UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
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)
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 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 shell company ( as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
CLASS ISSUED AND OUTSTANDING AT MARCH 31, 2007
----- ----------------------------------------
Common Stock, $0.001 par value 103,855,634
As of March 31, 2007, 103,855,634 shares of Common Stock of the Registrant were
issued and outstanding. This includes 4,658,216 shares of Treasury Stock.
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2007
TABLE OF CONTENTS
--------------
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
March 31, 2007 (unaudited) and December 31, 2006 3
Condensed Consolidated Statements of Operations
for the Three Months ended March 31, 2007 and
2006 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
for the Three Months ended March 31, 2007 and
2006 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
Item 4. Controls and Procedures 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 1A Risk Factors 16
Item 3. Defaults Upon Senior Securities 22
Item 6. Exhibits 22
SIGNATURES 23
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
ASSETS 2007 2006
------------- -------------
(unaudited)
Current Assets:
Cash ........................................... $ 6,000 $ 50,000
Trade receivables, net of allowances of
$17,000 and $17,000 respectively ............. 134,000 227,000
Inventories .................................... 8,000 8,000
Deposits ....................................... 4,000 4,000
Prepaid expenses ............................... 12,000 6,000
Other receivables .............................. 11,000 17,000
------------- -------------
Total current assets ........................ 175,000 312,000
Property and equipment, net ......................... 2,000 3,000
Other assets ........................................ 8,000 8,000
------------- -------------
Total assets ................................ $ 185,000 $ 323,000
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Note Payable ................................... $ 1,435,000 $ 1,427,000
Accounts payable subject to judgments .......... 1,653,000 1,653,000
Account payable - other ........................ 3,720,000 4,006,000
Accrued royalties .............................. 170,000 170,000
Deferred income ................................ 415,000 460,000
Note payable to officer and directors .......... 702,000 694,000
------------- -------------
Total current liabilities ................... 8,095,000 8,410,000
------------- -------------
Commitments and contingencies
Stockholders' Deficit:
Preferred stock, $0.001 par value 5,000,000
shares authorized; no shares issued or
outstanding,
Common stock, $0.001 par value 150,000,000
shares authorized; 103,855,634 shares
issued and outstanding ...................... 104,000 104,000
Paid-in capital ................................ 121,968,000 121,964,000
Accumulated deficit ............................ (129,976,000) (130,205,000)
Accumulated other comprehensive income (loss) .. (6,000) 50,000
Treasury stock of 4,658,216 shares ............. 0 0
------------- -------------
Total stockholders' deficit ................. (7,910,000) (8,087,000)
------------- -------------
Total liabilities and stockholders' deficit . $ 185,000 $ 323,000
============= =============
See accompanying notes.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2007 2006
------------- -------------
Net revenue from licensing ............................... $ 0 $ 38,000
Net revenues from distributors ........................... 79,000 68,000
------------- -------------
Total net revenues ............................... 79,000 106,000
Cost of goods sold ....................................... 4,000 6,000
------------- -------------
Gross profit ..................................... 75,000 100,000
------------- -------------
Operating expenses:
Marketing and sales ................................... 93,000 147,000
General and administrative ............................ 301,000 415,000
------------- -------------
Total operating expenses ......................... 394,000 562,000
------------- -------------
Operating (loss) income .................................. (319,000) (462,000)
------------- -------------
Other income (expense):
Interest expense ..................................... (30,000) (25,000)
Reversal of prior years recorded liabilities ......... 435,000 0
Other ................................................ 143,000 (42,000)
------------- -------------
Total other income (expense) ..................... 548,000 (67,000)
Income before benefit for income taxes ................... 229,000 (529,000)
Benefit for income taxes ................................. -- --
------------- -------------
Net income (loss) available to common stockholders $ 229,000 $ (529,000)
============= =============
Net income (loss) per common share:
Basic ............................................ $ .002 $ (.006)
============= =============
Diluted .......................................... $ .002 $ (.006)
============= =============
Shares used in calculating net income (loss) per
common share:
Basic ............................................ 99,197,418 89,197,418
============= =============
Diluted .......................................... 104,096,268 89,197,148
============= =============
See accompanying notes.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN CASH FLOWS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------
2007 2006
--------- ---------
Cash flows from operating activities:
Net (loss) income .......................................... $ 229,000 $(529,000)
Adjustments to reconcile net (loss) income to
cash (used) provided by operating activities:
Depreciation and amortization ........................... 1,000 1,000
Additional Paid in Capital - Option Expense ............. 4,000
Reversal of prior year recorded liabilities ............. (435,000)
Abandonment of property and equipment .................. -- (1,000)
Changes in operating assets and liabilities:
Trade receivables from related parties ............... 93,000 (6,000)
Trade receivables, net ............................... -- 267,000
Inventories .......................................... -- (1,000)
Prepaid licenses and royalties ....................... -- --
Prepaid expenses ..................................... (6,000) 39,000
Other current assets, net ............................ 6,000 8,000
Other assets ......................................... -- (46,000)
Accounts payable ..................................... 157,000 106,000
Accrued royalties .................................... -- 3,000
Note Payable Officers ................................ 8,000
Deferred revenue ..................................... (45,000)
Advances from distributor ............................ -- 68,000
Accumulated other compensation income ................ (56,000) 9,000
--------- ---------
Net cash provided by (used in) operating activities (44,000) (82,000)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment ......................... -- --
--------- ---------
Net cash used in investing activities ............. -- --
--------- ---------
Cash flows from financing activities:
Repayment of current debt .................................. -- --
--------- ---------
Net cash provided by (used in) financing activities -- --
--------- ---------
Effect of exchange rate changes on cash ....................... -- --
--------- ---------
Net increase (decrease) in cash ......................... (44,000) (82,000)
Cash, beginning of period ..................................... 50,000 122,000
--------- ---------
Cash, end of period ........................................... $ 6,000 $ 40,000
========= =========
Supplemental cash flow information:
Cash paid for:
Interest ................................................ $ 0 $ 0
========= =========
Taxes ................................................... $ 0 $ 0
========= =========
See accompanying notes.
5
INTERPLAY ENTERTAINMENT AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2007
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Interplay Entertainment Corp. (which we refer to as the "Company" in these
Notes) and its subsidiaries reflect all adjustments (consisting only of normal
recurring adjustments) that, in the opinion of management, are necessary for a
fair presentation of the results for the interim period in accordance with
instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all information and footnotes required by accounting principles
generally accepted in the United States ("GAAP") for complete financial
statements. The results of operations for the current interim period are not
necessarily indicative of results to be expected for the current year or any
other period. The balance sheet at December 31, 2006 has been derived from the
audited consolidated financial statements at that date, but does not include all
information and footnotes required by GAAP for complete financial statements.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2006 as filed with the U.S. Securities and Exchange Commission ("SEC").
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN STATUS
The Company's independent public accountant included a "going concern"
explanatory paragraph in his audit report on the December 31, 2006 consolidated
financial statements which were prepared assuming that the Company will continue
as a going concern.
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, and assuming full receipt of the
deferred consideration from the sale of "Fallout" (see Note 6) 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.
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.
6
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP 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 condensed consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Significant estimates made in preparing the
condensed consolidated financial statements include, among others, sales returns
and allowances, cash flows used to evaluate the recoverability of prepaid
licenses and royalties, channel exposure and long-lived assets, and certain
accrued liabilities related to litigation and the probability of what creditors
can collect on previously recorded accruals and payables.
PRINCIPLES OF 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)
the business of which was closed during the 4th quarter 2006 (immaterial to
consolidated results) and Games On-line. All significant inter-company accounts
and transactions have been eliminated.
NOTE 2. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings, claims, and
litigation arising in the ordinary course of Business, including disputes
arising over the ownership of intellectual property rights and collection
matters.
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 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. As of March 31,2007 The Company owed a
remaining balance of approximately $389,813 payable in one remaining installment
which was fully paid in May, 2007.
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 March 31,2007 is $126,548
7
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 owed approximately $136,000 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 $136,000 has been accrued as of
March 31, 2007 and was fully paid in April, 2007. The Company received notice
from the Employment Development Department (EDD) that it owes approximately
$105,000 in payroll taxes, interest and penalties for the periods ending 2003,
2004 and 2005 which has been accrued for on March 31, 2007 and was fully paid in
April 2007.
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, was cancelled in 2004.
The Company subsequently entered into a 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 has fully paid the
Labor Board in April, 2007.
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. Mark Strecker
obtained a $35,000 judgment against the Company.
On May 19, 2005 DZN, The Design Corporation filed an action against the
Company for various advertising services in the amount of $38,000. DZN obtained
a $38,000 judgment against the Company.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. Although the Company was never served with the
lawsuit, a judgment has been issued by a Florida court granting legal fees to
Mr. Sigel for an amount of $15,000.
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.
The Company has accrued in the Company's financial statements 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
NOTE 3. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2007 2006
------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- -------
(Dollars in thousands)
North America ...................... $ 2 3% $ 44 42%
Europe ............................. 77 97 0 0
Rest of World ...................... 0 0 15 14
OEM, royalty and
licensing .......................... 0 0 47 44
------- ------- ------- -------
$ 79 100% $ 106 100%
======= ======= ======= =======
NOTE 4. REVERSAL OF CERTAIN PRIOR YEAR ACCRUALS AND ACCOUNTS PAYABLES
During the quarter ended March 31, 2007 the Company has reversed certain
accruals and accounts payables of approximately $435,000. 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.
NOTE 5. EMPLOYEE STOCK OPTIONS
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.
At March 31, 2007, the Company has one stock-based employee compensation
plan. Stock-based employee compensation cost approximated $4,000 as reflected in
net income for the quarter ended March 31, 2007. No employee stock options were
granted during the quarter ended March 31, 2007.
9
NOTE 6. SUBSEQUENT EVENT
On April 4, 2007, the Company entered into, an Asset Purchase Agreement
(the "APA") and a Trademark License Agreement (the "License Back") with Bethesda
Softworks LLC, a video game developer and publisher ("Bethesda"), regarding
"FALLOUT", an intellectual property which was owned by the Company (the "IP").
Although such agreements were signed on April 4, 2007 they were agreed not to be
binding until closing which occurred on April 9, 2007.
Under the APA, the Company sold all of its rights to the IP to Bethesda for
a total amount of $5,750,000.00 payable to the Company, subject to various
conditions, in three cash installments. The first installment of $2,000,000.00
was paid following closing when $200,000.00 was paid to the Company and
$1,800,000.00 was deposited into an escrow account to satisfy various
liabilities. The Company expects to have fulfilled its obligations under the APA
and to receive full payment during the third quarter of 2007. The Company had
previously, on June 29, 2004, entered into, an exclusive licensing agreement
with Bethesda, regarding the IP which was superseded by the APA.
Under the License Back the Company obtained an exclusive license, under
certain conditions, to use the IP for the purpose of developing an Interplay
branded Fallout Massively Multiplayer Online Game ("MMOG").
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
Interplay Entertainment Corp., which we refer to in this Report as "we,"
"us," or "our," is a developer, publisher and licensor of interactive
entertainment software and intellectual properties for both core gamers and the
mass market. The information contained in this Form 10-Q is intended to update
the information contained in our Annual Report on Form 10-K for the year ended
December 31, 2005, as amended, and presumes that readers have access to, and
will have read, the "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other information contained in such
Form 10-K, as amended.
This Report on Form 10-Q contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 and such forward-looking statements are subject
to the safe harbors created thereby. For this purpose, any statements contained
in this Form 10-Q, except for historical information, may be deemed to be
forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "should," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to 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 herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
revenue or expense expectations, including those forward-looking statements in
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations", financing activities, future cash flows, cash constraints, sales
or mergers and cost reduction measures are forward-looking statements and there
can be no assurance that we will effect any or all of these objectives in the
future. Specifically, the forward-looking statements in this Item 2 assume that
we will continue as a going concern. Risks and Uncertainties that may affect our
future results are discussed in more detail in the section titled "Risk Factors"
in Item 1A of part II of this Form 10-Q. 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 Form 10-Q with the SEC
or otherwise to revise or update any oral or written forward-looking statement
that may be made from time to time by us or on our behalf.
10
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated 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, among others, 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.
RESULTS OF OPERATIONS
The following table sets forth certain selected consolidated statements of
operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED MARCH 31,
2007 2006
--------------------- ---------------------
% OF NET % OF NET
AMOUNT REVENUES AMOUNT REVENUES
-------- -------- -------- --------
(Dollars in thousands)
Net revenues ........................... $ 79 100% $ 106 100%
Cost of goods sold ..................... 4 5% 6 6%
-------- -------- -------- --------
Gross profit ...................... 75 95% 100 94%
-------- -------- -------- --------
Operating expenses:
Marketing and sales ............... 93 117% 147 138%
General and administrative ........ 301 381% 415 392%
Product development ............... 0 0% 0 0%
-------- -------- -------- --------
Total operating expenses .......... 394 498% 562 530%
-------- -------- -------- --------
Operating income (loss) ................ (319) (403)% (462) (436)%
Other (expense) income ................. 548 693% (67) (63)%
-------- -------- -------- --------
Net income (loss) ...................... $ 229 290% $ (529) (499)%
======== ======== ======== ========
Net revenues by geographic region:
North America ..................... $ 2 3% $ 44 5%
International ..................... 77 97% 15 88%
OEM, royalty and licensing ........ 0 0% 47 7%
-------- -------- -------- --------
79 100% 106 100%
======== ======== ======== ========
Net revenues by platform:
Personal computer ................. $ 71 90% $ 21 17%
Video game console ................ 8 10% 38 77%
OEM, royalty and licensing ........ 0 0% 47 6%
-------- -------- -------- --------
79 100% 106 100%
======== ======== ======== ========
11
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Geographically, our net revenues for the three months ended March 31, 2007
and 2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
North America ................... $ 2 $ 44 $ (42) (95)%
International ................... 77 15 62 413 %
OEM, Royalty & Licensing ........ 0 47 (47) (100)%
Net Revenues .................... $ 79 $ 106 $ (27) (26)%
Net revenues for the three months ended March 31, 2007 were $79,000, a
decrease of 26% compared to the same period in 2006. This decrease resulted from
a 95% decrease in North American net revenues, a 100% decrease in OEM, royalty
and licensing net revenues, and a 413% increase in International net revenues.
North American net revenues for the three months ended March 31, 2007 were
$2,000. The decrease in North American net revenues in 2007 was mainly due to a
95% decrease in back catalog sales.
OEM, royalty and licensing net revenues for the three months ended March
31, 2007 were $0, a decrease of $47,000 as compared to the same period in 2006.
There were no OEM Licensing deals during the first quarter of 2007.
International net revenu es for the three months ended March 31, 2007 were
$77,000. The increase in international net revenues for the three months ended
March 31, 2007 was mainly due to an 80% increase in back catalog sales.
PLATFORM NET REVENUES
Our platform net revenues for the three months ended March 31, 2007 and
2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
Personal Computer ............... $ 71 $ 21 $ 50 238%
Video Game Console .............. 8 38 (30) (79)%
OEM, Royalty & Licensing ........ 0 47 (47) (100)%
Net Revenues .................... 79 106 (27) (25)%
PC net revenues for the three months ended March 31, 2007 were $71,000, an
increase of 238% compared to the same period in 2006. The increase in PC net
revenues in 2007 was primarily due to higher back catalog sales. Video game
console net revenues were $8,000, a decrease of 79% for the three months ended
March 31, 2007 compared to the same period in 2006, due to lower back catalog
sales.
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our net revenues, cost of goods sold and gross margin for the three months
ended March 31, 2007 and 2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
Net Revenues .................... $ 79 $ 106 $ (27) (25)%
Cost of Goods Sold .............. 4 6 (2) (33)%
Gross Profit Margin ............. 75 100 (25) (25)%
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 is 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
12
and license fees paid 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 number of units shipped. We evaluate the
likelihood of future realization of prepaid royalties and license fees
quarterly, on a product-by-product basis, and charge the cost of goods sold for
any amounts that we deem unlikely to realize through future product sales.
Our cost of goods sold decreased 33% to $4,000 in the three months ended
March 31, 2007 compared to the same period in 2006.
Our gross margin remained the same at 94% for the 2007 period from 94% in
the 2006 period.
MARKETING AND SALES
Our marketing and sales expense for the three months ended March 31, 2007
and 2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
Marketing and Sales ............. $ 93 $ 147 $ (54) (37)%
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses for the three months ended March 31, 2007 were $93,000 a 37% decrease
compared to the 2006 period.
GENERAL AND ADMINISTRATIVE
Our general and administrative expense for the three months ended March 31,
2007 and 2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
General and Administrative ...... $ 301 $ 415 $ (114) (27)%
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended March 31, 2007 were $301,000 a 27% decrease as compared to
the same period in 2006. The decrease is mainly due to a $114,000 decrease in
officer, director compensation, personnel costs and general expenses.
OTHER EXPENSE (INCOME), NET
Our other expense (income) for the three months ended March 31, 2007 and
2006 breakdown as follows: (in thousands)
2007 2006 CHANGE % CHANGE
-------- -------- -------- --------
Other Expense ( Income) ......... $ (548) $ 67 $ (615) 917%
Other income consists primarily of reversals of certain prior year payables
in the amount of $435,000, recognition of expired contract in the amount of
$50,000, reversal of reserves, foreign currency exchange transaction gains and
losses, and interest expense on debt in the amount of $63,000. Other income for
the three months ended March 31, 2007 was $548,000, a 917% increase as compared
to the same period in 2006.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2007, we had a working capital deficit of approximately
$7.9 million, and our cash balance was approximately $6,000. 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
certain rights to one of our Intellectual Properties, Earthworm Jim, to a third
party. We have sold one of our Intellectual Properties, Fallout, to a third
party while obtaining a License back to allow us to create, develop and exploit
a "Fallout" Massively Multiplayer Online Game (MMOG).
13
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,, 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 assuming full
receipt of the deferred consideration from the sale of "Fallout".
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 $44,000 during the three months ended March 31, 2007, primarily
attributable to licensing and distribution net of expenditures.
We entered into various licensing agreements during the first quarter of
2007 under which we licensed others to exploit games that we have intellectual
property rights to. We expect in the remainder of 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 license of "Fallout" on Massively
Multiplayer Online Gaming (MMOG) and is reviewing the financial avenues for
funding MMOG.
If operating revenues 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 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, as amended) in an unconsolidated entity that is held by, and
material to, us, where such entity provides financing, liquidity, market risk or
credit risk support to, or engages in leasing, hedging or research and
development services with us.
14
CONTRACTUAL OBLIGATIONS
The following table summarizes certain of our contractual obligations under
non-cancelable contracts and other commitments at March 31, 2007, and the effect
such obligations are expected to have on our liquidity and cash flow in future
periods. (in thousands)
LESS THAN 1 - 3 3 - 5 MORE THAN
CONTRACTUAL OBLIGATIONS Total 1 YEAR YEARS YEARS 5 YEARS
------------------------- -------- -------- -------- -------- --------
Lease Commitments (1) ... 11 -- 11 -- --
-------- -------- -------- -------- --------
Total .................. 11 -- 11 -- --
(1) We have a lease commitment at the Beverly Hills office through April 2008.
We also have a lease commitment at our French representation office through
February 28, 2008 with an option for the Company to take up to an
additional 6 years.
Our current cash reserves plus our expected cash from existing operations
assuming full receipt of the deferred consideration from the sale of "Fallout"
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of March 31, 2007.
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 interest rate risk, or our risk associated
with foreign currency fluctuations.
INTEREST RATE RISK
Currently, we do not have a line of credit, but we anticipate we may
establish a line of credit in the future.
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.
We recognized gains of $ 40,000 and $2,500 during the three months ended
March 31, 2007 and 2006 respectively, primarily in connection with foreign
exchange fluctuations in the timing of payments received on accounts receivable
which have been from Interplay Productions Ltd.
ITEM 4. 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 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 period
specified in the SEC's 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 March 31, 2007 that have
materially affected or are reasonably likely to materially affect these
controls.
Our management, including the Chief Executive Officer and Interim Chief
Financial Officer, 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.
15
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 there can be no 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 II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required in this Item 1 is incorporated herein by reference
to the information in "Note 2. Commitments and Contingencies" to our condensed
consolidated financial statements located in Item 1, Part 1 of this Report.
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, FAIL TO OBTAIN APPROPRIATE RELIEF FROM BANKRUPTCY, AND/OR
BE MADE BANKRUPT AND/OR OUR STOCK MAY BECOME ILLIQUID OR WORTHLESS.
As of March 31, 2007, our cash balance was approximately $6,000 and our
outstanding and current liabilities 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 obtain
appropriate relief from 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 three months ended March 31, 2007, our net income from operations
was $229,000 but we have incurred significant net losses in previous years.
Although for the year ended December 31, 2006, our net income was $3.1 million,
16
$4.5 million of our revenue was recognized from the reversals of certain
settlements, reversal of reserves and prior year payables, (which did not
generate cash flow). As of March 31, 2007 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 licensees' product distributions and
licensing of our intellectual property, the rate of growth of our business, and
our 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 product development and marketing programs. These measures could materially
and adversely affect our ability to publish successful titles, and may not be
enough to permit us to operate profitability, or at all.
OUR ABILITY TO EFFECT A FINANCING TRANSACTION TO FUND OUR OPERATIONS COULD
ADVERSELY AFFECT THE VALUE OF YOUR STOCK.
We expect 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.
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 and has majority
ownership. 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. 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.
We are presently without a CFO, and Mr. Caen assumed the position of
interim-CFO and continues as CFO .
OUR BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL. IF WE FAIL TO DELIVER
OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER.
17
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
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.
18
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis by us or our
licensees. Because we and our licensees 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 or are licensees' products do not achieve market acceptance, we could be
forced to accept substantial product returns or grant significant pricing
concessions to maintain our or our licensees' relationship with retailers and
our or our licensees' access to distribution channels. If we or our licensees
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 97%
of our total net revenues for the quarter ending March 31, 2007 and 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;
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 OR OUR LICENSEES' CUSTOMERS HAVE THE ABILITY TO RETURN 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 or our licensees' distributors. Our or our licensees'
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 end users that products will be free from manufacturing defects. In
addition, our or our licensees' provide pricing concessions to customers to
manage customers' inventory levels in the distribution channel. Our or our
licensees' distributors could be forced to accept substantial product returns
and provide pricing concessions to maintain relationships with retailers and
their access to distribution channels.
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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.
o As the number of interactive entertainment software products increases
and the features and content of these products continue to overlap,
software developers increasingly may become subject to infringement
claims. Although we believe that we make reasonable efforts to ensure
that our products do not violate the intellectual property rights of
others, it is possible that third parties still may claim
infringement. From time to time, we receive communications from third
parties regarding such claims. Existing or future infringement claims
against us, whether valid or not, may be time consuming and expensive
to defend. Intellectual property litigation or claims could force us
to do one or more of the following:cease selling, incorporating or
using products or services that incorporate the challenged
intellectual property;
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.
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IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
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.
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
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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 3. DEFAULTS UPON SENIOR SECURITIES
We have received several notices of default on payment on principal and
interest from Warner Bros. Entertainment Inc. on an Amended and Restated Secured
Convertible Promissory Note, dated April 30, 2002, with an original principal
sum of $2,000,000. As of the date of this filing, the balance of the amount due
under the note has been paid in full.
ITEM 6. EXHIBITS
(a) Exhibits - The following exhibits, other than exhibit 32.1 which is
being furnished herewith, are filed as part of this report:
EXHIBIT
NUMBER EXHIBIT TITLE
------- -----------------------------------------------------
31.1 Certificate of Herve Caen, Chief Executive Officer of
Interplay Entertainment Corp. pursuant to Rule
13a-14(a) of the Securities and Exchange Act of 1934,
as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial
Officer of Interplay Entertainment Corp. pursuant to
Rule 13a-14(a) of the Securities and Exchange Act of
1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer
and Interim Chief Financial Officer of Interplay
Entertainment Corp. pursuant to Rule 13a-14(b) of the
Securities and Exchange Act of 1934, as amended.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: May 21, 2007 By: /S/ HERVE CAEN
------------------------------------
Herve Caen,
Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
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