Image-Enhancing DVD Format Restores Distributor’s Sales

Laserdisc video, the movies-on-CD technology on which Image Entertainment built its business, seems to be going the way of eight-track tapes and 45 rpm records. So why is Martin Greenwald, Image’s chairman and CEO, smiling?

And why has the company’s stock doubled in price over the past two months.

Call it luck or savvy, but it looks as if Image this time has bet on the right technology. The distributor of home video programming--a higher-quality alternative to videotape--has staked its future on the new digital disc format, DVD. That decision is paying off in a surge of new revenue. In the eyes of Wall Street, laserdiscs may be doomed, but Image is bouncing back without them.

The latest sales numbers from the company show how fast the technology shift has taken place. For the quarter ended Dec. 31, Image says, it expects to sell more than $14.5 million in DVD programming--more than double the sales of the prior quarter. The company says DVD now makes up more than 65% of its sales, up from just 20% a year earlier.

Greenwald says this is what the company was looking for--but not quite so fast.

“The actual change was at light speed, and we thought it would be at the speed of sound,” he said.

But even as DVD sales soar like a rocket, laserdisc sales are dropping like a rock. So Image’s overall revenue hasn’t yet recovered to where it was when laserdisc sales peaked three years ago.

In the fiscal year that ended March 31, 1996, the company earned $7.6 million (51 cents a share) on sales of $95.1 million. Two years later, sales had slumped to $75.5 million and the company lost $9.6 million, or 71 cents a share.

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The firm expects to turn a profit for the quarter just ended, but the $20-million-plus in expected sales may still fall short of the $26.3 million racked up in the same quarter a year earlier (the company says it will formally report sales and earnings by Feb. 15).

But the DVD boom looks strong enough to get Image back to its old strength, and then some, if it can hold onto a significant piece of this new market.

DVD Video Group, a trade association of companies making and marketing DVD technology, says 1.4-million DVD players have been shipped to retail outlets since they first went on sale in the spring of 1997. The group estimates that about a million households now have DVD players. It expects another 2 million to be sold this year as prices drop. The units, which also play music CDs, now retail for as little as $300.

That far outstrips the growth of earlier home-entertainment products when they came onto the market. Steven Hill, an analyst for the New York-based investment bank Commonwealth Associates, says only 90,000 VCRs and 250,000 CD players were sold in their first two years--and they went on to become the dominant formats for video and music. Laserdisc took 10 years to reach 2 million households.

“It’s a tremendous launch for any format,” said John Thrasher, vice president of video sales for Sacramento-based Tower Records Inc., which has been a leading seller of laserdiscs.

“Laserdisc sales have taken it on the chin” at Tower stores, he said, and he expects the format will “reach the end of the road within the next year or two.”

But he predicts that DVD will eventually be as popular as VHS videotape.

If that’s so, then DVD still has plenty of room to grow. Fewer than 1% of U.S. households with television sets now have DVD players, compared with 85% that have VHS video cassette recorders.

That would make DVD far different from the laserdisc market, which never got beyond about 2% of households--appealing to a niche market dominated by movie and video buffs and people in the industry. But DVD is different in another way, which is not as much to the advantage of independent distributors such as Image.

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Image makes its money as a wholesaler by selling titles under licenses from studios--sometimes buying exclusive rights to make and market the discs and sometimes simply distributing discs produced for others. Gross margins on the exclusive rights discs are much higher--about 50%, Hill says, compared with about 10% for nonexclusive discs.

The laserdisc market never seemed lucrative enough for the studios to market their product themselves, so Image was able to get exclusive licenses for a host of top-selling titles, enough to become the leading player.

But the DVD field is a lot more fragmented, with the studios apparently bent on keeping the best titles for themselves.

Amy Jo Donner, executive director of the DVD Video Group, said the biggest player is Time-Warner Inc.’s Warner Home Video, which has about a 40% market share with its Warner Brothers, MGM, New Line and HBO labels. Columbia / TriStar and Disney’s Buena Vista are not far behind.

Hill estimates that Image has over 4% of the DVD wholesale market, if Internet sales are included. It has about 3% of sales to retail stores. And though it may miss out on the latest blockbusters, it has a growing and eclectic list of exclusive titles--about 10% of the more than 2,000 now available in DVD format, Greenwald says.

The mix includes some fairly recent hits, such as Kevin Costner’s “Dances With Wolves” and “Bull Durham” along with classic silent films and foreign movies, rock concerts, operas and Playboy videos. And with its nonexclusive titles thrown in, Greenwald said, Image can be a “one-stop shop” for retailers.

In that role, it has gone well beyond the traditional record-store chains and into the new world of e-commerce. On a nonexclusive basis, it now distributes to most of the big online video retailers, including Amazon.com, DVDExpress and Reel.com. Greenwald said about 23% of its sales in the last quarter were to Internet retailers.

Image is not selling directly to consumers online, but it has just bought a business that does--the online and mail-order operations of Ken Crane’s Magnavox City, based in Westminster. Image financed the $7-million purchase from a secondary stock offering of 2.4-million shares that netted $10.9 million in December.

The new unit includes Kencranes.com, which is already a major Internet seller of DVD and laserdisc video.

If nothing else, say industry observers, this will keep a sales channel open for laserdiscs as long as buyers want them. With DVD crowding out laserdiscs in record stores, Donner says, “laser is probably going to become a completely Internet business.” For that reason, she said, “the purchase of Ken Crane’s was a very savvy move.”

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But Image sees more than that. For one thing, Chief Financial Officer Jeff Framer sees profit--not all that common in Internet retailing.

Based on unaudited results, he said, the Ken Crane’s unit is netting between $600,000 and $700,000 a year on more than $16 million in sales. “We were actually buying someone who was historically profitable and cash-flow positive,” he said.

The Ken Crane’s purchase also gives Image a new use for the distribution center it recently set up next to McCarren International Airport in Las Vegas. With the 70,000-square-foot facility available for filling and shipping orders, it can grow the new Internet and mail-order business without sacrificing speed and service. And with the center expandable to 360,000 square feet, Hill says, Image can do this not only for its own Internet outlet, but for other Internet retailers as well.

Hill says this potential to become a shipping center for other online retailers is a potentially lucrative new role for Image. “It is the part we love about this company,” he said. “They see themselves in the value chain of the future.”

The Internet is just one of the many marketplaces where DVD will be sold, Greenwald said, and his company has to reach as far and wide as possible--to bookstores, mini-marts, even card shops. This time, Image is not just trying to sell to the aficionados.

“The challenge that Image has today is to get its programming into as many venues as possible,” he said. “You have to throw away all preconceived notions of where DVD goes.”