UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission File No.: 1-14880

 

 

 

 

Lions Gate Entertainment Corp.

(Exact name of registrant as specified in its charter)

 

 

 

 

 

 

1055 West Hastings Street, Suite 2200
Vancouver, British Columbia V6E 2E9
and
2700 Colorado Avenue, Suite 200
Santa Monica, California 90404
(Address of principal executive offices)

 

 

 

 

(877) 848-3866
(Registrant’s telephone number, including area code)

 

 

 

 

 

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 þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ     Accelerated Filer o     Non-accelerated Filer o

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

 

TABLE OF CONTENTS

 

 

FORWARD-LOOKING STATEMENTS

 

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases you can identify forward-looking statements by terms such as “may,” “intend,” “will,” “could,” “would,” “expects,” “believe,” “estimate,” or the negative of these terms, and similar expressions intended to identify forward-looking statements.

 

These forward-looking statements reflect our current views with respect to future events and are based on assumptions and are subject to risks and uncertainties. Also, these forward-looking statements present our estimates and assumptions only as of the date of this report. Except for our ongoing obligation to disclose material information as required by federal securities laws, we do not intend to update you concerning any future revisions to any forward-looking statements to reflect events or circumstances occurring after the date of this report.

 

Actual results in the future could differ materially and adversely from those described in the forward-looking statements as a result of various important factors, including the substantial investment of capital required to produce and market films and television series, increased costs for producing and marketing feature films, budget overruns, limitations imposed by our credit facilities, unpredictability of the commercial success of our motion pictures and television programming, the cost of defending our intellectual property, difficulties in integrating acquired businesses, technological changes and other trends affecting the entertainment industry, and the risk factors found under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on June 14, 2006, which risk factors are incorporated herein by reference.

 

LIONS GATE ENTERTAINMENT CORP.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes.

LIONS GATE ENTERTAINMENT CORP.

 

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See accompanying notes.

 

LIONS GATE ENTERTAINMENT CORP.

 

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

 

See accompanying notes.

LIONS GATE ENTERTAINMENT CORP.

 

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying notes.

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

Nature of Operations

 

Lions Gate Entertainment Corp. (the “Company,” “Lionsgate,” “us” or “our”) is a diversified independent producer and distributor of motion pictures, television programming, home entertainment, video-on-demand and music content. The Company also acquires distribution rights from a wide variety of studios, production companies and independent producers.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Lionsgate and all of its majority-owned and controlled subsidiaries and consolidated variable interest entities, with a provision for minority interests.

 

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been reflected in these unaudited condensed consolidated financial statements. Operating results for the three and six months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ended March 31, 2007. The balance sheet at March 31, 2006 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by U.S. GAAP for complete financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006.

 

Certain amounts presented for fiscal 2006 have been reclassified to conform to the fiscal 2007 presentation.

 

Sale of Studio Facility and Revised Prior Year Presentation

 

As a result of the Company’s sale of the studio facilities on March 15, 2006, the Company’s consolidated statements of operations for the three and six months ended September 30, 2005 have been revised to reflect total revenues of $1.6 million and $3.0 million and total expenses of $0.7 million and $2.1 million of the studio facilities for the three and six months ended September 30, 2005, respectively, net within the discontinued operations section of the consolidated statements of operations.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. The most significant estimates made by management in the preparation of the financial statements relate to ultimate revenue and costs for investment in films and television programs; estimates of sales returns, provision for doubtful accounts, fair value of assets and liabilities for allocation of the purchase price of companies acquired, income taxes and accruals for contingent liabilities; and impairment assessments for investment in films and television programs, property and equipment, goodwill and intangible assets. Actual results could differ from such estimates.

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Recent Accounting Pronouncements

 

Statement of Financial Accounting Standards No. 123R.  In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)). SFAS No. 123(R) revises SFAS No. 123 and eliminates the alternative to use the intrinsic method of accounting under APB No. 25. SFAS No. 123(R) requires all public companies accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments, to account for these types of transactions using a fair-value-based method. Effective April 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), “Share-Based Payment,” (SFAS No. 123(R)) using the modified-prospective transition method. Under such transition method, compensation cost recognized in the three and six months ended September 30, 2006 includes: (a) compensation cost for all stock options granted prior to, but not yet vested as of, April 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted on or after April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). See note 12 for further discussion of the Company’s stock-based compensation in accordance with SFAS No. 123(R).

 

Statement of Financial Accounting Standards Staff Position 115-1.  In March 2004, the FASB ratified the measurement and recognition guidance and certain disclosure requirements for impaired securities as described in EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” In November 2005, the FASB issued FASB Staff Position SFAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“the FSP”). The FSP nullifies certain requirements of EITF Issue 03-1 and supersedes EITF Topic D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than temporary impairments. The FSP was effective for reporting periods beginning after December 15, 2005. The adoption of the FSP did not have a material effect on the Company’s results of operations, financial position or cash flows.

 

 

Investments classified as available-for-sale are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as other comprehensive income or loss (see note 10). The cost of investments sold is determined in accordance with the specific identification method and realized gains and losses are included in interest income. As of September 30, 2006, the cost, unrealized losses and carrying value of the Company’s available-for-sale investments were as follows:

 

 

Short-term investments at September 30, 2006 primarily consist of Auction Rate Securities (“ARS”) and corporate securities. The Company began investing in ARS during the fiscal year ended March 31, 2006. ARS carry

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

interest rates or dividend yields that are periodically re-set through auctions, typically every 7, 14, 28, or 35 days. ARS are usually issued with long-term maturities or in perpetuity and are auctioned at par. Thus, the return on the investment between auction dates is determined by the interest rate or dividend yield set through the auctions. Accordingly, dividends and interest earned on auction rate investments are computed as a percentage of the principal amount of the security. Interest and dividend income earned during the three and six month periods ended September 30, 2006 on ARS was $1.7 million and $3.6 million, respectively. There was no interest or dividend income earned on ARS during the three and six month periods ended September 30, 2005.

 

The Company minimizes its credit risk associated with investments by investing primarily in investment grade, highly liquid securities.

 

In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and based on our ability to market and sell these instruments, we classify ARS as available-for-sale securities and carry them at fair value.

 

Equity securities are comprised of the Company’s investment in the common shares of Image Entertainment, Inc. (“Image”), a distributor of DVDs and entertainment programming. During the fiscal year ended March 31, 2006, the Company purchased in the open market 1,150,000 common shares of Image for $3.5 million in cash, representing an average cost per share of $3.02. Also during the fiscal year ended March 31, 2006, the Company completed a negotiated exchange with certain shareholders of Image in which the Company exchanged 1,104,004 of its common shares (at $10.45 per share) in return for 2,883,996 common shares of Image (at $4.00 per share). The cost on an exchanged basis of the additional 2,883,996 common shares of Image is $11.5 million. As of September 30, 2006 and March 31, 2006, the Company held 4,033,996 common shares of Image acquired at an average cost per share of $3.72; the shares held by the Company represent approximately 18.7% of Image’s outstanding common shares as of October 31, 2006. The closing price of Image’s common shares on September 30, 2006 was $3.48 per common share (March 31, 2006 — $3.70 per common share). As a result, the Company had unrealized losses of $1.0 million and $0.1 million on its investment in Image common shares as of September 30, 2006 and March 31, 2006, respectively. The Company has reported the increase in the unrealized loss of $0.9 million as other comprehensive loss in the condensed consolidated statement of shareholders’ equity for the six months ended September 30, 2006.

 

 

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Acquired libraries of $100.0 million at September 30, 2006 (March 31, 2006 — $105.1 million) include the Trimark library acquired October 2000, the Artisan library acquired December 2003, the Modern Entertainment, Ltd. (“Modern”) library acquired in August 2005, and the Redbus library acquired in October 2005 (refer to note 8). On August 17, 2005, the Company acquired certain of the film assets and accounts receivable of Modern, a licensor of film rights to DVD distributors, broadcasters and cable networks for total consideration of $7.3 million, comprised of $3.5 million in cash and 399,042 shares of the Company’s common shares valued at $3.8 million. In addition, the Company recorded $0.2 million in direct transaction costs comprised primarily of legal costs incurred in connection with the purchased assets. The allocation of the Modern purchase price to the assets acquired was $5.3 million to investment in films and television programs and $2.2 million to accounts receivable. The Trimark library is amortized over its expected revenue stream for a period of 20 years from the acquisition date. The remaining amortization period on the Trimark library at September 30, 2006 is 14.0 years on unamortized costs of $17.0 million. The Artisan library includes titles released at least three years prior to the date of acquisition and is amortized over its expected revenue stream for a period of 20 years from the date of acquisition. The remaining amortization period on the Artisan library at September 30, 2006 is 17.25 years on unamortized costs of $76.0 million. The Modern library is amortized over its expected revenue stream for a period of 20 years from the acquisition date. The remaining amortization period on the Modern library at September 30, 2006 is 18.75 years on unamortized costs of $5.0 million. The Redbus library includes titles released at least three years prior to the date of acquisition and is amortized over its expected revenue stream for a period of 20 years from the date of acquisition. The remaining amortization period on the Redbus library at September 30, 2006 is 19.0 years on unamortized costs of $2.2 million. The preliminary estimate of the fair value of the individual film and television titles acquired as part of the acquisition of Debmar-Mercury LLC (note 8) were included in released, net of accumulated amortization in the direct-to-television category above.

 

The Company expects approximately 39% of completed films and television programs, net of accumulated amortization, will be amortized during the one-year period ending September 30, 2007. Additionally, the Company expects approximately 80% of completed and released films and television programs, net of accumulated amortization and excluding acquired libraries, will be amortized during the three-year period ending September 30, 2009.

 

 

 

Deferred Financing Costs.  Deferred financing costs primarily include costs incurred in connection with the credit facility (see note 5) and the issuance of the 4.875% Notes, the 2.9375% Notes and the 3.625% Notes (see note 7) that are deferred and amortized to interest expense.

 

Other Investments.

 

Maple:  On April 8, 2005, Lionsgate entered into library and output agreements with Maple Pictures, a Canadian corporation, for the distribution of Lionsgate’s motion picture, television and home video product in Canada. As part of this transaction, Maple Pictures purchased a majority of the Company’s interest in Christal Distribution, a number of production entities and other Lionsgate distribution assets in Canada. Maple Pictures was

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

formed by two former Lionsgate executives and a third-party equity investor. Lionsgate also acquired and currently owns a 10% minority interest in Maple Pictures.

 

As a result of these transactions with Maple Pictures, Lionsgate recorded an investment in Maple Pictures of $2.1 million in other assets in the consolidated balance sheet. The Company is accounting for the investment in Maple Pictures using the equity method because of the Company’s ownership percentage and Board representation. For the three and six months ended September 30, 2006, a loss of $0.1 million and nil, respectively, is recorded in equity interests in the consolidated statements of operations. For the three and six months ended September 30, 2005, a loss of $0.1 million is recorded in equity interests in the consolidated statements of operations. The investment in Maple Pictures is $2.0 million as of September 30, 2006 (March 31, 2006 — $2.0 million).

 

CinemaNow:  At March 31, 2006, the Company had a 30% equity interest on an undiluted basis in CinemaNow, Inc. (“CinemaNow”). The investment in CinemaNow was accounted for using the equity method. The investment in CinemaNow was nil at March 31, 2006. In June 2006, the Company purchased $1.0 million Series E Preferred Stock as part of a $20.3 million round of financing secured by CinemaNow. At September 30, 2006, the Company’s equity interest in CinemaNow is 18.8% on a fully diluted basis and 21.1% on an undiluted basis. For the three and six months ended September 30, 2006, a loss of $0.3 million is recorded in equity interests in the consolidated statements of operations. There was no gain or loss recorded for the three and six months ended September 30, 2005 in equity interests in the consolidated statements of operations. The investment in CinemaNow is $0.7 million as of September 30, 2006 (March 31, 2006 — nil).

 

 

At September 30, 2006, the Company had a $215 million revolving line of credit, of which $10 million is available for borrowing by the new Redbus subsidiaries in either U.S. dollars or British pounds sterling. At September 30, 2006, the Company had no borrowings (March 31, 2006 — nil) under the credit facility. The credit facility expires December 31, 2008 and bears interest at 2.75% over the “Adjusted LIBOR” or the “Canadian Bankers Acceptance” rate (as defined in the credit facility), or 1.75% over the U.S. or Canadian prime rates. The availability of funds under the credit facility is limited by the borrowing base. Amounts available under the credit facility are also limited by outstanding letters of credit, which amounted to $0.3 million at September 30, 2006. At September 30, 2006 there was $214.7 million available under the credit facility. The Company is required to pay a monthly commitment fee based upon 0.50% per annum on the total credit facility of $215 million less the amount drawn. Right, title and interest in and to all personal property of Lions Gate Entertainment Corp. and Lions Gate Entertainment Inc. is pledged as security for the credit facility. The credit facility is senior to the Company’s film obligations and subordinated notes. The credit facility restricts the Company from paying cash dividends on its common shares.

 

 

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company expects approximately 59% of accrued participants’ shares will be paid during the one-year period ending September 30, 2007.

 

 

3.625% Notes.  In February 2005, Lions Gate Entertainment Inc. sold $150.0 million of 3.625% Convertible Senior Subordinated Notes (the “3.625% Notes”). In connection with this sale, Lions Gate Entertainment Inc. granted the initial purchasers of the 3.625% Notes an option to purchase up to an additional $25.0 million of the 3.625% Notes for 13 days. The fair value of this option was not significant. The initial purchasers exercised this option in February 2005 and purchased an additional $25.0 million of the 3.625% Notes. The Company received $170.2 million of net proceeds after paying placement agents’ fees from the sale of $175.0 million of the 3.625% Notes. The Company also paid $0.6 million of offering expenses incurred in connection with the 3.625% Notes. Interest on the 3.625% Notes is payable semi-annually on March 15 and September 15, commencing on September 15, 2005. After March 15, 2012, interest will be 3.125% per annum on the principal amount of the 3.625% Notes, payable semi-annually on March 15 and September 15 of each year. The 3.625% Notes mature on March 15, 2025. Lions Gate Entertainment Inc. may redeem all or a portion of the 3.625% Notes at its option on or after March 15, 2012 at 100% of their principal amount, together with accrued and unpaid interest through the date of redemption.

 

The holder may require Lions Gate Entertainment Inc. to repurchase the 3.625% Notes on March 15, 2012, 2015 and 2020 or upon a change in control at a price equal to 100% of the principal amount, together with accrued and unpaid interest through the date of repurchase. Under certain circumstances, if the holder requires Lions Gate Entertainment Inc. to repurchase all or a portion of their notes upon a change in control, they will be entitled to receive a make whole premium. The amount of the make whole premium, if any, will be based on the price of our common shares on the effective date of the change in control. No make whole premium will be paid if the price of our common shares is less than $10.35 per share or if the price of the common shares of the Company exceeds $75.00 per share.

 

The 3.625% Notes are convertible, at the option of the holder, at any time before the close of business on or prior to the trading day immediately before the maturity date, if the notes have not been previously redeemed or repurchased, at a conversion rate of 70.0133 shares per $1,000 principal amount of the 3.625% Notes, subject to adjustment in certain circumstances, which is equal to a conversion price of approximately $14.28 per share. Upon conversion of the 3.625% Notes, the Company has the option to deliver, in lieu of common shares, cash or a combination of cash and our common shares. The holder may convert the 3.625% Notes into our common shares prior to maturity if the notes have been called for redemption, a change in control occurs or certain corporate transactions occur.

 

2.9375% Notes.  In October 2004, Lions Gate Entertainment Inc. sold $150.0 million of 2.9375% Convertible Senior Subordinated Notes (the “2.9375% Notes”). The Company received $146.0 million of net proceeds after paying placement agents’ fees from the sale of $150.0 million of the 2.9375% Notes. The Company also paid $0.7 million of offering expenses incurred in connection with the 2.9375% Notes. Interest on the 2.9375% Notes is payable semi-annually on April 15 and October 15, commencing on April 15, 2005, and the 2.9375% Notes mature on October 15, 2024. From October 15, 2009 to October 14, 2010, Lions Gate Entertainment Inc. may redeem the 2.9375% Notes at 100.839%; from October 15, 2010 to October 14, 2011, Lions Gate Entertainment Inc. may redeem the 2.9375% Notes at 100.420%; and thereafter at 100%.

 

The holder may require Lions Gate Entertainment Inc. to repurchase the 2.9375% Notes on October 15, 2011, 2014 and 2019 or upon a change in control at a price equal to 100% of the principal amount, together with accrued and unpaid interest through the date of repurchase. Under certain circumstances, if the holder requires Lions Gate Entertainment Inc. to repurchase all or a portion of their notes upon a change in control, they will be entitled to receive a make whole premium. The amount of the make whole premium, if any, will be based on the price of our

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

common shares on the effective date of the change in control. No make whole premium will be paid if the price of our common shares is less than $8.79 per share or if the price of our common shares exceeds $50.00 per share.

 

The holder may convert the 2.9375% Notes into our common shares prior to maturity only if the price of our common shares issuable upon conversion of a note reaches a specified threshold over a specified period, the trading price of the notes falls below certain thresholds, the notes have been called for redemption, a change in control occurs or certain corporate transactions occur. In addition, under certain circumstances, if the holder converts their notes upon a change in control, such holder will be entitled to receive a make whole premium. Before the close of business on or prior to the trading day immediately before the maturity date, if the notes have not been previously redeemed or repurchased, the holder may convert the notes into our common shares at a conversion rate of 86.9565 shares per $1,000 principal amount of the 2.9375% Notes, subject to adjustment in certain circumstances, which is equal to a conversion price of approximately $11.50 per share.

 

4.875% Notes.  In December 2003, Lions Gate Entertainment Inc. sold $60.0 million of 4.875% Convertible Senior Subordinated Notes (the “4.875% Notes”). The Company received $57.0 million of net proceeds after paying placement agents’ fees from the sale of $60.0 million of the 4.875% Notes. The Company also paid $0.7 million of offering expenses incurred in connection with the 4.875% Notes. Interest on the 4.875% Notes is due semi-annually on June 15 and December 15, commencing on June 15, 2004, and the 4.875% Notes mature on December 15, 2010.

 

The 4.875% Notes are convertible, at the option of the holder, at any time before the close of business on or prior to the trading day immediately before the maturity date if the notes have not been previously redeemed or repurchased at a conversion rate of 185.0944 shares per $1,000 principal amount of the 4.875% Notes, subject to adjustment in certain circumstances, which is equal to a conversion price of approximately $5.40 per share. Upon conversion of the 4.875% Notes, the Company has the option to deliver, in lieu of common shares, cash or a combination of cash and our common shares. The holder may convert the 4.875% Notes into our common shares prior to maturity if the notes have been called for redemption, a change in control occurs or certain corporate transactions occur.

 

On October 18, 2006, the Company announced its intention to redeem the 4.875% notes on the optional redemption date of December 15, 2006 at 100% of their principal amount, plus accrued and unpaid interest, if any. The noteholders will have the right to elect to convert their notes into the Company’s common shares pursuant to the indenture at any time prior to the close of business on December 14, 2006.

 

 

On July 3, 2006, the Company acquired all of the capital stock of Debmar-Mercury LLC (“Debmar”), an independent distributor of film and television packages. Consideration for the Debmar acquisition was $27.5 million, comprised of a combination of $24.5 million in cash paid on July 3, 2006 and up to $3.0 million in common shares of the Company to be issued as of January 1, 2008 if there are no breaches requiring indemnification by the seller of certain representations and warranties made by the seller. An additional $0.2 million has been incurred in acquisition costs. The $3.0 million of shares to be issued has been recorded as part of the purchase consideration and reflected as a liability. If no incremental liabilities become known by January 1, 2008 then the shares will be issued and the $3.0 million will be reclassified to equity. The purchase price may be adjusted for the payment of additional consideration contingent on the financial performance of Debmar for the five-year period ending June 30, 2011. The Debmar acquisition provides the Company with the rights to distribute certain television properties such as the television series, South Park, and provides the Company with an experienced management team to further enhance its capacity to syndicate its own television programming and feature film packages.

 

The Debmar acquisition was accounted for as a purchase, with the results of operations of Debmar consolidated from July 3, 2006. Goodwill of $11.1 million represents the excess of the purchase price over the

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

fair value of the net identifiable tangible and intangible assets acquired. The preliminary allocation of the purchase price to the tangible and intangible assets acquired and liabilities assumed based on their fair values is as follows:

 

 

The allocation above is preliminary until completion and receipt of final appraisals of the net assets acquired. The $11.1 million of goodwill was assigned to the television reporting segment. Pro forma information for the Debmar acquisition is not presented because the assets acquired and the results of operations were not material to the Company’s Condensed Consolidated Balance Sheets or Consolidated Statement of Operations, respectively.

 

On March 15, 2006, the Company sold its studio facility located in Vancouver, British Columbia. The purchase price of $35.3 million (net of commissions) was paid in cash. As a result of the sale of the studio facility, the Company recognized a gain, net of tax, of $4.9 million in the fiscal year ended March 31, 2006. Studios facilities previously comprised the Company’s studio facilities reporting segment.

 

As a result of the Company’s sale of the studio facilities, the Company’s consolidated financial statements for all previous periods presented have been revised to reflect the studio facilities’ operations, net of tax, as discontinued operations, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

Summarized financial information for the discontinued studio facilities operations is as follows (in millions):

 

 

On October 17, 2005, the Company acquired all outstanding shares of Redbus, an independent film distributor located in the United Kingdom. Consideration for the Redbus acquisition was $35.5 million, comprised of a combination of $28.0 million in cash, $6.4 million in Lionsgate common shares and direct transaction costs of $1.1 million. In addition, the Company assumed other obligations (including accounts payable and accrued liabilities and film obligations) of $19.4 million. At the closing of the transaction the Company issued 643,460 common shares to Redbus Group Limited (“RGL”) valued at approximately $5.6 million, or $8.77 per share, and will issue up to an additional 94,937 common shares to RGL upon satisfaction of the terms of the escrow agreement, valued at approximately $0.8 million and recorded as a liability until satisfaction of the terms of the escrow agreement. Assuming no incremental liabilities become known at the end of the escrow period, the additional shares will be issued to the sellers and the $0.8 million will be reclassified to equity. Direct transaction costs are considered liabilities assumed in the acquisition, and as such, are included in the purchase price. Direct transaction costs consist primarily of legal and accounting fees.

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The goodwill arising from the acquisition of Redbus is included in the goodwill of the motion pictures segment as disclosed in note 13. Pro forma information for the Redbus acquisition is not presented because the assets acquired and the results of operations were not material to the Company’s Condensed Consolidated Balance Sheets or Consolidated Statement of Operations, respectively.

 

 

 

Other expenses include the provision for doubtful accounts. The negative other expenses for the six months ended September 30, 2006 are due to the reversal of the provision for doubtful accounts associated with the collection of a portion of accounts receivable previously reserved.

 

 

 

 

The Company calculates earnings (loss) per share in accordance with SFAS No. 128, “Earnings Per Share.” Basic earnings (loss) per share is calculated based on the weighted average common shares outstanding for the period. Diluted earnings per share includes the impact of the convertible senior subordinated notes, share purchase warrants, stock options and restricted share units, if dilutive.

 

Basic earnings (loss) per common share is calculated using the weighted average number of common shares outstanding during the three and six months ended September 30, 2006 of 104,855,601 shares and 104,661,406 shares, respectively (2005 — 102,358,000 and 102,107,000 shares, respectively). The exercise of common share equivalents including stock options, the conversion features of the 4.875% Notes, the

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2.9375% Notes, the 3.625% Notes and restricted share units could potentially dilute income (loss) per share in the future, but were not reflected in diluted loss per share during the periods presented because to do so would be anti-dilutive.

 

 

Share-Based Compensation

 

Adoption of SFAS No. 123(R)

 

As of September 30, 2006, the Company had two stock option and long-term incentive plans that permit the grant of stock options and other equity awards to certain employees, officers and non-employee directors, which are described more fully below. Prior to April 1, 2006, the Company accounted for stock-based compensation under the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB Opinion No. 25), and related Interpretations, as permitted under SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123). The intrinsic value method requires recognition of compensation expense over the applicable vesting period for the difference between the exercise price of the stock option and the fair value of the underlying stock on the date of grant. Since the exercise price of our stock options is equal to the fair value of the underlying stock at the date of grant, the Company has not historically recognized compensation costs associated with share based awards, with the exception of stock appreciation rights (“SARs”) and restricted share units discussed below and to a very limited extent the modification of awards previously issued.

 

Effective April 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment” (SFAS No. 123 (R)), using the modified-prospective transition method. Under such transition method, compensation cost recognized in the three and six months ended September 30, 2006 includes: (a) compensation cost for all stock options granted prior to, but not yet vested as of, April 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted on or after April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated. As a result of adopting SFAS No. 123(R) on April 1, 2006, the Company’s loss from operations before income taxes and net loss for the three and six months ended September 30, 2006 are both $0.3 million and $1.8 million, respectively, lower than if the Company had continued to account for share-based compensation under APB Opinion No. 25. The $0.3 million charge for the three months ended September 30, 2006 consisted of the recognition of compensation expense of $0.4 million associated with stock options granted offset by a $0.1 million change in the fair value as compared to the change in the intrinsic value of stock appreciation rights. The $1.8 million charge for the six months ended September 30, 2006 consisted of the recognition of compensation expense of $0.9 million associated with stock options granted in previous years and $0.9 million attributable to the valuation of stock appreciation rights at fair value rather than intrinsic value as previously required. The Company’s loss per share for the three and six months ended September 30, 2006 would have been $0.01 lower if the Company had not adopted SFAS No. 123(R).

 

SFAS No. 123(R) requires the cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. There were no tax benefits realized from the deduction of amounts related to share based payments in the three and six months ended September 30, 2006 and 2005. Prior to the adoption of SFAS No. 123(R) and upon issuance of the restricted share units pursuant to the agreements, an unamortized compensation expense equivalent to the market value of the shares on the date of grant was charged to stockholders’ equity as unearned compensation and amortized over the applicable vested periods. As a result of adopting SFAS No. 123(R) on April 1, 2006, the Company transferred the remaining unearned compensation balance in its stockholders’ equity to common share capital. Prior to the adoption of SFAS No. 123(R), the Company recorded forfeitures of restricted share units, if any, and any compensation cost previously recognized for unvested restricted share units was reversed in the period of

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

forfeiture. Beginning April 1, 2006, the Company records forfeitures in accordance with SFAS No. 123(R) by estimating the forfeiture rates for share-based awards upfront and recording a true-up adjustment for the actual forfeitures. In the three and six months ended September 30, 2006, the calculation of forfeitures did not have a material effect on the Company’s results of operations, financial position or cash flows.

 

The fair value of each option award is estimated on the date of grant using a closed-form option valuation model (Black-Scholes) based on the assumptions noted in the following table. Expected volatilities are based on implied volatilities from traded options on our stock, historical volatility of Lionsgate stock and other factors. The expected term of options granted represents the period of time that options granted are expected to be outstanding. During the three and six months ended September 30, 2006, two officers were each granted options to purchase 1.1 million shares of common stock. The following table represents the assumptions used in the Black-Scholes option-pricing model for options granted during the six months ended September 30, 2006 and 2005:

 

 

The weighted-average grant-date fair values for options granted during the six months ended September 30, 2006 and 2005 were $3.57 and $3.61, respectively.

 

The following table illustrates the effect on net loss and loss per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock options issued and modified under the Company’s stock option plans to the three and six months ended September 30, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing model and amortized to expense over the options’ vesting periods.

 

 

The compensation cost under all of our various stock option and long-term incentive plans during the three and six months ended September 30, 2006 resulted in compensation expense of $3.2 million and $2.8 million respectively (2005 — reduction in expense of less than $0.1 and $0.8 million, respectively). There was no income

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

tax benefit recognized in the statement of operations for share-based compensation arrangements for the three and six months ended September 30, 2006 and 2005.

 

Stock Option and Long-Term Incentive Plans

 

The Company has two stock option and long-term incentive plans that permit the grant of stock options and other equity awards to certain employees, officers and non-employee directors for up to 16.0 million shares of common stock.

 

The shareholders approved an Employees’ and Directors’ Equity Incentive Plan (the “Plan”) that provides for the issue of up to 8.0 million common shares of the Company to eligible employees, directors and service providers of the Company and its affiliates. On July 25, 2003, the Board of Directors increased the number of shares authorized for stock options from 8.0 million to 9.0 million. Of the 9.0 million common shares allocated for issuance, up to a maximum of 250,000 common shares may be issued as discretionary bonuses in accordance with the terms of a share bonus plan. At September 30, 2006, 67,931 common shares were available for grant under the Plan.

 

On June 28, 2004, the Board of Directors adopted the 2004 Performance Incentive Plan (the “2004 Plan”). The shareholders approved the 2004 Plan at the 2004 Annual General Meeting of Shareholders held on September 14, 2004. With the approval of the 2004 Plan, no new awards were granted under the Plan subsequent to the 2004 Annual General Meeting of Shareholders. Any remaining shares available for additional grant purposes under the Plan may be issued under the 2004 Plan. The 2004 Plan provided for the issue of up to an additional 2.0 million common shares of the Company to eligible employees, directors, officers and other eligible persons through the grant of awards and incentives for high levels of individual performance and improved financial performance of the Company. On June 13, 2006, the Board of Directors approved, and on September 12, 2006, the Company’s shareholders approved, an increase of 5.0 million common shares, under the 2004 Plan. The 2004 Plan authorizes stock options, share appreciation rights, restricted shares, share bonuses and other forms of awards granted or denominated in the Company’s common shares. The per share exercise price of an option granted under the 2004 Plan generally may not be less than the fair market value of a common share of the Company on the date of grant. The maximum term of an option granted under the 2004 Plan is ten years from the date of grant. At September 30, 2006, 1,978,771 common shares were available for grant under the 2004 Plan.

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of option activity under the various plans as of September 30, 2006, and changes during the six months then ended is presented below:

 

 

The total intrinsic value of options exercised during the three and six months ended September 30, 2006 were $5.2 million and $6.0 million, respectively (2005 — $1.1 million and $1.3 million, respectively).

 

Restricted Share Units.  Effective June 27, 2005 the Company, pursuant to the 2004 Plan, entered into restricted share unit agreements with certain employees and directors. During the three and six months ended September 30, 2006, the Company awarded 912,083 and 1,264,958 restricted share units, respectively, under these agreements (2005 — 141,875 share units and 359,875 share units, respectively).

 

A summary of the status of the Company’s restricted share units as of September 30, 2006, and changes during the six months ended September 30, 2006, is presented below:

 

 

The fair values of restricted share units are determined based on the market value of the shares on the date of grant. The weighted-average grant-date fair values of restricted share units granted during the six months ended

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

September 30, 2006 and 2005 were $9.39 and $10.40, respectively. The total fair value of shares vested during the six months ended September 30, 2006 and 2005 were $1.2 million and $0.4 million, respectively. Compensation expense recorded for these restricted share units was $0.9 million and $1.4 million during the three and six months ended September 30, 2006, respectively (2005 — $0.7 million and $0.7 million, respectively). As of September 30, 2006, the total remaining unrecognized compensation cost related to nonvested stock options and restricted share units was $8.5 million and $14.4 million, respectively, which is expected to be recognized over a weighted-average period of 2.8 years and 2.6 years, respectively.

 

Under the Company’s two stock option and long term incentive plans, the Company withholds shares to satisfy minimum statutory federal, state and local tax withholding obligations arising from the vesting of restricted share units. During the six months ended September 30, 2006, 35,852 shares were withheld upon the vesting of restricted share units.

 

The Company becomes entitled to an income tax deduction in an amount equal to the taxable income reported by the holders of the stock options and restricted share units when vesting occurs, the restrictions are released and the shares are issued. Restricted share units are forfeited if the employees terminate prior to vesting.

 

Stock Appreciation Rights.  On November 13, 2001, the Board of Directors of the Company resolved that 750,000 options, granted to certain officers of the Company to purchase common shares of the Company, be revised as stock appreciation rights (“SARs”) which entitle the holders to receive cash only and not common shares. The amount of cash received will be equal to the amount by which the trading price of common shares on the exercise notice date exceeds the SARs’ price of $5.00 multiplied by the number of options exercised. Any twenty-day average trading price of common shares prior to the exercise notice date has to be $6.00 or above in order for the officers to exercise their SARs. These SARs are not considered part of the Employees’ and Directors’ Equity Incentive Plan. Through March 31, 2006, the Company measured compensation expense as the amount by which the market value of common shares exceeded the SARs’ price. Effective April 1, 2006, upon the adoption of SFAS No. 123R, the Company measures compensation expense based on the fair value of the SARs determined by using the Black-Scholes option-pricing model. For the three and six months ended September 30, 2006, the following assumptions were used in the Black-Scholes option-pricing model: Volatility of 41.8%, Risk Free Rate of 5.0%-5.2%, Expected Term of 0.17-1.25 years, and Dividend of 0%. On August 11, 2006, an officer exercised 375,000 SARs and received $1.6 million in cash. The trading price of common shares at the exercise date was $9.27. The Company recorded $0.3 million and a reduction of $0.3 million in stock-based compensation expense for the three and six months ended September 30, 2006, (2005 — reduction of expense of $0.3 million and $0.6 million, respectively), in the unaudited condensed consolidated statements of operations. The Company has no stock-based compensation accrual at September 30, 2006 related to this award (March 31, 2006 — $1.9 million). On September 20, 2006, another officer’s 375,000 fully vested and outstanding SARs were cancelled in exchange for $2.1 million in cash. The Company recorded $0.6 million and $0.1 million in stock-based compensation expense for the three and six months ended September 30, 2006 (2005 — reduction of expense of $0.3 million and $0.6 million, respectively). As of September 30, 2006, the $2.1 million cash consideration was not yet paid to the officer and therefore the Company has a stock-based compensation accrual in the amount of $2.1 million (March 31, 2006 — $1.9 million) included in accounts payable and accrued liabilities on the unaudited condensed consolidated balance sheets.

 

On February 2, 2004, an officer of the Company was granted 1,000,000 SARs, which entitle the officer to receive cash only, and not common shares. The amount of cash received will be equal to the amount by which the trading price of common shares on the exercise notice date exceeds the SARs’ price of $5.20 multiplied by the number of SARs exercised. The SARs vest one quarter immediately on the award date and one quarter on each of the first, second and third anniversaries of the award date. These SARs are not considered part of the Employees’ and Directors’ Equity Incentive Plan. Applying FIN No. 28 “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” the Company is accruing compensation expense over the service period, which is assumed to be the three-year vesting period, using a graded approach. Through March 31, 2006, the

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company measured compensation expense as the amount by which the market value of common shares exceeded the SARs’ price. Effective April 1, 2006, upon the adoption of SFAS No. 123R, the Company measures compensation expense based on the fair value of the SARs which is determined by using the Black-Scholes option-pricing model. For the three and six months ended September 30, 2006, the following assumptions were used in the Black-Scholes option-pricing model: Volatility of 39.1%-41.8%, Risk Free Rate of 4.7%-5.1%, Expected Term of 2.4 to 2.6 years, and Dividend of 0%. At September 30, 2006, the market price of our common shares was $10.01, the weighted average fair value of the SAR was $5.54, and 971,487 of the SARs had vested. Due to the increase in the market price of its common shares, the Company recorded additional stock-based compensation expense in the amount of $1.1 million and $0.7 million in general and administration expenses in the unaudited condensed consolidated statement of operations for the three and six months ended September 30, 2006 (2005 — reduction in expense of $0.2 million and $0.4 million, respectively). During the year ended March 31, 2005 the officer exercised 150,000 of the vested SARs and the Company paid $0.9 million. The compensation expense amount in the period is calculated by using the fair value of the SAR, multiplied by the remaining 971,487 SARs assumed to have vested under the graded methodology less the 150,000 SARs exercised less the amount previously recorded. At September 30, 2006, the Company has a stock-based compensation accrual in the amount of $4.5 million (March 31, 2006 — $3.9 million) included in accounts payable and accrued liabilities on the condensed consolidated balance sheets relating to these SARs.

 

 

SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” requires the Company to make certain disclosures about each reportable segment. The Company’s reportable segments are determined based on the distinct nature of their operations and each segment is a strategic business unit that offers different products and services and is managed separately. The Company evaluates performance of each segment using segment profit (loss) as defined below. The Company has two reportable business segments: Motion Pictures and Television.

 

Motion Pictures consists of the development and production of feature films, acquisition of North American and worldwide distribution rights, North American theatrical, video and television distribution of feature films produced and acquired and worldwide licensing of distribution rights to feature films produced and acquired.

 

Television consists of the development, production and worldwide distribution of television productions, including television series, television movies and mini-series and non-fiction programming.

 

As a result of the Company’s sale of the studio facilities on March 15, 2006, the Company no longer discloses its studio operations as a reportable segment.

 

LIONS GATE ENTERTAINMENT CORP.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Segmented information by business unit is as follows: