UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
INTERPLAY ENTERTAINMENT CORP.
(Exact name of the registrant as specified in its charter)
DELAWARE 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92606
(Address of principal executive offices)
(949) 553-6655
(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 [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
CLASS ISSUED AND OUTSTANDING AT MAY 12, 2001
----- --------------------------------------
Common Stock, $0.001 par value 93,060,857
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2002
TABLE OF CONTENTS
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Page
Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2002
(unaudited) and December 31, 2001 3
Condensed Consolidated Statements of Operations for
the Three Months ended March 31, 2002 and
2001 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for
the Three Months ended March 31, 2002 and
2001 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Changes in Securites and Use of Proceeds 33
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 35
Page 2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
MARCH 31, DECEMBER 31,
ASSETS 2002 2001
-------------- -------------
Current Assets: (UNAUDITED)
Cash $ 61 $ 119
Trade receivables from related parties, net of allowances
of $2,322 and $4,025, respectively 3,445 6,175
Trade receivables, net of allowances
of $4,123 and $3,516, respectively 1,986 3,312
Inventories 3,903 3,978
Prepaid licenses and royalties 10,499 10,341
Other current assets 675 1,162
------------ ------------
Total current assets 20,569 25,087
Property and equipment, net 4,656 5,038
Other assets 981 981
------------ ------------
$ 26,206 $ 31,106
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current debt $ - $ 1,576
Accounts payable 15,524 13,718
Accrued royalties 5,959 7,795
Other accrued liabilities 2,637 2,999
Advances from distributors and others 7,167 12,792
Advances from related party distributor 9,618 10,060
Loans from related parties 4,318 3,218
Payables to related parties 8,764 7,098
------------ ------------
Total current liabilities 53,987 59,256
------------ ------------
Commitments and contingencies (Notes 1, 5, 6 and 7)
Stockholders' Deficit:
Series A preferred stock, $.001 par value, authorized
719,424 shares; issued and outstanding zero and
383,354 shares, respectively - 11,753
Common stock, $.001 par value, authorized 100,000,000
issued and outstanding 93,060,857 and 44,995,821 shares,
respectively 93 45
Paid-in capital 121,396 110,701
Accumulated deficit (149,445) (150,807)
Accumulated other comprehensive income 175 158
------------ ------------
Total stockholders' deficit (27,781) (28,150)
------------ ------------
$ 26,206 $ 31,106
============ ============
See accompanying notes.
Page 3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
------------- -------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Net revenues $ 9,207 $ 15,465
Net revenues from related party distributors 6,168 1,373
------------- -------------
Total net revenues 15,375 16,838
Cost of goods sold 4,477 10,485
------------- -------------
Gross profit 10,898 6,353
------------- -------------
Operating expenses:
Marketing and sales 1,654 6,148
General and administrative 3,016 2,478
Product development 4,698 5,381
------------- -------------
Total operating expenses 9,368 14,007
------------- -------------
Operating income (loss) 1,530 (7,654)
------------- -------------
Other income (expense):
Interest expense (942) (662)
Other 907 (106)
------------- -------------
Net income (loss) $ 1,495 $ (8,422)
------------- -------------
Cumulative dividend on participating preferred stock $ 133 $ 300
Accretion of warrant - 199
------------- -------------
Net income (loss) available to common stockholders $ 1,362 $ (8,921)
============= =============
Net income (loss) per common share:
Basic $ 0.03 $ (0.30)
============= =============
Diluted $ 0.02 $ (0.30)
============= =============
Shares used in calculating net income (loss) per
common share:
Basic 54,437,592 30,153,572
============= =============
Diluted 54,502,505 30,153,572
============= =============
See accompanying notes.
Page 4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2002 2001
----------- -----------
Cash flows from operating activities: (DOLLARS IN THOUSANDS)
Net income (loss) $ 1,495 $ (8,422)
Adjustments to reconcile net income (loss) to
cash provided by operating activities:
Depreciation and amortization 463 629
Non-cash interest expense 74 -
Other 17 (22)
Changes in assets and liabilities:
Trade receivables, net (133) (5,718)
Trade receivables from related parties 4,189 9,338
Inventories 75 (146)
Prepaid licenses and royalties (158) (258)
Other current assets 487 (406)
Accounts payable 1,806 (1,577)
Accrued royalties (1,836) (1,570)
Other accrued liabilities (362) 4,460
Payables to related parties 437 2,016
Advances from distributors and others (6,067) 5,274
----------- -----------
Net cash provided by (used in) operating activities 487 3,598
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (81) (579)
----------- -----------
Net cash used in investing activities (81) (579)
----------- -----------
Cash flows from financing activities:
Net payment of line of credit (550) -
Net payment of previous line of credit - (326)
Net borrowings from supplemental line of credit - 2,074
Proceeds from exercise of stock options 86 9
----------- -----------
Net cash (used in) provided by financing activities (464) 1,757
----------- -----------
Net (decrease) increase in cash (58) 4,776
Cash, beginning of period 119 2,835
----------- -----------
Cash, end of period $ 61 $ 7,611
=========== ===========
Supplemental cash flow information:
Cash paid for:
Interest $ 106 $ 662
Supplemental disclosures of noncash transactions:
Acquisition of nine percent interest in Shiny $ - $ 600
Accrection of preferred stock to redemption value - 199
Dividend payable on partial conversion of preferred stock 1,229 -
Accrued dividend on participating preferred stock 133 300
Borrowings from former Chairman used to pay down line of credit 1,026 -
See accompanying notes.
Page 5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2002
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Interplay Entertainment Corp. and its subsidiaries (the "Company") reflect all
adjustments (consisting only of normal recurring adjustments) that, in the
opinion of management, are necessary for a fair presentation of the results for
the interim period in accordance with instructions for Form 10-Q and Rule 10-01
of Regulation S-X. Accordingly, they do not include all information and
footnotes required by generally accepted accounting principles in the United
States for complete financial statements. The results of operations for the
current interim period are not necessarily indicative of results to be expected
for the current year or any other period. The balance sheet at December 31, 2001
has been derived from the audited consolidated financial statements at that
date, but does not include all information and footnotes required by generally
accepted accounting principles in the United States for complete financial
statements.
These consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 as
filed with the Securities and Exchange Commission.
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN
The Company has incurred substantial operating losses and at March 31,
2002, had a stockholders' deficit of $27.8 million and a working capital deficit
of $33.4 million. The Company has historically funded its operations primarily
through the use of lines of credit, royalty and distribution fee advances, cash
generated by the private sale of securities, and proceeds of its initial public
offering.
In April 2001, the Company entered into a three year loan and security
agreement ("L&S Agreement") with a bank providing for a $15.0 million working
capital line of credit secured by all the assets of the Company. Concurrently,
the Company's former Chairman provided the bank a $2 million personal guarantee,
secured by $1 million in cash. In addition, the Chairman provided the Company
with $3 million payable in March 2002, with interest at 10 percent. The Company
was not in compliance with some of the financial covenants under the line of
credit at December 31, 2001. On October 26, 2001, the bank notified the Company
that the credit agreement was being terminated, that all related amounts
outstanding were immediately due and payable and that the Company would no
longer be able to draw on the credit facility to fund future operations. In
February 2002, the bank drew-down on $1.0 million of the $2.0 million personal
guarantee provided by the Company's former Chairman, which in combination with
cash paid by the Company, substantially paid off the remaining outstanding
balance on the line of credit. In March 2002, the Company entered into a
forbearance agreement with the bank and its former Chairman; subsequent to that
agreement, the Company repaid all remaining amounts due the bank under the line
of credit and agreed to repay its former Chairman for the $1.0 million
drawn-down by the bank pursuant to the former Chairman's guarantee. The Company
repaid all amounts due to its former Chairman in April 2002 with proceeds from
the sale of Shiny Entertainment, Inc. ("Shiny").
To reduce its working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles, which
management believes do not meet sufficient projected profit margins, and the
scaling back of certain marketing programs. Management will continue to pursue
various alternatives to improve future operating results, and further expense
reductions, some of which may have a long-term adverse impact on the Company's
ability to generate successful future business activities. In addition, the
Company continues to seek external sources of funding, including but not limited
to, a sale or merger of the Company, a private placement of the Company's
capital stock, the sale of selected assets, the licensing of certain product
rights in selected territories, selected distribution agreements, and/or other
strategic transactions sufficient to provide short-term funding, and potentially
achieve the Company's long-term strategic objectives.
In this regard, the Company completed the sale of Shiny in April 2002, for
approximately $47.2 million (Note 2). Management believes that the proceeds from
the sale, following the repayment of third party obligations, which are a
condition to the transaction, along with operating revenues from future product
releases, will be sufficient to fund the Company's operations at least through
December 31, 2002.
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
However, if the combination of proceeds from the sale of Shiny and
operating revenues from future product releases are not sufficient to fund the
Company's operations, no assurance can be given that alternative sources of
funding could be obtained on acceptable terms, or at all. These conditions,
combined with the Company's historical operating losses and its deficits in
stockholders' equity and working capital, raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets and
liabilities that may result from the outcome of this uncertainty.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates made in preparing the consolidated financial statements
include sales returns and allowances, cash flows used to evaluate the
recoverability of prepaid licenses and royalties and long-lived assets, and
certain accrued liabilities related to restructuring activities and litigation.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period's financial
statements to conform to classifications used in the current period.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under development arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables. Royalty advances are recoupable against future
sales based upon the contractual royalty rate. The Company amortizes the cost of
licenses, prepaid royalties and other outside production costs to cost of goods
sold over six months commencing with the initial shipment in each region of the
related title. The Company amortizes these amounts at a rate based upon the
actual number of units shipped with a minimum amortization of 75 percent in the
first month of release and a minimum of 5 percent for each of the next five
months after release. This minimum amortization rate reflects the Company's
typical product life cycle. Management evaluates the future realization of such
costs quarterly and charges to cost of goods sold any amounts that management
deems unlikely to be fully realized through future sales. Such costs are
classified as current and noncurrent assets based upon estimated product release
date.
SOFTWARE DEVELOPMENT COSTS
Research and development costs, which consist primarily of software
development costs, are expensed as incurred. Statement of Financial Accounting
Standards ("SFAS") No. 86, "Accounting for the Cost of Computer Software to be
Sold, Leased, or Otherwise Marketed", provides for the capitalization of certain
software development costs incurred after technological feasibility of the
software is established or for development costs that have alternative future
uses. Under the Company's current practice of developing new products, the
technological feasibility of the underlying software is not established until
substantially all product development is complete, which generally includes the
development of a working model. The Company has not capitalized any software
development costs on internal development projects, as the eligible costs were
determined to be insignificant.
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
ACCRUED ROYALTIES
Accrued royalties consist of amounts due to outside developers based on
contractual royalty rates for sales of shipped titles. The Company records a
royalty expense based upon a contractual royalty rate after it has fully
recouped the royalty advances paid to the outside developer, if any, prior to
shipping a title.
REVENUE RECOGNITION
Revenues are recorded when products are delivered to customers in
accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition" and SEC Staff Accounting Bulletin No. 101, Revenue Recognition.
With the signing of the Vivendi Universal Games, Inc. ("Vivendi") distribution
agreement in August 2001, substantially all of the Company's sales are made by
two related party distributors (Notes 5 and 10) as Vivendi owns approximately 5
percent of the outstanding shares of the Company's common stock. The Company
recognizes revenue from sales by distributors, net of sales commissions, only as
the distributor recognizes sales of the Company's products to unaffiliated third
parties. For those agreements that provide the customers the right to multiple
copies of a product in exchange for guaranteed amounts, revenue is recognized at
the delivery of the product master or the first copy. Per copy royalties on
sales that exceed the guarantee are recognized as earned. Guaranteed minimum
royalties on sales that do not meet the guarantee are recognized as the minimum
payments come due. The Company is generally not contractually obligated to
accept returns, except for defective, shelf-worn and damaged products in
accordance with negotiated terms. However, on a case by case negotiated basis,
the Company permits customers to return or exchange product and may provide
markdown allowances on products unsold by a customer. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue
Recognition when Right of Return Exists", revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The amount
of reserves ultimately required could differ materially in the near term from
the amounts included in the accompanying consolidated financial statements.
Customer support provided by the Company is limited to telephone and Internet
support. These costs are not material and are charged to expenses as incurred.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2001, the Emerging Issues Task Force reached a consensus on Issue
No. 00-25 ("EITF 00-25"), "Accounting for Consideration from a Vendor to a
Retailer in Connection with the Purchase or Promotion of the Vendor's Products",
which states that consideration from a vendor to a reseller of the vendor's
products is presumed to be a reduction of the selling prices of the vendor's
products and, therefore, should be characterized as a reduction of revenue when
recognized in the vendor's income statement. That presumption is overcome and
the consideration can be categorized as a cost incurred if, and to the extent
that, a benefit is or will be received from the recipient of the consideration.
That benefit must meet certain conditions described in EITF 00-25. The Company
adopted the provisions of EITF 00-25 on January 1, 2002 and as a result net
revenues and marketing expenses were reduced by $0.5 million for the three
months ended March 31, 2001. The adoption of EITF 00-25 did not impact the
Company's net loss for the three months ended March 31, 2001.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets" effective for fiscal years beginning after December 15, 2001.
Under the new rules all acquisition transactions entered into after June 30,
2001, must be accounted for on the purchase method and goodwill will no longer
be amortized but will be subject to annual impairment tests in accordance with
SFAS 142. Other intangible assets will continue to be amortized over their
useful lives. The Company adopted the new rules on accounting for goodwill and
other intangible assets on January 1, 2002. The adoption of SFAS No. 142 did not
have a material impact on the Company's consolidated financial position or
results of operations. Goodwill amortization for the three months ended March
31, 2001 was $96,000. With the sale of Shiny, the Company no longer has any
goodwill assets.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
assets and the associated asset retirement costs. The provisions of SFAS No. 143
are effective for financial statements issued for fiscal years beginning after
June 15, 2002, with early application encouraged and generally are to be applied
prospectively. The Company does not expect the adoption of SFAS No. 143 to have
a material impact on its consolidated financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that Opinion). The Company adopted the provisions of SFAS No. 144 on
January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on
the Company's consolidated financial position or results of operations.
NOTE 2. SUBSEQUENT EVENT
On April 30, 2002, the Company consummated the sale of Shiny, pursuant to
the terms of a Stock Purchase Agreement, dated April 23, 2002, as amended, among
the Company, Infogrames, Shiny, Shiny's president and Shiny Group, Inc. Pursuant
to the purchase agreement, Infogrames acquired all of the outstanding common
stock of Shiny for approximately $47.2 million, which was paid to or for the
benefit of the Company as follows:
o $3.0 million in cash paid to the Company at closing;
o $10.8 million to be paid to the Company pursuant to a promissory note
from Infogrames providing for scheduled payments with the final
payment due July 31, 2002;
o $26.1 million paid directly to third party creditors of the Company;
and
o $7.3 million was paid to Shiny's president and Shiny Group for their
common stock of Shiny that was issued to such parties to settle claims
relating to the Company's original acquisition of Shiny.
Concurrently with the closing of the sale, the Company settled a legal
dispute with Vivendi, relating to the parties' distribution agreement. The
Company also settled legal disputes with its former bank and its former
Chairman, relating to the Company's April 2001 credit facility with its former
bank that was partially guaranteed by its former Chairman. The disputes with
Vivendi, the bank and the former Chairman were dismissed, with prejudice,
following consummation of the sale.
Additionally, in connection with the sale, the Company issued to Warner
Bros., a division of Time Warner Entertainment Company, L.P., a Secured
Convertible Promissory Note, due April 30, 2003, in the principal amount of $2.0
million. The note was issued in partial payment of amounts due Warner Bros.
under the parties' license agreement for the video game based on the motion
picture THE MATRIX, which is being developed by Shiny. The note is secured by
all of the Company's assets, and may be converted by the holder thereof into
shares of the Company's common stock on the maturity date or, to the extent
there is any proposed prepayment, within the 30 day period prior to such
prepayment. The conversion price is equal to the lower of (a) $0.304 and (b) an
amount equal to the average closing price of a share of the Company's common
stock for the five business days ending on the day prior to the conversion date,
provided that in no event can the note be converted into more than 18,600,000
shares. If any amount remains due following conversion of the note into
18,600,000 shares, the remaining amount will be payable in cash. The Company
agreed to register with the Securities and Exchange Commission the resale by the
note holder of shares of common stock issued upon conversion of the note.
Page 9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
NOTE 3. INVENTORIES
Inventories consist of the following:
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
(DOLLARS IN THOUSANDS)
Packaged software $ 3,554 $ 3,230
CD-ROMs, cartridges, manuals, packaging
and supplies 349 748
------------ ------------
$ 3,903 $ 3,978
============ ============
NOTE 4. PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
MARCH 31, DECEMBER 31,
2002 2001
-------------- -------------
(DOLLARS IN THOUSANDS)
Prepaid royalties for titles in development $ 8,189 $ 7,539
Prepaid royalties for shipped titles, net of
amortization 229 710
Prepaid licenses and trademarks, net
of amortization 2,081 2,092
------------ ------------
$ 10,499 $ 10,341
============ ============
Amortization of prepaid licenses and royalties is included in cost of goods
sold and totaled $0.5 million and $2.7 million for the three months ended March
31, 2002 and 2001, respectively.
NOTE 5. ADVANCES FROM DISTRIBUTORS AND OTHERS
Advances from distributors and OEMs consist of the following:
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
(DOLLARS IN THOUSANDS)
Advance from console hardware manufacturer $ 5,000 $ 5,000
Advances for distribution rights to a future title - 4,000
Advances for other distribution rights 2,167 3,792
---------- ----------
$ 7,167 $ 12,792
========== ==========
Net advance from Vivendi distribution agreement $ 9,618 $ 10,060
========== ==========
In August 2001, the Company entered into a distribution agreement with
Vivendi providing for Vivendi to become the Company's distributor in North
America through December 31, 2003 for substantially all of its products, with
the exception of products with pre-existing distribution agreements. Under the
terms of the agreement, as amended, Vivendi earns a distribution fee based on
the net sales of the titles distributed. The agreement provided for three
advance payments from Vivendi totaling $10.0 million. In amendments to the
agreement, Vivendi agreed to advance the Company an additional $3.5 million. The
distribution agreement, as amended, provides for the acceleration of the
recoupment of the advances made to the Company, as defined. During the three
months ended March 31, 2002, Vivendi advanced the Company an additional $3.0
million bringing the total amounts advanced to the Company under the
distribution agreement with Vivendi to $16.5 million. As of March 31, 2002,
Vivendi has recouped $6.9 million of its advance to the Company in connection
with the North American distribution agreement as a result of sales it has made
of the Company's product. In April 2002, the distribution agreement was further
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
amended whereby Vivendi will distribute substantially all of the Company's
products through December 31, 2002, except certain future products, which
Vivendi will have the distribution rights for one year from the date of release.
In March 2001, the Company entered into a supplement to a licensing
agreement with a console hardware and software manufacturer under which it
received an advance of $5.0 million. The advance is to be repaid based on unit
sales of the products under this agreement, as defined. If the full amount of
the advance is not repaid by June 2003, then the remaining outstanding balance
is subject to interest at the prime rate plus one percent and is due by July 15,
2003. The advance is secured by all of the Company's assets. This advance was
repaid to the console hardware and software manufacturer with proceeds from the
sale of Shiny.
In July 2001, the Company entered into a distribution agreement with a
distributor whereby the distributor would have the North American distribution
rights to a future title. In return, the distributor paid the Company an advance
of $4.0 million to be recouped against future amounts due to the Company based
on net sales of the future title. In January 2002, the Company sold the
publishing rights to this title to the distributor in connection with a
settlement agreement entered into with the third party developer. The settlement
agreement provided, among other things, that the Company assign its rights and
obligations under the product agreement to the third party distributor. In
consideration for assigning the product agreement to the distributor, the
Company was not required to repay the $4.0 million advance nor repay $1.6
million related to past royalties and interest owed to the distributor. In
addition, the Company agreed to forgive $0.6 million in advances previously paid
to the developer. As a result, the Company recorded net revenues of $5.6 million
and a related cost of sales of $0.6 million in the three months ended March 31,
2002.
Other advances from distributors are repayable as products covered by those
agreements are sold.
In the event the Company does not perform its obligations under any of the
agreements noted above, it would be obligated to refund any advances not
recouped against future sales.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings, claims and litigation
arising in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the opinion
of management, the outcome of known routine claims will not have a material
adverse effect on the Company's business, financial condition or results of
operations.
Some of the Company's license, development and distribution agreements
contain provisions that allow the other party to terminate the agreement upon a
change in control of the Company. In August 2001, Titus converted a portion of
its Preferred Stock into Common Stock, which as of December 31, 2001 gave Titus
48 percent of the Company's total voting power. At the 2001 annual stockholders
meeting on September 18, 2001, Titus exercised its voting power to elect a
majority of the Board of Directors. In March 2002, Titus converted its remaining
shares of preferred stock into common stock. Titus now owns approximately 72% of
the Company's outstanding common stock. Some of the Company's third-party
developers and licensors may assert that these events constitute a change in
control of the Company and attempt to terminate their respective agreements with
the Company. In particular, the Company's license for "Matrix" allows for the
licensor to terminate the license if there is a substantial change of ownership
or control without their approval. The agreements with a console hardware and
software manufacturer (Note 5) require, among other things, that the Company
continues development of the Matrix product, and that the L&S Agreement (Note 1)
be maintained. As a result of the potential for termination of the Matrix
license and the termination of the L&S Agreement, the Company may be required to
repay the advance. In addition, the loss of the Matrix license in this matter
would materially harm the Company's ability to complete the sale of Shiny and
harm the Company's projected operating results and financial condition. With the
sale of Shiny in April 2002, the potential termination of the Matrix license is
no longer a contingency of the Company.
On January 15, 2002, Rage Games Limited ("Rage") filed a breach of contract
action against the Company relating to the August 3, 2000 North American
distribution agreement and the February 9, 2001 OEM distribution agreement. In
the complaint, Rage alleged that the Company failed to make royalty payments
under these
Page 11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
agreements. Rage sought damages in the amount of $2.9 million plus interest and
punitive damages. Furthermore, Rage sought to audit the Company's books, return
all of Rage's software and a cease & desist of all manufacturing & further
distribution of Rage's software. The Company settled all claims with Rage in
April 2002.
The Company's common stock currently is quoted on the Nasdaq National
Market System. On February 14, 2002, the Company received a deficiency notice
from Nasdaq stating that for the last 30 consecutive trading days, its common
stock has not maintained a minimum market value of publicly held shares of $15.0
million and a minimum bid price per share of $3.00, as required for continued
listing on the Nasdaq National Market. Additionally, the Company does not meet
Nasdaq's alternative listing requirements, which require, among other things,
that it have a stockholder's equity of $10 million, a minimum market value of
publicly held shares of $5,000,000 and a minimum bid price per share of $1.00.
The Company has been provided 90 calendar days, or until May 15, 2002, to regain
compliance. If the Company fails to regain compliance, the Company expects to be
notified by Nasdaq that its securities will be delisted. If this occurs, trading
of the Company's common stock may be conducted on the Nasdaq SmallCap Market, if
it qualified for listing at that time, in the over-the-counter market on the
"pink sheets" or, if available, the NASD's "Electronic Bulletin Board."
Subsequent to March 31, 2002, the Company has applied to be moved to the NASDAQ
SmallCap market.
The Internal Revenue Service ("the IRS") is currently examining the
Company's consolidated federal income tax returns for the years ended April 30,
1992 through 1997. The IRS has challenged the timing of certain tax deductions
taken by the Company, and has asserted that an additional tax liability is due.
As a result, the Company established a reserve in fiscal 2001 of $500,000,
representing management's best estimate of amounts to be paid in settlement of
the IRS claims. There have not been any changes in management's estimate for the
three months ended March 31, 2002.
NOTE 7. STOCKHOLDERS' EQUITY
In March 2002, Titus converted its remaining 383,354 shares of Series A
Preferred Stock into 47,492,162 shares of common stock. This conversion did not
include accumulated dividends of $1.2 million on the preferred stock, these were
reclassified as a payable to related parties as Titus has elected to receive the
dividends in cash. Subsequent to this conversion, Titus now owns 66,988,723
shares of the Company's common stock and Titus had 72 percent of the total
voting power of the Company's capital stock as of March 31, 2002.
In April 2001, the Company completed a private placement of 8,126,770 units
at $1.5625 per unit for total proceeds of $12.7 million, and net proceeds of
approximately $11.7 million. Each unit consisted of one share of common stock
and a warrant to purchase one share of common stock at $1.75 per share, which
was exercisable immediately. If the Company issues additional shares of common
stock at a per share price below the exercise price of the warrants, then the
warrants are to be repriced, as defined, subject to stockholder approval. The
warrants expire in March 2006. In addition to the warrants issued in the private
placement, the Company granted the investment banker associated with the
transaction a warrant for 500,000 shares of the Company's common stock. The
warrant has an exercise price of $1.5625 per share and vests one year after the
registration statement for the shares of common stock issued under the private
placement becomes effective. The warrant expires four years after it vests. The
transaction provided for registration rights with a registration statement to be
filed by April 16, 2001 and become effective by May 31, 2001. The effective date
of the registration statement was not met and the Company is incurring a penalty
of approximately $254,000 per month, payable in cash, until the effectiveness of
the registration. This obligation will continue to accrue each month that the
registration statement is not declared effective and does not have a limit on
the amount payable to these stockholders. Because the payment for non-compliance
is cumulative, such obligation could have a material adverse effect on the
consolidated financial condition of the Company. Moreover, the Company may be
unable to pay these stockholders the amount of money due to them. During the
three months ended March 31, 2002, the Company recorded these penalties as
interest expense of $0.8 million and at March 31, 2002 had accrued penalties of
$2.6 million, payable to these stockholders.
Page 12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
NOTE 8. NET EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed as net earnings (loss)
attributable to common stockholders divided by the weighted-average number of
common shares outstanding for the period and does not include the impact of any
potentially dilutive securities. Diluted earnings per share is computed by
dividing the net earnings attributable to the common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and common stock warrants.
THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
-------------- ------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS
Net income (loss) $ 1,495 $ (8,422)
------------ ------------
Shares used to compute net income (loss) per share:
Weighted-average common shares 54,437,592 30,153,572
Dilutive stock equivalents 64,913 -
------------ ------------
Dilutive potential common shares 54,502,505 30,153,572
============ ============
Net income (loss) per share:
Basic $ 0.03 $ (0.30)
Diluted $ 0.02 $ (0.30)
------------ ------------
The impact of the preferred stock conversion rights into common stock
shares were excluded from the net loss per share computation at March 31, 2001.
There were options and warrants outstanding to purchase 13,126,865 shares of
common stock at March 31, 2002, which were excluded from the earnings per share
computation as the exercise price was greater than the average market price of
the common shares.
Due to the net loss attributable for the three months ended March 31, 2001
on a diluted basis to common stockholders, stock options and warrants have been
excluded from the diluted earnings per share calculation as their inclusion
would have been antidilutive. Had net income been reported for the three months
ended March 31, 2001, an additional 4,489,967 shares would have been added to
diluted potential common shares. In addition, 484,848 shares of restricted
common stock would have been added to diluted potential common shares. The
weighted average exercise price of the outstanding stock options and common
stock warrants at March 31, 2002 and 2001 was $2.16 and $3.04, respectively.
NOTE 9. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of the following:
THREE MONTHS ENDED
MARCH 31,
----------------------
2002 2001
---------- ----------
(DOLLARS IN THOUSANDS)
Net income (loss) $ 1,495 $(8,422)
Other comprehensive loss, net of income taxes:
Foreign currency translation adjustments 17 (22)
---------- ----------
Total comprehensive income (loss) $ 1,512 $(8,444)
========== ==========
During the three months ended March 31, 2002 and 2001, the net effect of
income taxes on comprehensive loss was immaterial.
Page 13
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
NOTE 10. RELATED PARTIES
Amounts receivable from and payable to related parties are as follows:
MARCH 31, DECEMBER 31,
2002 2001
------------- -------------
(DOLLARS IN THOUSANDS)
Receivables from related parties:
Virgin $ 6,003 $ 7,504
Vivendi 1,393 2,437
Titus 172 260
Return allowance (4,123) (4,026)
------------- -------------
Total $ 3,445 $ 6,175
============= =============
Payables to related parties:
Virgin $ 5,797 $ 5,790
Titus 2,967 1,308
------------- -------------
Total $ 8,764 $ 7,098
============= =============
EVENTS WITH TITUS INTERACTIVE S.A.
Titus retained Europlay as consultants to assist with the restructuring of
the Company. This arrangement with Europlay is with Titus, however, the Company
agreed to reimburse Titus for consulting expenses incurred on its behalf. As of
March 31, 2002, the Company owed Titus $0.9 million as a result of this
arrangement. In connection with the sale of Shiny, the Company agreed to pay
Europlay directly for their services with the proceeds received from the sale,
which they received. The Company has also entered into a commission-based
agreement with Europlay where Europlay will assist the Company with strategic
transactions, such as debt or equity financing, the sale of assets or an
acquisition of the Company. Under this arrangement, Europlay assisted the
Company with the sale of Shiny.
DISTRIBUTION AND PUBLISHING AGREEMENTS
TITUS INTERACTIVE S.A.
In connection with the equity investments by Titus, the Company performs
distribution services on behalf of Titus for a fee. In connection with such
distribution services, the Company recognized fee income of zero and $20,000 for
the three months ended March 31, 2002 and 2001, respectively.
Amounts due to Titus at March 31, 2002 include dividends payable of $2.0
million and $0.9 million for services rendered by Europlay. Amounts due to Titus
at December 31, 2001 include dividends payable of $0.7 million and $0.5 million
for services rendered by Europlay.
VIRGIN INTERACTIVE ENTERTAINMENT LIMITED
Under an International Distribution Agreement with Virgin Interactive
Entertainment Limited ("Virgin"), a wholly owned subsidiary of Titus, Virgin
provides for the exclusive distribution of substantially all of the Company's
products in Europe, Commonwealth of Independent States, Africa and the Middle
East for a seven-year period, cancelable under certain conditions, subject to
termination penalties and costs. Under the Agreement, the Company pays Virgin a
monthly overhead fee, certain minimum operating charges, a distribution fee
based on net sales, and Virgin provides certain market preparation, warehousing,
sales and fulfillment services on behalf of the Company.
Page 14
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATMEENTS (UNAUDITED) - CONTINUED
MARCH 31, 2002
Under the terms of the amended International Distribution Agreement, the
Company pays Virgin a monthly overhead fee of $83,000 per month for the six
month period beginning January 2002, with no further overhead commitment for the
remainder of the term of the International Distribution Agreement.
In connection with the International Distribution Agreement, the Company
incurred distribution commission expense of $0.3 million and $0.2 million for
the three months ended March 31, 2002 and 2001, respectively. In addition, the
Company recognized overhead fees of $0.3 million and zero for the three months
ended March 31, 2002 and 2001, respectively.
Under a Product Publishing Agreement with Virgin, the Company has an
exclusive license to publish and distribute substantially all of Virgin's
products previously released and one future product release within North
America, Latin America and South America for a royalty based on net sales. In
connection with the Product Publishing Agreement with Virgin, the Company earned
zero and $20,000 for performing publishing and distribution services on behalf
of Virgin for the three months ended March 31, 2002 and 2001, respectively.
In connection with the International Distribution Agreement, the Company
subleases office space from Virgin. Rent expense paid to Virgin was $27,000 and
$27,000 for the three months ended March 31, 2002 and 2001, respectively.
VIVENDI UNIVERSAL GAMES, INC.
In connection with the distribution agreement with Vivendi, the Company
incurred distribution commission expense of $0.9 million for the three months
ended March 31, 2002.
NOTE 11. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U. S. headquarters.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED MARCH 31,
---------------------------------------------
2002 2001
-------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT
---------- -------- ----------- --------
(DOLLARS IN THOUSANDS)
North America $ 4,502 29 % $ 11,578 67 %
Europe 1,403 9 3,665 21
Rest of World 11 - 712 4
OEM, royalty and
licensing 9,459 62 1,358 8
---------- -------- ----------- -------
$15,375 100 % $ 17,313 100 %
========== ======== =========== =======
NOTE 12. OTHER EXPENSE, NET
In April 2002, the Company entered into a settlement agreement with the
landlord of an office facility in the United Kingdom, whereby the Company
returned the property back to the landlord and was released from any further
lease obligations. As a result of this settlement, the Company reduced its
amounts accrued for this contractual cash obligation by $0.8 million for the
three months ended March 31, 2002.
Page 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
The information contained in this Form 10-Q is intended to update the
information contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001 and presumes that readers have access to, and will have
read, the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other information contained in such Form 10-K.
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934 and such forward-looking statements are
subject to the safe harbors created thereby. For this purpose, any statements
contained in this Form 10-Q, except for historical information, may be deemed to
be forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "should," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
financing activities and cost reduction measures are forward-looking statements
and there can be no assurance that the Company will achieve its operating plans
or generate positive cash flow in the future, arrange adequate financing or
complete strategic transactions on satisfactory terms, if at all, or that any
cost reductions effected by the Company will be sufficient to offset any
negative cash flow from operations. Additional risks and uncertainties include
possible delays in the completion of products, the possible lack of consumer
appeal and acceptance of products released by the Company, fluctuations in
demand for the Company's products, lost sales because of the rescheduling of
products launched or orders delivered, failure of the Company's markets to
continue to grow, that the Company's products will remain accepted within their
respective markets, that competitive conditions within the Company's markets
will not change materially or adversely, that the Company will retain key
development and management personnel, that the Company's forecasts will
accurately anticipate market demand and that there will be no material adverse
change in the Company's operations or business. Additional factors that may
affect future operating results are discussed in more detail in "Factors
Affecting Future Performance" below as well as the Company's Annual Report on
Form 10-K on file with the Securities and Exchange Commission. Assumptions
relating to the foregoing involve judgments with respect to, among other things,
future economic, competitive and market conditions, and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond the control of the Company. Although the Company
believes that the assumptions underlying the forward-looking statements are
reasonable, the business and operations of the Company are subject to
substantial risks that increase the uncertainty inherent in the forward-looking
statements, and the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved. In addition, risks, uncertainties and
assumptions change as events or circumstances change. The Company disclaims any
obligation to publicly release the results of any revisions to these
forward-looking statements which may be made to reflect events or circumstances
occurring subsequent to the filing of this Form 10-Q with the SEC or otherwise
to revise or update any oral or written forward-looking statement that may be
made from time to time by or on behalf of the Company.
Page 16
RESULTS OF OPERATIONS
The following table sets forth certain selected consolidated statements of
operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED
MARCH 31,
-----------------------------------------------
2002 2001
---------------------- -----------------------
% OF NET % OF NET
AMOUNT REVENUES AMOUNT REVENUES
---------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
Net revenues $ 15,375 100% $ 16,838 100%
Cost of goods sold 4,477 29% 10,485 62%
---------- ---------- ----------- ----------
Gross profit 10,898 71% 6,353 38%
---------- ---------- ----------- ----------
Operating expenses:
Marketing and sales 1,654 11% 6,148 36%
General and administrative 3,016 20% 2,478 15%
Product development 4,698 30% 5,381 32%
---------- ---------- ----------- ----------
Total operating expenses 9,368 61% 14,007 83%
---------- ---------- ----------- ----------
Operating income (loss) 1,530 10% (7,654) -45%
Other expense 35 0% 768 5%
---------- ---------- ----------- ----------
Net income (loss) $ 1,495 10% $ (8,422) -50%
========== ========== =========== ==========
Net revenues by geographic region:
North America $ 4,502 29% $ 11,103 66%
International 1,414 9% 4,377 26%
OEM, royalty and licensing 9,459 62% 1,358 8%
Net revenues by platform:
Personal computer $ 4,200 27% $ 11,919 71%
Video game console 1,716 11% 3,561 21%
OEM, royalty and licensing 9,459 62% 1,358 8%
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the three months ended March 31, 2002 were $15.4 million,
a decrease of 9 percent compared to the same period in 2001. This decrease
resulted from a 60 percent decrease in North American net revenues, a 68 percent
decrease in International net revenues offset by a 597 percent increase in OEM,
royalties and licensing revenues.
North American net revenues for the three months ended March 31, 2002 were
$4.5 million. The decrease in North American net revenues in 2002 was mainly due
to not releasing any titles in 2002 compared to 3 titles in 2001 resulting in a
decrease in North American sales of $10.8 million, partially offset by a
decrease in product returns and price concessions of $4.2 million as compared to
the 2001 period. The decrease in title releases across all platforms is a result
of our continued focus on product planning and the releasing of fewer, higher
quality titles.
International net revenues for the three months ended March 31, 2002 were
$1.4 million. The decrease in International net revenues for the three months
ended March 31, 2002 was mainly due to the reduction in title releases during
the year which resulted in a $2.5 million decrease in revenue offset by an
increase in product returns and price concessions of $0.5 million compared to
the 2001 period. Our product planning efforts during 2002 also contributed to
the reduction of titles released in the International markets.
We expect that both our North American and International publishing net
revenues in fiscal 2002 will increase compared to fiscal 2001, as we anticipate
releasing more major titles than in 2001. We currently have 6 to 8 titles
scheduled for release during the remainder of the year.
OEM, royalty and licensing net revenues for the three months ended March
31, 2002 were $9.5 million, an increase of $8.1 million as compared to the same
period in 2001. The OEM business was consistent with the same period in 2001.
The three months ended March 31, 2002 also included revenues related to the sale
of publishing rights for one of our products and the recognition of deferred
revenue for a licensing transaction. In January 2002, we sold the publishing
rights to this title to the distributor in connection with a settlement
agreement entered into with the third party developer. The settlement agreement
provided, among other things, that we assign our rights and
Page 17
obligations under the product agreement to the third party distributor. As a
result, we recorded net revenues of $5.6 million in the three months ended March
31, 2002.In February 2002, a licensing transaction we entered into in 1999
expired and we recognized revenue of $1.2 million, the unearned portion of the
minimum guarantee. We expect that OEM, royalty and licensing net revenues in
fiscal 2002 will increase compared to fiscal 2001 as a result of these two
one-time transactions combined with a consistent level of OEM business.
PLATFORM NET REVENUES
PC net revenues for the three months ended March 31, 2002 were $4.2
million, a decrease of 65 percent compared to the same period in 2001. The
decrease in PC net revenues in 2002 was primarily due to not releasing any major
hit titles in 2002 as compared to two major hit titles released in 2001. We
expect our PC net revenues to decrease in 2002 as compared to 2001 as we expect
to release only two to three new titles as we continue to focus more on next
generation console products. Video game console net revenues decreased 52
percent for the three months ended March 31, 2002 compared to the same period in
2001, due to not releasing any major hit titles in 2002 as compared to one major
hit title in 2001. We anticipate releasing four to six new console titles in
fiscal 2002 and expect net revenues to increase in fiscal 2002 partly due to the
fact that we anticipate releasing the major hit title Baldur's Gate: Dark
Alliance (PlayStation 2) on Xbox and Gamecube in the latter half of 2002.
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our cost of goods sold decreased 57 percent to $4.5 million in the three
months ended March 31, 2002 compared to the same period in 2001. The decrease
was primarily due to the decrease in PC and console net revenues as a result of
not releasing any new titles in the 2002 period. We expect our cost of goods
sold to decrease in 2002 as compared to 2001 due to not anticipating any major
impairments of our prepaid royalties, offset by our expected higher gross
revenues from the planned release of more major titles in 2002. Our gross margin
increased to 71 percent for 2002 from 38 percent in 2001. This was due to the
publishing and licensing transactions in 2002, which did not bear any
significant cost of goods. We expect our gross profit margin and gross profit to
increase in fiscal 2002 as compared to fiscal 2001 as we expect not to incur any
significant, unusual product returns and price concessions or any write-offs of
prepaid royalties in 2002.
MARKETING AND SALES
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses for the three months ended March 31, 2002 were $1.7 million, a 73
percent decrease as compared to the 2001 period. The decrease in marketing and
sales expenses is due to a $36 million reduction in advertising and retail
marketing support expenditures due to not releasing any product in 2002 and a
$1.2 million decrease in personnel costs and general expenses due in part to our
shift from a direct sales force for North America to a distribution arrangement
with Vivendi. The decrease in marketing and sales expenses was partially offset
by $0.3 million in overhead fees paid to Virgin under our April 2001 settlement
with Virgin (See Activities with Related Parties). We expect our marketing and
sales expenses to decrease in fiscal 2002 compared to fiscal 2001, due to fewer
overall planned title releases in fiscal 2002 across all platforms, lower
personnel costs from our reduced headcount and a reduction in overhead fees paid
to Virgin pursuant to the April 2001 settlement.
GENERAL AND ADMINISTRATIVE
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended March 31, 2002 were $3.0 million, a 22 percent increase as
compared to the same period in 2001. The increase is due in part to $0.4 million
in loan termination fees associated with the termination of our line of credit
and $0.5 million in consulting expenses payable to our investment bankers,
Euorplay, incurred to assist us with the restructuring of the company offset by
a $0.4 million decrease in personnel costs and general expenses. We expect our
general and administrative expenses to decrease in fiscal 2002 compared to
fiscal 2001 primarily due to the reduction in headcount and the continued
reduction in other related costs.
Page 18
PRODUCT DEVELOPMENT
We charge internal product development expenses, which consist primarily of
personnel and support costs, to operations in the period incurred. Product
development expenses for the three months ended March 31, 2002 were $4.7
million, a 13 percent decrease as compared to the same period in 2001. This
decrease is due to a $0.7 million decrease in personal costs as a result of a
reduction in headcount. We expect our product development expenses to decrease
in fiscal 2002 compared to fiscal 2001 as a result of lower headcount and the
sale of Shiny Entertainment, Inc. in April 2002.
OTHER EXPENSE, NET
Other expenses for the three months ended March 31, 2002 were $35,000, a 95
percent decrease as compared to the same period in 2001. The decrease was due to
no interest expense related to lower net borrowings on our line of credit, no
losses associated with foreign currency exchanges and $0.9 million associated
with a gain in the settlement and termination of a building lease in the United
Kingdom offset by a $0.8 million penalty due to a delay in the effectiveness of
a registration statement in connection with our private placement of our common
stock.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date primarily through the use of
borrowings, royalty and distribution fee advances, cash generated by the private
sale of securities, proceeds of the initial public offering and from results of
operations. As of March 31, 2002, our principal resources included cash of
$61,000.
In April 2001, we entered into a three year loan and security agreement
with a bank providing for a $15.0 million working capital line of credit secured
by all of our assets. Concurrently, our former Chairman provided the bank a $2
million personal guarantee, secured by $1 million in cash. In addition, the
Chairman provided us with $3 million payable in March 2002, with interest at 10
percent. We were not in compliance with some of the financial covenants under
the line of credit at December 31, 2001. On October 26, 2001, the bank notified
us that the credit agreement was being terminated, that all related amounts
outstanding were immediately due and payable and that we would no longer be able
to draw on the credit facility to fund future operations. In February 2002, the
bank drew-down on $1.0 million of the $2.0 million personal guarantee provided
by our former Chairman, which in combination with cash paid by us, substantially
paid off the remaining outstanding balance on the line of credit. In March 2002,
we entered into a forbearance agreement with the bank and our former Chairman;
subsequent to that agreement, we repaid all remaining amounts due the bank under
the line of credit and agreed to repay our former Chairman for the $1.0 million
drawn-down by the bank pursuant to the former Chairman's guarantee. We repaid
all amounts due to our former Chairman in April 2002 with proceeds from the sale
of Shiny.
To reduce our working capital needs, we have implemented various measures
including a reduction of personnel, a reduction of fixed overhead commitments,
cancellation or suspension of development on future titles, which management
believes do not meet sufficient projected profit margins, and the scaling back
certain marketing programs. Management will continue to pursue various
alternatives to improve future operating results and further expense reductions,
some of which may have a long-term adverse impact on our ability to generate
successful future business activities. In addition, we continue to seek external
sources of funding, including but not limited to, a sale or merger of the
company, a private placement of our capital stock, the sale of selected assets,
the licensing of certain product rights in selected territories, selected
distribution agreements, and/or other strategic transactions sufficient to
provide short-term funding, and potentially achieve our long-term strategic
objectives.
In this regard, we completed the sale of Shiny in April 2002, for
approximately $47 million. Along with our projected product releases and cost
cutting measures, management believes that the proceeds from the sale of Shiny,
following the repayment of third party obligations, which are a condition to the
transaction, should be sufficient to fund our operations through December 31,
2002.
We are currently negotiating certain distribution rights with other
distributors to succeed Vivendi. If we are unable to secure these distribution
rights on terms favorable to us, or if the performance of the titles we release
does not achieve our expectations, we will be required to seek alternative
sources of funds, and, in such circumstances, if alternative sources of funding
cannot be obtained on acceptable terms, or at all. These conditions, combined
with our historical operating losses and deficits in stockholders' equity and
working capital, raise substantial doubt about our ability to continue as a
going concern. The accompanying consolidated financial statements do not include
any
Page 19
adjustments to reflect the possible future effects on the recoverability and
classification of assets and liabilities that may result from the outcome of
this uncertainty.
We have not had the registration statement declared effective in connection
with a private placement of 8,126,770 units consisting of one share of common
stock and one warrant to purchase an additional share of common stock. As a
result, we are subject to a penalty of approximately $254,000 per month, payable
in cash, until the registration statement is effective. This obligation will
continue to accrue each month that the registration statement is not declared
effective until the registration becomes effective or the shares are eligible
for resale under Rule 144(k), which would go into effect on April 16, 2003.
Because this payment is cumulative, this obligation could have a material
adverse effect on our consolidated financial condition and results of
operations. As of March 31, 2002, the amount accrued was $2.6 million. We may be
unable to pay the total penalty due to the investors.
Our primary capital needs have historically been to fund working capital
requirements necessary to fund our net losses, our sales growth, the development
and introduction of products and related technologies and the acquisition or
lease of equipment and other assets used in the product development process. Our
operating activities provided cash of $0.5 million during the three months ended
March 31, 2002, primarily attributable to net income of $1.5 million,
collections of accounts receivable and an increase in accounts payable due to
delays in payments to vendors, substantially offset by payments of royalty
liabilities and recoupment of advances received by distributors. Net cash used
by financing activities of $0.5 million for the three months ended March 31,
2002, consisted primarily of repayments of our working capital line of credit.
Cash used in investing activities of $0.1 million for the three months ended
March 31, 2002 consisted of normal capital expenditures, primarily for office
and computer equipment used in our operations. We do not currently have any
material commitments with respect to any future capital expenditures.
The following summarizes our contractual obligations under non-cancelable
operating leases and other borrowings at March 31, 2002, and the effect such
obligations are expected to have on our liquidity and cash flow in future
periods.
Less Than 1 - 3 After
March 31, 2002 Total 1 Year Years 3 Years
----------- ----------- --------- ---------
(In thousands)
Contractual cash obligations:
Other borrowings $ 4,318 $ 4,318 $ - $ -
Non-cancelable operating lease
obligations 6,284 1,403 3,053 1,828
----------- ----------- --------- ---------
Total contractual cash obligations $10,602 $ 5,721 $3,053 $1,828
=========== =========== ========= =========
In April 2002, we entered into a settlement agreement with the landlord of
an office facility in the United Kingdom, whereby we returned the property back
to the landlord and were released from any further lease obligations. This
settlement reduced our total contractual cash obligations by $1.3 million
through fiscal 2005.
During the three months of 2002, we did not release sufficient products to
generate sufficient accounts receivable to obtain an alternative to our
terminated credit line. We also anticipate that delays in product releases could
continue in the short-term, and, absent the sale of Shiny, funds available from
ongoing operations would not have been sufficient to satisfy our projected
working capital and capital expenditure requirements.
We will continue to pursue various alternatives to improve future operating
results, including strategic alliances and further expense reductions, some of
which may have a long-term adverse impact on our ability to generate successful
future business activities. In addition, we continue to seek external sources of
funding, including but not limited to, a sale or merger of the company, a
private placement of our capital stock, the sale of selected assets, the
licensing of certain product rights in selected territories, selected
distribution agreements, and/or other strategic transactions sufficient to
provide short-term funding, and potentially achieve our long-term strategic
objectives.
ACTIVITIES WITH RELATED PARTIES
Our operations involve significant transactions with Titus, our majority
stockholder, Virgin, a wholly-owned subsidiary of Titus, and Vivendi, an
indirect owner of 5 percent of our common stock. In addition, we obtained
financing from the former Chairman of the company.
Page 20
TRANSACTIONS WITH TITUS
In March 2002, Titus converted its remaining 383,354 shares of Series A
preferred stock into approximately 47.5 million shares of our common stock.
Titus now owns approximately 67 million shares of common stock, which represents
approximately 72% of our outstanding common stock, our only voting security,
immediately following the conversion.
Titus retained Europlay as consultants to assist with the restructuring of
the company. This arrangement with Europlay is with Titus, however, we agreed to
reimburse Titus for consulting expenses incurred on our behalf. As of March 31,
2002, we owed Titus $0.9 million as a result of this arrangement. In connection
with the sale of Shiny, we agreed to pay Europlay directly for their services
with the proceeds received from the sale. We have also entered into a
commission-based agreement with Europlay where Europlay will assist us with
strategic transactions, such as debt or equity financing, the sale of assets or
an acquisition of the company. Under this arrangement, Europlay assisted us with
the sale of Shiny.
In connection with the equity investments by Titus, we perform distribution
services on behalf of Titus for a fee. In connection with such distribution
services, we recognized fee income of zero and $20,000 for the three months
ended March 31, 2002 and 2001, respectively.
In March 2002, we entered into a distribution agreement with Titus pursuant
to which we granted to Titus the exclusive right to distribute one of our
products for the Sony Playstation console in North America, South America and
Central America in exchange for a minimum guarantee of $100,000 for the first
71,942 units of the product sold, plus $.69 per unit on any product sold above
the 71,942 units.
As of March 31, 2002 and December 31, 2001, Titus owed us $172,000 and
$260,000, respectively, and we owed Titus $3.0 million and $1.3 million,
respectively. Amounts due to Titus at March 31, 2002 include dividends payable
of $2.0 million and $0.9 million for services rendered by Europlay. Amounts due
to Titus at December 31, 2001 include dividends payable of $740,000 and $450,000
for services rendered by Europlay.
On April 26, 2002, we entered into an agreement with Titus, pursuant to
which, among other things, we sold to Titus all right, title and interest in the
games "EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter", "Sacrifice",
"MDK", "MDK II", and "Kingpin", and Titus licensed from us the right to develop,
publish, manufacture and distribute the games "Hunter I", "Hunter II", "Icewind
Dale I", "Icewind Dale II", and "BG: Dark Alliance II" solely on Nintendo
Advance GameBoy game system for the life of the games. As consideration for
these rights, Titus issued to us a promissory note in the principal amount of
$3.5 million, which note bears interest at 8% per annum. The promissory note is
due on August 31, 2002, and may be paid, at Titus' option, in cash or in shares
of Titus common stock with a per share value equal to 90% of the average trading
price of Titus' common stock over the 5 days immediately preceding the payment
date. Pursuant to our April 26, 2002 agreement with Titus, on or before July 25,
2002, we have the right to solicit offers from and negotiate with third parties
to sell the rights and licenses granted under the April 26, 2002 agreement. If
we enter into a binding agreement with a third party to sell these rights and
licenses for an amount in excess $3.5 million, we will rescind the April 26,
2002 agreement with Titus and recover all rights granted and release Titus from
all obligations thereunder. Moreover, we have provided Titus with a guarantee
under this agreement, which provides that in the event Titus does not achieve
gross sales of at least $3.5 million by June 25, 2003, and the shortfall is not
the result of Titus' failure to use best commercial efforts, we will pay to
Titus the difference between $3.5 million and the actual gross sales achieved by
Titus, not to exceed $2 million.
TRANSACTIONS WITH VIRGIN, A WHOLLY OWNED SUBSIDIARY OF TITUS
In February 1999, we entered into an International Distribution Agreement
with Virgin, which provides for the exclusive distribution of substantially all
of our products in Europe, Commonwealth of Independent States, Africa and the
Middle East for a seven-year period, cancelable under certain conditions,
subject to termination penalties and costs. Under this agreement, as amended, we
pay Virgin a monthly overhead fee, certain minimum operating charges, a
distribution fee based on net sales, and Virgin provides certain market
preparation, warehousing, sales and fulfillment services on our behalf.
Page 21
Under the April 2001 settlement, we pay Virgin a monthly overhead fee of
$83,000 per month for the six month period beginning January 2002, with no
further overhead commitment for the remainder of the term of the International
Distribution Agreement.
In connection with the International Distribution Agreement, we incurred
distribution commission expense of $0.3 million and $0.2 million for the three
months ended March 31, 2002 and 2001, respectively. In addition, we recognized
overhead fees of $250,000 and zero for the three months ended March 31, 2002 and
2001, respectively.
We have also entered into a Product Publishing Agreement with Virgin, which
provides us with an exclusive license to publish and distribute substantially
all of Virgin's products within North America, Latin America and South America
for a royalty based on net sales. As part of terms of the April 2001 settlement
between Virgin and us, the Product Publishing Agreement was amended to provide
for us to publish only one future title developed by Virgin. In connection with
the Product Publishing Agreement with Virgin, we earned zero and $20,000 for
performing publishing and distribution services on behalf of Virgin for the
three months ended March 31, 2002 and 2001, respectively.
In connection with the International Distribution Agreement, we sublease
office space from Virgin. Rent expense paid to Virgin was $27,000 and $27,000
for the three months ended March 31, 2002 and 2001, respectively.
As of March 31, 2002 and December 31, 2001, Virgin owed us $6.0 million and
$7.5 million, and we owed Virgin $5.8 million and $5.8 million, respectively.
TRANSACTIONS WITH VIVENDI
In connection with a distribution agreement with Vivendi, which indirectly
owns approximately 5 percent of our common stock at March 31, 2002 but does not
have representation on our Board of Directors, Vivendi is our distributor in
North America through December 31, 2002 for substantially all of our products,
with the exception of products with pre-existing distribution agreements and
certain selected future titles. Under the terms of the agreement, as amended,
Vivendi earns a distribution fee based on the net sales of the titles
distributed. Under the agreement, Vivendi made advance payments to us totaling
$16.5 million. Vivendi will recoup their advances from future sales of our
products, which will reduce our future cash in-flows. As of March 31, 2002,
Vivendi has recouped $6.9 million of the advance payments. In connection with
the sale of Shiny, Vivendi was repaid $6.5 million of their advances from the
proceeds.
In connection with the distribution agreement with Vivendi, we incurred
distribution commission expense of $0.9 million and zero for the three months
ended March 31, 2002 and 2001, respectively. As of March 31, 2002 and December
31, 2001, Vivendi owed us $1.4 million and $2.4 million, respectively.
In April 2002, we entered into an agreement with Vivendi, pursuant to
which, among other things, the parties amended the terms of the August 13, 2001
distribution agreement, as amended, as follows: (i) Vivendi was repaid $6.5
million of their advances under the August 13, 2002 distribution agreement; (ii)
Vivendi maintains the exclusive distribution rights to our back-catalog titles,
including "Baldur's Gate: Dark Alliance" through December 31, 2002, plus a six
month sell-off period; (iii) Vivendi will maintain exclusive distribution rights
to our upcoming new titles to be released, which includes "Icewind Dale 2" for
PC, "Hunter" on the Microsoft X-Box game console and "Run Like Hell" on the Sony
Playstation 2 game console for a term of 1 year from the date of release of each
new title, plus a 6 month sell-off period; (iv) Vivendi will retain 100% of
proceeds from the distribution of "Baldur's Gate: Dark Alliance" until such time
as the balance of Vivendi's advance under the August 13, 2001 distribution
agreement is fully recouped; and (iv) Vivendi's distribution rights to any of
our other titles under the August 13, 2001 distribution agreement were
terminated.
TRANSACTIONS WITH A BRIAN FARGO, A FORMER OFFICER OF THE COMPANY
In connection with our working capital line of credit obtained in April
2001, we obtained a $2 million personal guarantee in favor of the bank, secured
by $1.0 million in cash, from Brian Fargo, the former Chairman of the company.
In addition, Mr. Fargo provided us with a $3 million loan, payable in May 2002,
with interest at 10 percent. In connection with the guarantee and loan, Mr.
Fargo received warrants to purchase 500,000 shares of our common stock at $1.75
per share, expiring in April 2011. In January 2002, the bank redeemed the $1.0
million in cash pledged by Mr. Fargo in connection with his personal guarantee,
and subsequently we agreed to pay that amount back to Mr. Fargo. The amount was
fully paid in April 2002 in connection with the sale of Shiny.
Page 22
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2001, the Emerging Issues Task Force issued No. 00-25 ("EITF
00-25"), "Accounting for Consideration from a Vendor to a Retailer in Connection
with the Purchase or Promotion of the Vendor's Products", which states that
consideration from a vendor to a reseller of the vendor's products is presumed
to be a reduction of the selling prices of the vendor's products and, therefore,
should be characterized as a reduction of revenue when recognized in the
vendor's income statement. That presumption is overcome and the consideration
can be categorized as a cost incurred if, and to the extent that, a benefit is
or will be received from the recipient of the consideration. That benefit must
meet certain conditions described in EITF 00-25. We adopted the provision of
EITF 00-25 on January 1, 2002 and as a result net revenues and marketing
expenses were reduced by $0.5 million for the three months ended March 31, 2001.
The adoption of EITF 00-25 did not impact our net loss for the three months
ended March 31, 2001.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets" effective for fiscal years beginning after December 15, 2001.
Under the new rules all acquisition transactions entered into after June 30,
2001, must be accounted for on the purchase method and goodwill will no longer
be amortized but will be subject to annual impairment tests in accordance with
SFAS 142. Other intangible assets will continue to be amortized over their
useful lives. We adopted the new rules on accounting for goodwill and other
intangible assets January 1, 2002. Adoption of FAS 142 did not have a material
impact on our consolidated financial position or results of operations. Goodwill
amortization for the three months ended March 31, 2001 was $96,000. With the
sale of Shiny, we no longer have any goodwill assets.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The provisions of SFAS No. 143 are effective for financial statements
issued for fiscal years beginning after June 15, 2002, with early application
encouraged and generally are to be applied prospectively. We do not expect the
adoption of SFAS No. 143 to have a material impact on our consolidated financial
position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that Opinion). We adopted the provisions of SFAS No. 144 on January
1, 2002. The adoption of SFAS No. 144 did not have a material impact on our
consolidated financial position or results of operations.
FACTORS AFFECTING FUTURE PERFORMANCE
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. Some of the risks and uncertainties which may
cause our operating results to vary from anticipated results or which may
materially and adversely affect our operating results are as follows:
WE CURRENTLY HAVE A NUMBER OF OBLIGATIONS THAT WE ARE UNABLE TO MEET WITHOUT
GENERATING ADDITIONAL REVENUES OR RAISING ADDITIONAL CAPITAL. IF WE CANNOT
GENERATE ADDITIONAL REVENUES OR RAISE ADDITIONAL CAPITAL IN THE NEAR FUTURE, WE
MAY BECOME INSOLVENT AND OUR STOCK WOULD BECOME ILLIQUID OR WORTHLESS.
As of March 31, 2002, our cash balance was approximately $61,000 and our
outstanding accounts payable and current debt totaled approximately $54.0
million. On April 30, 2002, in connection with the sale of Shiny, we received a
cash payment of approximately $3 million and a promissory note in the principal
amount of approximately $10.8 million payable over three months, and applied
additional proceeds to repay approximately $26.1 million in accounts payable and
current debt. Even with the proceeds we received in the Shiny sale, we will need
to raise additional financing. If we do not receive sufficient financing we may
(i) liquidate assets, (ii) seek or be forced into bankruptcy and/or (iii)
continue operations, but incur material harm to our business, operations or
Page 23
financial condition. These measures could have a material adverse effect on our
ability to continue as a going concern. Additionally, because of our financial
condition, our Board of Directors has a duty to our creditors that may conflict
with the interests of our stockholders. When a Delaware corporation is operating
in the vicinity of insolvency, the Delaware courts have imposed upon the
corporation's directors a fiduciary duty to the corporation's creditors. If we
cannot obtain additional capital and become unable to pay our debts as they
become due, our Board of Directors may be required to make decisions that favor
the interests of creditors at the expense of our stockholders to fulfill its
fiduciary duty. For instance, we may be required to preserve our assets to
maximize the repayment of debts versus employing the assets to further grow our
business and increase shareholder value.
WE HAVE A HISTORY OF LOSSES, MAY NEVER GENERATE POSITIVE CASH FLOW FROM
OPERATIONS AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY CURTAILING FUTURE
OPERATIONS.
For the three months ended March 31, 2002, our net income was $1.5 million
and for the year ended December 31, 2001, our net loss was $46.3 million. Since
inception, we have incurred significant losses and negative cash flow, and as of
March 31, 2002 we had an accumulated deficit of $149 million. Our ability to
fund our capital requirements out of our available cash and cash generated from
our operations depends on a number of factors. Some of these factors include the
progress of our product development programs, the rate of growth of our
business, and our products' commercial success. If we cannot generate positive
cash flow from operations, we will have to continue to reduce our costs and
raise working capital from other sources. These measures could include selling
or consolidating certain operations, and delaying, canceling or scaling back
product development and marketing programs. These measures could materially and
adversely affect our ability to publish successful titles, and may not be enough
to permit us to operate profitability, or at all.
WE DEPEND, IN PART, ON EXTERNAL FINANCING TO FUND OUR CAPITAL NEEDS. IF WE ARE
UNABLE TO OBTAIN SUFFICIENT FINANCING ON FAVORABLE TERMS, WE MAY NOT BE ABLE TO
CONTINUE TO OPERATE OUR BUSINESS.
Historically, our business has not generated revenues sufficient to create
operating profits. To supplement our revenues, we have funded our capital
requirements with debt and equity financing. Our ability to obtain additional
equity or debt financing depends on a number of factors including our financial
performance, the overall conditions in our industry, and our credit rating. If
we cannot raise additional capital on favorable terms, we will have to reduce
our costs and sell or consolidate operations.
OUR STOCK PRICE MAY DECLINE SIGNIFICANTLY IF WE ARE DELISTED FROM THE NASDAQ
NATIONAL MARKET.
Our common stock currently is quoted on the Nasdaq National Market System.
On February 14, 2002, we received a deficiency notice from Nasdaq stating that
for the last 30 consecutive trading days, our common stock has not maintained a
minimum market value of publicly held shares of $15,000,000 and a minimum bid
price per share of $3.00, as required for continued listing on the Nasdaq
National Market. Additionally, we do not meet Nasdaq's alternative listing
requirements, which require, among other things, that we have a stockholder's
equity of $10 million, a minimum market value of publicly held shares of
$5,000,000 and a minimum bid price per share of $1.00. We have been provided 90
calendar days, or until May 15, 2002, to regain compliance, which we do not
believe will occur.
If we fail to regain compliance, the Company expects to be notified by
Nasdaq that its securities will be delisted. If this occurs, trading of our
common stock may be conducted on the Nasdaq SmallCap Market, if we qualify for
listing at that time, in the over-the-counter market on the "pink sheets" or, if
available, the NASD's "Electronic Bulletin Board." In any of those cases,
investors could find it more difficult to buy or sell, or to obtain accurate
quotations as to the value of our common stock. The trading price per share of
our common stock likely would be reduced as a result.
TITUS INTERACTIVE SA CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A
MAJORITY OF OUR BOARD OF DIRECTORS AND PREVENT AN ACQUISITION OF INTERPLAY THAT
IS FAVORABLE TO OUR OTHER STOCKHOLDERS.
On March 15, 2002, Titus converted its remaining 383,354 shares of Series A
Preferred Stock into approximately 47.5 million shares of our common stock.
Titus now owns approximately 67 million shares of common stock, which represents
approximately 72 percent of our outstanding common stock, our only voting
security, immediately following the conversion. As a consequence, Titus can
control substantially all matters requiring stockholder approval, including the
election of directors, subject to our stockholders' cumulative voting rights,
and the approval of mergers or other business combination transactions. At our
2001 annual stockholders
Page 24
meeting on September 18, 2001, Titus exercised its voting power to elect a
majority of our Board of Directors.
Three of the seven members of the Board are employees or directors of Titus, and
Titus' Chief Executive Officer serves as our President and interim Chief
Executive Officer. This concentration of voting power could discourage or
prevent a change in control that otherwise could result in a premium in the
price of our common stock.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES DEPEND ON OUR DISTRIBUTORS' DILIGENT
SALES EFFORTS AND OUR DISTRIBUTORS' AND RETAIL CUSTOMERS' TIMELY PAYMENTS TO US.
Since February 1999, Virgin has been the exclusive distributor for most of
our products in Europe, the Commonwealth of Independent States, Africa and the
Middle East. Our agreement with Virgin expires in February 2006. In August 2001,
we entered into a Distribution Agreement with Vivendi Universal Games, Inc.,
(formerly known as Vivendi Universal Interactive Publishing North America), or
"Vivendi," pursuant to which Vivendi distributes substantially all our products
in North America, as well as in South America, South Africa, Korea, Taiwan and
Australia. Our agreement with Vivendi expires in December 2002.
Virgin and Vivendi each have exclusive rights to distribute our products in
substantial portions of the world. As a consequence, the distribution of our
products by Virgin and Vivendi will generate a substantial majority of our
revenues, and proceeds from Virgin and Vivendi from the distribution of our
products will constitute a substantial majority of our operating cash flows.
Therefore, our revenues and cash flows could fall significantly and our business
and financial results could suffer material harm if:
o either Virgin or Vivendi fails to deliver to us the full proceeds owed
us from distribution of our products;
o either Virgin or Vivendi fails to effectively distribute our products
in their respective territories; or
o either Virgin or Vivendi otherwise fails to perform under their
respective distribution agreement.
We typically sell to distributors and retailers on unsecured credit, with
terms that vary depending upon the customer and the nature of the product. We
confront the risk of non-payment from our customers, whether due to their
financial inability to pay us, or otherwise. In addition, while we maintain a
reserve for uncollectible receivables, the reserve may not be sufficient in
every circumstance. As a result, a payment default by a significant customer
could cause material harm to our business.
THE TERMINATION OF OUR EXISTING CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL
REDUCTION IN THE CASH AVAILABLE TO FINANCE OUR OPERATIONS.
Pursuant to our credit agreement with LaSalle Business Credit Inc., or
"LaSalle", entered into in April 2001, we agreed to certain covenants. In
October 2001, LaSalle notified us that the credit agreement was being terminated
as a result of our failure to comply with some of those covenants and we would
no longer be able to continue to draw on the credit facility to fund future
operations. Because we depend on a credit agreement to fund our operations,
LaSalle's termination of the credit agreement has significantly impeded our
ability to fund our operations and has caused material harm to our business. We
will need to enter into a new credit agreement to fund our operations. There can
be no assurance that we will be able to enter into a new credit agreement or
that if we do enter into a new credit agreement, it will be on terms favorable
to us.
THE UNPREDICTABILITY OF FUTURE RESULTS MAY CAUSE OUR STOCK PRICE TO REMAIN
DEPRESSED OR TO DECLINE FURTHER.
Our operating results have fluctuated in the past and may fluctuate in the
future due to several factors, some of which are beyond our control. These
factors include:
o demand for our products and our competitors' products;
o the size and rate of growth of the market for interactive
entertainment software;
o changes in personal computer and video game console platforms;
Page 25
o the timing of announcements of new products by us and our competitors
and the number of new products and product enhancements released by us
and our competitors;
o changes in our product mix;
o the number of our products that are returned; and
o the level of our international and original equipment manufacturer
royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which
we will ship our products. Some of these factors include:
o the uncertainties associated with the interactive entertainment
software development process;
o approvals required from content and technology licensors; and
o the timing of the release and market penetration of new game hardware
platforms.
It is likely that in some future periods our operating results will not
meet the expectations of the public or of public market analysts. Any
unanticipated change in revenues or operating results is likely to cause our
stock price to fluctuate since such changes reflect new information available to
investors and analysts. New information may cause securities analysts and
investors to revalue our stock and this may cause fluctuations in our stock
price.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE INTRODUCTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
For the three months ended March 31, 2002, our net income was $1.5 million.
We have incurred significant net losses in recent periods, including a net loss
of $46.3 million for the year ended December 31, 2001. Our losses stem partly
from the significant costs we incur to develop our entertainment software
products. Moreover, a significant portion of our operating expenses is
relatively fixed, with planned expenditures based largely on sales forecasts. At
the same time, most of our products have a relatively short life cycle and sell
for a limited period of time after their initial release, usually less than one
year.
Relatively fixed costs and short windows in which to earn revenues mean
that sales of new products are important in enabling us to recover our
development costs, to fund operations and to replace declining net revenues from
older products. Our failure to accurately assess the commercial success of our
new products, and our delays in releasing new products, could reduce our net
revenues and our ability to recoup development and operational costs.
OUR GROWING DEPENDENCE ON REVENUES FROM GAME CONSOLE SOFTWARE PRODUCTS INCREASES
OUR EXPOSURE TO SEASONAL FLUCTUATIONS IN THE PURCHASES OF GAME CONSOLES.
The interactive entertainment software industry is highly seasonal, with
the highest levels of consumer demand occurring during the year-end holiday
buying season. As a result, our net revenues, gross profits and operating income
have historically been highest during the second half of the year. The impact of
this seasonality will increase as we rely more heavily on game console net
revenues in the future. Seasonal fluctuations in revenues from game console
products may cause material harm to our business and financial results.
IF OUR PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, OUR BUSINESS COULD BE
HARMED SIGNIFICANTLY.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our new products will achieve significant market acceptance, or
that we will be able to sustain this acceptance for a significant length of time
if we achieve it.
Page 26
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis. Because we introduce
a relatively limited number of new products in a given period, the failure of
one or more of these products to achieve market acceptance could cause material
harm to our business. Further, if our products do not achieve market acceptance,
we could be forced to accept substantial product returns or grant significant
pricing concessions to maintain our relationship with retailers and our access
to distribution channels. If we are forced to accept significant product returns
or grant significant pricing concessions, our business and financial results
could suffer material harm.
OUR RELIANCE ON THIRD PARTY SOFTWARE DEVELOPERS SUBJECTS US TO THE RISKS THAT
THESE DEVELOPERS WILL NOT SUPPLY US WITH HIGH QUALITY PRODUCTS IN A TIMELY
MANNER OR ON ACCEPTABLE TERMS.
Third party interactive entertainment software developers develop many of
our software products. Since we depend on these developers in the aggregate, we
remain subject to the following risks:
o limited financial resources may force developers out of business prior
to their completion of projects for us or require us to fund
additional costs; and
o the possibility that developers could demand that we renegotiate our
arrangements with them to include new terms less favorable to us.
Increased competition for skilled third party software developers also has
compelled us to agree to make advance payments on royalties and to guarantee
minimum royalty payments to intellectual property licensors and game developers.
Moreover, if the products subject to these arrangements, are not delivered
timely, or with acceptable quality, or do not generate sufficient sales volumes
to recover these royalty advances and guaranteed payments, we would have to
write-off unrecovered portions of these payments, which could cause material
harm to our business and financial results.
IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
o operating systems such as Microsoft Windows XP;
o technologies that support games with multi-player and online features;
o new media formats such as online delivery and digital video disks, or
DVDs; and
o recent releases of new video game consoles such as the Sony
Playstation 2, the Nintendo Gamecube and the Microsoft Xbox.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
New interactive entertainment software platforms and technologies also may
undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
o anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on favorable
terms; or
o create software for those new platforms on a timely basis.
WE COMPETE WITH A NUMBER OF COMPANIES THAT HAVE SUBSTANTIALLY GREATER FINANCIAL,
MARKETING AND PRODUCT DEVELOPMENT RESOURCES THAN WE DO.
The interactive entertainment software industry is intensely competitive
and new interactive entertainment software programs and platforms are regularly
introduced. The greater resources of our competitors permit them to undertake
more extensive marketing campaigns, adopt more aggressive pricing policies, and
pay higher fees than we
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can to licensors of desirable motion picture, television, sports and character
properties and to third party software developers.
We compete primarily with other publishers of personal computer and video
game console interactive entertainment software. Significant competitors include
Electronic Arts Inc., Activision, Inc., and Vivendi Universal Interactive
Publishing.
Many of these competitors have substantially greater financial, technical
and marketing resources, larger customer bases, longer operating histories,
greater name recognition and more established relationships in the industry than
we do. Competitors with more extensive customer bases, broader customer
relationships and broader industry alliances may be able to use such resources
to their advantage in competitive situations, including establishing
relationships with many of our current and potential customers.
In addition, integrated video game console hardware/software companies such
as Sony Computer Entertainment, Nintendo, and Microsoft Corporation compete
directly with us in the development of software titles for their respective
platforms and they have generally discretionary approval authority over the
products we develop for their platforms. Large diversified entertainment
companies, such as The Walt Disney Company, many of which own substantial
libraries of available content and have substantially greater financial
resources, may decide to compete directly with us or to enter into exclusive
relationships with our competitors. We also believe that the overall growth in
the use of the Internet and online services by consumers may pose a competitive
threat if customers and potential customers spend less of their available home
personal computing time using interactive entertainment software and more time
using the Internet and online services.
WE MAY FACE DIFFICULTY IN OBTAINING ACCESS TO RETAILERS NECESSARY TO MARKET AND
SELL OUR PRODUCTS EFFECTIVELY.
Retailers typically have a limited amount of shelf space and promotional
resources, and there is intense competition among consumer software producers,
and in particular producers of interactive entertainment software products, for
high quality retail shelf space and promotional support from retailers. To the
extent that the number of consumer software products and computer platforms
increases, competition for shelf space may intensify and require us to increase
our marketing expenditures. Due to increased competition for limited shelf
space, retailers and distributors are in an improving position to negotiate
favorable terms of sale, including price discounts, price protection, marketing
and display fees and product return policies. Our products constitute a
relatively small percentage of any retailer's sales volume, and we cannot assure
you that retailers will continue to purchase our products or to provide our
products with adequate levels of shelf space and promotional support. A
prolonged failure in this regard may cause material harm to our business.
We currently sell our products to retailers through external distribution
partners and co-publishing deals. We also derive revenues from licensing of our
products to hardware companies (or OEM), selling subscriptions on our online
gaming services, selling advertisements on our online web pages and selling our
packaged goods through our online store. The loss of, or significant reduction
in sales to, any of our principal distributors could cause material harm to our
business.
OUR CUSTOMERS HAVE THE ABILITY TO RETURN OUR PRODUCTS OR TO RECEIVE PRICING
CONCESSIONS AND SUCH RETURNS AND CONCESSIONS COULD REDUCE OUR NET REVENUES AND
RESULTS OF OPERATIONS.
We are exposed to the risk of product returns and pricing concessions with
respect to our distributors and retailers. We allow distributors and retailers
to return defective, shelf-worn and damaged products in accordance with
negotiated terms, and also offer a 90-day limited warranty to our end users that
our products will be free from manufacturing defects. In addition, we provide
pricing concessions to our customers to manage our customers' inventory levels
in the distribution channel. We could be forced to accept substantial product
returns and provide pricing concessions to maintain our relationships with
retailers and our access to distribution channels. Product return and pricing
concessions that exceed our reserves have caused material harm to our results of
operations in the recent past and may do so again in the future.
SUBSTANTIAL SALES OF OUR COMMON STOCK BY OUR EXISTING STOCKHOLDERS MAY REDUCE
THE PRICE OF OUR STOCK AND DILUTE EXISTING STOCKHOLDERS.
We have filed registration statements covering a total of approximately 53
million shares of our common stock for the benefit of those shareholders.
Assuming the effectiveness of these registration statements, these shares would
be eligible for immediate resale in the public market. Included in these
registrations are shares of common stock
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owned by Universal Studios, Inc. (now owned by Vivendi), which beneficially owns
approximately 5% of our common stock, Titus Interactive S.A., which beneficially
owns approximately 72% of our common stock, and investors that acquired shares
of common stock in our April 2001 financing.
Future sales of common stock by these holders could substantially increase
the volume of shares being publicly traded and could decrease the trading price
of our common stock and, therefore, the price at which you could resell your
shares. A lower market price for our shares also might impair our ability to
raise additional capital through the sale of our equity securities. Any future
sales of our stock would also dilute existing stockholders.
WE DEPEND UPON THIRD PARTY LICENSES OF CONTENT FOR MANY OF OUR PRODUCTS.
Many of our current and planned products, such as our Star Trek, Advanced
Dungeons and Dragons and Caesars Palace titles, are lines based on original
ideas or intellectual properties licensed from other parties. From time to time
we may not be in compliance with certain terms of these license agreements, and
our ability to market products based on these licenses may be negatively
impacted. Moreover, disputes regarding these license agreements may also
negatively impact our ability to market products based on these licenses.
Additionally, we may not be able to obtain new licenses, or maintain or renew
existing licenses, on commercially reasonable terms, if at all. If we are unable
to maintain current licenses or obtain new licenses for the underlying content
that we believe offers the greatest consumer appeal, we would either have to
seek alternative, potentially less appealing licenses, or release products
without the desired underlying content, either of which could limit our
commercial success and cause material harm to our business.
WE MAY FAIL TO MAINTAIN EXISTING LICENSES, OR OBTAIN NEW LICENSES FROM HARDWARE
COMPANIES ON ACCEPTABLE TERMS OR TO OBTAIN RENEWALS OF EXISTING OR FUTURE
LICENSES FROM LICENSORS.
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo and Microsoft. In
addition, each of these companies has the right to approve the technical
functionality and content of our products for their platforms prior to
distribution. Due to the competitive nature of the approval process, we must
make significant product development expenditures on a particular product prior
to the time we seek these approvals. Our inability to obtain these approvals
could cause material harm to our business.
OUR SALES VOLUME AND THE SUCCESS OF OUR PRODUCTS DEPENDS IN PART UPON THE NUMBER
OF PRODUCT TITLES DISTRIBUTED BY HARDWARE COMPANIES FOR USE WITH THEIR VIDEO
GAME PLATFORMS.
Even after we have obtained licenses to develop and distribute software, we
depend upon hardware companies such as Sony Computer Entertainment, Nintendo and
Microsoft, or their designated licensees, to manufacture the CD-ROM or DVD-ROM
media discs that contain our software. These discs are then run on the
companies' video game consoles. This process subjects us to the following risks:
o we are required to submit and pay for minimum numbers of discs we want
produced containing our software, regardless of whether these discs
are sold, shifting onto us the financial risk associated with poor
sales of the software developed by us; and
o reorders of discs are expensive, reducing the gross margin we receive
from software releases that have stronger sales than initially
anticipated and that require the production of additional discs.
As a result, video game console hardware licensors can shift onto us the
risk that if actual retailer and consumer demand for our interactive
entertainment software differs from our forecasts, we must either bear the loss
from overproduction or the lower per-unit revenues associated with producing
additional discs. Either situation could lead to material reductions in our net
revenues.
WE HAVE A LIMITED NUMBER OF KEY PERSONNEL. THE LOSS OF ANY SINGLE KEY PERSON OR
THE FAILURE TO HIRE AND INTEGRATE CAPABLE NEW KEY PERSONNEL COULD HARM OUR
BUSINESS.
Our interactive entertainment software requires extensive time and creative
effort to produce and market. The production of this software is closely tied to
the continued service of our key product design, development, sales, marketing
and management personnel. Our future success also will depend upon our ability
to attract, motivate and retain qualified employees and contractors,
particularly software design and development personnel. Competition for highly
skilled employees is intense, and we may fail to attract and retain such
personnel. Alternatively, we may
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incur increased costs in order to attract and retain skilled employees. Our
failure to retain the services of key personnel, including competent executive
management, or to attract and retain additional qualified employees could cause
material harm to our business.
OUR INTERNATIONAL SALES EXPOSE US TO RISKS OF UNSTABLE FOREIGN ECONOMIES,
DIFFICULTIES IN COLLECTION OF REVENUES, INCREASED COSTS OF ADMINISTERING
INTERNATIONAL BUSINESS TRANSACTIONS AND FLUCTUATIONS IN EXCHANGE RATES.
Our net revenues from international sales accounted for approximately 10
percent and 25 percent of our total net revenues for the three months ended
March 31, 2002 and 2001, respectively. Most of these revenues come from our
distribution relationship with Virgin, pursuant to which Virgin became the
exclusive distributor for most of our products in Europe, the Commonwealth of
Independent States, Africa and the Middle East. To the extent our resources
allow, we intend to continue to expand our direct and indirect sales, marketing
and product localization activities worldwide.
Our international sales and operations are subject to a number of inherent
risks, including the following:
o recessions in foreign economies may reduce purchases of our products;
o translating and localizing products for international markets is time-
consuming and expensive;
o accounts receivable are more difficult to collect and when they are
collectible, they may take longer to collect;
o regulatory requirements may change unexpectedly;
o it is difficult and costly to staff and manage foreign operations;
o fluctuations in foreign currency exchange rates; o political and
economic instability;
o our dependence on Virgin as our exclusive distributor in Europe, the
Commonwealth of Independent States, Africa and the Middle East; and
o delays in market penetration of new platforms in foreign territories.
These factors may cause material declines in our future international net
revenues and, consequently, could cause material harm to our business.
A significant, continuing risk we face from our international sales and
operations stems from currency exchange rate fluctuations. Because we do not
engage in currency hedging activities, fluctuations in currency exchange rates
have caused significant reductions in our net revenues from international sales
and licensing due to the loss in value upon conversion into U.S. Dollars. We may
suffer similar losses in the future.
INADEQUATE INTELLECTUAL PROPERTY PROTECTIONS COULD PREVENT US FROM ENFORCING OR
DEFENDING OUR PROPRIETARY TECHNOLOGY.
We regard our software as proprietary and rely on a combination of patent,
copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks, and hold the rights to one
patent application related to one of our titles. While we provide "shrinkwrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy
can be a persistent problem, especially in some international markets. Further,
the laws of some countries where our products are or may be distributed either
do not protect our products and intellectual property rights to the same extent
as the laws of the United States, or are weakly enforced. Legal protection of
our rights may be ineffective in such countries, and as we leverage our software
products using emerging technologies such as the Internet and online services,
our ability to protect our intellectual property rights and to avoid infringing
others' intellectual property rights may diminish. We cannot assure you that
existing intellectual property laws will provide adequate protection for our
products in connection with these emerging technologies.
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WE MAY UNINTENTIONALLY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
WHICH COULD EXPOSE US TO SUBSTANTIAL DAMAGES OR RESTRICT OUR OPERATIONS.
As the number of interactive entertainment software products increases and
the features and content of these products continue to overlap, software
developers increasingly may become subject to infringement claims. Although we
believe that we make reasonable efforts to ensure that our products do not
violate the intellectual property rights of others, it is possible that third
parties still may claim infringement. From time to time, we receive
communications from third parties regarding such claims. Existing or future
infringement claims against us, whether valid or not, may be time consuming and
expensive to defend. Intellectual property litigation or claims could force us
to do one or more of the following:
o cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property, which license, if available at all, may not be available on
commercially favorable terms; or
o redesign our interactive entertainment software products, possibly in
a manner that reduces their commercial appeal.
Any of these actions may cause material harm to our business and financial
results.
OUR SOFTWARE MAY BE SUBJECT TO GOVERNMENTAL RESTRICTIONS OR RATING SYSTEMS.
Legislation is periodically introduced at the state and federal levels in
the United States and in foreign countries to establish a system for providing
consumers with information about graphic violence and sexually explicit material
contained in interactive entertainment software products. In addition, many
foreign countries have laws that permit governmental entities to censor the
content of interactive entertainment software. We believe that mandatory
government-run rating systems eventually will be adopted in many countries that
are significant markets or potential markets for our products. We may be
required to modify our products to comply with new regulations, which could
delay the release of our products in those countries.
Due to the uncertainties regarding such rating systems, confusion in the
marketplace may occur, and we are unable to predict what effect, if any, such
rating systems would have on our business. In addition to such regulations,
certain retailers have in the past declined to stock some of our products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. While to date these actions
have not caused material harm to our business, we cannot assure you that similar
actions by our distributors or retailers in the future would not cause material
harm to our business.
WE MAY FAIL TO IMPLEMENT INTERNET-BASED PRODUCT OFFERINGS SUCCESSFULLY.
We seek to establish an online presence by creating and supporting sites on
the Internet and by offering our products through these sites. Our ability to
establish an online presence and to offer online products successfully depends
on:
o increases in the Internet's data transmission capability;
o growth in an online market sizeable enough to make commercial
transactions profitable.
Because global commerce and the exchange of information on the Internet and
other open networks are relatively new and evolving, a viable commercial
marketplace on the Internet may not emerge and complementary products for
providing and carrying Internet traffic and commerce may not be developed. Even
with the proper infrastructure, we may fail to develop a profitable online
presence or to generate any significant revenue from online product offerings in
the near future, or at all.
If the Internet does not become a viable commercial marketplace, or if this
development occurs but is insufficient to meet our needs or if such development
is delayed beyond the point where we plan to have established an online service,
our business and financial condition could suffer material harm.
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SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND INHIBIT OUR ABILITY TO RECEIVE A
PREMIUM PRICE FOR YOUR SHARES.
Our Board of Directors has the authority, without any action by the
stockholders, to issue up to 5,000,000 shares of preferred stock and to fix the
rights and preferences of such shares. In addition, our certificate of
incorporation and bylaws contain provisions that:
o eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to nominate
directors or submit proposals for stockholder approval.
These provisions may have the effect of delaying, deferring or preventing a
change in control, may discourage bids for our common stock at a premium over
its market price and may adversely affect the market price, and the voting and
other rights of the holders, of our common stock.
OUR STOCK PRICE IS VOLATILE.
The trading price of our common stock has previously fluctuated and could
continue to fluctuate in response to factors that are largely beyond our
control, and which may not be directly related to the actual operating
performance of our business, including:
o general conditions in the computer, software, entertainment, media or
electronics industries;
o changes in earnings estimates or buy/sell recommendations by analysts;
o investor perceptions and expectations regarding our products, plans
and strategic position and those of our competitors and customers; and
o price and trading volume volatility of the broader public markets,
particularly the high technology sections of the market.
WE DO NOT PAY DIVIDENDS ON OUR COMMON STOCK.
We have not paid any cash dividends on our common stock and do not
anticipate paying dividends in the foreseeable future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of March 31, 2002.
However, we are exposed to certain market risks arising from transactions in the
normal course of business, principally the risk associated with interest rate
fluctuations on any revolving line of credit agreement we maintain, and the risk
associated with foreign currency fluctuations. We do not hedge our interest rate
risk, or our risk associated with foreign currency fluctuations.
INTEREST RATE RISK
Our interest rate risk is due to our working capital lines of credit
typically having an interest rate based on either the bank's prime rate or
LIBOR. Currently, we do not have a line of credit, but we anticipate
establishing a line of credit in the future. With the consummation of the Shiny
sale on April 30, 2002 we retired all of our outstanding interest bearing debt
and provided a note payable with an interest rate of 6 percent per annum due in
2003 to a party to the transaction.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, primarily from Virgin. We
recognized foreign exchange gains of $65,000 and losses of $102,000 during the
three months ended March 31, 2002 and 2001, respectively, primarily in
connection with foreign exchange fluctuations in the timing of payments received
on accounts receivable from Virgin.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings, claims and
litigation arising in the ordinary course of business, including disputes
arising over the ownership of intellectual property rights and collection
matters. In the opinion of management, the outcome of known routine claims
will not have a material adverse effect on the Company's business,
financial condition or results of operations.
On January 15, 2002, Rage Games Limited ("Rage") filed a breach of
contract action against the Company in the Superior Court of California,
County of Orange, relating to the August 3, 2000 North American
distribution agreement and the February 9, 2001 OEM distribution agreement.
In the complaint, Rage alleged that the Company failed to make royalty
payments under these agreements. Rage sought damages in the amount of $2.9
million plus interest and punitive damages. Furthermore, Rage sought to
audit the Company's books, return all of Rage's software and a cease &
desist of all manufacturing & further distribution of Rage's software. The
Company settled all claims with Rage in April 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 30, 2002, the Company issued to Warner Bros., a division of
Time Warner Entertainment Company, L.P., a Secured Convertible Promissory
Note, due April 30, 2003, in the principal amount of $2.0 million. The note
was issued in partial payment of amounts due Warner Bros. under the
parties' license agreement for the video game based on the motion picture
THE MATRIX, which was being developed by a subsidiary of the Company. The
note is secured by all of the Company's assets, and may be converted by the
holder thereof into shares of the Company's common stock on the maturity
date or, to the extent there is any proposed prepayment, within the 30 day
period prior to such prepayment. The conversion price is equal to the lower
of (a) $0.304 and (b) an amount equal to the average closing price of a
share of the Company's common stock for the five business days ending on
the day prior to the conversion date, provided that in no event can the
note be converted into more than 18,600,000 shares. If any amount remains
due following conversion of the note into 18,600,000 shares, the remaining
amount will be payable in cash. Interplay agreed to register with the
Securities and Exchange Commission the resale by the note holder of shares
of common stock issued upon conversion of the note. In connection with the
sale of these securities, Warner Bros. represented to the Company that it
was an accredited investor with the meaning of the Securities Act and that
it was acquiring the securities for investment purposes only. The issuance
and sale of these securities was exempt from the registration and
prospectus delivery requirements of the Securities Act pursuant to Section
4(2) of the Securities Act as a transaction not involving any public
offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The following exhibits are filed as part of this report:
EXHIBIT NUMBER EXHIBIT TITLE
2.1 Stock Purchase Agreement by and between Infogrames, Inc., Shiny
Entertainment Inc., David Perry, Shiny Group, Inc., and Interplay
Entertainment Corp. dated April 23, 2002; incorporated herein by
reference to Exhibit 2.1 to the Company's Form 8-K filed May 6,
2002.
2.2 Amendment Number 1 to the Stock Purchase Agreement by and between
Interplay Entertainment Corp., Infogrames, Inc., Shiny
Entertainment, Inc., David Perry, and Shiny Group, Inc. dated
April 30, 2002; incorporated herein by reference to Exhibit 2.2 to
the Company's Form 8-K filed May 6, 2002.
10.1 Letter Agreement and Amendment Number 4 to Distribution Agreement
by and between Vivendi Universal Games, Inc. and Interplay
Entertainment Corp. dated January 18, 2002.
10.2 Fourth Amendment To Computer License Agreement by and between
Interplay Entertainment Corp. and Infogrames Interactive, Inc.
dated January 23, 2002. (Portions omitted pursuant to request for
confidential treatment.)
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10.3 Amendment Number Four to the Product Agreement by and between
Interplay Entertainment Corp., Infogrames Interactive, Inc., and
Bioware Corp. dated January 24, 2002.
10.4 Amended and Restated Amendment Number 1 to Product Agreement by
and between Interplay Entertainment Corp. and High Voltage
Software, Inc. dated March 5, 2002. (Portions omitted pursuant to
request for confidential treatment.)
10.5 Forbearance Agreement by and between LaSalle Business Credit,
Inc., Brian Fargo, Shiny Entertainment, Inc., Interplay
Entertainment Corp., Interplay OEM, Inc., and Gamesonline.com,
Inc. dated March 13, 2002.
10.6 Settlement Agreement and Release by and between Brian Fargo,
Interplay Entertainment Corp., Interplay OEM, Inc.,
Gamesonline.com, Inc., Shiny Entertainment, Inc., and Titus
Interactive S.A. dated March 13, 2002.
10.7 Agreement by and between Vivendi Universal Games Inc., Interplay
Entertainment Corp., and Shiny Entertainment, Inc. dated April of
2002.
10.8 Term Sheet by and between Titus Interactive S.A., and Interplay
Entertainment Corp. dated April 26, 2002.
10.9 Promissory Note by Titus Interactive S.A. in favor of Interplay
Entertainment Corp. dated April 26, 2002.
10.10 Amended and Restated Secured Convertible Promissory Note, dated
April 30, 2002, in favor of Warner Bros., a division of Time
Warner Entertainment Company, L.P.
(b) REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K on January 28,
2002, reporting the resignation of Brian Fargo as a director and
executive officer of the Company, and the appointment of Herve Caen as
interim Chief Executive Officer.
The Company filed a Current Report on Form 8-K on January 28,
2002, reporting that the Company and Bioware Corp. had entered into a
settlement of their legal dispute.
The Company filed a Current Report on Form 8-K on February 21,
2002, reporting that the Company had received a deficiency letter from
the Nasdaq Stock Market informing the Company of its failure to comply
with the minimum requirements for continued listing on the Nasdaq
National Market.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: May 15, 2002 By: /S/ HERVE CAEN
-----------------------------
Herve Caen,
President
(Principal Executive Officer)
Date: May 15, 2002 By: /S/ JEFF GONZALEZ
----------------------------
Jeff Gonzalez
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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