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, 2006
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.)
100 N. CRESCENT DRIVE, BEVERLY HILLS, CALIFORNIA 90210
(Address of principal executive offices)
(310) 432-1958
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act Yes [ ] No [X].
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [x] No [ ].
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ] Non- accelerated filer [x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [x].
As of December 29, 2006, the aggregate market value of voting common stock held
by non-affiliates was approximately $6,000,000 based upon the closing price of
the Common Stock on that date.
Documents incorporated by reference
Portions of the registrant's definitive proxy statement relating to its 2007
annual meeting of stockholders, which will be filed with the Securities and
Exchange Commission pursuant to regulation 14A within 120 days of the close of
the registrant's last fiscal year, are incorporated by reference into Part III
of this report.
As of December 29, 2006, 103,855,634 shares of Common Stock of the Registrant
were issued and outstanding. This includes 4,658,216 shares of Treasury Stock.
2
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2006
PAGE
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PART I
Item 1. Business 4
Item 1A Risk Factors 8
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosure about
Market Risk 29
Item 8. Consolidated Financial Statements and Supplementary
Data 29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 29
Item 9A Controls and Procedures
PART III
Item 10. Directors and Executive Officers of the Registrant 30
Item 11. Executive Compensation 30
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 30
Item 13. Certain Relationships and Related Transactions 30
Item 14. Principal Accounting Fees and Services 30
PART IV
Item 15. Exhibits, Financial Statement Schedules. 31
Signatures 32
Exhibit Index 33
3
THIS REPORT 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
REPORT EXCEPT FOR HISTORICAL INFORMATION MAY BE DEEMED TO BE FORWARD-LOOKING
STATEMENTS. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, OUR USE OF WORDS
SUCH AS "PLAN," "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND,"
"COULD," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR
COMPARABLE TERMINOLOGY ARE INTENDED TO HELP 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 REPORT 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,
CASH CONSTRAINTS, FINANCING ACTIVITIES, COST REDUCTION MEASURES, REPLACEMENT OF
OUR LINE OF CREDIT AND MERGERS, SALES OR ACQUISITIONS ARE FORWARD-LOOKING
STATEMENTS AND THERE CAN BE NO ASSURANCE THAT WE WILL AFFECT ANY OR ALL OF THESE
OBJECTIVES IN THE FUTURE. ADDITIONAL RISKS AND UNCERTAINTIES THAT MAY AFFECT OUR
FUTURE RESULTS ARE DISCUSSED IN MORE DETAIL IN THE SECTION TITLED "RISK FACTORS"
IN "ITEM 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS."
ASSUMPTIONS RELATING TO OUR FORWARD-LOOKING STATEMENTS 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 OUR CONTROL.
ALTHOUGH WE BELIEVE THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING
STATEMENTS ARE REASONABLE, OUR INDUSTRY, BUSINESS AND OPERATIONS ARE SUBJECT TO
SUBSTANTIAL RISKS, AND THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED
AS A REPRESENTATION BY MANAGEMENT THAT ANY PARTICULAR OBJECTIVE OR PLANS WILL BE
ACHIEVED. IN ADDITION, RISKS, UNCERTAINTIES AND ASSUMPTIONS CHANGE AS EVENTS OR
CIRCUMSTANCES CHANGE. WE DISCLAIM 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
REPORT 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 US OR ON OUR
BEHALF.
INTERPLAY (R), INTERPLAY PRODUCTIONS(R), GAMES ON LINE (R) AND CERTAIN OF
OUR OTHER PRODUCT NAMES AND PUBLISHING LABELS REFERRED TO IN THIS REPORT ARE THE
COMPANY'S TRADEMARKS. THIS REPORT ALSO CONTAINS TRADEMARKS BELONGING TO OTHERS.
PART I
ITEM 1. BUSINESS
OVERVIEW AND RECENT DEVELOPMENTS
Interplay Entertainment Corp., which we refer to in this Report as "we,"
"us," or "our," is a publisher and licensor 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 and licensed titles for many of the most popular interactive
entertainment software platforms.
We seek to publish or license out 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 or
licensed many such successful franchise titles to date.
The Company is planning to exploit its Intellectual Property "Fallout" on
Massively Multiplayer Online Gaming (MMOG) and is reviewing the financial
avenues for funding MMOG.
Our business and industry has certain risks and uncertainties. During 2006
we continued to operate under limited cash flow from operations. We expect to
operate under improved cash constraints during 2007. During 2006, because of
limited resources, we have been primarily engaged in exploiting existing titles.
We have had no new internal development of software titles. For a fuller
discussion of the risk and uncertainties relating to our financial results, our
business and our industry, please see the section titled "Risk Factors" in "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Our principal activities involve publishing of video game products,
licensing of our intellectual properties, online distribution, back catalog
licensing and OEM/ merchandising.
4
PRODUCTS
We publish and distribute interactive entertainment software titles that
provide immersive game experiences by combining advanced technology with
engaging content, vivid graphics and rich sound.
Our strategy is to invest in products for those platforms, whether PC or
video game console, that have or will have sufficient installed bases or a large
enough number of potential subscribers for the investment to be economically
viable. We do not currently internally develop new products.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
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. 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, from time to time, some of our product
development activities to third party developers. We contractually retain all
intellectual property rights related to such projects. We also license certain
products developed by third parties and pay royalties on such products.
While we provide "shrink wrap" 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, 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.
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, such as using 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. In some instances, we may need to
engage in litigation in the ordinary course of our business to defend against
such claims. 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.
PRODUCT DEVELOPMENT
We currently do not have any new products under development.
During the years ended December 31, 2006, 2005 and 2004, we spent $0,
$300,000 and $2.6 million, respectively, on product research and development
activities. Those amounts represented 0%, 3% and 20%, respectively, of net
revenues in each of those periods.
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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 13 of the Notes to our Consolidated Financial Statements included elsewhere
in this Report.
SALES AND DISTRIBUTION
NORTH AMERICA. We distribute and license rights to our products and
Intellectual Properties in North America and other selected territories from our
corporate offices in Beverly Hills, California.
INTERNATIONAL. We distribute and license rights to our products and
Intellectual Properties in Europe and other selected territories thru our wholly
owned subsidiary, Interplay Productions Ltd,located in London, England..
LICENSING
We entered into various licensing agreements during 2006 under which we
licensed others to exploit games that we have intellectual property rights to.
MARKETING
We assist our distributors in the development and implementation of
marketing programs and campaigns for each of our titles and product groups.
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 Activision,
Atari, Capcom, Eidos, Electronic Arts, Konami, Lucas Arts, Midway, Namco, Sega,
Take-Two Interactive, THQ, Ubi Soft. and Vivendi Games. In addition, integrated
video game console hardware/software companies such as Sony Computer
Entertainment, Microsoft Corporation, and Nintendo compete directly with us in
the development of software titles for their respective platforms. Large
diversified entertainment companies, such as The Walt Disney Company, and Time
Warner Inc., many of which own substantial libraries of available content and
have substantially greater financial resources than us, also compete directly
with us or have exclusive relationships with our competitors.
SEASONALITY
The interactive entertainment software industry is highly seasonal as a
whole, 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. Our business and financial results may therefore be affected by the timing
of our introduction of new releases.
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 third parties. Printing of manuals and packaging materials,
manufacturing of related materials and assembly of completed packages are
performed to our specifications by 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.
6
Sony Computer Entertainment, Microsoft Corporation and Nintendo manufacture
and ship finished products that are compatible with their video game consoles to
our licensees 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 manufacturers, our net sales and operating
results could be materially adversely affected.
BACKLOG
We do not carry inventories because all of our sales and distribution
efforts are handled by our licensees under the terms of our respective
distribution agreements with them. We do not have any backlog orders
EMPLOYEES
As of December 31, 2006, we had 6 employees, including 1 in software
engineering, 2 in sales and marketing and 3 in finance, general and
administrative.
From time to time, we have retained actors and/or "voice over" talent to
perform in certain of our products, and we may 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.
ADDITIONAL INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the U.S. Securities and Exchange Commission or SEC. You may
obtain copies of these reports via the Internet at the SEC's homepage located at
www.sec.gov. You may also go to our Internet address located at
www.interplay.com and go to "Investor Relations" which will link you to the
SEC's homepage for our filed reports. In addition, copies of the reports we file
with the SEC may also be obtained at the SEC's Public Reference Room at 450
Fifth Street, NW, Washington, DC 20549. You may obtain information on the
operation of the Public Reference Room by Calling the SEC at 1-800-SEC-0330.
7
ITEM 1A. RISK FACTORS
RISK FACTORS
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. These major risks and uncertainties are
discussed below. There may be additional risks and uncertainties which we do not
believe are currently material or are not yet known to us but which may become
such in the future. 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:
RISKS RELATED TO OUR FINANCIAL RESULTS
WE CURRENTLY HAVE A NUMBER OF OBLIGATIONS THAT WE ARE UNABLE TO MEET WITHOUT
GENERATING ADDITIONAL INCOME OR RAISING ADDITIONAL CAPITAL. IF WE CANNOT
GENERATE ADDITIONAL INCOME OR RAISE ADDITIONAL CAPITAL IN THE NEAR FUTURE, WE
MAY BECOME INSOLVENT AND/OR BE MADE BANKRUPT AND/OR OUR MAY BECOME ILLIQUID OR
WORTHLESS.
As of December 31, 2006, our cash balance was approximately $50,000 and our
working capital deficit totaled approximately $8.1 million. In particular, we
have some significant creditors that comprise a substantial proportion of
outstanding obligations, including many that have obtained judgments against us,
that we might not be able to satisfy. If we do not receive sufficient financing
or sufficient funds from our operations 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. 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. If we cannot generate enough income from our operations or are unable to
locate additional funds through financing, we will not have sufficient resources
to continue operations.
WE HAVE A HISTORY OF LOSSES, AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY
CURTAILING FUTURE OPERATIONS TO CONTINUE AS A BUSINESS.
For the year ended December 31, 2006, our net income was $3.1 million,
$4.5 million of our revenue was recognized from the reversals of certain
settlements, reversal of reserves, prior year payables. The $4.5 million of
reversals and settlements did not generate cash flow. However, since inception,
we have incurred significant losses and negative cash flow. As of December 31,
2006 we had an accumulated deficit of $130 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 distributions and licensing, 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 or assets, and delaying, canceling or
scaling back operations. 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.
OUR ABILITY TO EFFECT A FINANCING TRANSACTION TO FUND OUR OPERATIONS COULD
ADVERSELY AFFECT THE VALUE OF YOUR STOCK.
If we are not acquired by or merge with another entity or if we are not
able to raise additional capital by sale or license of certain of our assets, we
may need to consummate a financing transaction to receive additional liquidity.
This additional financing may take the form of raising additional capital
through public or private equity offerings or debt financing. To the extent we
raise additional capital by issuing equity securities, we cannot be certain that
additional capital will be available to us on favorable terms and our
stockholders will likely experience substantial dilution. Our certificate of
incorporation provides for the issuance of preferred stock however we currently
do not have any preferred stock issued and outstanding. Any new equity
securities issued may have greater rights, preferences or privileges than our
existing common stock. Material shortage of capital will require us to take
drastic steps such as reducing our level of operations, disposing of selected
assets, effecting financings on less than favorable terms or seeking protection
under federal bankruptcy laws.
8
RISKS RELATED TO OUR BUSINESS
TITUS INTERACTIVE SA (PLACED IN INVOLUNTARY BANKRUPTCY IN JANUARY, 2005)
CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A MAJORITY OF OUR BOARD OF
DIRECTORS AND PREVENT AN ACQUISITION OF US THAT IS FAVORABLE TO OUR OTHER
STOCKHOLDERS. ALTERNATIVELY, TITUS CAN ALSO CAUSE A SALE OF CONTROL OF OUR
COMPANY THAT MAY NOT BE FAVORABLE TO OUR OTHER STOCKHOLDERS.
Titus owns approximately 58 million shares of common stock. 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 2003 and 2002 annual stockholders meetings,
Titus exercised its voting power to elect a majority of our Board of Directors.
Currently, our Chief Executive Officer and interim Chief Financial Officer Herve
Caen was a director of various Titus affiliates. 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. Further, Titus' bankruptcy
could lead to a sale by its liquidator or other representative in bankruptcy, of
shares Titus holds in us, and/or a sale of Titus itself which would result in a
sale of control of our Company and such a sale may not be favorable to our other
stockholders. Such a sale, including if it involves a 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.
THE LACK OF ANY CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL REDUCTION IN THE
CASH AVAILABLE TO FINANCE OUR OPERATIONS.
We are currently operating without a credit agreement or credit facility.
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.
WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR
ABILITY TO MANAGE OUR FINANCIAL OPERATIONS.
IF WE FAIL TO DELIVER OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER.
We are presently without a CFO, and Mr. Caen has assumed the position of
interim-CFO and continues as CFO to date until a replacement can be found. o OUR
BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL.
Our business is highly seasonal, with the highest levels of consumer demand
occurring in the fourth quarter. Our industry is also cyclical. The timing of
hardware platform introduction is often tied to the year-end season and is not
within our control. As new platforms are being introduced into our industry,
consumers often choose to defer game software purchases until such new platforms
are available, which would cause sales of our products on current platforms to
decline. This decline may not be offset by increased sales of products for the
new platform.
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
9
o the timing of the release and market penetration of new game hardware
platforms.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE DISTRIBUTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
Although for the year ended December 31, 2006, our net income was $3.1
million, $4.5 million was from one time non recurring events, and we have
incurred significant net losses in previous years and $4.5 million did not
generate cash flow. Our losses in the past stemmed partly from the significant
costs we incurred to develop our entertainment software products, product
returns and price concessions. 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 licensing existing products could reduce our
net.
IF OUR PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, OUR BUSINESS COULD BE
HARMED SIGNIFICANTLY.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our licensing of 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.
WE HAVE A LIMITED NUMBER OF KEY MANAGEMENT AND OTHER PERSONNEL. THE LOSS OF ANY
SINGLE MEMBER OF MANAGEMENT OR KEY PERSON OR THE FAILURE TO HIRE AND INTEGRATE
CAPABLE NEW KEY PERSONNEL COULD HARM OUR BUSINESS.
Our business requires extensive time and creative effort to produce and
market. 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
executive management team currently consists of CEO and interim CFO Herve Caen.
Our failure to recruit or 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 66%
and 57% of our total net revenues for years ended December 31, 2006 and 2005,
respectively. 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 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;
10
o it is difficult and costly to staff and manage foreign operations;
o fluctuations in foreign currency exchange rates;
o political and economic instability; 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.
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. Our distributors allow 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, our distributors provide
pricing concessions to our customers to manage our customers' inventory levels
in the distribution channel. Our distributors could be forced to accept
substantial product returns and provide pricing concessions to maintain our
relationships with retailers and their access to distribution channels.
RISKS RELATED TO OUR INDUSTRY
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 "shrink-wrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy
can be a persistent problem, especially in some international markets. Further,
the laws of some countries where our products are or may be distributed either
do not protect our products and intellectual property rights to the same extent
as the laws of the United States, or are weakly enforced. Legal protection of
our rights may be ineffective in such countries, and as we leverage our software
products using emerging technologies such as the Internet and online services,
our ability to protect our intellectual property rights and to avoid infringing
others' intellectual property rights may diminish. We cannot assure you that
existing intellectual property laws will provide adequate protection for our
products in connection with these emerging technologies. We lack resources to
defend proprietary technology.
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;
11
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 BUSINESS IS INTENSELY COMPETITIVE AND PROFITABILITY IS INCREASINGLY DRIVEN
BY A FEW KEY TITLE RELEASES. IF WE ARE UNABLE TO DELIVER KEY TITLES, OUR
BUSINESS MAY BE HARMED.
Competition in our industry is intense. New videogame products are
regularly introduced. Increasingly, profits and revenues in our industry are
dominated by certain key product releases and are increasingly produced in
conjunction with the latest consumer and media trends. Many of our competitors
may have more finances and other resources for the development of product titles
than we do. If our competitors develop more successful products, or if we do not
continue to develop consistently high-quality products, our revenue will
decline.
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;
o new media formats
o releases of new video game consoles;
o new video game systems by Sony, Microsoft, Nintendo and others.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
New interactive entertainment software platforms and technologies also may
undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
o anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on favorable
terms; or
o create software for those new platforms on a timely basis.
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.
12
RISKS RELATED TO OUR STOCK
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 Certificate of Incorporation, as amended, provides for 5,000,000
authorized shares of Preferred Stock. Our Board of Directors has the authority,
without any action by the stockholders, to issue up to 4,280,576 shares of
preferred stock and to fix the rights and preferences of such shares. 719,424
shares of Series A Preferred Stock was issued to Titus in the past, which amount
has been fully converted into our common stock. In addition, our certificate of
incorporation and bylaws contain provisions that:
o eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to nominate
directors or submit proposals for stockholder approval.
These provisions may have the effect of delaying, deferring or preventing a
change in control, may discourage bids for our common stock at a premium over
its market price and may adversely affect the market price, and the voting and
other rights of the holders, of our common stock.
OUR COMMON STOCK MAY BE SUBJECT TO THE "PENNY STOCK" RULES WHICH COULD ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
"Penny stocks" generally include equity securities with a price of less
than $5.00 per share, which are not traded on a national stock exchange or on
Nasdaq, and are issued by a company that has tangible net assets of less than
$2,000,000 if the company has been operating for at least three years. The
"penny stock" rules require, among other things, broker dealers to satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving a purchaser's written consent prior to
any transaction. In addition, additional disclosure in connection with trades in
the common stock are required, including the delivery of a disclosure schedule
prescribed by the SEC relating to the "penny stock" market. These additional
burdens imposed on broker-dealers may discourage them from effecting
transactions in our common stock, which may make it more difficult for an
investor to sell their shares and adversely affect the market price of our
common stock.
OUR STOCK 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.
ITEM 2. PROPERTIES
The Company's headquarters are located in Beverly Hills, California, where
we leased approximately 3,100 square feet of office space. The facility is
leased through April 2008. We are currently subleasing approximately 1,100
square feet of our facility to an independent third party. We also have a
representation office in France.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings, claims, and
litigation arising in the ordinary course of Business, including disputes
arising over the ownership of intellectual property rights and collection
matters. In the opinion of management, the outcome of known routine claims will
not have a material adverse effect on the Company's business, financial
condition, or results of operations.
13
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the Company for various claims related to a
breach of a distributorship agreement. Synnex obtained a $172,000 judgment
against the Company.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against us in the Superior Court for the State of California, County
of Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal including
interest. We owe a remaining balance of approximately $383,000 payable in one
remaining installment. The Company is currently in default of the settlement
agreement.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $432,000. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has been in default of the forbearance agreement. On or about
November 1, 2006, Arden filed an involuntary bankruptcy petition against the
Company. The petition is pending before the bankruptcy court and the Company is
opposing it.
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,000 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000 additional interest has accrued in the amount
of $26,548, the total outstanding balance at December 31, 2006 is $126,548. If
Monte Cristo executes the judgment, it will negatively affect the Company's cash
flow, which could further restrict the Company's operations and cause material
harm to our business.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company for failure to pay development fees in the Orange County Superior Court
that was settled in July 2004. The Company was unable to make the payments and
Reflexive sought and obtained judgment against the company for approximately
$110,000. On or about November 1, 2006, Reflexive joined Arden in the filing of
an involuntary bankruptcy petition against the Company. The petition is pending
before the bankruptcy court and the Company is opposing it.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for failure to pay royalties. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further the settlement was entered into with Interplay OEM only in the
amount of $170,000, however KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment was not made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $110,000 pursuant to section 166 and section 186 of the
Internal Revenue Code in payroll tax penalties, and interest for late filing and
late payment of payroll taxes. Approximately $110,000 has been accrued as of
December 31, 2006 but remains unpaid. The Company received notice from the
Employment Development Department (EDD) that it owes approximately $103,000 in
payroll taxes, interest and penalties for the periods ending 2003, 2004 and 2005
which has been accrued for December 31, 2006. The Company is in the process of
establishing a payment plan with the Employment Development Department.
The Company was unable to meet certain 2004 payroll obligations to its
employees, as a result several employees filed claims with the State of
California Labor Board ("Labor Board"). The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and obtained
in August 2005 judgments totaling $118,000 in favor of former employees of the
Company , since this time $44,000 of the claims have been settled leaving, a
balance of $74,000. On or about November 1, 2006, two employees joined Arden and
Reflexive in the filing of an involuntary bankruptcy petition against the
Company. The petition is pending before the bankruptcy court and the Company is
opposing it.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled in
2004. The company subsequently entered into new workers compensation insurance
plan.
14
The Labor Board fined the Company approximately $79,000 for having lost workers
compensation insurance for a period of time. The Company is appealing the Labor
Board fines.
The Company received notice from the California State Board of Equalization
of a balance due in the amount of $73,000 for a prior year audit. The Company
has engaged an independent specialized accounting firm to appeal the prior year
audit calculations and submit a settlement proposal to the California State
Board of Equalization.
On September 14, 2005, Network Commercial Service, Inc. ("NCS") filed an
action against the Company alleging breach of contract relating to the provision
of copying equipment. NCS subsequently obtained a judgment against the company
for approximately $140,000.
On April 22, 2005, Mark Strecker filed an action against the Company for
various claims alleging unpaid services in the amount of $35,000. The Company is
evaluating the merit of the lawsuit.
On May 19, 2005 DZN, The Design Corporation filed an action against the
Company for various advertising services in the amount of $38,000. The Company
is evaluating the merit of the lawsuit.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. The Company is evaluating the merit of the lawsuit.
On March 7, 2006, Parallax Software Corp. entered a judgment against the
Company for a material breach of a settlement agreement related to royalties
owed in the amount of $219,000.
o 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") initiated legal
proceedings against the Company seeking damages of approximately $1.3 million,
alleging, among other things, that we failed to secure a timely effective date
for a Registration Statement for its shares purchased by Special Situations
under a common stock subscription agreement dated March 29, 2001 and that the
Company therefore, liable to pay Special Situations $1.3 million. Special
Situations entered into a settlement agreement with the Company in December,
2003 contemplating payments over time, which the Company later defaulted. In
August, 2004 the Company entered into a stipulation of settlement on which it
later defaulted. On January 12, 2005 a judgment of approximately $776,000 was
entered in the State of New York and on February 4, 2005 a judgment reflecting
the January 12, 2005 judgment was entered in the State of California. On May 3,
2006 the Company entered into a Stipulation of Settlement. Under this
Stipulation of Settlement, the Company issued a total of 10,000,000 shares of
its unregistered common stock and made a payment in the amount of approximately
$239,000. Following the issuance of such shares, and in consideration of such
issuance and such payment, satisfaction of judgments in the amount of
approximately $776,000 were filed. Such shares were issued in a private
placement pursuant to section 4(2) of the Securities Act of 1933 and were issued
at a price of $.0296 per share, using a value based on the then current market
price of shares of common stock discounted by such newly issued shares.
The Company has recorded an estimate for the liabilities related to the
aforementioned litigation. If any of the creditors execute their judgments
against the Company, the results will negatively affect the Company's cash flow,
which could restrict the Company's operations and cause material restraints to
its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company trades 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" or while non-compliant "IPLYE". At March
19, 2007, there were 100 holders of record of our common stock.
15
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, 2006 HIGH LOW
------------------------------------ ------- -------
First Quarter .............................. $ .04 $ .01
Second Quarter ............................. .04 .02
Third Quarter .............................. .03 .01
Fourth Quarter ............................. .29 .01
FOR THE YEAR ENDED DECEMBER 31, 2005 HIGH LOW
------------------------------------ ------- -------
First Quarter .............................. $ .02 $ .01
Second Quarter ............................. .01 .01
Third Quarter .............................. .01 .01
Fourth Quarter ............................. .01 .01
DIVIDEND POLICY
It is not currently our policy to pay dividends.
SECURITIES ISSUANCES
10,000,000 new shares were issued during the period ending December 31,
2006. (See Special Situation in Item 3 Legal Proceedings)
On October 2, 2006 the Company issued 6,370,000 warrants to purchase the
Company's common stock at $.0279 per share (average closing price over ten days
subsequent to the resolution authorizing the issuance of the warrants) to the
officer and directors.
The 6,100,000 warrants were issued to the officer to reduce his
compensation and to convert a portion of his unpaid compensation into a
conditional demand note. The conditions includes that such note will be paid
only if the tangible net worth of the Company exceeds $1 million or in a case of
change in control. The demand note will accrue interest at a rate of 5%
annually. These warrants were valued using the Black-Scholes Model.
In addition 270,000 warrants were issued to the directors to convert their
earned but unpaid director's fees to conditional demand notes. The conditions
include that such notes will be paid only if the tangible net worth of the
Company exceeds $1 million or in a case of change in control. The demand notes
will accrue interest at a rate of 5% annually. These warrants were valued using
the Black-Scholes Model.
On October 2, 2006 the Company issued 2,570,000 options to directors and
senior employees to purchase the Company's common stock at $.045 per share.
Such warrants and options were issued in a private placement pursuant to
section 4 (2) of the Securities Act of 1933.
16
STOCK COMPENSATION PLANS
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2006:
Number of securities
remaining available for
Number of securities to 01Weighted-average future issuance under equity
be issued upon exercise exercise price of compensation plans
of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
-------------------------- ------------------------- ---------------------- -----------------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders
Equity compensation
plans not approved
by security holders 9,970,298 0.029 7,360,000
------------------------- ---------------------- -----------------------------
Total 9,970,298 0.029 7,360,000
========================= ====================== =============================
We have one stock option plan currently outstanding. Under the 1997 Stock
Incentive Plan, as amended (the "1997 Plan"), we may grant up to 10 million
options to our employees, consultants and directors, which generally vest from
three to five years.
There were differences between the exercise price and the estimated fair
market value as compensation expense in the amount of $40,000, $0 and $0,
respectively, for financial reporting purposes. There was no compensation
expense for any vested portion for the years 2005 and 2004 respectively and 2006
the Company recorded a charge to income of $40,000 under FASB 123R.
17
PERFORMANCE GRAPH
The following graph sets forth the percentage change in cumulative total
stockholder return of our common stock during the period from December 31, 2001
to December 31, 2006, compared with the cumulative returns of the NASDAQ Stock
Market (U.S. Companies) Index and the Media General Index 820*. The comparison
assumes $100 was invested on December 31, 2001 in our common stock and in each
of the foregoing indices. Information presented below is as of the end of the
fiscal year ended December 31, 2006.
[PERFORMANCE GRAPH OMITTED]
----------------------------- ----------- ----------- ---------- ----------- ----------- -----------
12/01 12/02 12/03 12/04 12/05 12/06
----------------------------- ----------- ----------- ---------- ----------- ----------- -----------
INTERPLAY ENTERTAINMENT CORP. 100.00 13.04 16.30 3.04 1.74 29.35
NASDAQ COMPOSITE 100.00 71.97 107.18 117.07 120.50 137.02
NEW PEER GROUP 100.00 77.53 141.43 184.44 164.44 169.50
OLD PEER GROUP 100.00 70.27 127.35 166.00 153.05 156.65
In any of our fillings under the Securities Act of 1933, as amended or the
Securities Exchange Act of 1934, as amended that incorporate this performance
graph and the data related thereto by reference, this performance graph and data
related thereto will be considered excluded from the incorporation by reference
and will not be deemed a part of any such other filing unless we expressly state
that the performance graph and the data related thereto is so incorporated.
18
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for the years ended
December 31, 2006, 2005 and 2004 and the selected consolidated balance sheets
data as of December 31, 2006 and 2005 are derived from our audited consolidated
financial statements included elsewhere in this Report. 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 "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements included elsewhere in this
Report.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- --------- --------- ---------
(Dollars in thousands, except share
and per share amounts)
STATEMENTS OF OPERATIONS DATA:
Net revenues ....................................... $ 967 $ 7,158 $ 13,197 $ 36,301 $ 43,999
Cost of goods sold ................................. 167 478 6,826 13,120 26,706
--------- --------- --------- --------- ---------
Gross profit ....................................... 800 6,680 6,371 23,181 17,293
Operating expenses ................................. 2,069 3,197 8,853 21,787 29,653
--------- --------- --------- --------- ---------
Operating (income) loss ............................ (1,269) 3,483 (2,482) 1,394 (12,360)
Sale of subsidiary ................................. -- -- -- -- 28,813
Other income (expense) ............................. 4,348 2,445 (2,094) (82) (1,531)
--------- --------- --------- --------- ---------
Income (loss) before income taxes .................. 3,079 5,928 (4,576) 1,312 14,922
Provision (benefit) for income taxes ............... -- -- 154 -- (225)
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ 3,079 $ 5,928 $ (4,730) $ 1,312 $ 15,147
========= ========= ========= ========= =========
Cumulative dividend on participating preferred stock $ -- $ -- $ -- $ -- $ 133
Accretion of warrant ............................... -- -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) available to common stockholders . $ 3,079 $ 5,928 $ (4,730) $ 1,312 $ 15,014
========= ========= ========= ========= =========
Net income (loss) per common share:
Basic ......................................... $ 0.030 $ 0.063 $ (0.05) $ 0.01 $ 0.18
Diluted ....................................... $ 0.028 $ 0.063 $ (0.05) $ 0.01 $ 0.16
Shares used in calculating net income (loss) per
common share - basic ............................ 100,513 93,856 93,856 93,852 83,585
Shares used in calculating net income (loss) per
common share - diluted .......................... 102,603 93,856 93,856 104,314 96,070
SELECTED OPERATING DATA:
Net revenues by geographic region:
North America ................................. $ 203 $ 2,885 $ 1,544 $ 13,541 $ 26,184
International ................................. 632 4,056 9,934 6,484 5,674
OEM, royalty and licensing .................... 132 217 1,720 16,276 12,141
Net revenues by platform:
Personal computer ............................. $ 456 $ 631 $ 1,817 $ 7,671 $ 15,802
Video game console ............................ 379 971 9,660 12,354 16,056
OEM, royalty and licensing .................... 132 217 1,720 16,276 12,141
Recognition of Revenue from expired contracts . -- 4,571 -- -- --
Online licensing ..... -- 768 -- -- --
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- --------- --------- ---------
BALANCE SHEETS DATA: (Dollars in thousands)
Working capital (deficiency) ....................... $ (8,098) $ (11,497) $ (17,852) $ (14,750) $ (17,060)
Total assets ....................................... 323 673 834 5,486 14,298
Total debt ......................................... 1,572 1,549 1,575 837 2,082
Stockholders' equity (deficit) .................... (8,087) (11,490) (17,362) (12,636) (13,930)
19
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.
EXECUTIVE OVERVIEW AND SUMMARY
Interplay Entertainment Corp. is a publisher and licensor of interactive
entertainment software for both core gamers and the mass market. We are most
widely known for our titles in the action/arcade, adventure/role playing game
(RPG), and strategy/puzzle categories. We have produced and licensed titles for
many of the most popular interactive entertainment software platforms.
During 2006 we continued to operate under limited cash flow from
operations. We expect to operate under improved cash constraints during 2007.
Although we are now able to pay our current obligations as they come due,
we continue to face difficulties in paying off older liabilities, incurred
judgments and have pending litigation as a result of our continuing cash flow
difficulties.
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 or settlement
values. The Report of our Independent Auditors for the December 31, 2006
consolidated financial statements includes an explanatory paragraph expressing
substantial doubt about our ability to continue as a going concern.
We entered into various licensing agreements during 2006 under which we
licensed others to exploit games that we have intellectual property rights to.
We expect in 2007 to enter into similar license arrangements to generate cash
for the Company's operations.
Our products were either designed and created by our employees or by
external software developers. When we used external developers, we typically
advanced development funds to the developers in installment payments based upon
the completion of certain milestones. These advances were typically considered
advances against future royalties. We currently have no product in development
with external developers. We plan on creating additional products through
external developers but no assurance can be made that it will be successful.
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 new
console systems by Sony, Nintendo and Microsoft, our industry has entered into a
new cycle that could affect marketability of new products if any.
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.
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.
20
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. 104, Revenue Recognition.
Sales were formerly made by two distributors, Vivendi and Avalon, an
affiliate of our majority shareholder Titus Interactive S.A.until we ended our
relationship with them during 2005. 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 gold master. We recognize per copy royalties on sales that exceed the
guarantee as copies are duplicated.
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 as earned. guaranteed minimum royalties on sales, where
the guarantee is not recognized upon delivery, are recognized as the minimum
payments come due. The Company recognizes revenue on expired contracts when the
termination date of the contract is reached because guaranteed minimum royalties
are not reimbursable and are recorded as revenue.
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 products 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. The amount of reserves ultimately required could differ materially in the
near term from the amounts provided in the accompanying consolidated financial
statements.
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. We recognize revenue
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 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 amortized these amounts at a rate based upon the actual number of
units shipped with a minimum amortization of 75% in the first month of release
and a minimum of 5% for each of the next five months after release. This minimum
amortization rate reflects our typical product life cycle. Our management relies
on forecasted revenue to evaluate the future realization of prepaid royalties
and charges to cost of goods sold any amounts they deem unlikely to be fully
realized through future sales. Such costs are classified as current and non
current assets based upon estimated product release date. If actual revenue, or
revised sales forecasts, fall below the initial forecasted sales, the charge may
be larger than anticipated in any given quarter. Once the charge has been taken,
that amount will not be expensed in future quarters when the product has
shipped.
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 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.
21
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. Please
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.
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,
-------------------------------
2006 2005 2004
-------- -------- --------
STATEMENTS OF OPERATIONS DATA:
Net revenues ................................ 100 % 100 % 100 %
Cost of goods sold .......................... 17 7 52
-------- -------- --------
Gross margin ................................ 83 93 48
Operating expenses:
Marketing and sales .................... 52 4 13
General and administrative ............. 161 37 34
Product development .................... -- 4 20
Other .................................. --
-------- -------- --------
Total operating expenses ............... 213 45 67
-------- -------- --------
Operating income (loss) ..................... (130) 48 (19)
Other income (expense) ...................... 449 34 (16)
-------- -------- --------
Income (loss) before provision
for income taxes .......................... 319 82 (35)
Provision for income taxes .................. 1
-------- -------- --------
Net income (loss) ........................... 319 % 82 % (36)%
======== ======== ========
SELECTED OPERATING DATA:
Net revenues by segment:
North America .......................... 21 41 % 12 %
International .......................... 66 56 75
OEM, royalty and licensing ............. 13 3 13
-------- -------- --------
100 100 % 100 %
======== ======== ========
Net revenues by platform:
Personal computer ...................... 47 9 % 14 %
Video game console ..................... 39 14 73
OEM, royalty and licensing ............. 14 3 13
Recognition of revenue on
expired contracts ..................... N/A 63 N/A
Online licensing ........................ N/A 11 N/A
-------- -------- --------
100 % 100 % 100 %
======== ======== ========
Geographically, our net revenues for the years ended December 31, 2006 and
2005 breakdown as follows: (in thousands)
2006 2005 Change % Change
----------------------------------------- ------ ------ ------ --------
North America ........................... 203 2,885 (2,682) (92.9)%
----------------------------------------- ------ ------ ------ --------
International ........................... 632 4,056 (3,424) (84.4)%
----------------------------------------- ------ ------ ------ --------
OEM, Royalty & Licensing ................ 132 217 (85) (.4)%
----------------------------------------- ------ ------ ------ --------
Net Revenues ............................ 967 7,158 (6,191) (86.5)%
----------------------------------------- ------ ------ ------ --------
22
Geographically, our net revenues for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
North America ......................... 2,885 1,544 1,341 86.9%
--------------------------------------- ------ ------ ------ --------
International ......................... 4,056 9,934 (5,878) (59.2)%
--------------------------------------- ------ ------ ------ --------
OEM, Royalty & Licensing .............. 217 1,720 (1,503) (87.3)%
--------------------------------------- ------ ------ ------ --------
Net Revenues .......................... 7,158 13,197 (6,039) (45.7)%
--------------------------------------- ------ ------ ------ --------
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the year ended December 31, 2006 were $ 967,000, a
decrease of 86.5% compared to the same period in 2005. This decrease resulted
from a 92.9% decrease in North American net revenue, and a 84.4% decrease in
International net revenue, royalty and licensing revenues and a .4% decrease in
OEM net revenue.
Net revenues for the year ended December 31, 2005 were $7.1 million, a
decrease of 45.7% compared to the same period in 2004. This decrease resulted
from a 59.2% decrease in International net revenues and a 87.3% decrease in OEM,
royalties and licensing revenues, offset by a 86.9% increase in North American
net revenues.
North American net revenues for the year ended December 31, 2006 were
$203,000 as compared to $2.9 million for the year ended December 31, 2005. The
decrease in North American net revenues in 2006 was mainly due to no longer
recognizing as income advanced royalties on expired contracts and no new product
releases during the twelve months ended December 31, 2006.
North American net revenues for the year ended December 31, 2005 were $2.9
million as compared to $1.5 million for the year ended December 31, 2004. The
increase in North American net revenues in 2005 was mainly due to the
recognition of deferred revenue in the amount of $2.1 million on contracts
expiring and the balance attributable to licensing, royalties and catalog sales.
We expect that our North American publishing net revenues will increase in
2007 compared to 2006, mainly due to increased catalog sales.
International net revenues for the year ended December 31, 2006 were
$632,000, a decrease of $3.4 million as compared to International net revenues
for the year ended December 31, 2005. The decrease in International net revenues
compared to the year ended December 31, 2005 was mainly due to recognizing as
income advanced royalties on expired contracts and no new product releases
during the twelve months ended December 31, 2006
International net revenues for the year ended December 31, 2005 were $4.0
million, a decrease of $5.8 million as compared to International net revenues
for the year ended December 31, 2004. Included in the $4.0 million are $2.5
million of recognition of deferred revenues on contracts expiring. The decrease
in International net revenues compared to the year ended December 31, 2004 was
mainly due to releasing no new product during the twelve months ended December
31, 2005 compared to releasing BALDUR'S GATE DARK ALLIANCE II and FALLOUT:
BROTHERHOOD OF STEEL during 2004.
We expect that our International publishing net revenues will increase in
2007 as compared to 2006, mainly due to increased catalog sales.
OEM, royalty and licensing net revenues for the year ended December 31,
2006 were $132,000, a decrease of $85,000 as compared to the same period in
2005. The decrease in OEM business was mainly attributable to our
reorganization.
OEM, royalty and licensing net revenues for the year ended December 31,
2005 were $.2 million, a decrease of $1.5 million as compared to the same period
in 2004. The OEM business decreased $1.5 million as a consequence of our
reorganization.
PLATFORM, EXPIRED CONTRACTS AND LICENSING DEALS NET REVENUES
Our platform, expired contracts and licensing deals net revenues for the
years ended December 31, 2006 and 2005 breakdown as follows: (in thousands)
23
2006 2005 Change % Change
-------------------------------- ------ ------ ------ --------
Personal Computer .............. 456 631 (175) (27.7)%
-------------------------------- ------ ------ ------ --------
Video Game Console ............. 379 971 (592) (60.9)%
-------------------------------- ------ ------ ------ --------
OEM, Royalty & Licensing ....... 132 217 (85) (39.2)%
-------------------------------- ------ ------ ------ --------
Recognition of revenue on
expired contracts ............ -- 4,571 (4,571) (100.0)%
-------------------------------- ------ ------ ------ --------
Online Licensing ............... -- 768 (768) (100.0)%
-------------------------------- ------ ------ ------ --------
Net Revenues ................... 967 7,158 (6,191) (86.5)%
-------------------------------- ------ ------ ------ --------
PC net revenues for the year ended December 31, 2006 were $456,000, a
decrease of 27.7% compared to the same period in 2005. The decrease in PC net
revenues in 2006 was primarily due to no new releases and the expiration of our
distribution agreement with Vivendi ending in 2005. We expect our PC net
revenues to increase in 2007 as compared to 2006 as we continue to exploit our
back catalog.
Our video game console net revenues for the year ended December 31, 2006
were $379,000 a decrease of 60.9% compared to the same period in 2005. There was
no revenue recognition from deferred revenue of expired contracts for the year
ended December 31, 2006. Licensing for the year ended December 31, 2006 were $0.
The decrease in video game console net revenues was primarily due to no new
releases. Our catalog sales also decreased in 2006 as compared to 2005. Since we
anticipate releasing new console titles in 2007, we expect our video game
console net revenues to increase in 2007.
Our platform, expired contracts and licensing deals net revenues for the
years ended December 31, 2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
-------------------------------- ------ ------ ------ --------
Personal Computer .............. 631 1,817 (1,186) (65.3)%
-------------------------------- ------ ------ ------ --------
Video Game Console ............. 971 9,660 (8,689) (89.9)%
-------------------------------- ------ ------ ------ --------
OEM, Royalty & Licensing ....... 217 1,720 (1,503) (87.4)%
-------------------------------- ------ ------ ------ --------
Recognition of revenue on
expired contracts ............ 4,571 0 4,571 N/A
-------------------------------- ------ ------ ------ --------
Online Licensing ............... 768 0 768 N/A
-------------------------------- ------ ------ ------ --------
Net Revenues ................... 7,158 13,197 (6,039) (45.8)%
-------------------------------- ------ ------ ------ --------
PC net revenues for the year ended December 31, 2005 were $631,000, a
decrease of 65.3 % compared to the same period in 2004. The decrease in PC net
revenues in 2005 was primarily due to no new releases.
Our video game console net revenues for the year ended December 31, 2005
were $1 million a decrease of 89.9% compared to the same period in 2004. Revenue
recognition from deferred revenue of expired contracts for the year ended
December 31, 2005 were $4.6 million. Licensing for the year ended December 31,
2005 were $1 million. The decrease in video game console net revenues was
primarily due to no new releases. Our catalog sales also decreased in 2005 as
compared to 2004.
COST OF GOODS SOLD; GROSS MARGIN
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. 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.
24
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2006 and 2005 breakdown as follows: (in thousands)
2006 2005 Change % Change
--------------------------------------- ------ ------ ------ --------
Net Revenues .......................... 967 7,158 (6,191) (86.5)%
--------------------------------------- ------ ------ ------ --------
Cost of Goods Sold .................... 167 478 (311) (65.1)%
--------------------------------------- ------ ------ ------ --------
Gross Margin .......................... 800 6,680 (5,880) (88.0)%
--------------------------------------- ------ ------ ------ --------
Our cost of goods sold decreased to $167,000 in the year ended December 31,
2006 compared to $478,000 in the same period in 2005. We expect our cost of
goods sold to increase in 2007 as compared to 2006 because we anticipate new
product releases.
Our gross margin decreased to $800,000 for the twelve months ended December
31, 2006 from $6.7 million in the comparable period in 2005. The decrease in
gross margin was mainly attributable to our decrease in revenue.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
Net Revenues .......................... 7,158 13,197 (6,039) (45.8)%
--------------------------------------- ------ ------ ------ --------
Cost of Goods Sold .................... 478 6,826 (6,348) (93)%
--------------------------------------- ------ ------ ------ --------
Gross Margin .......................... 6,680 6,371 309 4.8%
--------------------------------------- ------ ------ ------ --------
Our cost of goods sold decreased 93% to $478,000 million in the year ended
December 31, 2005 compared to $6.8 million in the same period in 2004.
Our gross margin increased to 93.3% for the twelve months ended December
31, 2005 from 48.2% in the comparable period in 2004.
MARKETING AND SALES
Our marketing and sales expenses for the years ended December 31, 2006 and
2005 breakdown as follows: (in thousands)
2006 2005 Change % Change
------------------------------------------ ------ ------ ------ -------
Marketing and Sales ...................... 509 312 197 63.1%
------------------------------------------ ------ ------ ------ -------
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 twelve months ended December 31, 2006 were $509,000, a 63.1%
increase as compared to the 2005 period. The increase in marketing and sales
expenses is due to certain expenses being classified as marketing and sales in
2006 compared to the prior year classification into general and administration
and a continued effort to sell back catalog products. We expect our marketing
and sales expenses to increase in 2007 compared to 2006, as we expect to ship
new products.
Our marketing and sales expenses for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
Marketing and Sales ................... 312 1,703 (1,391) (81.7)%
--------------------------------------- ------ ------ ------ --------
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 twelve months ended December 31, 2005 were $312,000 million, a
81.7% decrease as compared to the 2004 period. The decrease in marketing and
sales expenses is due primarily to no new releases.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses for the years ended December 31,
2006 and 2005 breakdown as follows: (in thousands)
25
2006 2005 Change % Change
---------------------------------------- ------ ------ ------ --------
General and Administrative ............. 1,560 2,617 1,057 (40.4)%
---------------------------------------- ------ ------ ------ --------
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, 2006 were $1.6 million, a 40.4% decrease as compared to
the same period in 2005. The decrease is mainly due to decreases in personnel
costs and general expenses during 2006. The decrease in General and
administrative expenses is due to certain expenses being classified as marketing
and sales in 2006 compared to the prior year classification into general and
administration .
Our general and administrative expenses for the years ended December 31,
2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
General and Administrative ............ 2,617 4,514 (1,897) (42)%
--------------------------------------- ------ ------ ------ --------
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, 2005 were $2.6 million, a 42% decrease as compared to
the same period in 2004. The decrease is mainly due to decreases in personnel
costs and general expenses as a result of a reduction in administrative
personnel during 2005.
PRODUCT DEVELOPMENT
Our product development expenses for the years ended December 31, 2006 and
2005 breakdown as follows: (in thousands)
2006 2005 Change % Change
--------------------------------------- ------ ------ ------ --------
Product Development ................... 0 268 (268) (100)%
--------------------------------------- ------ ------ ------ --------
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, 2006 were $ 0, a 100%
decrease as compared to the same period in 2005. This decrease was due to us not
having any new product in development.
Our product development expenses for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
Product Development ................... 268 2,636 (2,368) (89.8)%
--------------------------------------- ------ ------ ------ --------
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, 2005 were $268,000, a 89.8%
decrease as compared to the same period in 2004. This decrease was mainly due to
a $2.4 million decrease in personnel costs and general expenses as a result of a
reduction in headcount and the closure of our internal development studio during
the year.
OTHER EXPENSE (INCOME), NET
Our other expense for the years ended December 31, 2006 and 2005 breakdown
as follows: (in thousands)
2006 2005 Change % Change
--------------------------------------- ------ ------ ------ --------
Other Expense (Income) ................ (4,348) (2,445) 1,903 78%
--------------------------------------- ------ ------ ------ --------
Other income consists primarily of settlement in the amount of
approximately $310,000, reversal of reserves in the amount of approximately $2.2
million, reduction of accrued royalties in the amount of $810,000, reversals of
accounts payable in the amount of $1.2 million, interest expense in the amount
of $135,000.and additional miscellaneous income.
26
Our other expense for the years ended December 31, 2005 and 2004 breakdown
as follows: (in thousands)
2005 2004 Change % Change
--------------------------------------- ------ ------ ------ --------
Other Expense (Income) ................ (2,445) 2,248 (4,693) 208%
--------------------------------------- ------ ------ ------ --------
Other income consists primarily of a settlement which was a reduction of
accrued royalties, accrued expenses and accounts payable in the amount of $1
million, an additional adjustment to accrued royalties in the amount of $1.6
million, an immaterial impairment of assets of $.3 million, recovery of bad debt
in the amount of $.06 million, an additional write down of Titus Software in the
amount of $.2 million, and immaterial foreign currency exchange transactions
gains and losses.
PROVISION (BENEFIT) FOR INCOME TAXES
We recorded no tax provision for the years ended December 31, 2006, 2005
and 2004.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2006, we had a working capital deficit of approximately
$8.1 million, and our cash balance was approximately $50,000. We currently have
no cash reserves and are only able to pay current liabilities. We cannot
continue in our current form without obtaining additional financing or income.
We have substantially reduced our operating expenses and have licensed two
of our Intellectual Properties, Earthworm Jim and Fallout to third parties. If
we do not receive sufficient financing or income we may (i) liquidate assets,
(ii) sell the company (iii) seek protection from our creditors including the
filing of voluntary bankruptcy or being the subject of involuntary bankruptcy,
and/or (iv) continue operations, but incur material harm to our business,
operations or financial conditions. These conditions, combined with our
historical operating losses and our deficits in stockholders' equity and working
capital, raise substantial doubt about our ability to continue as a going
concern.
Additionally, we have reduced our fixed overhead commitments, and cancelled
or suspended development on future titles and scaled back certain marketing
programs associated with the cancelled projects. Management will continue to
pursue various alternatives to improve future operating results.
We continue to seek external sources of funding, including but not limited
to, incurring debt, the sale of assets or stock, 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.
We have been operating without a credit facility since October 2001, which
has adversely affected cash flow. Although we are now able to pay our current
liabilities, we continue to face difficulties in paying our historical vendors,
and employees, and have pending lawsuits as a result of our continuing cash flow
difficulties. We expect these difficulties to improve during 2007.
Historically, we have funded our operations primarily through cash flow
from operations, including royalty and distribution fee advances.
Our primary capital needs have historically been working capital
requirements necessary to fund our operations. Our operating activities used
cash of $72,000 during the twelve months ended December 31, 2006, primarily
attributable to licensing and distribution net of expenditures.
The Company had $4.5 million in income from recognition of one time non
recurring events; however the Company does not expect material further non
recurring income in 2007.
We entered into various licensing agreements during 2006 under which we
licensed others to exploit games that we have intellectual property rights to.
We expect in 2007 to enter into similar license arrangements to generate cash
for the Company's operations.
Currently the Company has no internal development of new titles.
The Company is planning to exploit its Intellectual Property "Fallout" on
Massively Multiplayer Online Gaming (MMOG) and is reviewing the financial
avenues for funding MMOG.
27
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
deficits in stockholders' equity and working capital, raise substantial doubt
about our ability to continue as a going concern. The accompanying condensed
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. There can be
no guarantee that we will be able to meet all contractual obligations or
liabilities in the future, including payroll obligations.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements under which we have
obligations under a guaranteed contract that has any of the characteristics
identified in paragraph 3 of FASB Interpretation 3 of FASB Interpretation No. 45
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. We do not have any retained or
contingent interest in assets transferred to an unconsolidated entity or similar
arrangement that serves as credit, liquidity or market risk support to such
entity for such assets. We also do not have any obligation, including a
contingent obligation, under a contract that would be accounted for as a
derivative instrument. We have no obligations, including a contingent obligation
arising out of a variable interest (as referenced in FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (January 2003), as may be modified
or supplemented) in an unconsolidated entity that is held by, and material to,
the registrant, where such entity provides financing, liquidity, market risk or
credit risk support to, or engages in leasing, hedging or research and
development services with the registrant.
CONTRACTUAL OBLIGATIONS
The following table summarizes certain of our contractual obligations under
non-cancelable contracts and other commitments at December 31, 2006, and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods (in thousands).
LESS MORE
THAN 1 - 3 3 - 5 THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
----------------------------------- ------ ------ ------ ------ -------
Lease Commitments (1) ............. 162 121 41 0 0
----------------------------------- ------ ------ ------ ------ -------
(1) We have a lease commitment at the Beverly Hills office through April
2008. We also have a lease commitment at the French representation office
through February 28, 2008 with an option for an additional 6 years.
Our current cash reserves plus our expected cash from existing operations
will only be sufficient to fund our anticipated expenditures to March 31, 2008.
We will need to continue to consummate certain sales of assets and/or raise
additional financing to meet our contractual obligations.
ACTIVITIES WITH RELATED PARTIES
Our operations in prior years involved significant transactions with our
majority stockholder Titus and its affiliates. We had a major distribution
agreement with Avalon, an affiliate of Titus which is now cancelled.
TRANSACTIONS WITH TITUS AND AFFILIATES
Titus (placed in involuntary liquidation in January 2005) presently owns
approximately 58 million shares of our common stock.
As of December 31, 2006 and December 31, 2005, Titus and its affiliates
owed us $0 and $105,000, respectively. We owed Titus and its affiliates $0 and
$0 as of December 31, 2006 and December 31, 2005 respectively.
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. As of December 31, 2006 the Company had a balance
owed from Titus Japan of $ 226,000. During the twelve months ending December 31,
2006 our Japanese subsidiary incurred to Titus Japan costs of approximately
$106,000 in commissions, publishing and staff services. We closed our Japanese
subsidiary during the 4th quarter of 2006.
28
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES (FIN 48). FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS 109, ACCOUNTING FOR
INCOME TAXES. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 is effective for years
beginning after December 15, 2006. We will adopt FIN 48 as of December 30, 2006,
as required. Currently, we are not able to estimate the impact FIN 48 will have
on our financial statements.
In September 2006, the FASB issued SFAS 157, FAIR VALUE MEASUREMENTS, which
defines fair value, creates a framework for measuring fair value in generally
accepted accounting principles (GAAP), and expands disclosures about fair value
measurements. SFAS 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007. We will adopt SFAS 157 on its effective
date. The Company has not yet determined the effect, if any, that the
application of SFAS No. 157 will have on its consolidated financial statements.
In September 2006, the Securities and Exchange Commission ("SEC") issued
SAB No. 108, Topic 1-N, "Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements." SAB No.
108 requires companies to evaluate the materiality of current year misstatements
using both the rollover approach and the iron curtain approach. SAB No. 108 is
effective for statements covering the first fiscal year ending after November
15, 2006. The adoption of SAB No. 108 did not have a material impact on the
Company's consolidated financial position and results of operations.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of December 31,
2006. However, we are exposed to certain market risks arising from transactions
in the normal course of business, principally the risk associated with foreign
currency fluctuations. We do not hedge our risk associated with foreign currency
fluctuations.
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, which primarily have been from
Avalon.
We recognized a $3,000 loss, $10,000 loss and $33,000 loss during the years
ended December 31, 2006, 2005 and 2004, respectively, primarily in connection
with foreign exchange fluctuations in the timing of payments received on
accounts receivable from Avalon and other foreign distributors or licensees.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements begin on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information required by this Item 9 has been previously furnished and is
incorporated herein by reference to our forms 8-K filed on ( i) March 15,2005,
and amendment to such form 8-K filed on March 16, 2005, (ii) February 16, 2006
and amendment to such form 8-K filed on March 20, 2006
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and interim Chief Financial Officer of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
this evaluation, our Chief Executive Officer and interim
29
Chief Financial Officer concluded that our disclosure controls and procedures
were effective, at the reasonable assurance level, in ensuring that information
required to be disclosed is recorded, processed, summarized and reported within
the time periods specified by the SEC rules and forms and in timely alerting him
to material information required to be included in this report.
There were no changes made in our internal controls over financial
reporting that occurred during the quarter ended December 31, 2006 that have
materially affected or reasonably likely to materially affect these controls.
Our management, including the CEO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
necessarily prevent all fraud and material errors. An internal control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations on all internal
control systems, our internal control system can provide only reasonable
assurance of achieving its objectives and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within our Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, and/or by management override of the control. The design of any system
of internal control is also based in part upon certain assumptions about the
likelihood of future events, and can provide only reasonable, not absolute,
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Over time, controls may become inadequate because
of changes in circumstances, and/or the degree of compliance with the policies
and procedures may deteriorate.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information in Item10 is incorporated herein by reference to the
section entitled "Proposal One ---- Election of Directors" contained in the
Proxy Statement ( the "Proxy Statement") for the 2007 annual meeting of the
stockholders to be filed with the Securities and Exchange Commission within 120
days of the close of the fiscal year ended December 29, 2006.
ITEM 11. EXECUTIVE COMPENSATION
The information in Item 11 is incorporated herein by reference to the
section entitled "Proposal One ---- Election of Directors" contained in the
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information in Item12 is incorporated herein by reference to the
section entitled "General Information" ---- Security Ownership of Certain
Beneficial Owners and Management" and "Proposal One ---- Election of Directors"
contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in Item 13 is incorporated herein by reference to the
section entitled "Proposal One --- Election of Directors" contained in the Proxy
Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information in Item 14 is incorporated herein by reference to the
section entitled by reference to the section entitled "Proposal Two ---
Ratification of the Appointment of Independent Registered Public Accountant
Firm" contained in the Proxy Statement.
30
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents, except for exhibit 32.1 which is being furnished
herewith, 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.
31
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 Beverly Hills,
California this 9th day of April 2007.
INTERPLAY ENTERTAINMENT CORP.
By: /s/ Herve Caen
---------------------------------
Herve Caen
Its: Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
Exhibit 24.1
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, Interim April 9, 2007
Herve Caen Chief Financial Officer and
Director (Principal Executive
and Financial and Accounting
Officer)
/s/ Eric Caen
____________________ Director April 9, 2007
Eric Caen
/s/ Michel Welter
____________________ Director April 9, 2007
Michel Welter
32
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation of the Company;
(incorporated herein by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003).
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 the Company's
Annual Report on Form 10-K for the year ended December 31, 1999).
3.3 Certificate of Amendment of Certificate of Designation of Rights,
Preferences, Privileges and Restrictions of Series A Preferred Stock,
as filed with the Delaware Secretary of State on October 30, 2000;
(incorporated herein by reference to Exhibit 3.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003).
3.4 Certificate of Amendment of Amended and Restated Certificate of
Incorporation of the Company, as filed with the Delaware Secretary of
State on November 2, 2000; (incorporated herein by reference to Exhibit
3.4 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
3.5 Certificate of Amendment of Amended and Restated Certificate of
Incorporation of the Company, as filed with the Delaware Secretary of
State on January 21, 2004; (incorporated herein by reference to Exhibit
3.5 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
3.6 Amended and Restated Bylaws of the Company; (incorporated herein by
reference to Exhibit 3.6 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2003).
3.7 Amendment to the Amended and Restated Bylaws of the Company dated March
9, 2004; (incorporated herein by reference to Exhibit 3.7 to the
Company's Annual Report on Form 10-K for the year ended December 31,
2003).
4.1 Specimen form of stock certificate for Common Stock; (incorporated
herein by reference to Exhibit 4.1 to the Form S-1)
10.01 Third Amended and Restated 1997 Stock Incentive Plan (the "1997 Plan");
(incorporated herein by reference to Appendix A of the Definitive Proxy
Statement filed on August 20, 2002).
10.02 Form of Stock Option Agreement pertaining to the 1997 Plan.;
(incorporated herein by reference to exhibit 10.2 to the form S-1).
10.03 Form of Restricted Stock Purchase Agreement pertaining to the 1997
Plan; (incorporated herein by reference to Exhibit 10.3 to the Form
S-1).
10.05 Form of Indemnification Agreement for Officers and Directors of the
Company; (incorporated herein by reference to Exhibit 10.11 to the Form
S-1).
10.08 Stock Purchase Agreement between the Company and Titus Interactive SA,
dated March 18, 1999; (incorporated herein by reference to Exhibit
10.24 to The Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.12 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 the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999).
10.13 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 the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999).
33
10.14 Employment Agreement between the Company and Herve Caen dated November
9, 1999; (incorporated herein by reference to Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1999).
10.22 Agreement between the Company, 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).
10.34 Term Sheet by and between Titus Interactive S.A., and the Company,
dated April 26, 2002; (incorporated herein by reference to Exhibit 10.8
to Form 10-Q filed on May 15, 2002).
10.35 Promissory Note by Titus Interactive S.A. in favor of the Company,
dated April 26, 2002; (incorporated herein by reference to Exhibit 10.9
to Form 10-Q filed on May 15, 2002).
10.36 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).
10.47 Mutual Release Settlement Agreement by and between Warner Bros.
Entertainment, Inc. and the Company, dated October 13, 2003. ;
(incorporated herein by reference to exhibit 10.47 to the Company's
Annual Report on form 10-K for the year ended December 31, 2003 filed
on April 27, 2004).
10.48 Letter Agreement by and between Majorem Ltd and the Company, dated
December 21, 2004. ; (Incorporated herein by reference to exhibit 10.48
to the Company's Annual Report on form 10-K for the year ended December
31, 2004 filed on June 3, 2005).
14.1 Code of Ethics of the Company; (incorporated herein by reference to
Exhibit 14.1 to Amendment No. 1 to the Company's Annual Report on Form
10-K for the year ended December 31, 2003 filed on April 27, 2004).
21.1 Subsidiaries of the Company.
23.1 Consent of Jeffrey S. Gilbert, Independent Registered Public Accounting
firm
23.2 Consent of Rose, Snyder & Jacobs, Independent Registered Public
Accounting Firm.
24.1 Power of Attorney (included on signature page to this Form 10-K)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1 Certification of 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.
34
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORTS OF INDEPENDENT AUDITORS
PAGE
------
Reports of Independent Registered Public Accounting Firms F-2
Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2006 and 2005 F-4
Consolidated Statements of Operations for the years ended
December 31, 2006, 2005 and 2004 F-5
Consolidated Statements of Stockholder's Equity (Deficit)
for the years ended December 31, 2006, 2005, 2004 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005 and 2004 F-7
Notes to Consolidated Financial Statements F-9
Schedule II - Valuation and Qualifying Accounts S-1
35
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Interplay Entertainment Corp.
I have audited the consolidated balance sheets of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive,S.A.) and
Subsidiaries (the "Company") as of December 31, 2006 and 2005 and the related
consolidated statements of operations, stockholders' equity (deficit) and
comprehensive income(loss)and cash flows for the years then ended. My audit
included the schedule of valuation and qualifying accounts for the years ended
December 31, 2006 and 2005. These consolidated financial statements are the
responsibility of the Company's management. My responsibility is to express an
opinion on these consolidated financial statements and the schedule based on my
audit.
I conducted my audit in accordance with standards Of the Public
Company Accounting Oversight Board (United States). Those standards require that
I plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, I express no
such opinion. An audit also 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 financial
statement presentation. I believe my audit provides a reasonable basis for my
opinion.
In my opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Interplay Entertainment Corp. and Subsidiaries as of December 31,
2006 and 2005 and the results of their operations and their cash flows for the
two years then ended, in conformity with accounting principles generally
accepted in the United States of America. Also, in my opinion the related
financial statement schedule for the years ended December 31, 2006 and 2005,
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 consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 1 to
the consolidated financial statements, the Company has limited liquid resources,
a history of losses, negative working capital of $8,098,000, and stockholders'
deficit of $8,087,000. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also discussed in Note 1. In addition, on November 1, 2006 an
involuntary petition under Chapter 7 of the Bankruptcy Code was filed in Federal
Court by several of the Company's creditors (See Note 15). The consolidated
financial statements do not include any adjustment that might result from the
outcomes of these uncertainties.
/S/ JEFFREY S. GILBERT
Los Angeles, California
April 6, 2007
36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the consolidated statement of operations, shareholders'
equity (deficit) and other comprehensive income (loss) and cash flows for the
year ended December 31, 2004 of Interplay Entertainment Corp. (a majority-owned
subsidiary of Titus Interactive S.A.) and subsidiaries (the "Company"). Our
audit also included the schedule of valuation and qualifying accounts for the
year ended December 31, 2004. 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.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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 results of operations and cash
flows of Interplay Entertainment Corp. for the year ended December 31, 2004 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, 2004, 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 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 $17.8 million and a stockholders'
deficit of $17.3 million at December 31, 2004. 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/ Rose, Snyder & Jacobs
-----------------------------------
Rose, Snyder & Jacobs
A Corporation of Public Accountants
Encino, California
May 31, 2005
37
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
ASSETS 2006 2005
------------- -------------
Current Assets:
Cash ............................................................ $ 50,000 $ 122,000
Trade receivables from related parties, net of allowances
of $0 and $2,114,000, respectively .......................... 0 17,000
Trade receivables, net of allowances
of $17,000 and $76,000, respectively ........................ 227,000 428,000
Inventories ..................................................... 8,000 8,000
Deposits ........................................................ 4,000 8,000
Prepaid expenses ................................................ 6,000 60,000
Other receivables ................................................ 17,000 8,000
------------- -------------
Total current assets ......................................... 312,000 651,000
Property and equipment, net .......................................... 3,000 7,000
Other assets ......................................................... 8,000 15,000
------------- -------------
Total assets ............................... $ 323,000 $ 673,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Notes payable ................................................... $ 1,427,000 $ 1,406,000
Accounts payable subject to judgments ........................... 1,653,000 1,653,000
Accounts payable - other ........................................ 4,006,000 8,050,000
Accrued royalties ............................................... 170,000 949,000
Deferred income ................................................. 460,000 105,000
Notes payable officer and directors ............................. 694,000 0
------------- -------------
Total current liabilities .................................. 8,410,000 12,163,000
------------- -------------
Commitments and contingencies
Stockholders' Equity (Deficit):
Preferred stock, $0.001 par value 5,000,000 shares authorized;
no shares issued or outstanding, respectively,
Common stock, $0.001 par value 150,000,000 shares authorized;
issued and outstanding 103,855,634 shares in 2006 and
93,855,634 shares in 2005 .................................... 104,000 94,000
Paid-in capital ................................................. 121,964,000 121,640,000
Accumulated deficit ............................................. (130,205,000) (133,284,000)
Accumulated other comprehensive income .......................... 50,000 60,000
Treasury stock of 4,658,216 shares at December 31,2006 and 2005 . 0 0
------------- -------------
Total stockholders' (deficit) ............................. (8,087,000) (11,490,000)
------------- -------------
Total liabilities and stockholders'(deficit) $ 323,000 $ 673,000
============= =============
See accompanying notes.
38
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2006 2005 2004
------------- ------------- -------------
Net revenue from recognition on expired contracts .......... $ -- $ 4,571,000 $ --
Net revenues from licensing ................................ -- 768,000 1,932,000
Net revenues from related and non related party distributors 967,000 1,819,000 11,265,000
------------- ------------- -------------
Total net revenues ...................................... 967,000 7,158,000 13,197,000
Cost of goods sold ......................................... 167,000 478,000 6,826,000
------------- ------------- -------------
Gross profit ............................................ 800,000 6,680,000 6,371,000
------------- ------------- -------------
Operating expenses:
Marketing and sales ..................................... 509,000 312,000 1,703,000
General and administrative .............................. 1,560,000 2,617,000 4,514,000
Product development ..................................... 0 268,000 2,636,000
------------- ------------- -------------
Total operating expenses ............................. 2,069,000 3,197,000 8,853,000
------------- ------------- -------------
Operating income (loss) .............................. (1,269,000) 3,483,000 (2,482,000)
------------- ------------- -------------
Other income (expense):
Interest expense ........................................ (139,000) (146,000) (249,000)
Other (primarily reversal of prior year recorded
liabilities and settlements in 2006 and 2005) ........ 4,487,000 2,591,000 (1,999,000)
------------- ------------- -------------
Total other income (expense) ........................ 4,348,000 2,445,000 (2,248,000)
------------- ------------- -------------
Income (loss) before provision (benefit) for
income taxes ............................................ 3,079,000 5,928,000 (4,730,000)
Provision (benefit) for income taxes ....................... -- -- --
------------- ------------- -------------
Net income (loss) .......................................... $ 3,079,000 $ 5,928,000 $ (4,730,000)
============= ============= =============
Net income (loss) per common share:
Basic ...................................................... $ 0.030 $ 0.06 $ (0.05)
============= ============= =============
Diluted .................................................... $ 0.028 $ 0.06 $ (0.05)
============= ============= =============
Weighted average number of shares used in
calculating net income (loss) per
common share:
Basic ...................................................... 100,513,000 93,856,000 93,856,000
============= ============= =============
Diluted .................................................... 102,603,000 93,856,000 93,856,000
============= ============= =============
39
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPRESENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(DOLLARS IN THOUSANDS)
PREFERRED STOCK COMMON STOCK
------------------------- ------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2003 ... -- -- 93,855,634 $ 94 $ 121,640
Issuance of common stock,
net of issuance costs . -- -- -- -- --
Net Income ................ -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2004 ... -- -- 93,855,634 94 121,640
----------- ----------- ----------- ----------- -----------
Issuance of common stock,
net of issuance costs . -- -- -- -- --
Net Income ................ -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2005 ... -- -- 93,855,634 94 121,640
----------- ----------- ----------- ----------- -----------
Issuance of common stock,
net of issuance costs . -- -- -- -- --
Additional Paid in Capital
- Options ............. -- -- -- -- 38
Shares for Debt - Special
Situation ............. -- -- 10,000,000 10 286
Treasury stock
Net Income ................ -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance, December 31,2006 .... -- -- 103,855,634 $ 104 $ 121,964
=========== =========== =========== =========== ===========
ACCUMULATED
OTHER
ACCUMULATED COMPREHENSIVE
DEFICIT INCOME (LOSS) TOTAL
----------- ----------- -----------
Balance, December 31, 2003 ... $ (134,481) $ 111 $ (12,636)
Issuance of common stock,
net of issuance costs . -- -- --
Net Income ................ (4,730) -- (4,730)
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment -- 4 4
----------- ----------- -----------
Balance, December 31, 2004 ... (139,211) 115 (17,362)
----------- ----------- -----------
Issuance of common stock,
net of issuance costs . -- -- --
Net Income ................ 5,928 -- 5,928
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment -- (56) (56)
----------- ----------- -----------
Balance, December 31, 2005 ... (133,283) (59) (11,490)
----------- ----------- -----------
Issuance of common stock,
net of issuance costs . -- -- --
Additional Paid in Capital
- Options ............. -- -- 38
Shares for Debt - Special
Situation ............. -- -- 296
Treasury stock
Net Income ................ 3,079 -- 3,079
Other comprehensive income,
net of income taxes:
Foreign currency
translation adjustment (1) (9) (10)
----------- ----------- -----------
Balance, December 31,2006 .... $ (130,205) $ 50 $ (8,087)
=========== =========== ===========
See accompanying notes.
40
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------
2006 2005 2004
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss) .................................. $ 3,079,000 $ 5,928,000 $(4,730,000)
Adjustments to reconcile net income (loss) to
cash provided by (used in) operating activities--
Depreciation and amortization ................... 4,000 142,000 734,000
Deposit ......................................... 4,000 (8,000) 600,000
Additional Paid in Capital - Options expenses ... 38,000 -- --
Shares issued for settlement of liability ...... 296,000 -- --
Reversal of prior year recorded liabilities ..... (4,441,000) (2,345,000) --
Writeoff of prepaid licenses and royalties ...... -- -- 209,000
Abandonement of fixed assets .................... -- 323,000 --
Changes in assets and liabilities:
Restricted cash .............................. -- 2,000 --
Trade receivables, net ....................... 201,000 (297,000) (133,000)
Trade receivables from related parties ....... 17,000 (6,000) 554,000
Inventories .................................. -- 18,000 120,000
Prepaid licenses and royalties ............... -- -- --
Prepaid expenses ............................. 54,000 (60,000) 673,000
Loss on sale of assets ....................... -- -- 28,000
Loss on abandonment of assets ................ -- -- 862,000
Other current assets/receivables ............. (9,000) 129,000 (134,000)
Accounts payable ............................. (367,000) 885,000 1,704,000
Accrued royalties ............................ (7,000) (329,000) (1,566,000)
Note Payable Officers ........................ 694,000 -- --
Payables to related parties .................. -- (3,870,000) --
Advances - Vivendi ........................... -- -- 996,000
Deferred revenue - ( Non related Party) ...... 355,000 (475,000) 1,385,000
Deferred Income .............................. -- -- (1,923,000)
Accumulated other comprehensive income ....... 10,000 56,000 4,000
----------- ----------- -----------
Net cash provided by (used in) operating
activities ............................ (72,000) 93,000 (617,000)
----------- ----------- -----------
Cash flows from investing activities:
Purchases of property and equipment ................ -- -- --
----------- ----------- -----------
Net cash (used in) investing activities ... -- -- --
----------- ----------- -----------
Cash flows from financing activities:
Repayment of debt .................................. -- -- 61,000
Proceeds from debt ................................. -- -- (586,000)
----------- ----------- -----------
Net cash used in financing activities
-- -- (525,000)
----------- ----------- -----------
Effect of exchange rate changes on cash
----------- ----------- -----------
Cash, beginning of year ............................... 122,000 29,000 1,171,000
----------- ----------- -----------
Cash, end of year ..................................... $ 50,000 $ 122,000 $ 29,000
=========== =========== ===========
Supplemental cash flow information:
Cash paid during the year for interest ............ -- -- --
=========== =========== ===========
See accompanying notes.
41
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Interplay Entertainment Corp., a Delaware corporation, and its subsidiaries
(the "Company"), publish and license out 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 3, Microsoft Xbox360 and Nintendo Wii. As of December
31, 2006, Titus Interactive, S.A. ("Titus") which is in bankruptcy in France,
and was a France-based developer, publisher and distributor of interactive
entertainment software, owns approximately 56% of the Company's common stock.
The Company's common stock is quoted on the NASDAQ OTC Bulletin Board under the
symbol "IPLY", or while non-compliant "IPLYE".
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 had net income of $4.5 million in 2006,
primarily derived from one time non recurring non cash events which occurred in
2006. At December 31, 2006, the Company had a stockholders' deficit of $8.1
million and a working capital deficit of $8.1 million. The Company has
historically funded its operations from licensing fees, royalty and distribution
fee advances, and will continue to exploit its existing intellectual properties
to provide future funding.
To reduce working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments and cancellation or suspension of development on future titles.
Management will continue to pursue various alternatives to improve future
operating results and further expense reductions, some of which may have a
long-term adverse impact on the Company's ability to generate successful future
business activities.
In addition, the Company continues to seek, external sources of funding
including, but not limited to, a sale or merger of the Company, a private
placement or public offering of the Company's capital stock, the sale of
selected assets, the licensing of certain product rights in selected
territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
the Company's long-term strategic objectives. Although the Company has had some
success in licensing certain of its products in the past, no assurance can be
given that the Company will do so in the future.
The Company anticipates its current cash reserves, plus its expected
generation of cash from existing operations, will only be sufficient to fund its
anticipated expenditures through the end of first quarter of fiscal 2008.
Consequently, the Company expects that it will need to obtain additional
financing or income. However, no assurance can be given that alternative sources
of funding can be obtained on acceptable terms, or at all. These conditions,
combined with the Company's historical operating losses and its deficits in
stockholders' equity and working capital, raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets and
liabilities that 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 Co., Ltd., (Japan)
which was closed during the 4th quarter 2006 and Games On-line. All significant
inter-company accounts and transactions have been eliminated.
42
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates made in
preparing the consolidated financial statements include, among others, sales
returns and allowances, allowances for uncollectible receivables, 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. Actual results could differ from those estimates.
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.
INVENTORIES
Inventories consist of 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. Based on management's evaluation, the Company has not
established any valuation allowance at December 31, 2006 .
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.
PREPAID LICENSES AND ROYALTIES
The Company has in the past had prepaid licenses and royalties consisting
of fees paid to intellectual property rights holders for use of their trademarks
or copyrights. Also included in prepaid royalties were prepayments made to
independent software developers under development arrangements that have
alternative future uses. These payments were contingent upon the successful
completion of milestones, which generally represent specific deliverables.
Royalty advances were recoupable against future sales based upon the contractual
royalty rate. The Company amortized these costs 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 amortized these amounts at a rate based upon the actual number of units
shipped with a minimum amortization of 75% in the first month of release and a
minimum of 5% for each of the next five months after release. This minimum
amortization rate reflected 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 were classified as current and noncurrent
assets based upon estimated product release dates. There were no prepaid
licenses and royalties at December 31, 2006.
SOFTWARE DEVELOPMENT COSTS
Research and development costs, which consisted primarily of software
development costs, are expensed as incurred. Financial accounting Standards
Board ("FASB") 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 since 2003
on internal development projects, as the eligible costs were determined to be
insignificant.
43
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 period of five to seven years. 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 statements of
operations.
LONG-LIVED ASSETS
The Company reviews long-lived assets 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
estimated fair value, based on various models, including projected future
undiscounted net cash flows from such asset (excluding interest) and replacement
value, an impairment loss is recognized. Impairment losses are calculated as the
difference between the cost basis of an asset and its estimated fair value.
Management determined in 2005 that impairment existed related to specific items
of property and equipment and adjusted these assets to zero.. 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 additional
impairment of other long-lived assets in the future.
GOODWILL AND INTANGIBLE ASSETS
Goodwill and identifiable intangible assets that have indefinite useful
lives are 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. At December 31, 2006 and 2005, the Company
had no goodwill or intangible assets subject to amortization.
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. 104, Revenue Recognition.
With the signing of the new Vivendi Universal Games, Inc. distribution agreement
in August 2002, substantially all of the Company's sales were made by two
related party distributors (Notes 5 and 11 ), Vivendi Universal Games,Inc.
(Vivendi), which owned less than 5% of the outstanding shares of the Company's
common stock at that time, and Avalon Interactive Group Ltd. ("Avalon"),
formerly Virgin Interactive Entertainment Limited, a wholly owned subsidiary of
Titus until the Company ended its relationship with them during 2005, a
significant part of the Vivendi distribution agreement ended in August, 2005,
and Avalon, because of bankruptcy, ceased to be the distributor in February
2005.
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 gold 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.
44
The Company recognizes revenue on expired contracts when the termination date of
the contract is reached because guaranteed minimum royalties are not
reimbursable and is therefore, recorded as revenue.
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 basis, the Company may permit
customers to return or exchange product and may provide markdown allowances on
products unsold by a customer. Revenue is recorded net of an allowance for
estimated returns, exchanges, markdowns, price concessions and warranty costs.
Such allowances are based upon management's evaluation of historical experience,
current industry trends and estimated costs. Management of the Company estimated
that no allowances were necessary at December 31, 2006 and 2005. The amount of
allowances ultimately required could differ materially in the near term from the
amounts included in the accompanying consolidated financial statements.
Customer support provided by the Company is limited to 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 Company has entered into various licensing
agreements during 2006 under which it licensed others to exploit games to which
the Company had intellectual property rights.
REVERSAL OF CERTAIN PRIOR YEAR ACCRUALS AND ACCOUNTS PAYABLE
During the year ended December 31, 2006 and 2005 the Company has reversed
certain accruals and accounts payables of approximately $4.5 million and $2.6
million respectively. It is the Company's policy to reverse outstanding accruals
and accounts payables that have been outstanding for over 3 years and no effort
has been made by the vendor or claimant for that period of time to collect the
outstanding balances.
ADVANCES FROM DISTRIBUTORS
Deferred income is recognized when contracts with distributors expire or
are terminated.
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 $509,000, $312,000 and $1.2 million for the years ended December
31, 2006, 2005 and 2004, 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
has been provided for all deferred tax assets equal to the amounts of these
assets.
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
45
comprehensive loss. Gains and Losses resulting from foreign currency
transactions amounted to a $3,000 loss, $10,000 loss and $33,000 loss during the
years ended December 31, 2006, 2005 and 2004, respectively, and is 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 if any. For
the years ended December 31, 2005 and 2004, all options and warrants outstanding
to purchase common stock were excluded from the earnings per share computation
as the exercise price was greater than the average market price of the common
shares. For the year ended December 31, 2006 certain warrants and options were
dilutive and were included in diluted net income per share.
The Company discloses information regarding segments in accordance with
SFAS No. 131 DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.
SFAS No. 131 establishes standards for reporting of financial information about
operating segments in annual financial statements and requires reporting
selected information about operating segments in interim financial reports. The
Company is managed, and financial information is developed, on a geographical
basis, rather than a product line basis. Thus, the Company has provided segment
information on a geographical basis (see Note 13).
Allowance for Doubtful Accounts
Management establishes an allowance for doubtful accounts based on
qualitative and quantitative review of credit profiles of the Company's
customers, contractual terms and conditions, current economic trends and
historical payment, return and discount experience. Management reassesses the
allowance for doubtful accounts each period. If management made different
judgments or utilized different estimates for any period, material differences
in the amount and timing of revenue recognized could result. Accounts receivable
are written off when all collection attempts have failed.
Cost of Software Revenue
Cost of software revenue primarily reflects the manufacture expense and
royalties to third party developers, which are recognized upon delivery of the
product. Cost of support includes (i) sales commissions and salaries paid to
employees who provide support to clients and (ii) fees paid to consultants,
which are recognized as the services are performed. Sales commissions are
expensed as incurred.
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
Effective January 1, 2006 the Company adopted SFAS No. 123(R),
"SHARE-BASED PAYMENT" ("SFAS 123R"), which requires the measurement and
recognition of compensation cost at fair value for all share-based payments,
including stock options and restricted stock awards. The Company adopted SFAS
123R using the modified prospective transition method and, as a result, did not
retroactively adjust results from prior periods. Under this transition method,
stock-based compensation is recognized for: (1) expense related to the remaining
non-vested portion of all stock awards granted prior to January 1, 2006 based on
the grant date fair value estimated in accordance with the original provisions
of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123") and the
same straight-line attribution method used to determine the pro forma
disclosures under SFAS 123; and (2) expense related to all stock awards granted
on or subsequent to January 1, 2006, based on the grant date fair value
estimated in accordance with the provisions of SFAS 123R.
46
At December 31, 2006, the Company has one stock-based employee compensation
plan, which is described more fully in Note 10. Stock-based employee
compensation cost approximated $40,000, $0; $0 was reflected in net income for
the years ended December 31, 2006, 2005 and 2004, respectively. Stock-based
employee compensation:
YEARS ENDED DECEMBER 31,
-----------------------------------
2006 2005 2004
---------- ---------- ----------
(Dollars in thousands,
except per share amounts)
Net income (loss) available to common stockholders, as reported $ 3,079 $ 5,928 $ (4,730)
Pro forma estimated fair value compensation expense ........... -- -- --
---------- ---------- ----------
Pro forma net income (loss) available to common stockholders .. $ 3,079 $ 5,928 $ (4,730)
========== ========== ==========
Basic net income (loss) per common share as reported .......... $ .030 $ 0.06 $ (0.05)
Diluted net income (loss) per common share as reported ........ $ .028 $ 0.06 $ (0.05)
Basic pro forma net income (loss) per common share ............ $ .030 $ 0.06 $ (0.05)
Diluted pro forma net income (loss) per common share .......... $ .028 $ 0.06 $ (0.05)
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES (FIN 48). FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with SFAS 109, ACCOUNTING FOR
INCOME TAXES. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 is effective for years
beginning after December 15, 2006. We will adopt FIN 48 as of December 30, 2006,
as required. Currently, we are not able to estimate the impact FIN 48 will have
on our financial statements.
In September 2006, the FASB issued SFAS 157, FAIR VALUE MEASUREMENTS ,
which defines fair value, creates a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007. We will adopt SFAS 157 on
its effective date. The Company has not yet determined the effect, if any, that
the application of SFAS No. 157 will have on its consolidated financial
statements.
In September 2006, the Securities and Exchange Commission ("SEC") issued
SAB No. 108, Topic 1-N, "Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements." SAB No.
108 requires companies to evaluate the materiality of current year misstatements
using both the rollover approach and the iron curtain approach.. The adoption of
SAB No. 108 did not have a material impact on the Company's consolidated
financial position and results of operations.
3. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
------------------
2006 2005
------ ------
(Dollars in
thousands)
Computers and equipment ................................ $ 14 $ 14
Furniture and fixtures ................................. 8 8
Leasehold improvements ................................. -- --
------ ------
22 22
Less: Accumulated depreciation
and amortization .................................... (19) (15)
------ ------
Net Equipment ........................... $ 3 $ 7
====== ======
47
For the years ended December 31, 2006, 2005 and 2004, the Company incurred
depreciation and amortization expense of $4,000, $100,000 and $800,000,
respectively. During the years ended December 31, 2006, 2005 and 2004, the
Company disposed of fully depreciated equipment having an original cost of $0,
$1.4 and $4.7 million, respectively.
4. PROMISSORY NOTES
The Company issued to Warner Brothers Entertainment, Inc. ("Warner") a
Secured Convertible Promissory Note bearing interest at 6% per annum, due April
30, 2003, in the principal amount of $2.0 million in connection with the sale of
a subsidiary in 2002. The note was issued in partial payment of amounts due
Warner under the parties' license agreement for the video game based on the
motion picture, THE MATRIX. 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
exercises its conversion option. At December 31, 2005, the balance owed to
Warner, including accrued interest, is $360,000. On or about October 9, 2003,
Warner filed suit against the Company in the Superior Court for the State of
California, County of Orange, alleging default on an Amended and Restated
Secured Convertible Promissory Note held by Warner dated April 30, 2002, with an
original principal sum of $2.0 million. At the time the suit was filed, the
current remaining principal sum due under the note was $1.4 million in principal
and interest. The Company entered into a settlement agreement on this litigation
and entered into a payment plan with Warner to satisfy the balance of the note
by January 30, 2004. The Company is currently in default of the settlement
agreement with Warner and has entered into a payment plan, under which the
Company is in default, for the remaining balance of $383,000 as of December 31,
2006 .
The Company issued to Atari Interactive, Inc. ("Atari") a Promissory Note
bearing no interest, due December 31, 2006, in the principal amount of $2.0
million in connection with Atari entering into tri-party agreements with the
Company and its then main distributors, Vivendi and Avalon. On March 28, 2007
both parties agreed to extend the option period of the promissory note until
March 31, 2008. The note was issued in payment of all outstanding accrued
royalties due Atari under the Dungeons & Dragons license agreement which license
was terminated by Atari on April 23, 2004. At December 31, 2006, the balance
owed to Atari, is $1.0 million as a result of payments made by Vivendi and
Avalon on the Company's behalf to Atari.
Included in accounts payable not subject to judgments is a $140,000 advance
from the former President of Interplay Japan which has been closed.
5. ADVANCES FROM DISTRIBUTORS, RELATED PARTIES AND OTHERS
Advances from distributors consist of the following:
DECEMBER 31,
-----------------------
2006 2005
-------- --------
(Dollars in thousands)
Advances for other distribution rights ........... $460,000 $ 0
======== ========
48
6. INCOME TAXES
Income (loss) before provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
-------------------------------------------------
2006 2005 2004
----------- ----------- -----------
Domestic .............. $ 3,624,000 $ 6,554,000 $(4,574,000)
Foreign ............... (550,000) (626,000) (3,000)
----------- ----------- -----------
Total ................. $ 3,079,000 $ 5,928,000 $(4,577,000)
=========== =========== ===========
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
--------------------------------------
2006 2005 2004
-------- -------- --------
(Dollars in thousands)
Current:
Federal .................... $ -- $ -- $ --
State ...................... -- -- --
Foreign .................... -- -- --
-------- -------- --------
Deferred:
Federal .................... -- -- --
State ...................... -- -- --
-------- -------- --------
$ -- $ -- $ --
======== ======== =========
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 $125 million and expires through the year 2023.
The Company's NOL for California State tax reporting purposes approximate $64
million and expires through the year 2013. The utilization of the federal and
state net operating losses may be limited by Internal Revenue Code.
A reconciliation of the statutory Federal income tax rate and the effective
tax rate as a percentage of pretax loss is as follows:
2006 2005 2004
--------- --------- ----------
Statutory Federal income tax rate ... 34.0% 34.0% 34.0%
State income tax effect, net of
federal benefits .................. 5.8 5.8 --
Valuation allowance ............... (39.8) (39.5) (39.5)
Tax rate differentiation of
foreign earnings .............. -- -- --
Other ................................ -- -- --
--------- --------- ----------
-- % -- % -- %
========= ========= ==========
49
The components of the Company's net deferred income tax asset (liability)
are as follows:
DECEMBER 31,
----------------------
2006 2005
-------- --------
(Dollars in thousands)
Current deferred tax asset (liability):
Prepaid royalties ............................. $ 183 $ --
Nondeductible reserves ........................ -- 872
Accrued expenses .............................. 31 --
Foreign loss and credit carryforward .......... 2,954 2,766
Federal and state net operating losses ........ 50,609 49,766
Other ......................................... -- --
-------- --------
53,777 53,404
-------- --------
Non-current deferred tax asset (liability):
Depreciation expense .......................... -- --
Nondeductible reserves ........................ -- --
-------- --------
-- --
-------- --------
Net deferred tax asset before
valuation allowance ........................... 53,777 53,404
Valuation allowance ................................ (53,777) (53,404)
-------- --------
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 increased
$373,000 during the year ending December 31, 2006 and increased $2.1 million
during the year ending December 31, 2005.
7. COMMITMENTS AND CONTINGENCIES
LEASES
The Company's headquarters are located in Beverly Hills, California. The
facility is leased through April 2008. The Company is currently subleasing on a
short-term basis a portion of the office space to an independent third party.
The Company closed the satellite office in Irvine, California in May 2006. The
Company also has a lease commitment at the French representation office through
February 28, 2008 with an option for an additional 6 years.
The minimum annual net rentals for 2007 and 2008 are $121,000 and $41,000,
respectively.
Total net rent expense was $ 77,000 net, $40,000 and $400,000 for the years
ended December 31, 2006, 2005 and 2004, 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.
50
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the Company for various claims related to a
breach of a distributorship agreement. Synnex obtained a $172,000 judgment
against the Company.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against us in the Superior Court for the State of California, County
of Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal including
interest. We owe a remaining balance of approximately $383,000 payable in one
remaining installment. The Company is currently in default of the settlement
agreement.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $432,000. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has been in default of the forbearance agreement. On or about
November 1, 2006, Arden filed an involuntary bankruptcy petition against the
Company. The petition is pending before the bankruptcy court and the Company is
opposing it. (See Note 15)
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,000 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000 additional interest has accrued in the amount
of $26,548; the total outstanding balance at December 31, 2006 is $126,548. If
Monte Cristo executes the judgment, it will negatively affect the Company's cash
flow, which could further restrict the Company's operations and cause material
harm to our business.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company for failure to pay development fees in the Orange County Superior Court
that was settled in July 2004. The Company was unable to make the payments and
Reflexive sought and obtained judgment against the company for approximately
$110,000. On or about November 1, 2006, Reflexive joined Arden in the filing of
an involuntary bankruptcy petition against the Company. The petition is pending
before the bankruptcy court and the Company is opposing it. (See Note 15)
51
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for failure to pay royalties. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further the settlement was entered into with Interplay OEM only in the
amount of $170,000, however KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment was not made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $110,000 pursuant to section 166 and section 186 of the
Internal Revenue Code in payroll tax penalties, and interest for late filing and
late payment of payroll taxes. Approximately $110,000 has been accrued as of
December 31, 2005 but remains unpaid. The Company received notice from the
Employment Development Department (EDD) that it owes approximately $103,000 in
payroll taxes, interest and penalties owed for the periods ending 2003, 2004 and
2005 which has been accrued for December 31, 2006. The Company is in the process
of establishing a payment plan with the Employment Development Department.
The Company was unable to meet certain 2004 payroll obligations to its
employees, as a result several employees filed claims with the State of
California Labor Board ("Labor Board") . The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and obtained
in August 2005 judgments totaling $118,000 in favor of former employees of the
Company , since this time $44,000 of the claims have been settled and paid
leaving, a balance of $74,000. On or about November 1, 2006, two employees
joined Arden and Reflexive in the filing of an involuntary bankruptcy petition
against the Company. The petition is pending before the bankruptcy court and the
Company is opposing it. (See Note 15)
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled in
2004. The company subsequently entered into new workers compensation insurance
plan. The Labor Board fined the Company approximately $79,000 for having lost
workers compensation insurance for a period of time. The Company is appealing
the Labor Board fines.
The Company received notice from the California State Board of Equalization
of a balance due in the amount of $73,000 for a prior year audit. The Company
has engaged an independent specialized accounting firm to appeal the prior year
audit calculations and submit a settlement proposal to the California State
Board of Equalization.
On September 14, 2005, Network Commercial Service, Inc. ("NCS") filed an
action against the Company alleging breach of contract relating to the provision
of copying equipment. NCS subsequently obtained a judgment against the company
for approximately $140,000.
On April 22, 2005, Mark Strecker filed an action against the Company for
various claims alleging unpaid services in the amount of $35,000. The Company is
evaluating the merit of the lawsuit.
On May 19, 2005 DZN, The Design Corporation filed an action against the
Company for various advertising services in the amount of $38,000. The Company
is evaluating the merit of the lawsuit.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. The Company is evaluating the merit of the lawsuit.
On March 7, 2006, Parallax Software Corp. entered a judgment against the
Company for a material breach of a settlement agreement related to royalties
owed in the amount of $219,000.
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") initiated
legal proceedings against the Company seeking damages of approximately $1.3
million, alleging, among other things, that we failed to secure a timely
effective date for a Registration Statement for its shares purchased by Special
Situations under a common stock subscription agreement dated March 29, 2001 and
that the Company therefore, liable to pay Special Situations $1.3 million.
Special Situations entered into a settlement agreement with the Company in
December, 2003 contemplating payments over time, which the Company later
defaulted. In August, 2004 the Company entered into a stipulation of settlement
on which it later defaulted. On January 12, 2005 a judgment of approximately
$776,000 was entered in the State of New York and on February 4, 2005 a judgment
reflecting the January 12, 2005 judgment was entered in the State of California.
On May 3, 2006 the Company entered into a Stipulation of Settlement. Under this
Stipulation of Settlement, the Company issued a total of 10,000,000 shares of
its unregistered common stock and made a payment in the amount of approximately
$239,000. Following the issuance of such shares and in consideration of such
issuance and such payment, satisfaction of judgments in the amount of
approximately $776,000 were filed. Such shares were issued in a private
placement pursuant to section 4(2) of the Securities Act of 1933 and were issued
at a price of $.0296 per share, using a value based on the then current market
price of shares of common stock discounted by such newly issued shares.
The Company has recorded an estimate for the liabilities related to the
aforementioned litigation. If any of the creditors execute their judgments
against the Company, the results will negatively affect the Company's cash flow,
which could restrict the Company's operations and cause material restraints to
its business.
8. STOCKHOLDERS' EQUITY
PREFERRED STOCK AND COMMON STOCK
The Company's articles of incorporation authorize up to 5,000,000 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, 2006, there were no shares of preferred stock outstanding.
52
In connection with a private placement in April, 2001, the Company issued
warrants to purchase 8,126,770 shares of the Company's common stock at $1.75 per
shares. These warrants expired on March 31, 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 became effective. The warrant expires
four years after it vests. The Company incurred a penalty of approximately
$254,000 per month, payable in cash, until June 2002, when the required
registration statement was declared effective. During 2003, the Company settled
with certain of these investors with respect to payment. The total amount
accrued at December 31, 2005 and 2004 was $2.2 million and $3.1 million,
respectively. During 2006 the Company reversed the outstanding accrual of $2.2
million, as management of the Company determined that based on the time period
the debt was outstanding, it was no longer collectible by the creditors.
In August 2001, Titus converted 336,070 shares of Series A Preferred Stock
it purchased in April 2000 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 since 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. In connection with sale of Preferred Stock with Titus in April 2000 the
Company issued a warrant to purchase 350,000 shares of the Company's common
stock at $3.79 per share and another warrant to Titus to purchase 50,000 shares
of the Company's common stock at $3.79 per share. Both warrants expire in April
2010.
WARRANTS ISSUED
During 2006 the Company issued 6,370,000 warrants to purchase the Company's
common stock at $.0279 per share (average closing price over ten days subsequent
to the resolution authorizing the issuance of the warrants) to the officer and
directors.
The 6,100,000 warrants were issued to the officer to reduce his
compensation and to convert a portion of his unpaid compensation into a
conditional demand note. The conditions includes that such note will be paid
only if the tangible net worth of the Company exceeds $1 million or in a case of
change in control. The demand note will accrue interest at a rate of 5%
annually. These warrants were valued using the Black-Scholes Model.
In addition 270,000 warrants were issued to the directors to convert their
earned but unpaid director's fees to conditional demand notes. The conditions
include that such notes will be paid only if the tangible net worth of the
Company exceeds $1 million or in a case of change in control. The demand notes
will accrue interest at a rate of 5% annually, These warrants were valued using
the Black-Scholes Model.
The aggregate amount charged against income was approximately $40,000.
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock reserved for future issuance at December 31, 2006 is as
follows:
Stock option plans:
Outstanding ........................................ 2,640,000
Available for future grants ........................ 7,360,000
----------
10,000,000
----------
Warrants .................................................. 7,330,298
----------
Total ..................................................... 17,330,298
==========
TREASURY STOCK
In December 2005, NBC Universal returned their 4,658,216 shares of the
Company's common stock at no cost to the Company. The Company included these
shares as treasury stock in 2006 and 2005.
53
9. NET EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed as net earnings (loss)
available 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 available to the common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and common stock warrants and the conversion of
outstanding convertible debentures.
YEARS ENDED DECEMBER 31,
------------------------------
2006 2005 2004
-------- -------- --------
(Amounts in thousands,
except per share amounts)
Net income (loss) available to common stockholders ........... $ 3,079 $ 5,928 $ (4,730)
Interest related to conversion of secured convertible
promissory note ........................................ -- -- --
-------- -------- --------
Dilutive net income (loss) available to common stockholders $ 3,079 $ 5,928 $ (4,730)
-------- -------- --------
Shares used to compute net income (loss) per common share:
Weighted-average common shares ............................ 100,513 93,856 93,856
Dilutive stock equivalents ................................ 2,090 -- --
-------- -------- --------
Dilutive potential common shares .......................... 102,603 93,856 93,856
======== ======== ========
Net income (loss) per common share:
Basic ..................................................... $ 0.030 $ 0.06 $ (0.05)
Diluted ................................................... $ 0.028 $ 0.06 $ (0.05)
There were options and warrants outstanding to purchase 9,970,298 shares of
common stock at December 31, 2006, 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.
Due to the net loss attributable for the year ended December 31, 2004, 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. The weighted average exercise price at December
31, 2006, 2005 and 2004 was $.38, $1.84 and $1.84, respectively, for the options
and warrants outstanding. No dilution effect for options and warrants has been
made for 2005 as the market price of the common stock did not exceed the
exercise price of the options or warrants. The dilution effect for the year
ended December 31,2006 was 2,090,000 common shares related to warrants issued to
officer and directors.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
2006 2005 2004
------------------------ ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ---------- ---------- ---------- ---------- ----------
Warrants outstanding at
beginning of year ... 9,587,068 $ 1.84 9,587,068 $ 1.84 9,587,068 $ 1.84
Granted ............ 6,370,000 .0279 -- -- -- --
Exercised .......... -- -- -- -- -- --
Canceled ........... (8,626,770) -- -- -- -- --
---------- ---------- ----------
Warrants outstanding
and exercisable at
end of year ......... 7,330,298 $ .38 9,587,068 1.84 9,587,068 $ 1.84
========== ========== ==========
54
A detail of the warrants outstanding and exercisable as of December 31,
2006 is as follows:
WARRANTS OUTSTANDING AND EXERCISABLE
---------------------------------------------------
WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE
PRICES OUTSTANDING CONTRACT LIFE PRICE
--------------- ----------- ------------- -----------
$1.75 - $1.75 500,000 .47 $ 1.75
$3.79 - $3.79 460,298 4.29 3.79
$.0279 - $.0279 6,370,000 9.75 $ .0279
10. EMPLOYEE BENEFIT PLANS
STOCK OPTION PLANS
The Company has one stock option plan currently outstanding. Under the 1997
Stock Incentive Plan, as amended (the "1997 Plan"), the Company may grant
options to its employees, consultants and directors, which generally vest from
three to five years. At the Company's 2002 annual stockholders' meeting, its
stockholders voted to approve an amendment to the 1997 Plan to increase the
number of authorized shares of common stock available for issuance under the
1997 Plan from four million to 10 million. The Company's Incentive Stock Option,
Nonqualified Stock Option and Restricted Stock Purchase Plan- 1991, as amended
(the "1991 Plan"), and the Company's Incentive Stock Option and Nonqualified
Stock Option Plan-1994, as amended, (the "1994 Plan"), have been terminated.
The following is a summary of option activity pursuant to the Company's
stock option plans:
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
2006 2005 2004
------------------------ ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ---------- ---------- ---------- ---------- ----------
Options outstanding at
beginning of year ... 70,000 $ .30 211,150 $ 2.02 425,985 $ 1.95
Granted ............ 2,570,000 .045 -- -- 5,000 0.08
Exercised .......... -- -- -- -- -- --
Canceled ........... -- -- (141,150) 2.02 (219,835) 1.85
---------- ---------- ---------- ----------
Options outstanding
at end of year ...... 2,640,000 $ .05 70,000 $ .30 211,150 $ 2.02
========== ========== ==========
Options exercisable 2,620,002 50,002 171,686
========== ========== ==========
Black Scholes Single Option approach was used to estimate the fair value
information presented utilizing ratable amortization. There were 2,570,000, 0
and 5,000 options granted in 2006, 2005 and 2004, respectively.
55
A detail of the options outstanding and exercisable as of December 31, 2006
is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- -----------------------------
RANGE OF EXERCISE WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING CONTRACT LIFE PRICE OUTSTANDING PRICE
------------------------- ------------- ------------- ------------- ------------- -------------
$0.045 - $.68 2,640,000 8.75 $ .05 2,620,002 $ .05
------------- ------------- ------------- ------------- -------------
$0.045 - $.68 2,640,000 8.75 $ .05 2,620,002 $ .05
============= ============= ============= ============= =============
PROFIT SHARING 401(K) PLAN
In 2003, the employee stock purchase plan was terminated, the Profit
Sharing 401(k) plan during 2007 had distributed all assets in the plan and will
file their final pension plan returns during 2007.
11. RELATED PARTY TRANSACTIONS
Amounts receivable from and payable to related parties are as follows:
DECEMBER 31,
--------------------------
2006 2005
----------- -----------
(Dollars in thousands)
Receivables from related parties:
Titus TSC ...................................... $ 0 $ 70
Titus SARL ..................................... 0 18
VIE Acquisition Group (Titus owned) ............ 0 17
Avalon ......................................... 0 0
0 2,026
Less Reserves .................................. (0) (2,114)
----------- -----------
Total .......................................... $ 0 $ 17
=========== ===========
ACTIVITIES WITH RELATED PARTIES
It is the Company's policy that related party transactions shall be
reviewed and approved by a majority of the Company's disinterested directors or
its Independent Committee.
The Company's operations involve significant transactions with its majority
stockholder Titus and its affiliates. The Company had a major distribution
agreement with Avalon.
TRANSACTIONS WITH TITUS AND AFFILIATES
Titus (placed in French involuntary bankruptcy in January 2005) presently
owns approximately 58 million shares of Company common stock.
As of December 31, 2006 and December 31, 2005, Titus and its affiliates,
excluding Avalon owed the Company $0 and $105,000, respectively (See
transactions with Titus Software below
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions
56
in Japan. As of December 31, 2006 the Company had a balance owed from Titus
Japan of $ 226,000. During the twelve months ending December 31, 2006 the
Company's Japanese subsidiary incurred to Titus Japan costs of approximately
$106,000 in commissions, publishing and staff services. The Company closed our
Japanese subsidiary during the 4th quarter of 2006.
The amounts due from Avalon as of December 31, 2006 have been fully
reversed.
12. CONCENTRATION OF CREDIT RISK
Avalon was the exclusive distributor for most of the Company's products in
Europe, the Commonwealth of Independent States, Africa and the Middle East. The
Company's agreement with Avalon was terminated following the liquidation of
Avalon in February 2005. The Company subsequently appointed its wholly owned
subsidiary, Interplay Productions Ltd as its distributor for Europe.
Vivendi had exclusive rights to distribute the Company's products in North
America and selected International territories. The Company's agreement with
Vivendi expired in August 2005 for most of its products.
o The Company's revenues and cash flows could fall significantly, and
its business and financial results could suffer material harm if
Interplay Productions Ltd fails to effectively distribute the
Company's products.
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 has the risk of non-payment from its customers, whether due
to their financial inability to pay, 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 and
cash flow.
For the years ended December 31, 2005 and 2004 , Avalon accounted for
approximately 2% and 70% respectively, of net revenues in connection with the
International Distribution Agreement (Note 11). Vivendi accounted for 7 % and
21% of net revenues in the years ended December 31, 2005, and 2004,
respectively.
13. 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,
----------------------------------------------------------------
2006 2005 2004
------------------ -------------------- ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- -------
(Dollars in thousands)
North America .. $ 203 21% $ 2,885 (1) 40% $ 1,544 12%
Europe ......... 471 49 1,779 (1) 25 8,706 66
Rest of World .. 161 17 2,277 (1) 32 1,228 9
OEM, royalty and
licensing ... 132 13 217 3 1,720 13
------- ------- ------- ------- ------- -------
$ 967 100% $ 7,158 100% $13,197 100%
======= ======= ======= ======= ======= =======
(1) Included in net revenue by geographic regions are the recognition of
deferred revenue on contracts expiring as follows:
North America - $2,071 million Europe $363,000 Rest of the World $2,138
million.
57
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's summarized quarterly financial data is as follows:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ------------ ------------ ------------
(Dollars in thousands, except per share amounts)
Year ended December 31, 2006:
Net revenues ............................. $ 106 $ 239 $ 335 $ 287
============ ============ ============ ============
Gross profit ............................. $ 100 $ 93 $ 330 $ 277
============ ============ ============ ============
Net income (loss) ........................ $ (529) $ 2,060 $ 1,633 $ (85)
============ ============ ============ ============
Net income (loss) per common share basic . $ (0.006) $ 0.02 $ 0.02 $ (0.001)
============ ============ ============ ============
Net income (loss) per common share diluted $ (0.006) $ 0.02 $ 0.02 $ (0.001)
============ ============ ============ ============
Year ended December 31, 2005:
Net revenues ............................. $ 793 $ 468 $ 4,268 $ 1,629
============ ============ ============ ============
Gross profit ............................. $ 622 $ 372 $ 4,255 $ 1,431
============ ============ ============ ============
Net income (loss) ........................ $ (216) $ 631 $ 4,700 $ 812
============ ============ ============ ============
Net income (loss) per common share basic . $ (0.00) $ 0.01 $ 0.05 $ 0.01
============ ============ ============ ============
Net income (loss) per common share diluted $ (0.00) $ 0.01 $ 0.05 $ 0.01
============ ============ ============ ============
15. INVOLUNTARY BANKRUPTCY
On November 1, 2006 an involuntary petition under Chapter 7 of the
Bankruptcy Code was filed in Federal Court by several of the Company's
creditors. Involuntary bankruptcy is a process where a court appointed trustee
is empowered to liquidate the non exempt property, if any, of the debtor. The
Company is opposing the petition.
58
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
TRADE RECEIVABLES ALLOWANCE
------------------------------------------------------------------
BALANCE AT PROVISIONS FOR
BEGINNING OF RETURNS RETURNS AND BALANCE AT END
PERIOD PERIOD AND DISCOUNTS DISCOUNTS OF PERIOD
----------------------------------- -------------- -------------- ---------- --------------
Year ended December 31, 2004 ...... $ 725 $ 1,681 $ -- $ 2,406
============== ============== ============== ==============
Year ended December 31, 2005 ...... $ 2,406 $ (216) $ -- $ 2,190
============== ============== ============== ==============
Year ended December 31, 2006 ...... $ 2,190 $ (2,173) $ -- $ 17
============== ============== ============== ==============
59