-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RjAaRUInyonn7R2gipsVw8gKY5U228qy9IXxMDavoPnp/+1KWjJR8AuxvYYMUF0+ bhpCMOOmXY3pjbnAmz2TuA== 0000950148-97-003129.txt : 19971230 0000950148-97-003129.hdr.sgml : 19971230 ACCESSION NUMBER: 0000950148-97-003129 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971229 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KUSHNER LOCKE CO CENTRAL INDEX KEY: 0000842009 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MOTION PICTURE & VIDEO TAPE PRODUCTION [7812] IRS NUMBER: 954079057 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10661 FILM NUMBER: 97745768 BUSINESS ADDRESS: STREET 1: 11601 WILSHIRE BLVD 21ST FLR CITY: LOS ANGELES STATE: CA ZIP: 95202 BUSINESS PHONE: 3104451111 MAIL ADDRESS: STREET 1: 11601 WILSHIRE BLVD STREET 2: 21ST FLOOR CITY: LOS ANGELES STATE: CA ZIP: 90025 10-K 1 FORM 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 COMMISSION FILE NO. 0-17295 THE KUSHNER-LOCKE COMPANY (Exact name of registrant as specified in its charter) CALIFORNIA 95-4079057 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 11601 Wilshire Blvd., 21st Floor, Los Angeles, California 90025 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (310) 445-1111 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Not Applicable SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, without par value 10% Convertible Subordinated Debentures, Series A due 2000 13 3/4% Convertible Subordinated Debentures, Series B due 2000 Common Stock Purchase Warrants, Class C Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value based on the closing price of the Registrant's Common Stock held by nonaffiliates of the Registrant was approximately $22,260,000 as of December 23, 1997. There were 9,132,815 shares of outstanding Common Stock of the Registrant as of December 23, 1997. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A not later than 120 days after the end of the Registrant's fiscal year (September 30, 1997) are incorporated by reference in Part III Items 10, 11, 12 and 13 of this Form 10-K. Total number of pages 60. Exhibit Index begins on page 58. ================================================================================ 2 PART I 1. BUSINESS GENERAL The Kushner-Locke Company (the "Company") is a leading independent entertainment company which principally develops, produces, and distributes original feature films and television programming. The Company's television programming has included television series, mini-series, movies-for-television, animation, reality and game show programming for the major networks, cable television, first-run syndication and international markets. The Company's feature films are developed and produced for the theatrical, made-for-video and pay cable motion picture markets. The Company established its feature film production operations in 1993. In 1994, the Company established an international theatrical film subsidiary to expand into foreign theatrical distribution. In 1995, the Company formed KLC/New City ("KLC/New City"), a joint venture 82.5% owned by the Company, to acquire films for distribution through emerging new delivery systems, including pay cable, pay-per-view, basic cable, video-on-demand and satellite systems. The Company's feature film activities can be grouped into three areas: production and distribution of a limited number of higher-budget films intended for wide-screen domestic theatrical release, production and distribution of low-to-moderate budget films released direct-to-video or on pay cable television, and distribution licensing of acquired film rights. In certain cases, the Company's low-to-moderate budget films may have a limited theatrical release or a pay cable premiere before being released in home video. For fiscal 1997, the Company did not release a higher budget film, but earned revenues of more than $1,800,000 from the continued international exploitation of The Adventures of Pinocchio, which was originally released in fiscal 1996. The Company's feature slate for fiscal 1997 generated $19,800,000 of revenues principally from the international exploitation of Basil starring Christian Slater, Claire Forlani and Jared Leto, and Double Tap starring Heather Locklear and Stephen Rea, delivery of a film produced for Twentieth Century Fox Film Corporation, equity in the earnings of a joint venture which produced two sequels to the animated feature Brave Little Toaster, and seven children's fantasy adventure films. In various stages of production for the Company's currently anticipated fiscal 1998 distribution slate are Beowulf starring Christopher Lambert, Denial starring Jason Alexander and directed by Adam Rifkin, Minion starring Dolph Lundgren, Possums starring Mac Davis, Noose directed by Ted Demme, Susan's Plan written and directed by John Landis, Bone Daddy starring Rutger Hauer, Girl starring Dominique Swain, One Man's Hero starring Tom Berenger, Taxman starring Joe Pantoliano, Legion starring Parker Stevenson, Swing starring Lisa Stansfield, and three family films. The Company's distribution activities consist primarily of foreign distribution of product produced, overseen or acquired by the Company and, through KLC/New City, domestic distribution of over 100 low-budget feature films to the pay-per-view, pay cable, basic cable and other ancillary markets. In fiscal 1997, the Company generated $11,700,000 of revenues from licenses of its existing library and from domestic distribution of films acquired through KLC/New City. Since its inception in 1983, the Company has produced or distributed over 1,000 hours of original television programming, including various television series, movies-for-television and mini-series. The Company's recent movies-of-the-week which have aired include Princess in Love for CBS, starring Julie Cox, Every Woman's Dream for CBS starring Jeff Fahey, A Husband, A Wife and a Lover for CBS starring Judith Light, Echo for ABC starring Jack Wagner, Jack Reed for NBC, starring Brian Dennehy and Unlikely Angel for CBS, starring Dolly Parton. For fiscal 1997, the Company's television slate generated $22,800,000 of revenue principally from network and international licensing of Jack Reed, Unlikely Angel, and the television series Gun, and Hammer. Gun episodes starred Jennifer Tilly, Randy Quaid, Darryl Hannah, Rosanna Arquette and Peter Horton. The series was co-executive produced by Robert Altman (director of M*A*S*H, The Player and Pret-a-Porter) who directed the first episode. The Company is currently producing the one hour ABC prime time network series Cracker starring Robert Pastorelli (through a joint venture with Granada under a 22 episode order), 26 one hour episodes of the syndicated television series Hammer starring Stacy Keach, a half-hour HBO series which the Company is distributing to international and other domestic markets, and 26 half-hour episodes of Mowgli: The New Adventures of The Jungle Book, including 13 episodes for the Fox Kids Network and all 26 episodes for foreign distribution. As of September 30, 1997, the Company had 13 movies-for-television and various television series in different stages of development for potential production. 2 3 TV First, which is a partnership 50% owned by the Company, purchases media time for Christian music infomercials produced by the Company. TV First markets compact discs and audio and video cassettes. Fiscal 1997 sales by the joint venture exceeded $6,600,000. The Company recently entered into an agreement in principle with a major studio whereby the Company has the right to distribute in international territories up to nine moderate to high-budget motion pictures over a three year period. The Company has the right to select the motion pictures, if any, to be distributed among titles made available by the major studio. In the event the Company selects one or more films under the arrangement, management currently expects to finance its acquisition of the distribution rights via credit facilities not presently in place. There can be no assurance that definitive agreements for this distribution arrangement will be agreed to, that financing will be obtained, or that such activities will ultimately be profitable if undertaken. The Company's operating revenues were $56,935,000 for the fiscal year ended September 30, 1997, a decrease of 29% from the $80,157,000 recognized for the fiscal year ended September 30, 1996. This decrease reflects in part the Company's increased use of joint venture arrangements for its production and distribution of certain feature films and television programming. In certain cases the Company recognizes in its financial statements its equity in earnings of unconsolidated entities operating results rather than gross distribution revenues. For example, for fiscal 1997, the Company would have recognized an additional $8,500,000 for Cracker produced by Cracker Company LLC were this joint venture's revenues consolidated. The Company also did not release a high budget picture in 1997 similar to The Adventures of Pinocchio in 1996. If revenues generated by The Adventures of Pinocchio were excluded from both fiscal 1996 and 1997 periods, current year reported revenues would have increased 2%. In its production activities, the Company generally seeks to finance all or a substantial portion of its costs through domestic and international pre-sales, output arrangements or joint venture or distribution agreements with third parties, while retaining the benefit of ownership rights or profit participations in each film or television program. However, as the Company has shifted a significant portion of its product mix from its traditional base of network-television programming, the Company has become subject to the increased risks of such activities, including the longer lead times to complete new product and obtain cash receipts from exploitation of such product in the international marketplace. The Company's executive offices are located at 11601 Wilshire Boulevard, Suite 2100, Los Angeles, California 90025, and its telephone number is (310) 445- 1111. FORWARD LOOKING STATEMENTS Except for the historical information contained herein, certain of the matters discussed in this annual report are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995 which involve certain risks and uncertainties which could cause actual results to differ materially from those discussed herein. Such risks and uncertainties include, but are not limited to, liquidity and financing requirements, variability of quarterly results and prior losses, increased interest expense, dependence on a limited number of projects, certain accounting policies including amortization of film costs, dependence on key personnel, production deficits, the risk involved in the television and theatrical film industries, competition, government regulation, labor relations, and the volatility of public markets. See the relevant discussions elsewhere herein, and in the Company's registration statement on Form S-3 (Registration No. 333-40391), as filed on November 17, 1997 and the Company's periodic reports and other documents filed with the Securities and Exchange Commission for further discussions of these and other risks and uncertainties pertaining to the Company and its business. MOTION PICTURE INDUSTRY OVERVIEW The business of the motion picture industry may be broadly divided into two major segments: production, involving the development, financing and making of motion pictures, and distribution, involving the promotion and exploitation of completed motion pictures in a variety of media. Historically, the largest companies, the so-called "Majors" and "mini-Majors," have dominated the motion picture industry by both producing and distributing a majority of the motion pictures which generate significant box office receipts. Over the past decade, however, "Independents" or smaller film production and distribution companies, such as the Company, 3 4 have played an increasing role in the production and distribution of motion pictures to fill the increasing worldwide demand for filmed entertainment product. The Majors (and mini-Majors) include Universal Pictures, Warner Bros. Pictures, Metro-Goldwyn-Mayer Inc., Twentieth Century Fox Film Corporation, Paramount Pictures Corporation, Sony Pictures Entertainment (including Columbia Pictures, TriStar Pictures and Triumph Releasing) and The Walt Disney Company (Buena Vista Pictures, Touchstone Pictures and Hollywood Pictures). Generally, the Majors own their own production studios (including lots, sound stages and post-production facilities), have nationwide or worldwide distribution organizations, release pictures with direct production costs generally ranging from $25 million to $75 million, and provide a continual source of pictures to film exhibitors. In addition, some of the Majors have divisions which are promoted as "independent" distributors of motion pictures. These "independent" divisions of Majors include Miramax Films (a division of The Walt Disney Company), Sony Classics (a division of Sony Pictures), The Samuel Goldwyn Company (a division of Metro-Goldwyn-Mayer), October Films (a division of Universal), New Line (a division of Time Warner) and its Fine Line distribution label, and Republic Pictures (a division of Viacom). In addition to the Majors, the Independents engaged primarily in the distribution of motion pictures produced by companies other than the Majors include, among others, Trimark Holdings and Live Entertainment. The Independents typically do not own production studios or employ as large a development or production staff as the Majors. MOTION PICTURE PRODUCTION AND FINANCING The production of a motion picture usually involves four steps: development, pre-production, production and post-production. The development stage includes developing a concept internally, or obtaining an original screenplay or a screenplay based on a pre-existing literary work, or acquiring and rewriting a screenplay. Creative personnel may be contacted to determine availability and for planning the timing of the project, or in some cases actually hired. In pre-production, a budget is prepared, the remaining creative personnel, including a director, actors and various technical personnel are hired, shooting schedules and locations are planned and other steps necessary to prepare for principal photography are completed. Production is the principal photography of the project and generally continues for a period of not more than three months. In post-production, the film is edited and synchronized with music and dialogue and, in certain cases, special effects are added. The final edited synchronized product, the negative, is used to manufacture release prints suitable for public exhibition. The production of a motion picture requires the financing of the direct and indirect overhead costs of production. Direct production costs include film studio rental, cinematography, post-production costs and the compensation of creative and other production personnel. Distribution costs (including costs of advertising and release prints) are not included in direct production costs. The Majors generally have sufficient cash flow from their motion picture and related activities, or in some cases, from unrelated businesses (e.g., theme parks, publishing, electronics, and merchandising) to pay or otherwise provide for their production costs. Overhead costs are, in substantial part, the salaries and related costs of the production staff and physical facilities which the Majors maintain on a full-time basis. The Majors often enter into contracts with writers, producers and other creative personnel for multiple projects or for fixed periods of time. Independents generally avoid incurring substantial overhead costs by hiring creative and other production personnel and retaining the other elements required for pre-production principal photography and post-production activities only on a project-by-project basis. Unlike the Majors, Independents also typically finance their production activities from various sources, including bank loans, "pre-sales," equity offerings and joint ventures. Independents generally attempt to complete their financing of a motion picture production prior to commencement of principal photography, at which point substantial production costs begin to be incurred and to require payment. "Pre-sales" are often used by Independents to finance all or a portion of the direct production costs of a motion picture. Pre-sales consist of fees or advances paid or guaranteed to the producer by third parties in return for the right to exhibit the completed motion picture in theaters or to distribute it in home video, television, international or other ancillary 4 5 markets. Independents with distribution capabilities may retain the right to distribute the completed motion picture either domestically or in one or more international markets. Other independents may separately license theatrical, home video, television, international and other distribution rights among several licensees. Payment commitments in a pre-sale are typically subject to delivery and to the approval of a number of prenegotiated factors, including script, production budget, cast and director. Both Majors and Independents often acquire motion pictures for distribution through an arrangement known as a "negative pickup" under which the Major or Independent agrees to acquire from another production company some or all rights to a film upon its completion. The Independent often finances production of the motion picture pursuant to financing arrangements with banks or other lenders wherein the lender obtains a security interest in the film and in the Independent's rights under its distribution arrangement. When the Major or Independent "picks up" the completed motion picture, it may assume some or all of the production financing indebtedness incurred by the production company in connection with the film. In addition, the Independent is often paid a production fee and is granted a participation in the profits from distribution of the motion picture. Both Majors and Independents often grant third-party participations in connection with the distribution and production of a motion picture. Participations are contractual rights of actors, directors, screenwriters, producers, owners of rights and other creative and financial contributors entitling them to share in revenues or profits (as defined in the respective agreements) from a particular motion picture. Except for the most sought-after talent, participations are generally payable only after all distribution and marketing fees and costs, direct production costs (including overhead) and financing costs are recouped by the producer in full. MOTION PICTURE DISTRIBUTION Distribution of a motion picture involves the domestic and international licensing of the picture for (i) theatrical exhibition, (ii) home video, (iii) presentation on television, including pay-per-view, video-on-demand, satellites, pay cable, network, basic cable and syndication, (iv) non-theatrical exhibition, which includes airlines, hotels, armed forces facilities and schools and (v) marketing of the other rights in the picture, which may include books, CD-ROMs, merchandising and soundtrack recordings. Theatrical Distribution and Exhibition. Motion pictures are often exhibited first in theaters open to the public where an admission fee is charged. Theatrical distribution involves the manufacture of release prints; licensing of motion pictures to theatrical exhibitors; and promotion of the motion picture through advertising and promotional campaigns. The size and success of the promotional and advertising campaign may materially affect the revenues realized from its theatrical release, generally referred to as "box office gross." Box office gross represents the total amounts paid by patrons at motion picture theaters for a particular film, as determined from reports furnished by exhibitors. The ability to exhibit films during summer and holiday periods, which are generally considered peak exhibition seasons, may affect the theatrical success of a film. Competition among distributors to obtain exhibition dates in theaters during these seasons is significant. In addition, the costs incurred in connection with the distribution of a motion picture can vary significantly depending on the number of screens on which the motion picture is to be exhibited and the ability to exhibit motion pictures during peak exhibition seasons. Similarly, the ability to exhibit motion pictures in the most popular theaters in each area can affect theatrical revenues. Exhibition arrangements with theater operators for the first run of a film generally provide for the exhibitor to pay the greater of 90% of ticket sales in excess of fixed amounts relating to the theater's costs of operation and overhead, or a minimum percentage of ticket sales which varies from 40% to 70% for the first week of an engagement at a particular theater, decreasing each subsequent week to 25% to 30% for the final weeks of the engagement. The length of an engagement depends principally on the audience response to the film. 5 6 Films with theatrical releases (which generally may continue for up to six months) typically are made available for release in other media as follows:
MONTHS AFTER THEATRICAL APPROXIMATE RELEASE MARKET RELEASE PERIOD - ------ ------------ ------------------- Domestic home video.............................................. 4 - 6 months 6 months Domestic pay-per-view............................................ 6 - 9 months 3 months Domestic pay cable............................................... 10 - 18 months 12 - 21 months Domestic network or basic cable.................................. 30 - 36 months 18 - 36 months Domestic syndication............................................. 30 - 36 months 3 - 15 years International theatrical......................................... _ 4 - 6 months International home video......................................... 6 - 12 months 6 months International television......................................... 18 - 24 months 18 months - 10 years
Home Video. The home video distribution business involves the promotion and sale of videocassettes and videodiscs to video retailers (including video specialty stores, convenience stores, record stores and other outlets), which then rent or sell the videocassettes and videodiscs to consumers for private viewing. The home video marketplace now generates total revenues greater than the domestic theatrical exhibition market. Major feature films are usually scheduled for release in the home video market four to six months after theatrical release to capitalize on the recent theatrical advertising and publicity for the film. Promotion of new home video releases is generally undertaken during the nine to twelve weeks before the home video release date. Videocassettes of feature films are generally sold to domestic wholesalers on a unit basis. Unit-based sales typically involve the sales of individual videocassettes to wholesalers or distributors at approximately $50 to $60 per unit and generally are rented by consumers for fees ranging from $1 to $5 per day (with all rental fees retained by the retailer). Wholesalers who meet certain sales and performance objectives may earn rebates, return credits and cooperative advertising allowances. Selected titles including certain made-for-video programs, are priced significantly lower to encourage direct purchase by consumers. The market for direct sale to consumers is referred to as the "priced-for-sale" or "sell-through" market. Technological developments, including videoserver and compression technologies which regional telephone companies and others are developing, and expanding markets for DVD and laser discs, could make competing delivery systems economically viable and could significantly impact the home video market generally and, as a consequence, the Company's home video revenues. Pay-per-view. Pay-per-view television allows cable television subscribers to purchase individual programs, primarily recently released theatrical motion pictures, sporting events and music concerts, on a "per use" basis. The fee a subscriber is charged is typically split among the program distributor, the pay- per-view operator and the cable operator. Pay Cable. The domestic pay cable industry (as it pertains to motion pictures) currently consists primarily of HBO/Cinemax, Showtime/The Movie Channel, Encore/Starz and a number of regional pay services. Pay cable services are sold to cable system operators for a monthly license fee based on the number of subscribers receiving the service. These pay programming services are in turn offered by cable system operators to subscribers for a monthly subscription fee. The pay television networks generally acquire their film programming by purchasing the distribution rights from motion picture distributors. Non-Theatrical Markets. In addition to the distribution media described above, a number of sources of revenue exist for motion picture distribution through the exploitation of other rights, including the right to distribute films to airlines, schools, libraries, hotels, armed forces facilities and hospitals. International Markets. The worldwide demand for motion pictures has expanded significantly as evidenced by the development of new international markets and media. This growth is primarily driven by the overseas privatization of television stations, introduction of direct broadcast satellite services, growth of home video and increased cable penetration. 6 7 In September 1994 the Company established foreign theatrical distribution operations for its own and third party product. MOTION PICTURE ACQUISITION In addition to its own production activities, the Company continually seeks to acquire rights to films and other programming from Independent film producers, distribution companies and others in order to maximize the number of films it can distribute in the emerging new delivery systems. To be successful, the Company must locate and track the development and production of numerous independent feature films. Types of Motion Pictures Acquired. The Company generally seeks to produce or acquire motion pictures across a broad range of genres, including drama, thriller, comedy, science fiction, family, action and fantasy/adventure, which will individually appeal to a targeted audience. The Company has been very selective in acquiring higher budget (over $10 million) films because of the interest that the Majors have shown in acquiring such films, and the associated competition and higher production advances, minimum guarantees and other costs. The Company acquires projects when it believes it can limit its financial risk on such projects through, for example, significant presales, and when it believes that a project has significant marketability. In most cases, the Company attempts to acquire rights to motion pictures with a recognizable marquis "name" personality with public recognition, thereby enhancing promotion of the motion pictures in the home video or international markets. The Company believes that this approach increases the likelihood of producing a product capable of generating positive cash flow, ancillary rights income and the possibility of a theatrical release. Methods of Acquisition. The Company typically acquires films on either a "pick- up" basis or a "pre-buy" basis. The "pick-up" basis refers to those films in which the Company acquires distribution rights following completion of most or all of the production and post-production process. These films are generally acquired after management of the Company has viewed the film to evaluate its commercial viability. The "pre-buy" basis refers to films in which the Company acquires distribution rights prior to completion of a substantial portion of production and post-production. Management's willingness to acquire films on a pre-buy basis is based upon factors generally including the track record and reputation of the picture's producer, the quality and commercial value of the screenplay, the "package" elements of the picture, including the director and principal cast members, the budget of the picture and the genre of the picture. Before making an offer to acquire rights in a film on a pre-buy basis, the Company may work with the producer to modify certain of these elements. Once the modifications are considered acceptable, the Company's obligation to accept delivery and make payment is conditioned upon receipt of a finished film conforming to the script reviewed by the Company and other specifications considered important by the Company. Sources of Distribution Rights. Typically, projects are submitted directly to the Company for consideration. To promote the submission of projects, the Company relies primarily on its reputation as an Independent having significant access to the international markets. The Company also relies upon the personal contacts of its senior officers which have been generated through their prior business and personal dealings with Majors, other Independents, legal and accounting firms, business management firms, talent agencies, production lenders and personal managers who are actively involved in the production community. Acquisition Process. If the Company locates a motion picture project which it believes satisfies its criteria, the Company may pay an advance or a guaranteed minimum payment conditioned upon delivery of a completed film ("minimum guarantee") against a share or participation in the revenue actually received by the Company from the exploitation of a film in each licensed media. The minimum guarantee is generally paid prior to the film's release. Typically, the Company will recoup the minimum guarantee and certain other amounts from the distribution revenues realized by the Company prior to paying any additional revenue participation to the production company. In fiscal 1997, the Company acquired international distribution rights to "Double Tap" on this basis. In fiscal 1998, the Company anticipates acquiring "Bone Daddy" and certain family and other low-budget films on this basis. Film Library. The Company's distribution rights, which may include either worldwide, foreign, or domestic rights, generally range from an initial licensing cycle of seven to 21 years to perpetuity. 7 8 COMPANY FEATURE FILM PRODUCTION The Company's feature film division was established in 1993 to develop and produce low and medium budget films. The Company's low to medium budget films to date have had production budgets ranging from less than $1 million to $10 million, although the Company from time to time may release films having higher budgets. The Company's low-budget films are primarily targeted for direct distribution to the television market and its medium-budget films may be targeted for theatrical release. The Company generally retains distribution rights for licensing to third parties internationally. The Company's films generally are distributed by third parties domestically. In unique circumstances, the Company undertakes limited domestic distribution or co-distribution activities. The Company's feature film strategy generally is to develop and produce feature films when the production budgets for the films are expected to be substantially covered through a combination of pre-sales, output arrangements, equity arrangements and production loans with "gap" financing. To further limit the Company's financing risk or to obtain production loans, the Company often purchases completion bonds to guarantee the completion of production. The following films were released or delivered by the Company or its joint ventures in fiscal 1997.
Principal Picture Initial Media Delivery/Release Date Film Type Talent - ------------------------------------------------------------------------------------------------------------- The Brave Little Home Video June-97 Animated N/A Toaster Goes to Mars The Brave Little Home Video June-97 Animated N/A Toaster Goes to School The Incredible Genie Home Video Jan-97 Fantasy/Adventure N/A Dragon World: The Home Video Feb-97 Fantasy/Adventure N/A Legend Continues Johnny Mysto: Boy Home Video Dec-96 Fantasy/Adventure N/A Wizard The Midas Touch Home Video Dec-96 Fantasy/Adventure N/A Little Ghost Home Video Dec-96 Fantasy/Adventure N/A Waiting For The Man Home Video Dec-96 Drama Darren McGavin; Rae Dawn Chong Basil Theatrical September-97 Drama Christian Slater Double Tap HBO Premiere July - 97 Drama Heather Locklear, Stephen Rea
The following films were released or delivered or are currently scheduled for release or delivery by the Company in fiscal 1998:
Expected Picture Initial Media ---------------------------------------- Beowulf Theatrical Denial Theatrical Minion Theatrical Possums Theatrical Susan's Plan Theatrical Bone Daddy HBO Premiere Girl Theatrical One Man's Hero MGM Theatrical Taxman Pay Cable or Video Legion Pay Cable or Video Swing, Theatrical Jungle Book: The Pay Cable and Search for the Video Elephant Eye Diamond Five family pictures Video/Cable Noose Theatrical
8 9 There is no assurance that any motion picture which has not yet been released will be released, that a change in the scheduled release dates of any such films will not occur or, if such motion picture is released, it will be successful. The Company has various additional potential feature films under development. There is no assurance that any project under development will be produced. International Distribution The Company hired Pascal Borno in fiscal 1997 to head its international distribution activities as President of Kushner-Locke International. Mr. Borno also owns Conquistador Entertainment, which he previously headed on a full-time basis and which arranged the financing and distribution licensing of theatrical motion pictures. As part of the Company's agreement with Mr. Borno, Conquistador's pictures are now being distributed by the Company and the Company has hired former Conquistador employees as additional sales and marketing personnel. During the term of Mr. Borno's employment with the Company, Conquistador is not active outside the purview of the Company's arrangements with Mr. Borno and does not maintain any separate staffing. TELEVISION INDUSTRY OVERVIEW The domestic television market remains the largest in the world, consisting of the principal broadcast networks and their affiliates, independent television stations and cable television networks. Expanding international television broadcast, cable and satellite delivery systems offer further opportunities for the exploitation of television programming. Domestic Market. The domestic market for television programming primarily is composed of four submarkets: the broadcast television networks (ABC, CBS, NBC and Fox and emerging networks UPN and WBN), pay cable services (such as HBO/Cinemax, Encore/Starz and Showtime/The Movie Channel), basic cable services (such as USA Network, the Arts & Entertainment Network, Lifetime, The Family Channel, The Disney Channel, and Turner Broadcasting Network) and syndicators of first-run programming (such as MCA, King World Productions and Multimedia, Inc.). The domestic broadcast television market currently is dominated by the four major networks, each of which has approximately 200 affiliated stations. The affiliates broadcast network-supplied programming and national commercials in return for payments by the major networks. This relationship results in the networks being able to reach virtually all of the significant domestic television markets. There are also a significant number of independent commercial television stations in the United States. These stations offer an alternative to network distribution through syndication. The network schedule provides affiliates with only a portion of their daily program schedule, and the balance of the time is filled with programs acquired through television syndication companies or produced locally by the station. Cable services generally are classified as being in one of four categories: telephone delivery, superstations (e.g., Turner Broadcasting System), pay cable services (e.g., HBO/Cinemax) and basic cable networks (advertiser-supported, e.g., The Family Channel). The most successful cable networks reach more than 60% of the U.S. television households. Recently developed digital compression technology combined with fiber optics or small-sized satellite dishes may permit cable companies, telephone companies or direct broadcast satellite systems to expand the domestic television market up to 500 or more channels. Television Programming. Each of the three major television networks currently broadcasts approximately 22 hours of prime-time programming and approximately 30 hours of daytime programming each week. Prime-time programming generally consists of half-hour series (often situation comedies), reality shows, hour-length series, movies-for-television (films of two hours or less) and mini-series (dramatic epics of three hours or more). The increased channel capacity and large base of cable subscribers that have developed during the 1980s and 1990s have made possible the development of a number of pay cable and basic cable networks which have become important purchasers of both original and rerun television programming, including movies-for-television, mini-series and series. Suppliers of television programming include the production division or affiliated companies of the major networks, major film studios (Majors), station owners and independent producers (Independents) such as the Company. 9 10 International Markets. The number of international outlets for television programming has been increasing with the worldwide proliferation of broadcast, cable and satellite delivery systems. Over the last ten years, European governments have privatized television systems in several countries, including Germany, Italy, France and Spain. The Company believes privatized systems are more likely to broadcast American programming than government-owned networks. In addition, both the number of pay and satellite television systems in Europe and the number of subscribers to these systems have increased. Pay television and satellite distribution systems also are developing in other geographic areas, including many Asian countries. In international markets, suppliers of programming may be subject to local content and quota requirements which prohibit or limit the amount of American programming in particular markets. See "Business-Government Regulations." COMPANY TELEVISION STRATEGY The Company was founded in 1983 to develop and produce, on a cost-effective basis, quality television programming with broad appeal. The Company's television business has evolved from the production of programs owned by third parties and typically airing on local television stations in the first-run syndication market, such as the long-running daytime series Divorce Court, to the development, production and ownership of series, movies-for-television and mini-series for major domestic and international television networks and the expanding pay and basic cable markets. In 1991, the Company established an international distribution licensing operation for its own and acquired television programming. The Company believes that through the control of the distribution of its own programming this operation has increased the Company's ability to recover the cost of new programs and to retain the fees and profit potential previously realized by third parties. The Company seeks to increase the amount of programming it provides to the major U.S. networks, primarily one-hour series, movies-of-the-week and mini-series, in part because the Company believes network exhibition enhances a television program's potential value both in international markets and potential rerun syndication. To increase the likelihood of developing programs that will be licensed by the networks, the Company has expanded its roster of network approved writers, producers and actors and literary materials and rights acquisition budgets. As of September 30, 1997, the Company had 16 movies-for-television and various television series in active stages of development for potential production, many of which are being funded at least in part by the networks or other third parties. To position itself for the perceived growth in this market, the Company is actively acquiring various forms of domestic cable, video-on-demand and satellite rights from third party producers for license periods ranging from fifteen years to perpetuity through its KLC/New City joint venture. The customary release cycle includes a period of approximately six months of pay-per-view followed by 18 to 24 months of pay cable, finally 24 to 48 months of basic cable, and free television thereafter. The Company utilizes licensing and co-production arrangements to fund the costs of production, and generally retains additional licensing rights including, in the case of series, rerun syndication rights which offer future upside profit potential. The Company generally does not commence principal photography of its television programming without first obtaining license or other revenue commitments or production financing which equal all or a substantial portion of the budgeted production costs. By obtaining license fees and other pre-committed revenues through the efforts of its international television distribution division to cover a substantial portion or all of its budgeted production costs, the Company believes that it reduces many of the financial risks associated with an individual production. TELEVISION PROGRAM FINANCING Development Costs. The Company generally finances project development costs without third-party involvement until the script commitment stage. Because of the likelihood that the significant costs in producing scripts and pilots will not be recovered, the Company attempts to limit its financial investment by obtaining financial commitments from networks or other third parties to cover all or a substantial portion of these costs. See "Business-Television Projects in Development." Program Licensing. Generally, the Company licenses to a network the right to broadcast a program for a period ending the earlier of the second broadcast of the program or four years from delivery in exchange for a license fee which represents a portion of the program's budgeted production cost. The remaining amount is referred to as the "production deficit". The Company generally retains all other rights to the program and will usually license certain rights to international broadcasters, 10 11 enabling the Company to recoup all, or a portion, of the production deficit. In addition, the Company will typically license additional domestic releases in other media to cover the remainder, if any, of the production deficit. A production order sets forth the principal terms for a license of the Company's product to a network and specifies the license fee to be paid and the conditions to be met for payment. Production orders typically are contingent on the producer's obtaining certain approvals from the network, including the script, principal cast and director, prior to commencement of principal photography. The Company usually receives its license fee in installments, with one-third due on or prior to commencement of principal photography, one-third due upon completion of principal photography and one-third due upon delivery of the completed program. International distribution typically involves licensing the rights to exhibit programming in international territories to broadcasters within those territories for a fixed license fee usually payable after the program has been completed. Due to timing differences between the Company's receipt of license fees and its payment of production costs, the Company generally is required to fund at least a portion of its production costs from working capital or secured borrowings, even if the original license fees equal or exceed budgeted production costs. For first-run syndication programs, license agreements with the first-run syndicator generally provide the Company a fixed license fee and a percentage of revenues from distribution after the syndicator recoups the fixed license fee and its distribution fees and costs. An alternate first-run syndication revenue source is called "barter" sales. A television station, in lieu of or in combination with paying licensing fees, may grant to the Company's distributor the right to sell advertising spots during the exhibition of the Company's television program. For a program to be barterable, exhibition of the program on stations reaching at least 70% of the U.S. television households and in most of the top ten major metropolitan areas typically is required. The amount of the fee paid by the advertiser is conditioned upon the program achieving certain agreed upon ratings. If the specified rating is not achieved, the distributor is required to "make good" by giving the advertiser additional advertising time or cash payment, and the Company's share of barter revenues decreases. The Company has licensed its television series Hammer and Could It Be a Miracle on this basis. The Company seeks to cover most or all of its production costs with license fees and other pre-committed revenues, however it may finance some of the production costs on its own and may rely on subsequent licensing in international or other ancillary markets to recoup the remaining production costs. Additional profits from a television program initially shown on a network or cable service are realized from subsequent reruns of the program on local television stations, international delivery systems and cable services after exhibition on a major network or cable service. In any event, any production is subject to the risk of cost overruns, and there is no assurance that the Company will be able to recover any investment it undertakes in a deficit-financed project. Rerun Syndication. Domestic rerun syndication typically involves the exhibition of programming on local television stations and cable services after exhibition on a major network. Since production costs for network series may exceed network license fees and other pre-committed revenues, some television production companies depend on successful syndication of their programming for profitable operations. Generally, to be successful in rerun syndication, a television series must have at least 66 episodes (the equivalent of three full television seasons). TELEVISION PRODUCTION ACTIVITIES As a producer, the Company first develops literary properties internally or acquires them from third parties. The Company may refine the concept of an acquired property. It then attempts to interest one of the networks or another buyer in the project. If the buyer is interested in a concept presented to it, the buyer will usually order a script from the Company. Once the script is delivered, the buyer may order production of a single pilot episode or a limited number of episodes in the case of a series, or the entire production in the case of a movie-for-television or mini-series. Once production is ordered, the Company and the buyer negotiate a financing arrangement. The Company then undertakes pre-production activities in which a budget is prepared, the screenplay is polished or rewritten, director, actors, a line producer and technical personnel are engaged, filming is scheduled, locations are arranged and other steps are taken to prepare the project for principal photography. By this point, the Company generally has negotiated license fees and obtained other commitments to cover a substantial portion of the budgeted production costs. Principal photography is then undertaken, 11 12 followed by post-production, in which the film is edited, synchronized with music and dialogue and, in certain cases, special effects are added. In the case of a series, if episodes are ordered and the ratings are sufficiently strong, additional episodes may be ordered for the entire season and then for additional seasons. The Company hires writers, directors, cast and crew members on a project-by-project basis. The terms of employment and compensation are negotiated in light of an individual's previous experience, the prevailing market conditions and, where applicable, collective bargaining agreements. The Company also obtains locations, sets and post-production personnel and facilities on an as-needed basis. The Company believes that production and post-production personnel and facilities are in ample supply at competitive rates. The production of animated programming is a labor-intensive process that commences with artistic sketches of the various characters and the story line. Storyboards, models, songs and voice elements are then sent to various production companies, typically in Asia, where drawings of the animation frames are prepared. The frames are painted and then subsequently photographed to create film. The film is then usually sent back to the United States, where final editing of footage and mixing of sound effects, dialogue and music is completed, although on occasion final editing and mixing may be completed in Asia. The following table summarizes the Company's television programming for fiscal 1997 and certain programming scheduled for fiscal 1998, the type of program and the network or other medium where such programming initially exhibited or will exhibit:
Fiscal 1998 First Fiscal 1997 Expected Title Type of Program Exhibition Deliveries Deliveries ----- --------------- --------------------------------------------- Jack Reed V: Death Movie-of-the-week NBC Yes -- and Vengeance Gun (6 episodes) One-hour Series ABC Yes -- Unlikely Angel Movie-of-the-week CBS Yes -- Could It Be A Miracle One hour Series Syndication Yes -- (24 episodes) Mowgli: The New 1/2 hour Series Fox Kids 6 7* Adventures of The Worldwide Jungle Book (26 episodes) Erotic Confessions 13 1/2 hour Series HBO 6 7 Episodes Cracker (22 episodes) One hour Series ABC 5 17 Hammer (26 episodes) One hour Series Syndicaction 7 19
* Also 13 additional episodes for international distribution. There is no assurance that any television program which has not yet aired will be aired, that a change in the scheduled airing date of such programming will not occur or, if such television program is aired, that it will be successful. TELEVISION PROJECTS IN DEVELOPMENT The Company requires adequate access to program concepts, ideas and scripts. Such access is dependent upon numerous factors, including the reputation and credibility of the Company in the creative community, the relationships the Company has in the entertainment industry and the Company's financial and other resources. The Company occasionally enters into agreements with producers and writers to develop or acquire new programming. While the Company may finance the early development of such projects, the Company typically does not proceed with the preparation of a script or the production of a pilot, which involves a more significant financial commitment, unless a network or other buyer has agreed to fund all or a substantial portion of the costs associated therewith. 12 13 The following table sets forth potential television movies and television series in various stages of development and the potential network or other medium to which each may be delivered, if known:
Working Title Type of Program ----------------------------------------------------------- Silicone Valley One Hour Series (ABC) Prodigal Son Movie-of-the-week Beat Cop Movie-of-the-week (Fox) If I Can't Have You Movie-of-the-week (ABC) Jack London Movie-of-the-week (CBS) Aliens Ate My Homework Movie-of-the-week (Showtime) Jack Reed VI Movie-of-the-week (NBC) The Life She Left Behind Movie-of-the-week (CBS) Seven The Hard Way Movie-of-the-week (CBS) Undercover Girls One Hour Series (Fox) N.Y. Arts & Entertainment One Hour Series (Fox) Coleoptra Movie-of-the-week (HBO) Death Cloud Movie-of-the-week (Fox) Unlikely Angel II Movie-of-the-week (CBS) Silke One Hour Series (CBS) Air America Syndication
While the Company has many projects in development, as is typical in the industry, only a relatively small number of such projects are ultimately produced (with the likelihood of production being more remote in the case of television series). It is rare for any projects in development to have production commitments until late in the development process. There is no assurance that the Company's efforts in developing or acquiring potential new programs, including any of the projects described above, will lead to production commitments or that any programs that are ultimately produced will be successful. TELEVISION DISTRIBUTION ACTIVITIES Domestic Distribution. The Company's original programming generally is initially licensed to a network or cable broadcaster for a period expiring on the earlier of two broadcasts or a period of up to four years from delivery. Following the expiration of the license, the rights typically revert to the Company's library and become available for additional licensing. Further revenues are generally obtained from subsequent licensing in the domestic market in other media, including syndication, cable and home video. International Distribution. In 1991, the Company commenced the distribution of its own television programming and, to a lesser extent, acquired television programs for distribution in international markets. Previously the Company had utilized third parties to arrange for the distribution of its television programming in international markets. Programming is distributed primarily to local international broadcasters and, where available, the home video market, pay television and cable services. The Company's international television distribution operation has increased the Company's ability to recover the costs of new programs and to retain the fees and profit potential previously realized by outside distributors through the control of the distribution of its own television programming, including the ability to package such product for distribution in different media. The Company also believes its international television distribution operation enables it to increase its distribution of programs produced by others. In December 1994, the Company expanded its activities in international distribution by establishing an international distribution subsidiary. In June 1995, the Company hired Marvinia Anderson from World International Network as President of its television distribution activities, and she continues in this role. In April 1997 the Company hired Pascal Borno as President of the entire distribution operation. Mr. Borno also owns Conquistador Entertainment, which he previously headed on a full-time basis, and, prior to Conquistador, handled international sales and distribution for Dino de Laurentiis and for ITC Entertainment. The Company's combined film and television distribution division gives the Company increased control over the marketing of its product line, greater bargaining strength, and improved cost efficiencies. The Company's strategy has been to reduce its business risks in international markets by securing business relationships with strong local distributors and broadcasters. The Company has entered into output arrangements in certain 13 14 foreign territories with broadcasters and distributors who have agreed to license distribution rights in such markets for all of the Company's product produced during the specified term of the agreement (generally between three and five years) at designated prices for various types of film or television product. LIBRARY Since its inception in 1983, the Company has produced or acquired more than 1,000 hours of television programming. In addition, as a producer for hire, the Company produced 860 episodes of Divorce Court, 65 episodes of the Night Games game show, 34 episodes of the children's game show The Krypton Factor, the animated feature film Pound Puppies: The Legend of Big Paw and the Family Dog episode of Steven Spielberg's Amazing Stories. The Company's current library includes a variety of feature films, movies-for-television, television series, game shows and talk shows produced or acquired by the Company since its inception. The following table sets forth, as of September 30, 1997, certain completed feature films and television programming in which the Company has ownership rights, distribution rights or the right to share in future profit participation: Feature Film
Title First Exhibition - ----------------------------------------------------------------------- Animalympics NBC The Brave Little Toaster Disney Channel Andre Theatrical Babysitters Home Video Cafe Society Pay Cable Closer, The Theatrical Forbidden Passion Home Video Deadly Exposure Home Video Dragon World: The Legend Continues Home Video Dream Master Home Video Eggs From 70 Million B.C. Home Video Flesh Suitcase Pay Cable Freeway Pay Cable The Incredible Genie Home Video The Grave Pay Cable The Human Pets Home Video Indecent Behavior Home Video Johnny Mysto: Boy Wizard Home Video Journey to the Magic Cavern Home Video The Midas Touch Home Video Lady-in-Waiting Home Video Last Gasp Home Video Last Battle for the Universe Home Video The Last Time I Committed Suicide Theatrical Little Ghost Home Video Lost World of the Giants Home Video Medium Rare Home Video Mesmer Home Video Naked Souls Home Video Oblivion HBO The Adventures of Pinocchio Theatrical Planet of the Dino-Knights Home Video Red Hot Home Video Red Ribbon Blues Cable/Home Video Sensation HBO Serpent's Lair Pay Cable Shrunken Heads Home Video Test Tube Teens Home Video Trapped in Toyworld Home Video Wes Craven Presents: Mindripper Home Video The Whole Wide World Theatrical Alien Abduction Cable/Home Video
14 15 Angel of Passion Cable/Home Video Banished Behind Bars Cable/Home Video Bare Exposure Cable/Home Video Bikini Drive In Cable/Home Video Blonde Heaven Cable/Home Video Caged Hearts Cable/Home Video Call Girl Cable/Home Video Cave Girl Island Cable/Home Video Cellblock Sisters Cable/Home Video Centerfold Cable/Home Video Donor, The Cable/Home Video Electra Cable/Home Video Elke's Erotic Nights Cable/Home Video Forbidden Games Cable/Home Video Hard Bounty Cable/Home Video Illicit Dreams II Cable/Home Video Improper Conduct Cable/Home Video Innocence Betrayed Cable/Home Video International Beach Cable/Home Video Irresistible Impulse Cable/Home Video Jacko Cable/Home Video Jungle Law Cable/Home Video Lap Dancer Cable/Home Video Love Me Twice Cable/Home Video Lover's Concerto Cable/Home Video Lurid Tales Cable/Home Video Masseuse, The Cable/Home Video Miami Models Cable/Home Video Midnight Confessions Cable/Home Video Midnight Tease II Cable/Home Video Midnight Temptations Cable/Home Video Petticoat Planet Cable/Home Video Pleasure in Paradise Cable/Home Video Powder Burn Cable/Home Video Prelude to Love Cable/Home Video Private Obsession Cable/Home Video Professional Affair Cable/Home Video Raven's Kiss Cable/Home Video Second Sight Cable/Home Video Seduction of Innocence Cable/Home Video Sensuous Summer Cable/Home Video Shadow Dancer Cable/Home Video Siren's Kiss Cable/Home Video Softbodies, The Movie Cable/Home Video Spirit of the Night Cable/Home Video Stolen Heart Cable/Home Video Target of Seduction Cable/Home Video Totally Exposed Cable/Home Video Tropical Tease Cable/Home Video Under Lock and Key Cable/Home Video Under The Gun Cable/Home Video Uninhibited Cable/Home Video Virtual Desire Cable/Home Video Wager of Love Cable/Home Video
Television Movies and Mini-Series
Title First Exhibition - ----------------------------------------------------------------------- Aladdin International Glory Years (4 hours) HBO Family Pictures ABC JFK: Reckless Youth (3 hours) ABC
15 16 Carolina Skeletons NBC Confessions: Two Faces of Evil NBC Father and Son: Dangerous Relations NBC Fire in the Dark CBS Getting Gotti: The Diane Giacalone Story CBS Good Cops, Bad Cops NBC Jack Reed III: A Search For Justice NBC Jack Reed IV: A Killer Amongst Us NBC Jack Reed V: Death and Vengeance NBC Dangerous Intentions CBS Lady Killer CBS Murder C.O.D. NBC Kiss Shot CBS Liberace: Behind the Music CBS Overruled NBC Sins of the Mother CBS Sweet Bird of Youth NBC Then There Were Giants NBC To Save the Children CBS Your Mother Wears Combat Boots NBC Candles in the Dark Family Channel City Boy PBS Every Woman's Dream CBS A Husband, A Wife and A Lover CBS Innocent Victims NBC Princess in Love CBS Echo ABC Unlikely Angel CBS
Television Series/Game Show
Produced or Title In Production First Exhibition - ------------------------------------------------------------------------------------------ Sweating Bullets 66 CBS Pigasso's Place 13 Syndication Teen Wolf 21 CBS Mapletown 39 Syndication Cinematractions 26 Syndication 1st and Ten 80 HBO Harts of the West 15 CBS Trial Watch 118 NBC The Barbara De Angelis Show 70 CBS Heroes: Made in the USA 38 Syndication Profiles-Unauthorized Biographies 4 A&E Relatively Speaking 90 Syndication Erotic Confessions 39 HBO Could It Be a Miracle 24 Syndication Gun 6 ABC Cracker 22 ABC Hammer 26 Syndication Mowgli: The New Adventures of The Jungle Book 26 Fox Kids Worldwide
A significant portion of the Company's library is under license in many of the major domestic and international markets. Following the expiration of the licenses, rights generally revert to the Company for relicensing. JOINT VENTURES AND ANCILLARY ACTIVITIES The Company has expanded into areas which exploit the characters and story ideas in its feature films and television 16 17 programs through joint ventures and partnerships. The Company is actively marketing the music used in its productions through an arrangement with Cherry Lane Music, Inc., a music publisher. Using its expertise as a television producer, the Company produced two infomercials for its partnership TVFirst. TV First markets recorded Christian music sung by contemporary Christian artists. From October 1, 1995 through September 30, 1997 music revenues have exceeded $9,600,000. Responding to the increased demand for product by the pay-per-view, telephone delivery, pay cable and basic cable services, the Company formed called KLC/New City Tele-Ventures to acquire product from third parties for distribution in the cable, pay service and satellite markets, as well as other emerging markets. The joint venture has acquired over 100 films for this purpose. The Company owns 82.5% of this entity. The Company holds 50% ownership interests in BLT Ventures, which produced the two sequels to the animated feature Brave Little Toaster, and Cracker Company LLC, which is producing the network televison series Cracker. In November 1997 the Company obtained an option to acquire majority ownership and controlling interest in 800-U.S. Search, ("Search") in exchange for certain guaranties. The Company is assisting Search with its infomercial marketing efforts. Search engages in public records searches to locate individuals with whom the consumer has lost contact for a low fixed fee. International Co-Productions. An international co-production is a joint venture or partnership between entities in two or more countries which in certain cases take advantage of alternative sources of financing for its productions, to utilize international tax benefits, to pass foreign quota restrictions and to benefit from lower pre-production costs in certain foreign countries. In a typical co-production arrangement, the Company transfers all or part of its copyright ownership in the project to third parties (the co-production entities), which generally provide a portion of the production financing and other services. Typically, the co-production partners grant distribution rights to the Company. Receipts from its distribution of the project recoup production funding, production fees, talent participations, distribution fees and expenses. Excess receipts, if any, are distributed to the various parties in accordance with their agreed-upon profit participation. The Adventures of Pinocchio is an example of a co-production with German, French and English participation. Producer-for-Hire. In addition to developing and producing its own programs, the Company may be hired as a producer-for-hire for a creative concept or literary property owned by another person. There are at least two types of producer-for-hire arrangements. Under the first type, the Company receives a set fee and agrees to deliver the completed program for that fee. The Company's profit is the excess of its fee over its production costs. If production costs exceed the package fee, the Company bears the deficit. Under the second type, the Company furnishes personnel as a producer, receives a fixed fee per episode and the production costs of the program are reimbursed directly by the distributor. The Company's production of 860 episodes of Divorce Court from 1984 to 1988 was on a producer-for-hire basis. GOVERNMENT REGULATIONS The Federal Communications Commission ("FCC") repealed its financial interest and syndication rules effective in September 1995. Those FCC rules, which were adopted in 1970 to limit television network control over television programming and thereby foster the development of diverse programming sources, restricted the ability of the three established, major U.S. television networks (i.e., ABC, CBS and NBC), to own and syndicate television programming. The ultimate impact of the repeal of the FCC's financial interest and syndication rules on the Company's operations cannot be predicted at the present time, although there has been an increase in in-house productions of programming for the networks' own use since the effective date of the repeal of the FCC's financial interest and syndication rules, and this may place additional competitive pressures on program suppliers, such as the Company. Under the Telecommunications Act of 1996 (the "1996 Act"), manufacturers of television set equipment are required to equip all new television receivers with a so-called "V-Chip" which would allow for parental blocking of violent, sexually-explicit or indecent programming based on a rating for any given program that would be broadcast along with the program. The FCC is directed by the 1996 Act to develop a ratings system based upon the recommendations of an advisory committee selected by the FCC unless the television industry establishes its own voluntary ratings system by February 1997. The television networks did establish and have implemented such a system. Other provisions of the 1996 Act revise the broadcast multiple ownership rules, allow local exchange telephone companies to offer multichannel video programming 17 18 service, subject to certain regulatory requirements, and allow for cable companies to offer local exchange telephone service, subject to certain regulatory requirements. The impact on the Company of the changes brought about by the 1996 Act, including the new ratings guidelines and by accompanying changes in FCC rules cannot be predicted at the present time. However, it is possible that recent alliances of certain program producers and television station group owners, coupled with the recent FCC rule revisions allowing a single television station licensee to own television stations reaching up to 35% of the nation's television households, may place additional competitive pressures on program suppliers, such as the Company, to the extent they are unaligned with the major networks or any television station group owners. In international markets, the Company's programming is occasionally subject to local content and quota requirements, and/or other limitations, which prohibit or limit the amount of programming produced outside of the local market. Although the Company believes these requirements have not affected the Company's licensing of its programs in international markets to date, such restrictions, or new or different restrictions, could have an adverse impact on the Company's operations in the future should opportunities to obtain foreign content not be available. 2. PROPERTIES The Company leases approximately 23,000 square feet of office space on the 20th and 21st floors at 11601 Wilshire Boulevard, Los Angeles, California under a lease agreement through March 31, 2000. The annual rent under the lease is approximately $527,500. The Company rents studio facilities as needed for production, except that certain post-production off-line editing is performed at the Company's executive offices. 3. LEGAL PROCEEDINGS The Company is party to certain legal proceedings and claims arising out of the normal course of business. The Company believes that the ultimate resolution of all of these matters will not have a material adverse effect upon the Company's financial position. 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On August 19, 1997 the shareholders of the Company voted in the annual meeting to (A) re-elect directors, (B) re-appoint KPMG Peat Marwick LLP as independent accountants, (C) effect a 1-for-6 reverse stock split and (D) to amend the Company's Amended Articles of Incorporation to decrease the number of authorized shares of Common Stock of the Company from the previous amount of 150,000,000 shares to 50,000,000 shares. Finally, the shareholders voted not to amend the Company's Amended Articles of Incorporation to provide for 3,000,000 authorized shares of Preferred Stock of the Company. A majority of total shares voting was needed to approve proposals A and B, whereas a majority of shares outstanding was needed to approve proposals C and D, and the amendment to authorized Preferred Stock. The results of the voting, on an unadjusted (pre-reverse split) basis were as follows:
A) Election of directors: FOR AGAINST ABSTAIN Peter Locke 41,122,705 250,087 942,570 Donald Kushner 41,130,605 249,387 935,370 David Braun 41,169,612 236,880 908,870 S. James Coppersmith 41,169,347 235,145 910,870 Stuart Hersch 41,170,412 233,080 911,870 B) Approval of the appointment of KPMG Peat Marwick LLP as independent accountants for the fiscal year ended September 30, 1997:
18 19
FOR AGAINST ABSTAIN 41,552,897 539,188 223,277 C) Approval of the Reverse Stock Split FOR AGAINST ABSTAIN 40,045,361 2,090,323 179,678 D) Approval of the Common Stock Amendment: FOR AGAINST ABSTAIN 39,646,677 2,336,900 331,785 E) Approval of the Preferred Stock Amendment: FOR AGAINST ABSTAIN 7,773,357 3,890,988 500,182
PART II 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is quoted on the NASDAQ National Market ("NNM") under the symbol "KLOC." Additionally, the stock is listed on the Pacific Stock Exchange under the symbol "KLO." The following table sets forth the range of high and low sale price for the Common Stock, as reported on the NNM, for the periods indicated, as retroactively adjusted for a one-for-six reverse stock split effective September 5, 1997.
COMMON STOCK ------------------- HIGH LOW -------- -------- FISCAL 1996 First Quarter (ended December 31, 1995) . $ 4.50 $ 2.82 Second Quarter (ended March 31, 1996) ... 6.36 3.48 Third Quarter (ended June 30, 1996) ..... 9.00 5.46 Fourth Quarter (ended September 30, 1996) 8.64 3.36 FISCAL 1997 First Quarter (ended December 31, 1996) . 4.32 2.28 Second Quarter (ended March 31, 1997 .... 3.36 1.86 Third Quarter (ended June 30, 1997 ...... 3.00 1.32 Fourth Quarter (ended September 30, 1997 3.90 1.68 FISCAL 1998 First Quarter (through December 23, 1997) 5.25 2.44
On December 23, 1997, the last sale price for the Common Stock as reported on the NNM was $2.81 for the Common Stock. At December 23, 1997, there were approximately 745 record holders of the Common Stock. In September 1997 the Company effected a 1-for-6 reverse stock split. All stock prices presented herein give retroactive effect to the reverse split. RECENT SALES OF UNREGISTERED SECURITIES; USES OF PROCEEDS FROM REGISTERED SECURITIES. In October 1997, the Company issued to Lawrence Mortorff, a former employee of the Company, 66,667 shares of Common Stock in exchange for the 5% of the outstanding common stock of KL Features, Inc. not owned by the Company. The Common Stock was sold without registration under an exception from registration provided by Section 4(2) of the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. See Notes 6 and 8 of Notes to Consolidated Financial Statements for descriptions of warrants issued to Allen & Company, Incorporated and a financial consultant, and options granted to Messrs. Kushner, Locke and certain other persons under the Company's stock option plan in the fourth quarter of fiscal 1997. Such securities were issued without registration pursuant to the exception noted above. 19 20 REVERSE STOCK SPLIT On August 19, 1997, the Company's shareholders approved a one-for-six reverse stock split (the "Reverse Stock Split") of its outstanding common stock, no per value (the "Common Stock"). The Reverse Stock Split became effective on September 5, 1997 to shareholders of record at the close of business on September 4, 1997. As part of the Reverse Stock Split, the exercise price and the number of shares of Common Stock issuable upon exercise of the Company's Common Stock purchase warrants were also adjusted. In addition, the shareholders also approved an amendment to the Company's Restated Articles of Incorporation which reduced the number of authorized shares of Common Stock from 150,000,000 to 50,000,000 shares. DIVIDENDS The Company has never paid any cash dividends and has no present intention to declare or to pay cash dividends. The payment of dividends also is restricted by covenants in the Company's credit agreement and the indentures and fiscal agency agreements under which the Company's Convertible Subordinated Debentures were issued. It is the present policy of the Company to retain any earnings to finance the growth and development of the Company's business. 6. SELECTED FINANCIAL DATA The following table summarizes selected consolidated financial data for the Company and should be read in conjunction with the certain detailed consolidated financial statements included elsewhere in this Annual Report. The selected consolidated financial data for the fiscal years are derived from the consolidated financial statements audited by KPMG Peat Marwick LLP, independent certified public accountants, whose report with respect to the consolidated balance sheets of the Company as of September 30, 1997 and 1996, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the years in the three year period ended September 30, 1997 appears elsewhere in this Annual Report. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
YEAR ENDED SEPTEMBER 30, ------------------------------------------------------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Operating revenues ........................... $ 56,935 $ 80,157 $ 20,407 $ 50,736 $ 42,487 Costs relating to operating revenues ......... (52,084) (70,648) (17,404) (54,952) (41,497) Selling, general and administrative expenses . (5,333) (3,595) (3,838) (3,208) (2,797) -------- -------- -------- -------- -------- Earnings/(loss) from operations .............. (482) 5,914 (835) (7,424) (1,807) Interest income .............................. 163 198 300 197 78 Interest expense ............................. (4,027) (4,027) (3,409) (2,209) (1,173) Interest expense related to bridge note financing .................................. -- (943) -- -- -- -------- -------- -------- -------- -------- Earnings/(loss) before income taxes and cumulative effect of a change in accounting principle and extraordinary item ........... (4,346) 1,142 (3,944) (9,436) (2,902) Income taxes ................................. (23) (47) (31) 2,277 1,076 -------- -------- -------- -------- -------- Earnings/(loss) before cumulative effect of a change in accounting principle and extraordinary item ......................... (4,369) 1,095 (3,975) (7,159) (1,826) Cumulative effect of a change in accounting for income taxes ........................... -- -- -- 394 -- -------- -------- -------- -------- -------- (4,369) 1,095 (3,975) (6,765) (1,826) Extraordinary item: costs associated with repayment of credit facility ............... -- (365) -- -- -- -------- -------- -------- -------- -------- Net earnings/(loss) .......................... $ (4,369) $ 730 $ (3,975) $ (6,765) $ (1,826) ======== ======== ======== ======== ========
20 21 Earnings/(loss) per common and common equivalent share (2): Before cumulative effect of a change in accounting and extraordinary items $ (.49) $ .16 $ (.75) $ (1.46) $ (.39) Cumulative effect of a change in accounting for income taxes ....... -- -- -- .08 -- Extraordinary item .................... -- (.05) -- -- -- -------- -------- -------- -------- -------- Net earnings/(loss) ................... $ (.49) $ .11 $ (.75) $ (1.38) $ (.39) ======== ======== ======== ======== ======== Weighted average of common and common equivalent shares outstanding(2) ........... 8,959 6,668 5,286 4,896 4,729 ======== ======== ======== ======== ========
CONDENSED CONSOLIDATED BALANCE SHEET DATA:
SEPTEMBER 30, (IN THOUSANDS) 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Cash and cash equivalents(1) ........... $ 16,791 $ 11,636 $ 4,301 $ 15,681 $ 6,542 Accounts receivable, net ............... 27,696 22,885 7,864 6,177 5,360 Film and television property costs, net amortization ......................... 68,507 58,463 73,716 30,688 43,031 Total assets ........................... 124,368 100,152 88,952 54,254 56,131 Notes payable .......................... 62,647 41,481 28,398 9,600 8,007 Convertible subordinated debentures, net 11,631 12,039 17,745 22,056 4,296 Total liabilities ...................... 93,232 65,902 69,745 35,713 32,252 Stockholders' equity ................... 31,136 34,250 19,207 18,541 23,879 ======== ======== ======== ======== ========
- ----------- (1) $1,609 of cash and cash equivalents are restricted deposits that are collateral for a sale/leaseback transaction and for certain production loans for 1997 ($419 for 1996 and $1,162 for 1995) and $105 ($4,126 for 1996 and none for 1995) is cash collected by the Company and reserved for use by Chase Manhattan Bank to pay down outstanding borrowings under the Company's credit facility. (2) In September 1997 the Company effected a 1-for-6 reverse stock split. Amounts for all periods presented herein give retroactive effect to the reverse split. 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company's revenues are derived primarily from the production or the acquisition of distribution rights of films licensed for release domestically by studios, pay cable, basic cable and videocassette companies; and from the development, production and distribution of television programming for the major domestic television networks, basic and pay cable television and first-run syndicators; as well as from the licensing of rights to films and television programs in international markets. The Company generally finances all or a substantial portion of the budgeted production costs of its programming through advances obtained from distributors and borrowings secured by domestic and international licenses. The Company typically retains rights in its programming to be exploited in future periods or in additional markets or media. In 1993, the Company established a feature film operation which produces low and medium budget films for theatrical and/or home video or cable release. The Company produces a limited number of higher-budget theatrical films to the extent the Company is able to obtain an acceptable domestic studio to release the film theatrically in the U.S. 21 22 The Company's revenues and results of operations are significantly affected by accounting policies required for the industry and management's estimates of the ultimate realizable value of its films and programs (See Note 1 of Notes to Consolidated Financial Statements). Revenues from distributor production advances or license fees received prior to delivery or completion of a program are deferred. Production advances and deferred license fees are generally recognized as revenue on the date the film or program is delivered or available for delivery. Activities conducted through joint ventures, wherein the Company reports its equity in earnings as revenues, can significantly affect comparability of revenues. See "Results of Operations - Comparison of Fiscal Year Ended September 30, 1997 and 1996" below. The Company generally capitalizes the costs it has incurred to produce a film or television program. These costs include direct production expenditures, certain exploitation costs, production overhead, and interest relating to financing the project. Capitalized exploitation or distribution costs include those costs that clearly benefit future periods such as film prints and prerelease and early release advertising that is expected to benefit the film or program in future markets. These costs, as well as third party participations and talent residuals, are amortized each period on an individual film or television program basis in the ratio that the current period's gross revenues from all sources for the program bear to management's estimate of anticipated total gross revenues for such film or program from all sources. In the event management reduces its estimates of the future gross revenues associated with a particular product, which had been expected to yield greater future proceeds, a significant write-down and a corresponding decrease in the Company's earnings for the quarter and fiscal year end in which such write-down is taken could result. See "Results of Operations-Comparison of Fiscal Years Ended September 30, 1997 and 1996" and "Results of Operations-Comparison of Fiscal Years Ended September 30, 1996 and 1995." Gross profits for any period are a function in part of the number of programs delivered in that period and the recognition of costs in that period. Because initial licensing revenues and related costs generally are recognized either when the program has been delivered or is available for delivery, significant fluctuations in revenues and net earnings may occur from period to period. Thus, a change in the amount of entertainment product available for delivery from period to period has materially affected a given period's revenues and results of operations and year-to-year results may not be comparable. The continuing shift of the Company's product mix during the fiscal year may further affect the Company's quarter-to-quarter or year-to- year results of operations as new products may be amortized differently as determined by length of product life cycle and the number of related revenue sources. Film costs, net of accumulated amortization, increased to $68,507,000 at September 30, 1997 from $58,463,000 at September 30, 1996. Film costs in process or development at September 30, 1997 decreased to $10,497,000 from $16,527,000 at September 30, 1996. See "Results of Operations Comparison of Fiscal Years Ended September 30, 1997 and 1996" below. RESULTS OF OPERATIONS COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996 The Company's operating revenues for the fiscal year ended September 30, 1997 were $56,935,000, a decrease of $23,222,000 (29%), from $80,157,000 for the prior fiscal year. The decrease was due primarily to 1997 deliveries of joint venture projects whose gross revenues are not consolidated in the accompanying financial statements, and no repetition of the 1996 delivery of the higher-budget feature The Adventures of Pinocchio. If revenues generated by The Adventures of Pinocchio were excluded from both fiscal 1996 and 1997 periods, current year revenues would have increased 2%. The Company's production and deliveries during fiscal 1997 shifted somewhat toward increased episodic television programming with related start-up costs. For fiscal 1997, the Company did not release a higher budget film, but earned revenues of more than $1,800,000 (3% of total revenues) for the continued international exploitation of The Adventures of Pinocchio, which was originally released in fiscal 1996. The Company's feature slate for fiscal 1997 generated over $19,800,000 (35%) of revenues principally from the international exploitation of Basil starring Christian Slater, Claire Forlani and Jared Leto, and Double Tap starring Heather Locklear and Stephen Rea, delivery of a film produced for Twentieth Century Fox Film Corporation, equity in the earnings of the joint venture which produced two sequels to the animated feature Brave Little Toaster, and seven children's fantasy adventure films. In addition, the Company's television slate generated $22,800,000 (40%) of revenues during fiscal 1997 principally from the Company's six one hour prime time episodes of a mid-season replacement series for ABC entitled Gun which aired in the spring of 1997, equity in the earnings of the joint venture which produced five episodes of the ABC prime time network series 22 23 Cracker starring Robert Pastorelli, under a 22 episode order, seven episodes of the syndicated television series Hammer starring Stacy Keach, a half-hour series presently airing on HBO which the Company will also be distributing to international and other domestic markets, and 6 episodes of Mowgli: The New Adventures of the Jungle Book, out of a total of 13 half-hour episodes for the Fox Kids Network and 26 episodes for an international distributor. In addition, the Company recognized $4,400,000 (8%) of revenues from distribution to domestic cable and pay-per-view media for films acquired through KLC/New City. The Company also recognized $7,300,000 (13%) of revenues from continuing licenses of completed product from the Company's library to foreign distributors, domestic cable channel operators and international sub-distributors. Operating revenues include $2,189,000 relating to the Company's equity in earnings from the following joint ventures: Cracker Company LLC, formed to produce and distribute the Cracker series, TV First and the joint venture producing and distributing the Brave Little Toaster sequels. Gross revenues for the three joint ventures were $24,681,000 for fiscal 1997. The Company recognized approximately $44,100,000 (55%) of operating revenues for fiscal 1996, primarily attributable to the delivery and/or availability of 16 feature films, including $26,300,000 (33%)from the initial release of the feature film The Adventures of Pinocchio and $9,000,000 (11%) from the films Serpent's Lair, The Grave, Freeway, The Whole Wide World, and The Last Time I Committed Suicide. In addition, the Company recognized $22,800,000 (28%) of revenues during fiscal 1996 from the delivery and/or availability of 4 network movies, Princess in Love, Every Woman's Dream, A Husband, A Wife and a Lover and Echo, the network mini-series Innocent Victims and the network pilot for the Company's mid-season series Gun. Twelve other film and video projects generated $8,800,000 (11%) of revenues during fiscal 1996. In addition, the Company recognized approximately $4,100,000 (5%) of revenues from distribution to domestic cable for films acquired through KLC/New City. The Company also recognized additional revenues from continuing licenses of completed product from the Company's library to foreign distributors, domestic cable channel operators and international sub-distributors and from the national rollout of an infomercial marketing contemporary Christian music on compact discs. In various stages of production for the Company's fiscal 1998 distribution slate are Beowulf starring Christopher Lambert, Denial starring Jason Alexander and directed by Adam Rifkin, Minion starring Dolph Lundgren, Possums starring Mac Davis, Noose directed by Ted Demme, Susan's Plan written and directed by John Landis, Bone Daddy starring Rutger Hauer, Girl starring Dominique Swain, One Man's Hero starring Tom Berenger, Taxman starring Joe Pantoliano, Legion starring Parker Stevenson, and Swing starring Lisa Stansfield. The Company is also continuing its production of the television series Hammer, and Mowgli: The New Adventures of The Jungle Book, and a joint venture is continuing the production of the television series Cracker as described above. In addition, the Company continues to acquire domestic cable rights for films for distribution through KLC/New City and the international distribution rights to films for distribution through Kushner Locke International, Inc. Costs relating to operating revenues were $52,084,000 during fiscal 1997 as compared to $70,648,000 during fiscal 1996. As a percentage of operating revenues, costs relating to operating revenues were 91% for fiscal 1997 compared to 88% for fiscal 1996. In comparison to the third quarter's percentage of operating revenues, wherein margins were relatively high due to the delivery of two animated video sequels to Brave Little Toaster, in the fourth quarter the Company's joint venture with Granada Television delivered five episodes of Cracker, a recently introduced ABC television network series and the Company delivered the first seven episodes of Hammer. As is usually the case with newly-introduced episodic television series, the joint venture realized a relatively low operating margin on Cracker, and the Company realized relatively low operating margins on Hammer and certain additional new product. Also during the fourth quarter of fiscal 1997, the Company reduced prior estimates of future revenues of certain film and television productions. Principal among the productions so adjusted was Gun, which was not picked up by the ABC television network for its Fall 1997 or Spring 1998 broadcast seasons. These factors combined to decrease the carrying value of film and television inventory by $1,325,000 in the fourth quarter. Absent unforeseen developments, management expects margins to increase somewhat in 1998. Selling, general and administrative expenses increased to $5,333,000 in fiscal 1997 compared to $3,595,000 in fiscal 1996. This 48% increase results principally from over $1,300,000 of additions to the allowance for doubtful receivables ($800,000 greater than additions provided in 1996) in order to reflect net expected international collections, and increased salary and benefits expenses. 23 24 Interest expense for the year ended September 30, 1997 was $4,027,000 as compared to $4,970,000 for the year ended September 30, 1996. The 19% decrease in 1997 was primarily due to the absence of the $943,000 charge to interest expense in 1996 related to the issuance of shares of common stock as part of the refinancing by the Company and lower effective interest rates on the line of credit in 1997, which was offset in part by increased 1997 credit facility borrowings. The Company capitalized $306,000 less interest to film and television property costs in fiscal 1997. Total indebtedness for borrowed money increased 39% to $74,278,000 at September 30, 1997 from $53,520,000 at September 30, 1996 due to increased production borrowings to finance a larger production slate. The weighted average interest rate under the line of credit was 9.25% during fiscal 1997 compared to 9.98% during fiscal 1996, while the Series A, Series B, 8% and 9% Convertible Subordinated Debentures bear interest fixed at 10%, 13.75%, 8% and 9%, respectively. Management expects the level of borrowings and related interests costs to increase in fiscal 1998. The Company's effective income tax rate was (1%) for the year ended September 30, 1997 compared to an effective income tax rate of approximately 4% for the year ended September 30, 1996. The Company recognized minimum state income tax expense incurred despite its net loss and loss carryforwards. At September 30, 1997, the Company had net operating loss carryforwards of $39,308,000 for federal tax purposes compared to $33,030,000 at September 30, 1996. Such carryforwards expire in fiscal 2012. The Company reported a net loss of $(4,369,000), or $(.49) per share, for the fiscal year ended September 30, 1997, and net earnings of $730,000, or $.11 per share, for the fiscal year ended September 30, 1996. The per share amounts have been adjusted for the effects of a 1-for-6 reverse stock split effected in September 1997. The loss in 1997 resulted primarily from the Company's fourth quarter reduction of prior estimates of future revenues of certain film and television product, and fourth quarter increased allowance for doubtful receivables which aggregated $2,600,000, and also from start-up costs in connection with the Company's new distribution personnel and products activities, an increased allowance for doubtful receivables and lower margins on production released in the current year. The Company continues to use the intrinsic value-based method under Accounting Principles Board Opinion No. 25, as allowed under SFAS 123, to account for all of its employee stock-based compensation plans. Therefore, in consolidated financial statements for fiscal 1997, the Company has made the required pro forma disclosures in a footnote to the financial statements. SFAS No. 123 is not expected to have a material effect on the Company's results of operations or financial position. COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1996 AND 1995 The Company's operating revenues for the fiscal year ended September 30, 1996 were $80,157,000, an increase of $59,750,000 (292%) from $20,407,000 from the prior fiscal year. The increase was due primarily to the delivery and/or availability of a substantially increased slate of films and television programs. The Company shifted its product mix during fiscal 1996 towards an increased number of feature films. The Company recognized $44,100,000 (55%) of revenues during fiscal 1996 from the delivery and/or availability of 16 feature films, including $26,300,000 from the initial release of the feature film The Adventures of Pinocchio (with certain anticipated revenues to be recognized in fiscal 1997) and $9,000,000 from the films Serpent's Lair starring Jeff Fahey, The Grave starring Gabrielle Anwar, Eric Roberts and Craig Sheffer, Freeway executive produced by Oliver Stone and starring Reese Witherspoon, Keifer Sutherland and Brooke Shields, The Whole Wide World starring Vincent D'Onofrio and Renee Zellweger and being distributed in the U.S. by Sony Classics, and The Last Time I Committed Suicide starring Keanu Reeves. In addition, the Company recognized $22,800,000 (28%) of revenues during fiscal 1996 from the delivery and/or availability of 4 network movies, the network mini-series Innocent Victims and the network pilot for the Company's mid-season series Gun, including, $13,700,000 for the Company's four television network movies including Princess in Love, starring Julie Cox in the book version of Princess Diana's affair, for CBS, Every Woman's Dream starring Jeff Fahey for CBS, A Husband, A Wife and a Lover starring Judith Light, for CBS and Echo starring Jack Wagner, for ABC. Twelve other film and video projects generated $8,800,000 (11%) of revenues during fiscal 1996. In addition, the Company recognized $4,100,000 (5%) of revenues from distribution to domestic cable for films acquired through KLC/New City. The Company also recognized additional revenues from continuing licenses of completed product from the Company's library to foreign distributors, domestic cable channel operators and international sub-distributors and from the national rollout of an infomercial marketing 24 25 contemporary Christian music on compact discs. Operating revenues for fiscal 1995 were primarily attributable to the delivery and/or availability to Warner Vision of the three low budget feature films Lady in Waiting, The Last Gasp and Wes Craven Presents: Mindripper and $9,500,000 for the three television network movies Dangerous Intentions for CBS, Lady Killer for CBS and Jack Reed IV: A Killer Amongst Us for NBC. The majority of remaining revenues for the period came from the release of six adult thriller direct-to-video films; from two fantasy adventure feature films for Paramount Pictures under the banner JOSH KIRBY: TIME WARRIOR; and from continuing sales of licenses for completed product from the Company's library of titles to international distributors. Costs relating to operating revenues were $70,648,000 during fiscal 1996 as compared to $17,404,000 during fiscal 1995. As a percentage of operating revenues, costs relating to operating revenues were 88% for fiscal 1996 compared to 85% for fiscal 1995. During the fourth quarter of fiscal 1996, the Company revised its estimates of the future revenues of certain film and television product resulting in a net decrease of the carrying value of film and television inventory of $500,000. Without such reduction, costs relating to operating revenues would have been $70,148,000 for fiscal 1996. During the fourth quarter of 1995, the Company revised its estimates of future revenues for certain older television programs which resulted in reductions of the carrying value of such programs and an expense of $888,000 recorded during the fourth quarter of fiscal 1995. Without such reduction, costs related to operating revenues would have been $16,500,000 (81%) of revenues for fiscal 1995. Selling, general and administrative expenses decreased to $3,595,000 in fiscal 1996 compared to $3,838,000 in fiscal 1995. This decrease resulted from the capitalization of certain production overhead items to theatrical, television and cable product partially offset by an overall increase in staffing and personnel costs. Interest expense for the year ended September 30, 1996 was $4,970,000 as compared to $3,409,000 for the year ended September 30, 1995. The increase was primarily due to a $943,000 charge to interest expense related to the issuance of shares of common stock as part of the refinancing of Bridge Notes issued by the Company, plus a $365,000 charge relating to the repayment of the Company's previous $15,000,000 credit facility for fees including a non-cash charge of $65,000 related to the issuance of warrants to the former lender and the increased interest costs associated with the higher amount of borrowings under the new credit facility. The previous credit facility was replaced by an increased $40,000,000 credit facility led by The Chase Manhattan Bank, which was subsequently increased to $60,000,000. Total indebtedness for borrowed money increased to $53,520,000 at September 30, 1996 from $46,143,000 at September 30, 1995 due to increased production borrowings to finance a larger off-balance-sheet production slate, including The Adventures of Pinnochio and Magic Adventures. The weighted average interest rate under the line of credit was 9.98% during fiscal 1996 compared to 10% during fiscal 1995, while the Convertible Subordinated Debentures Series A, Series B, 8% and 9% bear interest fixed at 10%, 13 3/4%, 8% and 9%, respectively. The Company's effective income tax rate was 4% for the year ended September 30, 1996 compared to an effective income tax rate of 1% for the year ended September 30, 1995. At September 30, 1996, the Company had net operating loss carryforwards of $33,030,000 for federal tax purposes compared to $24,631,000 at September 30, 1995. Such carryforwards expire in fiscal 2011. The Company reported net earnings of $730,000, or $.02 per share, for the fiscal year ended September 30, 1996, and a net loss of $(3,975,000), or $(.13) per share, for the fiscal year ended September 30, 1995. The loss in fiscal 1995 resulted primarily from the above described non-cash reductions in the carrying value of certain programs no longer being produced by the Company and the increased interest expense and amortization of capitalized issuance costs. The losses in fiscal 1995 were impacted by certain expenses associated with the large amount of development and production of work in process scheduled to be delivered after the 1995 fiscal year and the expansion of the Company's feature film and international distribution divisions. LIQUIDITY AND CAPITAL RESOURCES 25 26 Cash and cash equivalents increased 44% to $16,791,000 (including $1,609,000 of restricted cash being used as collateral for a film sale/leaseback transaction and for certain production loans, and $105,000 of reserved cash to be applied against the Company's outstanding borrowings under its credit facility) at September 30, 1997 from $11,636,000 (including $419,000 of restricted cash and $4,126,000 of reserved cash) at September 30, 1996 primarily from an increase in cash flow attributable to non-recurring costs in fiscal 1996 incurred in connection with the issuance of common stock and from an increase in notes payable. The Company's production and distribution operations are capital intensive. The Company has funded its working capital requirements through receipt of third party domestic and international licensing payments as well as other operating revenues, and proceeds from debt and equity financing, and has relied upon its line of credit and transactional production loans to provide bridge production financing prior to receipt of license fees. The Company funds production and acquisition costs out of its working capital, including the line of credit, and through certain pre-sale of rights in international markets. In addition, the expansion of the Company's international distribution business and the establishment of its feature film division have significantly increased the Company's working capital requirements and use of related production loans. The Company experienced net negative cash flows from operating activities (primarily resulting from the Company's significant expansion of production) of $7,893,000 during the twelve months ended September 30, 1997, which was more than offset by net cash of $19,848,000 provided by financing activities from production loans, and greater usage of the Company's revolving line of credit. As a result primarily of an excess of cash collections plus borrowings over production and operating expense payments, net unrestricted cash increased by $7,986,000 to $15,077,000 $ on September 30, 1997. As the Company expands production and distribution activities and increases its debt service burdens, it will continue to experience net negative cash flows from operating activities, pending receipt of licensing revenues, other revenues and sales from its library. Credit Facility In June, 1996, the Company closed a $40,000,000 syndicated revolving credit agreement with a group of banks led by The Chase Manhattan Bank N.A. ("Chase"). In September 1997 that agreement was amended to increase the maximum amount of revolving credit to $60,000,000. The agreement provides for borrowing by the Company of up to $60,000,000 based on specified percentages of domestic and international accounts and contracts receivable and a specified amount based upon the Company's appraised library value for unsold or unlicensed rights In addition, the Company may from time to time allocate a production tranche in its line of credit for the Company's productions. Such tranche will allow the Company to borrow production funding after accounting for specified percentages of pre-sales, licensing fees and similar revenues from third parties and a required Company equity participation. All loans made pursuant to such agreement are secured by substantially all of the Company's otherwise unencumbered assets and bear interest, at the Company's option, either (i) at LIBOR (6% as of December 19, 1997) plus 3% (for that portion of the borrowing base supported by accounts or contracts receivable) or 4% (for that portion of the borrowing base [supported by [unamortized] library film costs or for loans made under the production tranche) or (ii) at the Alternate Base Rate (which is the greater of (a) Chase's Prime Rate (8.75% as of December 19, 1997), (b) Chase's Base CD Rate (5.81% as of December 24, 1997) plus 1% or (c) the Federal Funds Effective Rate (5.46% as of December 19, 1997) plus 1/2%) plus 2% (for that portion of the borrowing base supported by accounts or contracts receivable) or 3% (for that potion of the borrowing base supported by unamortized library film costs or loans made under the production tranche). The Company is required to pay a commitment fee of .5% per annum of the unused portion of the credit line. As of December 24, 1997, the Company had drawn down $53,080,000 under the credit facility out of a total net borrowing base availability of $57,829,000 and Chase also held $179,000 of reserved cash collected from distributors but not yet applied against existing loans. Also on that date, the Company held over $1,600,000 of unrestricted cash and over $1,500,000 of restricted cash. The credit agreement contains various restrictive covenants to which the Company must adhere. These covenants, among other things, include limitations on additional indebtedness, liens, investments, disposition of assets, guarantees, deficit financing, capital expenditures, affiliate transactions and the use of proceeds and prohibit payment of cash dividends and prepayment of subordinated debt. In addition, the credit agreement requires the Company to maintain a minimum liquidity level, limits overhead expense and requires the Company to meet certain ratios. The credit agreement also contains a provision permitting the bank to declare an event of default if either of Messrs. Locke or Kushner fails to be the Chief Executive Officer of the Company or if any person or group acquires ownership or control of capital stock of the Company having voting power greater than the voting power at the time controlled by Messrs. Kushner and Locke combined (other than any institutional investor able to report its holdings on Schedule 13G which holds no more than 15% of such voting 26 27 power). On December 23,1997 the credit agreement was further amended to change the interest coverage covenant effective on September 30, 1997. Securities Offerings As of September 30, 1997, $5,000,000 principal amount of 8% Convertible Subordinated Debentures and $4,100,000 principal amount of 9% Convertible Subordinated Debentures were outstanding. Through December 19, 1997, an additional $250,000 principal amount of the 8% Debentures were converted into 42,735 shares of Common Stock and no additional shares of 9% Debentures were converted. As of September 30, 1997, approximately $77,000 principal amount of Series A Debentures (convertible into common stock at an adjusted rate of approximately $7.61 per share) and $3,242,000 of Series B Debentures (convertible into common stock at an adjusted rate of approximately $9.27 per share) were outstanding. The Company has the right to redeem the Series A Debentures at redemption prices at par after September 30, 1997 and to redeem the Series B Debentures at redemption prices at par after October 1, 1997. All conversion rates are as adjusted for the Company's one-for-six reverse stock split effective September 5, 1997. In September 1994, the Company filed a registration statement covering an aggregate of 21,388,064 shares (now equivalent to 3,564,678 shares giving effect to the 1-for-6 reverse stock split) of common stock comprising the shares of common stock issuable upon conversion of the 8% Convertible Subordinated Debentures and the 9% Convertible Subordinated Debentures and certain warrants issued to underwriters. In May 1996, the Company issued $1,500,000 of short-term bridge notes in a private placement which were repaid in July 1996 in connection with the secondary public offering referred to below. In July 1996, the Company closed a secondary public offering of an aggregate of 4,750,000 units (a "Unit"), each Unit consisting of two shares of Common Stock (now equivalent to 1,583,334 shares in the aggregate giving effect to the 1-for-6 reverse stock split) and one five year Class C Redeemable Common Stock Purchase Warrant to purchase Common Stock at an adjusted exercise price of $6.8625 per share. The Company received net proceeds in the amount of $9,203,125. In connection with such offering, the Company issued warrants to purchase up to an aggregate of 475,000 Units (prior to the reverse split )at an adjusted rate of $18.00 per Unit to the underwriter thereof and a consultant. Production/Distribution Loans The Company's other short term borrowings, totaling $5,844,000 as of September 30, 1997, consisted of production loans from Banque Paribas (Los Angeles Agency) ("Paribas") and Imperial Bank to consolidated production entities. The Kushner-Locke Company provided limited corporate guarantees for a portion of the Paribas loan which is callable in the event that the production company does not repay the loans by the respective maturity date. The Imperial Bank production loans is recourse only to the production entity. Deposits on the purchase price paid by the distributing licensees are held as restricted cash collateral by the Lenders. To the extent the collateral value securing the loans exceeds the amount outstanding, the Company may determine in the future to assume such obligations in full under its Chase facility and take title to such assets. The table below shows certain production loans as of September 30, 1997.
KUSHNER-LOCKE AMOUNT WEIGHTED CORPORATE FILM LENDER LOAN AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY ---- --------------------------------------------------------------------------------------- Basil Paribas $ 6,300,000 $3,564,000 10% $1,000,000 3-30-98 Magic Adventures Imperial 5,150,000 2,280,000 9.92% -- 11-15-97* ----------- ---------- ---------- $11,450,000 $5,844,000 $1,000,000 =========== ========== ==========
* Fully repaid at maturity. 27 28 In April 1996, a $5,150,000 production loan was obtained from Imperial Bank to cover a portion of the production budgets of the Magic Adventures home video series. The loan bore interest at Prime plus 1.5%. The loan was secured by the rights, title and assets related to the film series which are being delivered to domestic and international sub-distributors. The loan was fully repaid in November 1997. In February 1997, a $6,300,000 production loan was obtained from Paribas to cover a portion of the production budget of Basil. The loan bears interest at Prime (8.75% as of December 19, 1997) plus 1.5% payable monthly plus certain loan fee amounts. The loan is secured by the rights, title and assets related to the film which is being delivered to sub-distributors. In May 1997 a third party invested $2,000,000 in the film project in exchange for certain rights and profit participations. As of September 30, 1996 the Company's consolidated entities had productions loans outstanding for Innocent Victims production loan and The Adventures of Pinocchio. In March 1997 the Innocent Victims loan was repaid. In September 1997 the The Adventures of Pinocchio loan was repaid. In November 1997, an $8,200,000 production loan was obtained from Comerica Bank - California by an unconsolidated company 25%-owned by the Company to cover a portion of the production budget of Beowulf. The loan bears interest at U.S. Prime (8.75% as of December 19, 1997) plus 1% or at LIBOR (6% as of December 19, 1997) plus 2%. The Company provided a corporate guaranty in the amount of $1,250,000 in connection with this loan. The loan matures on August 31, 1998. The loan is secured by the rights, title and assets related to the film. The Company recently entered into an agreement in principle with a major studio whereby the Company has the right to distribute in international territories up to nine moderate to high-budget motion pictures over a three year period. The Company has the right to select the motion pictures, if any, to be distributed among titles made available by the major studio. In the event the Company selects one or more films under the arrangement, management currently expects to finance its acquisition of the distribution rights via credit facilities not presently in place. There can be no assurance that definitive agreements for this distribution arrangement will be agreed to, that financing will be obtained, or that such activities will ultimately be profitable if undertaken. Management expects to finance future production and distribution arrangements through a combination of production loans and credit facility borrowings. No assurance can be given that such financing will be available when and if needed. Management believes the Company will comply with the restrictive covenants of the Chase agreement and accordingly the credit facility will be available through June 2000, the maturity date. SUMMARY Management believes that existing resources and cash generated from operating activities, together with amounts available under the syndicated revolving credit agreement with Chase will be sufficient to meet the Company's working capital requirements for at least the next twelve months. The Company from time to time will seek additional financing through the issuance of new debt or equity securities, additional bank financings, or other means available to the Company to increase its working capital. In addition to expanding production and its distribution business, whether internally or by acquisition, the Company also considers acquisition possibilities from time to time, including film libraries and companies ancillary to the Company's business, subject to the availability of financing as necessary. The Company's business and operations have not been materially affected by inflation. The Company utilizes third party provider computer programs to process certain information in order to maintain efficient business operations. No Company-created programming is utilized. Management is aware of the Year 2000 programming issue and is evaluating the adequacy of the third party providers' proposed or implemented solutions. At present, no assurance can be given that those solutions will resolve the issue, and therefore no assurance can be given that the Company will avoid significant deteriorations of operating efficiency or programming costs. 28 29 RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued SFAS No, 128, "Earnings Per Share." SFAS No. 128 specifies new standards designed to improve the earnings per share (EPS) information provided in financial statements by simplifying the existing computational guidelines, revising the disclosure requirements and increasing the comparability of EPS data on an international basis. Some of the changes made to simplify the EPS computations include: (a) eliminating the presentation of primary EPS and replacing it with basic, EPS, for which common stock equivalents are not considered, (b) eliminating the modified treasury stock method and the three percent materiality provision and (c) revising the contingent share provision and the supplemental EPS data requirements. SFAS No. 128 also makes a number of changes to existing disclosure statements issued for periods ending after December 15, 1997, including interim periods The Company's basic earnings per share as calculated under SFAS 128 are $(0.49), $0.11 and $(0.75) for the years ended September 30, 1997, 1996 and 1995, respectively. In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. SFAS No. 130 is effective for financial statements issued for periods beginning after December 15, 1997. Management believes that the impact of SFAS No. 130 will not be material to the Company's financial statements. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standard for the reporting of operating segment information in annual financial statements and in interim financial reports issued to shareholders. SFAS No. 131 is effective for financial statements issued for periods beginning after December 15, 1997. Management believes that the impact of SFAS No. 131 will not be material to the Company's financial statements. 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Item 8 are set forth in the pages indicated in Item 14. 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information called for in Item 10 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1997) in the Company's definitive Proxy Statement in connection with its 1998 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report of Form 10-K. 11. EXECUTIVE COMPENSATION The information called for in Item 11 of Part II I shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1997) in the Company's definitive Proxy Statement in connection with its 1998 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report on Form 10-K. 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for in Item 12 of Part III shall be filed not later than 120 days after the Company's fiscal year 29 30 end (September 30, 1997) in the Company's definitive Proxy Statement in connection with its 1998 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report on Form 10-K. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for in Item 13 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1997) in the Company's definitive Proxy Statement in connection with its 1998 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report on Form 10-K. 30 31 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) (1) Financial Statements: Independent Auditors' Report............................................................................ Consolidated Balance Sheets at September 30, 1997 and 1996.............................................. Consolidated Statements of Operations for the years ended September 30, 1997, 1996, and 1995............ Consolidated Statements of Cash Flows for the years ended September 30, 1997, 1996, and 1995............ Consolidated Statements of Stockholder Equity for the years ended September 30, 1997, 1996, and 1995.... Notes to Consolidated Financial Statements.............................................................. (2) Financial Statement Schedule Schedule II for the years ended September 30, 1997, 1996, and 1995...................................... All other schedules are inapplicable and, therefore, have been omitted. (3) Exhibits................................................................................................ Exhibits filed as part of this report are listed in the Exhibit Index, which follows the Signatures..... (b) Report on Form 8-K: Current Report of the Company on Form 8-K, as filed on September 2, 1997
31 32 INDEPENDENT AUDITORS' REPORT The Board of Directors The Kushner-Locke Company: We have audited the accompanying consolidated balance sheets of The Kushner-Locke Company and subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the years in the three-year period ended September 30, 1997. In connection with our audits of the consolidated financial statements, we have also audited the accompanying financial statement schedule. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Kushner-Locke Company and subsidiaries as of September 30, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1997, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Los Angeles, California December 26, 1997 32 33 THE KUSHNER-LOCKE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 ------------------ ------------------ ASSETS Cash and cash equivalents ............................................................. $ 15,077,000 $ 7,091,000 Reserved cash ......................................................................... 105,000 4,126,000 Restricted cash ....................................................................... 1,609,000 419,000 Accounts receivable, net of allowance for doubtful accounts of $891,000 in 1997 and $693,000 in 1996 .................................................................... 27,696,000 22,885,000 Due from affiliates ................................................................... 588,000 1,238,000 Note receivable from related party .................................................... 423,000 540,000 Film and television property costs, net of accumulated amortization ................... 68,507,000 58,463,000 Investments in unconsolidated entities, at equity ..................................... 5,326,000 1,514,000 Other assets .......................................................................... 5,037,000 3,876,000 ------------- ------------- $ 124,368,000 $ 100,152,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and accrued liabilities .............................................. $ 2,935,000 $ 3,277,000 Notes payable ......................................................................... 62,647,000 41,481,000 Deferred film license fees ............................................................ 3,362,000 3,460,000 Contractual obligations, principally participants' share payable and talent residuals . 6,155,000 3,512,000 Production advances ................................................................... 6,502,000 2,133,000 Convertible subordinated debentures, net of deferred issuance costs ................... 11,631,000 12,039,000 ------------- ------------- Total liabilities ........................................................... 93,232,000 65,902,000 Stockholders' equity: Common stock, no par value. Authorized 50,000,000 shares at September 30, 1997 and 80,000,000 at September 30, 1996: issued and outstanding 9,090,080 shares at September 30, 1997 and 8,777,541 shares at September 30, 1996 as adjusted ........ 38,905,000 37,650,000 Accumulated deficit ................................................................. (7,769,000) (3,400,000) ------------- ------------- Net stockholders' equity .................................................... 31,136,000 34,250,000 ------------- ------------- $ 124,368,000 $ 100,152,000 ============= =============
See accompanying notes to consolidated financial statements. 33 34 THE KUSHNER-LOCKE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
1997 1996 1995 ------------ ------------ ------------ Operating revenues ............................................ $ 56,935,000 $ 80,157,000 $ 20,407,000 Costs related to operating revenues ........................... (52,084,000) (70,648,000) (17,404,000) Selling, general and administrative expenses .................. (5,333,000) (3,595,000) (3,838,000) ------------ ------------ ------------ Earnings/(loss) from operations .......................... (482,000) 5,914,000 (835,000) Interest income ............................................... 163,000 198,000 300,000 Interest expense .............................................. (4,027,000) (4,027,000) (3,409,000) Interest expense related to Bridge Note financing ............. -- (943,000) -- ------------ ------------ ------------ Earnings/(loss) before income taxes and extraordinary item (4,346,000) 1,142,000 (3,944,000) Income tax (expense) .......................................... (23,000) (47,000) (31,000) ------------ ------------ ------------ Earnings/(loss) before extraordinary item ................ (4,369,000) 1,095,000 (3,975,000) Extraordinary item: costs associated with repayment of credit facility ......................................... -- (365,000) -- ------------ ------------ ------------ Net earnings/(loss) ...................................... $ (4,369,000) $ 730,000 $ (3,975,000) ============ ============ ============ Earnings/(loss) per common and common equivalent share: Before extraordinary item .................................. $ (.49) $ .16 $ (.75) Extraordinary item ......................................... -- (.05) -- ------------ ------------ ------------ Net earnings/(loss) ...................................... $ (.49) $ .11 $ (.75) ============ ============ ============ Weighted average common and common equivalent shares outstanding ................................................ 8,959,000 6,668,000 5,286,000 ============ ============ ============
See accompanying notes to consolidated financial statements. 34 35 THE KUSHNER-LOCKE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
1997 1996 1995 ------------ ------------ ------------ Cash flows from operating activities: Net earnings/(loss) ........................................................... $ (4,369,000) $ 730,000 $ (3,975,000) Adjustments to reconcile net earnings/(loss) to net cash used by operating activities: Amortization of film costs ................................................ 50,835,000 70,068,000 16,977,000 Depreciation and amortization ............................................. 192,000 190,000 239,000 Amortization of capitalized issuance costs ................................ 969,000 299,000 414,000 Interest on bridge loan ................................................... -- 750,000 -- Changes in assets and liabilities: Restricted cash ........................................................... (1,190,000) 743,000 (1,162,000) Reserved cash ............................................................. 4,021,000 (4,126,000) -- Accounts receivable, net .................................................. (4,811,000) (15,021,000) (1,687,000) Other receivables ......................................................... 767,000 (717,000) (766,000) Film costs ................................................................ (60,879,000) (54,815,000) (60,005,000) Accounts payable and accrued liabilities .................................. (342,000) 32,000 860,000 Deferred film license fees ................................................ (98,000) 707,000 2,389,000 Contractual obligations ................................................... 2,643,000 2,517,000 (221,000) Production advances ....................................................... 4,369,000 (14,476,000) 16,527,000 ------------ ------------ ------------ Net cash used by operating activities ................................ (7,893,000) (13,119,000) (30,410,000) ------------ ------------ ------------ Cash flows from investing activities: .......................................... -- Investments in unconsolidated entities ......................................... (3,812,000) (1,495,000) Increase in property and equipment, net ....................................... (157,000) (140,000) (317,000) ------------ ------------ ------------ Net cash used by investing activities ................................ (3,969,000) (1,635,000) (317,000) ------------ ------------ ------------ Cash flows from financing activities: Increase in notes payable ..................................................... 54,716,000 34,081,000 21,398,000 Repayment of notes payable .................................................... (33,550,000) (20,998,000) (2,600,000) Net proceeds from issuance of common stock .................................... -- 7,202,000 -- Net proceeds from exercise of stock options ................................... -- 412,000 -- Repayment of debentures/exercise of conversion options ........................ -- (56,000) (25,000) Other ......................................................................... (1,318,000) (1,935,000) (588,000) ------------ ------------ ------------ Net cash provided by financing activities ............................ 19,848,000 18,706,000 18,185,000 ------------ ------------ ------------ Net increase (decrease) in cash ...................................... 7,986,000 3,952,000 (12,542,000) Cash and cash equivalents at beginning of year ................................. 7,091,000 3,139,000 15,681,000 ------------ ------------ ------------ Cash and cash equivalents at end of year ....................................... $ 15,077,000 $ 7,091,000 $ 3,139,000 ============ ============ ============ Supplemental disclosure of cash flow information: Cash paid during the year for: Interest ................................................................. $ 4,487,000 $ 3,557,000 $ 2,952,000 Income taxes ............................................................. $ 23,000 $ 47,000 $ 27,200
See accompanying notes to consolidated financial statements. 35 36 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: (1) In fiscal 1995, $5,260,000 of convertible subordinated debentures were converted into 899,583 adjusted shares of common stock. (2) In fiscal 1996, $6,500,000 of convertible subordinated debentures were converted into 1,182,248 adjusted shares of common stock including 105,289 adjusted shares of common stock, valued at $750,000, relating to interest on the bridge loan. See accompanying notes to consolidated financial statements. (3) In fiscal 1997, $667,000 of convertible subordinated debentures were converted into 84,562 adjusted shares of common stock. 36 37 THE KUSHNER-LOCKE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
NUMBER OF (ACCUMULATED SHARES COMMON STOCK DEFICIT) NET ------------ ------------ ------------ ------------ Balance at September 30, 1994 ............ 5,011,517 $ 18,696,000 $ (155,000) $ 18,541,000 Conversion of subordinated debentures ......... 899,583 4,641,000 -- 4,641,000 Net loss ...................................... -- -- (3,975,000) (3,975,000) ------------ ------------ ------------ ------------ Balance at September 30, 1995 ............ 5,911,100 23,337,000 (4,130,000) 19,207,000 Issuance of common stock ...................... 1,583,333 7,202,000 -- 7,202,000 Stock options exercised ....................... 75,000 412,000 -- 412,000 Stock purchase warrants exercised ............. 25,860 -- -- -- Issuance of bridge loan stock ................. 105,289 750,000 -- 750,000 Conversion of subordinated debentures ......... 1,076,959 5,949,000 -- 5,949,000 Net earnings .................................. -- -- 730,000 730,000 ------------ ------------ ------------ ------------ Balance of September 30, 1996 ........... 8,777,541 37,650,000 (3,400,000) 34,250,000 Issuance of common stock ...................... 227,500 598,000 -- 598,000 Conversion of subordinated debentures ......... 84,562 613,000 -- 613,000 Other ......................................... 477 44,000 -- 44,000 Net loss ...................................... -- -- (4,369,000) (4,369,000) ============ ============ ============ ============ Balance at September 30, 1997 ............ 9,090,080 $ 38,905,000 $ (7,769,000) $ 31,136,000 ============ ============ ============ ============
See accompanying notes to consolidated financial statements. 37 38 THE KUSHNER-LOCKE COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies The Company The Kushner-Locke Company (the "Company") develops, produces and distributes feature films, direct-to-video films, television series, movies-for-television, mini-series and animated programming. In the last three years, the Company expanded its operations into related business lines in ancillary markets for its product such as merchandising, home video, cable and interactive/multimedia applications for characters and story ideas developed by the Company. Generally, theatrical films are first distributed in the theatrical and home video markets. Subsequently, theatrical films are made available for world-wide television network exhibition or pay television, television syndication and cable television. Generally, television films are first licensed for network exhibition and foreign syndication or home video, and subsequently for domestic syndication or cable television. Certain films are produced and/or distributed directly for initial exhibition by local television stations, advertiser-supported cable television, pay television and/or home video. The revenue cycle generally extends 7 to 10 years on film and television products. Basis of Presentation The consolidated financial statements include the accounts of The Kushner-Locke Company, its wholly-owned subsidiaries and certain less than wholly-owned entities which the Company controls. All material intercompany balances and transactions have been eliminated. Entities in which the Company holds a 20% to 50% interest and exercises significant influence are accounted for under the equity method. Certain reclassifications have been made to conform prior year balances with the current presentation. Revenue Recognition Revenues from feature film and television program distribution licensing agreements are recognized on the date the completed film or program is delivered or becomes available for delivery, is available for exploitation in the relevant media window purchased by that customer or licensee and certain other conditions of sale have been met pursuant to criteria specified by SFAS No. 53, Financial Reporting By Producers and Distributors of Motion Picture Films. Revenues from barter transactions, whereby the program is exchanged for television advertising time which is sold to product sponsors, are recognized when the television program has aired and all conditions precedent have been satisfied. Producer fees received from production of films and television programs for outside parties where the Company has no continuing ownership interest in the project are recognized on a percentage-of-completion basis as determined by applying the cost-to-cost method. The cost of such films and television series is expensed as incurred. Accounting for Film and Television Property Costs The Company capitalizes costs incurred to produce a film or television project, including the interest expense funded under the production loans. Such costs also include the actual direct costs of production, certain exploitation costs and production overhead. Capitalized exploitation or distribution costs include those costs that clearly benefit future periods such as film prints and prerelease and early release advertising that is expected to benefit the film in future markets. These costs, as well as expected revenue or profit participations and talent residuals, are amortized each period on an individual film or television program basis in the ratio that the current period's gross revenues from all sources for the program bear to 38 39 management's estimate of anticipated total gross revenues for such film or program from all sources. Revenue estimates are reviewed quarterly and adjusted where appropriate and the impact of such adjustments could be material. Film and television property costs are stated at the lower of unamortized cost or estimated net realizable value. Losses which may arise because unamortized costs of individual films or television series exceed anticipated revenues are charged to operations through additional amortization. The Company capitalized interest of $1,429,000, $1,735,000 and $631,000 to film and television property costs for the years ended September 30, 1997, 1996, and 1995, respectively. Participants' Share Payable and Talent Residuals The Company charges profit participation and talent residual costs to expense in the same manner as amortization of production costs, based on the ratio of current period gross revenues to management's estimate of total ultimate gross revenues, if it is anticipated such amounts will be payable. Payments for profit participations are made in accordance with the participants' contractual agreements. Payments for talent residuals are remitted to the respective guilds in accordance with the provisions of their union agreements. Production Advances The Company receives license fees for projects in the production phase. Production advances are generally nonrefundable and are recognized as earned revenue when the film or television program is available for delivery. Allowance for Doubtful Accounts The Company provides for doubtful accounts based on historical collection experience and periodically adjusts the allowance based on the aging of accounts receivable and other conditions. Receivables are written off against the allowance in the period they are deemed uncollectible. Cash and Cash Equivalents The Company considers certificates of deposit and other highly liquid investments with original maturities of three months or less to be cash equivalents. Restricted and Reserved Cash At September 30, 1997, the Company had $1,609,000 in restricted cash related to a deposit held at a British bank pursuant to a film sale/leaseback transaction, and to advances made by the Company to film producers for the acquisition of distribution rights or films not yet completed ($419,000 at September 30, 1996). The latter cash advances are held in escrow accounts as collateral by financial institutions providing production loans to those producers. In addition, the Company has $105,000 in cash collected by the Company and reserved for use by Chase Manhattan Bank to be applied against the Company's outstanding borrowings under the terms of the Company's credit facility ($4,126,000 at September 30, 1996.). International Currency Transactions The majority of the Company's foreign sales transactions are payable in U.S. dollars. Accordingly, international currency transaction gains and losses included in the consolidated statements of operations for the three years ended September 30, 1997 were not significant. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets 39 40 and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operating results in the period encompassing the enactment date. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Significant estimates are primarily related to ultimate revenues and ultimate costs relating to the Company's film and television properties and the collectibility of accounts receivable. Actual results may differ from estimated amounts. Stock-Based Compensation In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 is effective for fiscal years beginning after December 15, 1995, and requires that the Company either recognize in its consolidated financial statements costs related to its employee stock-based compensation plans, such as stock option and stock purchase plans, or make pro forma disclosures of such costs in a footnote to the consolidated financial statements. Fair Value of Financial Instruments The fair value of the Company's cash and cash equivalents, accounts receivable, due from affiliates, accounts payable and accrued liabilities, contractual obligations and participants' share payable for talent residuals approximate their recorded value due to the relatively short maturities of these instruments. The fair value of due from affiliates and note receivable from a related party have not been estimated due to the related party nature of such amounts. The fair value of notes payable and convertible subordinated debentures approximates the recorded value due to the stated interest rate on such instruments and the indeterminate nature of the value of the convertibility feature of such debt instrument. Reverse Stock Split In September 1997 the Company effected a 1-for-6 reverse split of the issued and outstanding shares of common stock which had been approved by the stockholders. All references to shares outstanding give effect to this reverse stock split as if it had occurred at the beginning of the earliest period presented. Earnings/(Loss) Per Share Earnings (loss) per common and common equivalent share is based upon the weighted average number of shares of common stock outstanding plus common equivalent shares consisting of dilutive outstanding warrants and stock options. The inclusion of the additional shares assuming the conversion of the Company's convertible subordinated debentures or assuming the exercise of warrants or stock options would have been anti-dilutive for all periods. (2) Film and Television Property Costs Film and television property costs consist of the following:
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 ------------------ ------------------ In process or development ......................................... $10,497,000 $16,527,000 Released, principally feature films and television productions, net of accumulated amortization ..................................... 58,010,000 41,936,000 ----------- ----------- Total ............................................................. $68,507,000 $58,463,000 =========== ===========
40 41 Based upon the Company's present estimates of anticipated future revenues at September 30, 1997, approximately 70% of the film costs related to released films and television series will be amortized during the three-year period ending September 30, 2000. (3) Investments in Unconsolidated Entities, at Equity Information regarding investments and advances, net as of September 30, 1997 and 1996 as follows:
OWNERSHIP NET EQUITY INVESTEE % INVESTMENT -------- ------------------------------- 1997: BLT Ventures 50% $1,925,000 Cracker Company, LLC 50% 2,533,000 TV First 50% 868,000 ---------- $5,326,000 ========== 1996: BLT Ventures 50% $ 19,000 TV First 50% 1,495,000 ---------- $1,514,000 ==========
Equity in earnings (losses) of unconsolidated entities and other investments for the years ended September 30, 1997 and 1996 which are included in operating revenues were as follows:
1997 1996 ----------- ----------- BLT Ventures $ 1,896,000 $ 243,000 Cracker Company, LLC 313,000 -- TV First (20,000) (17,000) ----------- ----------- $ 2,189,000 $ 226,000 =========== ===========
The following representation is a condensed combined unaudited summary of financial information of the Company's investments. Certain of the Company's other equity investments are not considered significant and are therefore not included:
COMBINED BALANCE SHEETS SEPTEMBER 30 ------------------------------------- 1997 1996 ----------- ----------- (Unaudited) Film and television programming costs net $12,510,000 $ 3,316,000 Cash 1,242,000 631,000 Other assets 3,304,000 1,198,000 ----------- ----------- Total assets $17,056,000 $ 5,145,000 =========== =========== Accounts payable $ 1,481,000 $ 1,037,000 Notes payable 208,000 -- Production advances 10,896,000 2,882,000 Ownership equity 4,471,000 1,226,000 ----------- ----------- Total Liabilities and ownership equity $17,056,000 $ 5,145,000 =========== ===========
41 42
COMBINED OPERATING STATEMENTS YEAR ENDED SEPTEMBER 30 ------------------------------- 1997 1996 ------------ ------------ (Unaudited) Operating income $ 24,681,000 $ 3,393,000 Costs relating to operating revenues (20,278,000) (2,896,000) Interest income 4,000 5,000 Interest expenses (29,000) (49,000) ------------ ------------ Net earnings $ 4,378,000 $ 453,000 ============ ============
No dividends were received from unconsolidated entities during fiscal 1997 or 1996. (4) Notes Payable Notes payable consist of the following:
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 ------------------ ------------------ Note payable to bank, under the revolving credit facility secured by substantially all Company assets, interest at varying rates as discussed below, outstanding principal balance due June 2000...................... $56,803,000 $29,037,000 Notes payable to banks and/or financial institutions consisting of two production loans secured by certain film rights held by producers, priced at different rates for each loan ..................... 5,844,000 12,444,000 ----------- ----------- Total .................................................................... $62,647,000 $41,481,000 =========== ===========
In June, 1996 the Company obtained a $40,000,000 syndicated borrowing base revolving credit facility. In conjunction with this new facility, the Company repaid amounts outstanding under its previously existing $15,000,000 credit facility. Unamortized issuance costs of $365,000 relating to this previous credit facility were expensed as an extraordinary item in 1996. In September 1997 the facility was increased to $60,000,000. The revolving credit facility is available through June 2000 and bears interest at the Company's option, either (i) at LIBOR (6% as of December 19, 1997) plus 3% (for that portion of the borrowing base supported by accounts or contracts receivable) or LIBOR (6% as of December 19, 1997) plus 4% (for that portion of the borrowing base supported by unamortized library film costs or for loans made under the production tranche) or (ii) at the Alternate Base Rate (which is the greater of (a) the agent bank's Prime Rate (8.75% as of December 19, 1997), (b) the agent bank's Base CD Rate (5.81% as of December 24, 1997) plus 1% or (c) the Federal Funds Effective Rate (5.46%) as of December 19, 1997) plus 1/2% plus 2% (for that portion of the borrowing base supported by accounts or contracts receivable) or 3% (for that portion of the borrowing base supported by unamortized library film costs or for loans made under the production tranche). The credit agreement contains restrictive covenants to which the Company must adhere. These covenants, among other things, include limitations on additional indebtedness, liens, investments, disposition of assets, guarantees, deficit financing, capital expenditures, affiliate transactions and the use of proceeds, and prohibit payment of cash dividends and prepayment of most subordinated debt. In addition, the Company must maintain a minimum liquidity level, limit overhead expense and to meet certain financial ratios. The bank could declare an event of default if either of Messrs. Locke or Kushner failed to be the Chief Executive Officer of the Company or if any person or group acquired ownership or control of capital stock of the Company having voting power greater than the voting power at the time controlled by Messrs. Kushner and Locke combined (other than any institutional investor able to report its holdings on Schedule 13G which holds no more than 15% of such voting power). On December 18, 1997 the Company received a waiver of covenants pertaining to the specified ratio of debt 42 43 to equity and the specified earnings coverage of interest costs which had not been met at September 30, 1997. On December 23,1997 the credit agreement was further amended to change the interest coverage covenant effective as of September 30, 1997, and the Company was in compliance with the amended covenant. The Company's other short term borrowings, totaling $5,844,000 as of September 30, 1997, consist of production loans from Banque Paribas (Los Angeles Agency) ("Paribas") and Imperial Bank ("Imperial") to consolidated production entities. The Paribas loan bears interest at Reference Rate (8.75% as of December 19, 1997) plus 1.5%. The Imperial loan, which was fully repaid by November 1997, bore interest at Prime plus 1.5%. The Kushner-Locke Company provided limited corporate guarantees for a portion of the Paribas loan which is callable in the event that the production company does not repay the loan made by the respective maturity date. Deposits on the purchase price paid by the distributing licensees are held as restricted cash collateral by the Lenders. During fiscal 1997 the $12,500,000 Newmarket loan and the $1,200,000 Paribas loan which were outstanding as of September 30, 1996 were fully repaid. The table below shows production loans as of September 30, 1997.
ORIGINAL LOAN AMOUNTS WEIGHTED FILM LENDER AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY - ----------------------------------------------------------------------------------------------------------------------- 10% Basil .................. Paribas $ 6,300,000 $3,564,000 $1,000,000 5-30-98 Magic Adventures........ Imperial 5,150,000 2,280,000 9.97% -- 11-15-97* ------------ ---------- ----------- Total ............ $ 11,450,000 $5,844,000 $1,000,000 ============ ========== ===========
- ----------------- * Fully repaid at maturity In April 1996, a $5,150,000 production loan was obtained from Imperial Bank to cover a portion of the production budgets of the Magic Adventures home video series. The loan bore interest at Prime plus 1.5% . The loan was secured by the rights, title and assets related to the film series which are being delivered to domestic and international sub-distributors. The loan was fully repaid in November 1997. In February 1997, a $6,300,000 production loan was obtained from Paribas to cover a portion of the production budget of Basil. The loan bears interest at Prime (8.75% as of December 19, 1997) plus 1.5% payable monthly plus certain loan fee amounts. The loan is secured by the rights, title and assets related to the film which is being delivered to sub-distributors. In May 1997 a third party invested $2,000,000 in the film project in exchange for certain rights and profit participations. In November 1997, a $8,200,000 loan was obtained from Comerica Bank - California by an unconsolidated company 25%-owned by the Company to cover a portion of the production budget of Beowulf. The Company provided its corporate guaranty in the amount of $1,250,000 in connection with this loan. The loan matures on August 31,1998. The loan bears interest. at Prime (8.75% as of December 19, 1997) plus 1% or at LIBOR (6% as of December 19, 1997) plus 2 %, payable monthly plus certain loan fee amounts. The loan is secured by the rights, title and assets related to the film. 43 44 (5) Convertible Subordinated Debentures
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996 ------------------ ------------------ Series A Convertible Subordinated Debentures due December 2000, bearing interest at 10% per annum payable June 15 and December 15, net ....................................... 71,000 $ 68,000 Series B Convertible Subordinated Debentures due December 2000, bearing interest at 13 3/4% per annum payable monthly, net of unamortized issuance costs ................. 3,029,000 2,976,000 8% Convertible Subordinated Debentures due December 2000, bearing interest at 8% per annum payable February 1 and August 1, net ........................................... 4,710,000 4,821,000 9% Convertible Subordinated Debentures due July 2002, bearing interest at 9% per annum payable January 1 and July 1, net .................................................... 3,821,000 4,174,000 ----------- ----------- Total .................................................................................. $11,631,000 $12,039,000 =========== ===========
Series A Debentures During fiscal 1991, the Company sold $1,500,000 principal amount of Series A Convertible Subordinated Debentures due 2000 and 4,200 units which represented an additional $4,200,000 principal amount of Series A Debentures. Each unit included warrants to purchase 84 shares of common stock of the Company at $12.00 per share, as adjusted for the reverse stock split. Each warrant has been valued at $1.50 (350,000 warrants with a total value of $525,000) and is included in common stock. As of September 30, 1997, the Company had outstanding $77,000 principal amount of Series A Debentures. The debentures are recorded net of unamortized underwriting discounts, expenses associated with the offering and warrants totaling $6,000 which are amortized using the interest method to interest expense over the term of the debentures. Approximately $3,000 of capitalized issuance costs have been amortized to interest expense for the year ended September 30, 1997. The Series A Debentures bear interest at 10% per annum, payable on June 15 and December 15 in each year. The Series A Debentures are convertible into common stock of the Company at the approximate adjusted rate of 132 shares for each $1,000 principal amount of debentures, subject to further adjustment under certain circumstances. The Company may redeem the debentures at par after September 30, 1997. The debentures are subordinated to all existing and future "senior indebtedness." The term "senior indebtedness" is defined to mean the principal of (and premium, if any) and interest on any and all indebtedness of the Company that is (i) incurred in connection with the borrowing of money from banks, insurance companies and similar institutional lenders, (ii) issued as a result of a public offering of debt securities pursuant to registration under the Securities Act of 1933, or (iii) incurred in connection with the borrowing of money with an original principal amount of at least $100,000 secured at least in advanced by companies engaged in the ordinary course of their business in the entertainment industry. Senior indebtedness does not include (i) the Series B Debentures, (ii) indebtedness to affiliates and (iii) indebtedness expressly subordinated to or on parity with the Series A Debentures, whether outstanding on the date of execution of the indenture or thereafter created, incurred, assumed or guaranteed. Series B Debentures During fiscal 1991, the Company sold $6,000,000 principal amount of Series B Convertible Subordinated Debentures due 2000. As of September 30, 1997 the Company had outstanding $3,242,000 principal amount of Series B Debentures due 2000. The debentures bear interest at 13.75% per annum. The Series B Debentures are recorded net of unamortized underwriting discounts and expenses associated with the offering totaling $212,000, which are amortized using the interest 44 45 method to interest expense over the term of the debentures. Approximately $72,000 of capitalized issuance costs had been amortized as interest expense for the year ended September 30, 1997. The terms of the Series B Debentures are generally similar to those of the Series A Debentures other than with respect to the interest rates, except that (i) interest is payable monthly on the Series B Debentures and (ii) the Series B Debentures are convertible into common stock of the Company at an adjusted rate of $9.2664 per share. The Series B Debentures rank pari passu (i.e., equally) in right of payment with the Company's other debentures. For the year ended September 30, 1997 $56,000 principal amount of Series B Debentures were repurchased upon the death of bondholders pursuant to the "Flower Bond" provision of the Series B Debentures. 8% Debentures During fiscal 1994, the Company sold $16,437,000 principal amount of 8% Convertible Subordinated Debentures due 2000. In connection with the issuance, the Company issued warrants to purchase up to 10% of the aggregate principal amount of debentures sold at an exercise price equal to 120% of the principal amount of the debentures which are exercisable through March 1999 for $9,613,700 principal amount and through April 1999 for $30,000 principal amount. As of September 30, 1997, the Company had outstanding $5,000,000 principal amount of 8% Debentures. The debentures are recorded net of unamortized underwriting discounts and expenses associated with the offering totaling $290,000 which are amortized using the interest method to interest expense over the term of the debentures. Approximately $106,000 of capitalized issuance costs had been amortized as interest expense for the year ended September 30, 1997. Approximately $217,000 principal amount of the 8% Debentures had been converted into 37,094 shares of common stock of the Company in fiscal year 1997. The terms of the 8% Debentures are generally similar to those of the Series A Debentures, other than with respect to the interest rates, except that (i) interest is payable on February 1 and August 1 in each year; (ii) the 8% Debentures are convertible into common stock of the Company at an adjusted rate of $5.85 per share; and (iii) the Company has the right to redeem the 8% Debentures at redemption prices commencing at 102.7% of par in February 1998 and declining to par commencing in February 2000. The 8% Debentures rank pari passu in right of payment with the Company's other debentures. 9% Debentures During fiscal 1994, the Company sold $5,050,000 principal amount of 9% Convertible Subordinated Debentures due 2002. In connection with the issuance, the Company issued warrants to purchase up to 9% of the aggregate principal amount of debentures sold at an exercise price equal to 120% of the principal amount of debentures which warrants are exerciseable July, 1999. As of September 30, 1997, the Company had outstanding $4,100,000 principal amount of 9% Debentures. The debentures bear interest at 9% per annum. The debentures are recorded net of unamortized underwriting discounts and expenses associated with the offering totaling $279,000, which are amortized using the interest method to interest expense over the term of the debentures. Approximately $97,000 of capitalized issuance costs had been amortized as interest expense for the year ended September 30, 1997. Approximately $450,000 principal amount of the 9% Debentures had been converted into 47,468 shares of common stock of the Company in fiscal year 1997. The terms of the 9% Debentures are generally similar to those of the Series A Debentures, other than with respect to the interest rates, except that: (i) interest is payable on January 1 and July 1 in each year; (ii) the 9% Debentures are convertible into common stock of the Company at an adjusted rate of $9.48 per share; and (iii) the Company has the right to redeem the 9% Debentures at redemption prices commencing at 103% of par in July 1998 and declining to par commencing in July 2000. The 9% Debentures rank pari passu in right of payment with the Company's other debentures. 45 46 (5) Income Taxes Income tax expense (benefit) consisted of the following:
------------------------------ YEAR ENDED SEPTEMBER 30, ------------------------------ 1997 1996 1995 ------------------------------ Current: Federal .................... $ -- $ -- $ -- State ...................... 23,000 47,000 31,000 ------------------------------ 23,000 47,000 31,000 Deferred: Federal .................... -- -- -- State ...................... -- -- -- ------------------------------ Total income tax expense $23,000 $47,000 $31,000 ==============================
A reconciliation of the statutory Federal income tax rate to the Company's effective rate is presented below:
YEAR ENDED SEPTEMBER 30, ------------------------- 1997 1996 1995 ------------------------- Statutory Federal income tax rate ............ (34)% 34% (34)% Change in valuation allowance ................ 34 (34) 34 State income taxes, net of Federal tax benefit (1) 4 (1) ------------------------- (1)% 4% (1)% =========================
Significant components of the Company's deferred tax assets and liabilities at September 30, 1997 and September 30, 1996 are as follows:
YEAR ENDED SEPTEMBER 30, ------------------------------ 1997 1996 ------------------------------ Deferred tax assets: Net operating loss carryforwards ................. $ 14,056,000 $ 11,492,000 Tax and general business tax credit carryforwards 857,000 751,000 Allowance for doubtful accounts and other reserves 691,000 250,000 Deferred film license fees ....................... 1,182,000 1,295,000 Other reserves ................................... 484,000 409,000 Depreciation ..................................... 30,000 100,000 ------------------------------ Total gross deferred assets .................. 17,300,000 14,297,000 Valuation allowance .......................... (5,198,000) (2,908,000) ------------------------------ Net deferred tax assets ...................... $ 12,102,000 $ 11,389,000 ============================== Deferred tax liabilities: Film amortization ................................ $ 11,825,000 $ 11,389,000 Partnerships ..................................... 153,000 State taxes ...................................... 124,000 - ------------------------------ Total deferred tax liabilities ............... $ 12,102,000 $ 11,389,000 ==============================
46 47 At September 30, 1997, the Company had total net operating loss carryforwards of approximately $39,309,000,000 for federal income tax purposes. Such carryforwards expire in fiscal 2012. For state tax purposes, the Company had net operating loss carryforwards of $7,436,000 which expire in fiscal 1999 through 2002. The Company's international tax credits, amounting to approximately $493,000, expire in fiscal 1997 through 2001. The Company's general business credit carryforwards, amounting to approximately $197,000, expire through 2003. Finally, the Company's alternative minimum tax credit carryforwards, amounting to approximately $173,000, have no expiration date. (6) Stockholder's Equity Authorized Stock In November 1996 the stockholders of the Company approved an increase in the number of authorized shares of Common Stock of the Company from 80,000,000 shares to 150,000,000 shares. In August 1997 the stockholders of the Company approved a reduction in the number of authorized shares of Common Stock from 150,000,000 to 50,000,000 in conjunction with a 1-for-6 reverse stock split. Warrants In 1991, in connection with the Series A Convertible Subordinated Debenture offering, the Company issued warrants to the underwriter to purchase up to 400 units of Series A Debentures at $1,200 per unit. Each unit consists of $1,000 principal amount of Series A Debentures and warrants to purchase 84 shares of common stock of the Company as adjusted at $12.00 per share as adjusted. The warrants, sold as part of the unit, were exerciseable through March, 1997 as extended. The Company issued 350,000 warrants as adjusted valued at $525,000 to purchase common stock at $12.00 per share, subject to adjustment in certain circumstances. No warrants were exercised. In 1992, in connection with its public offering of common stock, the Company issued warrants to the underwriters of the offering to purchase 116,667 shares of common stock as adjusted. The warrants were exerciseable through November 1997 at an adjusted price of $7.50 per share. No warrants were exercised. In 1994, in connection with the 8% Convertible Subordinated Debentures offering, the Company issued warrants to the underwriter to purchase up to 10% of the aggregate principal amount of debentures sold ($1,643,700) at an exercise price equal to 120% of the principal amount of the debentures, subject to adjustment in certain circumstances. The warrants are exerciseable March, 1999 for $1,613,700 principal amount and April, 1999 for $30,000 principal amount. In connection with the 9% Convertible Subordinated Debenture offering, the Company issued warrants to the underwriters to purchase up to 10% of the aggregate principal amount of debentures sold ($505,000) at an exercise price equal to 120% of the principal amount of the debentures, subject to adjustments in certain circumstances. The warrants are exercisable through July, 1999. Through September 30, 1997, no warrants had been exercised. In 1996, in connection with its public offering of 4,750,000 units consisting of two (pre-reverse split) shares of common stock and one warrant to purchase one share of common stock (a "Unit") for an adjusted price of $11.625 per unit, the Company issued 791,667 warrants to purchase common stock, as adjusted, and warrants to the underwriter to purchase up to 71,167 units at an exercise price of $19.18125 per Unit, as adjusted, subject to adjustment in certain circumstances. In addition, the Company issued warrants to a consultant to purchase up to 47,500 Units at $19.18125 per Unit, subject to adjustment in certain circumstances. The warrants underlying the Units are exercisable at an adjusted exercise price of $6.8625 per share subject to adjustments in certain circumstances through June 2001. Through September 30, 1997, no warrants had been exercised. In June 1997 the Company issued warrants to a financial consultant to purchase up to 50,000 shares of common stock of the Company at $1.6875 per share which are exercisable from December 27, 1997 through June 2002. These warrants replaced several earlier warrants grants to the consultant, which are no longer exercisable. In September 1997, in connection with a consulting agreement, the Company issued warrants to Allen & Company, 47 48 Incorporated to purchase up to 500,000 shares of common stock of the Company at $2.0625 per share. Of the total, warrants for 166,667 shares are immediately exercisable, an additional 166,667 become exercisable in September 1998, and the remaining 166,666 become exerciseable in September 1999, the latter two events subject to Allen & Company, Incorporated still being engaged as consultants by the Company. The warrants expire in September 2004. Also in September 1997 the Company issued warrants to a financial consultant to purchase up to 50,000 shares of common stock at $2.0625 per share. The terms of that warrant are the same as that pertaining to Allen & Company Incorporated. The fair value of such warrants will be amortized over the term of the consulting agreement. Options In 1989, the Board of Directors approved a stock incentive plan (the "Plan") that covers directors, third party consultants and advisors, independent contractors, officers and other employees of the Company. In May 1994, the stockholders of the Company voted to increase the authorized number of shares available under the Plan from 250,000 to 750,000, as adjusted. In November 1996 the stockholders voted to make certain amendments to the Plan, including increasing the number of shares of Common Stock reserved for issuance from 750,000 shares to 1,250,000 shares, as adjusted, as well as certain changes in accordance with new rules enacted under Section 16 of the Securities Exchange Act of 1934, as amended. The Plan allows for the issuance of options to purchase shares of the Company's common stock at an option price at least equal to the fair value of the stock on the date of grant. As of September 30, 1997, 1,078,692 stock options had been granted and were outstanding under the Plan. The schedule below includes stock options that the Company has granted as of September 30, 1997:
WEIGHTED AVERAGE EXERCISE SHARES PRICES ----------------------- Balance at September 30, 1994 ............... 698,268 Granted Fiscal 1995 .............................. 102,500 $4.50- Options Expired/Canceled ......................... (12,083) $8.28 Options Exercised ................................ --------- Balance at September 30, 1995 ............... 788,685 Granted Fiscal 1996 .............................. 16,667 $4.50 Options Expired/Canceled ......................... (30,833) $4.86 Options Exercised ................................ (75,000) $5.49 --------- Balance at September 30, 1996 ............... 699,519 Granted Fiscal 1997 .............................. 450,006 $1.98 Options Expired/Canceled ......................... (70,833) $2.58 --------- Balance at September 30, 1997 ............... 1,078,692 ========= Exercisable at September 30, 1997 ................ 528,141 $6.16 Exercisable at September 30, 1996 ................ 397,016 $7.04 Exercisable at September 30, ..................... 378,849 $5.24 =========
At September 30, 1997, the range of exercise prices and weighted average remaining contractual life of outstanding options was $1.86 - $15,78 and 6.4 years, respectively. At September 30, 1997, 171,308 shares remained available for future grant. 48 49 The Company applies APB opinion No. 25 and related Interpretations in accounting for its plan, and accordingly, no compensation cost has been recognized. Had compensation cost for the Company's plan been determined consistent with FASB Statement No. 123, the Company's net earnings (loss) and earnings loss per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED SEPTEMBER 30, --------------------------------- 1997 1996 --------------------------------- Net earnings (loss) As Reported $ (4,369,000) $ 730,000 --------------------------------- Pro forma $ (4,448,000) 730,000 ================================= Earnings (loss) per share As Reported $ (.49) $ .11 ================================= Pro forma $ (.50) $ .11 =================================
The pro forma disclosure of compensation cost under this pronouncement was based on the Black-Scholes single-option pricing model with the following weighted average assumption for 1997 and 1996: volatility of 58%, risk-free interest rate of 6.27%, and an expected option life of 10 years. Pro forma net earnings (loss) reflects only options granted in fiscal 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under FASB Statement No. 123 is not reflected in the pro forma net earnings (loss) amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to October 1, 1995 is not considered. (8) Commitments and Contingencies Officer Compensation Messrs. Kushner and Locke In March 1994, Messrs. Kushner and Locke each amended his respective employment agreement with the Company to (i) extend the term of the agreement to March 1999 and (ii) reduce the maximum annual performance bonus that each may receive to 4% of pre-tax earnings for the applicable period up to a maximum of $200,000 in fiscal 1994, $220,000 in fiscal 1995, $250,000 in fiscal 1996, $270,000 in fiscal 1997 and $290,000 in fiscal 1998. Under the revised employment agreements, Messrs. Kushner and Locke each have a base salary of and $425,000 through fiscal 1998, subject to potential increase upon review by the Company's Board of Directors after fiscal 1995. As approved by the Board of Directors in February 1996 and May 1996, Messrs. Kushner and Locke amended their employment agreements to waive their pre-tax earnings performance bonus in the event the Company's annual net income in fiscal 1996 was less than $1,250,000, but were to receive 6% of pre-tax earnings of the Company for fiscal 1996 in excess of $1,250,000 and up to $3,166,666; and were to receive 4% of pre-tax earnings of the Company for fiscal 1996 in excess of $3,166,666, but in no event were either one of them to be entitled to receive greater than $250,000 of performance bonus. No bonus was accrued or paid in fiscal 1995, 1996 or 1997. In order to induce Messrs. Kushner and Locke to amend their employment agreements, the Company granted to each in March 1994 options to purchase 150,000 shares of Common Stock as adjusted at an exercise price per share equal to $5.04 (the adjusted last reported sale price of the Common Stock on the date of the initial closing of the 8% Debentures). The options vest over a five year period, with 20% vesting at each anniversary of the date of grant (subject to possible acceleration following a "change-in-control"). In October, 1997, Messrs. Kushner and Locke each agreed to an amendment to his respective employment agreement with the Company to extend the term of the agreement to October, 2002. Under the revised employment agreements, Messrs. Kushner and Locke each have a base salary of $425,000 in fiscal 1997, and $25,000 annual increases up 49 50 to a maximum of $525,000 annual base compensation. In the event the Company achieves earnings before income taxes in excess of $2,000,000, each of Messrs. Kushner and Locke are entitled to certain profit bonuses at graduated rates ranging from 5% of annual earnings before income taxes up to $4,000,000 to 7.5% of annual earnings before income taxes in excess of $8,000,000. In order to induce Messrs. Kushner and Locke to enter into the amended employment agreements, the Company granted to each, as of August 1, 1997 , options to purchase 83,333 (post reverse split) shares of Common Stock at an exercise price per share equal to $1.875 (the last reported sale price of the Common Stock on the date prior to the award date, as adjusted). The options vest over a five year period, with 20% vesting respectively on each of the next five annual anniversary dates following the date of the grant (subject to possible acceleration following a "change-in-control" as defined in the Company's 1988 Stock Incentive Plan). The Company also granted to each of Messrs. Kushner and Locke options to purchase an additional 83,333 (post reverse split) shares of Common Stock at an exercise price per share equal to $1.875, vesting at the rate of 20% per year, but exercisable only upon the achievement of certain annual income targets to be set by the board of directors or the Company's Common Stock reaching certain public trading prices ranging from $2.00 to $6.00 per share. The Company also provides each of Messrs. Kushner and Locke with certain fringe benefits, including $3,500,000 of term life insurance with a split dollar ownership structure and disability insurance. The Company also agreed to assign any key-man life insurance policy to the employee after termination of the employment agreement. The agreements permit Messrs. Kushner and Locke to collect outside compensation which they may be entitled and to provide incidental and limited services outside of their employment with the Company and to receive compensation therefor, so long as such activities do not materially interfere with the performance of their duties under the agreements. Each of Messrs. Kushner and Locke also may require the Company to change its name to remove his name within one year after the expiration or termination of his employment agreement, except that the Company may continue to use such name for a period of one year after such notice, or for such longer period of time as is reasonably necessary to cause the Company not to default under any indebtedness for borrowed money or other material agreement. Mr. Lilliston. In September 1996, the Company entered into an employment agreement with Bruce St. J. Lilliston pursuant to which the Company hired Mr. Lilliston as the President and Chief Operating Officer of the Company effective October 1996 for a three year term. As part of the agreement, Mr. Lilliston is paid a base salary of $400,000 per year. In addition, he was advanced as a loan the sum of $100,000 on September 3, 1996 and $200,000 in October 1996 to assist Mr. Lilliston in the transition from his private practice to his duties as Chief Operating Officer of the Company. The loans accrue simple interest at the rate of 8% per annum and are to be repaid over a five year period at certain specified dates ending October 2001. Mr. Lilliston has the right to receive bonuses equal to the amount of the payments, and interest, due for such loan repayment if Mr. Lilliston is still employed by the Company (including the renewal of his employment agreement if applicable) on certain applicable dates (the "Employment Bonus"). Beginning October 1997, if Mr. Lilliston is still employed by the Company (including the renewal of his employment agreement if applicable), he shall be entitled to receive a bonus of $100,000 the first time the "Average Closing Price" (the average closing price of the common stock over a thirty calendar day period) is $6.00 or more greater than the "First Day Price" (the average closing price of the common stock over the thirty calendar day period immediately prior to October 1996). Thereafter, if Mr. Lilliston is still employed by the Company (including the renewal of his employment agreement if applicable), he shall be entitled to receive an additional $100,000 bonus the first time the Average Closing Price exceeds the First Day Price by $12.00 or more, and each six dollar increment through and including $60.00 (each such bonus, a "Stock Bonus"). The aggregate of such bonuses shall not exceed $1,000,000. The foregoing Stock Bonuses shall be reduced by an amount equal to the Employment Bonus up to $150,000 plus interest paid thereon from September 1996. The foregoing stock prices have been adjusted from the amounts specified in Mr. Lilliston's employment agreement to reflect the Company's 1-for-6 reverse stock split which became effective in September 1997. If the Company realizes pre-tax operating profits or earnings per share for any fiscal year of employment greater than 100% of the largest pre-tax operating profit or earnings per share amount for any of the preceding years of Mr. Lilliston's employment under his employment agreement or in any of the five fiscal years immediately preceding the commencement of such agreement, and if Mr. Lilliston is still employed by the Company at the end of the applicable fiscal 50 51 year, then Mr. Lilliston shall be entitled to receive a bonus of $50,000. As part of the agreement, the Company granted Mr. Lilliston options to purchase up to 41,668 shares of Common Stock as adjusted, with 20,834 of such options being granted and vested immediately, 8,334 and 12,500 of such options to be granted and vested one and two years, respectively, after the commencement of the term (the "Term") of the employment agreement (in each case, subject to Mr. Lilliston reaching certain performance criteria to be established by the Board of Directors or a committee thereof). If Mr. Lilliston's employment is extended for a second term pursuant to such agreement (the "Second Term"), the Company has agreed to grant Mr. Lilliston options to purchase up to an additional 83,334 shares of Common Stock as adjusted, 41,667, 16,667, and 25,000 of such options to be granted upon commencement and one and two years, respectively, after the commencement of the Second Term with one-half of each such grant to vest immediately upon grant and the remainder thereof to vest upon Mr. Lilliston reaching certain performance criteria to be established by the Board of Directors or a committee thereof. If Mr. Lilliston's employment is extended beyond a Second Term, the Company has agreed to grant Mr. Lilliston options to purchase up to an additional 41, 667 shares of Common Stock as adjusted, with such options granted in full upon such employment extension with one-half of such grant to vest immediately upon grant and the remainder thereof to vest upon Mr. Lilliston reaching certain performance criteria to be established by the Board of Directors or a committee thereof. In the event the performance goals are not met, such options vest at a fixed date in the future, contingent solely on future employment. The exercise price for such options shall be equal to the closing price of the Common Stock on the applicable date of grant. Finally, as part of Mr. Lilliston's agreement, he is allowed to maintain not more than two independent outside legal consultancy client relationships, subject to approval by the Chief Executive Officers, with earnings from such consultancies limited to $150,000 per year. Director Compensation Directors are compensated at $25,000 per year. During fiscal 1997 Messrs. David Braun and S. James Coppersmith received stock options totalling 16,667 adjusted shares each at an adjusted exercise price of $1.875. Employee Benefit Plans The Company participates in various multiemployer defined benefit and defined contribution pension plans under union and industry agreements. These plans include substantially all participating film production employees covered under various collective bargaining agreements. The Company funds the costs of such plans as incurred. Lease The Company is obligated under a noncancelable operating lease expiring in March 2000 for office space on the 20th and 21st floors at its principal executive offices in Los Angeles, California at September 30, 1997 as follows: Fiscal 1998 ...................................... $ 527,000 Fiscal 1999 ...................................... 527,000 Fiscal 2000 ...................................... 264,000 ---------- Total minimum future lease rental payments ............ $1,318,000 ==========
Rental expense for the years ended September 30, 1997, 1996 and 1995 was approximately $541,000, $540,000 and $530,000, respectively. Contingencies The Company is involved in certain legal proceedings and claims arising out of the normal conduct of its business. Management of the Company believes that the ultimate resolution of these matters will not have a material adverse effect upon the Company's results of operations or financial position. 51 52 In its normal course of business, the Company makes contractual down payments to acquire film distribution rights. This initial advance for rights ranges from 10% to 30% of the total purchase price. The balance of the payment is generally due upon the complete delivery by third party producers of acceptable film and video materials and other proof of rights held and insurance policies that may be required for the Company to begin exploitation of the product. As of September 30, 1997 the Company had made contractual agreements for an aggregate of $4,479,000 in payments due should those third party producers complete delivery to the Company. About one half of these obligations have originated in the Company's cable joint venture known as KLC/New City. These amounts are estimated to be payable over the next [eighteen] months. (9) Related Party Transactions In December 1994, the Company loaned August Entertainment, Inc. ("August") $650,000 against distribution rights to third party product. August is majority owned by Gregory Cascante, former President of the Company's international film distribution division. The loan bears interest at the lesser of (a) Prime (8.75% at December 23, 1997) plus 2% or (b) 10%. The distribution agreement is secured by all assets of August, including a pledge of all sales commissions due to August from the producers of the films Sleep With Me, Lawnmower Man II and Nostradamus. While the right of August to receive such commissions with respect to the film Lawnmower Man II is subordinate to the interests of the production lenders, The Allied Entertainment Group PLC, and its subsidiaries which produced the film have guaranteed payment of such commissions to the extent they would be payable had there been no production loan on that film. Repayment of principal and interest is by collection of commissions assigned as collateral. As of September 30, 1997 the Company had been repaid $384,000 toward interest and principal and approximately $423,000 principal amount remains outstanding. The loan matures in December 1997, but August and the Company have reached an agreement, subject to completion of documentation, to a one year extension to December 23, 1998 with August agreeing to make principal reduction payments totaling $205,000 on a scheduled basis prior to maturity. Mr. Cascante left the Company in April 1997 and his employment agreement was then settled. The Company's loan arrangement with August was not affected, and August has remained current on all interest and principal payment obligations since Mr. Cascante left the Company. In fiscal 1995 the Company became a general partner in TVFirst, which creates and markets infomercials. The Company's investment in TVFirst on the equity basis amounted to $868,000 as of September 30, 1997, which is included in other assets. One of TVFirst's current projects is a Christian music infomercial. TVFirst purchased air time for such infomercial but neither TVFirst nor either of its partners (including the Company) had the available resources to fund such purchases. Messrs. Locke and Kushner loaned TV First $355,000 during 1996 to enable TVFirst to purchase such air time. Such loans bore interest at prime (8.25% during the loan period) plus 1% and were repaid within fiscal year 1996. In addition, each lender received an additional amount equal to 10% of the principal amount loaned by such lender when the loans were repaid. Furthermore, each lender will receive a profit participation in the profits, if any, related to this Christian music infomercial, up to an amount equal to 5% of its principal amount, which amount will be payable on the first anniversary of such repayment. While the infomercial has generated revenues in excess of its programming and media costs to date, there is no assurance that future revenues will continue to exceed costs. The foregoing transaction was approved by a majority of the independent directors of the Company's Board of Directors. The Company has acquired from New City Releasing ("New City"), on a retroactive basis, one half of New City's interest in the KLC/New City Tele-Ventures joint venture (representing a 17.5% ownership interest in the joint venture as to which the Company previously held a 65% ownership interest) for 227,500 shares of Common Stock as adjusted. During fiscal 1989, the Company entered into a consulting agreement with Mr. Stuart Hersch to engage his services through September 1994 as an executive consultant. Pursuant to the consulting agreement the Company granted Mr. Hersch stock options to purchase 142,365 shares of common stock as adjusted at $9.33 per share, the adjusted fair market value on the date the Company committed to make the grant. During fiscal 1990, the consulting agreement was amended, reducing the options granted to 71,183 shares as adjusted. As of September 30, 1997, all of those options had vested. In consideration of the elimination of certain demand registration rights, the Company indemnified Mr. Hersch in the event Mr. Hersch sold 85,000 shares of the Company's common stock as adjusted to third parties at an adjusted price less than $10.50 per share. The Company paid Mr. Hersch a total of $275,000 during the three-year period ended September 30, 1994 related to such indemnification. 52 53 Mr. Hersch became a consultant to the Company effective April 1996 for which he is paid $90,000 per year. Mr. Hersch is assisting the Company in analyzing potential strategic acquisitions and is providing the Company consulting services in connection with the Company's involvement in infomercials. This agreement is on a month-to-month basis as needed by the Company. Mr. Hersch sold 8,333 shares of the Company's common stock in December, 1997 at $3.625 per share. (10) Major Customers and Export Sales Revenues to major customers which exceeded 10% of net operating revenues represented 20% 24% and 45% of operating revenues for the years ended September 30, 1997, 1996 and 1995, respectively, and consisted of the following:
YEAR ENDED SEPTEMBER 30, ------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Television Network CBS ..................... $ 3,029,000 $ 8,288,000 $ 6,045,000 Television Network ABC ..................... 4,925,000 10,550,000 _ Television Network NBC ..................... 3,107,000 _ 3,105,000 ----------- ----------- ----------- $11,061,000 $18,838,000 $ 9,150,000 =========== =========== ===========
Accounts receivable from these major customers totaled $ 0, $108,700 and $356,000 at September 30, 1997, 1996 and 1995, respectively. Domestic and international accounts receivable consisted of the following:
YEAR ENDED SEPTEMBER 30, ------------------------------ 1997 1996 ------------------------------ Accounts Receivable: Domestic ............................................... $ 8,072,000 $ 3,266,000 International .......................................... 20,515,000 20,312,000 28,587,000 23,578,000 Less: Allowance for Doubtful Accounts ................... (891,000) (693,000) ------------------------------ $ 27,696,000 $ 22,885,000 ==============================
Export sales by geographic areas were as follows:
YEAR ENDED SEPTEMBER 30, ------------------------------------------- 1997 1996 1995 ------------------------------------------- Europe ................... $12,100,000 $22,513,000 $ 3,500,000 Canada ................... 2,671,000 451,000 327,000 Other .................... 20,229,000 13,069,000 2,408,000 ------------------------------------------- $35,000,000 $36,033,000 $ 6,235,000 ===========================================
Other sales were principally to customers in Asia, South America and Australia. 53 54 (11) Fourth Quarter Adjustments During the fourth quarter of 1995, 1996 and 1997, the Company revised its estimates of future revenues for certain product no longer being produced by the Company. In 1995 and 1996 the impact was immaterial. In addition during the fourth quarter of 1997, the Company increased its provision for bad debts. The adjustments to revise estimates of future revenues and increase the allowance for doubtful accounts recorded in the fourth quarter of 1997 amounted to approximately $2,600,000. 54 55 THE KUSHNER-LOCKE COMPANY VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II
ADDITIONS --------- BALANCE AT CHARGED TO ---------- ---------- BEGINNING OF COSTS AND DEDUCTIONS DUE BALANCE AT END ------------ --------- -------------- -------------- PERIOD EXPENSES TO WRITE-OFFS OF PERIOD ---------- ---------- ---------- ------- Allowance for Doubtful Accounts: Year Ended 9/30/97 ................ $ 693,000 $1,310,000 (1,112,000) 891,000 ======================================================== Year Ended 9/30/96 ................ 400,000 499,000 (206,000) 693,000 ======================================================== Year Ended 9/30/95 ................ 650,000 450,000 (700,000) 400,000 ========================================================
55 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE KUSHNER-LOCKE COMPANY (Registrant) Dated: December 26, 1997 /s/ DONALD KUSHNER Donald Kushner Co-Chairman of the Board, Co-Chief Executive Officer and Secretary Dated: December 26, 1997 /s/ ROBERT SWAN Robert Swan Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and the capacities and on the dated indicated. THE KUSHNER-LOCKE COMPANY (Registrant) Dated: December 26, 1997 /s/ PETER LOCKE Peter Locke Co-Chairman of the Board and Co-Chief Executive Officer Dated: December 26, 1997 /s/ DONALD KUSHNER Donald Kushner Co-Chairman of the Board, Co-Chief Executive Officer and Secretary Dated: December 26, 1997 /s/ ROBERT SWAN Robert Swan Chief Financial Officer Dated: December 26, 1997 /s/ ADELINA VILLAFLOR Adelina Villaflor Controller Dated: December , 1997 Stuart Hersch Director Dated: December 26, 1997 /s/ DAVID BRAUN David Braun 56 57 Director Dated: December 26, 1997 /s/ S. JAMES COPPERSMITH S. James Coppersmith Director 57 58 INDEX TO EXHIBITS 3 Articles of Incorporation (A) 4.1 Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to 10% Convertible Subordinated Debentures Due 2000, Series A (E) 4.2 First Supplemental Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of March 15, 1991 pertaining to 10% Convertible Subordinated Debentures Due 2000, Series A (F) 4.3 Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to 13 3/4% Convertible Subordinated Debentures Due 2000, Series B (E) 4.4 Warrant agreement between the Company and City National Bank, as Warrant Agent, dated as of March 19, 1991 pertaining to Common Stock Purchase Warrants (F) 4.5 Warrant agreement dated September 5, 1997 between the Company and Allen & Company Incorporated.(U) 4.6 Warrant agreement dated September 5, 1997 between the Company and I. Friedman Equities, Inc. (U) 4.7 Warrant Agreement dated June 27, 1997 between the Company and I. Friedman Equities, Inc.(U) 4.8 Stock Purchase Agreement dated as of June 25, 1997 between the Company and Lawrence Mortorff. (U) 4.9 Stock Option Award Agreement dated March 1, 1994 between the Company and Lawrence Mortorff. (U) 10.1 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Donald Kushner. 10.2 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Peter Locke. 10.3 1988 Stock Incentive Plan of the Company (A) 10.4 Form of Indemnification Agreement (A) 10.5 Kushner-Locke Shareholders' Cross-Purchase Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (A) 10.5.1 Amendment dated as of May 14, 1992 to the Kushner-Locke Shareholders' Cross-Purchase Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (I) 10.6 Kushner-Locke Trust Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (A) 10.6.1 Amendment dated May 14, 1992 to the Kushner-Locke Trust Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (I) 10.12 Lease Agreement, dated as of November 1989, between the Company and 11601 Wilshire Associates (G) 10.12.1 Amended Lease Agreement (G) 10.16 Warrant Agreement between the Company and Chatfield Dean & Co., Inc. dated as of November 13, 1992 (J) 10.19 Fiscal Agency Agreement dated March 10, 1994 between and among the Company, Bank America National Trust Company and Bank of America National Trust and Savings Association (K) 10.19.1 Side letter between the Company and BankAmerica Trust Company to the Fiscal Agency Agreement dated March 10, 1994 between and among the Company, BankAmerica Trust Company and Bank of America National Trust and Savings Association (K) 10.20 Warrant Agreement dated March 10, 1994 between the Company and RAS Securities Corp. (K) 10.21 Warrant Agreement dated March 10, 1994 between the Company and I. Friedman Equities, Inc. (K) 10.22 Fiscal Agency Agreement dated July 25, 1994 between and among the Company, Bank America National Trust Company and Bank of America National Trust and Savings Association (L) 10.24 Employment Agreement dated September 1, 1994 between the Company and Gregory Cascante (M) 10.25 Employment Agreement dated September 1, 1994 between the Company and Eleanor Powell (M) 10.27 Loan and Security Agreement dated December 1, 1994 between the Company and August Entertainment, Inc., and Guarantees between the Company, August Entertainment, Inc. and the Allied Entertainments Group PLC and certain of its subsidiaries (M) 58 59 10.28 Letter Agreement, dated March 23, 1995, by and between Woodenhead Productions, Ltd. and Newmarket Capital Group, L.P. (N) 10.30* Letter Agreement dated February 6, 1995 by and between Savoy Pictures, Inc. and KL Features, Inc. (N)* 10.32 Guaranty, dated July 7, 1995, by and between The Kushner-Locke Company and Newmarket Capital Group, L.P. for loan and interest of Allied Pinocchio Productions, LTD. (The Legend of Pinocchio) (O) 10.41 Letter Agreement dated December 5, 1995 from New Line Cinema to The Kushner Locke Company summarizing New Line/Savoy deal regarding The Legend of Pinocchio (Q) 10.44 Amendment to the 1988 Stock Incentive Plan dated May 17, 1994 (Q) 10.46 First Amendment to Credit Documents dated December 22, 1995 between Allied Pinocchio Productions, Limited, Newmarket Capital Group L.P., Bank of American National Trust and Savings Associations, The Kushner-Locke Company and Kushner-Locke International, Inc. (The Legend of Pinocchio) (Q) 10.50 Cross Collateralization Agreement dated as of July 7, 1995 between The Kushner-Locke Company, Allied Pinocchio Productions Ltd., Dayton Way Pictures, Inc., Dayton Way Pictures II, Inc., Dayton Way Pictures IV, Inc. and Newmarket Capital Group, L.P. (Q) 10.51 First Amendment to Cross Collateralization Agreement dated January 10, 1996 between The Kushner-Locke Company, Allied Pinocchio Productions Ltd., Dayton Way Pictures, Inc., Dayton Way Pictures II, Inc., Dayton Way Pictures IV, Inc. and Newmarket Capital Group, L.P. (Q) 10.56 Letter Agreement, dated as of April 12, 1996, by and among The Kushner-Locke Company, Chemical Bank and Chase Securities Inc. (T) 10.57 Credit, Security, Guaranty and Pledge Agreement, dated as of June 19, 1996, among The Kushner-Locke Company, the Guarantors named therein, The Chase Manhattan Bank, N.A., (formerly Chemical Bank) as Agent, and The Chase Manhattan Bank, N.A., (formerly Chemical Bank) as Fronting Bank (T) 10.58 Employment Agreement dated September 14, 1996 between The Kushner-Locke Company and Bruce St. J Lilliston (V) 10.59 Loan and Security Agreement dated March 1, 1996 between The Kushner-Locke Company and its subsidiaries and Banque Paribas, Los Angeles Agency (V) 10.60 Loan and Security Agreement, dated as of April 19, 1996, by and between The Kushner-Locke Company, I. O. International Ltd., and Imperial Bank. (V) 10.61 Waiver of Section 6.17 Overhead Expenses of the Credit, Security, Guaranty and Pledge Agreement, dated as of June 19, 1996, among The Kushner-Locke Company, the Guarantors referred to therein, the Lenders referred to therein, and The Chase Manhattan Bank, N.A., (formerly known as Chemical Bank), as Agent. (V) 10.62 Amendment No. 5 dated as of December 22, 1997 to the Credit, Security, Guarantee and Pledge Agreements dated as of June 19, 1996, among The Kushner Locke Company, The Guarantors and The Chase Manhattan Bank. 23.1 Consent of KPMG Peat Marwick LLP - ---------------------- * Confidential Treatment Granted. (A) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-18, as amended, effective December 5, 1988 (Commission File No. 33-25101-LA). (B) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1989. (C) Incorporated by reference from the Exhibit to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1990. (D) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-1 (File No. 33-37192), as initially filed on October 5, 1990 or as amended on November 30, 1990. (E) Incorporated by reference from the Exhibits to the Company's Registration Statements on Form S-1, as amended, effective November 30, 1990 (File No. 33-37192), and effective December 20, 1990 (File No. 33-37193). 59 60 (F) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended, effective March 20, 1991. (G) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1991. (H) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1991. (I) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1992. (J) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-2, as amended, effective November 12, 1992 (Commission File No. 33-51544). (K) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal quarter ended March 31, 1994. (L) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1994. (M) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1994. (N) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1995. (O) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1995. (P) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1995. (Q) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended December 31, 1995. (R) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1996. (S) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1996. (T) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-2, as amended, effective August 15, 1996 (Commission File No. 333-05089). (U) Incorporated by reference from the Exhibits to the Company's Registration Statement on form S-3 as filed November 17, 1997 (Commission File No. 333-40391). (V) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1996. 60 EX-10.1 2 EXHIBIT 10.1 1 AMENDED AND RESTATED EMPLOYMENT AGREEMENT THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (this "Agreement") executed as of October 1, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation ("Employer" or the "Company"), and DONALD KUSHNER ("Employee") amends and restates effective as of October 1, 1997 the Employment Agreement dated as of October 1, 1988, as amended to date, between the parties. The parties hereto agree as follows: 1. Employment of Employee and Duties. Employer hereby hires Employee and Employee hereby accepts employment upon the terms and conditions described herein. Employee shall be Co-Chairman of the Board and Co-Chief Executive Officer of Employer. Employee's duties shall include responsibility for and supervision of all of Employer's activities and projects with respect to television and motion picture production and distribution and such other activities and duties as Employer may reasonably require from time to time. Employee shall be the most senior executive of Employer along with Peter Locke (so long as he shall be so employed), and Employee shall report solely to the Board of Directors of Employer (the "Board"). During the Term, Employee shall be elected as a director of Employer and each subsidiary thereof, and, if there is an Executive Committee, then as a member thereof. Employee agrees to use his best efforts to promote and further the reputation and good name of Employer and Employee shall promptly and faithfully comply with all instructions, directions, requests, rules and regulations made or issued by the Board of Directors from time to time. 2. Exclusivity. (a) Employee shall use his full business time and efforts in the discharge of his duties hereunder and shall faithfully and industriously and to the best of his ability, experience, and talent, perform all of the duties that may be required of and from him pursuant to the express and implicit terms hereof, to the reasonable satisfaction of Employer. Such duties shall be rendered at such place or places as Employer shall in good faith require within the County of Los Angeles, State of California, or, on any occasional basis, at such other places as the interests, needs, business, and opportunities of Employer shall require or deem advisable. (b) Employee's business services shall be exclusive to Employer; provided, however, that Employee may render incidental services (such as serving as a member of a board of directors) and devote such time as is reasonably necessary to manage his personal business affairs that do not interfere with the discharge of his duties hereunder. During the term of this Agreement, Employee shall not be engaged, employed, concerned or have any financial interest, directly or indirectly, in any corporation, partnership, firm or entity that is in competition with Employer; provided, however, that notwithstanding the foregoing, Employee shall not be prohibited from owning, directly or indirectly, up to five percent (5%) of the outstanding securities of any publicly traded company that is in competition with Employer, provided that 2 such five percent (5%) interest does not provide a direct or indirect controlling interest in such company. (c) Employee may devote such time and activity as he may reasonably require to enable him to administer, monitor and collect such revenues, reimbursements, fees or other sums to which he may be entitled, and to provide incidental and limited services outside of his employment hereunder and retain any compensation or other income related thereto with respect to completed productions not owned by the Company and owned by Employee as of the date hereof as set forth below, so long as such activities and services do not materially interfere with Employee's performance of his obligations hereunder. Employee now owns certain rights in the property "Animalympics." The Company may, but shall not be obligated to, purchase an option for such rights from Employee. Employee may retain any payments made by the Company to him for such rights and as a result of future exploitation. 3. Term of Agreement. This Agreement shall commence on October 1, 1997 and shall continue, unless terminated as provided in Section 10 hereof, for five (5) years from the date hereof (the "Term"). Each year of the Term, commencing as of October 1, is referred to herein as an "Employment Year." 4. Compensation. During the term of this Agreement, Employer shall pay to Employee, in full payment for Employee's services hereunder, the following compensation: (a) Base Salary. Employee shall receive a salary (the "Base Salary") of Four Hundred Twenty-Five Thousand Dollars ($425,000) per annum. Commencing with the second Employment Year, and for each subsequent Employment Year, the amount of the Base Salary shall be increased by Twenty-Five Thousand Dollars ($25,000) over the then Base Salary payable to Employee, but such Base Salary shall not exceed Five Hundred Twenty-Five Thousand Dollars ($525,000) per annum for any Employment Year. (b) Profit Bonus. Employee shall be paid a bonus (the "Profit Bonus"), if any, for each Employment Year (or portion thereof) commencing with the first Employment Year, in an amount equal to a percentage as set forth below of the "Earnings Before Income Taxes" calculated prior to Employee's and Peter Locke's profit bonus ("EBIT"), as reflected on Employer's annual consolidated financial statements, as certified by the independent public accountants retained by Employer at such time (the "Accountants") and as filed with the Securities and Exchange Commission (the "SEC") on the Employer's Form 10-K with respect to such Employment Year. Such percentage utilized for the determination of Profit Bonus, if any, for each Employment Year shall be calculated as follows: 2 3
Through EBIT Profit Bonus EBIT Above: Up To and Including: Percentage ----------- -------------------- ---------- 0 $2 million 0% $2 million $4 million 5% $4 million $6 million 5.5% $6 million $8 million 6% $8 million Not applicable 7.5%
For EBIT above Two Million Dollars ($2,000,000) and up to and including Four Million Dollars ($4,000,000), the five percent (5%) Profit Bonus percentage shall be applied to the first dollars of EBIT up to and including Four Million Dollars ($4,000,000). However, for EBIT above Four Million Dollars ($4,000,000), the applicable higher Profit Bonus percentage(s) shall only be applied to the amount of EBIT within the range corresponding to such higher Profit Bonus percentage(s). By way of example only, assuming EBIT for any applicable fiscal year is Five Million Dollars ($5,000,000), the Profit Bonus for such fiscal year would be Two Hundred Fifty-Five Thousand Dollars ($255,000) based on the following calculation: (($4,000,000 x .05) + ($1,000,000 x .055)). The Employment Year and the fiscal year of the Company are currently the same. If at any time the fiscal year is changed then appropriate adjustments must be made to the provisions involved in calculating Profit Bonus. Notwithstanding the foregoing provisions, in no event shall the Profit Bonus with respect to any full fiscal year exceed two (2) times the Base Salary for such fiscal year (such maximum amount being pro-rated for any partial year). (c) The Profit Bonus shall be payable within ten (10) days following the delivery of the opinion of the Accountants on the year-end financial statements of the Company (for such fiscal year). Employer shall use its good faith reasonable efforts to cause the Accountants, within ninety (90) days of the close of such fiscal year, to certify such statements and issue its opinion. (d) Options. Employer hereby confirms that Employer unconditionally committed to issue as of August 1, 1997 options to purchase 500,000 shares on a pre-split basis of Employer's common stock, no par value (the "Common Stock") at an exercise price equal to the closing price of the Common Stock on such date (subject to appropriate adjustment based on the reverse stock split) and vesting on a time vesting basis (the "Time Vesting Options") and options to purchase an additional 500,000 shares on a pre-split basis of the Common Stock at the same exercise price vesting on a time vesting basis but exercisable only upon Employer's achievement of certain annual operating income targets or Employer's Common Stock reaching certain public trading prices (the "Performance Options"). The aforesaid options have been granted under Employer's 1988 Stock Incentive Plan, as amended (the "Plan") as evidenced (on a post-split basis) by the option agreements set forth in Exhibit A and Exhibit B hereto. 3 4 5. Benefits. During the Term of this Agreement, Employer shall provide the following fringe benefits to Employee. (a) Employee and his eligible dependents shall be included in any group hospital, surgical, medical and dental benefit plans of the Company or, at Employee's option, the Company shall reimburse Employee for the out-of-pocket cost of his premiums if he has his own policy and is not covered under the Company's applicable group hospital, surgical, medical and dental benefit plans, up to a maximum amount equal to the savings the Company realizes as a result of not insuring Employee. (b) The Company agrees to provide a life insurance policy (the "Policy") on the life of Employee in the face amount of Three Million Five Hundred Thousand Dollars ($3,500,000) with a split dollar ownership structure. The Company and Employee shall share the premiums on such policy and the incidents of ownership in accordance with a Split Dollar Agreement to be entered into between the Company and Employee contemporaneously herewith. If Employee is terminated by the Company (other than pursuant to Section 10(a)) or by Employee for cause pursuant to Section 10(b), the Company shall promptly pay to the insurance company to whom premiums are payable with respect to the Policy an amount equal to the present value of any and all unpaid Company premiums on such Policy for the ten (10) year period commencing February 12, 1997, less any premiums which have already been paid. The Company will cause The Kushner-Locke Company Shareholders' Cross-Purchase Agreement, dated October 1, 1988, as amended, and the Trust Agreement, dated October 1, 1988, as amended, entered into thereunder to be terminated. (c) Within 10 days following the termination of Employee for any reason (other than death), at Employee's request, the Company shall assign any key-man life insurance policies insuring the life of Employee and in favor of the Company to Employee, whereupon Employee shall assume all related premium payment and other obligations, and the Company shall not be responsible for further premium payments on any such policy or policies; provided, however, that, in the event Employee terminates his employment, or if, at the time of any termination Employee is critically or terminally ill, the Company shall have the option of retaining such life insurance policy or policies and continuing to pay all premiums as they come due for up to one year after such termination, after which time such policy or policies shall be assigned to Employee. Any benefits paid for an event occurring within such one year period shall be paid to and remain the property of the Company. Notwithstanding the foregoing, however, the Company shall have no obligation to assign any such key-man life insurance policy or take any action relating thereto if such action would cause, upon notice or with lapse of time, or both, the Company to be in default of any material agreement, including, without limitation, any credit agreements or guarantees. (d) During the Term hereof, the Company, subject to Employee's insurability at a reasonable cost, agrees to pay to Employee as additional compensation to Executive an amount equal to the premiums on a portable, individual disability income insurance policy providing benefits of $15,000 per month (or the maximum available at standard rates, if less) 4 5 during the period of any disability. The Company shall have no interest in or claim to the policy or the proceeds thereof. (e) Employer shall provide Employee with a monthly automobile allowance at a rate not to exceed Twenty-One Thousand Six Hundred Dollars ($21,600) per Employment Year. (f) Employer shall reimburse Employee for the cost of the monthly base operating fee and for business related calls made or received by Employee from his car phone. Reimbursement of such expenses shall be made only against receipts and a signed itemized list of such expenditures. The car phone will remain the sole property of Employee. (g) In accordance with their terms, Employee shall be entitled to participate in any plans or agreements, if any, that Employer may maintain with respect to retirement benefits applicable to Employer's executive officers. (h) The Company will pay for or reimburse Employee for all first-class travel and all other out-of-pocket business or entertainment expenses reasonably incurred by him in connection with the performance of his duties hereunder. Employee will attend conventions, symposia, film and television festivals and other business meetings selected by him and reasonably related to the business of the Company, and will be required to be on location for production of Employee's programs, and the reasonable expenses of such attendance by Employee and, if he is required to be out of Los Angeles for more than one week, the reasonable expenses of his spouse, up to but not in excess of $10,000 in the aggregate in any Employment Year, will be paid for or reimbursed by the Company. Employee acknowledges that the Company may be obligated to withhold from his Base Salary and/or deliver Form 1099 regarding the compensation elements inherent in any of the fringe benefits paid hereunder. (i) The Company will pay for or reimburse Employee for the initiation fee (not to exceed $1,000) and the monthly dues (not to exceed $175.00 per month) for membership in an athletic or country club, which membership, in the sole opinion of Employee will assist Employee in the development of relationships valuable to Employee's position in the entertainment community. (j) In addition to the benefits provided above, Employer shall provide Employee with a non-accountable expense allowance equal to Twenty-Five Thousand Dollars ($25,000) per year (before deduction of all required withholding taxes), payable quarterly in advance on the 1st day of each quarter commencing October 1, 1997. 6. Vacation. Employee shall be entitled to take four (4) weeks (20 business days) of paid vacation which shall accrue monthly during each twelve (12) months of Employee's employment hereunder, and which vacation shall be taken on dates to be selected by mutual agreement of the Company and Employee. Paid vacation days will not accrue at any time Employee has accrued 30 days or more of unused vacation time. 5 6 7. Credit. Subject to obligations of the Company to third parties Employee shall be accorded credit as an executive producer or producer at Employee's election on all Covered Programs (as defined below), the production of which commenced at any time Employee was employed by the Company. Such credit shall be in the main titles and shall be equal in size, type and style of the credits accorded other producers or executive producers on the respective Covered Programs. The foregoing credit shall be accorded in all paid ads issued by or under the direct control of Company. Except as expressly provided herein, Company shall, in its sole discretion, determine the manner, form, size, style, nature and placement of any credit given to Employee. No casual or inadvertent failure to comply with the foregoing credit provisions will constitute a breach of this Agreement. Company shall use its reasonable efforts to cure prospectively any breach of these credit provisions following receipt of notice of same from Employee. "Covered Program" means any production: (i) the teleplay or screenplay of which was written in whole or part at any time Employee was employed by the Company, (ii) the underlying property or rights to which were acquired at any time Employee was employed by the Company, (iii) with respect to which a production order was received at any time Employee was employed by the Company; and (iv) principal photography of which took place in whole or part at any time Employee was employed by the Company, and/or which was delivered to the initial licensee at any time Employee was employed by the Company. 8. Rights and Materials. Company and Employee acknowledge and confirm that the relationship between them is exclusively that of an employer and employee, and that Company's obligations to Employee are exclusively contractual in nature. Company shall own, in perpetuity, throughout the universe, all right, title and interest in and to the results and proceeds of Employee's services hereunder and all material produced thereby and/or furnished by Employee, of any kind and nature whatsoever, it being understood and agreed that Company hereby acquires the maximum rights permitted to be obtained by employers and purchasers of literary material and other proprietary rights and information. Any such materials and/or ideas submitted to Company hereunder shall automatically become the property of Company and Employee hereby transfers and agrees to transfer and assign to Company all of said rights and materials (including, without limitation, all copyrights and similar protections, renewals and extensions of copyright, and any and all causes of action that may have heretofore accrued to Employee's favor for infringement of copyright), it being understood that Employee, for purposes hereof, is acting entirely as Company's employee-for-hire. Employee, shall, at Company's request, execute and deliver to Company or procure the execution and delivery to Company of such documents or other instruments which Company may from time to time deem necessary or desirable to evidence, maintain and protect its rights hereunder and to carry out the intent and purposes of this Agreement and to convey to Company all rights in and to the material supplied to Company by Employee hereunder. Employee shall not, except as provided in writing to the contrary by a separate agreement signed by the parties, render at his own initiative or be required to render any writing services which may be covered by the Writers Guild of America Basic Agreement then in effect during the course of Employee's employment hereunder. It is 6 7 acknowledged that Employee will be acting solely as a producer in a supervisory capacity and not as a "writer" as defined in said Basic Agreement. 9. Name and Likeness. Employee grants to the Company the right to use, and permit others to use, Employee's name, likeness, voice, biography, photograph and picture, in connection with Employee's services, the Covered Programs, and the advertising or exploitation of the same, for promotional, commercial advertising, publicity or other commercial exploitation purposes in connection with any product, commodity or service produced, manufactured, licensed or distributed by Company or any station, network or other licensee of any Covered Programs or any rights hereunder or the sponsor or advertising agency of the foregoing, provided that such use is not in the nature of a direct endorsement of any such product, commodity or service without Employee's consent. Employee shall be consulted with respect to the likeness, biography, photographs and pictures to be used in connection with the foregoing. However, Employee shall have the right to cause the Company to change the name of the Company to remove Employee's name, provided such right is executed within one year after the expiration or termination of the Term and the Company may use the name for one year after notice of Employee's exercise of such right (or such longer period of time as reasonably necessary to cause the Company not to default under any indebtedness for borrowed money or other material agreement). Notwithstanding the change of the name of the Company, the Company may continue in perpetuity to use Employee's name as part of the Company name on all Company product released with his name thereon prior to the termination of the right to use the name. 10. Termination. (a) Termination by Company "For Cause". The Company may terminate this Agreement for cause, or upon the disability of Employee. For purposes of this Agreement, the term "cause," when used in connection with the termination by the Company under this Section 10(a), shall be limited to: (i) the willful engaging by Employee in gross misconduct which is materially injurious to the Company; (ii) conviction of Employee of a felony (A) involving any financial impropriety, or (B) which would materially interfere with Employee's ability to perform his services required under this Agreement or otherwise be materially injurious to the Company in the good faith judgment of the Board of Directors; or (iii) the failure of Employee to perform in a material respect his obligations under this Agreement without proper cause. For purposes of this Section 10(a) no act, or failure to act, on Employee's part shall be considered "willful" unless done, or admitted to be done, by Employee in bad faith and without reasonable belief that such action or omission was in the best interest of the Company. For purposes of this Agreement, "disability" is defined as the incapacity, illness or mental or physical disability which incapacitates or prevents Employee from rendering his services to the Company for a period of 180 days consecutive days or 180 days in the aggregate during any twelve (12) month period during the Term. The Company may terminate this agreement upon the death of Employee. (b) Termination by Employee "For Cause". Employee shall have the right to terminate this Agreement for cause. For purposes of this Agreement, the term "cause" when used in connection with the termination by Employee under this Section 10(b), shall be limited 7 8 to: (i) the failure of the Company to perform in a material respect its obligations under this Agreement without proper cause; (ii) the wrongful termination by the Company of this Agreement; (iii) the failure to elect Employee as a member of the Board of Directors or Executive Committee of the Company and each subsidiary to which Employee has, from time to time, requested that he be elected, or to elect Employee as the senior executive officer (other than Peter Locke who may have equal seniority) of the Company and each subsidiary to which Employee has, from time to time, requested he be elected, with duties and responsibilities commensurate with such position, provided, however, that Employee is ready, willing and able to serve in such capacities; (iv) the material reduction in the aggregate benefits provided to Employee pursuant to this Agreement; (v) the relocation of the Company's principal office or the principal place where Employee is to perform his duties by more than twenty-five (25) miles except as otherwise permitted or required pursuant to this Agreement; (vi) upon notice by Employee within 180 days following a Change of Control of the Company; or (vii) the failure of the Company to maintain directors and officers insurance covering Employee to the extent reasonably available. (c) Except for a termination pursuant to Section 10(b)(vi), any termination of this Agreement by the Company pursuant to Section 10(a) (if for cause) or by Employee pursuant to Section 10(b) above shall be effective only if (i) the terminating party exercises such right of termination by written notice delivered to the non-terminating party within sixty (60) days of the terminating party having actual knowledge of the event giving rise to the right of termination, which notice shall specify in reasonable detail the events giving rise to, and the reasons for, such termination; and (ii) except as to the cause defined in Section 10(a)(ii) or Section 10(b)(vi), the non-terminating party shall have failed to correct or reverse the event giving rise to such right of termination within thirty (30) days of the giving of such notice. Such termination shall be effective upon the expiration of the period referred to in item 10(c)(i) or (ii) above, as the case may be. (d) If this Agreement is terminated by the Company pursuant to Section 10(a), the Company shall pay to Employee the accrued amount of the compensation, benefits, reimbursement and other sums payable pursuant to this Agreement, prorated through the date of termination (other than proper expense reimbursements which will be paid in full). Except for the amounts payable by the Company pursuant to the preceding sentence, all obligations of the Company with respect to compensation and benefits under this Agreement shall cease upon any such termination. (e) If this Agreement is terminated for any reason: (i) Employee shall have no further obligation under this Agreement (except with respect to those provisions of this Agreement which, by their terms, require performance by the parties subsequent to termination of this Agreement). If this Agreement is terminated by Employee pursuant to Section 10(b) or by Employer (other than pursuant to Section 10(a) or as a result of Employee's death or disability), Employee shall be entitled immediately to all compensation and benefits provided for in this Agreement for the remainder of the Term which shall be discounted at the rate of 10% per annum but not be reduced by any amounts earned or received by Employee from any third party 8 9 at any time. If this Agreement is terminated by Employee pursuant to Section 10(b) or wrongfully by the Company, all unvested options theretofore granted to Employee shall immediately vest. Without limiting the generality of the foregoing, in the case of any termination of this Agreement by Employee pursuant to Section 10(b) there shall be no requirement on the part of Employee to mitigate damages and no amounts received by him from others may be used to mitigate damages. (f) Nothing contained in this Agreement shall limit the other rights and remedies, at law or in equity, of the Company or Employee in the event of a breach by any party of any of its or his obligations pursuant to this Agreement, and the parties acknowledge that the non-breaching party may proceed, at its option, pursuant to this Section 10, or by an action at law or in equity arising from such breach, or any combination of the foregoing. 11. Trade Secrets of Employer; Non-Solicitation. (a) During the term of this Agreement, Employee will have access to and become acquainted with various trade secrets of Employer, including, without limitation, scripts, stories, treatments, ideas, photographs, films, videotapes, drawings, devices, secret inventions, processes, compilations of information, records, and specifications, that are owned by Employer and that are regularly used in the operation of the business of Employer ("Trade Secrets"). Employee shall not discuss any Trade Secrets, directly or indirectly, or use them in any way, either during the term of this Agreement, or at any time thereafter, except as required in the course of his employment by Employer. All scripts, stories, treatments, ideas, files, photographs, film, videotape, drawings, records, documents, and specifications and similar items relating to the business of Employer, whether prepared by Employee or otherwise, coming into his possession shall remain the exclusive property of Employer, and shall not be removed for purposes other than work related from the premises where the work of Employer is being carried on without prior written consent of Employer. Nothing contained in this Section 11 shall prevent Employee from competing with Employer subsequent to the termination of this Agreement; provided, however, that Employee shall not utilize subsequent to the termination of this Agreement Trade Secrets of Employer obtained by Employee during the term of this Agreement. (b) During the period ending two (2) years following the termination of this Agreement, Employee shall not solicit or induce any of the Company's or its subsidiaries' employees to terminate their employment with the Company or any of its subsidiaries or hire or cause any of the then current employees of the Company or any of its subsidiaries to be hired by any other company in which Employee is an officer, director, consultant, employee or investor. 12. Services Unique. Employee acknowledges that his services hereunder are special, unique, unusual and extraordinary in character, the loss of which cannot be reasonably or adequately compensated in damages in an action at law, and by reason thereof, Employee agrees that Employer shall be entitled to injunctive or other equitable relief to prevent or curtail any 9 10 breach of this Agreement by Employee. In the event of any breach by Employer of this Agreement, Employee shall be limited to Employee's remedy at law for damages, if any. 13. Notices. All notices, requests, demands and other communications pertaining to the subject matter hereof shall be in writing and shall be deemed to be duly rendered upon personal delivery or telefax or, if mailed, seven (7) days after deposit in the United States mail, postage prepaid, registered or certified with return receipt requested and addressed as follows, or as either party may hereafter designate to the other in writing: IF TO EMPLOYER: The Kushner-Locke Company 11601 Wilshire Boulevard Twenty-First Floor Los Angeles, California 90025 Attn: Chief Financial Officer IF TO EMPLOYEE: Donald Kushner 11601 Wilshire Boulevard Twenty-First Floor Los Angeles, California 90025 If to either, then cc: Barry L. Dastin, Esq. Kaye, Scholer, Fierman, Hays & Handler LLP 1999 Avenue of the Stars Suite 1600 Los Angeles, CA 90067 14. Attorneys' Fees, Expenses. In the event of any dispute or litigation arising out of or relating to the meaning, interpretation or breach of or compliance or non-compliance with the terms of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees and costs, to be paid by the losing party. Each party shall bear its own expenses in connection with the execution and delivery of this Agreement except that Employer shall reimburse Employee for his actual out-of-pocket legal expenses in connection therewith up to but not exceeding $10,000. 15. Jurisdiction, Severability and Integration. This Agreement has been executed in and shall be governed by and construed in accordance with the laws of the State of California without giving effect to any conflict of law provisions thereof. If any provisions of this Agreement shall be invalid or unenforceable for any reason and to any extent, the remainder of this Agreement shall not be affected thereby, but 10 11 rather shall be enforced to the greatest extent permitted by law. This Agreement contains the entire understanding between the parties hereto and supersedes any prior understandings and agreements, either oral or written, between and among the parties hereto relating to the subject matter of this Agreement which are not fully expressed herein. 16. Binding Agreement. This Agreement shall be binding upon the parties hereto, their successors and assigns, and legal representatives, but may not be assigned or delegated without the prior written consent of the other party(ies). This Agreement, together with all outstanding option agreements between Employer and Employee, supersedes and replaces all prior employment agreements, as amended, or similar understandings, between the parties hereto, each of which agreements are hereby terminated, but does not supersede any outstanding option agreements. 17. Counterparts. This Agreement may be executed in several counterparts, and all so executed shall constitute one agreement, binding on all of the parties hereto, notwithstanding that all the parties are not signatory to the original or the same counterparts. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement on the date first above written. "Employer" THE KUSHNER-LOCKE COMPANY, a California corporation By:__________________________________ Title:_______________________________ "Employee" _____________________________________ DONALD KUSHNER 11 12 EXHIBIT A STOCK OPTION AWARD AGREEMENT (TIME VESTING) THIS AWARD AGREEMENT is dated as of the 1st day of October, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation (the "Corporation") and DONALD KUSHNER ("Participant"). W I T N E S S E T H WHEREAS, pursuant to the Corporation's 1988 Stock Incentive Plan (the "Plan"), the Corporation's Stock Option Committee , acting through the non-employee director members thereof (the "Committee"), committed to grant to the Participant, effective as of August 1, 1997 (for purposes of such grant, the "Award Date"), a non-qualified stock option (the "Option") to purchase all or any part of 83,333 shares of Common Stock (on a post reverse stock split basis), without par value, of the Corporation (the "Common Stock") upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties hereto agree as follows: 1. Grant of Option. The Corporation has granted to the Participant as a matter of separate inducement and agreement in connection with the Participant's employment with, or other services to, the Corporation, but not in lieu of any salary or other compensation for such services, the right and option to purchase, in accordance with the Plan and on the terms and conditions hereinafter and therein set forth, all or any part of an aggregate of 83,333 shares of Common Stock at the exercise price of $1.875 per share (the "Price"), exercisable from time to time, subject to the provisions of this Award Agreement prior to the close of business on August 1, 2007, unless earlier terminated pursuant to the provisions of the Plan upon termination of Participant's relationship with the Corporation, which provisions are incorporated herein by this reference (the "Expiration Date"). 2. Exercisability of Option. Except as otherwise provided in this Award Agreement, the Option shall vest from time to time, as follows: 16,667 shares shall vest on August 1, 1998 16,666 shares shall vest on August 1, 1999 16,667 shares shall vest on August 1, 2000 16,667 shares shall vest on August 1, 2001 16,666 shares shall vest on August 1, 2002 provided, however, that the Option may not be exercised as to less than 100 shares at any one time unless the number of shares purchased is the total number at the time available for purchase 13 under the Option. The Option may be exercised only as to whole shares; fractional share interests shall be disregarded except that they may be accumulated. 3. Method of Exercise and Payment. (a) Exercise of Option. Each exercise of the Option shall be by means of written notice of exercise duly delivered to the Corporation, specifying the number of whole shares with respect to which the Option is then being exercised, together with any written statements required pursuant hereto or under the Plan and payment of the Price in full in cash or by check payable to the order of the Corporation. The Participant may, in lieu of payment of a portion or all of the Price in cash or by check, also deliver in payment of a portion or all of the Price, certificates evidencing Common Stock valued at the aggregate amount of such portion or all of the Price, each share of Common Stock shall be valued at the Fair Market Value on the date of exercise of the Option. At the option of the Committee, the Participant may, in lieu of payment of a portion or all of the Price in cash, by check or in certificates evidencing Common Stock, pay for all or a portion of the Price by means of a promissory note to the Corporation, on such terms and conditions, including as to security, as the Committee may determine. 4. Continuance of Employment. Nothing contained in this Award Agreement or in the Plan shall confer upon the Participant any right to continue in the employ of, or to continue rendering services to, the Corporation or constitute any contract or agreement of engagement or employment. The Participant acknowledges that the Corporation has the right to terminate the Participant's employment or services at will except as may be otherwise provided by separate agreement. Nothing contained in this Award Agreement or in the Plan shall interfere in any way with the right of the Corporation to (i) terminate the employment or services of the Participant at any time for any reason whatsoever, with or without cause, or (ii) reduce the Participant's compensation. 5. Non-Assignability of Option. Interest in the Option shall not be subject to sale, transfer, pledge, assignment, encumbrance, change or alienation other than by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code, regardless of any community property or other interest therein of the Participant's spouse or such spouse's successor in interest. In the event that the spouse of the Participant shall have acquired a community property interest in the Option, the Participant, or his permitted transferees, may exercise it on behalf of the spouse of the Participant or such spouse's successor in interest. 6. Adjustments Upon Specified Changes. Upon the occurrence of certain events relating to the Corporation's stock as set forth in the Plan, including stock splits, combinations, extraordinary cash dividends or mergers in which the Corporation is not the Surviving Corporation, adjustments will be made in the number and kind of shares that may be issuable under, or in the consideration payable with respect to, the Option as such adjustments are set forth in the Plan. 2 14 7. Acceleration. Upon the occurrence of certain Events, including a Change of Control or in the event Participant's Employment Agreement, dated as of October 1, 1988, as amended, is terminated by Participant under Section 10(b) thereof, or is wrongfully terminated by the Corporation, the Option shall become immediately vested and exercisable to the full extent theretofore not either vested or exercisable unless prior to the Event the Board determines otherwise. Notwithstanding the forgoing, however, any acceleration of this Option shall comply with all applicable regulatory requirements and the Plan. 8. Application of Securities Laws. (a) No shares of Common Stock may be purchased pursuant to the Option unless and until any then applicable requirements of the Commission, and any other regulatory agencies, including any state securities agencies having jurisdiction over the Corporation or such issuance, and any exchanges upon which the Common Stock may be listed, shall have been fully satisfied. The Participant represents, agrees and certifies that: (1) The Participant understands that the Option and the shares issuable upon exercise of the Option have not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities or blue sky law in reliance on available exemptions and that the Corporation is relying upon the Participant's representations and warranties herein in availing itself of said exemptions. (2) The Participant has had a full opportunity to ask questions of and receive answers from the Chief Financial Officer and the President of the Company concerning the terms and conditions of this investment. The Participant has received and reviewed carefully a copy of the Plan. (3) The Participant (a) can bear the economic risk of losing the Participant's entire investment; and (a) has adequate means of providing for the Participant's current needs and possible personal contingencies. (4) The Option hereby granted to the Participant is being acquired solely for the Participant's own account for investment purposes, and is not being purchased with a view to or for the purposes of the resale, transfer or other distribution thereof; and the Participant has no present plans to enter into any contract, undertaking, agreement or arrangement for such resale, transfer or distribution and the Participant further agrees that the Option and Common Stock acquired pursuant to the exercising of the Option will not be resold, transferred or otherwise distributed without (a) first having presented to the Corporation a written opinion of legal counsel in form and substance satisfactory to the Corporation's counsel indicating the proposed transfer will not be in violation of any of the provisions of the Act and applicable state securities laws and the rules and regulations promulgated thereunder or (b) a registration statement covering the resale of such Common Stock being effective. The Participant recognizes that a legend reading substantially as follows shall be placed on all certificates representing the Common Stock as well as on the Option issued pursuant hereto and a stop order shall be placed 3 15 in the stock register of the Corporation against a transfer of same in accordance with the following legend: THESE SECURITIES HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES OR BLUE SKY LAWS. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR AN EXEMPTION FROM REGISTRATION OR QUALIFICATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. (5) The Participant either has a preexisting personal or business relationship with the Corporation or any of its officers, directors or controlling persons, or by reason of the Participant's business or financial experience or the business or financial experience of its professional advisors who are unaffiliated with and who are not compensated by the Corporation or any affiliated or selling agent, directly or indirectly, can be reasonably assumed to have the capacity to protect his own interests in connection with acquisition of the Option and exercise thereof. The foregoing representations and warranties are true and accurate as of the Award Date and of the date of delivery of Common Stock acquired pursuant to the Option and shall survive such date and such delivery. If, in any respect, such representations and warranties shall not be true and accurate as of any of the foregoing dates, the Participant shall give written notice of such fact to the Corporation specifying which representations and warranties are not true and accurate and the reasons therefor. (b) The Committee may impose such conditions on the Option or on its exercise or acceleration or on the payment of any withholding obligation (including, without limitation, restricting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including, without limitation, Rule 16b-3 (or any successor rule) promulgated by the Commission pursuant to the Exchange Act. 9. Notices. Any notice to be given to the Corporation under the terms of the Award Agreement or pursuant to the Plan shall be in writing and addressed to the Secretary of the Corporation at its principal office and any notice to be given to the Participant shall be sent to the Participant at the address given beneath the Participant's signature hereto, or at such other address as either party may hereafter designate in writing to the other party. Any such notice shall be deemed to have been duly given on the date of delivery, if delivered by hand, or 3 days after deposit into U.S. mails of a notice sent by registered or certified mail (postage and registry or certification fee prepaid) or the date after being timely delivered to a recognized messenger service or overnight courier for next day delivery (delivery charges prepaid). 4 16 10. Effect of Award Agreement. The Award Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors of the Corporation to the extent provided in the Plan and to any permitted successor, assign and transferee of the Participant. 11. Tax Withholding. The provisions of the Plan are hereby incorporated and shall govern any withholding that the Corporation is required to make with respect to an exercise of the Option as well as the Corporation's right to condition a transfer of Common Stock upon compliance with the applicable withholding requirements of federal, state and local authorities. No Common Stock acquired pursuant to an exercise of the Option may be transferred to the Participant or any permitted successor, assign or transferee unless and until the Corporation has withheld, or has received payment from the Participant or such permitted successor, assign or transferee of, all amounts the Corporation is so required to withhold. 12. Terms of the Plan Govern. Except with respect to terms specifically set forth in this Award Agreement, the Award and this Award Agreement are subject to, and the Corporation and the Participant agree to be bound by, all of the terms and conditions of the Plan. Capitalized terms not otherwise defined herein shall have the respective meanings assigned to them in the Plan. The rights of the Participant are subject to limitations, adjustments, modifications, suspension and termination in certain circumstances and upon the occurrence of certain conditions as set forth in the Plan. 13. Laws Applicable to Construction. The interpretation, performance and enforcement of the Award and this Award Agreement shall be governed by the laws of the State of California without giving effect to any conflict of law provisions. 5 17 IN WITNESS WHEREOF, the Corporation has caused this Award Agreement to be executed on its behalf by a duly authorized officer and the Participant has hereunto set his hand as of the date and year first above written. THE KUSHNER-LOCKE COMPANY By:___________________________ Bruce Lilliston President PARTICIPANT ______________________________ Donald Kushner ______________________________ (Address) ______________________________ (City, State, Zip Code) ______________________________ (Social Security Number) 6 18 EXHIBIT B STOCK OPTION AWARD AGREEMENT (PERFORMANCE) THIS AWARD AGREEMENT is dated as of the 1st day of October, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation (the "Corporation") and DONALD KUSHNER ("Participant"). W I T N E S S E T H WHEREAS, pursuant to the Corporation's 1988 Stock Incentive Plan (the "Plan"), the Corporation's Stock Option Committee, acting through the non-employee director members thereof (the "Committee"), committed to grant to the Participant, effective as of August 1, 1997 (for purposes of such grant, the "Award Date"), a non-qualified stock option (the "Option") to purchase all or any part of 83,333 shares of Common Stock (on a post reverse stock split basis), without par value, of the Corporation (the "Common Stock") upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties hereto agree as follows: 1. Grant of Option. The Corporation has granted to the Participant as a matter of separate inducement and agreement in connection with the Participant's employment with, or other services to, the Corporation, but not in lieu of any salary or other compensation for such services, the right and option to purchase, in accordance with the Plan and on the terms and conditions hereinafter and therein set forth, all or any part of an aggregate of 83,333 shares of Common Stock at the exercise price of $1.875 per share (the "Price"), exercisable from time to time subject to the provisions of this Award Agreement prior to the close of business on August 1, 2007, unless earlier terminated pursuant to the provisions of the Plan upon termination of Participant's relationship with the Corporation, which provisions are incorporated herein by this reference (the "Expiration Date"). 1. Exercisability of Option. Except as otherwise provided in this Award Agreement, the Option shall vest from time to time, as follows: 16,667 shares shall vest on August 1, 1998 16,666 shares shall vest on August 1, 1999 16,667 shares shall vest on August 1, 2000 16,667 shares shall vest on August 1, 2001 16,666 shares shall vest on August 1, 2002 provided, however, that no vested options may be exercised except in the following circumstances: 1/3 of all vested options may be exercised commencing the earlier of (x) the day 19 following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days, as quoted on the Nasdaq National Market or other principal national stock exchange or market on which the Common Stock is then listed (the "Market Price"), is equal to or greater than $3.00 or (y) the day after the Corporation announces its fiscal year earnings if, in such fiscal year, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors; an additional 1/3 of all vested options may be exercised commencing the earlier of (x) the day following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days as so quoted is equal to or greater than $4.50 or (y) the day after the Corporation announces its fiscal year earnings if, in any two fiscal years during the term hereof, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors; and the remaining 1/3 of all vested options may be exercised commencing the earlier of (x) the day following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days as so quoted is equal to or greater than $6.00 or (y) the day after the Corporation announces its fiscal year earnings if, in any three fiscal years during the term hereof, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors. In addition, the Option may not be exercised as to less than 100 shares at any one time unless the number of shares purchased is the total number at the time available for purchase under an installment of the Option. The Option may be exercised only as to whole shares; fractional share interests shall be disregarded except that they may be accumulated. 3. Method of Exercise and Payment. (a) Exercise of Option. Each exercise of the Option shall be by means of written notice of exercise duly delivered to the Corporation, specifying the number of whole shares with respect to which the Option is then being exercised, together with any written statements required pursuant hereto or under the Plan and payment of the Price in full in cash or by check payable to the order of the Corporation. The Participant may, in lieu of payment of a portion or all of the Price in cash or by check, also deliver in payment of a portion or all of the Price, certificates evidencing Common Stock valued at the aggregate amount of such portion or all of the Price, each share of Common Stock shall be valued at the Fair Market Value on the date of exercise of the Option. At the option of the Committee, the Participant may, in lieu of payment of a portion or all of the Price in cash, by check or in certificates evidencing Common Stock, pay for all or a portion of the Price by means of a promissory note to the Corporation, on such terms and conditions, including as to security, as the Committee may determine. 4. Continuance of Employment. Nothing contained in this Award Agreement or in the Plan shall confer upon the Participant any right to continue in the employ of, or to continue rendering services to, the Corporation or constitute any contract or agreement of engagement or 2 20 employment. The Participant acknowledges that the Corporation has the right to terminate the Participant's employment or services at will except as may be otherwise provided by separate agreement. Nothing contained in this Award Agreement or in the Plan shall interfere in any way with the right of the Corporation to (i) terminate the employment or services of the Participant at any time for any reason whatsoever, with or without cause, or (ii) reduce the Participant's compensation. 5. Non-Assignability of Option. Interest in the Option shall not be subject to sale, transfer, pledge, assignment, encumbrance, change or alienation other than by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code, regardless of any community property or other interest therein of the Participant's spouse or such spouse's successor in interest. In the event that the spouse of the Participant shall have acquired a community property interest in the Option, the Participant, or his permitted transferees, may exercise it on behalf of the spouse of the Participant or such spouse's successor in interest. 6. Adjustments Upon Specified Changes. Upon the occurrence of certain events relating to the Corporation's stock as set forth in the Plan, including stock splits, combinations, extraordinary cash dividends or mergers in which the Corporation is not the Surviving Corporation, adjustments will be made in the number and kind of shares that may be issuable under, or in the consideration payable with respect to, the Option as such adjustments are set forth in the Plan. 7. Acceleration. Upon the occurrence of certain Events, including a Change of Control or in the event Participant's Employment Agreement, dated as of October 1, 1988, as amended, is terminated by Participant under Section 10(b) thereof, or is wrongfully terminated by the Corporation, the Option shall become immediately vested and exercisable to the full extent theretofore not either vested or exercisable unless prior to the Event the Board determines otherwise. Notwithstanding the forgoing, however, any acceleration of this Option shall comply with all applicable regulatory requirements and the Plan. 8. Application of Securities Laws. (a) No shares of Common Stock may be purchased pursuant to the Option unless and until any then applicable requirements of the Commission, and any other regulatory agencies, including any state securities agencies having jurisdiction over the Corporation or such issuance, and any exchanges upon which the Common Stock may be listed, shall have been fully satisfied. The Participant represents, agrees and certifies that: (1) The Participant understands that the Option and the shares issuable upon exercise of the Option have not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities or blue sky law in reliance on available exemptions and that the Corporation is relying upon the Participant's representations and warranties herein in availing itself of said exemptions. 3 21 (2) The Participant has had a full opportunity to ask questions of and receive answers from the Chief Financial Officer and the President of the Corporation concerning the terms and conditions of this investment. The Participant has received and reviewed carefully a copy of the Plan. (3) The Participant (A) can bear the economic risk of losing the Participant's entire investment; and (a) has adequate means of providing for the Participant's current needs and possible personal contingencies. (4) The Option hereby granted to the Participant is being acquired solely for the Participant's own account for investment purposes, and is not being purchased with a view to or for the purposes of the resale, transfer or other distribution thereof; and the Participant has no present plans to enter into any contract, undertaking, agreement or arrangement for such resale, transfer or distribution and the Participant further agrees that the Option and Common Stock acquired pursuant to the exercising of the Option will not be resold, transferred or otherwise distributed without (a) first having presented to the Corporation a written opinion of legal counsel in form and substance satisfactory to the Corporation's counsel indicating the proposed transfer will not be in violation of any of the provisions of the Act and applicable state securities laws and the rules and regulations promulgated thereunder or (b) a registration statement covering the resale of such Common Stock being effective. The Participant recognizes that a legend reading substantially as follows shall be placed on all certificates representing the Common Stock as well as on the Option issued pursuant hereto and a stop order shall be placed in the stock register of the Corporation against a transfer of same in accordance with the following legend: THESE SECURITIES HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES OR BLUE SKY LAWS. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR AN EXEMPTION FROM REGISTRATION OR QUALIFICATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. (5) The Participant either has a preexisting personal or business relationship with the Corporation or any of its officers, directors or controlling persons, or by reason of the Participant's business or financial experience or the business or financial experience of its professional advisors who are unaffiliated with and who are not compensated by the Corporation or any affiliated or selling agent, directly or indirectly, can be reasonably assumed to have the capacity to protect his own interests in connection with acquisition of the Option and exercise thereof. 4 22 The foregoing representations and warranties are true and accurate as of the Award Date and of the date of delivery of Common Stock acquired pursuant to the Option and shall survive such date and such delivery. If, in any respect, such representations and warranties shall not be true and accurate as of any of the foregoing dates, the Participant shall give written notice of such fact to the Corporation specifying which representations and warranties are not true and accurate and the reasons therefor. (b) The Committee may impose such conditions on the Option or on its exercise or acceleration or on the payment of any withholding obligation (including, without limitation, restricting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including, without limitation, Rule 16b-3 (or any successor rule) promulgated by the Commission pursuant to the Exchange Act. 9. Notices. Any notice to be given to the Corporation under the terms of the Award Agreement or pursuant to the Plan shall be in writing and addressed to the Secretary of the Corporation at its principal office and any notice to be given to the Participant shall be sent to the Participant at the address given beneath the Participant's signature hereto, or at such other address as either party may hereafter designate in writing to the other party. Any such notice shall be deemed to have been duly given on the date of delivery, if delivered by hand, or 3 days after deposit into U.S. mails of a notice sent by registered or certified mail (postage and registry or certification fee prepaid) or the date after being timely delivered to a recognized messenger service or overnight courier for next day delivery (delivery charges prepaid). 10. Effect of Award Agreement. The Award Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors of the Corporation to the extent provided in the Plan and to any permitted successor, assign and transferee of the Participant. 11. Tax Withholding. The provisions of the Plan are hereby incorporated and shall govern any withholding that the Corporation is required to make with respect to an exercise of the Option as well as the Corporation's right to condition a transfer of Common Stock upon compliance with the applicable withholding requirements of federal, state and local authorities. No Common Stock acquired pursuant to an exercise of the Option may be transferred to the Participant or any permitted successor, assign or transferee unless and until the Corporation has withheld, or has received payment from the Participant or such permitted successor, assign or transferee of, all amounts the Corporation is so required to withhold. 12. Terms of the Plan Govern. Except with respect to terms specifically set forth in this Award Agreement, the Award and this Award Agreement are subject to, and the Corporation and the Participant agree to be bound by, all of the terms and conditions of the Plan. Capitalized terms not otherwise defined herein shall have the respective meanings assigned to them in the Plan. The rights of the Participant are subject to limitations, adjustments, modifications, suspension and termination in certain circumstances and upon the occurrence of certain conditions as set forth in the Plan. 5 23 13. Laws Applicable to Construction. The interpretation, performance and enforcement of the Award and this Award Agreement shall be governed by the laws of the State of California without giving effect to any conflict of law provisions. IN WITNESS WHEREOF, the Corporation has caused this Award Agreement to be executed on its behalf by a duly authorized officer and the Participant has hereunto set his hand as of the date and year first above written. THE KUSHNER-LOCKE COMPANY By:____________________________ Bruce Lilliston President PARTICIPANT ______________________________ Donald Kushner ______________________________ (Address) ______________________________ (City, State, Zip Code) ______________________________ (Social Security Number) 6 EX-10.2 3 EXHIBIT 10.2 1 AMENDED AND RESTATED EMPLOYMENT AGREEMENT THIS AMENDED AND RESTATED EMPLOYMENT AGREEMENT (this "Agreement") executed as of October 1, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation ("Employer" or the "Company"), and PETER LOCKE ("Employee") amends and restates effective as of October 1, 1997 the Employment Agreement dated as of October 1, 1988, as amended to date, between the parties. The parties hereto agree as follows: 1. Employment of Employee and Duties. Employer hereby hires Employee and Employee hereby accepts employment upon the terms and conditions described herein. Employee shall be Co-Chairman of the Board and Co-Chief Executive Officer of Employer. Employee's duties shall include responsibility for and supervision of all of Employer's activities and projects with respect to television and motion picture production and distribution and such other activities and duties as Employer may reasonably require from time to time. Employee shall be the most senior executive of Employer along with Donald Kushner (so long as he shall be so employed), and Employee shall report solely to the Board of Directors of Employer (the "Board"). During the Term, Employee shall be elected as a director of Employer and each subsidiary thereof, and, if there is an Executive Committee, then as a member thereof. Employee agrees to use his best efforts to promote and further the reputation and good name of Employer and Employee shall promptly and faithfully comply with all instructions, directions, requests, rules and regulations made or issued by the Board of Directors from time to time. 2. Exclusivity. (a) Employee shall use his full business time and efforts in the discharge of his duties hereunder and shall faithfully and industriously and to the best of his ability, experience, and talent, perform all of the duties that may be required of and from him pursuant to the express and implicit terms hereof, to the reasonable satisfaction of Employer. Such duties shall be rendered at such place or places as Employer shall in good faith require within the County of Los Angeles, State of California, or, on any occasional basis, at such other places as the interests, needs, business, and opportunities of Employer shall require or deem advisable. (b) Employee's business services shall be exclusive to Employer; provided, however, that Employee may render incidental services (such as serving as a member of a board of directors) and devote such time as is reasonably necessary to manage his personal business affairs that do not interfere with the discharge of his duties hereunder. During the term of this Agreement, Employee shall not be engaged, employed, concerned or have any financial interest, directly or indirectly, in any corporation, partnership, firm or entity that is in competition with Employer; provided, however, that notwithstanding the foregoing, Employee shall not be prohibited from owning, directly or indirectly, up to five percent (5%) of the outstanding securities of any publicly traded company that is in competition with Employer, provided that 2 such five percent (5%) interest does not provide a direct or indirect controlling interest in such company. (c) Employee may devote such time and activity as he may reasonably require to enable him to administer, monitor and collect such revenues, reimbursements, fees or other sums to which he may be entitled, and to provide incidental and limited services outside of his employment hereunder and retain any compensation or other income related thereto with respect to completed productions not owned by the Company and owned by Employee as of the date hereof as set forth below, so long as such activities and services do not materially interfere with Employee's performance of his obligations hereunder. Employee now owns certain rights in the property "The Hills Have Eyes III." The Company may, but shall not be obligated to, purchase an option for such rights from Employee. Employee may retain any payments made by the Company to him for such rights and as a result of future exploitation. 3. Term of Agreement. This Agreement shall commence on October 1, 1997 and shall continue, unless terminated as provided in Section 10 hereof, for five (5) years from the date hereof (the "Term"). Each year of the Term, commencing as of October 1, is referred to herein as an "Employment Year." 4. Compensation. During the term of this Agreement, Employer shall pay to Employee, in full payment for Employee's services hereunder, the following compensation: (a) Base Salary. Employee shall receive a salary (the "Base Salary") of Four Hundred Twenty-Five Thousand Dollars ($425,000) per annum. Commencing with the second Employment Year, and for each subsequent Employment Year, the amount of the Base Salary shall be increased by Twenty-Five Thousand Dollars ($25,000) over the then Base Salary payable to Employee, but such Base Salary shall not exceed Five Hundred Twenty-Five Thousand Dollars ($525,000) per annum for any Employment Year. (b) Profit Bonus. Employee shall be paid a bonus (the "Profit Bonus"), if any, for each Employment Year (or portion thereof) commencing with the first Employment Year, in an amount equal to a percentage as set forth below of the "Earnings Before Income Taxes" calculated prior to Employee's and Donald Kushner's profit bonus ("EBIT"), as reflected on Employer's annual consolidated financial statements, as certified by the independent public accountants retained by Employer at such time (the "Accountants") and as filed with the Securities and Exchange Commission (the "SEC") on the Employer's Form 10-K with respect to such Employment Year. Such percentage utilized for the determination of Profit Bonus, if any, for each Employment Year shall be calculated as follows: 2 3
Through EBIT Profit Bonus EBIT Above: Up To and Including: Percentage ----------- -------------------- ---------- 0 $2 million 0% $2 million $4 million 5% $4 million $6 million 5.5% $6 million $8 million 6% $8 million Not applicable 7.5%
For EBIT above Two Million Dollars ($2,000,000) and up to and including Four Million Dollars ($4,000,000), the five percent (5%) Profit Bonus percentage shall be applied to the first dollars of EBIT up to and including Four Million Dollars ($4,000,000). However, for EBIT above Four Million Dollars ($4,000,000), the applicable higher Profit Bonus percentage(s) shall only be applied to the amount of EBIT within the range corresponding to such higher Profit Bonus percentage(s). By way of example only, assuming EBIT for any applicable fiscal year is Five Million Dollars ($5,000,000), the Profit Bonus for such fiscal year would be Two Hundred Fifty-Five Thousand Dollars ($255,000) based on the following calculation: (($4,000,000 x .05) + ($1,000,000 x .055)). The Employment Year and the fiscal year of the Company are currently the same. If at any time the fiscal year is changed then appropriate adjustments must be made to the provisions involved in calculating Profit Bonus. Notwithstanding the foregoing provisions, in no event shall the Profit Bonus with respect to any full fiscal year exceed two (2) times the Base Salary for such fiscal year (such maximum amount being pro-rated for any partial year). (c) The Profit Bonus shall be payable within ten (10) days following the delivery of the opinion of the Accountants on the year-end financial statements of the Company (for such fiscal year). Employer shall use its good faith reasonable efforts to cause the Accountants, within ninety (90) days of the close of such fiscal year, to certify such statements and issue its opinion. (d) Options. Employer hereby confirms that Employer unconditionally committed to issue as of August 1, 1997 options to purchase 500,000 shares on a pre-split basis of Employer's common stock, no par value (the "Common Stock") at an exercise price equal to the closing price of the Common Stock on such date (subject to appropriate adjustment based on the reverse stock split) and vesting on a time vesting basis (the "Time Vesting Options") and options to purchase an additional 500,000 shares on a pre-split basis of the Common Stock at the same exercise price vesting on a time vesting basis but exercisable only upon Employer's achievement of certain annual operating income targets or Employer's Common Stock reaching certain public trading prices (the "Performance Options"). The aforesaid options have been granted under Employer's 1988 Stock Incentive Plan, as amended (the "Plan") as evidenced (on a post-split basis) by the option agreements set forth in Exhibit A and Exhibit B hereto. 3 4 5. Benefits. During the Term of this Agreement, Employer shall provide the following fringe benefits to Employee. (a) Employee and his eligible dependents shall be included in any group hospital, surgical, medical and dental benefit plans of the Company or, at Employee's option, the Company shall reimburse Employee for the out-of-pocket cost of his premiums if he has his own policy and is not covered under the Company's applicable group hospital, surgical, medical and dental benefit plans, up to a maximum amount equal to the savings the Company realizes as a result of not insuring Employee. (b) The Company agrees to provide a life insurance policy (the "Policy") on the life of Employee in the face amount of Three Million Five Hundred Thousand Dollars ($3,500,000) with a split dollar ownership structure. The Company and Employee shall share the premiums on such policy and the incidents of ownership in accordance with a Split Dollar Agreement to be entered into between the Company and Employee contemporaneously herewith. If Employee is terminated by the Company (other than pursuant to Section 10(a)) or by Employee for cause pursuant to Section 10(b), the Company shall promptly pay to the insurance company to whom premiums are payable with respect to the Policy an amount equal to the present value of any and all unpaid Company premiums on such Policy for the ten (10) year period commencing February 12, 1997, less any premiums which have already been paid. The Company will cause The Kushner-Locke Company Shareholders' Cross-Purchase Agreement, dated October 1, 1988, as amended, and the Trust Agreement, dated October 1, 1988, as amended, entered into thereunder to be terminated. (c) Within 10 days following the termination of Employee for any reason (other than death), at Employee's request, the Company shall assign any key-man life insurance policies insuring the life of Employee and in favor of the Company to Employee, whereupon Employee shall assume all related premium payment and other obligations, and the Company shall not be responsible for further premium payments on any such policy or policies; provided, however, that, in the event Employee terminates his employment, or if, at the time of any termination Employee is critically or terminally ill, the Company shall have the option of retaining such life insurance policy or policies and continuing to pay all premiums as they come due for up to one year after such termination, after which time such policy or policies shall be assigned to Employee. Any benefits paid for an event occurring within such one year period shall be paid to and remain the property of the Company. Notwithstanding the foregoing, however, the Company shall have no obligation to assign any such key-man life insurance policy or take any action relating thereto if such action would cause, upon notice or with lapse of time, or both, the Company to be in default of any material agreement, including, without limitation, any credit agreements or guarantees. (d) During the Term hereof, the Company, subject to Employee's insurability at a reasonable cost, agrees to pay to Employee as additional compensation to Executive an amount equal to the premiums on a portable, individual disability income insurance policy providing benefits of $15,000 per month (or the maximum available at standard rates, if less) 4 5 during the period of any disability. The Company shall have no interest in or claim to the policy or the proceeds thereof. (e) Employer shall provide Employee with a monthly automobile allowance at a rate not to exceed Twenty-One Thousand Six Hundred Dollars ($21,600) per Employment Year. (f) Employer shall reimburse Employee for the cost of the monthly base operating fee and for business related calls made or received by Employee from his car phone. Reimbursement of such expenses shall be made only against receipts and a signed itemized list of such expenditures. The car phone will remain the sole property of Employee. (g) In accordance with their terms, Employee shall be entitled to participate in any plans or agreements, if any, that Employer may maintain with respect to retirement benefits applicable to Employer's executive officers. (h) The Company will pay for or reimburse Employee for all first-class travel and all other out-of-pocket business or entertainment expenses reasonably incurred by him in connection with the performance of his duties hereunder. Employee will attend conventions, symposia, film and television festivals and other business meetings selected by him and reasonably related to the business of the Company, and will be required to be on location for production of Employee's programs, and the reasonable expenses of such attendance by Employee and, if he is required to be out of Los Angeles for more than one week, the reasonable expenses of his spouse, up to but not in excess of $10,000 in the aggregate in any Employment Year, will be paid for or reimbursed by the Company. Employee acknowledges that the Company may be obligated to withhold from his Base Salary and/or deliver Form 1099 regarding the compensation elements inherent in any of the fringe benefits paid hereunder. (i) The Company will pay for or reimburse Employee for the initiation fee (not to exceed $1,000) and the monthly dues (not to exceed $175.00 per month) for membership in an athletic or country club, which membership, in the sole opinion of Employee will assist Employee in the development of relationships valuable to Employee's position in the entertainment community. (j) In addition to the benefits provided above, Employer shall provide Employee with a non-accountable expense allowance equal to Twenty-Five Thousand Dollars ($25,000) per year (before deduction of all required withholding taxes), payable quarterly in advance on the 1st day of each quarter commencing October 1, 1997. 6. Vacation. Employee shall be entitled to take four (4) weeks (20 business days) of paid vacation which shall accrue monthly during each twelve (12) months of Employee's employment hereunder, and which vacation shall be taken on dates to be selected by mutual agreement of the Company and Employee. Paid vacation days will not accrue at any time Employee has accrued 30 days or more of unused vacation time. 5 6 7. Credit. Subject to obligations of the Company to third parties Employee shall be accorded credit as an executive producer or producer at Employee's election on all Covered Programs (as defined below), the production of which commenced at any time Employee was employed by the Company. Such credit shall be in the main titles and shall be equal in size, type and style of the credits accorded other producers or executive producers on the respective Covered Programs. The foregoing credit shall be accorded in all paid ads issued by or under the direct control of Company. Except as expressly provided herein, Company shall, in its sole discretion, determine the manner, form, size, style, nature and placement of any credit given to Employee. No casual or inadvertent failure to comply with the foregoing credit provisions will constitute a breach of this Agreement. Company shall use its reasonable efforts to cure prospectively any breach of these credit provisions following receipt of notice of same from Employee. "Covered Program" means any production: (i) the teleplay or screenplay of which was written in whole or part at any time Employee was employed by the Company, (ii) the underlying property or rights to which were acquired at any time Employee was employed by the Company, (iii) with respect to which a production order was received at any time Employee was employed by the Company; and (iv) principal photography of which took place in whole or part at any time Employee was employed by the Company, and/or which was delivered to the initial licensee at any time Employee was employed by the Company. 8. Rights and Materials. Company and Employee acknowledge and confirm that the relationship between them is exclusively that of an employer and employee, and that Company's obligations to Employee are exclusively contractual in nature. Company shall own, in perpetuity, throughout the universe, all right, title and interest in and to the results and proceeds of Employee's services hereunder and all material produced thereby and/or furnished by Employee, of any kind and nature whatsoever, it being understood and agreed that Company hereby acquires the maximum rights permitted to be obtained by employers and purchasers of literary material and other proprietary rights and information. Any such materials and/or ideas submitted to Company hereunder shall automatically become the property of Company and Employee hereby transfers and agrees to transfer and assign to Company all of said rights and materials (including, without limitation, all copyrights and similar protections, renewals and extensions of copyright, and any and all causes of action that may have heretofore accrued to Employee's favor for infringement of copyright), it being understood that Employee, for purposes hereof, is acting entirely as Company's employee-for-hire. Employee, shall, at Company's request, execute and deliver to Company or procure the execution and delivery to Company of such documents or other instruments which Company may from time to time deem necessary or desirable to evidence, maintain and protect its rights hereunder and to carry out the intent and purposes of this Agreement and to convey to Company all rights in and to the material supplied to Company by Employee hereunder. Employee shall not, except as provided in writing to the contrary by a separate agreement signed by the parties, render at his own initiative or be required to render any writing services which may be covered by the Writers Guild of America Basic Agreement then in effect during the course of Employee's employment hereunder. It is 6 7 acknowledged that Employee will be acting solely as a producer in a supervisory capacity and not as a "writer" as defined in said Basic Agreement. 9. Name and Likeness. Employee grants to the Company the right to use, and permit others to use, Employee's name, likeness, voice, biography, photograph and picture, in connection with Employee's services, the Covered Programs, and the advertising or exploitation of the same, for promotional, commercial advertising, publicity or other commercial exploitation purposes in connection with any product, commodity or service produced, manufactured, licensed or distributed by Company or any station, network or other licensee of any Covered Programs or any rights hereunder or the sponsor or advertising agency of the foregoing, provided that such use is not in the nature of a direct endorsement of any such product, commodity or service without Employee's consent. Employee shall be consulted with respect to the likeness, biography, photographs and pictures to be used in connection with the foregoing. However, Employee shall have the right to cause the Company to change the name of the Company to remove Employee's name, provided such right is executed within one year after the expiration or termination of the Term and the Company may use the name for one year after notice of Employee's exercise of such right (or such longer period of time as reasonably necessary to cause the Company not to default under any indebtedness for borrowed money or other material agreement). Notwithstanding the change of the name of the Company, the Company may continue in perpetuity to use Employee's name as part of the Company name on all Company product released with his name thereon prior to the termination of the right to use the name. 10. Termination. (a) Termination by Company "For Cause". The Company may terminate this Agreement for cause, or upon the disability of Employee. For purposes of this Agreement, the term "cause," when used in connection with the termination by the Company under this Section 10(a), shall be limited to: (i) the willful engaging by Employee in gross misconduct which is materially injurious to the Company; (ii) conviction of Employee of a felony (A) involving any financial impropriety, or (B) which would materially interfere with Employee's ability to perform his services required under this Agreement or otherwise be materially injurious to the Company in the good faith judgment of the Board of Directors; or (iii) the failure of Employee to perform in a material respect his obligations under this Agreement without proper cause. For purposes of this Section 10(a) no act, or failure to act, on Employee's part shall be considered "willful" unless done, or admitted to be done, by Employee in bad faith and without reasonable belief that such action or omission was in the best interest of the Company. For purposes of this Agreement, "disability" is defined as the incapacity, illness or mental or physical disability which incapacitates or prevents Employee from rendering his services to the Company for a period of 180 days consecutive days or 180 days in the aggregate during any twelve (12) month period during the Term. The Company may terminate this agreement upon the death of Employee. (b) Termination by Employee "For Cause". Employee shall have the right to terminate this Agreement for cause. For purposes of this Agreement, the term "cause" when used in connection with the termination by Employee under this Section 10(b), shall be limited 7 8 to: (i) the failure of the Company to perform in a material respect its obligations under this Agreement without proper cause; (ii) the wrongful termination by the Company of this Agreement; (iii) the failure to elect Employee as a member of the Board of Directors or Executive Committee of the Company and each subsidiary to which Employee has, from time to time, requested that he be elected, or to elect Employee as the senior executive officer (other than Donald Kushner who may have equal seniority) of the Company and each subsidiary to which Employee has, from time to time, requested he be elected, with duties and responsibilities commensurate with such position, provided, however, that Employee is ready, willing and able to serve in such capacities; (iv) the material reduction in the aggregate benefits provided to Employee pursuant to this Agreement; (v) the relocation of the Company's principal office or the principal place where Employee is to perform his duties by more than twenty-five (25) miles except as otherwise permitted or required pursuant to this Agreement; (vi) upon notice by Employee within 180 days following a Change of Control of the Company; or (vii) the failure of the Company to maintain directors and officers insurance covering Employee to the extent reasonably available. (c) Except for a termination pursuant to Section 10(b)(vi), any termination of this Agreement by the Company pursuant to Section 10(a) (if for cause) or by Employee pursuant to Section 10(b) above shall be effective only if (i) the terminating party exercises such right of termination by written notice delivered to the non-terminating party within sixty (60) days of the terminating party having actual knowledge of the event giving rise to the right of termination, which notice shall specify in reasonable detail the events giving rise to, and the reasons for, such termination; and (ii) except as to the cause defined in Section 10(a)(ii) or Section 10(b)(vi), the non-terminating party shall have failed to correct or reverse the event giving rise to such right of termination within thirty (30) days of the giving of such notice. Such termination shall be effective upon the expiration of the period referred to in item 10(c)(i) or (ii) above, as the case may be. (d) If this Agreement is terminated by the Company pursuant to Section 10(a), the Company shall pay to Employee the accrued amount of the compensation, benefits, reimbursement and other sums payable pursuant to this Agreement, prorated through the date of termination (other than proper expense reimbursements which will be paid in full). Except for the amounts payable by the Company pursuant to the preceding sentence, all obligations of the Company with respect to compensation and benefits under this Agreement shall cease upon any such termination. (e) If this Agreement is terminated for any reason: (i) Employee shall have no further obligation under this Agreement (except with respect to those provisions of this Agreement which, by their terms, require performance by the parties subsequent to termination of this Agreement). If this Agreement is terminated by Employee pursuant to Section 10(b) or by Employer (other than pursuant to Section 10(a) or as a result of Employee's death or disability), Employee shall be entitled immediately to all compensation and benefits provided for in this Agreement for the remainder of the Term which shall be discounted at the rate of 10% per annum but not be reduced by any amounts earned or received by Employee from any third party 8 9 at any time. If this Agreement is terminated by Employee pursuant to Section 10(b) or wrongfully by the Company, all unvested options theretofore granted to Employee shall immediately vest. Without limiting the generality of the foregoing, in the case of any termination of this Agreement by Employee pursuant to Section 10(b) there shall be no requirement on the part of Employee to mitigate damages and no amounts received by him from others may be used to mitigate damages. (f) Nothing contained in this Agreement shall limit the other rights and remedies, at law or in equity, of the Company or Employee in the event of a breach by any party of any of its or his obligations pursuant to this Agreement, and the parties acknowledge that the non-breaching party may proceed, at its option, pursuant to this Section 10, or by an action at law or in equity arising from such breach, or any combination of the foregoing. 11. Trade Secrets of Employer; Non-Solicitation. (a) During the term of this Agreement, Employee will have access to and become acquainted with various trade secrets of Employer, including, without limitation, scripts, stories, treatments, ideas, photographs, films, videotapes, drawings, devices, secret inventions, processes, compilations of information, records, and specifications, that are owned by Employer and that are regularly used in the operation of the business of Employer ("Trade Secrets"). Employee shall not discuss any Trade Secrets, directly or indirectly, or use them in any way, either during the term of this Agreement, or at any time thereafter, except as required in the course of his employment by Employer. All scripts, stories, treatments, ideas, files, photographs, film, videotape, drawings, records, documents, and specifications and similar items relating to the business of Employer, whether prepared by Employee or otherwise, coming into his possession shall remain the exclusive property of Employer, and shall not be removed for purposes other than work related from the premises where the work of Employer is being carried on without prior written consent of Employer. Nothing contained in this Section 11 shall prevent Employee from competing with Employer subsequent to the termination of this Agreement; provided, however, that Employee shall not utilize subsequent to the termination of this Agreement Trade Secrets of Employer obtained by Employee during the term of this Agreement. (b) During the period ending two (2) years following the termination of this Agreement, Employee shall not solicit or induce any of the Company's or its subsidiaries' employees to terminate their employment with the Company or any of its subsidiaries or hire or cause any of the then current employees of the Company or any of its subsidiaries to be hired by any other company in which Employee is an officer, director, consultant, employee or investor. 12. Services Unique. Employee acknowledges that his services hereunder are special, unique, unusual and extraordinary in character, the loss of which cannot be reasonably or adequately compensated in damages in an action at law, and by reason thereof, Employee agrees that Employer shall be entitled to injunctive or other equitable relief to prevent or curtail any 9 10 breach of this Agreement by Employee. In the event of any breach by Employer of this Agreement, Employee shall be limited to Employee's remedy at law for damages, if any. 13. Notices. All notices, requests, demands and other communications pertaining to the subject matter hereof shall be in writing and shall be deemed to be duly rendered upon personal delivery or telefax or, if mailed, seven (7) days after deposit in the United States mail, postage prepaid, registered or certified with return receipt requested and addressed as follows, or as either party may hereafter designate to the other in writing: IF TO EMPLOYER: The Kushner-Locke Company 11601 Wilshire Boulevard Twenty-First Floor Los Angeles, California 90025 Attn: Chief Financial Officer IF TO EMPLOYEE: Peter Locke 11601 Wilshire Boulevard Twenty-First Floor Los Angeles, California 90025 If to either, then cc: Barry L. Dastin, Esq. Kaye, Scholer, Fierman, Hays & Handler LLP 1999 Avenue of the Stars Suite 1600 Los Angeles, CA 90067 14. Attorneys' Fees, Expenses. In the event of any dispute or litigation arising out of or relating to the meaning, interpretation or breach of or compliance or non-compliance with the terms of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees and costs, to be paid by the losing party. Each party shall bear its own expenses in connection with the execution and delivery of this Agreement except that Employer shall reimburse Employee for his actual out-of-pocket legal expenses in connection therewith up to but not exceeding $10,000. 15. Jurisdiction, Severability and Integration. This Agreement has been executed in and shall be governed by and construed in accordance with the laws of the State of California without giving effect to any conflict of law provisions thereof. If any provisions of this Agreement shall be invalid or unenforceable for any reason and to any extent, the remainder of this Agreement shall not be affected thereby, but 10 11 rather shall be enforced to the greatest extent permitted by law. This Agreement contains the entire understanding between the parties hereto and supersedes any prior understandings and agreements, either oral or written, between and among the parties hereto relating to the subject matter of this Agreement which are not fully expressed herein. 16. Binding Agreement. This Agreement shall be binding upon the parties hereto, their successors and assigns, and legal representatives, but may not be assigned or delegated without the prior written consent of the other party(ies). This Agreement, together with all outstanding option agreements between Employer and Employee, supersedes and replaces all prior employment agreements, as amended, or similar understandings, between the parties hereto, each of which agreements are hereby terminated, but does not supersede any outstanding option agreements. 17. Counterparts. This Agreement may be executed in several counterparts, and all so executed shall constitute one agreement, binding on all of the parties hereto, notwithstanding that all the parties are not signatory to the original or the same counterparts. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement on the date first above written. "Employer" THE KUSHNER-LOCKE COMPANY, a California corporation By:_________________________________ Title:______________________________ "Employee" _____________________________________ PETER LOCKE 11 12 EXHIBIT A STOCK OPTION AWARD AGREEMENT (TIME VESTING) THIS AWARD AGREEMENT is dated as of the 1st day of October, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation (the "Corporation") and PETER LOCKE ("Participant"). W I T N E S S E T H WHEREAS, pursuant to the Corporation's 1988 Stock Incentive Plan (the "Plan"), the Corporation's Stock Option Committee, acting through the non-employee director members thereof (the "Committee"), committed to grant to the Participant, effective as of August 1, 1997 (for purposes of such grant, the "Award Date"), a non-qualified stock option (the "Option") to purchase all or any part of 83,333 shares of Common Stock (on a post reverse stock split basis), without par value, of the Corporation (the "Common Stock") upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties hereto agree as follows: 1. Grant of Option. The Corporation has granted to the Participant as a matter of separate inducement and agreement in connection with the Participant's employment with, or other services to, the Corporation, but not in lieu of any salary or other compensation for such services, the right and option to purchase, in accordance with the Plan and on the terms and conditions hereinafter and therein set forth, all or any part of an aggregate of 83,333 shares of Common Stock at the exercise price of $1.875 per share (the "Price"), exercisable from time to time, subject to the provisions of this Award Agreement prior to the close of business on August 1, 2007, unless earlier terminated pursuant to the provisions of the Plan upon termination of Participant's relationship with the Corporation, which provisions are incorporated herein by this reference (the "Expiration Date"). 2. Exercisability of Option. Except as otherwise provided in this Award Agreement, the Option shall vest from time to time, as follows: 16,667 shares shall vest on August 1, 1998 16,666 shares shall vest on August 1, 1999 16,667 shares shall vest on August 1, 2000 16,667 shares shall vest on August 1, 2001 16,666 shares shall vest on August 1, 2002 provided, however, that the Option may not be exercised as to less than 100 shares at any one time unless the number of shares purchased is the total number at the time available for purchase 13 under the Option. The Option may be exercised only as to whole shares; fractional share interests shall be disregarded except that they may be accumulated. 3. Method of Exercise and Payment. (a) Exercise of Option. Each exercise of the Option shall be by means of written notice of exercise duly delivered to the Corporation, specifying the number of whole shares with respect to which the Option is then being exercised, together with any written statements required pursuant hereto or under the Plan and payment of the Price in full in cash or by check payable to the order of the Corporation. The Participant may, in lieu of payment of a portion or all of the Price in cash or by check, also deliver in payment of a portion or all of the Price, certificates evidencing Common Stock valued at the aggregate amount of such portion or all of the Price, each share of Common Stock shall be valued at the Fair Market Value on the date of exercise of the Option. At the option of the Committee, the Participant may, in lieu of payment of a portion or all of the Price in cash, by check or in certificates evidencing Common Stock, pay for all or a portion of the Price by means of a promissory note to the Corporation, on such terms and conditions, including as to security, as the Committee may determine. 4. Continuance of Employment. Nothing contained in this Award Agreement or in the Plan shall confer upon the Participant any right to continue in the employ of, or to continue rendering services to, the Corporation or constitute any contract or agreement of engagement or employment. The Participant acknowledges that the Corporation has the right to terminate the Participant's employment or services at will except as may be otherwise provided by separate agreement. Nothing contained in this Award Agreement or in the Plan shall interfere in any way with the right of the Corporation to (i) terminate the employment or services of the Participant at any time for any reason whatsoever, with or without cause, or (ii) reduce the Participant's compensation. 5. Non-Assignability of Option. Interest in the Option shall not be subject to sale, transfer, pledge, assignment, encumbrance, change or alienation other than by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code, regardless of any community property or other interest therein of the Participant's spouse or such spouse's successor in interest. In the event that the spouse of the Participant shall have acquired a community property interest in the Option, the Participant, or his permitted transferees, may exercise it on behalf of the spouse of the Participant or such spouse's successor in interest. 6. Adjustments Upon Specified Changes. Upon the occurrence of certain events relating to the Corporation's stock as set forth in the Plan, including stock splits, combinations, extraordinary cash dividends or mergers in which the Corporation is not the Surviving Corporation, adjustments will be made in the number and kind of shares that may be issuable under, or in the consideration payable with respect to, the Option as such adjustments are set forth in the Plan. 2 14 7. Acceleration. Upon the occurrence of certain Events, including a Change of Control or in the event Participant's Employment Agreement, dated as of October 1, 1988, as amended, is terminated by Participant under Section 10(b) thereof, or is wrongfully terminated by the Corporation, the Option shall become immediately vested and exercisable to the full extent theretofore not either vested or exercisable unless prior to the Event the Board determines otherwise. Notwithstanding the forgoing, however, any acceleration of this Option shall comply with all applicable regulatory requirements and the Plan. 8. Application of Securities Laws. (a) No shares of Common Stock may be purchased pursuant to the Option unless and until any then applicable requirements of the Commission, and any other regulatory agencies, including any state securities agencies having jurisdiction over the Corporation or such issuance, and any exchanges upon which the Common Stock may be listed, shall have been fully satisfied. The Participant represents, agrees and certifies that: (1) The Participant understands that the Option and the shares issuable upon exercise of the Option have not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities or blue sky law in reliance on available exemptions and that the Corporation is relying upon the Participant's representations and warranties herein in availing itself of said exemptions. (2) The Participant has had a full opportunity to ask questions of and receive answers from the Chief Financial Officer and the President of the Company concerning the terms and conditions of this investment. The Participant has received and reviewed carefully a copy of the Plan. (3) The Participant (a) can bear the economic risk of losing the Participant's entire investment; and (a) has adequate means of providing for the Participant's current needs and possible personal contingencies. (4) The Option hereby granted to the Participant is being acquired solely for the Participant's own account for investment purposes, and is not being purchased with a view to or for the purposes of the resale, transfer or other distribution thereof; and the Participant has no present plans to enter into any contract, undertaking, agreement or arrangement for such resale, transfer or distribution and the Participant further agrees that the Option and Common Stock acquired pursuant to the exercising of the Option will not be resold, transferred or otherwise distributed without (a) first having presented to the Corporation a written opinion of legal counsel in form and substance satisfactory to the Corporation's counsel indicating the proposed transfer will not be in violation of any of the provisions of the Act and applicable state securities laws and the rules and regulations promulgated thereunder or (b) a registration statement covering the resale of such Common Stock being effective. The Participant recognizes that a legend reading substantially as follows shall be placed on all certificates representing the Common Stock as well as on the Option issued pursuant hereto and a stop order shall be placed 3 15 in the stock register of the Corporation against a transfer of same in accordance with the following legend: THESE SECURITIES HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES OR BLUE SKY LAWS. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR AN EXEMPTION FROM REGISTRATION OR QUALIFICATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. (5) The Participant either has a preexisting personal or business relationship with the Corporation or any of its officers, directors or controlling persons, or by reason of the Participant's business or financial experience or the business or financial experience of its professional advisors who are unaffiliated with and who are not compensated by the Corporation or any affiliated or selling agent, directly or indirectly, can be reasonably assumed to have the capacity to protect his own interests in connection with acquisition of the Option and exercise thereof. The foregoing representations and warranties are true and accurate as of the Award Date and of the date of delivery of Common Stock acquired pursuant to the Option and shall survive such date and such delivery. If, in any respect, such representations and warranties shall not be true and accurate as of any of the foregoing dates, the Participant shall give written notice of such fact to the Corporation specifying which representations and warranties are not true and accurate and the reasons therefor. (b) The Committee may impose such conditions on the Option or on its exercise or acceleration or on the payment of any withholding obligation (including, without limitation, restricting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including, without limitation, Rule 16b-3 (or any successor rule) promulgated by the Commission pursuant to the Exchange Act. 9. Notices. Any notice to be given to the Corporation under the terms of the Award Agreement or pursuant to the Plan shall be in writing and addressed to the Secretary of the Corporation at its principal office and any notice to be given to the Participant shall be sent to the Participant at the address given beneath the Participant's signature hereto, or at such other address as either party may hereafter designate in writing to the other party. Any such notice shall be deemed to have been duly given on the date of delivery, if delivered by hand, or 3 days after deposit into U.S. mails of a notice sent by registered or certified mail (postage and registry or certification fee prepaid) or the date after being timely delivered to a recognized messenger service or overnight courier for next day delivery (delivery charges prepaid). 4 16 10. Effect of Award Agreement. The Award Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors of the Corporation to the extent provided in the Plan and to any permitted successor, assign and transferee of the Participant. 11. Tax Withholding. The provisions of the Plan are hereby incorporated and shall govern any withholding that the Corporation is required to make with respect to an exercise of the Option as well as the Corporation's right to condition a transfer of Common Stock upon compliance with the applicable withholding requirements of federal, state and local authorities. No Common Stock acquired pursuant to an exercise of the Option may be transferred to the Participant or any permitted successor, assign or transferee unless and until the Corporation has withheld, or has received payment from the Participant or such permitted successor, assign or transferee of, all amounts the Corporation is so required to withhold. 12. Terms of the Plan Govern. Except with respect to terms specifically set forth in this Award Agreement, the Award and this Award Agreement are subject to, and the Corporation and the Participant agree to be bound by, all of the terms and conditions of the Plan. Capitalized terms not otherwise defined herein shall have the respective meanings assigned to them in the Plan. The rights of the Participant are subject to limitations, adjustments, modifications, suspension and termination in certain circumstances and upon the occurrence of certain conditions as set forth in the Plan. 13. Laws Applicable to Construction. The interpretation, performance and enforcement of the Award and this Award Agreement shall be governed by the laws of the State of California without giving effect to any conflict of law provisions. 5 17 IN WITNESS WHEREOF, the Corporation has caused this Award Agreement to be executed on its behalf by a duly authorized officer and the Participant has hereunto set his hand as of the date and year first above written. THE KUSHNER-LOCKE COMPANY By:_____________________________ Bruce Lilliston President PARTICIPANT ________________________________ Peter Locke ________________________________ (Address) ________________________________ (City, State, Zip Code) ________________________________ (Social Security Number) 6 18 EXHIBIT B STOCK OPTION AWARD AGREEMENT (PERFORMANCE) THIS AWARD AGREEMENT is dated as of the 1st day of October, 1997, by and between THE KUSHNER-LOCKE COMPANY, a California corporation (the "Corporation") and PETER LOCKE ("Participant"). W I T N E S S E T H WHEREAS, pursuant to the Corporation's 1988 Stock Incentive Plan (the "Plan"), the Corporation's Stock Option Committee, acting through the non-employee director members thereof (the "Committee"), committed to grant to the Participant, effective as of August 1, 1997 (for purposes of such grant, the "Award Date"), a non-qualified stock option (the "Option") to purchase all or any part of 83,333 shares of Common Stock (on a post reverse stock split basis), without par value, of the Corporation (the "Common Stock") upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual promises and covenants made herein and the mutual benefits to be derived herefrom, the parties hereto agree as follows: 1. Grant of Option. The Corporation has granted to the Participant as a matter of separate inducement and agreement in connection with the Participant's employment with, or other services to, the Corporation, but not in lieu of any salary or other compensation for such services, the right and option to purchase, in accordance with the Plan and on the terms and conditions hereinafter and therein set forth, all or any part of an aggregate of 83,333 shares of Common Stock at the exercise price of $1.875 per share (the "Price"), exercisable from time to time subject to the provisions of this Award Agreement prior to the close of business on August 1, 2007, unless earlier terminated pursuant to the provisions of the Plan upon termination of Participant's relationship with the Corporation, which provisions are incorporated herein by this reference (the "Expiration Date"). 2. Exercisability of Option. Except as otherwise provided in this Award Agreement, the Option shall vest from time to time, as follows: 16,667 shares shall vest on August 1, 1998 16,666 shares shall vest on August 1, 1999 16,667 shares shall vest on August 1, 2000 16,667 shares shall vest on August 1, 2001 16,666 shares shall vest on August 1, 2002 provided, however, that no vested options may be exercised except in the following circumstances: 1/3 of all vested options may be exercised commencing the earlier of (x) the day 19 following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days, as quoted on the Nasdaq National Market or other principal national stock exchange or market on which the Common Stock is then listed (the "Market Price"), is equal to or greater than $3.00 or (y) the day after the Corporation announces its fiscal year earnings if, in such fiscal year, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors; an additional 1/3 of all vested options may be exercised commencing the earlier of (x) the day following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days as so quoted is equal to or greater than $4.50 or (y) the day after the Corporation announces its fiscal year earnings if, in any two fiscal years during the term hereof, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors; and the remaining 1/3 of all vested options may be exercised commencing the earlier of (x) the day following the date the average closing price of the Common Stock for the previous twenty (20) consecutive trading days as so quoted is equal to or greater than $6.00 or (y) the day after the Corporation announces its fiscal year earnings if, in any three fiscal years during the term hereof, the Corporation earns, exclusive of extraordinary gains or losses, at least 85% of its projected earnings before taxes pursuant to the Corporation's business plan previously approved by the Board of Directors. In addition, the Option may not be exercised as to less than 100 shares at any one time unless the number of shares purchased is the total number at the time available for purchase under an installment of the Option. The Option may be exercised only as to whole shares; fractional share interests shall be disregarded except that they may be accumulated. 3. Method of Exercise and Payment. (a) Exercise of Option. Each exercise of the Option shall be by means of written notice of exercise duly delivered to the Corporation, specifying the number of whole shares with respect to which the Option is then being exercised, together with any written statements required pursuant hereto or under the Plan and payment of the Price in full in cash or by check payable to the order of the Corporation. The Participant may, in lieu of payment of a portion or all of the Price in cash or by check, also deliver in payment of a portion or all of the Price, certificates evidencing Common Stock valued at the aggregate amount of such portion or all of the Price, each share of Common Stock shall be valued at the Fair Market Value on the date of exercise of the Option. At the option of the Committee, the Participant may, in lieu of payment of a portion or all of the Price in cash, by check or in certificates evidencing Common Stock, pay for all or a portion of the Price by means of a promissory note to the Corporation, on such terms and conditions, including as to security, as the Committee may determine. 4. Continuance of Employment. Nothing contained in this Award Agreement or in the Plan shall confer upon the Participant any right to continue in the employ of, or to continue rendering services to, the Corporation or constitute any contract or agreement of engagement or 2 20 employment. The Participant acknowledges that the Corporation has the right to terminate the Participant's employment or services at will except as may be otherwise provided by separate agreement. Nothing contained in this Award Agreement or in the Plan shall interfere in any way with the right of the Corporation to (i) terminate the employment or services of the Participant at any time for any reason whatsoever, with or without cause, or (ii) reduce the Participant's compensation. 5. Non-Assignability of Option. Interest in the Option shall not be subject to sale, transfer, pledge, assignment, encumbrance, change or alienation other than by will or the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code, regardless of any community property or other interest therein of the Participant's spouse or such spouse's successor in interest. In the event that the spouse of the Participant shall have acquired a community property interest in the Option, the Participant, or his permitted transferees, may exercise it on behalf of the spouse of the Participant or such spouse's successor in interest. 6. Adjustments Upon Specified Changes. Upon the occurrence of certain events relating to the Corporation's stock as set forth in the Plan, including stock splits, combinations, extraordinary cash dividends or mergers in which the Corporation is not the Surviving Corporation, adjustments will be made in the number and kind of shares that may be issuable under, or in the consideration payable with respect to, the Option as such adjustments are set forth in the Plan. 7. Acceleration. Upon the occurrence of certain Events, including a Change of Control or in the event Participant's Employment Agreement, dated as of October 1, 1988, as amended, is terminated by Participant under Section 10(b) thereof, or is wrongfully terminated by the Corporation, the Option shall become immediately vested and exercisable to the full extent theretofore not either vested or exercisable unless prior to the Event the Board determines otherwise. Notwithstanding the forgoing, however, any acceleration of this Option shall comply with all applicable regulatory requirements and the Plan. 8. Application of Securities Laws. (a) No shares of Common Stock may be purchased pursuant to the Option unless and until any then applicable requirements of the Commission, and any other regulatory agencies, including any state securities agencies having jurisdiction over the Corporation or such issuance, and any exchanges upon which the Common Stock may be listed, shall have been fully satisfied. The Participant represents, agrees and certifies that: (1) The Participant understands that the Option and the shares issuable upon exercise of the Option have not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities or blue sky law in reliance on available exemptions and that the Corporation is relying upon the Participant's representations and warranties herein in availing itself of said exemptions. 3 21 (2) The Participant has had a full opportunity to ask questions of and receive answers from the Chief Financial Officer and the President of the Corporation concerning the terms and conditions of this investment. The Participant has received and reviewed carefully a copy of the Plan. (3) The Participant (a) can bear the economic risk of losing the Participant's entire investment; and (a) has adequate means of providing for the Participant's current needs and possible personal contingencies. (4) The Option hereby granted to the Participant is being acquired solely for the Participant's own account for investment purposes, and is not being purchased with a view to or for the purposes of the resale, transfer or other distribution thereof; and the Participant has no present plans to enter into any contract, undertaking, agreement or arrangement for such resale, transfer or distribution and the Participant further agrees that the Option and Common Stock acquired pursuant to the exercising of the Option will not be resold, transferred or otherwise distributed without (a) first having presented to the Corporation a written opinion of legal counsel in form and substance satisfactory to the Corporation's counsel indicating the proposed transfer will not be in violation of any of the provisions of the Act and applicable state securities laws and the rules and regulations promulgated thereunder or (b) a registration statement covering the resale of such Common Stock being effective. The Participant recognizes that a legend reading substantially as follows shall be placed on all certificates representing the Common Stock as well as on the Option issued pursuant hereto and a stop order shall be placed in the stock register of the Corporation against a transfer of same in accordance with the following legend: THESE SECURITIES HAVE NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES OR BLUE SKY LAWS. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR AN EXEMPTION FROM REGISTRATION OR QUALIFICATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. (5) The Participant either has a preexisting personal or business relationship with the Corporation or any of its officers, directors or controlling persons, or by reason of the Participant's business or financial experience or the business or financial experience of its professional advisors who are unaffiliated with and who are not compensated by the Corporation or any affiliated or selling agent, directly or indirectly, can be reasonably assumed to have the capacity to protect his own interests in connection with acquisition of the Option and exercise thereof. 4 22 The foregoing representations and warranties are true and accurate as of the Award Date and of the date of delivery of Common Stock acquired pursuant to the Option and shall survive such date and such delivery. If, in any respect, such representations and warranties shall not be true and accurate as of any of the foregoing dates, the Participant shall give written notice of such fact to the Corporation specifying which representations and warranties are not true and accurate and the reasons therefor. (b) The Committee may impose such conditions on the Option or on its exercise or acceleration or on the payment of any withholding obligation (including, without limitation, restricting the time of exercise to specified periods) as may be required to satisfy applicable regulatory requirements, including, without limitation, Rule 16b-3 (or any successor rule) promulgated by the Commission pursuant to the Exchange Act. 9. Notices. Any notice to be given to the Corporation under the terms of the Award Agreement or pursuant to the Plan shall be in writing and addressed to the Secretary of the Corporation at its principal office and any notice to be given to the Participant shall be sent to the Participant at the address given beneath the Participant's signature hereto, or at such other address as either party may hereafter designate in writing to the other party. Any such notice shall be deemed to have been duly given on the date of delivery, if delivered by hand, or 3 days after deposit into U.S. mails of a notice sent by registered or certified mail (postage and registry or certification fee prepaid) or the date after being timely delivered to a recognized messenger service or overnight courier for next day delivery (delivery charges prepaid). 10. Effect of Award Agreement. The Award Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors of the Corporation to the extent provided in the Plan and to any permitted successor, assign and transferee of the Participant. 11. Tax Withholding. The provisions of the Plan are hereby incorporated and shall govern any withholding that the Corporation is required to make with respect to an exercise of the Option as well as the Corporation's right to condition a transfer of Common Stock upon compliance with the applicable withholding requirements of federal, state and local authorities. No Common Stock acquired pursuant to an exercise of the Option may be transferred to the Participant or any permitted successor, assign or transferee unless and until the Corporation has withheld, or has received payment from the Participant or such permitted successor, assign or transferee of, all amounts the Corporation is so required to withhold. 12. Terms of the Plan Govern. Except with respect to terms specifically set forth in this Award Agreement, the Award and this Award Agreement are subject to, and the Corporation and the Participant agree to be bound by, all of the terms and conditions of the Plan. Capitalized terms not otherwise defined herein shall have the respective meanings assigned to them in the Plan. The rights of the Participant are subject to limitations, adjustments, modifications, suspension and termination in certain circumstances and upon the occurrence of certain conditions as set forth in the Plan. 5 23 13. Laws Applicable to Construction. The interpretation, performance and enforcement of the Award and this Award Agreement shall be governed by the laws of the State of California without giving effect to any conflict of law provisions. IN WITNESS WHEREOF, the Corporation has caused this Award Agreement to be executed on its behalf by a duly authorized officer and the Participant has hereunto set his hand as of the date and year first above written. THE KUSHNER-LOCKE COMPANY By:____________________________ Bruce Lilliston President PARTICIPANT ________________________________ Peter Locke ________________________________ (Address) ________________________________ (City, State, Zip Code) ________________________________ (Social Security Number) 6 EX-10.62 4 EXHIBIT 10.62 1 AMENDMENT NO. 5 dated as of December 22, 1997 to the Credit, Security, Guaranty and Pledge Agreement dated as of June 19, 1996, as amended, among THE KUSHNER-LOCKE COMPANY (the "Borrower"), the Guarantors named therein, the Lenders referred to therein and THE CHASE MANHATTAN BANK (formerly known as Chemical Bank), as Agent and as Fronting Bank for the Lenders (the "Agent") (as heretofore amended, the "Credit Agreement"). INTRODUCTORY STATEMENT The Lenders have made available to the Borrower a revolving credit facility pursuant to the terms of the Credit Agreement. The Borrower has requested certain modifications to the Credit Agreement. The Borrower, the Guarantor, the Lenders and the Agent have agreed to make revisions to the Credit Agreement, all on the terms and subject to the conditions hereinafter set forth. Therefore, the parties hereto hereby agree as follows: Section 1. Defined Terms. Capitalized terms used herein and not otherwise defined herein shall have the meaning given them in the Credit Agreement. Section 2. Amendments to the Credit Agreement. Subject to the satisfaction of the conditions precedent set forth in Section 3 hereof, the Credit Agreement is hereby amended as of September 30, 1997 (the "Effective Date") as follows: (A) The definition of "Consolidated Interest Expense" appearing in Article 1 of the Credit Agreement is hereby amended in its entirety to read as follows: "Consolidated Interest Expense" shall mean for any period for which such amount is being determined, total interest expense paid or payable in cash (including that properly attributable to Capital Leases in accordance with GAAP and all capitalized interest but excluding in any event all amortization of debt discount and debt issuance costs) of the Borrower and its Consolidated -1- 2 Subsidiaries on a consolidated basis including, without limitation, all commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing and net cash costs (or net profits) under Interest Rate Protection Agreements, net of interest received in cash." (B) Section 6.19 of the Credit Agreement is hereby deleted in its entirety and replaced with the following new Section 6.19: "SECTION 6.19 EBIT to Interest Expense Ratio. For any rolling four quarter period, permit the ratio of (i) the sum of EBIT and film amortization minus 50% of investments in film inventory made during such period, to (ii) Consolidated Interest Expense, to be less than 2.25.1." Section 3. Conditions to Effectiveness. The effectiveness of this Amendment is subject to the satisfaction in full of each of the conditions precedent set forth in this Section 3: (A) the Agent shall have received counterparts of this Amendment which, when taken together, bear the signatures of the Borrower, each Guarantor, the Agent and such of the Lenders as are required by the Credit Agreement; and (B) all legal matters incident to this Amendment shall be satisfactory to Morgan, Lewis & Bockius LLP, counsel for the Agent. Section 4. Waiver. Each of the Lenders, by its execution hereof, hereby waives the Credit Parties' non-compliance with Section 6.18 regarding the ratio of Total Unsubordinated Liabilities to Consolidated Capital Base, solely through the period ending September 30, 1997. Section 5. Representations and Warranties. Each Credit Party represents and warrants that: (A) after giving effect to this Amendment, the representations and warranties contained in the Credit Agreement are true and correct in all material respects on and as of the date hereof as if such representations and warranties had been made on and as of the date hereof (except to the extent that any such representations and warranties specifically relate to an earlier date); and (B) after giving effect to this Amendment, no Event of Default or Default will have occurred and be continuing on and as of the date hereof. Section 5. Further Assurances. At any time and from time to time, upon the Agent's request and at the sole expense of the Credit Parties, each Credit Party will promptly and duly execute and deliver any and all further instruments and documents and take such further action as the Agent reasonably deems necessary to effect the purposes of this Amendment. -2- 3 Section 7. Fundamental Documents. This Amendment is designated a Fundamental Document by the Agent. Section 8. Full Force and Effect. Except as expressly amended hereby, the Credit Agreement and the other Fundamental Documents shall continue in full force and effect in accordance with the provisions thereof on the date hereof. As used in the Credit Agreement, the terms "Agreement", "this Agreement", "herein", "hereafter", "hereto", "hereof", and words of similar import, shall, unless the context otherwise requires, mean the Credit Agreement as amended by this Amendment. Section 9. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. Section 10. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which when taken together shall constitute but one instrument. Section 11. Expenses. The Borrower agrees to pay all out-of-pocket expenses incurred by the Agent in connection with the preparation, execution and delivery of this Amendment, including, but not limited to, the reasonable fees and disbursements of counsel for the Agent. Section 12. Headings. The headings of this Amendment are for the purposes of reference only and shall not affect the construction of or be taken into consideration in interpreting this Amendment. IN WITNESS WHEREOF, the parties hereby have caused this Amendment to be duly executed as of the date first written above. BORROWER: THE KUSHNER-LOCKE COMPANY By: /s/ ROBERT SWAN ----------------------------------- Name: Robert Swan Title: Chief Financial Officer -3- 4 GUARANTORS: KL PRODUCTIONS, INC. KL INTERNATIONAL, INC. ACME PRODUCTIONS, INC. KUSHNER-LOCKE PRODUCTIONS, INC. THE RELATIVES COMPANY POST AND PRODUCTION SERVICES, INC. L-K ENTERTAINMENT, INC. INTERNATIONAL COURTROOM NEWS SERVICE FAMILY PICTURES, INC. TROPICAL HEAT, INC. KL SYNDICATION, INC. ANDRE PRODUCTIONS, INC. TKLC NO. 2, INC. TWILIGHT ENTERTAINMENT, INC. KLC FILMS, INC. KL FEATURES, INC. KLF GUILD CO. KLF DEVELOPMENT CO. KLTV GUILD CO. KLTV DEVELOPMENT CO. KUSHNER-LOCKE INTERNATIONAL, INC. KL INTERACTIVE MEDIA, INC. By /s/ ROBERT SWAN ------------------------------- Name: Robert Swan Title: Chief Financial Officer KLC/NEW CITY By its General Partner THE KUSHNER-LOCKE COMPANY By /s/ ROBERT SWAN ------------------------------- Name: Robert Swan Title: Chief Financial Officer -4- 5 DAYTON WAY PICTURES, INC. DAYTON WAY PICTURES II, INC. DAYTON WAY PICTURES III, INC. DAYTON WAY PICTURES IV, INC. FW COLD CO., INC. BY /s/ ROBERT SWAN ------------------------------ Name: Robert Swan Title: Chief Financial Officer LENDERS: Executed in New York, New York THE CHASE MANHATTAN BANK (formerly On December 29, 1997 known as Chemical Bank), as Agent BY /s/ ANN B. KERNS ------------------------------ Name: Ann B. Kerns Title: Vice President DE NATIONALE INVESTERINGSBANK N.V. BY /s/ ERIC H. SNATERSE ------------------------------ Name: Eric H. Snaterse Title: BY /s/ J.L.J.M REISEN ------------------------------ Name: J.L.J.M Reisen Title: COMERICA BANK -- CALIFORNIA BY /s/ D. JEFFREY ANDRICK ------------------------------ Name: D. Jeffrey Andrick Title: V.P. -5- EX-23.1 5 EXHIBIT 23.1 1 EXHIBIT 23.1 The Board of Directors The Kushner-Locke Company: We consent to incorporation by reference in the registration statements (Nos. 333-10239 and 33-82942) on Form S-3 and (Nos. 33-45248 and 33-86768) on Form S-8 of The Kushner-Locke Company of our report dated December 26, 1997, relating to the consolidated balance sheets of The Kushner-Locke Company and subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended September 30, 1997, and the related schedule, which report appears in the September 30, 1997 annual report on Form 10-K of The Kushner-Locke Company. KPMG Peat Marwick LLP Los Angeles, California December 26, 1997 EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 YEAR SEP-30-1997 OCT-01-1996 SEP-30-1997 16,791 0 28,587 891 68,507 0 0 0 124,368 2,935 11,631 0 0 38,905 (7,769) 124,368 0 56,935 52,084 52,084 5,333 0 4,027 (4,346) 23 (4,369) 0 0 0 (4,369) (.49) (.49)
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