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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 June 30, 2001
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 August 13, 2001
----- -----------------------------------------
Common Stock, $0.001 par value 44,980,708
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2001
TABLE OF CONTENTS
----------------
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2001 (unaudited)
and December 31, 2000....................................... 3
Consolidated Statements of Operations for the Three and Six
Months ended June 30, 2001 and 2000 (unaudited)............. 4
Consolidated Statements of Cash Flows for the Six Months
ended June 30, 2001 and 2000 (unaudited).................... 5
Notes to Unaudited Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 35
Part II. Other Information
Item 1. Legal Proceedings........................................... 36
Item 5. Other Information........................................... 36
Item 6. Exhibits and Reports on Form 8-K............................ 36
Signatures............................................................ 37
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2001 2000
----------- ------------
(Unaudited)
(Dollars in thousands)
ASSETS
Current Assets:
Cash................................................ $ 677 $ 2,835
Trade receivables, net of allowances of $5,150 and
$6,543, respectively............................... 11,780 28,136
Inventories......................................... 2,358 3,359
Prepaid licenses and royalties...................... 16,754 17,704
Other............................................... 853 772
--------- ---------
Total current assets.............................. 32,422 52,806
--------- ---------
Property and Equipment, net........................... 5,332 5,331
Other Assets.......................................... 1,293 944
--------- ---------
$ 39,047 $ 59,081
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current debt........................................ $ 9,281 $ 25,433
Accounts payable.................................... 14,820 12,270
Accrued liabilities................................. 7,220 7,722
Royalty liabilities................................. 10,319 7,258
--------- ---------
Total current liabilities......................... 41,640 52,683
--------- ---------
Commitments and Contingencies (Notes 1 and 5)
Stockholders' Equity (Deficit) (Notes 6 and 12):
Series A Preferred stock, $0.001 par value,
authorized 5,000,000 shares; issued and
outstanding, 719,424 shares........................ 21,470 20,604
Common stock, $0.001 par value, authorized
100,000,000 shares; issued and outstanding
38,301,402 and 30,143,636 shares, respectively..... 38 30
Paid-in-capital..................................... 100,632 88,759
Accumulated deficit................................. (124,951) (103,259)
Accumulated other comprehensive income.............. 218 264
--------- ---------
Total stockholders' equity (deficit).............. (2,593) 6,398
--------- ---------
$ 39,047 $ 59,081
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
(Dollars in thousands, except per share
amounts)
Net revenues.................. $ 14,802 $ 24,921 $ 32,115 $ 43,064
Cost of goods sold............ 10,993 11,456 21,478 21,028
---------- ---------- ---------- ----------
Gross profit.................. 3,809 13,465 10,637 22,036
Operating expenses:
Marketing and sales......... 5,825 6,541 12,511 11,404
General and administrative.. 4,097 2,428 6,583 4,987
Product development......... 5,332 5,678 10,649 11,313
---------- ---------- ---------- ----------
Total operating expenses.. 15,254 14,647 29,743 27,704
---------- ---------- ---------- ----------
Operating loss............ (11,445) (1,182) (19,106) (5,668)
Other expense:
Interest expense, net....... 707 637 1,366 1,555
Other expense, net.......... 246 84 354 176
---------- ---------- ---------- ----------
Total other expense....... 953 721 1,720 1,731
---------- ---------- ---------- ----------
Net loss...................... $ (12,398) $ (1,903) $ (20,826) $ (7,399)
========== ========== ========== ==========
Cumulative dividend on
participating preferred
stock........................ $ 300 $ -- $ 600 $ --
Accretion of warrants on
preferred stock.............. 67 133 266 133
---------- ---------- ---------- ----------
Net loss attributable to
common stockholders.......... $ (12,765) $ (2,036) $ (21,692) $ (7,532)
========== ========== ========== ==========
Net loss per common share:
Basic and diluted........... $ (0.34) $ (0.07) $ (0.64) $ (0.25)
========== ========== ========== ==========
Weighted average number of
common shares outstanding:
Basic and diluted........... 37,483,443 30,022,811 33,838,756 30,009,698
========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
------------------
2001 2000
-------- --------
(Dollars in
thousands)
Cash flows from operating activities:
Net loss.................................................. $(20,826) $ (7,399)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization............................ 1,330 1,401
Write-off of prepaid royalties........................... 2,251 --
Changes in assets and liabilities:
Trade receivables....................................... 16,306 (10,310)
Inventories............................................. 1,001 2,212
Prepaid licenses and royalties.......................... (1,301) (929)
Other current assets.................................... (81) (303)
Accounts payable........................................ 2,550 (8,142)
Accrued liabilities..................................... (5,985) 7,234
Royalty liabilities..................................... 3,061 (3,468)
-------- --------
Net cash used in operating activities.................. (1,694) (19,704)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment........................ (1,080) (1,604)
-------- --------
Net cash used in investing activities.................. (1,080) (1,604)
-------- --------
Cash flows from financing activities:
Net borrowings on line of credit.......................... 6,064 1,202
Net payment of previous line of credit.................... (24,433) --
Net payment of supplemental line of credit................ (1,000) --
Net proceeds from issuance of Series A Preferred Stock and
warrants................................................. -- 20,000
Net proceeds from issuance of common stock................ 11,872 236
Proceeds (payments) on notes payable...................... 3,000 (375)
Proceeds from exercise of stock options................... 9 21
Interest proceeds from restricted cash.................... -- 69
Proceeds from other advances.............................. 5,000 --
Proceeds (payments) on other debt......................... 150 (37)
-------- --------
Net cash provided by financing activities.............. 662 21,116
-------- --------
Effect of exchange rate changes on cash.................... (46) 3
-------- --------
Net decrease in cash................................... (2,158) (189)
Cash, beginning of period.................................. 2,835 399
-------- --------
Cash, end of period........................................ $ 677 $ 210
======== ========
Supplemental cash flow information:
Cash paid for:
Interest................................................ $ 1,305 $ 1,555
Income taxes............................................ -- --
======== ========
Supplemental disclosures of Noncash transactions:
Acquisition of nine percent interest in Shiny............. $ 600 $ --
Accreution of preferred stock to redemption value.......... 266 133
Accrued dividend on participating preferred stock.......... 600 270
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying interim consolidated financial statements of Interplay
Entertainment Corp. and its subsidiaries (the "Company") are unaudited and
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.
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, 2000 as
filed with the Securities and Exchange Commission.
Factors Affecting Future Performance and Going Concern
For the six months ended June 30, 2001, the Company incurred a net loss of
$20.8 million. However, net cash used in operating activities was $1.7 million
as the Company's negative operating results were largely offset by strong
trade receivable collections and conservative management of inventories and
disbursements. During the same period last year, the net cash used in
operating activities was $19.7 million.
In April 2001, the Company secured a new $15 million line of credit with a
bank and completed the sale of $12.7 million of Common Stock in a private
placement transaction. The net proceeds of $11.9 million from the private
placement were used towards paying the outstanding balance under the Company's
previous bank line of credit which was expiring, and enabled the Company to
secure the new line of credit to fund ongoing operations (See Notes 4 and 6).
Advances under the new line of credit are limited to an amount based on
accounts receivable and inventories. The Company has not released sufficient
product during the three month period ended June 30, 2001 to generate a
profitable level of revenues, or sufficient accounts receivable to maximize
the use of its line of credit. The Company also anticipates that delays in
product releases could continue in the short-term, and funds available under
its new line of credit and from ongoing operations are not sufficient to
satisfy the projected working capital and capital expenditure needs in the
normal course of business. In addition, the Company is not in compliance with
certain financial covenants set forth in the new line of credit agreement as
of June 30, 2001. If the bank does not waive compliance with the required
covenants, terminates the credit agreement and demands acceleration of payment
of the outstanding amounts, the Company would not have the funds to repay the
bank and would be unable to continue to draw on the credit facility to fund
future operations (See Note 4).
The Company continues to implement cost reduction programs including a
reduction of personnel, a reduction of fixed overhead commitments, cancelled
or suspended development on future titles and have scaled back certain
marketing programs. The Company is also seeking external sources of funding,
including but not limited to, a sale or merger of the Company, a private
placement of Company 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 carry out management's long-term strategic
objectives. However, there can be no assurance that the Company can complete
the transactions necessary to provide the required funding on a timely basis
in order to continue ongoing operations in the normal course of business.
If the Company is unable to secure the required funding on a timely basis,
it will continue to reduce its costs by selling or consolidating its
operations, and by continuing to delay or cancel product development and
marketing programs. These measures could have a material adverse effect on the
Company's ability to continue as a going concern.
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition to the continuing risks related to the Company's future
liquidity, the Company also faces numerous other risks associated with its
industry. These risks include dependence on new platform introductions by
hardware manufacturers, commercially successful new product introductions by
the Company, new product introduction delays, rapidly changing technology,
intense competition, dependence on distribution channels and risk of customer
returns.
The Company's consolidated financial statements have been presented on the
basis that the Company is a going concern. Accordingly, the consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities or any other adjustments that might result
should the Company be unable to continue as a going concern.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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.
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 payments for intellectual
property rights and advanced royalty payments to outside developers. Such
costs include certain other outside production costs generally consisting of
film cost and amounts paid for digitized motion data with alternative future
uses. Payments to developers represent contractual advanced payments made for
future royalties. 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 of the related title at a rate based upon
the number of units shipped. Management evaluates the future realization of
such costs quarterly by reviewing the forecasted sales of the future titles in
development. When a title is an externally developed title and the Company is
paying royalty advances to the third party developer, the Company compares the
forecasted net proceeds after selling costs to the amount capitalized. If the
amount of net proceeds is greater than the amount capitalized, the advance on
royalties is not considered to be impaired. If the amount capitalized is
greater than the amount of net proceeds, the advance is considered impaired
and the amount capitalized in excess of forecasted net proceeds is charged to
cost of goods sold. Such costs are classified as current and noncurrent assets
based upon estimated net product sales.
Royalty Liabilities
Royalty liabilities 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. Royalty liabilities also include unearned advances received
by the Company from console hardware and software manufacturers for the
development of titles for their console platforms.
7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue Recognition
Revenues are recorded when products are delivered to customers in
accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition". For those agreements that provide the customers the right to
multiple copies 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, the Company permits
customers to return or exchange product and may provide price protection 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 is an estimate and the
amount 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 expense as incurred.
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. The consensus should be applied no later than in annual or interim
financial statements for periods beginning after December 15, 2001. The
Company is currently evaluating the impact of this consensus on its Statement
of Operations.
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 will apply the new rules on
accounting for goodwill and other intangible assets beginning in the first
quarter of 2002. The Company will perform the first of the required impairment
tests of goodwill as of January 1, 2002 and has not yet determined what the
effect of these tests will be on the earnings and financial position of the
Company.
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2. Inventories
Inventories consist of the following:
June 30, December 31,
2001 2000
-------- ------------
(Dollars in
thousands)
Packaged software.............................. $1,873 $2,628
CD-ROMs, cartridges, manuals, packaging and
supplies...................................... 485 731
------ ------
$2,358 $3,359
====== ====== ===
Note 3. Prepaid licenses and royalties
Prepaid licenses and royalties are as follows:
June
30, December 31,
2001 2000
------- ------------
(Dollars in
thousands)
Prepaid royalties for titles in development......... $12,851 $ 9,254
Prepaid royalties for shipped titles, net of
amortization....................................... 1,580 6,174
Prepaid licenses and trademarks, net of
amortization....................................... 2,323 2,276
------- -------
$16,754 $17,704
======= =======
During the three and six months ended June 30, 2001, the Company expensed
$1.5 million and $2.3 million, respectively, for prepaid royalties that were
impaired due to the cancellation of certain development projects. No amounts
were impared and expensed during the three and six month periods ended June
30, 2000.
Note 4. Current Debt
Current debt consists of the following:
June 30, December 31,
2001 2000
-------- ------------
(Dollars in
thousands)
Working capital line of credit...................... $6,064 $24,433
Loan from Chairman and Chief Executive Officer...... 3,067 --
Supplemental line of credit from Titus.............. -- 1,000
Other............................................... 150 --
------ -------
$9,281 $25,433
====== =======
Working Capital Line of Credit
In April 2001, the Company entered into a new three year loan and security
agreement with a bank providing for a $15 million working capital line of
credit. The agreement with a new bank replaced an agreement with a former bank
that was expiring. The expiring line of credit bore an interest rate of LIBOR
(6.78 percent at December 31, 2000) plus 4.87 percent (11.65 percent at
December 31, 2000). In April 2001, all amounts outstanding to the former Bank
were paid in full. Advances under the new line of credit are limited to an
amount based on qualified accounts receivable and inventory. The new line
bears interest at the bank's prime rate, or, at the Company's option, a
portion of the outstanding balance would bear interest at LIBOR plus 2.5% for
a fixed
9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
short-term. At June 30, 2001, borrowings under the working capital line of
credit bore interest at various interest rates ranging between 6.39 percent
and 7 percent, and the amount available for borrowing under the line was $3.1
million.
The line is subject to review and renewal by the bank on April 30, 2002 and
2003, and is secured by substantially all of the Company's assets, plus a
personal guarantee of $2 million from the Chairman, secured by $1 million in
cash (See Note 6). The line requires that the Company meet certain financial
covenants set forth in the agreement. The Company is not in compliance with
the financial covenants related to net worth and minimum earnings before
interest, taxes, depreciation and amortization as of June 30, 2001. If the
bank does not waive compliance with the required covenants under the credit
agreement, the bank could terminate the credit agreement and accelerate
payment of all outstanding amounts. Because the Company depends on proceeds
from its credit agreement to fund its operations, and the Company does not
have the funds to pay the outstanding balance in the event payment is
accelerated, the termination of the credit agreement and the acceleration of
payment by the bank would have a material adverse effect on the Company's
ability to continue as a going concern (See Note 1).
Loan from Chairman and Chief Executive Officer
In April 2001, the Chairman provided the Company with a $3 million loan,
payable in May 2002, with interest at 10 percent (See Note 6).
Supplemental line of credit from Titus
In April 2000, the Company secured a $5 million supplemental line of credit
with Titus Interactive SA ("Titus"), a major shareholder of the Company,
expiring in May 2001. In connection with this line of credit, Titus received a
warrant exercisable for 60,298 shares of the Company's Common Stock at $3.79
per share that will expire in April 2010. In April 2001, the total outstanding
balance plus accrued interest in the aggregate amount of approximately $3.1
million was paid in full and the commitment under the supplemental line of
credit was terminated. As of June 30, 2001, Titus has not exercised these
warrants.
Note 5. Commitments and Contingencies
The Company and the former owner of the Company's wholly owned subsidiary
Shiny Entertainment ("Shiny") had a dispute over cash payments upon the
delivery and acceptance of interactive entertainment software titles that
Shiny was committed to deliver over time. In March 2001, the Company entered
into an amendment to the Shiny purchase agreement which, among other things,
settled the dispute with the former owner of Shiny, and provided for the
Company to acquire the remaining nine percent equity interest in Shiny for
$600,000 payable in installments of cash and stock. The amendment also
provided for additional cash payments to the former owner of Shiny for two
interactive entertainment software titles to be delivered in the future. The
former owner of Shiny will earn royalties after the future delivery of the two
titles to the Company. At June 30, 2001, the Company owed the former owner of
Shiny $150,000.
Virgin Interactive Entertainment Limited ("Virgin"), whose ultimate parent
is Titus, had disputed an amendment to the International Distribution
Agreement with the Company, and claimed that the Company was obligated, among
other things, to pay a contribution to their overhead of up to $9.3 million
annually, subject to reductions by the amount of commissions earned by Virgin
on its distribution of the Company's products. In April 2001, the Company
settled this dispute with Virgin, and amended the International Distribution
Agreement, the Termination Agreement and the Product Publishing Agreement, all
of which were entered into in February 10, 1999 when the Company acquired an
equity interest in Virgin's parent company VIE Acquisition Group LLC ("VIE").
As a result of the settlement, Virgin dismissed its claim for overhead fees,
VIE fully redeemed the
10
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company's membership interest in VIE and Virgin paid the Company $3.1 million
in net past due balances owed under the International Distribution Agreement.
In addition, the Company will pay Virgin a one-time marketing fee of $333,000
for the period ending June 30, 2001 and the monthly overhead fee was revised
for the Company to pay $111,000 per month for the nine month period beginning
April 2001, and $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. The Company no longer has an equity
interest in VIE or Virgin as of June 30, 2001.
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 million. The advance is to be repaid at $20 per unit
upon the sale of product under this agreement, as defined. If the full amount
of the advance is not paid by June 2003, then the remaining outstanding
balance is subject to interest at the prime rate plus one percent. This
advance has been included in royalty liabilities on the accompanying
consolidated balance sheet.
Note 6. Stockholders' Equity
In April 2001, the Company completed a private placement of 8,126,770
shares of Common Stock for $12.7 million, and received net proceeds of
approximately $11.9 million. The shares were issued at $1.5625 per share, and
included warrants to purchase one share of Common Stock for each share sold.
The warrants are exercisable at $1.75, and can be exercised 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
April 2006. In addition to the warrants issued with 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 provides 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
two percent penalty (approximately $250,000) 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 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 month period ended June 30, 2001 the Company accrued
$254,000 payable to these stockholders, which was charged to results of
operations and classified as other expense.
In April 2001, the Chairman provided the Company with a $3 million loan,
payable in May 2002. In connection with this loan to the Company and the
Chairman's $2 million personal guarantee of the Company's new credit facility
(See Note 4), the Chairman received warrants to purchase 500,000 shares of the
Company's Common Stock at $1.75 per share, vesting upon issuance and expiring
in April 2004.
Note 7. General and Administrative Expenses
Included in general and administrative expenses for the three months ended
June 30, 2001 were a $0.6 million provision for the termination of a building
lease in the United Kingdom and $0.5 million in legal, audit and investment
banking fees and expenses incurred principally in connection with the efforts
of a proposed sale of the Company to a third party which has been terminated.
11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 8. Net Loss Per Share
Basic net loss per share is calculated by dividing net loss available to
common stockholders by the weighted average number of common shares
outstanding and does not include the impact of any potentially dilutive
securities. Diluted net loss per share is the same as basic net loss per share
because the effect of outstanding stock options and warrants is anti-dilutive.
The impact of the Preferred Stock conversion into Common Stock shares was
excluded from the loss per share computation at June 30, 2001 and 2000 (See
Note 12). There were options and warrants outstanding to purchase 13,950,739
and 3,886,680 shares of Common Stock at June 30, 2001 and 2000, respectively,
which were excluded from the loss per share computation as they were anti-
dilutive. At June 30, 2000, there were 484,848 shares of restricted Common
Stock that were excluded from the loss per share computation as they were
anti-dilutive. The weighted average exercise price of the outstanding options
and warrants at June 30, 2001 and 2000 was $2.12 and $3.56, respectively.
Note 9. Comprehensive Loss
Comprehensive loss consists of the following:
Three Months
Ended Six Months Ended
June 30, June 30,
----------------- -----------------
2001 2000 2001 2000
-------- ------- -------- -------
(Dollars in thousands)
Net loss............................. $(12,398) $(1,903) $(20,826) $(7,399)
Other comprehensive loss, net of
income taxes:
Foreign currency translation
adjustments....................... (24) (1) (46) 3
-------- ------- -------- -------
Total comprehensive loss........... $(12,422) $(1,904) $(20,872) $(7,396)
======== ======= ======== =======
During the three and six months ended June 30, 2001 and 2000, the net
effect of income taxes on comprehensive loss was immaterial.
Note 10. Related Parties
Distribution and Publishing Agreements
In connection with the amended International Distribution Agreement with
Virgin, the Company incurred distribution commission expense of $341,000 and
$758,000 for the three months ended June 30, 2001 and 2000 and $583,000 and
$1,530,000 for the six months ended June 30, 2001 and 2000, respectively.
In connection with the Product Publishing Agreement with Virgin, the Company
earned $185,000 for performing publishing and distribution services on behalf
of Virgin during the three months ended June 30, 2000 and $15,000 and $176,000
during the six months ended June 30, 2001 and 2000, respectively. No amounts
were earned during the three month period ended June 30, 2001. As part of the
terms of the April 2001 settlement between Virgin and the Company, the Product
Publishing Agreement was amended to provide for the Company to publish only
one future title developed by Virgin (see Note 5).
As of June 30, 2001 and December 31, 2000, Virgin owed the Company $1.3
million and $12.1 million and the Company owed Virgin $0.4 million and $4.8
million, respectively. The net amounts due to the Company from Virgin as of
December 31, 2000, were paid in full in April 2001.
12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company performs distribution services on behalf of Titus for a fee. In
connection with such distribution services during the three months ended June
30, 2001 and 2000 the Company recognized distribution fee revenue of $7,000
and $45,000, and $28,000 and $445,000 during the six months ended June 30,
2001 and 2000, respectively.
As of June 30, 2001 and December 31, 2000, Titus owed the Company $269,000
and $280,000 and the Company owed Titus $269,000 and $1.1 million,
respectively, including amounts owed under the supplemental line of credit
(See Note 4).
Investment in Affiliate
The Company accounted for its investment in VIE in accordance with the
equity method of accounting. The Company did not recognize any material income
or loss in connection with its investment in VIE for the three and six months
ended June 30, 2001 and 2000. In April 2001, VIE fully redeemed the Company's
membership interest in VIE in connection with the April 2001 settlement
between Virgin and the Company. The Company no longer has an equity interest
in VIE or Virgin as of June 30, 2001.
Note 11. Segment and Geographical Information
The Company operates in one principal business segment. Information about
the Company's operations in the United States and foreign markets is presented
below:
Three Months
Ended Six Months Ended
June 30, June 30,
----------------- -----------------
2001 2000 2001 2000
-------- ------- -------- -------
(Dollars in thousands)
Net revenues:
United States......................... $ 14,802 $24,921 $ 32,115 $43,022
United Kingdom........................ -- -- -- 42
-------- ------- -------- -------
Consolidated net revenues........... $ 14,802 $24,921 $ 32,115 $43,064
======== ======= ======== =======
Operating loss:
United States......................... $(10,692) $ (925) $(18,045) $(5,129)
United Kingdom........................ (753) (257) (1,061) (539)
-------- ------- -------- -------
Consolidated loss from operations... $(11,445) $(1,182) $(19,106) $(5,668)
======== ======= ======== =======
Expenditures made for the acquisition of
long-lived assets:
United States......................... $ 492 $ 856 $ 1,062 $ 1,560
United Kingdom........................ 9 41 18 44
-------- ------- -------- -------
Total expenditures for long-lived
assets............................. $ 501 $ 897 $ 1,080 $ 1,604
======== ======= ======== =======
13
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net revenues by geographic regions were as follows:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -------------------------------
2001 2000 2001 2000
--------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
North America........... $ 9,941 67.1% $12,752 51.2% $23,897 74.4% $23,482 54.5%
Europe.................. 2,482 16.8 5,375 21.5 3,820 11.9 9,607 22.3
Rest of World........... 914 6.2 1,389 5.6 1,579 4.9 2,436 5.7
OEM, royalty and
licensing.............. 1,465 9.9 5,405 21.7 2,819 8.8 7,539 17.5
------- ----- ------- ----- ------- ----- ------- -----
$14,802 100.0% $24,921 100.0% $32,115 100.0% $43,064 100.0%
======= ===== ======= ===== ======= ===== ======= =====
Net investments in long-lived assets by geographic regions were as follows:
June 30, December 31,
2001 2000
-------------- --------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
United States................................ $6,474 97.7% $6,139 97.8%
United Kingdom............................... 86 1.3 76 1.2
OEM, royalty and licensing................... 65 1.0 60 1.0
------ ----- ------ -----
$6,625 100.0% $6,275 100.0%
====== ===== ====== =====
Note 12. Subsequent Events
Conversion of Series A Preferred Stock
On August 13, 2001, Titus converted 336,070 shares of Series A Preferred
Stock into 6,679,306 shares of Common Stock. Subsequent to this partial
conversion, Titus owns 19,496,561 shares of Common Stock and 383,354 shares of
Series A Preferred Stock with voting rights equivalent to 4,059,903 shares of
Common Stock. Collectively, Titus has 48 percent of the total voting power of
the Company's capital stock as of August 13, 2001.
Distribution Agreement
In August 2001, the Company received an advance of $4 million for the North
American distribution rights of a future title. The advance will be recouped
against future distribution commissions payable, based on the future sales of
the title.
14
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, 2000 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, cost reduction measures, compliance with the Company's
line of credit and an extension or replacement of such line are forward-
looking statements and there can be no assurance that the Company will achieve
its operating plans, generate positive cash flow in the future or that the
Company will be able to maintain or replace its current financing arrangements
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.
15
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 Six Months Ended
June 30, June 30,
------------------------------------- -------------------------------------
2001 2000 2001 2000
------------------ ----------------- ------------------ -----------------
% of Net % of Net % of Net % of Net
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
-------- -------- ------- -------- -------- -------- ------- --------
(Dollars in thousands)
Net revenues............ $ 14,802 100.0% $24,921 100.0% $ 32,115 100.0% $43,064 100.0%
Cost of goods sold...... 10,993 74.3% 11,456 46.0% 21,478 66.9% 21,028 48.8%
-------- ----- ------- ----- -------- ----- ------- -----
Gross profit........... 3,809 25.7% 13,465 54.0% 10,637 33.1% 22,036 51.2%
-------- ----- ------- ----- -------- ----- ------- -----
Operating expenses:
Marketing and sales.... 5,825 39.4% 6,541 26.2% 12,511 39.0% 11,404 26.5%
General and
administrative........ 4,097 27.7% 2,428 9.7% 6,583 20.5% 4,987 11.6%
Product development.... 5,332 36.0% 5,678 22.8% 10,649 33.2% 11,313 26.3%
-------- ----- ------- ----- -------- ----- ------- -----
Total operating
expenses.............. 15,254 103.1% 14,647 58.7% 29,743 92.7% 27,704 64.4%
-------- ----- ------- ----- -------- ----- ------- -----
Operating loss.......... (11,445) (77.4)% (1,182) (4.6)% (19,106) (59.6)% (5,668) (13.1)%
Other expense.......... 953 6.4% 721 2.9% 1,720 5.4% 1,731 4.0%
-------- ----- ------- ----- -------- ----- ------- -----
Net loss............... $(12,398) (83.8)% $(1,903) (7.5)% $(20,826) (65.0)% $(7,399) (17.2)%
======== ===== ======= ===== ======== ===== ======= =====
Net revenues by
geographic region:
North America.......... $ 9,941 67.2% $12,752 51.2% $ 23,897 74.4% $23,482 54.5%
International.......... 3,396 22.9% 6,764 27.1% 5,399 16.8% 12,043 28.0%
OEM, royalty and
licensing............. 1,465 9.9% 5,405 21.7% 2,819 8.8% 7,539 17.5%
Net revenues by
platform:
Personal computer...... $ 12,270 82.9% $15,222 61.1% $ 24,609 76.6% $28,420 66.0%
Video game console..... 1,067 7.2% 4,294 17.2% 4,687 14.6% 7,105 16.5%
OEM, royalty and
licensing............. 1,465 9.9% 5,405 21.7% 2,819 8.8% 7,539 17.5%
North American, International and OEM, Royalty and Licensing Net Revenues
Overall, net revenues for the three months ended June 30, 2001 decreased 41
percent compared to the same period in 2000. This decrease resulted from a 22
percent decrease in North American net revenues, a 50 percent decrease in
International net revenues and a 73 percent decrease in OEM, royalty and
licensing, as described below. The decrease in North American and
International net revenues for the three months ended June 30, 2001 was mainly
because the titles released during the period generated $6.2 million less
sales volume compared to the same period in 2000. We released six fewer titles
this year as compared to last year. In addition, the volume of product returns
and price concessions remained about the same for the current three month
period as compared to the three months ended June 30, 2000. We expect that
North American and International publishing net revenues in 2001 will decrease
compared to 2000 as certain titles originally scheduled for release in the
second half of 2001 have been rescheduled for release in 2002. Furthermore, we
have canceled or suspended selected future titles in an effort to reduce
future expenditures. The $3.9 million decrease in OEM, royalty and licensing
net revenues in the three months ended June 30, 2001 compared to the same
period in 2000 was due to decreased net revenues in the OEM business and in
licensing transactions. This decrease was due to a $1 million decrease in the
OEM business was primarily due to a decrease in the volume of transactions
which relates to the general market decrease in personal computer sales, and
the decrease in licensing transactions is primarily due to a $3 million multi-
product licensing transaction with Titus Interactive SA ("Titus"), our major
stockholder, in 2000 that did not recur in 2001. We expect that OEM, royalty
and licensing net revenues in 2001 will decrease compared to 2000.
Net revenues for the six months ended June 30, 2001 decreased 25 percent
compared to the same six month period in 2000. The decrease resulted from a 55
percent decrease in International net revenues, a 63 percent decrease in OEM,
royalty and licensing, offset by a two percent increase in North American net
revenues, as
16
described below. International net revenues decreased for the six months ended
June 30, 2001 mainly because the titles released during the period generated
$4.6 million less sales volume as well as higher product returns and price
concessions compared to the same period in 2000. Overall, we released 14 fewer
titles across multiple platforms this year as compared to the same period last
year. The $4.7 million decrease in OEM, royalty and licensing net revenues in
the six months ended June 30, 2001 compared to the same period in 2000 was due
to decreased net revenues in the OEM business and in licensing transactions.
The $1.7 million decrease in the OEM business was primarily due to a decrease
in the volume of transactions which relates to the general market decrease in
personal computer sales, and the decrease in licensing transactions is
primarily due to a $3 million multi-product licensing transaction with Titus
in 2000 that did not recur in 2001. The increase in North American net
revenues for the six months ended June 30, 2001 was mainly because the titles
released during the period generated $1.2 million more sales volume compared
to the same period in 2000.
Platform Net Revenues
PC net revenues decreased 19 percent during the three months ended June 30,
2001 compared to the same period in 2000. The decrease in PC net revenues was
attributable to the release of four titles during the three months ended June
30, 2001 compared to six titles in the 2000 period. We expect our PC net
revenues to decrease in 2001 due to our increased focus on next generation
console titles, the cancellation of one selected project and rescheduling the
release of certain titles from 2001 to 2002. We do not anticipate releasing
any new major PC titles during the remainder of 2001. Video game console net
revenues decreased 75 percent during the three months ended June 30, 2001
compared to the same period in 2000, due to only releasing the international
version of one PlayStation 2 title compared to the same period last year, in
which we released four video game console titles. We expect our video game
console net revenues to increase in 2001 as a result of a substantial increase
in planned title releases for next generation game consoles in 2001 compared
to 2000. Our anticipated major video game console releases for the remainder
of the year include Baldur's Gate: Dark Alliance (PlayStation 2) and Giants
(PlayStation 2).
For the six months ended June 30, 2001, PC net revenues decreased 13
percent compared to the same period in 2000. The decrease is mainly due to
releasing six titles in the 2001 period compared to 15 titles in the 2000
period. We released three major titles during the six months ended June 30,
2001 versus two in the comparable 2000 period, however, two of the titles were
expansions to previously released games resulting in a lower average selling
price than a stand alone game. The decrease in net PC revenues from fewer
title releases and higher than anticipated price concessions was partially
offset by the 2001 period titles having higher sales volume as compared to the
2000 period title releases. Video game console net revenues decreased 34
percent in the six months ended June 30, 2001 compared to the same period in
2000 due to only releasing one video game console title versus six titles.
Cost of Goods Sold; Gross Profit Margin
Cost of goods sold decreased four percent in the three months ended June
30, 2001 compared to the same period in 2000 due to a lower gross revenues
base offset by higher amortization of prepaid royalties on externally
developed products, including approximately $1.5 million in write-offs of
canceled development projects. The 72 percent decrease in gross profit margin
was due to product returns and price concessions increasing as a percentage of
gross revenues, no internally developed products released in the 2001 period
versus two titles in the 2000 period, licensing revenue decreasing by $3
million and $1.5 million in write-offs of canceled development projects. We
expect our cost of goods sold to decrease in 2001 as compared to 2000 due to
an expected lower net revenues base partially offset by a higher proportion of
console titles released. In addition, we expect our gross profit margin in
2001 to decrease as compared to 2000 due to an increase in console title
revenues, which typically have a higher cost of goods than PC titles.
Cost of goods sold increased two percent in the six months ended June 30,
2001 compared to the same period in 2000, due to higher amortization of
prepaid royalties. Prepaid royalty amortization increased due to a lack of
internally developed titles and $2.2 million in write-offs of canceled
development projects. The 52 percent
17
decrease in gross profit margin was primarily due to product returns and price
concessions increasing $1.9 million and increasing as a percentage of gross
revenues, one internally developed expansion title released in the 2001 period
versus three internally developed stand alone titles in the 2000 period,
licensing revenue decreasing by $3.1 million and $2.2 million in write-offs in
connection with canceled development projects.
We may incur additional write-offs of prepaid royalties for titles in
development if additional projects are cancelled or suspended in order to
reduce future expenditures and reduce the funding requirements of future
operations.
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. The 11 percent decrease
in marketing and sales expenses for the three months ended June 30, 2001
compared to the 2000 period is primarily attributable to a $1.2 million
decrease in worldwide advertising and retail marketing support expenditures
and $0.2 million decrease in personnel costs and operating expenses, offset by
$0.7 million in overhead fees payable to Virgin in 2001, in connection with
the terms of the April 2001 settlement of a dispute with Virgin. We expect our
marketing and sales expenses to decrease in 2001 as compared to 2000, due to
decreased advertising and retail marketing support expenditures and lower
personnel costs as a result of a reduction of headcount subsequent to June 30,
2001, offset by the overhead fees payable to Virgin in 2001, in connection
with the terms of the April 2001 settlement of a dispute with Virgin.
The 10 percent increase in marketing and sales expenses for the six months
ended June 30, 2001 compared to the 2000 period is attributable primarily to a
$0.4 million increase in marketing and sales expenses for increased worldwide
advertising and retail marketing support expenditures that increased promotion
and retail sell-through of previously released titles and $0.7 million in
overhead fees payable to Virgin in 2001, in connection with the terms of the
April 2001 settlement of a dispute with Virgin.
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 June 30, 2001 increased 69 percent due to a $0.6 million
provision for the termination of a building lease in the United Kingdom, $0.1
million increase in the provision for bad debt, $0.5 million in legal, audit
and investment banking fees and expenses incurred principally in connection
with the efforts of a proposed sale of the Company which has been terminated
and $0.5 million increase in personnel costs. Although we are continuing our
efforts to reduce North American operating expenses including a reduction of
headcount subsequent to June 30, 2001, we expect general and administrative
expenses to increase slightly in 2001 as compared to 2000 as a result of the
already incurred additional expenditures disclosed above.
The 32 percent increase in general and administrative expenses for the six
months ended June 30, 2001 compared to the same period in 2000 is primarily
attributable to the additional expenditures in the three months ended June 30,
2001 as discussed in the previous paragraph.
Product Development
Product development expenses, which primarily consist of personnel and
support costs, are charged to operations in the period incurred. The six
percent decrease in product development expenses for the three months ended
June 30, 2001 is primarily due to $0.4 million decrease in expenditures
associated with resources dedicated to completing two major internally
developed titles, which did not recur in the current period. We expect product
development expenses to decrease in 2001 compared to 2000, due to canceled or
suspended future projects in an effort to reduce expenditures and a reduction
in headcount subsequent to June 30, 2001.
The six percent decrease in product development expenses for the six months
ended June 30, 2001 compared to the same period in 2000 is due to $0.7 million
decrease in expenditures associated with resources dedicated to completing
three major internally developed titles, which did not recur in the current
period.
18
Other Expense, net
Other expense consists primarily of interest expense on our lines of credit
and foreign currency exchange transaction losses. Other expense increased 32
percent in the three months ended June 30, 2001 compared to the same period in
2000 due to $0.4 million in loan fees associated with the transition of our
line of credit, $0.3 million penalty due to a delay in the effectiveness of a
registration statement in connection with the private placement of 8,126,770
shares of Common Stock, offset by a $0.4 million decrease in interest expense
on lower total debt. If the registration statement for the Common Stock shares
sold in a private placement in April 2001 is not declared effective, we will
continue to accrue a two percent penalty (approximately $250,000) each month
that the registration statement is not declared effective and there is no
limit on the amount payable. Because this payment is cumulative, this
obligation could have a material adverse effect on our financial condition.
Moreover, we may be unable to pay the total penalties due to the investors in
the private placement of Common Stock.
The two percent decrease for the six months ended June 30, 2001 compared to
the same period in 2000 was due to $0.4 million in loan fees paid to the
former bank associated with the transition of our line of credit to a new
bank, $0.3 million penalty due to the registration statement for the private
placement of 8,126,770 shares of Common Stock, offset by a $0.7 million
decrease in interest expense on lower total debt under the new line of credit
agreement.
Liquidity and Capital Resources
We have funded our operations to date primarily through the use of lines of
credit, from royalty and distribution fee advances, through cash generated by
the private sale of securities, from proceeds of the initial public offering
and from results of operations. As of June 30, 2001 our principal sources of
liquidity included cash of $0.7 million and availability of $3.1 million under
our working capital line of credit. In August 2001, we received a $4 million
advance for the North American distribution rights of a future title.
In April 2001, we secured a new working capital line of credit from a bank
and repaid all amounts outstanding on our former line of credit and
supplemental line of credit. These lines of credit were terminated upon full
payment. Our new working capital line of credit line bears interest at the
bank's prime rate, or, at our option, a portion of the outstanding balance
bears interest at LIBOR plus 2.5%, for a fixed short-term. At June 30, 2001,
borrowings under the new working capital line of credit bore interest at
various interest rates between 6.39 percent and 7 percent. Our new line of
credit provides for borrowings and letters of credit of up to $15 million
based in part upon qualifying receivables and inventory. Under the new line of
credit the Company is required to maintain a $2 million personal guarantee by
the Company's Chairman and Chief Executive Officer ("Chairman"). The new line
of credit has a term of three years, subject to review and renewal by the bank
on April 30 of each subsequent year. As of June 30, 2001, we are not in
compliance with the financial covenants under the new line of credit
pertaining to net worth and minimum earnings before interest, taxes,
depreciation and amortization. If the bank does not waive compliance with the
required covenants under the credit agreement, the bank could terminate the
credit agreement and accelerate payment of all outstanding amounts. Because we
depend on this credit agreement to fund our operations, the bank's termination
of the credit agreement could cause material harm to our business, including
our inability to continue as a going concern.
In addition, in April 2001, we completed a private placement of 8,126,770
shares of Common Stock for $12.7 million, and received net proceeds of
approximately $11.9 million. The shares were issued at $1.5625 per share, and
included warrants to purchase one share of Common Stock for each share sold.
The warrants are exercisable at $1.75 per share, and the warrants can be
exercised immediately. The warrants expire in March 2006. The transaction
provides for a registration statement covering the shares sold or issuable
upon exercise of such warrants to be filed by April 16, 2001 and become
effective by May 31, 2001. In the event that the agreed effective date of the
registration statement is not met, we are subject to a two percent penalty per
month, payable in cash, until the registration statement is effective. We did
not meet the effective date of the registration statement and we are incurring
a monthly penalty of $254,000, payable in cash, until the effectiveness of the
19
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 investors. Because this payment is cumulative,
this obligation could have a material adverse effect on our financial
condition. Moreover, we may be unable to pay the total penalty due to the
investors.
In April 2001, the Chairman provided us with a $3 million loan, payable in
May 2002, with interest at 10 percent. In connection with this loan to us and
the $2 million guarantee he provided under the new line of credit from a bank,
the Chairman received warrants to purchase 500,000 shares of our Common Stock
at $1.75 per share, vesting upon issuance and expiring in April 2004.
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 used cash of $1.7 million during
the six months ended June 30, 2001, primarily attributable to the net loss for
the year, substantially offset by collections of accounts receivable. Net cash
provided by financing activities of $0.7 million for the six months ended June
30, 2001, consisted primarily of the proceeds from the private placement of
8,126,770 shares of our Common Stock, an advance for the development of future
titles on a next generation video game console, borrowings under our new
working capital line of credit and borrowings under a loan payable to our
Chairman, offset by repayments of our previous line of credit and supplemental
line of credit from Titus. Cash used in investing activities of $1.1 million
for the six months ended June 30, 2001 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.
To reduce our working capital needs, we have implemented various measures
including a reduction of personnel, a reduction of fixed overhead commitments,
cancelled or suspended development on future titles and have scaled back
certain marketing programs. We will continue to pursue various alternatives to
improve future operating results, including further expense reductions, some
of which may have a long-term adverse impact on our ability to generate
successful future business activities.
Advances under our line of credit are limited to an amount calculated as a
percentage of accounts receivable and inventories. We have not released
sufficient product during the three month period ended June 30, 2001 to
generate a profitable level of revenues, or sufficient accounts receivable to
maximize the use of our credit line. We also anticipate that delays in product
releases could continue in the short-term, and funds available under our new
credit line and from ongoing operations are not sufficient to satisfy the
projected working capital and capital expenditures to continue operating in
the normal course of business. In addition, we are not in compliance with the
financial covenants required under our credit line and the bank could
terminate the financing agreement and accelerate payment of outstanding
amounts.
We will request waivers for non-compliance and extension of the line of
credit from our bank, continue to implement cost reduction programs, including
a reduction of personnel, a reduction of fixed overhead commitments, cancelled
or suspended development on future titles and have scaled back certain
marketing programs, and we will continue 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 our long-term strategic
objectives. However, there is no assurance that we can complete the
transactions necessary to provide the required funding on a timely basis in
order to continue operating as a going concern.
Our consolidated financial statements have been presented on the basis that
we are a going concern. However, our independent public accountant has
informed us that if we are unable to resolve the covenant violations on our
line of credit with our current bank or obtain alternative debt or equity
financing sufficient to cover our operating cash flow requirements through
December 31, 2001 and beyond, or to adequately address the issues described
above, that it is likely that they will issue a modified report for going
concern on our financial statements as of December 31, 2001.
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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 June 30, 2001, our cash balance was approximately $677,000 and our
outstanding accounts payables totaled approximately $14.8 million. 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 financial condition. In addition, because
we have not yet registered the shares issued in our April 2001 private
placement of common stock, we have, as of August 1, 2001, an accrued
obligation to pay the private placement investors an aggregate amount of
$508,000 in cash payable on demand. This obligation will continue to accrue at
approximately $250,000 each month that we do not register the shares. There is
no cap on the penalty due to our failure to register such shares. Because of
our financial condition, our Board of Directors has a duty to our creditors
that may conflict with the interests of our stockholders. If we cannot obtain
additional capital, the Board may make decisions that favor the interests of
creditors at the expense of our stockholders.
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 and debt financing depends on a number of factors including:
. the progress and timely completion of our product development programs;
. our products' commercial success;
. our ability to license intellectual property on favorable terms;
. the introduction and acceptance of new hardware platforms by third
parties; and
. our compliance with the financial covenants of our existing line of
credit.
If we cannot raise additional capital on favorable terms, we will have to
reduce our costs by selling or consolidating our operations, and by delaying,
canceling, suspending or scaling back product development and marketing
programs. These measures could materially limit our ability to publish
successful titles and may not decrease our costs enough to restore our
operations to profitability.
Our failure to comply with the covenants in our existing credit agreement
could result in the termination of the agreement and 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 safeguard, maintain and insure substantially all of our property,
which property is collateral for any loans made under the credit
agreement;
. not to incur additional debt, except for trade payables and similar
transactions, or to make loans;
. not to enter into any significant corporate transaction, such as a
merger or sale of substantially all of our assets without the knowledge
of and consent LaSalle;
. to maintain an agreed-upon tangible consolidated net worth, to be set by
the parties for periods subsequent to April 2001;
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. to maintain a ratio of earnings before interest, taxes, depreciation and
amortization, or EBITDA, to interest expense of at least 1.25 to 1.00;
. not to make capital expenditures in an aggregate amount of more than
$2.5 million in any fiscal year without the consent of LaSalle; and
. to maintain EBITDA of at least the following amounts for the following
periods:
. negative $7.2 million for the six month period from January 1, 2001
through June 30, 2001;
. negative $3.5 million for the nine month period from January 1, 2001
through September 30, 2001; and
. $7.7 million during any consecutive twelve-month period from and
after January 1, 2001.
We are not in compliance with the financial covenants pertaining to net
worth and minimum EBITDA. If LaSalle does not waive compliance with these
covenants, or if we breach other covenants or if there are other events of
default in effect under the credit agreement and LaSalle does not waive
compliance with them, LaSalle would be able to terminate the credit agreement
and all outstanding amounts owed to LaSalle would immediately become due and
payable. Because we depend on our credit agreement to fund our operations,
LaSalle's termination of the credit agreement could cause material harm to our
business.
A change of control may cause the termination of several of our material
contracts with our licensors and distributors.
If there were a change of control of our Board of Directors, certain of our
third-party developers and licensors may assert that this event constitutes a
change of control and they may attempt to terminate existing development and
distribution agreements with us. In particular, our license for "the Matrix"
allows for the licensor to terminate the license if there is a change of
control without their approval. The loss of the Matrix license would
materially harm our projected operating results and financial condition.
The unpredictability of our quarterly results may cause our stock price to
decline.
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:
. demand for our products and our competitors' products;
. the size and rate of growth of the market for interactive entertainment
software;
. changes in personal computer and video game console platforms;
. 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;
. changes in our product mix;
. the number of our products that are returned; and
. 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:
. the uncertainties associated with the interactive entertainment software
development process;
. approvals required from content and technology licensors; and
. 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.
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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.
We have incurred significant net losses in recent periods, including a net
loss of $20.8 million in the six months ended June 30, 2001, $12.1 million
during 2000 and $41.7 million during 1999. Our losses stem partly from the
significant costs we incur to develop our entertainment software products.
Moreover, a significant portion of our operating expenses are 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.
In the past, revenues have been reduced by:
. delays in the introduction of new software products;
. delays in the introduction, manufacture or distribution of the platform
for which a software product was developed;
. a higher than expected level of product returns and markdowns on
products released during the year;
. the cost of restructuring our operations, including international
distribution arrangements; and
. lower than expected worldwide sales of entertainment software releases.
Similar problems may occur in the future. Any reductions in our net
revenues could harm our business and financial results.
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. Moreover, delays in game console software
products largely depend on the timeliness of introduction of game console
platforms by the manufacturers of those platforms, such as Sega and Nintendo.
The introduction by a manufacturer of a new game platform too late in the
holiday buying season could result in a substantial loss of revenues by us.
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.
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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 we 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 largest stockholder, Titus Interactive SA, may implement or block
corporate actions in ways that are not in the best interests of our
stockholders as a whole.
Titus currently owns approximately 43.3% of our common stock, and, in
connection with their ownership of our Series A Preferred Stock, controls
approximately 48% of the total voting power of our stock. Upon conversion of
the Series A Preferred Stock held by Titus as of August 14, 2001, Titus could
own up to approximately 7.7 million additional shares of our common stock,
bringing its total ownership to approximately 51.6%, of our common stock.
Titus may continue to convert each share of their Series A Preferred Stock, to
the extent not previously redeemed by us, into a number of shares of our
Common Stock determined by dividing $27.80 by the lesser of (i) $2.78 or (ii)
85 percent of the average closing price per share as reported by Nasdaq for
the twenty trading days preceding the date of conversion. Pursuant to the
terms of our Series A Preferred Stock, Titus also has the ability to block
approval of a merger or change in control that the holders of a majority of
our common stock may deem beneficial.
In connection with its investment, Titus has elected its Chief Executive
Officer and its President to serve as members of our Board of Directors and
Titus' Chief Executive Officer serves as our President. Titus may elect
additional members that would constitute a majority of directors.
As a consequence of its stock ownership and Board and management
representation, Titus exerts significant influence over corporate policy and
potentially may implement or block corporate actions that are not in the
interests of Interplay and its stockholders as a whole. For example, Titus
could compel us to enter into agreements with Titus or its subsidiaries on
terms more favorable than those we would agree to with a third party or to
forego enforcement of our rights against Titus or its subsidiaries. Titus
could also use its veto over mergers to prevent a merger than may be in the
best interests of our stockholders as a whole or to try to negotiate more
favorable merger consideration for itself.
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.
For continued inclusion on the Nasdaq National Market, we must meet certain
tests, including a minimum bid price of $1.00 and net tangible assets of at
least $4 million. We currently are not in compliance with the minimum net
tangible assets requirement. In addition, during the second quarter of fiscal
2000 we were subject to a hearing before a Nasdaq Listing Qualifications
Panel, which determined to continue the listing of our common stock on the
Nasdaq National Market subject to certain conditions, all of which were
fulfilled. However, if we continue to fail to satisfy the listing standards on
a continuous basis, Nasdaq may delist our common stock from its National
Market System.
The variable conversion price of our Series A Preferred Stock increases our
risk of being delisted in several ways:
. Bid Price. The substantial number of shares that are potentially
issuable upon conversion of the Series A Preferred Stock and the short
selling that may occur as a result of the future priced nature of those
shares increases the risk that our stock price will fall below Nasdaq's
minimum bid price requirement and could, as noted above, result in our
being delisted. See our risk factors "Substantial sales of our common
stock by our existing stockholders may reduce the price of our stock and
dilute existing stockholders" and "The holder of our Series A Preferred
Stock could engage in short selling . . ."
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. Public Interest Concerns. If the returns on our Series A Preferred Stock
are deemed "excessive" compared with those of public investors in our
common stock, Nasdaq may deny inclusion or apply more stringent criteria
to the continued listing of our common stock. In making this analysis,
Nasdaq considers:
-- the amount raised in the transaction relative to our capital
structure at the time of issuance;
-- the dilutive effect of the transaction on our existing holders of
common stock;
-- the risk undertaken by Titus in purchasing our Series A Preferred
Stock;
-- the relationship between Titus and us;
-- whether the transaction was preceded by other similar transactions;
and
-- whether the transaction is consistent with the just and equitable
principles of trade.
Nasdaq also considers, as mitigating factors in its analysis,
incentives that encourage Titus to hold the Series A Preferred Stock
for a longer time period and limit the number of shares into which the
Series A Preferred Stock may be converted. Such features may limit the
dilutive effect of the transaction and increase the risk undertaken by
Titus in relationship to the reward available.
. Change of Control and Change of Financial Structure. As of August 14,
2001, the Series A Preferred Stock was convertible into 7.7 million
shares of our common stock. The exercise of these conversion rights
could increase Titus' percentage ownership of our capital stock
significantly and may cause Nasdaq to determine that (i) a merger or
consolidation that results in a change of control or (ii) a change in
financial structure has occurred. If Nasdaq determines that the
conversion of our Series A Preferred Stock constitutes a change in
control and a change in financial structure, we would need to re-apply
for listing on Nasdaq and satisfy all initial listing requirements as of
that time. We currently do not satisfy those initial listing
requirements.
If our common stock were delisted from the Nasdaq National Market, trading
of our common stock, if any, may be conducted on the Nasdaq Small Cap Market,
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.
A significant percentage of our international sales depend on our distribution
agreement with Virgin and Virgin's diligent sales efforts and timely payments
pursuant to that agreement.
In connection with our acquisition in February 1999 of a 43.9% limited
liability company membership interest in VIE Acquisition Group, LLC, or VIE,
the parent entity of Virgin Interactive Entertainment Limited, or Virgin, we
signed an international distribution agreement with Virgin. Under this
agreement, we appointed Virgin as exclusive distributor for most of our
products in Europe, the Commonwealth of Independent States, Africa and the
Middle East, for a seven-year period. During the course of the last two years,
due to a dispute regarding the amount of overhead fees and commissions we owed
Virgin, Virgin withheld material amounts of proceeds from us from their
distribution of our products from time to time.
In April 2001, we entered into a settlement agreement with Virgin in which:
. each party entered into a general release from claims against the other
party;
. Virgin paid us $3.1 million in settlement of amounts due us under the
distribution agreement;
. we paid Virgin $330,000 for marketing overhead related to sales of our
products;
. VIE redeemed our membership interest in VIE in full in exchange for the
performance of our obligations under the settlement agreement;
. pursuant to the concurrent third amendment to our distribution agreement
with Virgin, the overhead fees owed to Virgin going forward were
immediately reduced and will be eliminated by July 2002; and
. we no longer have an equity interest in Virgin. Virgin is a wholly owned
subsidiary and is controlled by Titus.
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Virgin remains our exclusive distributor throughout much of the world,
therefore our revenues could fall significantly and our business and financial
results could suffer material harm if:
. further disputes arise over amounts payable by us to Virgin;
. Virgin fails to deliver to the full proceeds owed us from distribution
of our products;
. fails to effectively distribute our products abroad; or
. otherwise fails to perform under the distribution agreement.
Two of our directors have substantial, conflicting interests in our most
significant distributor, Virgin Interactive Entertainment, Limited.
All of the equity interests of VIE are owned by Titus, a significant
stockholder of Interplay, which is controlled by two of our directors, Messrs.
Herve Caen and Eric Caen. Herve Caen is the Chief Executive Officer of Titus
and Eric Caen is the President of Titus. Herve Caen also serves as our
President. Due to their positions with both of us and Titus, either of the
Caens could influence or induce us to enter into agreements or business
arrangements with VIE, or its subsidiary Virgin, on terms less favorable to us
than we would negotiate with an unaffiliated third party in an arm's length
transaction.
Our long-term exclusive distribution agreement with Virgin may discourage
potential acquirors from acquiring us.
Pursuant to the settlement agreement we entered into with Titus, Virgin and
VIE on April 11, 2001, during the seven-year term of our February 1999
distribution agreement with Virgin, we agreed not to sell, license our
publishing rights, or enter into any agreement to either sell or license our
publishing rights with respect to any products covered by the distribution
agreement in the territory covered by the distribution agreement, with the
exception of two qualified sales each year.
The restrictions on sales and licensing of publishing rights until 2006 may
discourage potential acquirors from entering into an acquisition transaction
with us, or may cause potential acquirors to demand terms that are less
favorable to our stockholders. In addition, the settlement agreement contains
termination penalties of a minimum of $10 million, subject to substantial
increases pursuant to the terms of the settlement agreement, which also may
discourage potential acquirors that already have their own distribution
capabilities in these territories.
Our reliance on third party software developers subjects us to the risks that
these developers will not supply us in a timely manner with high quality
products or on acceptable terms.
Third party interactive entertainment software developers, such as Bioware
Corp. and Planet Moon Studios develop many of our software products. Since we
depend on these developers in the aggregate, we remain subject to the
following risks:
. continuing strong demand for the developers' products may cause
developers who developed products for us in the past to instead work for
our competitors in the future;
. the inability for us to control whether developers complete products on
a timely basis or within acceptable quality standards, or at all;
. 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
. 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. If the products subject to these arrangements 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.
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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:
. operating systems such as Microsoft Windows 2000;
. technologies that support games with multi-player and online features;
. new media formats such as online delivery and digital video disks, or
DVDs; and
. recent releases or planned releases in the near future 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 which gain widespread consumer acceptance. Our business and
financial results may suffer material harm if we fail to:
. anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
. obtain licenses to develop products for those platforms on favorable
terms; or
. 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 can to licensors of desirable motion
picture, television, sports and character properties and to third party
software developers. We believe that the main competitive factors in the
interactive entertainment software industry include:
. product features;
. brand name recognition,
. access to distribution channels;
. quality;
. ease of use, price, marketing support and quality of customer service;
and
. ability to obtain licenses to popular 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.
27
. Infogrames Entertainment
. Microsoft Corporation
. LucasArts Entertainment Company
. Midway Games Inc.
. Acclaim Entertainment, Inc.
. Vivendi Universal Interactive Publishing
. Ubi Soft Entertainment Publishing
. The 3DO Company
. Take Two Interactive Software, Inc.
. Eidos PLC
. THQ Inc.
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, Microsoft Corporation and Sega
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 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 sale
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.
Because we sell a substantial portion of our products on a purchase order
basis, our sales may decline substantially without warning and in a brief
period of time.
We currently sell our products through our sales force to mass merchants,
warehouse club stores, large computer and software specialty chains and
through catalogs in the United States and Canada, as well as to certain
distributors. Outside North America, we generally sell products to third party
distributors. We make our sales primarily on a purchase order basis, without
long-term agreements. The loss of, or significant reduction in sales to, any
of our principal retail customers or distributors could cause material harm to
our business.
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If we are compelled to sell a larger proportion of our products to
distributors, our gross profit may decline.
Mass merchants are the most important distribution channel for retail sales
of interactive entertainment software. A number of these mass merchants have
entered into exclusive buying arrangements with software developers or other
distributors, which arrangements could prevent us from selling some or all of
our products directly to that mass merchant. If the number of mass merchants
entering into exclusive buying arrangements with our competitors were to
increase, our ability to sell to such merchants would be restricted to selling
through the exclusive distributor. Because sales to distributors typically
have a lower gross profit than sales to retailers, this would lower our gross
profit. This trend could cause material harm to our business.
If our distributors or retailers cannot honor their credit arrangements with
us, we may be burdened with payment defaults and uncollectible accounts.
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
have risk of non-payment from our customers due to financial inability to pay,
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.
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
49.4 million shares of our common stock for the benefit of the holders we
describe below. Assuming the effectiveness of these registration statements,
these shares would be eligible for immediate resale in the public market.
. Universal Studios, Inc. holds approximately 10.4%, of our outstanding
common stock, all of which are being registered.
. Titus currently holds approximately 43.3% of our outstanding common
stock and upon conversion of all its shares of Series A Preferred Stock,
may own up to approximately 51.6% of our common stock. All of the shares
of common stock issuable to Titus upon the conversion of the preferred
stock or the exercise of the warrants are being registered in this
registration statement.
. Pursuant to registration statement 333-59008, filed on April 4, 2001, we
intend to register shares equal to approximately 18% of our outstanding
common stock, held by a number of our investors as set forth in that
registration statement.
. Employees and directors hold options and warrants to purchase 10.8% of
our common stock, substantially most of which are eligible for immediate
resale. We may issue options to purchase up to an additional 2.0% of our
common stock to employees and directors, which we anticipate will be
freely tradable when issued.
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Although the holders described above are subject to restrictions on the
transfer of our common stock, future sales by such holders 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, Matrix 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. We may not be able to obtain new licenses, or maintain or renew
existing licenses, on commercially reasonable terms, if at all. For example,
Viacom Consumer Products, Inc. has granted the Star Trek license to another
party upon the expiration of our rights in 2002. If we are unable to obtain
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 the 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 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 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:
. 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
. reorders of discs are expensive, reducing the revenues we receive from
software releases that have stronger sales than initially anticipated
and that require the production of additional discs.
As a result, Sony, Nintendo and Microsoft 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 lesser 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, and in particular on the leadership,
strategic vision and industry reputation of our founder and Chief Executive
Officer, Brian Fargo. Our future success also will depend upon
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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 incur increased costs
in order to attract and retain skilled employees. Our failure to retain the
services of Brian Fargo or other key personnel, including competent executive
management, or to attract and retain additional qualified employees could
cause material harm to our business.
Titus intends to gain control of our board of directors, which could result in
a significant change in management and operations.
Titus has stated that they intend to gain control of our Board of
Directors. It is possible that this change in control could result in a change
in our management and operations. Significant changes in the composition of
our executive management team may hinder our ability to address the other
challenges we face, and may cause material harm to our business or financial
condition.
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 17 percent of our
total net revenues for the six months ended June 30, 2001 and 28 percent for
the six months ended June 30, 2000. 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:
. recessions in foreign economies may reduce purchases of our products;
. translating and localizing products for international markets is time-
consuming and expensive;
. accounts receivable are more difficult to collect and when they are
collectible, they may take longer to collect;
. regulatory requirements may change unexpectedly;
. it is difficult and costly to staff and manage foreign operations;
. fluctuations in foreign currency exchange rates;
. political and economic instability;
. we depend on Virgin as our exclusive distributor in Europe, the
Commonwealth of Independent States, Africa and the Middle East; and
. 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 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.
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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.
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:
. cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
. 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
. 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
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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.
Our directors and officers control a large percentage of our voting stock and
may use this control to compel corporate actions that are not in the best
interests of our stockholders as a whole.
Including Titus, our directors and executive officers beneficially own
approximately 69% of our aggregate common stock. In the event Titus converts
all of its shares of Series A Preferred Stock into common stock, the
additional shares could increase Titus' ownership to approximately 51.6%.
These stockholders 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. 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.
Moreover, since Titus owns 100% of VIE and only up to approximately 51.6%
of Interplay, Titus will recognize more revenue on a consolidated basis to the
extent it is able to divert revenues to the Virgin entities at the expense of
Interplay. Therefore, Titus has an incentive to compel Interplay to enter into
transactions with the Virgin entities on terms less favorable than might
prevail in a transaction with an unaffiliated third party.
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:
. increases in the Internet's data transmission capability;
. 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.
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 4,616,646 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:
. eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
. require stockholders to give advance notice if they wish to nominate
directors or submit proposals for stockholder approval.
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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.
The holder of our Series A Preferred Stock could engage in short selling to
increase the number of shares of common stock issuable upon conversion of our
Series A Preferred Stock. If this occurs, the market price of our common stock
and the value of your investment may decline.
Titus, the sole holder of shares of our Series A Preferred Stock, may
convert those shares into shares of our common stock. The shares of our Series
A Preferred Stock generally are convertible into a number of shares of common
stock determined by dividing $27.80 by the lesser of (a) $2.78 and (b) 85
percent of the average of the closing prices per share as reported by the
Nasdaq National Market for the twenty trading days preceding the date of
conversion.
Based on the above formula, the number of shares of our common stock that
are issuable upon conversion of the Series A Preferred Stock increases as the
price of our common stock decreases. Increases in the number of shares of our
common stock which are publicly traded could put downward pressure on the
market price of our common stock. Depending on the trading volume of our
stock, the sale of a relatively limited number of shares could cause a
significant decrease in price. Therefore, Titus could sell short our common
stock prior to conversion of the Series A Preferred Stock, potentially causing
the market price to decline and a greater number of shares to become issuable
upon conversion of the Series A Preferred Stock. Titus could then convert its
Series A Preferred Stock and use the shares of common stock received upon
conversion to cover its short positions. Titus could thereby profit by the
decline in the market price of our common stock caused by its short selling.
See also the risk factor entitled "Substantial sales of our common stock by
our existing stockholders may reduce the price of our stock and dilute
existing stockholders."
Our stock price is volatile.
The trading price of our common stock has previously 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:
. general conditions in the computer, software, entertainment, media or
electronics industries;
. changes in earnings estimates or buy/sell recommendations by analysts;
. investor perceptions and expectations regarding our products, plans and
strategic position and those of our competitors and customers;
. 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.
Increases in interest rates will increase the cost of our debt.
Our working capital line of credit bears interest at either the bank's
prime rate or LIBOR, at our option both of which are variable rates. As such,
if interest rates increase, we will have to use more cash to service our debt,
which could impede our ability to meet other expenses as they become due and
could cause material harm to our business and financial condition.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of June 30, 2001.
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 our revolving line of credit agreement, 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
The table below provides information as of June 30, 2001 about our other
financial instruments that are sensitive to changes in interest rates.
Working Capital Line of Credit (Variable Rate)
----------------------------------------------
Amount borrowed at June 30, 2001......................... $6.1 million
Maximum amount of Line................................... $15 million(1)
Variable interest rates.................................. 6.39-7.0%(2)
Expiration............................................... April 30, 2004(3)
--------
(1) Advances under the line are limited to an advance formula of qualified
accounts receivable and inventory. At June 30, 2001, the amount available
for borrowing under the line was $3.1 million.
(2) Borrowings bear interest at the bank's prime rate, or, at our option, a
portion of the outstanding balance at LIBOR plus 2.5 percent.
(3) The line is subject to review and renewal by the bank on April 30, 2002
and 2003. At June 30, 2001, we were not in compliance with certain
financial covenants and the line may be subject to termination and
acceleration of payment.
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 losses of $339,000 for the six months ended June
30, 2001 and $935,000 for the year ended December 31, 2000, primarily in
connection with foreign exchange fluctuations in the timing of payments
received on accounts receivable from Virgin. Based upon the average foreign
currency rates for the six months ended June 30, 2001, a hypothetical 10
percent change in the applicable foreign exchange rates would have increased
our loss by approximately $34,000.
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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.
Item 5. Other Information
On August 13, 2001, the Company's largest stockholder, Titus Interactive,
S.A., converted 336,070 shares of Series A Preferred Stock of the Company into
6,679,306 shares of Common Stock. After the conversion, Titus owns
approximately 19,496,561 shares of Common Stock, which constitutes
approximately 43 percent of the total outstanding common stock of the Company.
In addition, Titus holds a remaining 383,354 shares of Series A Preferred
Stock, which depending upon the conversion ratio, upon conversion most likely
would result in Titus owning a majority of the Company's issued and
outstanding shares of Common Stock. Titus did not pay any additional
consideration for the Common Stock issued upon conversion of the Series A
preferred stock. As of August 13, Titus controls approximately 48 percent of
the voting securities of the Company.
The Company previously had announced discussions during the quarter with a
third party concerning the acquisitions of the Company. The discussions with
such third party have terminated.
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
------- -------------
10.1 Loan and Security Agreement between the Company and LaSalle Business
Credit, Inc., dated April 11, 2001
10.2 Warrant to Purchase Common Stock issued to Brian Fargo, dated April
11, 2001
10.3 Secured Promissory Note issued to Brian Fargo, dated April 11, 2001
10.4 Security Agreement between the Company and Brian Fargo, dated April
11, 2001
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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: August 17, 2001 /s/ Brian Fargo
By: _________________________________
Brian Fargo,
Chairman of the Board and Chief
Executive Officer
(Principal Executive Officer)
Date: August 17, 2001 /s/ Manuel Marrero
By: _________________________________
Manuel Marrero,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
37