Officer; Bill Bromiley, our Chief Acquisitions Officer; Rick Eiberg, Executive Vice President of Operations and Chief Technology Officer; Burgess Wilson, our Senior Vice President of Digital Operations; and of course Michael Bayer, our Associate General Counsel and Vice President of Business and Legal Affairs.

Before I turn the call over to Jeff to review the financial details of the past quarter and full year, I’d like to take a few moments and provide some of my own remarks. You’re not going to get an argument from me that Image’s fiscal 2008 was filled with anticipation, excitement, challenges, and disappointment, all pretty much in that order. On the corporate front, the year was primarily consumed with efforts to close on an intended merger of a BTP acquisition company, which after numerous BTP requests and extensions, culminated in the merger transaction being terminated by Image’s Board of Directors in early February. What ensued was a litany of disputes between the parties as to which party was responsible for the failure of the deal followed by the filing of lawsuits and cross complaints by the respected parties. All this was unproductive and certainly a distraction for management and the company as a whole.

If there is a silver lining in any of this, here it is. I’m very pleased to announce that on June 24, two short days ago, Image and BTP executed a settlement agreement which among other things called for the immediate mutual release and dismissal of each party’s claims, actions, and lawsuits. Pivotal in all of this was a dispute over an output distribution agreement that was entered into back in December 2007 with CT1 Holdings, the parent company of ThinkFilm and Capitol Films and a related part of the BTP. While the output agreement has also been terminated as part of the settlement, Image and CT1 continue to work together under an interim distribution arrangement as well as through standalone single picture agreements. The signing of the settlement agreement is great news, not only for Image but also for its customers, business partners, and stockholders and was celebrated by our board, our lender, our outside counsel, and our auditors as well.

On the general business front, we had our fair share of challenges. The DVD market is rapidly maturing, and the industry faces a constriction of available DVD shelf space at brick-and-mortar retailers. Due to this trend, on can’t deny that it’s proving more difficult to keep DVD products, specifically catalog titles, in front of the consumer, and therefore management embarked that an overall review of its future DVD sales projections of previously released titles and determined it was appropriate to take a significant charge against many of its titles for which Image still had outstanding un-recouped balances or excess on-hand DVD inventories. This was not an easy decision, but it was a prudent decision and one that we feel allows us to more accurately reflect our current business without compromising future revenue projections.

Let’s not forget that even in the face of the market maturation, shelf space limitations, and a slight downturn in overall industry revenues, Image is still part of a DVD market where consumers spend in excess of $20 billion annually. We have experienced growth in our online customer sales as reduced shelf space is not a factor. We have also seen tremendous year-over-year growth on the digital side of our business which we expect to continue as this burgeoning entertainment platform develops.

Our stockholders must not lose sight that image has built an incredible distribution infrastructure that is not easily replicated and is known to one of Image’s most valuable assets. We probably foster direct relationships with every major retailer in the country, built a digital distribution division that rivals our competition including the major studios and amassed an exclusive library programming that can and will be exploited across numerous formats and platforms for many years to come.

Based on these factors alone, management does not believe that Image’s current share price accurately reflects the true value of the company. Image has openly discussed its recent movement into the acquisition and distribution of finished cast-driven films. We’ve worked very hard over the past nine months to add the skill set necessary to operate in the film distribution business, all the while maintaining a strong focus on the core and non-film business that has been Image’s mainstay.

To that end, we established a future film acquisition team, a worldwide television sales group, and increased our internal focus on the brands we represent like Criterion, Discovery, and Levity. We also expanded our digital distribution rates by broadening our customer base and improved our retail sales efforts by having dedicated rental, sell-through, and special market sales teams.

As it specially pertains to the film part of the business, we feel very confident that this initiative is a catalyst for increased revenues and a great way to leverage the fixed cost of our infrastructure. Images have positioned itself well and is recognized by producers, talent agents, investment groups, foreign sales companies as a formidable competitor in the feature film acquisition and distribution arena.

Here is a sampling of some of our more significant feature films Image is or will be distributing in 2009: The Air I Breathe starring Andy Garcia, Sarah Michelle Gellar, Forest Whitaker, and Brendan Fraser with DVD street date of May 27; Numb starring Matthew Perry, Kevin Pollak, and Mary Steenburgen with DVD street date of May 13; Before the Devil Knows You're Dead starring Philip Seymour Hoffman, Ethan Hawke, Marisa Tomei, and Albert Finney. That DVD street date is April 15. Love and Other Disasters starring Brittany Murphy, DVD just steeted on June 17. The Secret starring David Duchovny. DVT street date is August 12. Then She Found Me which is currently playing at theaters nationwide directed by and starring Helen Hunt, Matthew Broderick, Colin Firth, and Bette Midler. That DVD street will be October 7. My Name is Bruce which was financed by Image starring Bruce Campbell of The Evil Dead and Army of Darkness fame. This film has a planned theatrical release of early November, with DVD’s street date following in January ’09; and The Chosen One starring Rob Schneider, with a DVD street date planned for February ‘09.

I’m happy that our new fiscal year is upon us as management embarks on a turnaround plan dedicated to increasing revenues, returning the company to profitability, and ultimately maximizing stockholder value. While this plan will not happen overnight, it is something that should unfold nicely over the coming quarter. As the company’s recently appointed president, I thank everyone for their support and look forward to an exciting year ahead. Jeff?

Jeff Framer

Thanks, Dave. Thank you everybody for joining this call and good afternoon. I’m going to spend a few minutes with you on our consolidated financial results for our fourth quarter and fiscal year ended in more detail.

Let’s first start with the fourth quarter. Net revenues were down 14% to $26 million which is compared with $30.2 million for the fourth quarter of last fiscal year. We had growth in our digital distribution revenues. They grew 30% to $535,000, up from $412,000 for last year’s fourth quarter. We did see lower DVD and CD sales during this quarter, both in new releases and previously released programming. Some of our bigger title sales of this particular quarter were Suburban Girl, the feature film, Last Emperor which is a Criterion Collection film, and Chronicles of Narnia which is a BBC remastered boxed set.

The issue that, I think, you are going to notice by looking at all the numbers is that in the fourth quarter we actually showed a negative gross profit margin of 14.6% compared to a positive gross profit margin of 16.3% for the fourth quarter a year ago. During the fourth quarter, we recorded a charge of $10.4 million or $0.48 per diluted share which represented accelerated amortization and fair value write-downs of our advanced royalty and distribution and fees and inventory. The charge resulted from primarily reducing our forecast of future revenues to be generated from deep catalog programming.

As David mentioned, during our fourth quarter, the industry trade magazines came out and said that for the first year ever DVD sales actually decreased rather than increase which pretty much signaled the maturation of the DVD industry, and again the good news is it was still $23.4 billion last year in terms of consumers buying and renting DVDs, but for us, being essentially a non-hit distributor, we are subject to the shelf space constraints more so than other companies. We have 3500 titles, and the last time you walked into any big retailer, you don’t see those 3500 titles, you see a very, very small percentage of those, and really where you’ll find them is on the internet, through internet retailers where they have virtual shelf space. The $10.4 million charge negatively impacted our gross margins by 40.2% in the fourth quarter of 2008. In other words, the reason we had negative gross margin of 14.6% is because we lowered our actual margin by 40.2% based on this quarter’s net sales.

Selling expenses were 13% of net revenues, up from 8.1% of net revenues for the fourth quarter of last year. We had increased advertising and promotional expenses of $547,000, 78% of them were related to titles where we incurred the advertising prior to street date, and that street date will have the next fiscal year or fiscal first quarter ending June 30, 2008. We also had $196,000 in increased personnel costs which is associated with the addition of our new feature film staff consisting of marketing and sales personnel. G&A expenses increased 29.2% to $6,114,000, as compared to $4,734,000 for the fourth quarter of last year, and the components of unique items that we spent funds on at this particular fiscal year fourth quarter: $744,000 or $0.03 per diluted share on expenses associated with the negotiations related to disputes with BTP. The good news is after settling, we should not see that going forward in a significant way. In the fourth quarter of last year, we incurred $1.2 million, or $0.06 per diluted share in expenses associated with negotiating the sale of the company.

Also this quarter, we incurred $979,000 or $0.05 per diluted in the CEO retirement package as well as several accruals for two other individuals who left at March 31, 2008. We had $246,000 in legal settlement expenses in relation to the separation of employment with an executive officer. We had $168,000 in consulting fees associated with the required March 31, 2008, Sarbanes-Oxley which we were compliant as of March 31, 2008. Interest expense was $843,000, which is compared to $746,000 for last year’s fourth quarter, and a big portion of that is non-cash interest expense. So, of the $843,000, $409,000 was non-cash interest expense associated with the amortization of our debt discounts and deferred financing costs. Last year, $431,000 or 57.7% of the $746,000 was again associated with non-cash interest expense. We recorded also in the fourth quarter a net non-cash charge of $599,000 or $0.05 per diluted share which reflects the change in fair value of our embedded derivatives within our convertible note payable, partially offset by the reduction in the fair value of the associated long-term warrant liability. Purely an accounting charge, again non-cash.

Net loss for the quarter was $14,719,000, or $0.68 per diluted share compared to a net loss of $3,050,000 or $0.14 per diluted share for last year’s fourth quarter.

I’m going go over the net loss components. It’s $14.7 million. I just want to take you through some specific components of this loss which are either non-cash or non-recurring, and let’s go through them now. All of these by the way total $13,806,000. So, of our $14.7 million loss, $13.8 million I’m going to give you the components of. Non-cash interest expense was $408,000, normal depreciation and amortization of intangibles and property, plant, and equipment was $400,000, direct expenses related to BTP $744,000, legal expenses related to the separation of employment that I mentioned earlier $246,000, severance accruals $979,000, write-down of advance royalties and distribution fees $7,222,000 (part of the $10.4 million charge), write-down of inventory $3.2 million (again part of the $10.4 million charge), and the change in fair value of the warrant and derivative instrument $599,000. I just wanted to give you what those components are to better help you assess what would be continuing or not continuing and help you see how that quarter loss got to be so big.

In April 2008, the company and Wachovia, our lender, amended our May 2007 three-year loan and security agreement to increase our maximum borrowing availability under the line to $20 million, and this was up from $15 million. Now our borrowings are based on our eligible accounts receivable, so if our eligible accounts receivable are higher, we can borrow all the way up to the $20 million.

They also reduced the minimum financial covenant levels on a going forward basis to help us with our compliance with those covenants, which used to be cumulative, and now they’re quarter by quarter and then later in the fiscal year they become 6-month covenants. We were in compliance with our covenants at March 31, 2008. We had borrowed $5.2 million out of the $20 million line and had an additional $8.2 million in borrowing availability at March 31, 2008.

Now the financial summary for fiscal 2008, the whole fiscal year: Net revenues were $95.8 million, compared to $99.8 million for fiscal 2007. Digital revenues were $2.148 million, up 77%, from $1,214,000 for last year’s fourth quarter. Overall gross profit margins were 10.8%, down from 17.8% for fiscal 2007. That fourth quarter charge that I discussed earlier, which was $0.48 per diluted share reduced our annual gross profits margins by 10.9%. In other words, where we started after taking 10.9% the way we ended up with 10.8% as our reported gross profit margin.

Consolidated selling expenses marginally increased to 10.9% of net revenues, up from 10.5% for 2007. General and administrative expenses were up $1.6 million, or 9.2%, compared to fiscal 2007. Here comes the laundry list of the unique items that we had during this fiscal year. $1.9 million or $0.09 per dilute shared in BTP-related expenses, $979,000, or $0.05 per diluted share on CEO retirement package along with the severance of the other individuals, $400,000 or $0.02 per diluted share in accelerated depreciation and amortization of fixed assets associated with the close of the Nevada distribution facility, $384,000 or $0.02 per share in consulting fees associated with our required Sarbanes-Oxley Section 404 compliance as of March 31, 2008, $346,000, or $0.02 per diluted share, in legal settlement expenses relating to the separation of employment with an executive officer, $250,000, or $0.01 per diluted share, in legal expenses for the dismissed stockholder claim associated with the BTP proposed merger.

For comparative purposes, during fiscal 2007 the Company incurred expenses of (this was a year ago): $1.4 million, or $0.06 per share in expenses and fees associated with negotiating the sale of the company, $634,000, or $0.03 per diluted share, in expenses and fees associated with the Image's board of directors special committee process and the Lions Gate proxy contest, $263,000, or $0.01 per diluted share, in severance costs and UK office closure costs.

Restructuring expenses was (which we normally don't have) $612,000, or $0.03 per diluted share, relating to the closure of the Las Vegas, Nevada distribution facility when we moved our warehousing and fulfillment to Arvato Digital Services. That includes $364,000 in involuntary employee termination expense and $248,000 in lease termination expenses.

Non-cash interest expense for the year $1,666,000, or $0.08 per diluted share, versus $1,273,000, or $0.06 per diluted share, a year ago. Total interest expense was $3,345,000, of which the non-cash portion was $1,666,000, and a year ago, total interest expense was $2,434,000. The non-cash portion was a gain of $1,273,000.

Net loss for the year was $23,053,000, or $1.06 per diluted share compared to a net loss of $12,611,000, or $0.59 per diluted share.

I want to go through the components of the $23 million net loss for you, again with either recurring, non-cash, or non-recurring. We have non-cash interest expense of $1,666,000, we have normal depreciation and amortization of intangibles and also property, plant, and equipment of $1,698,000, we have the close of Las Vegas distribution facility $858,000, termination of the Nevada distribution facility lease of $170,000, non-continuing Las Vegas distribution expenses of $703,000 were incurred during this last fiscal year that won’t be duplicated next year, BTP-related expenses of $1,918,000, shareholder claim that was dismissed relating to the BTP merger of $250,000, expenses in relation to the separation of separation of employment with an executive officer $346,000, severance accruals of $979,000, and $10.4 million in the charge to reduce the inventories and advanced royalties. All that totals almost $19 million, so we have $19 million of the $23 million as just being discussed as to what they relate to.

Our best-selling DVD, new releases, and catalog releases for the fiscal year ended March 31, 2008, were Jeff Dunham: Spark of Insanity; Jeff Dunham: Arguing With Myself; Twilight Zone: The Definitive Collection; The Criterion Collection’s version of Fear and Loathing in Las Vegas; Discovery Channel’s Shark Week: 20th Anniversary Collection; Katt Williams: Live; Short Circuit; and Gabriel Iglesis.

It’s important to note the unusual non-operating cash flow items over the past three years that contributed to our $5.2 million in borrowings at the end of March 31, 2008. We have the $4.5 million in legal and investment banking and related BTP and Lions Gate Proxy Contest expenditures, we have that settlement charge relating to the executive, we have severance paid to Las Vegas facility of $3.164 million, and we have advances paid to BTP for exclusive content for titles we have yet to release, and then of course, offsetting all that, we received an advance from our Canadian distributor, Entertainment One, of $1,333,000 on March 31, 2008. All of that totals including the offset $6.7 million, we borrowed $5.2 million, so I believe that we can safely say that all this has contributed to our borrowing little.

It’s been a very, very tough fiscal 2008, full of distractions. With the settlement of the BTP dispute, we are excited about not having distractions going into the next fiscal year. Plus with our featured film initiative where when you read the 10-K, we go through in detail the types of programming coming our next fiscal year. We didn’t have that kind of programming in fiscal 2008. We believe we are the best distributor of non-hits of selected programming, the best of everything that is non-studio-type release. What we were missing would be the featured film releases that actually have known casts. We think that by adding those two offerings plus internal broadcast elements plus the exciting growth that we are seeing in the digital side, that we actually have a real shot to grow our revenues, when in the past, without the featured films, it has been a struggle, and with that we have provided annual guidance of between $115 million and $125 million for fiscal 2009. We are not providing quarterly guidance at this time. We are not providing any EPS guidance or earnings guidance at this time either. Hopefully, as this year unfolds and we start seeing some consistency, we can provide that information to you.

Now, I’ll turn the call back over to Dave Borshell. Dave?

Dave Borshell

Operator, I think we are ready to take any questions.

Question-and-Answer Session

Operator

Thank you. The question and the answer session will begin at this time (Operator Instructions). As there are no questions, I’d like to turn the conference back to Mr. Borshell.

Dave Borshell

No hurt feelings on our side with no questions. We will be back early part of August to announce our first quarter fiscal 2009. In the meantime, we appreciate you joining us on this call, and look forward to talking to you again in the near future. Operator, I think we’re done.

Operator

Ladies and gentlemen, if you wish to access a replay for this call, you may do so by dialing 1-888-203-1112, or 719-457-0820. Pass code 3407160. This concludes our conference for today. Thank you for participating, and have a nice day!

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