UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
Interplay Entertainment Corp.
(Exact name of the registrant as specified in its charter)
Delaware 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 Von Karman Avenue, Irvine, California 92606
(Address of principal executive offices)
(949) 553-6655 (Registrant's telephone number, including area code)
Securities registered pursuant of Section 12 (b) of the Act: None
Securities registered pursuant of Section 12 (g) of the Act:
Common Stock, $0.001 par value
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 28, 2002, the aggregate market value of voting common stock held by
non-affiliates was $3,056,628, based upon the closing price of the Common Stock
on that date.
As of March 21, 2003, 93,849,176 shares of Common Stock of the Registrant were
issued and outstanding.
Documents Incorporated by Reference
Portions of the definitive proxy statement for the issuer's 2003 Annual Meeting
of Stockholders are incorporated by reference into Part III of this Report.
INTERPLAY ENTERTAINMENT CORP.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002
PAGE
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PART I
Item 1. Business 4
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 13
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosure about
Market Risk 38
Item 8. Consolidated Financial Statements and Supplementary
Data 39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 39
PART III
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 39
Item 13. Certain Relationships and Related Transactions 39
Item 14. Controls and Procedures 39
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 40
Signatures 41
Exhibit Index 43
2
This Form 10-K 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-K 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," "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 in this Form 10-K are based on
current expectations that involve a number of risks and uncertainties, as well
as certain assumptions. For example, any statements regarding future cash flow,
financing activities, cost reduction measures, replacement of the Company's
terminated line of credit are forward-looking statements and there can be no
assurance that the Company will generate positive cash flow in the future or
that the Company will be able to obtain financing 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; or that the Company will be able
to renew or replace its line of credit. 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, lost sales because of the rescheduling of product launches or order
deliveries, 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 changes in the Company's operations
or business. Additional factors that may affect future operating results are
discussed in more detail in "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Future Performance".
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-K 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.
Interplay (R), Interplay Productions(R) and certain of the Company's
product names and publishing labels referred to in this Form 10-K are the
Company's trademarks. This Annual Report on Form 10-K also contains trademarks
belonging to others.
3
PART I
Item 1. BUSINESS
OVERVIEW AND RECENT DEVELOPMENTS
Interplay Entertainment Corp., which we refer to in this Form 10-K as "we,"
"us," or "our," is a developer and publisher of interactive entertainment
software for both core gamers and the mass market. We were incorporated in the
State of California in 1982 and were reincorporated in the State of Delaware in
May 1998. We are most widely known for our titles in the action/arcade,
adventure/role playing game (RPG), and strategy/puzzle categories. We have
produced titles for many of the most popular interactive entertainment software
platforms, and currently balance our publishing and distribution business by
developing interactive entertainment software for PCs and next generation video
game consoles, such as the Sony PlayStation 2, Microsoft Xbox and Nintendo
GameCube.
We seek to publish interactive entertainment software titles that are, or
have the potential to become, franchise software titles that can be leveraged
across several releases and/or platforms, and have published many such
successful franchise titles to date. In addition, we hold licenses to use
popular brands, such as Advanced Dungeons and Dragons, for incorporation into
certain of our products.
During 2002 we continued to experience cash flow difficulties from
operations, and relied upon sales of assets to pay liabilities, reduce future
operational costs and fund our ongoing operations. We have been operating
without a credit facility since October 2001, which has adversely affected cash
flow. We expect these difficulties to continue during 2003.
In February 2003 Virgin Interactive Entertainment (Europe) Limited, the
operating subsidiary of Virgin Interactive Entertainment Limited ("Virgin"), our
European distributor, filed for a Company Voluntary Arrangement or "CVA", a
process of reorganization in the United Kingdom, which must be approved by
Virgin's creditors. Virgin owed us approximately $1.8 million at December 31,
2002. As of March 28, 2003, the CVA was rejected by Virgin's creditors, and
Virgin is presently negotiating with its creditors to propose a new CVA. We do
not know what affect approval of the CVA will have on our ability to collect
amounts Virgin owes us. If the new CVA is not approved, we expect Virgin to
cease operations and liquidate, in which event we will most likely not receive
any amounts presently due us by Virgin, and will not have a distributor for our
products in Europe and the other territories in which Virgin presently
distributes our products.
In February 2003, we amended our license agreement with Infogrames, the
holder of the TSR license which we rely on to publish the Baldur's Gate,
Baldur's Gate: Dark Alliance, and Icewind Dale titles, to, among other things,
(i) extend the license term for approximately an additional two years to
December 31, 2008 (provided we make a timely extension payment required for such
extension), and (ii) extend our rights with respect to certain of the Advanced
Dungeons & Dragons properties. The amendment further terminates our rights to
certain titles in the event Interplay is unable to obtain certain third-party
waivers in accordance with the terms of the amendment. We were unable to obtain
the required waivers within the permitted time period and as a result have lost
rights to publish Baldur's Gate 3 and its sequels on the PC, a significant
product franchise. We are in negotiations with Infogrames to reinstate these
rights, but no assurance can be given that we will be successful.
In January 2002, we settled a dispute with a developer related to the sale
of publishing rights for one of our products and the recognition of deferred
revenue for a licensing transaction. We sold the publishing rights to this title
to the distributor in connection with a settlement agreement entered into with
the third party developer. The settlement agreement provided, among other
things, that we assign our rights and obligations under the product agreement to
the third party distributor. As a result, we recorded net revenues of $5.6
million in the three months ended March 31, 2002.
In April 2002, we sold our product development subsidiary, Shiny
Entertainment, Inc. for $47.2 million which was paid as follows: we received
$13.8 million in cash payments, $26.1 million was paid directly to third party
creditors, and $7.3 million was paid to Shiny's president and Shiny Group, his
wholly-owned subsidiary, for Shiny common stock that was issued to them to
settle claims relating to our original acquisition of Shiny. We recognized a
gain of $28.8 million on the sale of Shiny.
4
In August 2002, we entered into a new distribution arrangement with Vivendi
Universal Games, Inc. (the parent company of Universal Studios, Inc., who as of
today owns approximately 5 percent of our common stock), or "Vivendi," whereby,
Vivendi will distribute substantially all of our products in North America for a
period of three years as a whole and two years with respect to each product
giving a potential maximum term of five years. Under the August 2002 agreement,
Vivendi will pay us sales proceeds less amounts for distribution fees, price
concessions and returns. Vivendi is responsible for all manufacturing, marketing
and distribution expenditures, and bears all credit, price concessions and
inventory risk, including product returns. Upon our delivery of a gold master to
Vivendi, Vivendi will pay us, as a non-refundable minimum guarantee, a specified
percent of the projected amount due to us based on projected initial shipment
sales, which are established by Vivendi in accordance with the terms of the
agreement. The remaining amounts are due upon shipment of the titles to
Vivendi's customers. Payments for future sales that exceed the projected initial
shipment sales are paid on a monthly basis.
PRODUCTS
We develop and publish interactive entertainment software titles that
provide immersive game experiences by combining advanced technology with
engaging content, vivid graphics and rich sound. We utilize the experience and
judgment of the avid gamers in our product development group to select and
produce the products we publish. Our strategy is to invest in products for those
platforms, whether PC or video game console, that have or will have sufficient
installed bases for the investment to be economically viable. We currently
develop and publish products for the PC platform compatible with Microsoft
Windows, and for video game consoles such as the Sony PlayStation 2, the
Microsoft Xbox and the Nintendo GameCube. In addition, we anticipate substantial
growth in the use of high-speed Internet access, which could possibly provide
significantly expanded technical capabilities for the PC platform.
We assess the potential acceptance and success of emerging platforms and
the anticipated continued viability of existing platforms based on many factors,
including the number of competing titles, the ratio of software sales to
hardware sales with respect to the platform, the platform's installed base,
changes in the rate of the platform's sales and the cost and timing of
development for the platform. We must continually anticipate and assess the
emergence of, and market acceptance of, new interactive entertainment hardware
platforms well in advance of the time the platform is introduced to consumers.
Because product development cycles are difficult to predict, we are required to
make substantial product development and other investments in a particular
platform well in advance of the platform's introduction. If a platform for which
we develop software is not released on a timely basis or does not attain
significant market penetration, our business, operating results and financial
condition could be materially adversely affected. Alternatively, if we fail to
develop products for a platform that does achieve significant market
penetration, then our business, operating results and financial condition could
also be materially adversely affected.
We have entered into license agreements with Sega, Sony Computer
Entertainment, Microsoft Corporation and Nintendo pursuant to which the Company
has the right to develop, sublicense, publish, and distribute products for the
licensor's respective platforms in specified territories. In certain cases, the
products are manufactured for us by the licensor. We pay the licensor a royalty
or manufacturing fee in exchange for such license and manufacturing services.
Such agreements grant the licensor certain approval rights over the products
developed for their platform, including packaging and marketing materials for
such products. There can be no assurance that we will be able to obtain future
licenses from platform companies on acceptable terms or that any existing or
future licenses will be renewed by the licensors. Our inability to obtain such
licenses or approvals could have a material adverse effect on our business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors Affecting
Future Performance-- We may fail to maintain existing licenses, or obtain new
licenses from hardware companies on acceptable terms or to obtain renewals of
existing or future licenses from licensors."
The interactive entertainment software industry is highly seasonal, with
the highest levels of consumer demand occurring during the year-end holiday
buying season. As a result, our net revenues, gross profits and operating income
have historically been highest during the second half of the year. The impact of
this seasonality will increase as we rely more heavily on game console net
revenues in the future. Seasonal fluctuations in revenues from game console
products may cause material harm to our business and financial results.
5
PRODUCT DEVELOPMENT
We develop or acquire our products from a variety of sources, including our
internal development studios and publishing relationships with leading
independent developers.
The Development Process. We develop original products both internally,
using our in-house development staff, and externally, using third party software
developers working under contract with us. Producers on our internal staff
monitor the work of both inside and third party development teams through design
review, progress evaluation, milestone review and quality assurance. In
particular, each milestone submission is thoroughly evaluated by our product
development staff to ensure compliance with the product's design specifications
and our quality standards. We enter into consulting or development agreements
with third party developers, generally on a flat-fee, work-for-hire basis or on
a royalty basis, whereby we pay development fees or royalty advances based on
the achievement of milestones. In royalty arrangements, we ultimately pay
continuation royalties to developers once our advances have been recouped. In
addition, in certain cases, we will utilize third party developers to convert
products for use with new platforms.
Our products typically have short life cycles, and we therefore depend on
the timely introduction of successful new products, including enhancements of or
sequels to existing products and conversions of previously-released products to
additional platforms, to generate revenues to fund operations and to replace
declining revenues from existing products. The development cycle of new products
is difficult to predict, and involves a number of risks. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting Future Performance-- If we fail to anticipate
changes in video game platforms and technology, our business may be harmed."
During the years ended December 31, 2002, 2001 and 2000, we spent $16.2
million, $20.6 million and $22.2 million, respectively, on product research and
development activities. Those amounts represented 37 percent, 36 percent and 21
percent, respectively, of revenue in each of those periods.
INTERNAL PRODUCT DEVELOPMENT
U.S. Product Development. Our internal product development group in the
United States consisted of approximately 157 people at December 31, 2002. Once
we select a design for a product, we establish a production team, development
schedule and budget for the product. Our internal development process includes
initial design and concept layout, computer graphic design, 2D and 3D artwork,
programming, prototype testing, sound engineering and quality control. The
development process for an original, internally developed product typically
takes from 12 to 24 months, and six to 12 months for the porting of a product to
a different technology platform. We utilize a variety of advanced hardware and
software development tools, including animation, sound compression utilities and
video compression for the production and development of our interactive
entertainment software titles. Our internal development organization is divided
into separate studios, each dedicated to the production and development of
products for a particular product category. Within each studio, development
teams are assigned to a particular project. These teams are generally led by a
producer or associate producer and include game designers, software programmers,
artists, product managers and sound technicians. We believe that the separate
studios approach promotes the creative and entrepreneurial environment necessary
to develop innovative and successful titles. In addition, we believe that
breaking down the development function into separate studios enables us to
improve our software design capabilities, to better manage our internal and
external development processes and to create and enhance our software
development tools and techniques, thereby enabling us to obtain greater
efficiency and improved predictability in the software development process.
Shiny Entertainment. In April 2002, we sold our former subsidiary Shiny
Entertainment, Inc., which was developing a video game based on the motion
picture "The Matrix," to Infogrames Entertainment, Inc. for $47.2 million. After
recognizing closing costs, consideration to Warner Brothers for their consent to
transfer the Matrix license and expensing amounts previously paid for the Matrix
license, we recognized a gain of $28.8 million on this sale.
International Development. During 2001, we reassigned the process of
Interplay Productions Limited, our European subsidiary responsible for our
product development efforts in Europe to our corporate headquarters. Prior to
the reassignment, Interplay Productions Limited engaged and managed the efforts
of third party developers located in various European countries. We currently
have one original product under development in Europe, which we now manage from
our corporate headquarters in Irvine, California.
6
EXTERNAL PRODUCT DEVELOPMENT
To expand our product offerings to include hit titles created by third
party developers, and to leverage our publishing capabilities, we enter into
publishing arrangements with third party developers. In the years ended December
31, 2002, 2001 and 2000, approximately 67 percent, 80 percent and 70 percent,
respectively, of new products we released and which we believe are or will
become franchise titles were developed by third party developers. We expect that
the proportion of our new products which are developed externally may vary
significantly from period to period as different products are released. In
selecting external titles to publish, we seek titles that combine advanced
technologies with creative game design. Our publishing agreements usually
provide us with the exclusive right to distribute, or license another party to
distribute, a product on a worldwide basis (although, in certain instances our
rights are limited to a specified territory). We typically fund external
development through the payment of advances upon the completion of milestones,
which advances are credited against royalties based on sales of the products.
Further, our publishing arrangements typically provide us with ownership of the
trademarks relating to the product as well as exclusive rights to sequels to the
product. We manage the production of external development projects by appointing
a producer from one of our internal product development studios to oversee the
development process and work with the third party developer to design, develop
and test the game. At December 31, 2002, we had six titles being developed by
third party developers.
We believe this strategy of cultivating relationships with talented third
party developers provides an excellent source of quality products, and a number
of our commercially successful products have been developed under this strategy.
However, our reliance on third party software developers for the development of
a significant number of our interactive software entertainment products involves
a number of risks. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Future Performance--Our
reliance on third party software developers subjects us to the risks that these
developers will not supply us with high quality products in a timely manner or
on acceptable terms."
SEGMENT INFORMATION
We operate primarily in one industry segment, the development, publishing
and distribution of interactive entertainment software. For information
regarding the revenues and assets associated with our geographic segments, see
Note 14 of the Notes to our Consolidated Financial Statements included elsewhere
in this Report.
SALES AND DISTRIBUTION
Our sales and distribution is handled by Vivendi in North America and
selected rest-of-world countries and by Virgin in Europe, the Commonwealth of
Independent States, Africa and the Middle East and through licensing strategies
elsewhere. We also distribute our software products through on line services.
North America. In August 2001, we entered into a distribution agreement
with Vivendi providing for Vivendi to become our distributor in North America
through December 31, 2003 for substantially all of our products, with the
exception of products with pre-existing distribution agreements. OEM rights were
not among the rights granted to Vivendi under the distribution agreement. Under
the terms of the agreement, as amended, Vivendi earned a distribution fee based
on the net sales of the titles distributed. Under the agreement, as amended,
Vivendi made four advance payments to us totaling $13.5 million. Vivendi
recouped these advances from sales of our products in 2002 and we repaid a
portion of the advances with the proceeds received from the sale of Shiny.
In August 2002, we entered into a new distribution arrangement with
Vivendi, whereby, Vivendi will distribute substantially all of our products in
North America for a period of three years as a whole and two years with respect
to each product providing for a potential maximum term of five years. Under the
August 2002 agreement, Vivendi will pay us sales proceeds less amounts for
distribution fees, price concessions and returns. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon our
delivery of a gold master to Vivendi, Vivendi will pay us, as a non-refundable
minimum guarantee, a specified percent of the projected amount due to us based
on projected initial shipment sales, which are established by Vivendi in
accordance with the terms of the agreement. The remaining amounts are due upon
shipment of the titles to Vivendi's customers. Payments for future sales that
exceed the projected initial shipment sales are paid on a monthly basis. We also
continue to distribute products directly to end-users who can order products by
7
using a toll-free number or by accessing our web site. Prior to entering into
our original North America distribution agreement with Vivendi, in North America
we sold our products primarily to mass merchants, warehouse club stores, large
computer and software specialty retail chains and through catalogs and Internet
commerce sites. A majority of our North American retail sales were to direct
accounts, and a lesser percentage were to third party distributors. Our
principal direct retail accounts included CompUSA, Best Buy, Electronics
Boutique, Wal-Mart, K-Mart, Target, Toys-r-us and GameStop (Babbages). Our
principal distributors in North America included Navarre and Softek. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting Future Performance--A significant percentage of
our revenues depend on our distributors' diligent sales efforts and our
distributors' and retail customers' timely payments to us."
Our distributor seeks to extend the life cycle and financial return of many
of our products by marketing those products differently during the various
stages of the product's sales cycle. Although the product sales cycle for a
title varies based on a number of factors, including the quality of the title,
the number and quality of competing titles, and in certain instances
seasonality, we typically consider a title to be a "back catalog" item once it
incurs its first price drop after its initial release. Our distributor utilizes
marketing programs appropriate for each particular title, which generally
include progressive price reductions over time to increase the product's
longevity in the retail channel as they shift their advertising support to newer
releases.
Our distributor provides terms of sale comparable to competitors in our
industry. In addition, we provide technical support for our products in North
America through our customer support and we provide a 90-day limited warranty to
end-users that our products will be free from manufacturing defects. While to
date we have not experienced any material warranty claims, there can be no
assurance that we will not experience material warranty claims in the future.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting Future Performance--A significant percentage of
our revenues depend on our distributors' diligent sales efforts and our
distributors' and retail customers' timely payments to us."
International. In February 1999, we entered into a distribution agreement
with Virgin, pursuant to which Virgin commenced distributing substantially all
of our titles in Europe, the Commonwealth of Independent States, Africa and the
Middle East for a seven year period. Under the agreement, as amended, Virgin
earns a distribution fee for its marketing and distribution of our products, and
we reimburse Virgin for certain direct costs and expenses. In February 2003,
Virgin's operating subsidiary filed for a Company Voluntary Agreement, or CVA, a
process of reorganization in the United Kingdom. As of March 28, 2003, the CVA
was rejected by Virgin's creditors, and Virgin is presently negotiating with its
creditors to propose a new CVA. If a new CVA is not approved, we expect Virgin
to cease operations and liquidate, in which event we will not have a distributor
for our products in Europe and the other territories in which Virgin presently
distributes our products. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Future Performance--A
significant percentage of our revenues depend on our distributors' diligent
sales efforts and our distributors' and retail customers' timely payments to
us."
In January 2003, we entered into an agreement with Vivendi to distribute
substantially all of our products in select rest-of-world countries.
Interplay OEM. Our wholly owned subsidiary, Interplay OEM, distributes our
interactive entertainment software titles, as well as those of other software
publishers, to computer and peripheral device manufacturers for use in bundling
arrangements. As a result of changes in market conditions for bundling
arrangements and the limited amount of resources we have available, we no longer
have any personnel applying their efforts towards bundling arrangements. In
December 2002, we assigned our OEM distribution rights to Vivendi and will
utilize Vivendi's resources in our future OEM business. Under OEM arrangements,
one or more software titles, which are either limited-feature versions or the
retail version of a game, are bundled with computer or peripheral devices and
are sold by an original equipment manufacturer so that the purchaser of the
hardware device obtains the software as part of the hardware purchase. Although
it is customary for OEM customers to pay a lower per unit price on sales through
OEM bundling contracts, such arrangements involve a high unit volume commitment.
Interplay OEM net revenues generally are incremental net revenues and do not
have significant additional product development or sales and marketing costs.
Our North American and International ultimate distribution channels are
characterized by continuous change, including consolidation, financial
difficulties of certain retailers, and the emergence of new distributors and new
retail
8
channels such as warehouse chains, mass merchants, computer superstores and
Internet commerce sites. Under the terms of some of our distribution agreements,
we are exposed to the risk of product returns and markdown allowances by our
distributors. Under the same distribution agreements, we allow our distributors
to return defective, shelf-worn and damaged products in accordance with
negotiated terms. We also offer a 90-day limited warranty to our end users that
our products will be free from manufacturing defects. In addition, our
distributors provide markdown allowances, which consist of credits given to
resellers to induce them to lower the retail sales price of certain of our
products to increase sell through and to help the reseller manage its inventory
levels. Although we maintain a reserve for returns and markdown allowances, and
although we manage our returns and markdown allowances through an authorization
procedure, we could be forced to accept substantial product returns and provide
markdown allowances to maintain our access to certain distribution channels. Our
reserve for estimated returns, exchanges, markdowns, price concessions, and
warranty costs was $1.1 million and $7.5 million at December 31, 2002 and 2001,
respectively. Product returns and markdown allowances that exceed our reserves,
if any, could have a material adverse effect on our business, operating results
and financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Future Performance--A
significant percentage of our revenues depend on our distributors' diligent
sales efforts and our distributors' and retail customers' timely payments to
us."
MARKETING
Our marketing department assists our distributors in the development and
implementation of marketing programs and campaigns for each of our titles and
product groups. Our distributors' marketing activities in preparation for a
product launch include print advertising, game reviews in consumer and trade
publications, retail in-store promotions, attendance at trade shows and public
relations. Our distributors also send direct and electronic mail promotional
materials to our database of gamers, and may selectively use radio and
television advertisements in connection with the introduction of certain of our
products. Our distributors budget a portion of each product's sales for
cooperative advertising and market development funds with retailers. Every title
and brand is launched with a multi-tiered marketing campaign that is developed
on an individual basis to promote product awareness and customer pre-orders.
Our distributors engage in on-line marketing through Internet advertising
and the maintenance of several Internet web sites. These web sites provide news
and information of interest to our customers through free demonstration versions
of games, contests, games, tournaments and promotions. Also, to generate
interest in new product introductions, we provide free demonstration versions of
upcoming titles through magazines and game samples that consumers can download
from our web site. In addition, through our marketing department, we host
on-line events and maintain a vast collection of message boards to keep
customers informed on shipped and upcoming titles.
COMPETITION
The interactive entertainment software industry is intensely competitive
and is characterized by the frequent introduction of new hardware systems and
software products. Our competitors vary in size from small companies to very
large corporations with significantly greater financial, marketing and product
development resources than ours. Due to these greater resources, certain of our
competitors are able to undertake more extensive marketing campaigns, adopt more
aggressive pricing policies, pay higher fees to licensors of desirable motion
picture, television, sports and character properties and pay more to third party
software developers than us. We believe that the principal 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.
We compete primarily with other publishers of PC and video game console
interactive entertainment software. Significant competitors include Electronic
Arts Inc., Take Two Interactive Software Inc, THQ Inc., The 3DO Company, Eidos
PLC, Infogrames Entertainment, Activision, Inc., Microsoft Corporation,
LucasArts Entertainment Company, Midway Games Inc., Acclaim Entertainment, Inc.,
Vivendi Universal Games, Inc. and Ubi Soft Entertainment Inc. In addition,
integrated video game console hardware/software companies such as Sony Computer
Entertainment, Microsoft Corporation, Nintendo and Sega compete directly with us
in the development of software titles for their respective 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 than us, 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 on-line services by consumers
may pose a competitive threat if customers and potential
9
customers spend less of their available time using interactive entertainment
software and more time on the Internet and on-line services.
Retailers of our products typically have a limited amount of shelf space
and promotional resources. Consequently, there is intense competition among
consumer software producers, and in particular interactive entertainment
software producers, for high quality retail shelf space and promotional support
from retailers. If the number of consumer software products and computer
platforms increase, competition for shelf space will intensify which may require
us to increase our marketing expenditures. This increased demand for limited
shelf space, places retailers and distributors in an increasingly better
position to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return policies. As our
products constitute a relatively small percentage of any retailer's sales
volume, there can be no assurance that retailers will continue to purchase our
products or provide our products with adequate shelf space and promotional
support. A prolonged failure by retailers to provide shelf space and promotional
support would have a material adverse effect on our business, operating results
and financial condition.
MANUFACTURING
Our PC-based products consist primarily of CD-ROMs and DVDs, manuals, and
packaging materials. Substantially all of our CD-ROM and DVD duplication is
performed by unaffiliated third parties. Printing of manuals and packaging
materials, manufacturing of related materials and assembly of completed packages
are performed to our specifications by unaffiliated third parties. To date, we
have not experienced any material difficulties or delays in the manufacture and
assembly of our CD-ROM and DVD based products, and we have not experienced
significant returns due to manufacturing defects.
Sony Computer Entertainment, Microsoft Corporation and Nintendo manufacture
and ship finished products that are compatible with their video game consoles to
our distributors for distribution. PlayStation 2, Xbox and GameCube products
consist of the game disks and include manuals and packaging and are typically
delivered within a relatively short lead-time.
If we experience unanticipated delays in the delivery of manufactured
software products by our third party manufactures, our net sales and operating
results could be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors Affecting
Future Performance--Our sales volume and the success of our products depend in
part upon the number of product titles distributed by hardware companies for use
with their video game platforms."
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
We hold copyrights on our products, product literature and advertising and
other materials, and hold trademark rights in our name and certain of our
product names and publishing labels. We have licensed certain products to third
parties for distribution in particular geographic markets or for particular
platforms, and receive royalties on such licenses. We also outsource some of our
product development activities to third party developers, contractually
retaining all intellectual property rights related to such projects. We also
license certain products developed by third parties and pay royalties on such
products. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Our reliance on third party software developers subjects
us to the risks that these developers will not supply us with high quality
products in a timely manner or on acceptable terms."
We regard our software as proprietary and rely primarily 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. While we provide "shrinkwrap"
license agreements or limitations on use with our software, the enforceability
of such agreements or limitations is uncertain. We are aware that 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, our operating results could be materially adversely
affected. We use copy protection on selected products and do not provide source
code to third parties unless they have signed nondisclosure agreements.
10
We rely on existing copyright laws to prevent the unauthorized distribution
of our software. Existing copyright laws afford only limited protection.
Policing unauthorized use of our products is difficult, and we expect software
piracy to be a persistent problem, especially in certain international markets.
Further, the laws of certain countries in which 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 U.S. 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 on-line services, our ability to protect our intellectual property rights,
and to avoid infringing the intellectual property rights of others, becomes more
difficult. In addition, the intellectual property laws are less clear with
respect to such emerging technologies. There can be no assurance that existing
intellectual property laws will provide our products with adequate protection in
connection with such emerging technologies.
As the number of software products in the interactive entertainment
software industry increases and the features and content of these products
further overlap, interactive entertainment software developers may increasingly
become subject to infringement claims. Although we take reasonable efforts to
ensure that our products do not violate the intellectual property rights of
others, there can be no assurance that claims of infringement will not be made.
Any such claims, with or without merit, can be time consuming and expensive to
defend. From time to time, we have received communications from third parties
asserting that features or content of certain of our products may infringe upon
such party's intellectual property rights. There can be no assurance that
existing or future infringement claims against us will not result in costly
litigation or require that we license the intellectual property rights of third
parties, either of which could have a material adverse effect on our business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Factors Affecting
Future Performance--We may unintentionally infringe on the intellectual property
rights of others, which could expose us to substantial damages or restrict our
operations."
EMPLOYEES
As of December 31, 2002, we had 207 employees, including 157 in product
development, 11 in sales and marketing and 36 in finance, general and
administrative. Included in these counts are 2 employees of Interplay OEM and 1
employee of Interplay UK. We also retain independent contractors to provide
certain services, primarily in connection with our product development
activities. Neither we nor our full time employees are subject to any collective
bargaining agreements and we believe that our relations with our employees are
good.
From time to time, we have retained actors and/or "voice over" talent to
perform in certain of our products, and we expect to continue this practice in
the future. These performers are typically members of the Screen Actors Guild or
other performers' guilds, which guilds have established collective bargaining
agreements governing their members' participation in interactive media projects.
We may be required to become subject to one or more of these collective
bargaining agreements in order to engage the services of these performers in
connection with future development projects.
Item 2. PROPERTIES
Our headquarters are located in Irvine, California, where we lease
approximately 81,000 square feet of office space. This lease expires in June
2006 and provides us with one five year option to extend the term of the lease
and expansion rights, on an "as available basis," to approximately double the
size of the office space. In addition, we rent approximately 800 square feet of
office space in Central London, England from Virgin. This agreement is on a
quarter by quarter basis. We believe that our facilities are adequate for our
current needs and that suitable additional or substitute space will be available
in the future to accommodate potential expansion of our operations.
Item 3. LEGAL PROCEEDINGS
We are occasionally 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. We do not believe the outcome of such routine claims will have a
material adverse effect on the Company's business, financial condition or
results of operations.
11
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and our subsidiary
GamesOnline.com, Inc., alleging, among other things, breach of contract,
misappropriation of trade secrets, breach of fiduciary duties and breach of
implied covenant of good faith in connection with an electronic distribution
agreement dated November 2001 between KBK and GamesOnline.com, Inc. KBK has
alleged that GamesOnline.com failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Infogrames. We believe this complaint is without merit and will vigorously
defend our position.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") filed a
motion for summary judgment in lieu of complaint against us in the amount of
$1.3 million, alleging, among other things, that we are liable to pay Special
Situations $1.3 million for our failure to timely register for resale with the
Securities and Exchange Commission certain shares of our common stock that
Special Situations purchased from us in April 2001. We dispute the amount of the
claim and will vigorously defend our position.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 10, 2002, the Company held its annual stockholders' meeting.
There were 93,138,176 shares of Common Stock outstanding entitled to vote and a
total of 82,350,413 shares (88.4%) were represented at the meeting in person or
by proxy. The following summarizes vote results of proposals submitted to the
Company's stockholders.
1. Proposal to elect directors, each for a term extending until the next annual
meeting of Stockholders or until their successors are duly elected and
qualified.
For Withheld
---------- --------
Herve Caen................................ 81,982,528 367,885
Nathan Peck............................... 81,548,426 801,987
Michel Welter............................. 82,121,096 229,317
R. Parker Jones........................... 82,124,012 226,401
Eric Caen................................. 81,987,528 326,885
Michel H. Vulpillat....................... 82,019,427 330,986
Maren Stenseth............................ 81,627,672 772,801
2. Proposal to amend the Company's 1997 Stock Incentive Plan to increase the
number of authorized shares by 6,000,000 shares.
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
57,523,156 1,966,938 179,769 22,680,550
12
3. Proposal to amend the Company's Amended and Restated Certificate of
Incorporation to effect a one-for-ten reverse stock split of shares of the
Company's Common Stock.
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
81,599,812 573,226 177,375 -0-
Although this proposal was approved by the stockholders, the Company has not
taken action on the proposal.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 16, 2002, the listing of our common stock was moved from the Nasdaq
National Market System to the Nasdaq SmallCap Market System. We had until August
13, 2002 to comply with the requirements of the SmallCap market. As a result of
our inability to maintain certain minimum listing requirements of the SmallCap
market, on October 9, 2002, our common stock was delisted and began trading on
the NASD-operated Over-the-Counter Bulletin Board. Our common stock is currently
traded on the NASD-operated Over-the-Counter Bulletin Board under the symbol
"IPLY.OB." At December 31, 2002, there were 110 holders of record of our common
stock.
The following table sets forth the range of high and low sales prices for
our common stock for the periods indicated.
For the Year ended December 31, 2002 High Low
------------------------------------ -------- --------
First Quarter ........................ $ 0.61 $ 0.18
Second Quarter ....................... 0.59 0.24
Third Quarter ........................ 0.41 0.12
Fourth Quarter ....................... 0.13 0.06
For the Year ended December 31, 2001 High Low
------------------------------------ -------- --------
First Quarter ........................ $ 3.25 $ 1.50
Second Quarter ....................... 3.11 1.33
Third Quarter ........................ 2.20 0.33
Fourth Quarter ....................... 0.96 0.31
DIVIDEND POLICY
We have never paid any dividends on our common stock. We intend to retain
any earnings for use in our business and do not intend to pay any cash dividends
on our common stock in the foreseeable future.
13
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding the Company's
equity compensation plans as of December 31, 2002.
Plan Category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under equity
warrants and rights warrants and rights compensation plans
(excluding securities
reflected in column (a))
--------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 1,091,697 3.10 3,209,735
approved by security
holders
Equity compensation plans - - -
not approved by security
holders
-----------------------------------------------------------------------------
Total 1,091,697 3.10 3,209,735
=============================================================================
14
Item 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for the years ended
December 31, 2002, 2001 and 2000 and the selected consolidated balance sheets
data as of December 31, 2002 and 2001 are derived from our audited consolidated
financial statements included elsewhere in this Form 10-K. The selected
consolidated statements of operations data for the years ended December 31, 1999
and 1998 and the selected consolidated balance sheets data as of December 31,
2000, 1999 and 1998 are derived from our audited consolidated financial
statements not included in this Form 10-K. Our historical results are not
necessarily indicative of the results that may be achieved for any other period.
The following data should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements included elsewhere in this Form 10-K.
Years Ended December 31,
-------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
Statements of Operations Data:
Net revenues ......................... $ 43,999 $ 56,448 $ 101,426 $ 101,930 $ 126,862
Cost of goods sold ................... 26,706 45,816 54,061 61,103 71,928
--------- --------- --------- --------- ---------
Gross profit ......................... 17,293 10,632 47,365 40,827 54,934
Operating expenses:
Marketing and sales ............. 5,814 18,697 23,326 32,432 39,471
General and administrative ...... 7,655 12,622 10,249 18,155 12,841
Product development ............. 16,184 20,603 22,176 20,629 24,472
Other ........................... -- -- -- 2,415 --
--------- --------- --------- --------- ---------
Total operating expenses ........ 29,653 51,922 55,751 73,631 76,784
--------- --------- --------- --------- ---------
Operating loss ....................... (12,360) (41,290) (8,386) (32,804) (21,850)
Sale of Shiny ........................ 28,813 -- -- -- --
Other income (expense) ............... (1,531) (4,526) (3,689) (3,471) (4,933)
--------- --------- --------- --------- ---------
Income (loss) before income taxes .... 14,922 (45,816) (12,075) (36,275) (26,783)
Provision (benefit) for income taxes . (225) 500 -- 5,410 1,437
--------- --------- --------- --------- ---------
Net income (loss) .................... $ 15,147 $ (46,316) $ (12,075) $ (41,685) $ (28,220)
========= ========= ========= ========= =========
Cumulative dividend on participating
preferred stock ................. $ 133 $ 966 $ 870 $ -- $ --
Accretion of warrant ................. -- 266 532 -- --
--------- --------- --------- --------- ---------
Net income (loss) available to common
stockholders .................... $ 15,014 $ (47,548) $ (13,477) $ (41,685) $ (28,220)
========= ========= ========= ========= =========
Net income (loss) per common share:
Basic ........................... $ 0.18 $ (1.23) $ (0.45) $ (1.86) $ (1.91)
Diluted ......................... $ 0.16 $ (1.23) $ (0.45) $ (1.86) $ (1.91)
Shares used in calculating net income
(loss) per common share - basic . 83,585 38,670 30,047 22,418 14,763
Shares used in calculating net income
(loss) per common share - diluted 96,070 38,670 30,047 22,418 14,763
Selected Operating Data:
Net revenues by geographic region:
North America ................... $ 26,184 $ 34,998 $ 53,298 $ 49,443 $ 73,865
International ................... 5,674 15,451 35,077 30,310 35,793
OEM, royalty and licensing ...... 12,141 5,999 13,051 22,177 17,204
Net revenues by platform:
Personal computer ............... $ 15,802 $ 34,912 $ 73,730 $ 65,397 $ 67,406
Video game console .............. 16,056 15,537 14,645 14,356 42,252
OEM, royalty and licensing ...... 12,141 5,999 13,051 22,177 17,204
December 31,
-------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
Balance Sheets Data: (Dollars in thousands)
Working capital (deficiency) ......... $ (17,060) $ (34,169) $ 123 $ (7,622) $ (3,135)
Total assets ......................... 14,298 31,106 59,081 56,936 74,944
Total debt ........................... 2,082 4,794 25,433 19,630 24,651
Stockholders' equity (deficit) ...... (13,930) (28,150) 6,398 (2,071) 4,193
15
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Consolidated Financial Statements and notes thereto and other information
included or incorporated by reference herein.
GENERAL
We derive net revenues primarily from sales of software products to
distributors in North America and internationally, and from sales of software
products to end-users through our catalogs and the Internet. We also derive
royalty-based revenues from licensing arrangements and from original equipment
manufacturing, or OEM bundling transactions.
During 2002 we continued to experience cash flow difficulties from
operations, and relied upon sales of assets to pay liabilities, reduce future
operational costs and und our ongoing operations. We have been operating without
a credit facility since October 2001, which has adersely affected cash flow. We
continue to face difficulties in paying our vendors and have pending lawsuits as
a result of our continuing cash flow difficulties. We expect these difficulties
to continue during 2003.
In February 2003, Virgin Interactive Entertainment (Europe) Limited,, the
operating subsidiary of Virgin Interactive Entertainment Limited ("Virgin"), our
European distributor, filed for a Company Voluntary Arrangement, or CVA, a
process of reorganization in the United Kingdom which must be approved by
Virgin's creditors. Virgin owed us approximately $1.8 million at December 31,
2002. As of March 28, 2003, the CVA was rejected by Virgin's creditors, and
Virgin is presently negotiating with its creditors to propose a new CVA. We do
not know what affect approval of the CVA will have on our ability to collect
amounts Virgin owes us. If the new CVA is not approved, we expect Virgin to
cease operations and liquidate, in which event we will most likely not receive
any amounts presently due us by Virgin, and will not have a distributor for our
products in Europe and the other territories in which Virgin presently
distributes our products.
In February 2003, we amended our license agreement with Infogrames, the
holder of the TSR license which we rely on to publish the Baldur's Gate,
Baldur's Gate: Dark Alliance, and Icewind Dale titles, to, among other things,
(i) extend the license term for approximately an additional two years to
December 31, 2008 (provided we make a timely extension payment required for such
extension), and (ii) extend our rights with respect to certain of the Advanced
Dungeons & Dragons properties. The amendment further terminates our rights to
certain titles in the event Interplay is unable to obtain certain third-party
waivers in accordance with the terms of the amendment. We were unable to obtain
the required waivers within the permitted time period and as a result have lost
rights to publish Baldur's Gate 3 and its sequels on the PC, a significant
product franchise. We are in negotiations with Infogrames to reinstate these
rights, but no assurance can be given that we will be successful.
We have been able to retain our third party developers to date, but if our
current liquidity issues continue, our future title development could be
adversely affected.
In August 2001, we entered into a distribution agreement with Vivendi
Universal Games, Inc. (an affiliate company of Universal Studios, Inc., who as
of today owns approximately 5 percent of our common stock) providing for Vivendi
to become our distributor in North America through December 31, 2003 for
substantially all of our products, with the exception of products with
pre-existing distribution agreements. OEM rights were not among the rights
granted to Vivendi under the distribution agreement. Under the terms of the
agreement, as amended, Vivendi earned a distribution fee based on the net sales
of the titles distributed. Under the agreement, as amended, Vivendi made four
advance payments to us totaling $13.5 million. Vivendi recouped these advances
from sales of our products in 2002 and we repaid a portion of the advances with
the proceeds received from the sale of Shiny. In an effort to minimize the
number of product returns following the transition of our North America
distribution to Vivendi, we granted large price concessions to resellers on
products in their inventory. As we continue to conclude our relations these
resellers, we have decreased our sales allowances from 44 percent of our total
accounts receivable in 2001 to 29 percent of our total accounts receivable in
2002.
16
In August 2002, we entered into a new distribution arrangement with Vivendi
whereby Vivendi will distribute substantially all of our products in North
America for a period of three years as a whole and two years with respect to
each product providing for a potential maximum term of five years. Under the
August 2002 agreement, Vivendi will pay us sales proceeds less amounts for
distribution fees, price concessions and returns. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon our
delivery of a gold master to Vivendi, Vivendi will pay us, as a non-refundable
minimum guarantee, a specified percent of the projected amount due to us based
on projected initial shipment sales, which are established by Vivendi in
accordance with the terms of the agreement. The remaining amounts are due upon
shipment of the titles to Vivendi's customers. Payments for future sales that
exceed the projected initial shipment sales are paid on a monthly basis. We
expect this new arrangement to improve our short-term liquidity, but should not
impact our overall liquidity. Under this new distribution arrangement, we expect
our net revenues to decrease as a result of incurring a higher commission
expense, however, we expect our operating margins to remain comparable to prior
periods as we are no longer incurring any manufacturing, marketing or
distribution expenditures.
Our wholly-owned subsidiary, Interplay OEM, distributed our interactive
entertainment software titles, as well as those of other software publishers, to
computer and peripheral device manufacturers for use in bundling arrangements.
As a result of changes in the market conditions for bundling arrangements and
the limited amount of resources we have available, we no longer have any
personnel applying their efforts towards bundling arrangements. In December
2002, we licensed our OEM distribution rights to Vivendi and will utilize
Vivendi's resources in our future OEM business. We also derive net revenues from
the licensing of intellectual property and products to third parties for
distribution in markets and through channels that are outside of our primary
focus. OEM, royalty and licensing net revenues collectively accounted for 27
percent of net revenues for the year ended December 31, 2002, 11 percent for the
year ended December 31, 2001, and 13 percent for the year ended December 31,
2000. OEM, royalty and licensing net revenues generally are incremental net
revenues and do not have significant additional product development or sales and
marketing costs.
Cost of goods sold related to PC and video game console net revenues
represents the manufacturing and related costs of interactive entertainment
software products, including costs of media, manuals, duplication, packaging
materials, assembly, freight and royalties paid to developers, licensors and
hardware manufacturers. For sales of titles under the new distribution
arrangement with Vivendi, our cost of goods consists of royalties paid to
developers. Cost of goods sold related to royalty-based net revenues primarily
represents third party licensing fees and royalties paid by us. Typically, cost
of goods sold as a percentage of net revenues for video game console products
are higher than cost of goods sold as a percentage of net revenues for PC based
products due to the relatively higher manufacturing and royalty costs associated
with video game console and affiliate label products. We also include in the
cost of goods sold the amortization of prepaid royalty and license fees we pay
to third party software developers. We expense prepaid royalties over a period
of six months commencing with the initial shipment of the title at a rate based
upon the numbers of units shipped. We evaluate the likelihood of future
realization of prepaid royalties and license fees quarterly, on a
product-by-product basis, and charge the cost of goods sold for any amounts that
we deem unlikely to realize through future product sales.
Our operating results have fluctuated significantly in the past and likely
will fluctuate significantly in the future, both on a quarterly and an annual
basis. A number of factors may cause or contribute to such fluctuations, and
many of such factors are beyond our control. We cannot assure you that we will
be profitable in any particular period. It is likely that our operating results
in one or more future periods will fail to meet or exceed the expectations of
securities analysts or investors. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Factors Affecting Future
Performance -The unpredictability of future results may cause our stock price to
remain depressed or to decline further."
Our operating results will continue to be impacted by economic, industry
and business trends affecting the interactive entertainment industry. Our
industry is highly seasonal, with the highest levels of consumer demand
occurring during the year-end holiday buying season. With the release of next
generation console systems by Sony, Nintendo and Microsoft, our industry has
entered into a growth period that could be sustained for the next couple of
years.
The accompanying consolidated financial statements have been prepared
assuming that we will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The carrying amounts of assets and liabilities presented in the
financial statements do not purport to represent realizable
17
or settlement values. The Report of our Independent Auditors for the December
31, 2002 consolidated financial statements includes an explanatory paragraph
expressing substantial doubt about our ability to continue as a going concern.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, prepaid licenses and royalties and software
development costs. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in preparation of our
consolidated financial statements.
Revenue Recognition
We record revenues when we deliver products to customers in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." and SEC
Staff Accounting Bulletin No. 101, Revenue Recognition. Commencing in August
2001, substantially all of our sales are made by two related party distributors,
Vivendi Universal Games, Inc. and Virgin Interactive Entertainment Ltd. We
recognize revenue from sales by distributors, net of sales commissions, only as
the distributor recognizes sales of our products to unaffiliated third parties.
For those agreements that provide the customers the right to multiple copies of
a product in exchange for guaranteed amounts, we recognize revenue at the
delivery and acceptance of the product master. We recognize per copy royalties
on sales that exceed the guarantee as copies are duplicated.
We generally are not contractually obligated to accept returns, except for
defective, shelf-worn and damaged products. However, on a case-by-case
negotiated basis, we permit customers to return or exchange product and may
provide price concessions to our retail distribution customers on unsold or slow
moving products. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 48, "Revenue Recognition when Right of Return Exists," we record
revenue net of a provision for estimated returns, exchanges, markdowns, price
concessions, and warranty costs. We record such reserves based upon management's
evaluation of historical experience, current industry trends and estimated
costs. During 2001, we substantially increased our sales allowances as a result
of the granting of price concessions to resellers on products in their
inventory, in an effort to minimize product returns following the transition of
our North American distribution rights to Vivendi. As a result, sales allowances
as a percentage of our total accounts receivable increased to 44 percent at
December 31, 2001 from 19 percent at December 31, 2000. With the transition to
Vivendi complete, sales allowances as a percentage of sales decreased to 29
percent at December 31, 2002. The amount of reserves ultimately required could
differ materially in the near term from the amounts provided in the accompanying
consolidated financial statements.
We provide customer support only via telephone and the Internet. Customer
support costs are not significant and we charge such costs to expenses as we
incur them.
We also engage in the sale of licensing rights on certain products. The
terms of the licensing rights differ, but normally include the right to develop
and distribute a product on a specific video game platform. Revenue is
recognized when the rights have been transferred and no other obligations exist.
Prepaid Licenses and Royalties
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under developer arrangements that have alternative future uses. These payments
are contingent upon the successful
18
completion of milestones, which generally represent specific deliverables.
Royalty advances are recoupable against future sales based upon the contractual
royalty rate. We amortize the cost of licenses, prepaid royalties and other
outside production costs to cost of goods sold over six months commencing with
the initial shipment in each region of the related title. We amortize these
amounts at a rate based upon the actual number of units shipped with a minimum
amortization of 75 percent in the first month of release and a minimum of 5
percent for each of the next five months after release. This minimum
amortization rate reflects our typical product life cycle. Management evaluates
the future realization of such costs quarterly and charges to cost of goods sold
any amounts that management deems unlikely to be fully realized through future
sales. Such costs are classified as current and noncurrent assets based upon
estimated product release date.
Software Development Costs
Our internal research and development costs, which consist primarily of
software development costs, are expensed as incurred. Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed", provides for the
capitalization of certain software development costs incurred after
technological feasibility of the software is established or for development
costs that have alternative future uses. Under our current practice of
developing new products, the technological feasibility of the underlying
software is not established until substantially all of the product development
is complete. As a result, we have not capitalized any software development costs
on internal development projects, as the eligible costs were determined to be
insignificant.
Other Significant Accounting Policies
Other significant accounting policies not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. The policies related to
consolidation and loss contingencies require difficult judgments on complex
matters that are often subject to multiple sources of authoritative guidance.
Certain of these matters are among topics currently under reexamination by
accounting standards setters and regulators. Although no specific conclusions
reached by these standard setters appear likely to cause a material change in
our accounting policies, outcomes cannot be predicted with confidence. Also see
Note 2 of Notes to Consolidated Financial Statements, Summary of Significant
Accounting Policies, which discusses accounting policies that must be selected
by management when there are acceptable alternatives.
19
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data and segment and platform data for the periods indicated
expressed as a percentage of net revenues:
Years Ended December 31,
2002 2001 2000
---- ---- ----
Statements of Operations Data:
Net revenues ............................... 100% 100% 100%
Cost of goods sold ......................... 61 81 53
---- ---- ----
Gross margin ............................... 39 19 47
Operating expenses:
Marketing and sales ................... 13 33 23
General and administrative ............ 17 22 10
Product development ................... 37 37 22
---- ---- ----
Total operating expenses .............. 67 92 55
---- ---- ----
Operating loss ............................. (28) (73) (8)
Other income (expense) ..................... 62 (8) (4)
---- ---- ----
Income (loss) before provision
for income taxes ........................ 34 (81) (12)
Provision for income taxes ................. -- 1 --
---- ---- ----
Net income (loss) .......................... 34% (82)% (12)%
==== ==== ====
Selected Operating Data:
Net revenues by segment:
North America ......................... 60% 62% 52%
International ......................... 13 27 35
OEM, royalty and licensing ............ 27 11 13
---- ---- ----
100% 100% 100%
==== ==== ====
Net revenues by platform:
Personal computer ..................... 36% 62% 73%
Video game console .................... 37 27 14
OEM, royalty and licensing ............ 27 11 13
---- ---- ----
100% 100% 100%
==== ==== ====
North American, International and OEM, Royalty and Licensing Net Revenues
Net revenues for the year ended December 31, 2002 were $44.0 million, a
decrease of 22 percent compared to the same period in 2001. This decrease
resulted from a 25 percent decrease in North American net revenues, a 63 percent
decrease in International net revenues, offset by a 102 percent increase in OEM,
royalties and licensing revenues. Net revenues for the year ended December 31,
2001 were $56.4 million, a decrease of 44 percent compared to the same period in
2000. This decrease resulted from a 34 percent decrease in North American net
revenues, a 56 percent decrease in International net revenues and a 54 percent
decrease in OEM, royalties and licensing revenues.
North American net revenues for the year ended December 31, 2002 were $26.2
million. The decrease in North American net revenues in 2002 was mainly due to
lower total units sales as a result of releasing 6 titles in 2002 compared to 8
titles in 2001. Furthermore, five of the titles were released by Vivendi under
the terms of the new distribution agreement, whereby Vivendi pays us a lower per
unit rate and in return assumes all credit, product return and price concession
risks, as well as being responsible for all manufacturing, marketing and
distribution expenditures. These resulted in a decrease in North American sales
of $18.3 million, partially offset by a decrease in product returns and price
concessions of $9.5 million as compared to the 2001 period. The decrease in
title releases across all platforms is a result of our continued focus on
product planning and the releasing of fewer, higher quality titles. Our returns
were lower in 2002 due primarily to price concessions we granted in 2001 in
connection with the North American Distribution Agreement we entered into with
Vivendi in 2001.
20
We expect that our North American publishing net revenues will decrease in
2003 compared to 2002, mainly due to decreased unit sales and releasing all new
titles under the terms of the August 2002 distribution agreement with Vivendi.
North American net revenues for the year ended December 31, 2001 were $35.0
million. The decrease in North American net revenues in 2001 was mainly due to
our release of only 8 titles in 2001 compared to 26 titles in 2000 resulting in
a decrease in North American sales of $21.6 million, partially offset by a
decrease in product returns and price concessions of $2.8 million as compared to
the 2000 period. The decrease in title releases across all platforms is a result
of our continued focus on product planning and the release of fewer, higher
quality titles. Our returns were a higher percentage of sales due primarily to
price concessions we granted in connection with the North American distribution
agreement we entered into with Vivendi.
International net revenues for the year ended December 31, 2002 were $5.7
million. The decrease in International net revenues for the year ended December
31, 2002 was mainly due to the reduction in title releases during the year which
resulted in a $12.2 million decrease in revenue, partially offset by a decrease
in product returns and price concessions of $2.4 million compared to the 2001
period. Our product planning efforts during 2002 also contributed to the
reduction of titles released in the International markets. Furthermore, our
returns as a percentage of revenue, continued to increase as we experienced a
high level of product returns and price concessions due to certain titles not
gaining broad market acceptance.
We expect that our International publishing net revenues will increase in
2003 as compared to 2002, mainly due to increased unit sales. However, if Virgin
Europe is not able to reorganize and liquidates, we may need to obtain a new
European distributor in a short amount of time. If we are not able to engage a
new distributor, it could have a material negative impact on our European sales.
International net revenues for the year ended December 31, 2001 were $15.5
million. The decrease in International net revenues for the year ended December
31, 2001 was mainly due to the reduction in title releases during the year which
resulted in a $17.4 million decrease in revenue and an increase in product
returns and price concessions of $1.8 million compared to the 2000 period. Our
product planning efforts during 2001 also contributed to the reduction of titles
released in the International markets. Furthermore, our returns as a percentage
of revenue, increased as we experienced a high level of product returns and
price concessions due to certain titles not gaining broad market acceptance.
OEM, royalty and licensing net revenues for the year ended December 31,
2002 were $12.1 million, an increase of $6.1 million as compared to the same
period in 2001. The OEM business decreased $1.3 million as a result of our
efforts to focus on our core business of developing and publishing video game
titles for distribution directly to the end users and our continued focus on
video game console titles, which typically are not bundled with other products.
The year ended December 31, 2002 also included revenues related to the sale of
publishing rights for one of our products and the recognition of deferred
revenue for a licensing transaction. In January 2002, we sold the publishing
rights to this title to the distributor in connection with a settlement
agreement entered into with the third party developer. The settlement agreement
provided, among other things, that we assign our rights and obligations under
the product agreement to the third party distributor. As a result, we recorded
net revenues of $5.6 million in the three months ended March 31, 2002. In
February 2002, a licensing transaction we entered into in 1999 expired and we
recognized revenue of $1.2 million, the unearned portion of the minimum
guarantee. We expect that OEM, royalty and licensing net revenues in 2003 will
increase compared to 2002 primarily related to the recording of $15 million in
revenue resulting from the sale of the Hunter video game franchise in February
2003.
OEM, royalty and licensing net revenues for the year ended December 31,
2001 were $6.0 million, a decrease of $7.1 million as compared to the same
period in 2000. The OEM business decreased $3.9 million as a result of general
market decreases in personal computer sales. The year ended December 31, 2000
also included $3 million of revenues related to a multi-product licensing
transaction with Titus Interactive S.A., our majority stockholder, which did not
recur in 2001.
Platform Net Revenues
PC net revenues for the year ended December 31, 2002 were $15.8 million, a
decrease of 55 percent compared to the same period in 2001. The decrease in PC
net revenues in 2002 was primarily due to the release of one major hit title in
21
2002 (Icewind Dale II), which was released under the new distribution agreement
with Vivendi in North America, as compared to three major hit titles released in
2001. The decrease in PC net revenues were further affected by releasing only 1
title in 2002 compared to a total of 7 titles in 2001. We expect our PC net
revenues to decrease in 2003 as compared to 2002 as we expect to release only
one to two new titles and as we continue to focus on video game console titles.
Video game console net revenues increased 3 percent for the year ended December
31, 2002 compared to the same period in 2001, due to sales generated from the
release of Hunter: The Reckoning (Xbox), and continued sales of Baldur's Gate:
Dark Alliance (PlayStation 2), which was released in 2001. Our other video game
releases in 2002 included RLH (PlayStation 2), Baldur's Gate: Dark Alliance
(Xbox), Baldur's Gate: Dark Alliance (Gamecube) and Hunter (Gamecube). Even
though we released 5 titles in 2002 as compared to 3 in 2001, net revenues did
not increase substantially mainly due to releasing titles under the new
distribution agreement with Vivendi, whereby, we record a lower per unit rate
and in return Vivendi is responsible for all manufacturing, marketing, and
distribution expenditures. We anticipate releasing four to five new titles in
2003 and expect net revenues to increase in 2003 partly due to the fact that we
anticipate releasing the sequel to the major title release Baldur's Gate: Dark
Alliance on PlayStation 2 and Xbox in the latter half of 2003.
PC net revenues for the year ended December 31, 2001 were $34.9 million, a
decrease of 53 percent compared to the same period in 2000. The decrease in PC
net revenues in 2001 was primarily due to the release of three major hit titles
in 2001 (Icewind Dale: Heart of Winter, Fallout Tactics and Baldur's Gate II:
Throne of Bhaal), as compared to seven major hit titles released in 2000. The
decrease in PC net revenues was further affected by releasing only a total of 7
titles in 2001 compared to a total of 18 titles in 2000. Video game console net
revenues increased 6 percent for the year ended December 31, 2001 compared to
the same period in 2000, due to sales generated from the release of Baldur's
Gate: Dark Alliance (PlayStation 2). Our other video game releases include MDK
2: Armageddon (PlayStation 2) and Giants (PlayStation 2). In 2001, our 3 title
releases were developed for next generation video game consoles and as a result
price points for the 2001 releases were higher than the 4 title releases in
2000.
Cost of Goods Sold; Gross Margin
Our cost of goods sold decreased 42 percent to $26.7 million in the year
ended December 31, 2002 compared to the same period in 2001. Furthermore, we
incurred $4.1 million of non-recurring charges related to the write-off of
prepaid royalties on titles that were not expected to meet our desired profit
requirements as compared to $8.1 million in the 2001 period. In addition, the
decrease was a result of distributing five titles through Vivendi under the new
distribution agreement, in which the only cost of goods element we incur is
royalty expense. Under this new agreement, Vivendi pays us a lower per unit rate
and in return is responsible for all manufacturing, marketing and distribution
expenditures. We expect our cost of goods sold to decrease in 2003 as compared
to 2002 due to the continuation of our distributing all of our new releases in
North America through this new agreement with Vivendi. Our gross margin
increased to 39 percent in 2002 from 19 percent in 2001. This was due to a
decrease in our royalty expense as a result of a decrease of $4.0 million in
write-off of prepaid royalties, a decrease in our product cost of goods and a
decrease in product returns and price concessions as compared to the 2001 period
due to distributing the majority of our new releases in North America under the
new agreement with Vivendi. We expect our gross profit margin and gross profit
to increase in 2003 as compared to 2002 mainly due to the sale of the Hunter
franchise in February 2003, and the fact that we do not expect to incur any
unusual product returns and price concessions or any write-offs of prepaid
royalties in 2003.
Our cost of goods sold decreased 15 percent to $45.8 million in the year
ended December 31, 2001 compared to the same period in 2000. Furthermore, we
incurred $8.1 million of non-recurring charges related to the write-off of
prepaid royalties on titles that we decided to cancel because these titles were
not expected to meet our desired profit requirements. Our gross margin decreased
to 19 percent for 2001 from 47 percent in 2000. This was due to an increase in
our royalty expense as a result of the $8.1 million write-off of prepaid
royalties, an increase in our product cost of goods due to our increase in video
game console title sales, which typically have a higher per unit cost, and an
increase in our product returns and price concessions as compared to 2000.
Marketing and Sales
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses for the year ended December 31, 2002 were $5.8 million, a 69 percent
decrease as compared to the 2001
22
period. The decrease in marketing and sales expenses is due to a $7.9 million
reduction in advertising and retail marketing support expenditures and a
decrease of $4.5 million in personnel costs and general expenses due to fewer
product releases in 2002 and our shift from a direct sales force for North
America to a distribution arrangement with Vivendi. Also, the decrease in
marketing and sales expenses was a result of a decrease of $0.5 million in
overhead fees paid to Virgin under our April 2001 settlement with Virgin (See
Activities with Related Parties). We expect our marketing and sales expenses to
decrease in 2003 compared to 2002, due to lower personnel costs from our reduced
headcount, a reduction in overhead fees paid to Virgin pursuant to the April
2001 settlement and releasing titles under the terms of the new distribution
agreement whereby Vivendi pays us a lower per unit rate and in return assumes
all marketing expenditures.
Marketing and sales expenses for the year ended December 31, 2001 were
$18.7 million, a 20 percent decrease as compared to the 2000 period. The
decrease in marketing and sales expenses was due to a $3.9 million reduction in
advertising and retail marketing support expenditures due to fewer product
releases in 2001 and a $2.0 million decrease in personnel costs and general
expenses due in part to our shift from a direct sales force for North America to
a distribution arrangement with Vivendi. The decrease in marketing and sales
expenses was partially offset by $1.3 million in overhead fees paid to Virgin
under our April 2001 settlement with Virgin (See Activities with Related
Parties).
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
year ended December 31, 2002 were $7.7 million, a 39 percent decrease as
compared to the same period in 2001. The decrease is due to a $4.9 million
decrease in personnel costs and general expenses. In the 2002 period, we
incurred significant charges of $0.4 million in loan termination fees associated
with the termination of our line of credit and $0.5 million in consulting
expenses payable to our investment bankers, Europlay 1, LLC, incurred to assist
us with the restructuring of the company. In the 2001 period, we incurred
significant charges of $0.7 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 which was terminated. We expect our general and
administrative expenses to remain relatively constant in 2003 compared to 2002.
General and administrative expenses for the year ended December 31, 2001
were $12.6 million, a 23 percent increase as compared to the same period in
2000. The increase is due in part to a $0.7 million provision for the
termination of a building lease in the United Kingdom, a $0.1 million increase
in the provision for bad debt, $0.5 million in legal, accounting and investment
banking fees and expenses incurred principally in connection with efforts to
sell the company which was terminated, $0.5 million in consulting expenses
payable to Titus, incurred to assist us with the restructuring of the company
and a $0.6 million increase in personnel costs and general expenses.
Product Development
We charge internal product development expenses, which consist primarily of
personnel and support costs, to operations in the period incurred. Product
development expenses for the year ended December 31, 2002 were $16.2 million, a
21 percent decrease as compared to the same period in 2001. This decrease was
due to a $4.4 million decrease in personnel costs as a result of a reduction in
headcount and the sale of Shiny Entertainment, Inc. in April 2002. We expect our
product development expenses to increase in 2003 compared to 2002 as we plan on
releasing more internally developed titles in 2003.
Product development expenses for the year ended December 31, 2001 were
$20.6 million, a 7 percent decrease as compared to the same period in 2000. This
decrease was due to a $1.7 million decrease in expenditures associated with
resources dedicated to completing four major internally developed titles in the
2000 period, which did not recur in the 2001 period as well as a reduction in
headcount.
Sale of Shiny Entertainment, Inc.
In April 2002, we sold our former subsidiary Shiny Entertainment, Inc. to
Infogrames Entertainment, Inc. for $47.2 million. We recognized a gain of $28.8
million on this sale. See Note 3 of Notes to Consolidated Financial Statements.
23
Other Expense, Net
Other expense consists primarily of interest expense on our lines of credit
and foreign currency exchange transaction losses. Other expenses for the year
ended December 31, 2002 were $1.5 million, a 66 percent decrease as compared to
the same period in 2001. The decreases were due to a reduction in interest
expense related to lower net borrowings and a $0.9 million gain in the
settlement and termination of a building lease in the United Kingdom.
Other expenses for the year ended December 31, 2001 were $4.5 million, a 23
percent increase as compared to the same period in 2000 due to a $0.2 million
expense associated with foreign tax withholdings, $0.4 million in loan fees paid
to our former bank associated with the transition of our line of credit to a new
bank, $0.7 million in expense related to the issuance of a warrant to a former
officer in connection with his personal guarantee on our new line of credit and
a $1.8 million penalty due to a delay in the effectiveness of a registration
statement in connection with our private placement of 8,126,770 shares of Common
Stock, offset by a $1.6 million decrease in interest expense related to lower
net borrowings on our line of credit and a $0.7 million decrease in losses
associated with foreign currency exchanges.
Provision (Benefit) for Income Taxes
We recorded a tax benefit of $0.2 million for the year ended December 31,
2002, compared with a tax provision of $0.5 million for the year ended December
31, 2001. In June 2002, the Internal Revenue Service concluded their examination
of our consolidated federal income tax returns for the years ended April 30,
1992 through 1997. In fiscal 2001, we established a reserve of $500,000,
representing management's best estimate of amounts to be paid in settlement of
the IRS claims. With the executed settlement, the actual amount owed was only
$275,000, accordingly, we adjusted our reserve and, as a result, recognized an
income tax benefit of $225,000. We have a deferred tax asset of approximately
$54 million that has been fully reserved at December 31, 2002. This tax asset
would reduce future provisions for income taxes and related tax liabilities when
realized, subject to limitations.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date primarily through the use of lines of
credit, royalty and distribution fee advances, cash generated by the private
sale of securities, proceeds of our initial public offering, the sale of assets
and from results of operations. Since October 2001, we have been operating
without a line of credit, which has materially and adversely affected our
ability to finance our ongoing operations.
As of December 31, 2002, we had a working capital deficit of $17.1 million,
and our cash balance was approximately $134,000. We anticipate our current cash
reserves, proceeds from the sale of the Hunter franchise, plus our expected
generation of cash from existing operations, will only be sufficient to fund our
anticipated expenditures into the second quarter of fiscal 2003. Consequently,
we expect that we will need to substantially reduce our working capital needs
and/or raise additional financing. Along these lines, we have entered into a new
distribution agreement with Vivendi, which accelerates cash collections through
non-refundable minimum guarantees. If we do not receive sufficient financing we
may (i) liquidate assets, (ii) sell the company (iii) seek protection from our
creditors, and/or (iv) continue operations, but incur material harm to our
business, operations or financial conditions.
Our primary capital needs have historically been to fund working capital
requirements necessary to fund our net losses, 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 $28.2 million during the year ended December 31, 2002,
primarily attributable to payments for accounts payable and royalty liabilities,
recoupment of advances received by distributors, and refund of advances received
from Vivendi and a console hardware manufacturer for the development of titles
for its console platform in connection with the sale of Shiny. These uses of
cash in operating activities were partially offset by collections of accounts
receivable and accounts receivable from related parties and reductions of
inventory.
Net cash used by financing activities of $4.7 million for the year ended
December 31, 2002, consisted primarily of repayments of our working capital line
of credit and repayments to our former Chairman. Cash provided by investing
activities of $32.9 million for the year ended December 31, 2002 consisted of
proceeds from the sale of Shiny, offset by
24
normal capital expenditures, primarily for office and computer equipment used in
our operations. We do not currently have any material commitments with respect
to any future capital expenditures.
The following summarizes our contractual obligations under non-cancelable
operating leases and other borrowings at December 31, 2002, and the effect such
obligations are expected to have on our liquidity and cash flow in future
periods.
Less Than 1 - 3 After
December 31, 2002 Total 1 Year Years 3 Years
--------- --------- ------- --------
(In thousands)
Contractual cash obligations -
Non-cancelable operating
lease obligations $ 5,215 $ 1,386 $ 3,065 $ 764
========= ========= ======= ========
In April 2002, we entered into a settlement agreement with the landlord of
an office facility in the United Kingdom, whereby we returned the property back
to the landlord and were released from any further lease obligations. This
settlement reduced our total contractual cash obligations by $1.3 million
through fiscal 2005.
Our main source of capital is from the release of new titles. Historically,
we have had some delays in the release of new titles and we anticipate that we
may continue to incur delays in the release of future titles. These delays can
have a negative impact on our short-term liquidity, but should not affect our
overall liquidity.
To reduce our working capital needs, we have implemented various measures
including a reduction of personnel, a reduction of fixed overhead commitments,
cancellation or suspension of development on future titles which management
believes do not meet sufficient projected profit margins, and the scaling back
of certain marketing programs associated with the cancelled projects. Management
will continue to pursue various alternatives to improve future operating results
and further expense reductions, some of which may have a long-term adverse
impact on our ability to generate successful future business activities. In
addition, we continue to seek external sources of funding, including but not
limited to, a sale or merger of the company, a private placement of our capital
stock, the sale of selected assets, the licensing of certain product rights in
selected territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
our long-term strategic objectives. In this regard, we completed the sale of
Shiny in April 2002, for approximately $47.2 million. Additionally, in August
2002, our Board of Directors established a Special Committee comprised of
directors that are independent of our largest stockholder, Titus Interactive
S.A., to investigate strategic options, including raising capital from the sale
of debt or equity securities and a sale of the company.
In order to improve our cash flow, in August 2002, we entered into a new
distribution arrangement with Vivendi, whereby, Vivendi will distribute
substantially all of our products in North America for a period of three years
as a whole and two years with respect to each product providing for a potential
maximum term of five years. Under the August 2002 agreement, Vivendi will pay us
sales proceeds less amounts for distribution fees, price concessions and
returns. Vivendi is responsible for all manufacturing, marketing and
distribution expenditures, and bears all credit, price concessions and inventory
risk, including product returns. Upon our delivery of a gold master to Vivendi,
Vivendi will pay us, as a non-refundable minimum guarantee, a specified percent
of the projected amount due to us based on projected initial shipment sales,
which are established by Vivendi in accordance with the terms of the agreement.
The remaining amounts are due upon shipment of the titles to Vivendi's
customers. Payments for future sales that exceed the projected initial shipment
sales are paid on a monthly basis. We expect this new arrangement to improve our
short-term liquidity, but should not impact our overall liquidity.
If operating revenues from product releases are not sufficient to fund our
operations, no assurance can be given that alternative sources of funding could
be obtained on acceptable terms, or at all. These conditions, combined with our
historical operating losses and deficits in stockholders' equity and working
capital, raise substantial doubt about our ability to continue as a going
concern. The accompanying consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets and liabilities that may result from the outcome of
this uncertainty.
25
ACTIVITIES WITH RELATED PARTIES
Our operations involve significant transactions with Titus, our majority
stockholder, Virgin, a wholly-owned subsidiary of Titus, and Vivendi, an owner
of 5 percent of our common stock. In addition, we obtained financing from the
former Chairman of the company.
Transactions with Titus
In March 2002, Titus converted its remaining 383,354 shares of Series A
preferred stock into approximately 47.5 million shares of our common stock.
Titus now owns approximately 67 million shares of common stock, which represents
approximately 71 percent of our outstanding common stock, our only voting
security, immediately following the conversion.
Titus retained Europlay as consultants to assist with the restructuring of
the company. This arrangement with Europlay is with Titus, however, we agreed to
reimburse Titus for consulting expenses incurred on our behalf. In connection
with the sale of Shiny, we agreed to pay Europlay directly for their services
with the proceeds received from the sale, which Europlay received. We have also
entered into a commission-based agreement with Europlay where Europlay will
assist us with strategic transactions, such as debt or equity financing, the
sale of assets or an acquisition of the company. Under this arrangement,
Europlay assisted us with the sale of Shiny.
In connection with the equity investments by Titus, we perform distribution
services on behalf of Titus for a fee. In connection with such distribution
services, we recognized fee income of $22,000, $21,000 and $435,000 for the
years ended December 31, 2002, 2001 and 2000, respectively.
In March 2003, we entered into a note receivable with Titus Software Corp.,
or "TSC", a subsidiary of Titus, for $226,000. The note earns interest at 8
percent per annum and is due in February 2004. The note is secured by (i) 4
million shares of our common stock held by Titus (ii) TSC's rights in and to a
note receivable due from the President of Interplay and (iii) rights in and to
TSC's most current video game title releases during 2003 and 2004.
In March 2003, our Board of Directors further authorized an additional
$500,000 loan to Titus, with interest at 8 percent per annum and a maturity date
in February 2004, on the condition that Titus is able to provide sufficient
security that is acceptable to the Board, which shall include, without
limitation, 9.3 million shares of our common stock held by Titus and (ii) rights
in and to Titus' most current video game title releases during 2003 and 2004.
In April 2002, we entered into an agreement with Titus, pursuant to which,
among other things, we sold to Titus all right, title and interest in the games
"EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter", "Sacrifice", "MDK",
"MDK II", and "Kingpin", and Titus licensed from us the right to develop,
publish, manufacture and distribute the games "Hunter I", "Hunter II", "Icewind
Dale I", "Icewind Dale II", and "BG: Dark Alliance II" solely on Nintendo
Advance GameBoy game system for the life of the games. As consideration for
these rights, Titus issued to us a promissory note in the principal amount of
$3.5 million, which note bears interest at 6 percent per annum. The promissory
note was due on August 31, 2002, and may be paid, at Titus' option, in cash or
in shares of Titus common stock with a per share value equal to 90 percent of
the average trading price of Titus' common stock over the 5 days immediately
preceding the payment date. Pursuant to our April 26, 2002 agreement with Titus,
on or before July 25, 2002, we had the right to solicit offers from and
negotiate with third parties to sell the rights and licenses granted under the
April 26, 2002 agreement. If we had entered into a binding agreement with a
third party to sell these rights and licenses for an amount in excess $3.5
million, we would have rescinded the April 26, 2002 agreement with Titus and
recovered all rights granted and released Titus from all obligations thereunder.
The Company's efforts to enter into a binding agreement with a third party were
unsuccessful. Moreover, we have provided Titus with a guarantee under this
agreement, which provides that in the event Titus does not achieve gross sales
of at least $3.5 million by June 25, 2003, and the shortfall is not the result
of Titus' failure to use best commercial efforts, we will pay to Titus the
difference between $3.5 million and the actual gross sales achieved by Titus,
not to exceed $2 million. We are in the later stages of negotiations with Titus
to repurchase these assets for a purchase price payable by canceling the $3.5
million promissory note, and any unpaid accrued interest thereon. Concurrently,
Titus and us would terminate any executory obligations relating to the original
sale, including our obligation to pay Titus up to $2 million if Titus does not
achieve gross sales of at least $3.5 million by
26
June 25, 2003. As Titus is our majority stockholder and the probability of the
agreement being terminated, we have offset the related note receivable in the
amount of $3.5 million against the deferred revenue in the amount of $3.5
million.
In March 2002, we entered into a distribution agreement with Titus pursuant
to which we granted to Titus the exclusive right to distribute one of our
products for the Sony Playstation console in North America, South America and
Central America in exchange for a minimum guarantee of $100,000 for the first
71,942 units of the product sold, plus $.69 per unit on any product sold above
the 71,942 units.
During the year ended December 31, 2000, we recognized $3 million in
licensing revenue under a multi-product license agreement with Titus for the
technology underlying one title and the content of three titles for multiple
game platforms, extended for a maximum period of twelve years, with variable
royalties payable to us from five to ten percent, as defined. We earned a $3
million non-refundable fully-recoupable advance against royalties upon signing
and completing all of our obligations under the agreement. During the year ended
December 31, 1999, we executed publishing agreements with Titus for three
titles. As a result of these agreements, we recognized revenue of $2.6 million
for delivery of these titles to Titus.
As of December 31, 2002 and 2001, Titus owed us $200,000 and $260,000,
respectively, and we owed Titus $321,000 and $1.3 million, respectively. Amounts
due to Titus at December 31, 2002 consisted primarily of trade payables. Amounts
due to Titus at December 31, 2001 include dividends payable of $740,000 and
$450,000 for services rendered by Europlay.
Transactions with Virgin, a wholly owned subsidiary of Titus
In February 1999, we entered into an International Distribution Agreement
with Virgin, which provides for the exclusive distribution of substantially all
of our products in Europe, Commonwealth of Independent States, Africa and the
Middle East for a seven-year period, cancelable under certain conditions,
subject to termination penalties and costs. Under this agreement, as amended, we
pay Virgin a distribution fee based on net sales, and Virgin provides certain
market preparation, warehousing, sales and fulfillment services on our behalf.
Under an April 2001 settlement, we paid Virgin a monthly overhead fee of
$83,000 per month for the six month period beginning January 2002, with no
further overhead commitment for the remainder of the term of the International
Distribution Agreement.
In January 2003, we and Virgin entered into a waiver related to the
distribution of a video game title in which we sold the European distribution
rights to Vivendi. In consideration for Virgin relinquishing its rights, we
agreed to pay Virgin $650,000 and will pay Virgin 50 percent of all proceeds in
excess of the advance received from Vivendi. As of December 31, 2002 the Company
had paid Virgin $220,000 of the $650,000 due under the waiver agreement.
In February 2003, Virgin Interactive Entertainment (Europe) Limited,, the
operating subsidiary of filed for a Company Voluntary Arrangement, or CVA, a
process of reorganization in the United Kingdom which must be approved by
Virgin's creditors. Virgin owed us approximately $1.8 million at December 31,
2002. As of March 28, 2003, the CVA was rejected by Virgin's creditors, and
Virgin is presently negotiating with its creditors to propose a new CVA. We do
not know what affect approval of the CVA will have on our ability to collect
amounts Virgin owes us. If the new CVA is not approved, we expect Virgin to
cease operations and liquidate, in which event we will most likely not receive
any amounts presently due us by Virgin, and will not have a distributor for our
products in Europe and the other territories in which Virgin presently
distributes our products.
In connection with the International Distribution Agreement, we incurred
distribution commission expense of $0.9 million, $2.3 million and $4.6 million
for the years ended December 31, 2002, 2001 and 2000, respectively. In addition,
we recognized overhead fees of $0.5 million, $1.0 million and zero and certain
minimum operating charges to Virgin of zero, $333,000 and zero for the years
ended December 31, 2002, 2001 and 2000, respectively.
We have also entered into a Product Publishing Agreement with Virgin, which
provides us with an exclusive license to publish and distribute substantially
all of Virgin's products within North America, Latin America and South America
for a royalty based on net sales. As part of terms of an April 2001 settlement
between Virgin and us, the Product Publishing Agreement was amended to provide
for us to publish only one future title developed by Virgin. In connection
27
with the Product Publishing Agreement with Virgin, we earned $66,000, $36,000
and $63,000 for performing publishing and distribution services on behalf of
Virgin for the years ended December 31, 2002, 2001 and 2000, respectively.
In connection with the International Distribution Agreement, we sublease
office space from Virgin. Rent expense paid to Virgin was $104,000, $104,000 and
$101,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
Transactions with Vivendi
In August 2001, we entered into a distribution agreement with Vivendi (an
affiliate company of Universal Studios, Inc., which currently owns approximately
5 percent of our common stock at December 31, 2002 but does not have
representation on our Board of Directors) providing for Vivendi to become our
distributor in North America through December 31, 2003 for substantially all of
our products, with the exception of products with pre-existing distribution
agreements. OEM rights were not among the rights granted to Vivendi under the
distribution agreement. Under the terms of the agreement, as amended, Vivendi
earns a distribution fee based on the net sales of the titles distributed. Under
the agreement, Vivendi made four advance payments to us $10.0 million. In
amendments to the agreement, Vivendi agreed to advance us an additional $3.5
million. The distribution agreement, as amended, provides for the acceleration
of the recoupment of the advances made to us, as defined. During the three
months ended March 31, 2002, Vivendi advanced us an additional $3.0 million
bringing the total amounts advanced to us under the distribution agreement with
Vivendi to $16.5 million. In April 2002, the distribution agreement was further
amended to provide for Vivendi to distribute substantially all of our products
through December 31, 2002, except certain future products, which Vivendi would
have the right to distribute for one year from the date of release. As of August
1, 2002, all distribution advances relating to the August 2001 agreement from
Vivendi were fully recouped or repaid.
In August 2002, we entered into a new distribution agreement with Vivendi
whereby Vivendi will distribute substantially all of our products in North
America for a period of three years as a whole and two years with respect to
each product giving a potential maximum term of five years. Under the August
2002 agreement, Vivendi will pay us sales proceeds less amounts for distribution
fees, price concessions and returns. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon our
delivery of a gold master to Vivendi, Vivendi will pay us as a minimum
guarantee, a specified percent of the projected amount due us based on projected
initial shipment sales, which are established by Vivendi in accordance with the
terms of the agreement. The remaining amounts are due upon shipment of the
titles to Vivendi's customers. Payments for future sales that exceed the
projected initial shipment sales are paid on a monthly basis. As of December 31,
2002, Vivendi had advanced us $3.6 million related to future minimum guarantees
on undelivered products.
Transactions with Brian Fargo, a former officer of the Company
In connection with our working capital line of credit obtained in April
2001, we obtained a $2 million personal guarantee in favor of the bank, secured
by $1.0 million in cash, from Brian Fargo, the former Chairman of the company.
In addition, Mr. Fargo provided us with a $3.0 million loan, payable in May
2002, with interest at 10 percent. In connection with the guarantee and loan,
Mr. Fargo received warrants to purchase 500,000 shares of our common stock at
$1.75 per share, expiring in April 2011. In January 2002, the bank redeemed the
$1.0 million in cash pledged by Mr. Fargo in connection with his personal
guarantee, and subsequently we agreed to pay that amount back to Mr. Fargo. The
amount was fully paid in April 2002 in connection with the sale of Shiny.
We had amounts due from a business controlled by Mr. Fargo. Net amounts
due, prior to reserves, at December 31, 2000 were $2.5 million. Such amounts at
December 31, 2000 are fully reserved. In 2001, we wrote off this receivable.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2001, the Emerging Issues Task Force reached a consensus on Issue
No. 00-25 ("EITF 00-25"), "Accounting for Consideration from a Vendor to a
Retailer in Connection with the Purchase or Promotion of the Vendor's Products",
which requires that amounts paid by 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
28
categorized as a cost incurred if, and to the extent that, a benefit is or will
be received from the recipient of the consideration. That benefit must meet
certain conditions described in EITF 00-25. We adopted the provisions of the
consensus on January 1, 2002 resulting in a reduction of revenue and a reduction
of marketing and sales of $1.3 million and $3.2 million for the years ended
December 31, 2001 and 2000, respectively. The adoption of EITF 00-25 did not
impact our net loss.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of SFAS
No. 146 are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. We do not expect the
adoption of SFAS No. 146 to have a material impact on our consolidated financial
position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires a guarantor to
(i) include disclosure of certain obligations, and (ii) if applicable, at the
inception of the guarantee, recognize a liability for the fair value of other
certain obligations undertaken in issuing a guarantee. The disclosure provisions
of the Interpretation are effective for financial statements of interim or
annual reports that end after December 15, 2002 and we have adopted these
requirements. However, the provisions for initial recognition and measurement
are effective on a prospective basis for guarantees that are issued or modified
after December 31, 2002, irrespective. As of December 31, 2002, we have not
guaranteed the indebtedness of our subsidiaries or any related parties.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123". SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income and earnings per share and the entity's accounting policy decisions with
respect to stock-based employee compensation. Certain of the disclosure
requirements are required for all companies, regardless of whether the fair
value method or intrinsic value method is used to account for stock-based
employee compensation arrangements. We continue to account for its employee
incentive stock option plans using the intrinsic value method in accordance with
the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." The amendments to
SFAS 123 will be effective for financial statements for fiscal years ended after
December 15, 2002 and for interim periods beginning after December 15, 2002. We
have adopted the disclosure provisions of this statement during the year ended
December 31, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). This interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements," addresses
consolidation by business enterprises of variable interest entities. Under
current practice, two enterprises generally have been included in consolidated
financial statements because one enterprise controls the other through voting
interests. FIN 46 defines the concept of "variable interests" and requires
existing unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risks among
the parties involved. This interpretation applies immediately to variable
interest entities created after January 31, 2003. It applies in the first fiscal
year or interim period beginning after June 15, 2003, to variable interest
entities in which an enterprise holds a variable interest that it acquired
before February 1, 2003. If it is reasonably possible that an enterprise will
consolidate or disclose information about a variable interest entity when FIN 46
becomes effective, the enterprise shall disclose information about those
entities in all financial statements issued after January 31, 2003. The
interpretation may be applied prospectively with a cumulative-effect adjustment
as of the date on which it is first applied or by restating previously issued
financial statements for one or more years with a cumulative-effect adjustment
as of the beginning of the first year restated. Based on the recent release of
FIN 46, we have not completed our assessment as to whether or not the adoption
of FIN 46 will have a material impact on our consolidated financial statements.
29
FACTORS THAT MAY AFFECT FINANCIAL CONDITION AND FUTURE RESULTS
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 December 31, 2002, our cash balance was approximately $134,000 and
our outstanding accounts payable and current liabilities totaled approximately
$28.2 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.
These measures could have a material adverse effect on our ability to continue
as a going concern. Additionally, because of our financial condition, our Board
of Directors has a duty to our creditors that may conflict with the interests of
our stockholders. When a Delaware corporation is operating in the vicinity of
insolvency, the Delaware courts have imposed upon the corporation's directors a
fiduciary duty to the corporation's creditors. If we cannot obtain additional
capital and become unable to pay our debts as they become due, our Board of
Directors may be required to make decisions that favor the interests of
creditors at the expense of our stockholders to fulfill its fiduciary duty. For
instance, we may be required to preserve our assets to maximize the repayment of
debts versus employing the assets to further grow our business and increase
shareholder value.
WE HAVE A HISTORY OF LOSSES, MAY NEVER GENERATE POSITIVE CASH FLOW FROM
OPERATIONS AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY CURTAILING FUTURE
OPERATIONS.
For the year ended December 31, 2002, our net loss from operations was
$12.4 million and for the year ended December 31, 2001, our net loss was $46.3
million. Since inception, we have incurred significant losses and negative cash
flow, and as of December 31, 2002 we had an accumulated deficit of $13.9
million. Our ability to fund our capital requirements out of our available cash
and cash generated from our operations depends on a number of factors. Some of
these factors include the progress of our product development programs, the rate
of growth of our business, and our products' commercial success. If we cannot
generate positive cash flow from operations, we will have to continue to reduce
our costs and raise working capital from other sources. These measures could
include selling or consolidating certain operations, and delaying, canceling or
scaling back product development and marketing programs. These measures could
materially and adversely affect our ability to publish successful titles, and
may not be enough to permit us to operate profitability, or at all.
WE DEPEND, IN PART, ON EXTERNAL FINANCING TO FUND OUR CAPITAL NEEDS. IF WE ARE
UNABLE TO OBTAIN SUFFICIENT FINANCING ON FAVORABLE TERMS, WE MAY NOT BE ABLE TO
CONTINUE TO OPERATE OUR BUSINESS.
Historically, our business has not generated revenues sufficient to create
operating profits. To supplement our revenues, we have funded our capital
requirements with debt and equity financing. Our ability to obtain additional
equity or debt financing depends on a number of factors including our financial
performance, the overall conditions in our industry, and our credit rating. If
we cannot raise additional capital on favorable terms, we will have to reduce
our costs and sell or consolidate operations.
TITUS INTERACTIVE SA CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A
MAJORITY OF OUR BOARD OF DIRECTORS AND PREVENT AN ACQUISITION OF INTERPLAY THAT
IS FAVORABLE TO OUR OTHER STOCKHOLDERS.
Titus owns approximately 67 million shares of common stock, which
represents approximately 71 percent of our outstanding common stock, our only
voting security. As a consequence, Titus can control substantially all matters
requiring stockholder approval, including the election of directors, subject to
our stockholders' cumulative voting rights, and the approval of mergers or other
business combination transactions. At our 2001 and 2002 annual stockholders
meetings, Titus exercised its voting power to elect a majority of our Board of
Directors. Currently, three of the seven members of our Board are employees or
directors of Titus, and Titus' Chief Executive Officer serves as our Chief
30
Executive Officer and interim Chief Financial Officer. This concentration of
voting power could discourage or prevent a change in control that otherwise
could result in a premium in the price of our common stock.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES DEPEND ON OUR DISTRIBUTORS' DILIGENT
SALES EFFORTS AND OUR DISTRIBUTORS' AND RETAIL CUSTOMERS' TIMELY PAYMENTS TO US.
Since February 1999, Virgin has been the exclusive distributor for most of
our products in Europe, the Commonwealth of Independent States, Africa and the
Middle East. Our agreement with Virgin expires in February 2006. In August 2002,
we entered into a new Distribution Agreement with Vivendi pursuant to which
Vivendi distributes substantially all our products in North America, as well as
in South America, South Africa, Korea, Taiwan and Australia. Our agreement with
Vivendi expires in August 2005.
Virgin and Vivendi each have exclusive rights to distribute our products in
substantial portions of the world. As a consequence, the distribution of our
products by Virgin and Vivendi will generate a substantial majority of our
revenues, and proceeds from Virgin and Vivendi from the distribution of our
products will constitute a substantial majority of our operating cash flows.
Therefore, our revenues and cash flows could fall significantly and our business
and financial results could suffer material harm if:
o either Virgin or Vivendi fails to deliver to us the full proceeds owed
us from distribution of our products;
o either Virgin or Vivendi fails to effectively distribute our products
in their respective territories; or
o either Virgin or Vivendi otherwise fails to perform under their
respective distribution agreement.
We typically sell to distributors and retailers on unsecured credit, with
terms that vary depending upon the customer and the nature of the product. We
confront the risk of non-payment from our customers, whether due to their
financial inability to pay us, or otherwise. In addition, while we maintain a
reserve for uncollectible receivables, the reserve may not be sufficient in
every circumstance. As a result, a payment default by a significant customer
could cause material harm to our business.
In February 2003, Virgin Interactive Entertainment (Europe) Limited,, the
operating subsidiary of Virgin filed for a Company Voluntary Arrangement, or
CVA, a process of reorganization in the United Kingdom which must be approved by
Virgin's creditors. Virgin owed us approximately $1.8 million at December 31,
2002. As of March 28, 2003, the CVA was rejected by Virgin's creditors, and
Virgin is presently negotiating with its creditors to propose a new CVA. We do
not know what affect approval of the CVA will have on our ability to collect
amounts Virgin owes us. If the new CVA is not approved, we expect Virgin to
cease operations and liquidate, in which event we will most likely not receive
any amounts presently due us by Virgin, and will not have a distributor for our
products in Europe and the other territories in which Virgin presently
distributes our products.
THE TERMINATION OF OUR EXISTING CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL
REDUCTION IN THE CASH AVAILABLE TO FINANCE OUR OPERATIONS.
We have been operating without a credit facility since October 2001, when
LaSalle Business Credit Inc., or "LaSalle", notified us that our then existing
credit agreement was being terminated as a result of our failure to comply with
some of the agreement's operating covenants and we would no longer be able to
continue to draw on the credit facility to fund future operations. Because we
depend on a credit agreement to fund our operations, the lack of a credit
agreement has significantly impeded our ability to fund our operations and has
caused material harm to our business. We will need to enter into a new credit
agreement to help fund our operations. There can be no assurance that we will be
able to enter into a new credit agreement or that if we do enter into a new
credit agreement, it will be on terms favorable to us.
31
THE UNPREDICTABILITY OF FUTURE RESULTS MAY CAUSE OUR STOCK PRICE TO REMAIN
DEPRESSED OR TO DECLINE FURTHER.
Our operating results have fluctuated in the past and may fluctuate in the
future due to several factors, some of which are beyond our control. These
factors include:
o demand for our products and our competitors' products;
o the size and rate of growth of the market for interactive
entertainment software;
o changes in personal computer and video game console platforms;
o the timing of announcements of new products by us and our competitors
and the number of new products and product enhancements released by us
and our competitors;
o changes in our product mix;
o the number of our products that are returned; and
o the level of our international and original equipment manufacturer
royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which
we will ship our products. Some of these factors include:
o the uncertainties associated with the interactive entertainment
software development process;
o approvals required from content and technology licensors; and
o the timing of the release and market penetration of new game hardware
platforms.
It is likely that in some future periods our operating results will not
meet the expectations of the public or of public market analysts. Any
unanticipated change in revenues or operating results is likely to cause our
stock price to fluctuate since such changes reflect new information available to
investors and analysts. New information may cause securities analysts and
investors to revalue our stock and this may cause fluctuations in our stock
price.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE INTRODUCTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
For the year ended December 31, 2002, our net loss from operations was
$12.4 million. We have incurred significant net losses in recent periods,
including a net loss of $46.3 million for the year ended December 31, 2001. Our
losses stem partly from the significant costs we incur to develop our
entertainment software products. Moreover, a significant portion of our
operating expenses is relatively fixed, with planned expenditures based largely
on sales forecasts. At the same time, most of our products have a relatively
short life cycle and sell for a limited period of time after their initial
release, usually less than one year.
Relatively fixed costs and short windows in which to earn revenues mean
that sales of new products are important in enabling us to recover our
development costs, to fund operations and to replace declining net revenues from
older products. Our failure to accurately assess the commercial success of our
new products, and our delays in releasing new products, could reduce our net
revenues and our ability to recoup development and operational costs.
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
32
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.
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis. Because we introduce
a relatively limited number of new products in a given period, the failure of
one or more of these products to achieve market acceptance could cause material
harm to our business. Further, if our products do not achieve market acceptance,
we could be forced to accept substantial product returns or grant significant
pricing concessions to maintain our relationship with retailers and our access
to distribution channels. If we are forced to accept significant product returns
or grant significant pricing concessions, our business and financial results
could suffer material harm.
OUR RELIANCE ON THIRD PARTY SOFTWARE DEVELOPERS SUBJECTS US TO THE RISKS THAT
THESE DEVELOPERS WILL NOT SUPPLY US WITH HIGH QUALITY PRODUCTS IN A TIMELY
MANNER OR ON ACCEPTABLE TERMS.
Third party interactive entertainment software developers develop many of
our software products. Since we depend on these developers in the aggregate, we
remain subject to the following risks:
o limited financial resources may force developers out of business prior
to their completion of projects for us or require us to fund
additional costs; and
o the possibility that developers could demand that we renegotiate our
arrangements with them to include new terms less favorable to us.
Increased competition for skilled third party software developers also has
compelled us to agree to make advance payments on royalties and to guarantee
minimum royalty payments to intellectual property licensors and game developers.
Moreover, if the products subject to these arrangements, are not delivered
timely, or with acceptable quality, or do not generate sufficient sales volumes
to recover these royalty advances and guaranteed payments, we would have to
write-off unrecovered portions of these payments, which could cause material
harm to our business and financial results.
IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
o operating systems such as Microsoft Windows XP;
o technologies that support games with multi-player and online features;
o new media formats such as online delivery and digital video disks, or
DVDs; and
o recent releases of new video game consoles such as the Sony
Playstation 2, the Nintendo Gamecube and the Microsoft Xbox.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
New interactive entertainment software platforms and technologies also may
undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
33
o anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on favorable
terms; or
o create software for those new platforms on a timely basis.
WE COMPETE WITH A NUMBER OF COMPANIES THAT HAVE SUBSTANTIALLY GREATER FINANCIAL,
MARKETING AND PRODUCT DEVELOPMENT RESOURCES THAN WE DO.
The greater resources of our competitors permit them to pay higher fees
than we can to licensors of desirable motion picture, television, sports and
character properties and to third party software developers.
We compete primarily with other publishers of personal computer and video
game console interactive entertainment software. Significant competitors include
Electronic Arts Inc. and Activision, Inc. Many of these competitors have
substantially greater financial, technical resources, larger customer bases,
longer operating histories, greater name recognition and more established
relationships in the industry than we do.
In addition, integrated video game console hardware/software companies such
as Sony Computer Entertainment, Nintendo, and Microsoft Corporation compete
directly with us in the development of software titles for their respective
platforms and they have generally discretionary approval authority over the
products we develop for their platforms. Large diversified entertainment
companies, such as The Walt Disney Company, many of which own substantial
libraries of available content and have substantially greater financial
resources, may decide to compete directly with us or to enter into exclusive
relationships with our competitors. We also believe that the overall growth in
the use of the Internet and online services by consumers may pose a competitive
threat if customers and potential customers spend less of their available home
personal computing time using interactive entertainment software and more time
using the Internet and online services.
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. We have
mitigated this risk in North America under the new distribution arrangement with
Vivendi, as sales will be guaranteed with no offset against returns.
WE HAVE RELIED ON LOANS FROM TITUS INTERACTIVE S.A. IN THE PAST TO ENABLE US TO
MEET OUR SHORT-TERM CASH NEEDS. TITUS INTERACTIVE S.A.'S CURRENT FINANCIAL
CONDITION MAY RESULT IN OUR INABILITY TO SECURE CASH TO FUND OPERATIONS, MAY
LEAD TO A SALE BY TITUS OF SHARES IT HOLDS IN US, AND MAY MAKE A SALE OF US MORE
DIFFICULT.
On March 21, 2003, due to Titus' lack of sufficient operating capital and
need for immediate cash, we agreed to loan Titus Software Corp., a subsidiary of
Titus, the sum of $226,000, with this amount secured by a percentage of our
shares held by Titus pursuant to a stock pledge agreement and certain other
collateral pursuant to a security agreement. Our Board of Directors further
authorized an additional $500,000 loan to Titus, on the condition that Titus is
able to provide sufficient security that is acceptable to the Board. In the
past, Titus, our majority shareholder, has loaned us money to enable us to meet
our short-term cash needs. Now it appears that, at least in the near term, Titus
will not have the ability to support us should we find ourselves with
insufficient cash to fund operations. Further, should Titus ever be forced to
cease operations due to lack of capital, that situation could lead to a sale by
Titus, or its administrator or other representative in bankruptcy, of shares
Titus holds in us, thereby potentially reducing the value of our shares and
market
34
capitalization. Such a sale and dispersion of shares to multiple stockholders
further could have the effect of making any business combination, or a sale of
all of our shares as a whole, more difficult.
WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR
ABILITY TO MANAGE OUR FINANCIAL OPERATIONS.
Our former Chief Financial Officer ("CFO") Jeff Gonzalez resigned in
October 2002. Following Mr. Gonzalez' resignation, CEO Herve Caen also assumed
the position of interim-CFO for a period of 5 months until March 3, 2003, at
which time we hired a replacement CFO. On March 21, 2003, our new CFO resigned
effectively immediately. We are presently without a CFO, and Mr. Caen has again
assumed the position of interim-CFO.
WE DEPEND UPON THIRD PARTY LICENSES OF CONTENT FOR MANY OF OUR PRODUCTS.
Many of our current and planned products, such as our Advanced Dungeons and
Dragons titles, are lines based on original ideas or intellectual properties
licensed from other parties. From time to time we may not be in compliance with
certain terms of these license agreements, and our ability to market products
based on these licenses may be negatively impacted. Moreover, disputes regarding
these license agreements may also negatively impact our ability to market
products based on these licenses. Additionally, we may not be able to obtain new
licenses, or maintain or renew existing licenses, on commercially reasonable
terms, if at all. If we are unable to maintain current licenses or obtain new
licenses for the underlying content that we believe offers the greatest consumer
appeal, we would either have to seek alternative, potentially less appealing
licenses, or release products without the desired underlying content, either of
which could limit our commercial success and cause material harm to our
business.
WE MAY FAIL TO MAINTAIN EXISTING LICENSES, OR OBTAIN NEW LICENSES FROM HARDWARE
COMPANIES ON ACCEPTABLE TERMS OR TO OBTAIN RENEWALS OF EXISTING OR FUTURE
LICENSES FROM LICENSORS.
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo and Microsoft. In
addition, each of these companies has the right to approve the technical
functionality and content of our products for their platforms prior to
distribution. Due to the competitive nature of the approval process, we must
make significant product development expenditures on a particular product prior
to the time we seek these approvals. Our inability to obtain these approvals
could cause material harm to our business.
OUR SALES VOLUME AND THE SUCCESS OF OUR PRODUCTS DEPEND IN PART UPON THE NUMBER
OF PRODUCT TITLES DISTRIBUTED BY HARDWARE COMPANIES FOR USE WITH THEIR VIDEO
GAME PLATFORMS.
Even after we have obtained licenses to develop and distribute software, we
depend upon hardware companies such as Sony Computer Entertainment, Nintendo and
Microsoft, or their designated licensees, to manufacture the CD-ROM or DVD-ROM
media discs that contain our software. These discs are then run on the
companies' video game consoles. This process subjects us to the following risks:
o we are required to submit and pay for minimum numbers of discs we want
produced containing our software, regardless of whether these discs
are sold, shifting onto us the financial risk associated with poor
sales of the software developed by us; and
o reorders of discs are expensive, reducing the gross margin we receive
from software releases that have stronger sales than initially
anticipated and that require the production of additional discs.
As a result, video game console hardware licensors can shift onto us the
risk that if actual retailer and consumer demand for our interactive
entertainment software differs from our forecasts, we must either bear the loss
from overproduction or the lower per-unit revenues associated with producing
additional discs. Either situation could lead to material reductions in our net
revenues.
WE HAVE A LIMITED NUMBER OF KEY PERSONNEL. THE LOSS OF ANY SINGLE KEY PERSON OR
THE FAILURE TO HIRE AND INTEGRATE CAPABLE NEW KEY PERSONNEL COULD HARM OUR
BUSINESS.
35
Our interactive entertainment software requires extensive time and creative
effort to produce and market. The production of this software is closely tied to
the continued service of our key product design, development, sales, marketing
and management personnel. Our future success also will depend upon our ability
to attract, motivate and retain qualified employees and contractors,
particularly software design and development personnel. Competition for highly
skilled employees is intense, and we may fail to attract and retain such
personnel. Alternatively, we may incur increased costs in order to attract and
retain skilled employees. Our failure to retain the services of key personnel,
including competent executive management, or to attract and retain additional
qualified employees could cause material harm to our business.
Our international sales expose us to risks of unstable foreign economies,
difficulties in collection of revenues, increased costs of administering
international business transactions and fluctuations in exchange rates.
Our net revenues from international sales accounted for approximately 13
percent and 27 percent of our total net revenues for years ended December 31,
2002 and 2001, respectively. Most of these revenues come from our distribution
relationship with Virgin, pursuant to which Virgin became the exclusive
distributor for most of our products in Europe, the Commonwealth of Independent
States, Africa and the Middle East. To the extent our resources allow, we intend
to continue to expand our direct and indirect sales, marketing and product
localization activities worldwide.
Our international sales and operations are subject to a number of inherent
risks, including the following:
o recessions in foreign economies may reduce purchases of our products;
o translating and localizing products for international markets is time-
consuming and expensive;
o accounts receivable are more difficult to collect and when they are
collectible, they may take longer to collect;
o regulatory requirements may change unexpectedly;
o it is difficult and costly to staff and manage foreign operations;
o fluctuations in foreign currency exchange rates;
o political and economic instability;
o our dependence on Virgin as our exclusive distributor in Europe, the
Commonwealth of Independent States, Africa and the Middle East; and
o delays in market penetration of new platforms in foreign territories.
These factors may cause material declines in our future international net
revenues and, consequently, could cause material harm to our business.
A significant, continuing risk we face from our international sales and
operations stems from currency exchange rate fluctuations. Because we do not
engage in currency hedging activities, fluctuations in currency exchange rates
have caused significant reductions in our net revenues from international sales
and licensing due to the loss in value upon conversion into U.S. Dollars. We may
suffer similar losses in the future.
INADEQUATE INTELLECTUAL PROPERTY PROTECTIONS COULD PREVENT US FROM ENFORCING OR
DEFENDING OUR PROPRIETARY TECHNOLOGY.
We regard our software as proprietary and rely on a combination of patent,
copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks, and hold the rights to one
patent application related to one of our titles. While we provide "shrinkwrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
36
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:
o cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property, which license, if available at all, may not be available on
commercially favorable terms; or
o redesign our interactive entertainment software products, possibly in
a manner that reduces their commercial appeal.
Any of these actions may cause material harm to our business and financial
results.
OUR SOFTWARE MAY BE SUBJECT TO GOVERNMENTAL RESTRICTIONS OR RATING SYSTEMS.
Legislation is periodically introduced at the state and federal levels in
the United States and in foreign countries to establish a system for providing
consumers with information about graphic violence and sexually explicit material
contained in interactive entertainment software products. In addition, many
foreign countries have laws that permit governmental entities to censor the
content of interactive entertainment software. We believe that mandatory
government-run rating systems eventually will be adopted in many countries that
are significant markets or potential markets for our products. We may be
required to modify our products to comply with new regulations, which could
delay the release of our products in those countries.
Due to the uncertainties regarding such rating systems, confusion in the
marketplace may occur, and we are unable to predict what effect, if any, such
rating systems would have on our business. In addition to such regulations,
certain retailers have in the past declined to stock some of our products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. While to date these actions
have not caused material harm to our business, we cannot assure you that similar
actions by our distributors or retailers in the future would not cause material
harm to our business.
SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND INHIBIT OUR ABILITY TO RECEIVE A
PREMIUM PRICE FOR YOUR SHARES.
Our Board of Directors has the authority, without any action by the
stockholders, to issue up to 5,000,000 shares of preferred stock and to fix the
rights and preferences of such shares. In addition, our certificate of
incorporation and bylaws contain provisions that:
37
o eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to nominate
directors or submit proposals for stockholder approval.
These provisions may have the effect of delaying, deferring or preventing a
change in control, may discourage bids for our common stock at a premium over
its market price and may adversely affect the market price, and the voting and
other rights of the holders, of our common stock.
OUR STOCK PRICE IS VOLATILE.
The trading price of our common stock has previously fluctuated and could
continue to fluctuate in response to factors that are largely beyond our
control, and which may not be directly related to the actual operating
performance of our business, including:
o general conditions in the computer, software, entertainment, media or
electronics industries;
o changes in earnings estimates or buy/sell recommendations by analysts;
o investor perceptions and expectations regarding our products, plans
and strategic position and those of our competitors and customers; and
o price and trading volume volatility of the broader public markets,
particularly the high technology sections of the market.
WE DO NOT PAY DIVIDENDS ON OUR COMMON STOCK.
We have not paid any cash dividends on our common stock and do not
anticipate paying dividends in the foreseeable future.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of December 31,
2002. However, we are exposed to certain market risks arising from transactions
in the normal course of business, principally the risk associated with interest
rate fluctuations on any revolving line of credit agreement we maintain, and the
risk associated with foreign currency fluctuations. We do not hedge our interest
rate risk, or our risk associated with foreign currency fluctuations.
Interest Rate Risk
Our interest rate risk is due to our working capital lines of credit
typically having an interest rate based on either the bank's prime rate or
LIBOR. Currently, we do not have a line of credit, but we anticipate
establishing a line of credit in the future. A change in interest rates would
not have an effect on our interest expense on the Secured Convertible Promissory
Note because this instrument bears a fixed rate of interest.
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 losses of $104,000, $237,000 and $935,000 during the years ended
December 31, 2002, 2001 and 2000, respectively, primarily in connection with
foreign exchange fluctuations in the timing of payments received on accounts
receivable from Virgin.
38
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements begin on page F-1 of this
report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item 10 will appear in our proxy statement for
the 2003 Annual Meeting of Stockholders, and is incorporated herein by
reference.
Item 11. EXECUTIVE COMPENSATION
Information required by this Item 11 will appear in our proxy statement for
the 2003 Annual Meeting of Stockholders, and is incorporated herein by
reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this Item 12 will appear in our proxy statement for
the 2003 Annual Meeting of Stockholders, and is incorporated herein by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item 13 will appear in our proxy statement for
the 2003 Annual Meeting of Stockholders, and is incorporated herein by
reference.
Item 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, our Chief
Executive Officer and interim Chief Financial Officer, Herve Caen, with the
participation of our management, carried out an evaluation of the effectiveness
of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14.
Based upon that evaluation, Mr. Caen believes that, as of the date of the
evaluation, our disclosure controls and procedures are effective in making known
to him material information relating to us (including our consolidated
subsidiaries) required to be included in this report.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There were no significant changes in our internal controls or in other
factors that could significantly affect internal controls, known to Mr. Caen,
subsequent to the date of the evaluation.
39
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements
The list of financial statements contained in the accompanying Index to
Consolidated Financial Statements covered by the Reports of Independent Auditors
is herein incorporated by reference.
(2) Financial Statement Schedules
The list of financial statement schedules contained in the accompanying
Index to Consolidated Financial Statements covered by the Reports of Independent
Auditors is herein incorporated by reference.
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or the
Notes thereto.
(3) Exhibits
The list of exhibits on the accompanying Exhibit Index is herein
incorporated by reference.
(b) Reports on Form 8-K.
None.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized, at Irvine, California
this 30th day of March 2003.
INTERPLAY ENTERTAINMENT CORP.
/s/ Herve Caen
By:___________________________________
Herve Caen
Its: Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
POWER OF ATTORNEY
The undersigned directors and officers of Interplay Entertainment Corp. do
hereby constitute and appoint Herve Caen with full power of substitution and
resubstitution, as their true and lawful attorneys and agents, to do any and all
acts and things in our name and behalf in our capacities as directors and
officers and to execute any and all instruments for us and in our names in the
capacities indicated below, which said attorney and agent, may deem necessary or
advisable to enable said corporation to comply with the Securities Exchange Act
of 1934, as amended and any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with this Annual Report on
Form 10-K, including specifically but without limitation, power and authority to
sign for us or any of us in our names in the capacities indicated below, any and
all amendments (including post-effective amendments) hereto, and we do hereby
ratify and confirm all that said attorneys and agents, or either of them, shall
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Annual Report and Form 10-K has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
Signature Title Date
--------- ----- ----
/s/ Herve Caen
_________________________ Chief Executive Officer, March 30, 2003
Herve Caen Interim Chief Financial Officer
and Director (Principal
Executive and Financial and
Accounting Officer)
/s/ Nathan Peck
_________________________ Director March 30, 2003
Nathan Peck
/s/ Eric Caen
_________________________ Director March 30, 2003
Eric Caen
41
/s/ R. Parker Jones, Jr.
_________________________ Director March 30, 2003
R. Parker Jones, Jr.
/s/ Maren Stenseth
_________________________ Director March 30, 2003
Maren Stenseth
/s/ Michel H. Vulpillat
_________________________ Director March 30, 2003
Michel H. Vulpillat
/s/ Michel Welter
_________________________ Director March 30, 2003
Michel Welter
42
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------------------------------------------------------------------
2.1 Agreement and Plan of Reorganization and Merger, dated May 29, 1998,
between the Company and Interplay Productions. (incorporated herein by
reference to Exhibit 2.1 to the Company's Registration Statement on
Form S-1, No. 333-48473 (the "Form S-1"))
2.2 Stock Purchase Agreement by and between Infogrames, Inc., Shiny
Entertainment Inc., David Perry, Shiny Group, Inc., and Interplay
Entertainment Corp. dated April 23, 2002; incorporated herein by
reference to Exhibit 2.1 to the Company's Form 8-K filed May 6, 2002.
2.3 Amendment Number 1 to the Stock Purchase Agreement by and between
Interplay Entertainment Corp., Infogrames, Inc., Shiny Entertainment,
Inc., David Perry, and Shiny Group, Inc. dated April 30, 2002;
incorporated herein by reference to Exhibit 2.2 to the Company's Form
8-K filed May 6, 2002.
3.1 Amended and Restated Certificate of Incorporation of the Company.
(incorporated herein by reference to Exhibit 3.1 to the Form S-1)
3.2 Certificate of Designation of Preferences of Series A Preferred Stock,
as filed with the Delaware Secretary of State on April 14, 2000.
(incorporated herein by reference to Exhibit 10.32 to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999.)
3.3 Amended and Restated Bylaws of the Company. (incorporated herein by
reference to Exhibit 3.2 to the Form S-1)
4.1 Specimen form of stock certificate for Common Stock. (incorporated
herein by reference to Exhibit 4.1 to the Form S-1)
4.2 Shareholders' Agreement among MCA Inc., the Company, and Brian Fargo,
dated March 30, 1994, as amended. (incorporated herein by reference to
Exhibit 4.2 to the Form S-1)
4.3 Investors' Rights Agreement dated October 10, 1996, as amended, among
the Company and holders of its Subordinated Secured Promissory Notes
and Warrants to purchase Common Stock. (incorporated herein by
reference to Exhibit 4.3 to the Form S-1)
10.1 Amended and Restated 1997 Stock Incentive Plan (the "1997 Plan").
(incorporated herein by reference to Exhibit 10.1 to the Form S-1)
10.2 Form of Stock Option Agreement pertaining to the 1997 Plan.
(incorporated herein by reference to Exhibit 10.2 to the Form S-1)
10.3 Form of Restricted Stock Purchase Agreement pertaining to the 1997
Plan. (incorporated herein by reference to Exhibit 10.3 to the Form
S-1)
10.4 Incentive Stock Option and Nonqualified Stock Option Plan--1994, as
amended (the "1994 Plan"). (incorporated herein by reference to Exhibit
10.4 to the Form S-1)
10.5 Form of Nonqualified Stock Option Agreement pertaining to the 1994
Plan. (incorporated herein by reference to Exhibit 10.5 to the Form
S-1)
10.6 Incentive Stock Option, Nonqualified Stock Option and Restricted Stock
Purchase Plan--1991, as amended (the "1991 Plan"). (incorporated herein
by rference to Exhibit 10.6 to the Form S-1)
10.7 Form of Incentive Stock Option Agreement pertaining to the 1991 Plan.
(incorporated herein by reference to Exhibit 10.7 to the Form S-1)
10.8 Form of Nonqualified Stock Option Agreement pertaining to the 1991
Plan. (incorporated herein by reference to Exhibit 10.8 to the Form
S-1)
10.9 Employee Stock Purchase Plan. (incorporated herein by reference to
Exhibit 10.10 to the Form S-1)
10.10 Form of Indemnification Agreement for Officers and Directors of the
Company. (incorporated herein by reference to Exhibit 10.11 to the Form
S-1)
10.11 Von Karman Corporate Center Office Building Lease between the Company
and Aetna Life Insurance Company of Illinois, dated September 8, 1995,
together with amendments thereto. (incorporated herein by reference to
Exhibit 10.14 to the Form S-1)
10.12 Loan and Security Agreement among Greyrock Business Credit, a Division
of NationsCredit Commercial Corporation ("Greyrock"), the Company, and
Interplay OEM, Inc. ("Interplay OEM"), dated June 16, 1997, as amended,
with Schedules. (incorporated herein by reference to Exhibit 10.15 to
the Form S-1)
10.13 Letter of Credit Agreement among Greyrock, the Company and Interplay
OEM, dated September 10, 1997. (incorporated herein by reference to
Exhibit 10.18 to the Form S-1)
43
10.14 Letter of Credit Agreement among Greyrock, the Company and Interplay
OEM, dated September 24, 1997. (incorporated herein by reference to
Exhibit 10.19 to the Form S-1)
10.15 Master Equipment Lease between Brentwood Credit Corporation and the
Company, dated March 28, 1996, with Schedules. (incorporated herein by
reference to Exhibit 10.20 to the Form S-1)
10.16 Master Equipment Lease Agreement between General Electric Capital
Computer Leasing Corporation and the Company, dated December 14, 1994,
as amended, with Schedules. (incorporated herein by reference to
Exhibit 10.22 to the Form S-1)
10.17 Confidential License Agreement for Nintendo 64 Video Game System,
between the Company and Nintendo of America, Inc., dated October 7,
1997. (Portions omitted and filed separately with the Securities and
Exchange Commission pursuant to a request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.23 to the Form S-1)
10.18 PlayStation License Agreement, between Sony Computer Entertainment of
America and the Company, dated February 16, 1995. (Portions omitted and
filed separately with the Securities and Exchange Commission pursuant
to a request for confidential treatment.) (incorporated herein by
reference to Exhibit 10.24 to the Form S-1)
10.19 Master Merchandising License Agreement between Paramount Pictures
Corporation and the Company, dated as of June 16, 1992. (Portions
omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.25 to the Form S-1)
10.20 Heads of Agreement concerning Sales and Distribution between the
Company and Activision, Inc., dated November 19, 1998, as amended
(incorporated herein by reference to Exhibit 10.23 to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1998.)
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
10.21 Stock Purchase Agreement between the Company and Titus Interactive SA,
dated March 18, 1999 (incorporated herein by reference to Exhibit 10.24
to Registrant's Annual Report on Form 10-K for the year ended December
1998.)
10.22 International Distribution Agreement between the Company and Virgin
Interactive Entertainment Limited, dated February 10, 1999
(incorporated herein by reference to Exhibit 10.26 to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1998.)
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
10.23 Termination Agreement among the Company, Virgin Interactive
Entertainment Limited, VIE Acquisition Group, LLC and VIE Acquisition
Holdings, LLC, dated February 10, 1999 (incorporated herein by
reference to Exhibit 10.27 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.) (Portions omitted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment.)
10.24 Amendment to Loan Documents among the Company, Interplay OEM, Inc. and
Greyrock, dated March 18, 1999 (incorporated herein by reference to
Exhibit 10.28 to Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998.)
10.25 Fifth Amendment to Lease for Von Karman Corporate Center Office
Building between the Company and Arden Realty Finance IV, L.L.C., dated
December 4, 1998 (incorporated herein by reference to Exhibit 10.29 to
Registrant's Annual Report on Form 10-K for the year ended December 31,
1998.)
10.26 Stock Purchase Agreement dated July 20, 1999, by and among the Company,
Titus Interactive S.A., and Brian Fargo (incorporated herein by
reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999.)
10.27 Exchange Agreement dated July 20, 1999, by and among Titus Interactive
S.A., Brian Fargo, Herve Caen and Eric Caen (incorporated herein by
reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999.)
10.28 Employment Agreement between the Company and Herve Caen dated November
9, 1999 (incorporated herein by reference to Exhibit 10.3 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.)
10.29 Employment Agreement between the Company and Brian Fargo dated November
9, 1999 (incorporated herein by reference to Exhibit 10.2 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.)
10.30 Stockholder Agreement among the Company, Titus Interactive S.A. and
Brian Fargo dated November 9, 1999 (incorporated herein by reference to
Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999.)
44
10.31 Stock Purchase Agreement between the Company and Titus Interactive
S.A., dated April 14, 2000. (incorporated herein by reference to
Exhibit 10.31 to Registrant's Annual Report on Form 10-K for the year
ended December 31, 1999.)
10.32 Warrant (350,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000. (incorporated herein by
reference to Exhibit 10.33 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999.)
10.33 Warrant (50,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000. (incorporated herein by
reference to Exhibit 10.34 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999.)
10.34 Warrant (100,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000. (incorporated herein by
reference to Exhibit 10.35 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999.)
10.35 Amendment to Loan Documents among the Company, Interplay OEM, Inc. and
Greyrock, dated April 14, 2000. (incorporated herein by reference to
Exhibit 10.36 to Registrant's Annual Report on Form 10-K for the year
ended December 31, 1999.)
10.36 Revolving Note between the Company and Titus Interactive S.A., dated
April 14, 2000. (incorporated herein by reference to Exhibit 10.37 to
Registrant's Annual Report on Form 10-K for the year ended December 31,
1999.)
10.37 Reimbursement and Security Agreement between the Company and Titus
Interactive S.A., dated April 14, 2000. (incorporated herein by
reference to Exhibit 10.38 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1999.)
10.38 Amendment Number 1 to International Distribution Agreement between the
Company and Virgin Interactive Entertainment Limited, dated July 1,
1999. (incorporated herein by reference to Exhibit 10.39 to
Registrant's Annual Report on Form 10-K for the year ended December 31,
1999.)
10.39 Interplay Entertainment Corp. Common Stock Subscription Agreement,
dated March 29, 2001. (incorporated herein by reference to Exhibit 4.1
to the Form S-3 filed on April 17, 2001.)
10.40 Common Stock Purchase Warrant. (incorporated herein by reference to
Exhibit 4.2 to the Form S-3 filed on April 17, 2001)
10.41 Microsoft Corporation Xbox Publisher License Agreement, dated October
12, 2000. (incorporated herein by reference to Exhibit 10.39 to Form
10-K/A for the year ended December 31, 2000.)
10.42 Warrant to Purchase Common Stock of Interplay Entertainment Corp.,
dated April 25, 2001. (incorporated herein by reference to Exhibit 10.4
to the Form S-3 filed on May 4, 2001.)
10.43 Financial Public Relations Agreement, dated August 7, 2000.
(incorporated herein by reference to Exhibit 10.5 of the Form S-3 filed
on May 4, 2001.)
10.44 Agreement between Interplay Entertainment Corp., Brian Fargo, Titus
Interactive S.A., and Herve Caen, dated May 15, 2001. (incorporated
herein by reference to Exhibit 99 to Form SCD 13D/A.)
10.45 Distribution Agreement, dated August 23, 2001. (Portions omitted and
filed separately with the Securities and Exchange Commission pursuant
to a request for confidential treatment.) (incorporated herein by
reference to Exhibit 10.1 to the Form 10-Q for the quarter ending
September 30, 2001.)
10.46 Letter Agreement re: Amendment #1 to Distribution Agreement dated
August 23, 2001, dated September 14, 2001. (Portions omitted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment.) (incorporated herein by reference
to Exhibit 10.2 to the Form 10-Q for the quarter ending September 30,
2001.)
10.47 Letter Agreement re: Secured Advance and Amendment #2 to Distribution
Agreement, dated November 20, 2001 by and between Interplay
Entertainment Corp. and Vivendi Universal Interactive Publishing North
America, Inc. (incorporated herein by reference to Exhibit 10.47 to the
Form 10-K for the year ended December 31, 2001)
10.48 Letter Agreement re: Secured Advance and Amendment #3 to Distribution
Agreement, dated December 13, 2001 by and between Interplay
Entertainment Corp. and Vivendi Universal Interactive Publishing North
America, Inc. (incorporated herein by reference to Exhibit 10.48 to the
Form 10-K for the year ended December 31, 2001)
10.49 Third Amendment to Computer License Agreement, dated July 25, 2001 by
and between Interplay Entertainment Corp. and Infogrames, Inc.
(incorporated herein by reference to Exhibit 10.49 to the Form 10-K for
the year ended December 31, 2001)
45
10.50 Letter Agreement and Amendment Number 4 to Distribution Agreement by
and between Vivendi Universal Games, Inc. and Interplay Entertainment
Corp. dated January 18, 2002. (incorporated herein by reference to
Exhibit 10.1 to Form 10-Q filed on May 15, 2002)
10.51 Fourth Amendment To Computer License Agreement by and between Interplay
Entertainment Corp. and Infogrames Interactive, Inc. dated January 23,
2002. (Portions omitted and filed separately with the Securities and
Exchange Commission pursuant to request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.2 to Form 10-Q filed on
May 15, 2002)
10.52 Amendment Number Four to the Product Agreement by and between Interplay
Entertainment Corp., Infogrames Interactive, Inc., and Bioware Corp.
dated January 24, 2002. (incorporated herein by reference to Exhibit
10.3 to Form 10-Q filed on May 15, 2002)
10.53 Amended and Restated Amendment Number 1 to Product Agreement by and
between Interplay Entertainment Corp. and High Voltage Software, Inc.
dated March 5, 2002. (Portions omitted and filed separately with the
Securities and Exchange Commission pursuant to request for confidential
treatment.) (incorporated herein by reference to Exhibit 10.4 to Form
10-Q filed on May 15, 2002)
10.54 Forbearance Agreement by and between LaSalle Business Credit, Inc.,
Brian Fargo, Shiny Entertainment, Inc., Interplay Entertainment Corp.,
Interplay OEM, Inc., and Gamesonline.com, Inc. dated March 13, 2002.
(incorporated herein by reference to Exhibit 10.5 to Form 10-Q filed on
May 15, 2002)
10.55 Settlement Agreement and Release by and between Brian Fargo, Interplay
Entertainment Corp., Interplay OEM, Inc., Gamesonline.com, Inc., Shiny
Entertainment, Inc., and Titus Interactive S.A. dated March 13, 2002.
(incorporated herein by reference to Exhibit 10.6 to Form 10-Q filed on
May 15, 2002)
10.56 Agreement by and between Vivendi Universal Games Inc., Interplay
Entertainment Corp., and Shiny Entertainment, Inc. dated April of 2002.
(incorporated herein by reference to Exhibit 10.7 to Form 10-Q filed on
May 15, 2002)
10.57 Term Sheet by and between Titus Interactive S.A., and Interplay
Entertainment Corp. dated April 26, 2002. (incorporated herein by
reference to Exhibit 10.8 to Form 10-Q filed on May 15, 2002)
10.58 Promissory Note by Titus Interactive S.A. in favor of Interplay
Entertainment Corp. dated April 26, 2002. (incorporated herein by
reference to Exhibit 10.9 to Form 10-Q filed on May 15, 2002)
10.59 Amended and Restated Secured Convertible Promissory Note, dated April
30, 2002, in favor of Warner Bros., a division of Time Warner
Entertainment Company, L.P. (incorporated herein by reference to
Exhibit 10.10 to Form 10-Q filed on May 15, 2002)
10.60 Video Game Distribution Agreement by and between Vivendi Universal
Games, Inc. and Interplay Entertainment Corp. dated August 9, 2002.
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.1 to Form 10-Q filed on
November 19, 2002)
10.61 Letter of Intent by and between Vivendi Universal Games, Inc. and
Interplay Entertainment Corp. dated August 9, 2002. (Portions omitted
and filed separately with the Securities and Exchange Commission
pursuant to a request for confidential treatment.) (incorporated herein
by reference to Exhibit 10.2 to Form 10-Q filed on November 19, 2002)
10.62 Letter Agreement and Amendment #2 by and between Vivendi Universal
Games, Inc. and Interplay Entertainment Corp. dated August 29, 2002.
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.3 to Form 10-Q filed on
November 19, 2002)
10.63 Letter Agreement and Amendment #3 by and between Vivendi Universal
Games, Inc. and Interplay Entertainment Corp. dated September 12, 2002.
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment.)
(incorporated herein by reference to Exhibit 10.4 to Form 10-Q filed on
November 19, 2002)
10.64 Letter Agreement and Amendment # 4 (OEM & Back-Catalog) to Video Game
Distribution Agreement dated August 9, 2002 by and between Vivendi
Universal Games, Inc. and Interplay Entertainment Corp. dated December
20, 2002. (Portions omitted and filed separately with the Securities
and Exchange Commission pursuant to a request for confidential
treatment.)
10.65 Letter Agreement and Amendment # 5 (Asia Pacific & Australia) to Video
Game Distribution Agreement dated August 9, 2002 by and between Vivendi
Universal Games, Inc. and Interplay Entertainment Corp. dated January
13, 2003. (Portions omitted and filed separately with the Securities
and Exchange Commission pursuant to a request for confidential
treatment.)
21.1 Subsidiaries of the Company. (incorporated herein by reference to
Exhibit 21.1. to the Form S-1)
46
23.1 Consent of Squar Milner, Independent Auditors.
23.2 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (included as page 41 to this Form 10-K).
99.1 Certification of our Chief Executive Officer and interim Chief
Financial Officer, pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Herve
Caen.
99.2 Press Release, dated August 15, 2002. (incorporated herein by reference
to Exhibit 99.2 to Form 10-Q filed August 19, 2002).
47
Certification of CEO Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Herve Caen, certify that:
1. I have reviewed this annual report on Form 10-K of Interplay
Entertainment Corp.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 30, 2003
/s/ Herve Caen
-----------------------
Herve Caen
Chief Executive Officer
48
Certification of Interim CFO Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Herve Caen, certify that:
1. I have reviewed this annual report on Form 10-K of Interplay
Entertainment Corp.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 30, 2003
/s/ Herve Caen
-------------------------------
Herve Caen
Interim Chief Financial Officer
49
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORTS OF INDEPENDENT AUDITORS
PAGE
----
Reports of Independent Auditors F-2
Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2002 and 2001 F-5
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000 F-6
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 2002, 2001 and 2000 F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000 F-8
Notes to Consolidated Financial Statements F-10
Schedule II - Valuation and Qualifying Accounts S-1
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated balance sheet of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive S.A., and
subsidiaries (the "Company"), as of December 31, 2002, and the related
consolidated statements of operations, shareholders' equity (deficit) and other
comprehensive income and cash flows for the year then ended. Our audit also
included the financial statement schedule listed in the Index at Item 15(a) (2)
for the year ended December 31, 2002. These consolidated financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audit. The December 31, 2000 consolidated
financial statements of the Company were audited by other auditors whose report
dated April 16, 2001/August 23, 2001, expressed an unqualified opinion on those
financial statements. This predecessor auditors' report included a paragraph
stating that there was substantial doubt about the Company's ability to continue
as a going concern. For reasons explained in Note 18 to the consolidated
financial statements, this predecessor auditor was unable to reissue their audit
report.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Interplay
Entertainment Corp. and subsidiaries as of December 31, 2002, and the results of
their operations and their cash flows for year then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule for the year ended
December 31, 2002, when considered in relation to the basic financial
statements, taken as a whole, presents fairly in all material respects the
information se forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has negative working capital of $17.1 million and a stockholders'
deficit of $13.9 million at December 31, 2002, losses from operations through
December 31, 2002 and negative operating cash flow for the year then ended.
These factors, among others, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Squar Milner Reehl & Williamson, LLP
----------------------------------------
Newport Beach, California
March 7, 2003
F-2
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated balance sheet of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive S.A.) and
subsidiaries (the Company), as of December 31, 2001, and the related
consolidated statements of operations, stockholders' equity (deficit) and
comprehensive income (loss), and cash flows for the year then ended. Our audit
also included the financial statement schedule listed in the Index at Item
15(a)(2) for the year ended December 31, 2001. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Interplay
Entertainment Corp. and subsidiaries, at December 31, 2001, and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule for the year
ended December 31, 2001, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
The accompanying financial statements have been prepared assuming Interplay
Entertainment Corp. will continue as a going concern. As more fully described in
Note 1, the Company's recurring losses from operations and its stockholders' and
working capital deficits at December 31, 2001 raise substantial doubt about its
ability to continue as a going concern. Management's plans regarding these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/ ERNST & YOUNG LLP
----------------------
Orange County, California
March 18, 2002
F-3
The following report of Arthur Andersen LLP ("Andersen") is a copy of the
original report dated April 16, 2001, rendered on the prior years' financial
statements. The SEC has recently provided regulatory relief designed to allow
public companies to dispense with the requirement that they file a consent of
Andersen in certain circumstances. After reasonable efforts we have not been
able to obtain a re-issued report or consent from Andersen.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Interplay Entertainment Corp.:
We have audited the accompanying consolidated statements of operations,
stockholders' equity (deficit) and cash flows of Interplay Entertainment Corp.
(a Delaware corporation) and subsidiaries for the one year period ended December
31, 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interplay Entertainment
Corp. and subsidiaries as of December 31, 2000 and the results of their
operations and their cash flows for the one year period ended December 31, 2000,
in conformity with accounting principles generally accepted in the United
States.
As discussed further in Notes 1 and 15, subsequent to April 16, 2001, the
date of our original report, the Company incurred losses of $20.8 million during
the six months ended June 30, 2001, and as of that date, based on unaudited
financial statements, the Company's current liabilities exceeded its current
assets by $9.2 million and the Company has experienced, and expects to continue
to experience, negative operating cash flows which will require the need for
additional financing. Additionally, the Company is in violation of its debt
covenants. These factors, among others, as described in Notes 1 and 15, create a
substantial doubt about the Company's ability to continue as a going concern and
an uncertainty as to the recoverability and classification of recorded asset
amounts and the amounts and classification of liabilities. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern.
Our audits were made for the purpose of forming an opinion on the
accompanying financial statements taken as a whole. The supplemental Schedule II
as shown on page S-1 is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic consolidated financial statements
taken as a whole.
Arthur Andersen LLP*
------------------------
ARTHUR ANDERSEN LLP
Orange County, California
April 16, 2001, except for the matters discussed in Note 15 as to which the date
is August 23, 2001.**
* See Note 18 to the accompanying financial statements.
** Note 15 which was included in the Company's December 31, 2001 Form 10-K, has
been deleted for the accompanying consolidated financial statements.
F-4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-----------------------
2002 2001
--------- ---------
ASSETS
------
Current Assets:
Cash .......................................... $ 134 $ 119
Trade receivables from related parties,
net of allowances of $231 and $4,025,
respectively .............................. 2,506 6,175
Trade receivables, net of allowances
of $855 and $3,516, respectively .......... 170 3,312
Inventories ................................... 2,029 3,978
Prepaid licenses and royalties ................ 5,129 10,341
Other current assets .......................... 1,200 1,162
--------- ---------
Total current assets ...................... 11,168 25,087
Property and equipment, net ........................ 3,130 5,038
Other assets ....................................... -- 981
--------- ---------
$ 14,298 $ 31,106
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current Liabilities:
Current debt .................................. $ 2,082 $ 1,576
Accounts payable .............................. 9,241 13,718
Accrued royalties ............................. 4,775 7,795
Other accrued liabilities ..................... 1,039 2,999
Advances from distributors and others ......... 101 12,792
Advances from related party distributor ....... 3,550 10,060
Loans from related parties .................... -- 3,218
Payables to related parties ................... 7,440 7,098
--------- ---------
Total current liabilities ................. 28,228 59,256
--------- ---------
Commitments and contingencies
Stockholders' Deficit:
Series A preferred stock, $.001 par
value, authorized 5,000,000 shares;
issued and outstanding zero and
383,354 shares, respectively .............. -- 11,753
Common stock, $.001 par value,
authorized 100,000,000 issued and
outstanding 93,849,176 and 44,995,821
shares, respectively ...................... 94 45
Paid-in capital ............................... 121,637 110,701
Accumulated deficit ........................... (135,793) (150,807)
Accumulated other comprehensive income ........ 132 158
--------- ---------
Total stockholders' deficit ............... (13,930) (28,150)
--------- ---------
$ 14,298 $ 31,106
========= =========
See accompanying notes.
F-5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000
--------- --------- ---------
Net revenues ............................ $ 15,021 $ 33,795 $ 73,319
Net revenues from related party
distributors ....................... 28,978 22,653 28,107
--------- --------- ---------
Total net revenues ................... 43,999 56,448 101,426
Cost of goods sold ...................... 26,706 45,816 54,061
--------- --------- ---------
Gross profit ......................... 17,293 10,632 47,365
--------- --------- ---------
Operating expenses:
Marketing and sales .................. 5,814 18,697 23,326
General and administrative ........... 7,655 12,622 10,249
Product development .................. 16,184 20,603 22,176
--------- --------- ---------
Total operating expenses .......... 29,653 51,922 55,751
--------- --------- ---------
Operating loss .................... (12,360) (41,290) (8,386)
--------- --------- ---------
Other income (expense):
Interest expense ..................... (2,214) (4,285) (2,992)
Gain on sale of Shiny ................ 28,813 -- --
Other ................................ 683 (241) (697)
--------- --------- ---------
Total other income (expense) ..... 27,282 (4,526) (3,689)
--------- --------- ---------
Income (loss) before provision
for income taxes ................... 14,922 (45,816) (12,075)
(Benefit) provision for income taxes .... (225) 500 --
--------- --------- ---------
Net income (loss) ....................... $ 15,147 $ (46,316) $ (12,075)
--------- --------- ---------
Cumulative dividend on participating
preferred stock .................... $ 133 $ 966 $ 870
Accretion of warrant .................... -- 266 532
--------- --------- ---------
Net income (loss) available to common
stockholders ....................... $ 15,014 $ (47,548) $ (13,477)
========= ========= =========
Net income (loss) per common share:
Basic ................................... $ 0.18 $ (1.23) $ (0.45)
========= ========= =========
Diluted ................................. $ 0.16 $ (1.23) $ (0.45)
========= ========= =========
Shares used in calculating net income
(loss) per common share:
Basic ................................... 83,585 38,670 30,047
========= ========= =========
Diluted ................................. 96,070 38,670 30,047
========= ========= =========
See accompanying notes.
F-6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPRESENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(DOLLARS IN THOUSANDS)
ACCUMULATED
OTHER
COMPRE-
PREFERRED STOCK COMMON STOCK HENSIVE
------------------------ ----------------------- PAID-IN ACCUMULATED INCOME
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT (LOSS)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 1999 ....... -- $ -- 29,989,125 $ 30 $ 87,390 $ (89,782) $ 291
Issuance of common stock,
net of issuance costs ...... -- -- 40,661 -- 439 -- --
Issuance of Series A preferred
stock ...................... 719,424 19,202 -- -- -- -- --
Issuance of warrants .......... -- -- -- -- 798 -- --
Exercise of stock options ..... -- -- 113,850 -- 42 -- --
Accretion of warrant .......... -- 532 -- -- -- (532) --
Accumulated accrued dividend on
Series A preferred stock ... -- 870 -- -- -- (870) --
Compensation for stock options
granted .................... -- -- -- -- 90 -- --
Net loss ...................... -- -- -- -- -- (12,075) --
Other comprehensive loss, net
of income taxes:
Foreign currency
translation
adjustment .......... -- -- -- -- -- -- (27)
Comprehensive loss .
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2000 ....... 719,424 20,604 30,143,636 30 88,759 (103,259) 264
Issuance of common stock,
net of issuance costs ..... -- -- 8,151,253 8 11,743 -- --
Conversion of Series A
preferred stock into common
stock ...................... (336,070) (9,343) 6,679,306 7 9,336 -- --
Dividend payable in connection
with preferred stock
conversion ................. -- (740) -- -- -- --
Issuance of warrants .......... -- -- -- -- 675 -- --
Exercise of stock options ..... -- -- 21,626 -- 9 -- --
Accretion of warrant .......... -- 266 -- -- -- (266) --
Accumulated accrued dividend on
Series A preferred stock ... -- 966 -- -- -- (966) --
Compensation for stock options
granted .................... -- -- -- -- 4 -- --
Capital contribution by Titus . -- -- -- -- 75 -- --
Option issued in connection
with settlement ............ -- -- -- -- 100 -- --
Net loss ...................... -- -- -- -- -- (46,316) --
Other comprehensive loss,
net of income taxes:
Foreign currency
translation
adjustment ............ -- -- -- -- -- -- (106)
Comprehensive loss .
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2001 ....... 383,354 11,753 44,995,821 45 110,701 (150,807) 158
Issuance of common stock,
net of issuance costs ..... -- -- 721,652 1 208 -- --
Accumulated accrued dividend on
Series A preferred stock ... -- 133 -- -- -- (133) --
Conversion of Series A
preferred stock into common
stock ...................... (383,354) (10,657) 47,492,162 47 10,610 -- --
Dividend payable in connection
with preferred stock
conversion ................. -- (1,229) -- -- -- -- --
Issuance of warrants .......... -- -- -- -- 33 -- --
Exercise of stock options ..... -- -- 639,541 1 85 -- --
Net income .................... -- -- -- -- -- 15,147 --
Other comprehensive income, net
of income taxes:
Foreign currency
translation adjustment -- -- -- -- -- -- (26)
Comprehensive income
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2002 ....... -- $ -- 93,849,176 $ 94 $ 121,637 $ (135,793) $ 132
========== ========== ========== ========== ========== ========== ==========
COMPRE-
HENSIVE
INCOME
(LOSS) TOTAL
---------- ---------
Balance, December 31, 1999 ....... $ (2,071)
Issuance of common stock,
net of issuance costs ...... 439
Issuance of Series A preferred
stock ...................... 19,202
Issuance of warrants .......... 798
Exercise of stock options ..... 42
Accretion of warrant .......... --
Accumulated accrued dividend on
Series A preferred stock ... --
Compensation for stock options
granted .................... 90
Net loss ...................... $ (12,075) (12,075)
Other comprehensive loss, net
of income taxes:
Foreign currency
translation
adjustment .......... (27) (27)
----------
Comprehensive loss . $ (12,102)
========== ---------
Balance, December 31, 2000 ....... 6,398
Issuance of common stock,
net of issuance costs ..... 11,751
Conversion of Series A
preferred stock into common
stock ...................... --
Dividend payable in connection
with preferred stock
conversion ................. (740)
Issuance of warrants .......... 675
Exercise of stock options ..... 9
Accretion of warrant .......... --
Accumulated accrued dividend on
Series A preferred stock ... --
Compensation for stock options
granted .................... 4
Capital contribution by Titus . 75
Option issued in connection
with settlement ............ 100
Net loss ...................... $ (46,316) (46,316)
Other comprehensive loss,
net of income taxes:
Foreign currency
translation
adjustment ............ (106) (106)
----------
Comprehensive loss . $ (46,422)
========== ---------
Balance, December 31, 2001 ....... (28,150)
Issuance of common stock,
net of issuance costs ..... 209
Accumulated accrued dividend on
Series A preferred stock ... --
Conversion of Series A
preferred stock into common
stock ...................... --
Dividend payable in connection
with preferred stock
conversion ................. (1,229)
Issuance of warrants .......... 33
Exercise of stock options ..... 86
Net income .................... $ 15,147 15,147
Other comprehensive income, net
of income taxes:
Foreign currency
translation adjustment (26) (26)
----------
Comprehensive income $ 15,121
========== ---------
Balance, December 31, 2002 ....... $ (13,930)
=========
See accompanying notes.
F-7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
2002 2001 2000
-------- -------- --------
Cash flows from operating activities:
Net income (loss) ....................... $ 15,147 $(46,316) $(12,075)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities--
Depreciation and amortization ........ 1,671 2,613 2,512
Noncash expense for stock
compensation ...................... 238 679 90
Noncash interest expense ............. 1,860 -- --
Writeoff of prepaid licenses
and royalties ..................... 4,100 8,124 --
Gain on sale of Shiny ................ (28,813) -- --
Other ................................ (26) (6) (27)
Changes in assets and liabilities:
Trade receivables, net ............ 3,139 14,360 (3,428)
Trade receivables from related
parties ........................ 3,669 4,239 (2,499)
Inventories ....................... 1,949 (619) 2,698
Prepaid licenses and royalties .... (533) (761) 1,545
Other current assets .............. (51) (390) 102
Accounts payable .................. (5,777) 3,246 (2,875)
Accrued royalties ................. (2,887) (10) (145)
Other accrued liabilities ......... (1,806) (425) (5,905)
Payables to related parties ....... (887) 2,185 (3,202)
Advances from distributors
and others ..................... (19,201) 21,144 --
-------- -------- --------
Net cash provided by
(used in) operating
activities .............. (28,208) 8,063 (23,209)
-------- -------- --------
Cash flows used in investing activities:
Purchase of property and equipment ...... (207) (1,757) (3,236)
Proceeds from sale of Shiny ............. 33,134 -- --
-------- -------- --------
Net cash provided by (used in)
investing activities ........... 32,927 (1,757) (3,236)
-------- -------- --------
Cash flows from financing activities:
Net borrowings (payments) on line
of credit ............................ (1,576) 1,576 --
Net borrowings (payments) of
previous line of credit .............. -- (24,433) 5,215
Net borrowings (payments) of
supplemental line of credit .......... -- (1,000) 1,000
(Repayment) borrowings from former
Chairman ............................. (3,218) 3,000 (412)
Net proceeds from issuance of
common stock ......................... 4 11,751 439
Net proceeds from issuance of
Series A preferred stock and
warrants ............................. -- -- 20,000
Proceeds from exercise of stock
options .............................. 86 9 42
Reductions of restricted cash ........... -- -- 2,597
Other financing activities .............. -- 75 --
-------- -------- --------
Net cash (used in) provided
by financing activities ........ (4,704) (9,022) 28,881
-------- -------- --------
Net increase (decrease) in cash ............ 15 (2,716) 2,436
Cash, beginning of year .................... 119 2,835 399
-------- -------- --------
Cash, end of year .......................... $ 134 $ 119 $ 2,835
======== ======== ========
See accompanying notes.
F-8
INTERPLAY ENTERTAINMENT CORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
2002 2001 2000
------ ------ ------
Supplemental cash flow information:
Cash paid during the year for
interest ................................ $ 344 $1,592 $3,027
Suplemental disclosure of non-cash
investing and financing activities:
Acquisition of remaining interest
in Shiny for options on common
stock .................................. -- 100 --
Accretion of preferred stock to
redemption value ....................... -- 266 532
Dividend payable on partial
conversion of preferred stock .......... 1,229 740 --
Accrued dividend on participating
preferred stock ........................ 133 966 870
Common stock issued under Product
Agreement .............................. 205 -- --
See accompanying notes.
F-9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Interplay Entertainment Corp., a Delaware corporation, and its subsidiaries
(the "Company"), develop and publish interactive entertainment software. The
Company's software is developed for use on various interactive entertainment
software platforms, including personal computers and video game consoles, such
as the Sony PlayStation 2, Microsoft Xbox and Nintendo GameCube. As of December
31, 2002, Titus Interactive, S.A. ("Titus"), a France-based developer, publisher
and distributor of interactive entertainment software, owned 71 percent of the
Company's common stock. The Company's common stock trades on the NASDAQ OTC
Bulletin Board under the symbol "IPLY.OB."
GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern, which contemplates, among
other things, the realization of assets and satisfaction of liabilities in the
normal course of business. The Company has incurred substantial operating losses
during the last three years, and at December 31, 2002, has a stockholders'
deficit of $13.9 million and a working capital deficit of $17.1 million. The
Company has historically funded its operations primarily through the use of
lines of credit, royalty and distribution fee advances, cash generated by the
private sale of securities, and proceeds of its initial public offering.
To reduce its working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles, which
management believes do not meet sufficient projected profit margins, and the
scaling back of certain marketing programs. Management will continue to pursue
various alternatives to improve future operating results, and further expense
reductions, some of which may have a long-term adverse impact on the Company's
ability to generate successful future business activities.
In addition, the Company continues to seek and expects to require 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 (Note 17), the licensing of certain product rights in selected
territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
the Company's long-term strategic objectives. In this regard, the Company
completed the sale of its subsidiary Shiny Entertainment, Inc. ("Shiny") in
April 2002, for approximately $47.2 million (Note 3). The Company used the
proceeds from the sale of Shiny to fund operations and to pay existing
obligations, including $11.5 million of prepaid advances that were accelerated
as a condition of the transaction. Additionally, in August 2002, the Company's
Board of Directors approved and commenced the process of establishing a Special
Committee comprised of directors that are independent of the Company's largest
stockholder, Titus Interactive S.A. ("Titus"), to investigate strategic options,
including raising capital from the sale of debt or equity securities and a sale
of the Company.
In August 2002, the Company has entered into a new three-year North
American distribution agreement with Vivendi Universal Games, Inc. ("Vivendi"),
which substantially replaces the August 2001 agreement with Vivendi (Note 6).
Under the new agreement, the Company receives cash payments from Vivendi for
distributed products sooner than under the Company's August 2001 agreement with
Vivendi. The Company has amended its agreement with Vivendi to increase the
number of territories in which Vivendi can distribute the Company's products. In
return, the Company has received additional advances from Vivendi for these
additional rights. In February 2003, the Company sold to Vivendi the rights to
develop and publish future titles under the Company's "Hunter" license (Note
17).
The Company anticipates its current cash reserves, proceeds from the sale
of the Hunter franchise, plus its expected generation of cash from existing
operations, will only be sufficient to fund its anticipated expenditures into
the second quarter of fiscal 2003. Consequently, the Company expects that it
will need to substantially reduce its working capital needs and/or raise
additional financing. However, no assurance can be given that alternative
sources of funding could be obtained on acceptable terms, or at all. These
conditions, combined with the Company's historical operating losses and its
deficits in stockholders' equity and working capital, raise substantial doubt
about
F-10
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
the Company's ability to continue as a going concern. The accompanying
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets and
liabilities that might result from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Interplay Entertainment Corp. and its wholly-owned subsidiaries, Interplay
Productions Limited (U.K.), Interplay OEM, Inc., Interplay Productions Pty Ltd
(Australia), Interplay Co., Ltd., (Japan) and Games On-line. Shiny
Entertainment, Inc., which was sold by the Company in April 2002, is included in
the consolidated financial statements up to the date of the sale. All
significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates made in preparing the consolidated financial statements
include, among others, sales returns and allowances, cash flows used to evaluate
the recoverability of prepaid licenses and royalties and long-lived assets, and
certain accrued liabilities related to restructuring activities and litigation.
RISKS AND UNCERTAINTIES
The Company operates in a highly competitive industry that is subject to
intense competition, potential government regulation and rapid technological
change. The Company's operations are subject to significant risks and
uncertainties including financial, operational, technological, regulatory and
other business risks associated with such a company.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period's financial
statements to conform to classifications used in the current period.
INVENTORIES
Inventories consist of CD-ROMs, DVDs, manuals, packaging materials and
supplies, and packaged software ready for shipment, including video game console
software. Inventories are valued at the lower of cost (first-in, first-out) or
market. The Company regularly monitors inventory for excess or obsolete items
and makes any valuation corrections when such adjustments are known.
Net realizable value is based on management's forecast for sales of the
Company's products in the ensuing years. The industry in which the Company
operates is characterized by technological advancement and changes. Should
demand for the Company's products prove to be significantly less than
anticipated, the ultimate realizable value of the Company's inventories could be
substantially less than the amount shown on the accompanying consolidated
balance sheets.
F-11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under development arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables. Royalty advances are recoupable against future
sales based upon the contractual royalty rate. The Company amortizes the cost of
licenses, prepaid royalties and other outside production costs to cost of goods
sold over six months commencing with the initial shipment in each region of the
related title. The Company amortizes these amounts at a rate based upon the
actual number of units shipped with a minimum amortization of 75 percent in the
first month of release and a minimum of 5 percent for each of the next five
months after release. This minimum amortization rate reflects the Company's
typical product life cycle. Management evaluates the future realization of such
costs quarterly and charges to cost of goods sold any amounts that management
deems unlikely to be fully realized through future sales. Such costs are
classified as current and noncurrent assets based upon estimated product release
date.
SOFTWARE DEVELOPMENT COSTS
Research and development costs, which consist primarily of software
development costs, are expensed as incurred. Statement of Financial Accounting
Standards ("SFAS") No. 86, "Accounting for the Cost of Computer Software to be
Sold, Leased, or Otherwise Marketed", provides for the capitalization of certain
software development costs incurred after technological feasibility of the
software is established or for development costs that have alternative future
uses. Under the Company's current practice of developing new products, the
technological feasibility of the underlying software is not established until
substantially all product development is complete, which generally includes the
development of a working model. The Company has not capitalized any software
development costs on internal development projects, as the eligible costs were
determined to be insignificant.
ACCRUED ROYALTIES
Accrued royalties consist of amounts due to outside developers and
licensors 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.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of computers,
equipment and furniture and fixtures is provided using the straight-line method
over a five year period. Leasehold improvements are amortized on a straight-line
basis over the lesser of the estimated useful life or the remaining lease term.
Upon the sale or retirement of property and equipment, the accounts are relieved
of the cost and the related accumulated depreciation, with any resulting gain or
loss included in the consolidated statement of operations.
OTHER NON-CURRENT ASSETS
At December 31, 2001, other non-current assets consisted primarily of
goodwill related to our Shiny subsidiary, which was sold in April 2002.
LONG-LIVED ASSETS
On January 1, 2002, the Company adopted Financial Accounting Statements
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." SFAS 144 requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. If the cost basis of a long-lived asset
is greater than the projected future undiscounted net cash flows from such asset
(excluding interest), an impairment loss is recognized. Impairment losses are
calculated as the difference between the cost basis
F-12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
of an asset and its estimated fair value. SFAS 144, which supercedes SFAS 121,
also requires companies to separately report discontinued operations and extends
that reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to shareholders) or is classified as
held for sale. Assets to be disposed are reported at the lower of the carrying
amount or fair value less costs to sell. The adoption of SFAS 144 did not have a
material impact on the Company's financial position or results of operations. To
date, management has determined that no impairment exists and therefore, no
adjustments have been made to the carrying values of long-lived assets. There
can be no assurance, however, that market conditions will not change or demand
for the Company's products or services will continue which could result in
impairment of long-lived assets in the future.
GOODWILL AND INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS," which addresses how intangible assets that are acquired
individually or with a group of other assets should be accounted for in the
financial statements upon their acquisition and after they have been initially
recognized in the financial statements. SFAS 142 requires that goodwill and
identifiable intangible assets that have indefinite useful lives not be
amortized but rather be tested at least annually for impairment, and
identifiable intangible assets that have finite useful lives be amortized over
their useful lives. SFAS 142 provides specific guidance for testing goodwill and
identifiable intangible assets that will not be amortized for impairment. In
addition, SFAS 142 expands the disclosure requirements about goodwill and other
intangible assets in the years subsequent to their acquisition. The adoption of
SFAS 142 did not have a material effect on the Company's financial statements at
December 31, 2002.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable and accounts payable
approximates the fair value. In addition, the carrying value of all borrowings
approximates fair value based on interest rates currently available to the
Company. The fair value of trade receivable from related parties, advances from
related party distributor, loans to/from related parties and payables to related
parties are not determinable as these transactions are with related parties.
REVENUE RECOGNITION
Revenues are recorded when products are delivered to customers in
accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition" and SEC Staff Accounting Bulletin No. 101, Revenue Recognition.
With the signing of the Vivendi distribution agreement in August 2001,
substantially all of the Company's sales are made by two related party
distributors (Notes 6 and 12), Vivendi, which owns approximately 5 percent of
the outstanding shares of the Company's common stock, and Virgin Interactive
Entertainment Limited ("Virgin"), a subsidiary of Titus, the Company's largest
stockholder.
The Company recognizes revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of the Company's products
to unaffiliated third parties. For those agreements that provide the customers
the right to multiple copies of a product in exchange for guaranteed amounts,
revenue is recognized at the delivery and acceptance of the product master. Per
copy royalties on sales that exceed the guarantee are recognized as earned.
Guaranteed minimum royalties on sales, where the guarantee is not recognizable
upon delivery, are recognized as the minimum payments come due.
The Company is generally not contractually obligated to accept returns,
except for defective, shelf-worn and damaged products in accordance with
negotiated terms. However, on a case by case negotiated basis, the Company
permits customers to return or exchange product and may provide markdown
allowances on products unsold by a customer. In accordance with SFAS No. 48,
"Revenue Recognition when Right of Return Exists", revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The amount
of reserves ultimately required could differ materially in the near term from
the amounts included in the accompanying consolidated financial statements.
F-13
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
Customer support provided by the Company is limited to telephone and
Internet support. These costs are not significant and are charged to expenses as
incurred.
The Company also engages in the sale of licensing rights on certain
products. The terms of the licensing rights differ, but normally include the
right to develop and distribute a product on a specific video game platform. For
these activities, revenue is recognized when the rights have been transferred
and no other obligations exist.
The Emerging Issues Task Force (EITF) issued EITF 01-09 in November 2001.
The pronouncement codifies and reconciles the consensus reached on EITF 00-14,
00-22 and 00-25, which addresses the recognition, measurement and profit and
loss account classification of certain selling expenses. The adoption of this
issue has resulted in the reclassification of certain selling expenses including
sales incentives, slotting fees, buydowns and distributor payments from cost of
sales and administrative expenses to a reduction in sales. Additionally, prior
period amounts were reclassified to conform to the new requirements. The impact
of this pronouncement resulted in a reduction of net sales of $0.1 million, $1.3
million and $3.2 million for the years ended December 31, 2002, 2001 and 2000,
respectively. These amounts, consisting principally of promotional allowances to
the Company's retail customers were previously recorded as sales and marketing
expenses; therefore, there was no impact to net income for any period.
ADVERTISING COSTS
The Company generally expenses advertising costs as incurred, except for
production costs associated with media campaigns that are deferred and charged
to expense at the first run of the ad. Cooperative advertising with distributors
and retailers is accrued when revenue is recognized. Cooperative advertising
credits are reimbursed when qualifying claims are submitted. Advertising costs
approximated $3.0 million, $6.7 million and $8.8 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
INCOME TAXES
The Company accounts for income taxes using the liability method as
prescribed by the SFAS No. 109, "Accounting for Income Taxes." The statement
requires an asset and liability approach for financial accounting and reporting
of income taxes. Deferred income taxes are provided for temporary differences in
the recognition of certain income and expense items for financial reporting and
tax purposes given the provisions of the enacted tax laws. A valuation allowance
is provided for significant deferred tax assets when it is more likely than not
those assets will not be recovered
FOREIGN CURRENCY
The Company follows the principles of SFAS No. 52, "Foreign Currency
Translation," using the local currency of its operating subsidiaries as the
functional currency. Accordingly, all assets and liabilities outside the United
States are translated into U.S. dollars at the rate of exchange in effect at the
balance sheet date. Income and expense items are translated at the weighted
average exchange rate prevailing during the period. Gains or losses arising from
the translation of the foreign subsidiaries' financial statements are included
in the accompanying consolidated financial statements as a component of other
comprehensive loss. Losses resulting from foreign currency transactions amounted
to $104,000, $237,000 and $935,000 during the years ended December 31, 2002,
2001 and 2000, respectively, and are included in other income (expense) in the
consolidated statements of operations.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per common share is computed by dividing income
(loss) attributable to common stockholders by the weighted average number of
common shares outstanding. Diluted net income (loss) per common share is
computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding plus the effect of any
convertible debt, dilutive stock options and common stock warrants. For the year
ended December 31, 2002, all options and warrants outstanding to purchase common
stock
F-14
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
were excluded from the earnings per share computation as the exercise price was
greater than the average market price of the common shares and for years ended
December 31, 2001 and 2000, all options and warrants to purchase common stock
were excluded from the diluted loss per share calculation, as the effect of such
inclusion would be antidilutive.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) of the Company includes net income (loss)
adjusted for the change in foreign currency translation adjustments. The net
effect of income taxes on comprehensive income (loss) is immaterial.
STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with the
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and related Interpretations and makes the necessary pro forma
disclosures mandated by SFAS No. 123 "Accounting for Stock-based Compensation".
In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"),
Accounting for Certain Transactions Involving Stock Compensation - an
Interpretation of APB 25. This Interpretation clarifies (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a non-compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 became effective July 1, 2000, but
certain conclusions in FIN 44 cover specific events that occur after either
December 15, 1998, or January 12, 2000. Management believes that the Company
accounts for its employee stock based compensation in accordance with FIN 44.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123". SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income and earnings per share and the entity's accounting policy decisions with
respect to stock-based employee compensation. Certain of the disclosure
requirements are required for all companies, regardless of whether the fair
value method or intrinsic value method is used to account for stock-based
employee compensation arrangements. The Company continues to account for its
employee incentive stock option plans using the intrinsic value method in
accordance with the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
SFAS 148 is effective for financial statements for fiscal years ended after
December 15, 2002 and for interim periods beginning after December 15, 2002. The
Company has adopted the disclosure provisions of this statement during the year
ended December 31, 2002.
F-15
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
At December 31, 2002, the Company has three stock-based employee
compensation plans, which are described more fully in Note 11. The Company
accounts for those plans under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. Stock-based employee compensation cost reflected in net income
was zero, $4,000 and $90,000 for the years ended December 31, 2002, 2001 and
2000, respectively. The following table illustrates the effect on net income and
earnings per common share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation,"
to stock-based employee compensation.
YEARS ENDED DECEMBER 31,
2002 2001 2000
-------- -------- --------
(Dollars in thousands, except per
share amounts)
Net income (loss) available to
common stockholders, as
reported .......................... $ 15,014 $(47,548) $(13,477)
Pro forma compensation expense ....... (232) (1,177) (1,370)
-------- -------- --------
Pro forma net income (loss)
available to common
stockholders ...................... $ 14,782 $(48,725) $(14,847)
======== ======== ========
Basic and diluted net income
(loss) as reported ................ $ 0.18 $ (1.23) $ (0.45)
Basic and diluted pro forma
net income (loss) ................. $ 0.18 $ (1.26) $ (0.49)
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The provisions of SFAS No. 143
are effective for financial statements issued for fiscal years beginning after
June 15, 2002, with early application encouraged and generally are to be applied
prospectively. The Company does not expect the adoption of SFAS No. 143 to have
a material impact on its consolidated financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". The provisions of SFAS
No. 146 are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Company does not
expect the adoption of SFAS No. 146 to have a material impact on its
consolidated financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 requires a guarantor to
(i) include disclosure of certain obligations, and (ii) if applicable, at the
inception of the guarantee, recognize a liability for the fair value of other
certain obligations undertaken in issuing a guarantee. The disclosure provisions
of the Interpretation are effective for financial statements of interim or
annual reports that end after December 15, 2002 and the Company has adopted
these requirements. However, the provisions for initial recognition and
measurement are effective on a prospective basis for guarantees that are issued
or modified after December 31, 2002, irrespective. As of December 31, 2002, the
Company has not guaranteed the indebtedness of its subsidiaries or any related
parties.
In January 2003, the FASB issued Interpretation No. 46, "CONSOLIDATION OF
VARIABLE INTEREST ENTITIES" ("FIN 46"). This interpretation of Accounting
Research Bulletin No. 51, "CONSOLIDATED FINANCIAL STATEMENTS," addresses
consolidation by business enterprises of variable interest entities. Under
current practice, two enterprises generally have been included in consolidated
financial statements because one enterprise controls the other through voting
interests. FIN 46 defines the concept of "variable interests" and requires
existing unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risks among
the
F-16
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
parties involved. This interpretation applies immediately to variable interest
entities created after January 31, 2003. It applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. If it is reasonably possible that an enterprise will consolidate or
disclose information about a variable interest entity when FIN 46 becomes
effective, the enterprise shall disclose information about those entities in all
financial statements issued after January 31, 2003. The interpretation may be
applied prospectively with a cumulative-effect adjustment as of the date on
which it is first applied or by restating previously issued financial statements
for one or more years with a cumulative-effect adjustment as of the beginning of
the first year restated. Based on the recent release of FIN 46, the Company has
not completed its assessment as to whether or not the adoption of FIN 46 will
have a material impact on its consolidated financial statements.
3. SHINY ENTERTAINMENT, INC
In 1995, the Company acquired a 91 percent interest in Shiny Entertainment,
Inc. ("Shiny") for $3.6 million in cash and stock. The acquisition was accounted
for using the purchase method. The allocation of purchase price included $3
million of goodwill. The purchase agreement required the Company to pay the
former owner of Shiny additional cash payments of up to $5.6 million upon the
delivery and acceptance of five future Shiny interactive entertainment software
titles (the "earnout payments"). In March 2001, the Company entered into an
amendment to the Shiny purchase agreement which, among other things, settled all
outstanding claims under the earnout payments, and resulted in the Company
acquiring the remaining nine percent equity interest in Shiny for $600,000,
payable in installments of cash and options on common 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 would have earned royalties after the future delivery of
the two titles to the Company. At December 31, 2001, the Company owed the former
owner of Shiny $200,000 related to this amendment, which is recorded under
accounts payable in the accompanying consolidated balance sheets.
On April 30, 2002, the Company consummated the sale of Shiny, pursuant to
the terms of a Stock Purchase Agreement, dated April 23, 2002, as amended, among
the Company, Infogrames, Inc., Shiny, Shiny's president and Shiny Group, Inc.
Pursuant to the purchase agreement, Infogrames acquired all of the outstanding
common stock of Shiny for approximately $47.2 million, which was paid to or for
the benefit of the Company as follows:
o $3.0 million in cash paid to the Company at closing;
o $10.8 million to be paid to the Company pursuant to a promissory note
from Infogrames providing for scheduled payments with the final
payment due July 31, 2002;
o $26.1 million paid directly to third party creditors of the Company;
and
o $7.3 million paid to Shiny's president and Shiny Group for Shiny
common stock that was issued to such parties to settle claims relating
to the Company's original acquisition of Shiny.
The promissory note receivable from Infogrames was paid in full in August
2002.
F-17
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
The Company recognized a gain of $28.8 million on the sale of Shiny. The
details of the sale are as follows:
(In millions)
Sale price of Shiny ........................................... $ 47.2
Net assets of Shiny at April 30, 2002 ......................... 2.3
Transaction related costs:
Cash payment to Warner Brothers for consent to
transfer Matrix license ............................... 2.2
Note payable issued to Warner Brothers for
consent to transfer Matrix license (Note 5) ........... 2.0
Payment to Shiny's President & Shiny Group ............... 7.1
Commission fees to Europlay I, LLC ....................... 3.9
Legal fees ............................................... 0.9
-------
Gain on sale .................................................. $ 28.8
=======
In addition, the Company recorded a tax provision of $150,000 in connection
with the sale of Shiny.
Concurrently with the closing of the sale, the Company settled a legal
dispute with Vivendi, relating to the parties' August 2001 distribution
agreement. The Company also settled legal disputes with its former bank and its
former Chairman, relating to the Company's April 2001 credit facility with its
former bank that was partially guaranteed by its former Chairman. The disputes
with Vivendi, the bank and the former Chairman were settled and dismissed, with
prejudice, following consummation of the sale.
4. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS
INVENTORIES
Inventories consist of the following:
DECEMBER 31,
2002 2001
------ ------
(Dollars in thousands)
Packaged software .................................. $2,029 $3,230
CD-ROMs, DVDs, manuals, packaging and supplies ..... -- 748
------ ------
$2,029 $3,978
====== ======
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
DECEMBER 31,
2002 2001
------- -------
(Dollars in thousands)
Prepaid royalties for titles in development ........ $ 4,644 $ 7,539
Prepaid royalties for shipped titles ............... 431 710
Prepaid licenses and trademarks .................... 54 2,092
------- -------
$ 5,129 $10,341
======= =======
F-18
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
Amortization of prepaid licenses and royalties is included in cost of goods
sold and totaled $9.7 million, $8.0 million and $14.7 million for the years
ended December 31, 2002, 2001 and 2000, respectively.
During the years ended December 31, 2002 and 2001, the Company wrote-off
$4.1 million and $8.1 million, respectively, of prepaid royalties for titles in
development that were impaired due to the cancellation of certain development
projects, which the Company has recorded under cost of goods sold in the
accompanying consolidated statements of operations. No amounts were written-off
during the year ended December 31, 2000.
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
2002 2001
-------- --------
(Dollars in thousands)
Computers and equipment ...................... $ 9,125 $ 9,756
Furniture and fixtures ....................... 107 107
Leasehold improvements ....................... 1,232 1,226
-------- --------
10,464 11,089
Less: Accumulated depreciation
and amortization ........................ (7,334) (6,051)
-------- --------
$ 3,130 $ 5,038
======== ========
For the years ended December 31, 2002, 2001 and 2000, the Company incurred
depreciation and amortization expense of $1.7 million, $2.1 million and $2.1
million, respectively. Shiny's property and equipment, which had accumulated
depreciation of $0.4 million at December 31, 2001, was sold with the sale of
Shiny. During the years ended December 31, 2001 and 2000, the Company disposed
of fully depreciated equipment having an original cost of $2.3 million and $8.3
million, respectively.
5. PROMISSORY NOTE, WORKING CAPITAL LINE OF CREDIT AND LOANS FROM RELATED
PARTIES
The Company issued to Warner Bros. a Secured Convertible Promissory Note
bearing interest at 6 percent per annum, due April 30, 2003, in the principal
amount of $2.0 million in connection with the sale of Shiny (Note 3). The note
was issued in partial payment of amounts due Warner Bros. under the parties'
license agreement for the video game based on the motion picture THE MATRIX,
which is being developed by Shiny. The note is secured by all of the Company's
assets, and may be converted by the holder thereof into shares of the Company's
common stock on the maturity date or, to the extent there is any proposed
prepayment, within the 30 day period prior to such prepayment. The conversion
price is equal to the lower of (a) $0.304 or (b) an amount equal to the average
closing price of a share of the Company's common stock for the five business
days ending on the day prior to the conversion date, provided that in no event
can the note be converted into more than 18,600,000 shares. If any amount
remains due following conversion of the note into 18,600,000 shares, the
remaining amount will be payable in cash. The Company agrees to register with
the Securities and Exchange Commission the shares of common stock to be issued
in the event Warner Bros. exercises its conversion option. At December 31, 2002,
the balance owed to Warner Bros., including accrued interest, is $2.1 million.
In April 2001, the Company entered into a three year loan and security
agreement ("L&S Agreement") with a bank providing for a $15.0 million working
capital line of credit secured by all the assets of the Company. The L&S
Agreement replaced an expiring agreement with another bank that was repaid and
terminated. Advances under the new line of credit were limited to an amount
based on qualified accounts receivable and inventory, as defined, and bore
interest at the bank's prime rate (4.75 percent at December 31, 2001), or LIBOR
plus 2.5 percent. The default rate under the line of credit was the bank's prime
rate plus 2 percent. At December 31, 2001, the Company was in default and
borrowings under the working capital line of credit bore interest at 6.75
percent.
F-19
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
At December 31, 2001, the Company was in violation of certain financial
covenants set forth under the L&S Agreement and the bank exercised its right to
terminate the agreement effective October 26, 2001. Accordingly, the remaining
unamortized value of the warrant issued to the former Chairman was charged to
interest expense during the fourth quarter of 2001. In 2002, the outstanding
balance was paid in full and the L&S Agreement was terminated.
In connection with the L&S Agreement, and the retirement of the former line
of credit, a secured personal guarantee of $5 million previously provided by the
Company's former Chairman was released, and a new personal guarantee for $2
million, secured by $1 million in cash, was provided to the new bank by the
former Chairman. In addition, the former Chairman provided the Company with a $3
million loan, payable in May 2002, with interest at 10 percent secured by all
the assets of the Company. In connection with the new guarantee and loan, the
former Chairman received a warrant to purchase 500,000 shares of the Company's
Common Stock at $1.75 per share, expiring in April 2011. The fair value of the
warrant of $675,000 (estimated by the Company based on the Black-Scholes option
pricing model pursuant to SFAS 123 and EITF 00-27, "Application of Issue No.
98-5 to Certain Convertible Instruments") was deferred and was being amortized
to interest expense over the term of the L&S agreement. In connection with the
sale of Shiny (Note 3), the loan from the former Chairman was paid in full in
April 2002.
6. ADVANCES FROM DISTRIBUTORS AND OTHERS
Advances from distributors and OEMs consist of the following:
DECEMBER 31,
2002 2001
------- -------
(Dollars in thousands)
Advance from console hardware manufacturer ............. $ -- $ 5,000
Advances for distribution rights to a future title ..... -- 4,000
Advances for other distribution rights ................. 101 3,792
------- -------
$ 101 $12,792
======= =======
Net advance from Vivendi distribution agreement
(related party) ..................................... $ 3,550 $10,060
======= =======
In March 2001, the Company entered into a supplement to a licensing
agreement with a console hardware and software manufacturer under which it
received an advance of $5.0 million. This advance was repaid with proceeds from
the sale of Shiny.
In July 2001, the Company entered into a distribution agreement with a
distributor whereby the distributor would have the North American distribution
rights to a future title. In return, the distributor paid the Company an advance
of $4.0 million to be recouped against future amounts due to the Company based
on net sales of the future title. In January 2002, the Company sold the
publishing rights to this title to the distributor in connection with a
settlement agreement entered into with the third party developer. The settlement
agreement provided, among other things, that the Company assign its rights and
obligations under the product agreement to the third party distributor. In
consideration for assigning the product agreement to the distributor, the
Company was not required to repay the $4.0 million advance nor repay $1.6
million related to past royalties and interest owed to the distributor. In
addition, the Company agreed to forgive $0.6 million in advances previously paid
to the developer. As a result, the Company recorded net revenues of $5.6 million
and a related cost of sales of $0.6 million in the year ended December 31, 2002.
Other advances from distributors are repayable as products covered by those
agreements are sold.
F-20
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
In April 2002, the Company entered into an agreement with Titus, pursuant
to which, among other things, the Company sold to Titus all right, title and
interest in the games "EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter",
"Sacrifice", "MDK", "MDK II", and "Kingpin", and Titus licensed from the Company
the right to develop, publish, manufacture and distribute the games "Hunter I",
"Hunter II", "Icewind Dale I", "Icewind Dale II", and "BG: Dark Alliance II"
solely on the Nintendo Advance GameBoy game system for the life of the games. As
consideration for these rights, Titus issued to the Company a promissory note in
the principal amount of $3.5 million, which note bears interest at 6 percent per
annum. The promissory note was due on August 31, 2002, and may be paid, at
Titus' option, in cash or in shares of Titus common stock with a per share value
equal to 90 percent of the average trading price of Titus' common stock over the
5 days immediately preceding the payment date. The Company has provided Titus
with a guarantee under this agreement, which provides that in the event Titus
does not achieve gross sales of at least $3.5 million by June 25, 2003, and the
shortfall is not the result of Titus' failure to use best commercial efforts,
the Company will pay to Titus the difference between $3.5 million and the actual
gross sales achieved by Titus, not to exceed $2.0 million. The Company is in the
later stages of negotiations with Titus to repurchase these assets for a
purchase price payable by canceling the $3.5 million promissory note, and any
unpaid accrued interest thereon. Concurrently, the Company and Titus would
terminate any executory obligations relating to the original sale, including the
Company's obligation to pay Titus up to $2 million if Titus does not achieve
gross sales of at least $3.5 million by June 25, 2003. As Titus is the majority
stockholder of the Company and the probability of the agreement being
terminated, the Company has offset the related note receivable in the amount of
$3.5 million against the deferred revenue in the amount of $3.5 million.
In August 2001, the Company entered into a distribution agreement with
Vivendi providing for Vivendi to become the Company's distributor in North
America through December 31, 2003 for substantially all of its products, with
the exception of products with pre-existing distribution agreements. Under the
terms of the agreement, as amended, Vivendi earns a distribution fee based on
the net sales of the titles distributed. The agreement provided for advance
payments from Vivendi totaling $10.0 million. In amendments to the agreement,
Vivendi agreed to advance the Company an additional $3.5 million. The
distribution agreement, as amended, provides for the acceleration of the
recoupment of the advances made to the Company, as defined. During the three
months ended March 31, 2002, Vivendi advanced the Company an additional $3.0
million bringing the total amounts advanced to the Company under the
distribution agreement with Vivendi to $16.5 million. In April 2002, the
distribution agreement was further amended to provide for Vivendi to distribute
substantially all of the Company's products through December 31, 2002, except
certain future products, which Vivendi would have the right to distribute for
one year from the date of release. As of August 1, 2002, all distribution
advances relating to the August 2001 agreement from Vivendi were fully recouped
or repaid.
In August 2002, the Company entered into a new distribution agreement with
Vivendi whereby Vivendi will distribute substantially all of the Company
products in North America for a period of three years as a whole and two years
with respect to each product giving a potential maximum term of five years.
Under the August 2002 agreement, Vivendi will pay the Company sales proceeds
less amounts for distribution fees, price concessions and returns. Vivendi is
responsible for all manufacturing, marketing and distribution expenditures, and
bears all credit, price concessions and inventory risk, including product
returns. Upon the Company's delivery of a gold master to Vivendi, Vivendi will
pay the Company as a non-refundable minimum guarantee, a specified percent of
the projected amount due the Company based on projected initial shipment sales,
which are established by Vivendi in accordance with the terms of the agreement.
The remaining amounts are due upon shipment of the titles to Vivendi's
customers. Payments for future sales that exceed the projected initial shipment
sales are paid on a monthly basis. As of December 31, 2002, Vivendi had advanced
the Company $3.6 million related to future minimum guarantees on undelivered
products.
F-21
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
7. INCOME TAXES
Income (loss) before provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Domestic ................. $ 14,922 $(44,264) $(10,801)
Foreign .................. -- (1,552) (1,274)
-------- -------- --------
Total .................... $ 14,922 $(45,816) $(12,075)
======== ======== ========
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
----- ----- -----
(Dollars in thousands)
Current:
Federal ..................... $(225) $ 500 $ --
State ....................... -- -- --
Foreign ..................... -- -- --
----- ----- -----
(225) 500 --
Deferred:
Federal ..................... -- -- --
State ....................... -- -- --
----- ----- -----
-- -- --
----- ----- -----
$(225) $ 500 $ --
===== ===== =====
The Company files a consolidated U.S. Federal income tax return, which
includes all of its domestic operations. The Company files separate tax returns
for each of its foreign subsidiaries in the countries in which they reside. The
Company's available net operating loss ("NOL") carryforward for Federal tax
reporting purposes approximates $131 million and expires through the year 2022.
The Company's NOL's for State tax reporting purposes approximate $93 million and
expires through the year 2012. The utilization of the federal and state net
operating losses may be limited by Internal Revenue Code Section 382. Further,
utilization of the Company's state NOLs for tax years beginning in 2002 and
2003, will be suspended under provisions of California law.
In June 2002, the Internal Revenue Service ("the IRS") concluded its
examination of the Company's consolidated federal income tax returns for the
years ended April 30, 1992 through 1997. In 2001, the Company established a
reserve of $500,000, representing management's best estimate of amounts to be
paid in settlement of the IRS claims. In the second quarter of 2002, the Company
reached a settlement with the IRS and agreed to pay $275,000 to settle all
outstanding issues. With the executed settlement, the Company has adjusted its
reserve and, as a result, recorded an income tax benefit of $225,000 in the year
ended December 31, 2002.
F-22
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
A reconciliation of the statutory Federal income tax rate and the effective
tax rate as a percentage of pretax loss is as follows:
YEARS ENDED DECEMBER 31,
------------------------------
2002 2001 2000
------ ------ ------
Statutory income tax rate .................. 34.0% (34.0)% (34.0)%
State and local income taxes, net of
Federal income tax benefit .............. 2.0 (6.0) (3.0)
Valuation allowance ..................... (36.0) 40.0 37.0
Other ...................................... (1.5) 1.1 --
------ ------ ------
(1.5)% 1.1 % -- %
====== ====== ======
The components of the Company's net deferred income tax asset (liability)
are as follows:
DECEMBER 31,
---------------------
2002 2001
-------- --------
(Dollars in thousands)
Current deferred tax asset (liability):
Prepaid royalties ............................... $ 422 $ (4,485)
Nondeductible reserves .......................... 468 3,645
Reserve for advances ............................ (2,041) --
Accrued expenses ................................ (1,297) 666
Foreign loss and credit carryforward ............ 2,556 867
Federal and state net operating losses .......... 51,192 53,741
Research and development credit carryforward .... 2,374 831
Other ........................................... 909 305
-------- --------
54,583 55,570
-------- --------
Non-current deferred tax asset (liability):
Depreciation expense ............................ (192) (181)
Nondeductible reserves .......................... -- 532
-------- --------
(192) 351
-------- --------
Net deferred tax asset before
valuation allowance ............................. 54,390 55,921
Valuation allowance .................................. (54,390) (55,921)
-------- --------
Net deferred tax asset ............................... $ -- $ --
======== ========
The Company maintains a valuation allowance against its deferred tax assets
due to the uncertainty regarding future realization. In assessing the
realizability of its deferred tax assets, management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies. The valuation allowance on deferred tax assets decreased
$1.5 million during December 31, 2002 and increased $16.9 million during
December 31, 2001.
F-23
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
8. COMMITMENTS AND CONTINGENCIES
LEASES
The Company has various leases for the office space it occupies including
its corporate offices in Irvine, California. The lease for corporate offices
expires in June 2006 with one five-year option to extend the term of the lease.
The Company has also entered into various office equipment operating leases.
Future minimum lease payments under noncancelable operating leases are as
follows:
Year ending December 31 (Dollars in thousands):
2003 ........................... $ 1,386
2004 ........................... 1,533
2005 ........................... 1,532
2006 ........................... 764
2007 ........................... --
---------
$ 5,215
=========
Total rent expense was $2.1 million, $2.7 million and $2.8 million for the
years ended December 31, 2002, 2001 and 2000, respectively.
LITIGATION
The Company is involved in various legal proceedings, claims and litigation
arising in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the opinion
of management, the outcome of known routine claims will not have a material
adverse effect on the Company's business, financial condition or results of
operations.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and the Company's
subsidiary GamesOnline.com, Inc., alleging, among other things, breach of
contract, misappropriation of trade secrets, breach of fiduciary duties and
breach of implied covenant of good faith in connection with an electronic
distribution agreement dated November 2001 between KBK and GamesOnline.com, Inc.
KBK has alleged that GamesOnline.com failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Infogrames. The Company believes this complaint is without merit and will
vigorously defend its position.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") filed a
motion for summary judgment in lieu of complaint against the Company in the
amount of $1.3 million, alleging, among other things, that the Company is liable
to pay Special Situations $1.3 million for its failure to secure a timely
effective date for a Registration Statement for the Company's shares which
Special Situations purchased pursuant to a common stock subscription agreement
dated March 29, 2002 between Special Situations and the Company. The Company
disputes the amount owed and will vigorously defend its position.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain key
employees providing for, among other things, salary, bonuses and the right to
participate in certain incentive compensation and other employee benefit plans
established by the Company. Under these agreements, upon termination without
cause or resignation for good reason, as defined, the employees may be entitled
to certain severance benefits, as defined. These agreements expire through 2003.
F-24
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
NASDAQ DELISTING
On October 9, 2002, the Company's common stock was delisted from The Nasdaq
SmallCap Market due to the Company's failure to maintain certain minimum listing
requirements and began trading on the NASD-operated Over-the-Counter Bulletin
Board.
9. STOCKHOLDERS' EQUITY
PREFERRED STOCK AND COMMON STOCK
The Company's articles of incorporation authorize up to 10,000,000 shares
of $0.001 par value preferred stock. Shares of preferred stock may be issued in
one or more classes or series at such time as the Board of Directors determine.
As of December 31, 2002, there were no shares of preferred stock outstanding.
In 2002, the Company amended a development agreement with a developer
whereby the developer would receive shares of the Company's common stock in
return for meeting certain milestones. As a result of the developer meeting
these milestones, the Company has agreed to issue 700,000 shares of its common
stock. The accompanying statement of operations includes royalty expense of
$205,000 based on the value of the common stock on the day the common stock was
earned. The Company issued the stock in February 2003.
In April 2001, the Company completed a private placement of 8,126,770 units
at $1.5625 per unit for total proceeds of $12.7 million, and net proceeds of
approximately $11.7 million. Each unit consisted of one share of common stock
and a warrant to purchase one share of common stock at $1.75 per share, which
was exercisable immediately. If the Company issues additional shares of common
stock at a per share price below the exercise price of the warrants, then the
warrants are to be repriced, as defined, subject to stockholder approval. The
warrants expire in March 2006. In addition to the warrants issued in the private
placement, the Company granted the investment banker associated with the
transaction a warrant for 500,000 shares of the Company's common stock. The
warrant has an exercise price of $1.5625 per share and vests one year after the
registration statement for the shares of common stock issued under the private
placement becomes effective. The warrant expires four years after it vests. The
registration statement was not declared effective by May 31, 2001 and in
accordance with the terms of the agreement, the Company incurred a penalty of
approximately $254,000 per month, payable in cash, until June 2002, when the
registration statement was declared effective. The Company is currently involved
in negotiations with certain of these investors with respect to payment of these
penalties. During the year ended December 31, 2002 and 2001, the Company accrued
penalties of $1.8 million and $1.8 million, respectively, payable to these
stockholders, which was charged to results of operations and classified as
interest expense. The total amount accrued at December 31, 2002 and 2001is $3.6
million and $1.8 million, respectively.
In April 2000, the Company completed a $20 million transaction with Titus
under a Stock Purchase Agreement and issued 719,424 shares of newly designated
Series A Preferred Stock ("Preferred Stock") and a warrant for 350,000 shares of
the Company's Common Stock, which had preferences under certain events, as
defined. The Preferred Stock was convertible by Titus, redeemable by the
Company, and accrued a 6 percent cumulative dividend per annum payable in cash
or, at the option of Titus, in shares of the Company's Common Stock as declared
by the Company's Board of Directors. The Company held rights to redeem the
Preferred Stock shares at the original issue price plus all accrued but unpaid
dividends. Titus was entitled to convert the Preferred Stock shares into shares
of Common Stock at any time after May 2001. The conversion rate was the lesser
of $2.78 (7,194,240 shares of Common Stock) or 85 percent of the market price
per share at the time of conversion, as defined. The Preferred Stock was
entitled to the same voting rights as if it had been converted to Common Stock
shares subject to a maximum of 7,619,047 votes. In October 2000, the Company's
stockholders approved the issuance of the Preferred Stock to Titus. In
connection with this transaction, Titus received a warrant for 350,000 shares of
the Company's Common Stock exercisable at $3.79 per share at anytime. The fair
value of the warrant was estimated on the date of the grant using the
Black-Scholes pricing model. This resulted in the Company allocating $19,202,000
to the Preferred Stock and $798,000 to the warrant, which is included in paid in
capital. The discount on the Preferred
F-25
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
Stock was accreted over a one-year period as a dividend to the Preferred Stock
in the amount of $532,000 and $266,000 during the year ended December 31, 2001
and 2000, respectively. As of December 31, 2001, the Company had accreted the
full amount. In addition, Titus received a warrant for 50,000 shares of the
Company's Common Stock exercisable at $3.79 per share, because the Company did
not meet certain financial operating performance targets for the year ended
December 31, 2000. The fair value of this warrant was recorded as additional
interest expense. Both warrants expire in April 2010.
In August 2001, Titus converted 336,070 shares of Series A Preferred Stock
into 6,679,306 shares of Common Stock. This conversion did not include
accumulated dividends of $740,000 on the Preferred Stock, these were
reclassified as an accrued liability as Titus had elected to receive the
dividends in cash. In March 2002, Titus converted its remaining 383,354 shares
of Series A Preferred Stock into 47,492,162 shares of Common Stock. This
conversion did not include accumulated dividends of $1.2 million on the
Preferred Stock, these were reclassified as an accrued liability as Titus had
elected to receive the dividends in cash. Collectively, Titus has 71 percent of
the total voting power of the Company's capital stock at December 31, 2002.
In August 2000, the Company issued a warrant to purchase up to 100,000
shares of the Company's Common Stock to a vendor in connection with public
relations services they provided to the Company. The fair value of the warrant
was amortized to general and administrative expenses over the vesting period.
The warrant vests at certain dates over a one year period and has exercise
prices between $3.00 per share and $6.00 per share, as defined. The warrant
expires in August 2003.
During 2000, the Company's Board of Directors approved a resolution that
increased the number of authorized shares of the Company's Common Stock from 50
million to 100 million.
EMPLOYEE STOCK PURCHASE PLAN
Under this plan, eligible employees may purchase shares of the Company's
Common Stock at 85% of fair market value at specific, predetermined dates. In
2000, the Board of Directors increased the number of shares authorized to
300,000. Of the 300,000 shares authorized to be issued under the plan,
approximately 84,877 shares remained available for issuance at December 31,
2002. Employees purchased 21,652 and 24,483 shares in 2002 and 2001 for $4,000
and $31,000, respectively.
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock reserved for future issuance at December 31, 2002 is as
follows:
Stock option plans:
Outstanding ........................................ 1,091,697
Available for future grants ........................ 3,209,735
Employee Stock Purchase Plan .............................. 84,877
Warrants .................................................. 9,687,068
----------
Total ..................................................... 14,073,377
==========
10. NET EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed as net earnings (loss)
attributable to common stockholders divided by the weighted average number of
common shares outstanding for the period and does not include the impact of any
potentially dilutive securities. Diluted earnings per common share is computed
by dividing the net earnings attributable to the common stockholders by the
weighted average number of common shares outstanding
F-26
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
plus the effect of any dilutive stock options and common stock warrants and the
conversion of outstanding convertible debentures.
YEARS ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
-------- -------- --------
(Amounts in thousands, except
per share amounts)
Net income (loss) available to common
stockholders ............................. $ 15,015 $(47,548) $(13,477)
Interest related to conversion of
secured convertible
promissory note ....................... 82 -- --
-------- -------- --------
Dilutive net income (loss)
available to common stockholders ...... $ 15,097 $(47,548) $(13,477)
======== ======== ========
Shares used to compute net income
(loss) per share:
Weighted-average common shares ........... 83,585 38,670 30,047
Dilutive stock equivalents ............... 12,485 -- --
-------- -------- --------
Dilutive potential common shares ......... 96,070 38,670 30,047
======== ======== ========
Net income (loss) per share:
Basic .................................... $ 0.18 $ (1.23) $ (0.45)
Diluted .................................. $ 0.16 $ (1.23) $ (0.45)
There were options and warrants outstanding to purchase 10,778,765 shares
of common stock at December 31, 2002, which were excluded from the earnings per
common share computation as the exercise price was greater than the average
market price of the common shares. The dilutive stock equivalents in the above
calculation related to the outstanding convertible debentures at December 31,
2002, which the Company utilized the "if converted" method pursuant to SFAS 128.
Due to the net loss attributable for the years ended December 31, 2001 and
2000, on a diluted basis to common stockholders, stock options and warrants have
been excluded from the diluted earnings per share calculation as their inclusion
would have been antidilutive. Had net income been reported for the years ended
December 31, 2001 and 2000, an additional 13,694,739 and 4,449,967 shares would
have been added to dilutive potential common shares, respectively, and there
were 484,848 shares of restricted Common Stock at December 31, 2000, which would
have been added dilutive potential common shares. The weighted average exercise
price at December 31, 2002, 2001 and 2000 was $1.99, $2.07 and $3.03,
respectively, for the options and warrants outstanding.
11. EMPLOYEE BENEFIT PLANS
STOCK OPTION PLANS
The Company has three stock option plans. Under the Incentive Stock Option,
Nonqualified Stock Option and Restricted Stock Purchase Plan--1991 ("1991
Plan"), the Company was authorized to grant options to its employees to purchase
up to 111,000 shares of common stock. Under the Incentive Stock Option and
Nonqualified Stock Option Plan--1994 ("1994 Plan"), the Company was authorized
to grant options to its employees to purchase up to 150,000 shares of common
stock. Under the 1997 Stock Incentive Plan, as amended, the Company may grant
options to its employees, consultants and directors to purchase up to 6,000,000
shares of common stock.
Options under all three plans generally vest from three to five years.
Holders of options under the 1991 Plan and the 1994 Plan shall be deemed 100
percent vested in the event of a merger in which the Company is not the
surviving entity, a sale of substantially all of the assets of the Company, or a
sale of all shares of Common Stock of the Company. The Company has treated the
difference, if any, between the exercise price and the estimated fair market
value as compensation expense for financial reporting purposes, pursuant to APB
25. Compensation expense for the vested portion aggregated zero, $4,000 and
$90,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
F-27
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
The following is a summary of option activity pursuant to the Company's
stock option plans:
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
2002 2001 2000
---------------------- ---------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- -------- ---------- -------- ---------- --------
Options outstanding at
beginning of period 4,007,969 $2.57 3,539,828 $2.90 3,340,780 $3.30
Granted - - 739,667 1.25 968,498 2.64
Exercised (639,541) 0.14 (21,626) 0.47 (113,850) 0.37
Canceled (2,276,731) 3.44 (249,900) 3.36 (655,600) 5.14
---------- ---------- ----------
Options outstanding
at end of period 1,091,697 $3.10 4,007,969 $2.57 3,539,828 $2.90
========== ========== ==========
Options exercisable 744,892 2,093,606 1,496,007
========== ========== ==========
The following outlines the significant assumptions used to estimated the
fair value information presented utilizing the Black-Scholes Single Option
approach with ratable amortization. There were no options granted in 2002.
YEARS ENDED DECEMBER 31,
--------------------------
2001 2000
--------- ---------
Risk free rate ................................. 4.5% 6.2%
Expected life .................................. 6.7 years 7.3 years
Expected volatility ............................ 94% 90%
Expected dividends ............................. -- --
Weighted- average grant-date fair value
of options granted .......................... $ 1.02 $ 2.14
A detail of the options outstanding and exercisable as of December 31, 2002
is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contract Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
--------------------------------------------------------------------------------
$ 0.68 - $ 2.31 281,000 7.82 $ 1.50 140,871 $ 1.92
$ 2.44 - $ 2.64 214,834 7.64 2.63 141,539 2.64
$ 2.69 - $ 2.69 292,300 6.52 2.69 225,700 2.69
$ 3.25 - $ 8.00 303,563 5.40 5.30 236,782 5.75
---------- ----- -------- --------- --------
$ 0.68 - $ 8.00 1,091,697 6.76 $ 3.10 744,892 $ 3.51
========== ===== ======== ========= ========
PROFIT SHARING 401(K) PLAN
The Company sponsors a 401(k) plan ("the Plan") for most full-time
employees. The Company matches 50 percent of the participant's contributions up
to six percent of the participant's base compensation. The profit sharing
contribution amount is at the sole discretion of the Company's Board of
Directors. Participants vest at a rate of 20 percent per year after the first
year of service for profit sharing contributions and 20 percent per year after
the first two years of service for matching contributions. Participants become
100 percent vested upon death, permanent
F-28
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
disability or termination of the Plan. Benefit expense for the years ended
December 31, 2002, 2001 and 2000 was $79,000, $255,000 and $267,000,
respectively.
12. RELATED PARTY TRANSACTIONS
Amounts receivable from and payable to related parties are as follows:
DECEMBER 31,
2002 2001
------- -------
(Dollars in thousands)
Receivables from related parties:
Virgin ................................. $ 2,050 $ 7,504
Vivendi (Note 6) ....................... 487 2,437
Titus .................................. 200 260
Return allowance ....................... (231) (4,026)
------- -------
Total .................................. $ 2,506 $ 6,175
======= =======
Payables to related parties:
Virgin ................................. $ 1,797 $ 5,790
Vivendi ................................ 5,322 --
Titus .................................. 321 1,308
------- -------
Total .................................. $ 7,440 $ 7,098
======= =======
EVENTS WITH TITUS INTERACTIVE S.A.
Titus, the Company's largest stockholder, has a majority of the Company's
stockholders' voting power, providing Titus with the ability to control the
outcome of votes on proposals presented to the Company's stockholders, as well
as the ability to elect a majority of the Company's directors. The events
relating to Titus' gaining of majority voting power are as follows:
o On September 5, 2001, the Company entered into a Support Agreement
with Titus providing for the nomination to the Company's Board of
Directors a slate of six individuals mutually acceptable to Titus and
the Company for election as directors at the Company's 2001 annual
meeting of stockholders, and appointing a Chief Administrative Officer
("CAO") to the Company. Also on September 5, 2001, as part of the
Support Agreement, three of the existing directors resigned and three
new directors acceptable to Titus were appointed by the remaining
directors to fill the three vacancies. As a consequence, from
September 6, 2001 until the 2001 annual meeting on September 18, 2001,
the Board of Directors consisted of five individuals nominated by
Titus, and two directors previously nominated by management.
o On September 13, 2001, the Company's Board of Directors established an
Executive Committee, consisting of the Company's President and CAO, to
administer and oversee all aspects of the Company's day-to-day
operations, including, without limitation, (a) the relationship with
lenders, including LaSalle Business Credit, Inc.; (b) relations with
Europlay I, LLC ("Europlay"), consultants retained to effect a
restructuring of the Company; (c) capital raising efforts; (d)
relationships with vendors and licensors; (e) employment of officers
and employees; (f) retaining and managing outside professionals and
consultants; and (g) directing management.
o The Company's 2001 annual meeting was held on September 18, 2001. At
the annual meeting, the five Titus nominees and one of the directors
previously nominated by management were elected to continue to serve
as directors. Subsequent to September 18, 2001, two additional
independent directors were elected to the Board of Directors.
F-29
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
In September 2001, Titus retained Europlay as consultants to assist with
the restructuring of the Company. Because the arrangement with Europlay is with
Titus and Europlay's services have a direct benefit to the Company, the Company
has recorded an expense and a capital contribution by Titus of $75,000 for the
year ended December 31, 2001 in accordance with the SEC's Staff Accounting
Bulletin No. 79 "Accounting for Expenses and Liabilities Paid by Principal
Stockholders." Beginning in October 2001, the Company agreed to reimburse Titus
for consulting expense incurred on behalf of the Company. As of December 31,
2001, the Company owed Titus $450,000 as a result of this arrangement. The
amounts owed to Europlay by Titus under this arrangement, were paid directly to
Europlay with the sale of Shiny in April 2002 (Note 3). The Company has also
entered into a commission-based agreement with Europlay where Europlay will
assist the Company with strategic transactions, such as debt financing or equity
financing, the sale of assets or an acquisition of the Company. Europlay
assisted the Company with the sale of Shiny, and as a result, earned a
commission based on the sales price of Shiny.
In March 2003, the Company entered into a note receivable with Titus
Software Corp. ("TSC"), a subsidiary of Titus, for $226,000. The note earns
interest at 8 percent per annum and is due in February 2004. The note is secured
by (i) 4.0 million shares of the Company's common stock held by Titus (ii) TSC's
rights in and to a note receivable due from the President of Interplay and (iii)
rights in and to TSC's most current video game title releases during 2003 and
2004.
In March 2003, the Company's Board of Directors further authorized an
additional $500,000 loan to Titus, with interest at 8 percent per annum and a
maturity date in February 2004, on the condition that Titus is able to provide
sufficient security that is acceptable to the Board, which shall include,
without limitation, a minimum of 9.3 million shares of our common stock held by
Titus and (ii) rights in and to Titus' most current video game title releases
during 2003 and 2004.
DISTRIBUTION AND PUBLISHING AGREEMENTS
Titus Interactive S.A.
In connection with the equity investments by Titus (Note 9), the Company
performs distribution services on behalf of Titus for a fee. In connection with
such distribution services, the Company recognized fee income of $22,000,
$21,000 and $435,000 for the years ended December 31, 2002, 2001 and 2000,
respectively.
During the year ended December 31, 2000, the Company recognized $3 million
in licensing revenue under a multi-product license agreement with Titus for the
technology underlying one title and the content of three titles for multiple
game platforms, extended for a maximum period of twelve years, with variable
royalties payable to the Company from five to ten percent, as defined. The
Company earned a $3 million non-refundable fully-recoupable advance against
royalties upon signing and completing all of its obligations under the
agreement.
Amounts due to Titus at December 31, 2002 consisted primarily of trade
payables. Amounts due to Titus at December 31, 2001 include dividends payable of
$740,000 and $450,000 for services rendered by Europlay.
Virgin Interactive Entertainment Limited
In February 1999, the Company entered into an International Distribution
Agreement with Virgin Interactive Entertainment Limited ("Virgin"), a wholly
owned subsidiary of Titus, which provides for the exclusive distribution of
substantially all of the Company's products in Europe, Commonwealth of
Independent States, Africa and the Middle East for a seven-year period,
cancelable under certain conditions, subject to termination penalties and costs.
Under the Agreement, the Company pays Virgin a monthly overhead fee, certain
minimum operating charges, a distribution fee based on net sales, and Virgin
provides certain market preparation, warehousing, sales and fulfillment services
on behalf of the Company.
The Company amended its International Distribution Agreement with Virgin
effective January 1, 2000. Under the amended Agreement, the Company no longer
pays Virgin an overhead fee or minimum commissions. In
F-30
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
addition, the Company extended the term of the agreement through February 2007
and implemented an incentive plan that will allow Virgin to earn a higher
commission rate, as defined. Virgin disputed the amendment to the International
Distribution Agreement with the Company, and claimed that the Company was
obligated, among other things, to pay for a portion of Virgin's overhead of up
to approximately $9.3 million annually, subject to decrease by the amount of
commissions earned by Virgin on its distribution of the Company's products.
The Company settled this dispute with Virgin in April 2001 and further
amended the International Distribution Agreement and amended the Termination
Agreement and the Product Publishing Agreement, all of which were entered into
on February 10, 1999 when the Company acquired an equity interest in VIE
Acquisition Group LLC ("VIE"), the parent entity of Virgin. As a result of the
April 2001 settlement, Virgin dismissed its claim for overhead fees, VIE fully
redeemed the Company's ownership 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 paid 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 April 2001.
In January 2003, Virgin and the Company entered into a waiver related to
the distribution of a video game title in which the Company sold the European
distribution rights to Vivendi. In consideration for Virgin relinquishing its
rights, the Company agreed to pay Virgin $650,000 and will pay Virgin 50 percent
of all proceeds in excess of the advance received from Vivendi. As of December
31, 2002 the Company had paid Virgin $220,000 of the $650,000 due under the
waiver agreement.
In February 2003, Virgin Interactive Entertainment (Europe) Limited,, the
operating subsidiary of Virgin filed for a Company Voluntary Arrangement, or
CVA, a process of reorganization in the United Kingdom which must be approved by
Virgin's creditors. Virgin owed the Company, prior to reserve, approximately
$1.8 million at December 31, 2002. As of March 28, 2003, the CVA was rejected by
Virgin's creditors, and Virgin is presently negotiating with its creditors to
propose a new CVA. The Company does not know what affect approval of the CVA
will have on its ability to collect amounts Virgin owes the Company. If the new
CVA is not approved, the Company expects Virgin to cease operations and
liquidate, in which event the Company will most likely not receive any amounts
presently due to it by Virgin, and will not have a distributor for its products
in Europe and the other territories in which Virgin presently distributes its
products.
In connection with the International Distribution Agreement, the Company
incurred distribution commission expense of $0.9 million, $2.3 million and $4.6
million for the years ended December 31, 2002, 2001 and 2000, respectively. In
addition, the Company recognized overhead fees of $0.5 million, $1.0 million and
zero and certain minimum operating charges to Virgin of zero, $333,000 and zero
for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company has also entered into a Product Publishing Agreement with
Virgin, which provides the Company with an exclusive license to publish and
distribute substantially all of Virgin's products within North America, Latin
America and South America for a royalty based on net sales. As part of terms of
the April 2001 settlement between Virgin and the Company, the Product Publishing
Agreement was amended to provide for the Company to publish only one future
title developed by Virgin. In connection with the Product Publishing Agreement
with Virgin, the Company earned $66,000, $36,000 and $63,000 for performing
publishing and distribution services on behalf of Virgin for the years ended
December 31, 2002, 2001 and 2000, respectively.
In connection with the International Distribution Agreement, the Company
subleases office space from Virgin. Rent expense paid to Virgin was $104,000,
$104,000 and $101,000 for the years ended December 31, 2002, 2001 and 2000,
respectively.
F-31
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
Vivendi Universal Games, Inc.
In connection with the distribution agreements with Vivendi (Note 6), the
Company incurred distribution commission expense of $14.0 million and $2.2
million for the years ended December 31, 2002 and 2001, respectively.
Distribution commission expense in 2002 for titles released under the August
2002 agreement, were inclusive of all marketing, manufacturing and distribution
expenditures.
INVESTMENT IN AFFILIATE
In connection with the International Distribution Agreement and Product
Publishing Agreement, the Company had also entered into an Operating Agreement
with Virgin Acquisition Holdings, LLC, which, among other terms and conditions,
provided the Company with a 43.9 percent equity interest in VIE. During 1999,
Titus acquired a 50.1 percent equity interest in VIE and in 2000, Titus acquired
the 6 percent originally owned by the two former members of the management of
Interplay Productions Limited, the Company's United Kingdom subsidiary. The
Company and Titus together held a 100 percent equity interest in VIE as of
December 31, 2000. As part of the terms of the April 2001 settlement with
Virgin, VIE redeemed the Company's ownership interest in VIE. The Company no
longer has any equity interest in VIE or Virgin as of April 2001.
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 years ended December
31, 2001 and 2000.
OTHER
The Company had amounts due from a business controlled by the former
Chairman of the Company. Net amounts due, prior to reserves, at December 31,
2000 were $2.5 million. Such amounts at December 31, 2000 are fully reserved. In
2001, the Company wrote off this receivable.
13. CONCENTRATION OF CREDIT RISK
As of December 31, 2002, substantially all of the Company's sales were to
its distributors Virgin and Vivendi. Virgin and Vivendi each have exclusive
rights to distribute the Company's products in substantial portions of the
world. As a consequence, the distribution of the Company's products by Virgin
and Vivendi will generate a substantial majority of the Company's revenues, and
proceeds from Virgin and Vivendi from the distribution of the Company's products
will constitute a substantial majority of the Company's operating cash flows.
Therefore, the Company's revenues and cash flows could fall significantly and
the Company's business and financial results could suffer material harm if:
o either Virgin or Vivendi fails to deliver to the Company the full
proceeds owed it from distribution of its products;
o either Virgin or Vivendi fails to effectively distribute the Company's
products in their respective territories; or
o either Virgin or Vivendi otherwise fails to perform under their
respective distribution agreements.
The Company typically sells to distributors and retailers on unsecured
credit, with terms that vary depending upon the customer and the nature of the
product. The Company confronts the risk of non-payment from its customers,
whether due to their financial inability to pay the Company, or otherwise. In
addition, while the Company maintains 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 the Company's
business.
For the years ended December 31, 2002, 2001 and 2000, Virgin accounted for
approximately 11, 22 and 29 percent, respectively, of net revenues in connection
with the International Distribution Agreement (Note 12).
F-32
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
Vivendi accounted for 71 and 17 percent of net revenues in the year ended
December 31, 2002 and 2001, respectively.
14. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2002 2001 2000
------------------ ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
North America .. $ 26,184 60 % $ 34,998 62 % $ 53,298 52 %
Europe ......... 4,988 11 12,597 22 28,107 28
Rest of World .. 686 2 2,854 5 6,970 7
OEM, royalty and
licensing ... 12,141 27 5,999 11 13,051 13
-------- ------- -------- ------- -------- -------
$ 43,999 100 % $ 56,448 100 % $101,426 100 %
======== ======= ======== ======= ======== =======
15. OTHER EXPENSE, NET
In April 2002, the Company entered into a settlement agreement with the
landlord of an office facility in the United Kingdom, whereby the Company
returned the property back to the landlord and was released from any further
lease obligations. As a result of this settlement, the Company reduced its
amounts accrued for this contractual cash obligation by $0.8 million for the
year ended December 31, 2002.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's summarized quarterly financial data is as follow:
MAR. 31 JUN. 30 SEPT. 30 DEC. 31
-------- --------- ---------- --------
(Dollars in thousands, except per share amounts)
Year ended December 31, 2002:
Net revenues ................ $ 15,375 $ 11,842 $ 9,677 $ 7,105
======== ========= ========== ========
Gross profit ................ $ 10,898 $ 1,240 $ 4,002 $ 1,153
======== ========= ========== ========
Net income (loss) ........... $ 1,495 $ 20,868 $ (1,847) $ (5,369)
======== ========= ========== ========
Net income (loss) per common
share basic .............. $ 0.03 $ 0.22 $ (0.02) $ (0.06)
======== ========= ========== ========
Net income (loss) per common
share diluted ............ $ 0.02 $ 0.22 $ (0.02) $ (0.06)
======== ========= ========== ========
Year ended December 31, 2001:
Net revenues ................ $ 16,813 $ 14,302 $ 3,825 $ 21,508
======== ========= ========== ========
Gross profit ................ $ 6,328 $ 3,309 $ (7,623) $ 8,618
======== ========= ========== ========
Net loss .................... $ (8,422) $ (12,398) $ (20,648) $ (4,848)
======== ========= ========== ========
Net loss per common share
basic/diluted ............ $ (0.30) $ (0.34) $ (0.50) $ (0.09)
======== ========= ========== ========
F-33
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2002
17. SUBSEQUENT EVENTS
In February 2003, the Company has sold all future interactive entertainment
publishing rights to the "Hunter: The Reckoning" franchise for $15 million,
payable in installments. The Company retains the rights to the previously
published "Hunter: The Reckoning" titles on Microsoft Xbox and Nintendo
GameCube.
18. ARTHUR ANDERSEN, LLP'S REPORT ON 2000 CONSOLIDATED FINANCIAL STATEMENTS
On or about August 31, 2002, Arthur Andersen, LLP ("AA") discontinued its
public audit practice and AA effectively no longer exists as an operating public
accounting firm. Therefore, AA was unable to reissue its audit report on the
Company's December 31, 2000 consolidated financial statements. The audit report
on such consolidated financial statements included in this filing is only a copy
of their previously issued audit report.
F-34
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
TRADE RECEIVABLES ALLOWANCE
---------------------------------------------------------
BALANCE AT PROVISIONS FOR BALANCE AT
BEGINNING OF RETURNS RETURNS AND END OF
PERIOD PERIOD AND DISCOUNTS DISCOUNTS PERIOD
------ ------------ ------------ ---------- ----------
Year ended December 31, 2000 $ 9,161 $ 19,016 $ (21,634) $ 6,543
============ ============ ========== ==========
Year ended December 31, 2001 $ 6,543 $ 19,875 $ (18,877) $ 7,541
============ ============ ========== ==========
Year ended December 31, 2002 $ 7,541 $ 2,586 $ (9,041) $ 1,086
============ ============ ========== ==========
S-1