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, 2001
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
Interplay Entertainment Corp.
(Exact name of the registrant as specified in its charter)
Delaware 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 Von Karman Avenue, Irvine, California 92606
(Address of principal executive offices)
(949) 553-6655
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Class Issued and Outstanding at May 11, 2001
----- --------------------------------------
Common Stock, $0.001 par value 38,280,267
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2001
TABLE OF CONTENTS
______________
Page Number
-----------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2001
(unaudited) and December 31, 2000 3
Consolidated Statements of Operations for the Three Months
ended March 31, 2001 and 2000 (unaudited) 4
Consolidated Statements of Cash Flows for the Three Months
ended March 31, 2001 and 2000 (unaudited) 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
Part II. Other Information
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
ASSETS 2001 2000
------ ------------ ------------
(Unaudited)
Current Assets: (Dollars in thousands)
Cash $ 7,611 $ 2,835
Trade receivables, net of allowances
of $5,334 and $6,543, respectively 24,466 28,136
Inventories 3,505 3,359
Prepaid licenses and royalties 17,962 17,704
Other 1,178 772
------------ ------------
Total current assets 54,722 52,806
Property and Equipment, net 5,377 5,331
Other Assets 1,448 944
------------ ------------
$ 61,547 $ 59,081
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current Liabilities:
Current debt $ 27,181 $ 25,433
Accounts payable 16,374 12,270
Accrued liabilities 20,029 14,980
------------ ------------
Total current liabilities 63,584 52,683
------------ ------------
Commitments and Contingencies
Stockholders' Equity (Deficit) (Notes 5 and 10):
Series A Preferred stock, $.001 par value,
authorized 5,000,000 shares; issued and
outstanding, 719,424 shares 21,103 20,604
Common stock, $.001 par value, authorized
100,000,000 shares; issued and outstanding
30,160,262 and 30,143,636 shares, respectively 30 30
Paid-in-capital 88,768 88,759
Accumulated deficit (112,180) (103,259)
Accumulated other comprehensive income 242 264
------------ ------------
Total stockholders' equity (deficit)
(Notes 5 and 10) (2,037) 6,398
------------ ------------
$ 61,547 $ 59,081
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
-------------------------
2001 2000
---------- ----------
(Dollars in thousands,
except per share amounts)
Net revenues $ 17,313 $ 18,143
Cost of goods sold 10,485 9,572
---------- ----------
Gross profit 6,828 8,571
Operating expenses:
Marketing and sales 6,623 4,863
General and administrative 2,478 2,561
Product development 5,381 5,635
---------- ----------
Total operating expenses 14,482 13,059
---------- ----------
Operating loss (7,654) (4,488)
Other expense:
Interest expense, net 662 916
Other expense, net 106 94
---------- ----------
Total other expense 768 1,010
---------- ----------
Net loss $ (8,422) $ (5,498)
========== ==========
Cumulative dividend on participating preferred stock $ 300 $ -
Accretion of warrants on preferred stock 199 -
---------- ----------
Net loss attributable to common stockholders $ (8,921) $ (5,498)
========== ==========
Net loss per common share:
Basic and diluted $ (0.30) $ (0.18)
========== ==========
Weighted average number of
common shares outstanding:
Basic and diluted 30,153,572 29,996,585
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months
Ended
March 31,
---------------------
2001 2000
-------- -------
Cash flows from operating activities: (Dollars in thousands)
Net loss $(8,422) $(5,498)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 629 765
Changes in assets and liabilities:
Trade receivables 3,620 4,977
Inventories (146) 1,776
Prepaid licenses and royalties (258) (435)
Other current assets (406) (302)
Accounts payable 4,104 (4,817)
Accrued liabilities (501) (4,853)
-------- -------
Net cash used in operating activities (1,380) (8,387)
-------- -------
Cash flows from investing activities:
Purchase of property and equipment (579) (711)
-------- -------
Net cash used in investing activities (579) (711)
-------- -------
Cash flows from financing activities:
Net borrowings on line of credit 1,748 1,203
Net proceeds from issuance of notes payable - 10,000
Proceeds from exercise of stock options 9 21
(Additions) reductions to restricted cash - (37)
Proceeds from other advances 5,000 -
Payments on other debt - (37)
-------- -------
Net cash provided by financing activities 6,757 11,150
-------- -------
Effect of exchange rate changes on cash (22) 4
-------- -------
Net increase in cash 4,776 2,056
Cash, beginning of period 2,835 399
-------- -------
Cash, end of period $ 7,611 $ 2,455
======== =======
Supplemental cash flow information:
Cash paid for:
Interest $ 662 $ 916
Income taxes - -
======== =======
Supplemental disclosures of Noncash transactions:
Acquistion of nine percent interest in Shiny $ 600 $ -
======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying interim consolidated financial statements of Interplay
Entertainment Corp. and its subsidiaries (the "Company") are unaudited and
reflect all adjustments (consisting only of normal recurring adjustments) that,
in the opinion of management, are necessary for a fair presentation of the
results for the interim period in accordance with instructions for Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all information
and footnotes required by generally accepted accounting principles in the United
States for complete financial statements. The results of operations for the
current interim period are not necessarily indicative of results to be expected
for the current year or any other period.
These consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
annual report on Form 10-K for the year ended December 31, 2000 as filed with
the Securities and Exchange Commission.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the prior period's financial
statements to conform to classifications used in the current period.
Revenue Recognition
Revenues are recorded when products are delivered to customers in accordance
with Statement of Position ("SOP") 97-2, "Software Revenue Recognition". For
those agreements that provide the customers the right to multiple copies in
exchange for guaranteed amounts, revenue is recognized at the delivery of the
product master or the first copy. Per copy royalties on sales that exceed the
guarantee are recognized as earned. Guaranteed minimum royalties on sales that
do not meet the guarantee are recognized as the minimum payments come due. The
Company is generally not contractually obligated to accept returns, except for
defective, shelf-worn and damaged products in accordance with negotiated terms.
However, the Company permits customers to return or exchange product and may
provide price protection on products unsold by a customer. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue
Recognition when Right of Return Exists," revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions, and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The amount
of reserves is an estimate and the amount ultimately required could differ
materially in the near term from the amounts included in the accompanying
consolidated financial statements. Customer support provided by the Company is
limited to telephone and Internet support. These costs are not material and are
charged to expense as incurred.
Factors Affecting Future Performance
For the three months ended March 31, 2001, the Company incurred a net loss of
$8.4 million. However, net cash used in operating activities was $1.4 million as
the Company's negative operating results were largely offset by strong trade
receivable collections and conservative management of disbursements. During the
same period last year, the net cash used in operating activities was $8.4
million.
In April 2001, the Company obtained a new $15 million three year working
capital line of credit with a bank and completed the sale of $12.7 million of
Common Stock in a private placement transaction (see Notes 3 and 10).
The Company believes that funds available under its new line of credit, funds
received from the sale of equity securities and anticipated funds from
operations including licensing and distribution transactions should be
sufficient to satisfy the Company's projected working capital and capital
expenditure needs in the normal course of business at
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
least through March 31, 2002 (See Notes 3 and 10). However, there can be no
assurance that the Company will be able to raise sufficient funds to satisfy its
projected working capital and capital expenditure needs beyond March 31, 2002.
In addition to the continuing risks related to the Company's future liquidity,
the Company also faces numerous other risks associated with its industry. These
risks include dependence on new platform introductions by hardware
manufacturers, new product introductions by the Company, product delays, rapidly
changing technology, intense competition, dependence on distribution channels
and risk of customer returns.
The Company's consolidated financial statements have been presented on the
basis that the Company is a going concern. Accordingly, the consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities or any other adjustments that might result should
the Company be unable to continue as a going concern.
Note 2. Inventories
Inventories consist of the following:
March 31, December 31,
2001 2000
--------- -----------
(Dollars in thousands)
Packaged software $2,992 $2,628
CD-ROMs, cartridges, manuals, packaging and supplies 513 731
------ ------
$3,505 $3,359
====== ======
Note 3. Current Debt
Current debt consists of the following:
March 31, December 31,
2001 2000
--------- -----------
(Dollars in thousands)
Loan agreement $24,106 $24,433
Supplemental line of credit from Titus 3,075 1,000
------- -------
$27,181 $25,433
======= =======
Loan Agreement
Borrowings under the Loan and Security Agreement ("Loan Agreement") bear
interest at LIBOR (5.29 percent at March 31, 2001 and 6.78 percent at
December 31, 2000) plus 4.87 percent (10.16 percent at March 31, 2001 and 11.65
percent at December 31, 2000). The Loan Agreement provided for maximum
borrowings of $25 million, limited to $7 million in excess of its borrowing
base, which was based on qualifying receivables and inventory. At March 31,
2001, the Company had availability of $900,000 on its line of credit. In
addition, the Company was required to maintain the $5 million personal guarantee
from the Company's Chairman and Chief Executive Officer ("Chairman") and Titus
was required to provide a $20 million corporate guarantee. In April 2001, the
Company replaced its line of credit under a loan and security agreement with a
new bank (see Note 10).
Supplemental line of credit from Titus
In April 2000, the Company secured a $5 million supplemental line of credit
with Titus expiring in May 2001. Amounts borrowed under this line are subject
to interest at the maximum legal rate for parties other than financial
institutions, currently 10 percent per annum, payable quarterly. In connection
with this line of credit, Titus received a warrant for up to 100,000 shares of
the Company's Common Stock at $3.79 per share that will expire in April 2010 and
is exercisable if and to the extent that the Company borrows under the line of
credit, as defined. The Company's availability under the supplemental line of
credit was approximately $2 million as of March 31, 2001. In April 2001, the
total outstanding balance plus accrued interest in the aggregate amount of
approximately $3.1 million was paid in full and the commitment under the
supplemental line of credit terminated (see Note 10).
7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 4. Commitments and Contingencies
The Company and the former owner of Shiny Entertainment ("Shiny") had a
dispute over additional cash payments upon the delivery and acceptance of
interactive entertainment software titles that Shiny was committed to deliver
over time. In March 2001, the Company entered into an amendment to the Shiny
purchase agreement which, among other things, settled the dispute with the
former owner of Shiny, and provided for the Company to acquire the remaining
nine percent equity interest in Shiny for $600,000 payable in installments of
cash and stock. The amendment also provided for additional cash payments to the
former owner of Shiny for two interactive entertainment software titles to be
delivered in the future. The former owner of Shiny will earn royalties after the
future delivery of the two titles to the Company.
Virgin Interactive Entertainment Limited ("Virgin") had disputed an amendment
effective as of January 2000 to the International Distribution Agreement with
the Company, and claimed that the Company was obligated, among other things, to
pay a contribution to their overhead of up to $9.3 million annually, subject to
reductions by the amount of commissions earned by Virgin on its distribution of
the Company's products. The Company settled this dispute with Virgin in April
2001 (see Note 10).
In March 2001, the Company entered into a supplement to a licensing agreement
under which it received an advance of $5 million. The advance is to be repaid
at $20 per unit upon the sale of product under this agreement, as defined. If
the full amount of the advance is not paid by June 2003, then the remaining
outstanding balance is subject to interest at the prime rate plus one percent.
This advance has been included in accrued liabilities on the accompanying
consolidated balance sheet.
Note 5. Stockholders' Equity
In April 2001, the Company completed a private placement of 8,126,770 shares
of Common Stock for $12.7 million, and received net proceeds of approximately
$11.5 million. The shares were issued at $1.5625 per share, and included
warrants to purchase one share of Common Stock for each share sold. The warrants
are exercisable at $1.75, and one half of the warrants can be exercised
immediately with the other half exercisable after June 27, 2001, only if prior
to this date, the Company's Common Stock as reported by Nasdaq does not exceed
$2.75 for a period of 20 consecutive trading days during the 90 day period
following the closing. The warrants must be exercised by the holder if the
Company's Common Stock trades at or above $3.00 during such period. If the
Company issues additional shares of Common Stock at a per share price below the
exercise price of the warrants, then the warrants are to be repriced, as
defined, subject to stockholder approval. The warrants expire in April 2006. The
transaction provides for registration rights with a registration statement to be
filed by April 16, 2001 and become effective by May 31, 2001. In the event that
the filing and effective dates of the registration statement are not met, the
Company is subject to a two percent penalty per month, payable in cash or stock,
until the filing and effective dates are met. (see Note 10).
Note 6. Net Loss Per Share
Basic net loss per share is calculated by dividing net loss available to
common stockholders by the weighted average number of common shares outstanding
and does not include the impact of any potentially dilutive securities. Diluted
net loss per share is the same as basic net loss per share because the effect of
outstanding stock options and warrants is anti-dilutive.
The impact of the Preferred Stock conversion rights into Common Stock shares
were excluded from the loss per share computation at March 31, 2001 and 2000.
There were options and warrants outstanding to purchase 4,489,967 and 3,561,780
shares of Common Stock at March 31, 2001 and 2000, respectively, and there were
484,848 shares of restricted Common Stock at March 31, 2001 and 2000, which were
excluded from the loss per share computation. The weighted average exercise
price of the outstanding options and warrants at March 31, 2001 and 2000 was
$3.04 and $3.23, respectively.
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 7. Comprehensive Loss
Comprehensive loss consists of the following:
Three Months Ended
March 31,
----------------------
2001 2000
-------- --------
(Dollars in thousands)
Net loss $(8,422) $(5,498)
Other comprehensive loss, net of income taxes:
Foreign currency translation adjustments (22) 4
-------- --------
Total comprehensive loss $(8,444) $(5,494)
======== ========
During the three months ended March 31, 2001 and 2000, the net effect of
income taxes on comprehensive loss was immaterial.
Note 8. Related Parties
Distribution and Publishing Agreements
In connection with the amended International Distribution Agreement with
Virgin, the Company incurred distribution commission expense of $241,000 and
$772,000 for the three months ended March 31, 2001 and 2000, respectively.
In connection with the Product Publishing Agreement with Virgin, the Company
earned $20,000 and zero for performing publishing and distribution services on
behalf of Virgin during the three months ended March 31, 2001 and 2000,
respectively. As part of terms of the April 2001 settlement between Virgin and
the Company, the Product Publishing Agreement was amended to provide for the
Company to publish only one future title developed by Virgin (see Note 10).
As of March 31, 2001 and December 31, 2000, Virgin owed the Company $9.3
million and $12.1 million and the Company owed Virgin $6.9 million and $4.8
million, respectively. The net amounts due to the Company from Virgin as of
December 31, 2000, were paid in full in April 2001.
The Company performs distribution services on behalf of Titus for a fee. In
connection with such distribution services during the three months ended
March 31, 2001 and 2000, the Company recognized distribution fee revenue of
$20,000 and $400,000, respectively.
As of March 31, 2001 and December 31, 2000, Titus owed the Company $272,000
and $280,000 and the Company owed Titus $3.1 million and $1.1 million,
respectively, including amounts owed under the supplemental line of credit (see
Note 3).
Investment in Affiliate
The Company accounts for its investment in VIE Acquisition Group LLC ("VIE")
in accordance with the equity method of accounting. The Company did not
recognize any material income or loss in connection with its investment in VIE
for the three months ended March 31, 2001 and 2000. In April 2001, VIE fully
redeemed the Company's membership interest in VIE in connection with the April
2001 settlement between Virgin and the Company.
9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 9. Segment and Geographical Information
The Company operates in one principal business segment. Information about the
Company's operations in the United States and foreign markets is presented
below:
Three Months Ended
March 31,
-------------------
2001 2000
-------- --------
Net revenues: (Dollars in thousands)
United States $ 17,313 $ 18,100
United Kingdom - 43
-------- --------
Consolidated net revenues $ 17,313 $ 18,143
======== ========
Operating loss:
United States $ (7,353) $ (4,205)
United Kingdom (301) (283)
-------- --------
Consolidated loss from operations $ (7,654) $ (4,488)
======== ========
Expenditures made for the acquisition
of long-lived assets:
United States $ 570 $ 711
United Kingdom 9 -
-------- --------
Total expenditures for
long-lived assets $ 579 $ 711
======== ========
Net revenues by geographic regions were as follows:
Three Months Ended March 31,
--------------------------------------------
2001 2000
------------------- --------------------
Amount Percent Amount Percent
------- ------- -------- --------
(Dollars in thousands)
North America $11,578 66.9 % $10,019 55.2 %
Europe 3,665 21.2 4,919 27.1
Rest of World 712 4.1 1,064 5.9
OEM, royalty and
licensing 1,358 7.8 2,141 11.8
------- ------ ------- -------
$17,313 100.0 % $18,143 100.0 %
======= ====== ======= =======
Net investments in long-lived assets by geographic regions were as follows:
March 31, December 31,
2001 2000
------------------- --------------------
Amount Percent Amount Percent
------- ------- -------- --------
(Dollars in thousands)
United States $ 6,689 98.0 % $ 6,139 97.8 %
United Kingdom 80 1.2 76 1.2
OEM, royalty and
licensing 56 0.8 60 1.0
------- ------ ------- -------
$ 6,825 100.0 % $ 6,275 100.0 %
======= ====== ======= =======
10
INTERPLAY ENTERTAINMENT CORP. AND SUSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 10. Subsequent Events
Replacement of Credit Facility
In April 2001, the Company entered into a new three year loan and security
agreement with a bank providing for a $15 million working capital line of
credit. Advances under the line are limited to an advance formula of qualified
accounts receivable and inventory, and bear interest at the bank's prime rate,
or at LIBOR plus 2.5% at the Company's option. The line is subject to review and
renewal by the bank on April 30, 2002 and 2003, and is secured by substantially
all of the Company's assets, plus a personal guarantee from the Chairman of $2
million, secured by $1 million in cash. The line requires that the Company meet
certain financial covenants set forth in the agreement. The funds available
from this transaction have been used to retire current debt under the Loan
Agreement (see Note 3) existing at March 31, 2001, and to fund future
operations.
Sale of Common Stock
In April 2001, the Company completed a private placement of 8,126,770 shares
of Common Stock for $12.7 million, and received net proceeds of approximately
$11.5 million. The shares were issued at $1.5625 per share, and included
warrants to purchase one share of Common Stock for each share sold. The warrants
are exercisable at $1.75 per share, and one-half of the warrants can be
exercised immediately with the other half exercisable after June 27, 2001, if
(and only if) the closing price of the Company's Common Stock as reported on
Nasdaq does not equal or exceed $2.75 for 20 consecutive trading days prior to
June 27, 2001. The Company may also require the holder to exercise the warrants
if the closing price of the Company's Common Stock as reported on Nasdaq does
not equal or exceed $3.00 for 20 consecutive trading days prior to June 27,
2001. The warrants expire in April 2006. The transaction provides for a
registration statement covering the shares sold or issuable upon exercise of
such warrants to be filed by April 16, 2001 and become effective by May 31,
2001. In the event that the filing and effective dates of the registration
statement are not met, the Company is subject to a two percent penalty per
month, payable in cash or stock, until the filing and effective dates are met.
The funds available from this transaction have been used to retire current debt
under the Loan Agreement (see Note 3) existing at March 31, 2001, and to fund
future operations.
Settlement of Dispute with Virgin Interactive Entertainment Limited
In April 2001, the Company settled a dispute with Virgin (see Note 4) and
amended the International Distribution Agreement, the Termination Agreement and
the Product Publishing Agreement entered into in February 10, 1999. As a result
of the settlement, Virgin dismissed its claim for overhead fees, VIE Acquisition
Group LLC ("VIE") fully redeemed the Company's membership interest in VIE and
Virgin paid the Company $3.1 million in net past due balances owed under the
International Distribution Agreement. In addition, the Company will pay Virgin
a one-time marketing fee of $333,000 for the period ending June 30, 2001 and the
monthly overhead fee was revised for the Company to pay $111,000 per month for a
nine month period beginning April 2001, and $83,000 per month for a six month
period beginning January 2002, with no further overhead commitment for the
remainder of the term of the International Distribution Agreement. The Company
used the $3.1 million to pay down its previous line of credit.
11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Unaudited Pro-forma Condensed Balance Sheet
In April 2001, current debt was reduced by approximately $18.7 million. The
following pro-forma balance sheet reflects the Company's financial position as
if the new financing, including the private placement of Common Stock, and the
new working capital line of credit had been completed as of March 31, 2001.
UNAUDITED PRO-FORMA CONDENSED
CONSOLIDATED BALANCE SHEET
March 31, 2001
Actual Adjustment Pro-forma
------------------------------------------------------
(Dollars in thousands)
ASSETS
------
Current Assets:
Cash $ 7,611 $ 11,546 (1)
3,132 (2)
3,000 (3)
(3,075)(5)
(18,606)(6) $ 3,608
Trade receivables, net 24,466 (7,926)(2) 16,540
Inventories 3,505 3,505
Prepaid licenses and royalties 17,962 17,962
Other 1,178 1,178
--------- ----------
Total current assets 54,722 42,793
--------- ----------
Property and Equipment, net 5,377 5,377
Other Assets 1,448 1,448
--------- ----------
$ 61,547 $ 49,618
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Current debt $ 27,181 $ (3,000)(3)
5,500 (4)
(5,500)(4)
3,075 (5)
18,606 (6) $ 8,500
Accounts payable 16,374 4,794 (2) 11,580
Accrued liabilities 20,029 20,029
--------- ----------
Total current liabilities 63,584 40,109
--------- ----------
Commitments and Contingencies
Stockholders' Equity:
Series A Preferred stock, $.001 par value,
authorized 5,000,000 shares;
issued and outstanding 719,424 shares 21,103 21,103
Common stock, $.001 par value,
authorized 100,000,000 shares;
issued and outstanding 30,160,262 and
38,287,032 proforma shares 30 (8)(1) 38
Paid-in capital 88,768 (11,538)(1) 100,306
Accumulated deficit (112,180) (112,180)
Accumulated other comprehensive income 242 242
--------- ----------
Total stockholders' equity (2,037) 9,509
--------- ----------
$ 61,547 $ 49,618
========= ==========
- ---------------
(1) Company received net cash proceeds of $11.5 million from its private
placement of Common Stock.
(2) Company received net cash proceeds of $3.1 million from Virgin, which
represents payment in full of $7.9 million owed to the Company and payment
of $4.8 million owed to Virgin.
(3) Company received a $3 million loan from its Chairman.
(4) Company borrowed $5.5 million from its new line of credit to pay down its
old line of credit.
(5) Company used $3.1 million in cash to payoff Titus supplemental line of
credit.
(6) Company used $18.6 million of cash to payoff its old line of credit.
Loan from Chairman and Chief Executive Officer
In April 2001, the Chairman provided the Company with a $3 million loan,
payable in May 2002, with interest at 10 percent. In connection with this loan
to the Company and the $2 million guarantee on behalf of the Company for the new
credit facility, the Chairman received warrants to purchase 500,000 shares of
the Company's Common Stock at $1.75 per share, expiring in April 2011.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement
The information contained in this Form 10-Q is intended to update the
information contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 2000 and presumes that readers have access to, and will have
read, the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other information contained in such Form 10-K.
This Form 10-Q contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
and Exchange Act of 1934 and such forward-looking statements are subject to the
safe harbors created thereby. For this purpose, any statements contained in
this Form 10-Q, except for historical information, may be deemed to be forward-
looking statements. Without limiting the generality of the foregoing, words
such as "may," "will," "expect," "believe," "anticipate," "intend," "could,"
"should," "estimate" or "continue" or the negative or other variations thereof
or comparable terminology are intended to identify forward-looking statements.
In addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
financing activities, cost reduction measures, compliance with the Company's
line of credit and an extension or replacement of such line are forward-looking
statements and there can be no assurance that the Company will achieve its
operating plans, generate positive cash flow in the future or that the Company
will be able to obtain financing on satisfactory terms, if at all, or that any
cost reductions effected by the Company will be sufficient to offset any
negative cash flow from operations or that the Company will remain in compliance
with its line of credit or be able to renew or replace such line. Additional
risks and uncertainties include possible delays in the completion of products,
the possible lack of consumer appeal and acceptance of products released by the
Company, fluctuations in demand, lost sales because of the rescheduling of
products launched or orders delivered, failure of the Company's markets to
continue to grow, that the Company's products will remain accepted within their
respective markets, that competitive conditions within the Company's markets
will not change materially or adversely, that the Company will retain key
development and management personnel, that the Company's forecasts will
accurately anticipate market demand, that there will be no material adverse
change in the Company's operations or business. Additional factors that may
affect future operating results are discussed in more detail in "Factors
Affecting Future Performance," below as well as the Company's Annual Report on
Form 10-K on file with the Securities and Exchange Commission. Assumptions
relating to the foregoing involve judgments with respect to, among other things,
future economic, competitive and market conditions, and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond the control of the Company. Although the Company
believes that the assumptions underlying the forward-looking statements are
reasonable, the business and operations of the Company are subject to
substantial risks that increase the uncertainty inherent in the forward-looking
statements, and the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved. In addition, risks, uncertainties and
assumptions change as events or circumstances change. The Company disclaims any
obligation to publicly release the results of any revisions to these forward-
looking statements which may be made to reflect events or circumstances
occurring subsequent to the filing of this Form 10-Q with the SEC or otherwise
to revise or update any oral or written forward-looking statement that may be
made from time to time by or on behalf of the Company.
13
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,
------------------------------------------
2001 2000
------------------ --------------------
% of Net % of Net
Amount Revenues Amount Revenues
------- -------- -------- --------
(Dollars in thousands)
Net revenues $17,313 100.0% $18,143 100.0%
Cost of goods sold 10,485 60.6% 9,572 52.8%
------- -------- -------- --------
Gross profit 6,828 39.4% 8,571 47.2%
------- -------- -------- --------
Operating expenses:
Marketing and sales 6,623 38.3% 4,863 26.8%
General and administrative 2,478 14.3% 2,561 14.1%
Product development 5,381 31.1% 5,635 31.1%
Total operating expenses 14,482 83.7% 13,059 72.0%
------- -------- -------- --------
Operating loss (7,654) -44.1% (4,488) -24.6%
Other expense 768 4.4% 1,010 5.6%
------- -------- -------- --------
Net loss $(8,422) -48.5% $(5,498) -30.2%
======= ======== ======== ========
Net revenues by geographic region:
North America $11,578 66.9% $10,019 55.2%
International 4,377 25.3% 5,983 33.0%
OEM, royalty and licensing 1,358 7.8% 2,141 11.8%
Net revenues by platform:
Personal computer $12,285 71.0% $12,962 71.4%
Video game console 3,670 21.2% 3,040 16.8%
OEM, royalty and licensing 1,358 7.8% 2,141 11.8%
North American, International and OEM, Royalty and Licensing Net Revenues
Overall, net revenues for the three months ended March 31, 2001 decreased 5
percent compared to the same period in 2000. The increase in North American net
revenues for the three months ended March 31, 2001 was primarily due to higher
sales volume on fewer title releases across multiple platforms this year as
compared to last year and increased revenue from the Company's back-catalog of
PC based titles. The Company believes that this results from the Company's
efforts of a more focused product planning and release schedule of less, but
higher quality titles and increased promotion and retail sell-through of
previously released titles. The Company expects that future North American net
revenues in 2001 will increase compared to 2000. The 27 percent decrease in
international net revenues was primarily due to releasing only the English
version of Fallout Tactics (PC) in the applicable international territories. The
Company expects to release foreign language versions of this title in the second
quarter of 2001. The Company expects that international net revenues in 2001
will increase compared to 2000. OEM, royalty and licensing net revenues
decreased 37 percent in the three months ended March 31, 2001 compared to the
same period in 2000 due primarily to a decrease in the volume of transactions
resulting from the general market decrease in personal computer sales affecting
this sector of the business. The Company expects that future OEM, royalty and
licensing net revenues in 2001 will increase as compared to 2000.
Platform Net Revenues
PC net revenues decreased 5 percent during the three months ended March 31,
2001 compared to the same period in 2000. The Company released two titles in the
2001 period, Icewind Dale: Heart of Winter and Fallout Tactics, as compared to
nine titles in the 2000 period. The decrease in net PC revenues from fewer title
releases and higher than anticipated returns was partially offset by the 2001
period titles having higher sales volume as compared to the 2000 period title
releases. The Company believes that this is a result of the Company's efforts of
a more focused product planning and release schedule of less, but higher quality
titles. Furthermore, the decrease in net PC revenues for the 2001 period was
attributable to releasing only the English version of Fallout Tactics in the
applicable international territories. The Company expects to
14
the release of foreign language versions of this title in the second quarter of
2001. The Company expects its PC net revenues to decrease in 2001 compared to
2000 due to its increased focus on next generation console titles. Video game
console net revenues increased 21 percent in the three months ended March 31,
2001 compared to the same period in 2000 due to higher unit sales and strong
sales of previously released back catalog product. The Company released one
video game console title MDK 2: Armageddon, in North America during the three
months ended March 31, 2001 compared to one worldwide title release and one
North America title release in the same period last year. The Company expects to
release the localized versions of this title in the second quarter of 2001. The
Company expects its video game console net revenues to increase in 2001 compared
to 2000 as a result of a substantial increase in planned major title releases
for new generation game consoles in 2001.
Cost of Goods Sold; Gross Profit Margin
Cost of goods sold increased and gross profit margin decreased in the three
months ended March 31, 2001 compared to the same period in 2000 due to increased
sales of console product which normally have higher cost of goods than PC and
higher amortization of prepaid royalties on externally developed products,
including approximately $750,000 in write-offs of canceled development projects.
The Company expects its cost of goods sold to increase in the second half of
2001 as compared to 2000 due to an expected higher net revenues base and a
higher proportion of console titles released. The Company expects its gross
profit margin in 2001 to decrease as compared to 2000 due to an increase in
console title releases which typically have a higher cost of goods relative to
net revenues. However, the Company expects to have higher gross profit in
absolute dollars on an increased net revenue base in 2001 compared to 2000.
Marketing and Sales
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. The increase in marketing
and sales expenses for the three months ended March 31, 2001 compared to the
2000 period is attributable primarily to increased world-wide advertising and
retail marketing support expenditures that increased promotion and retail sell-
through of previously released titles. The Company expects its marketing and
sales expenses to increase in 2001 as compared to 2000, due to decreased
advertising and retail marketing support expenditures and lower personnel costs,
offset by the overhead fees payable to Virgin in 2001, in connection with the
terms of the April 2001 settlement between Virgin and the Company.
General and Administrative
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended March 31, 2001 were slightly less than the same three month
period last year. The Company is continuing its efforts to reduce North
American operating expenses and expects its general and administrative expenses
to decrease in 2001 as compared to 2000.
Product Development
Product development expenses, which primarily consist of personnel and support
costs, are charged to operations in the period incurred. The decrease in product
development expenses for the three months ended March 31, 2001 is primarily due
to higher expenditures in the 2000 period associated with resources dedicated to
completing one major internally developed title, which did not recur in the
current period. The Company expects its product development expenses to remain
approximately constant in absolute dollars in 2001 as compared to 2000.
Other Expense, net
Other expense consists primarily of interest expense on the Company's line of
credit and foreign currency exchange transaction losses. Other expense
decreased in the three months ended March 31, 2001 compared to the same period
in 2000 due to decreased interest expense on lower total debt.
15
Liquidity and Capital Resources
The Company has funded its operations to date primarily through the use of
lines of credit, from royalty and distribution fee advances, through cash
generated by the private sale of securities, from its proceeds of the initial
public offering and from results of operations.
As of March 31, 2001 the Company's principal sources of liquidity included
cash of $7.6 million and availability under the Company's lines of credit. In
April 2001, the Company repaid all amounts outstanding on its lines of credit,
such lines of credit were terminated and the Company secured a new line of
credit from a bank bearing interest at the lender's prime rate, or at LIBOR plus
2.5 percent, at the Company's option. Such line of credit provides for
borrowings and letters of credit of up to $15 million based in part upon
qualifying receivables and inventory. Under the line of credit the Company is
required to maintain a $2 million personal guarantee by the Company's Chairman
and Chief Executive Officer ("Chairman"). Such line of credit has a term of
three years, subject to review and renewal by the bank on April 30 of each year.
In addition, in April 2001, the Company completed a private placement of
8,126,770 shares of Common Stock for $12.7 million, and received net proceeds of
approximately $11.5 million. The shares were issued at $1.5625 per share, and
included warrants to purchase one share of Common Stock for each share sold. The
warrants are exercisable at $1.75 per share, and one-half of the warrants can be
exercised immediately with the other half exercisable after June 27, 2001, if
(and only if) the closing price of the Company's Common Stock as reported on
Nasdaq does not equal or exceed $2.75 for 20 consecutive trading days prior to
June 27, 2001. The Company may also require the holder to exercise the warrants
if the closing price of the Company's Common Stock as reported on Nasdaq equals
or exceeds $3.00 for 20 consecutive trading days prior to June 27, 2001. The
warrants expire in March 2006. The transaction provides for a registration
statement covering the shares sold or issuable upon exercise of such warrants to
be filed by April 16, 2001 and become effective by May 31, 2001. In the event
that the filing and effective dates of the registration statement are not met,
the Company is subject to a two percent penalty per month, payable in cash or
stock, until the filing and effective dates are met.
In April 2001, the Chairman provided the Company with a $3 million loan,
payable in May 2002, with interest at 10 percent. In connection with this loan
to the Company and the $2 million guarantee he provided under the new line of
credit from a bank, the Chairman received warrants to purchase 500,000 shares of
the Company's Common Stock at $1.75 per share, expiring in April 2011.
The Company's primary capital needs have historically been to fund working
capital requirements necessary to fund its net losses, its sales growth, the
development and introduction of products and related technologies and the
acquisition or lease of equipment and other assets used in the product
development process. The Company's operating activities used cash of $1.4
million during the three months ended March 31, 2001, primarily attributable to
the net loss for the year, partially offset by a decrease in accounts receivable
and an increase in accounts payable. Cash provided by financing activities of
$6.8 million for the three months ended March 31, 2001 consisted primarily of
the proceeds from an advance for the development of future titles on a next
generation video game console and borrowings on the Company's line of credit.
Cash used in investing activities of $0.6 million for the three months ended
March 31, 2001 consisted of normal capital expenditures, primarily for office
and computer equipment used in Company operations. The Company does not
currently have any material commitments with respect to any future capital
expenditures.
To reduce the Company's working capital needs, the Company has implemented
various measures including a reduction of personnel, a reduction of fixed
overhead commitments, and has scaled back certain marketing programs. The
Company will continue to pursue various alternatives to improve future operating
results, including further expense reductions as long as they do not have an
adverse impact on its ability to generate successful future business activities.
The Company believes that funds available under its new line of credit,
amounts received from the equity financings transactions discussed above,
amounts to be received under various product license and distribution agreements
and anticipated funds from operations should be sufficient to satisfy the
Company's projected working capital and capital expenditure needs in the normal
course of business at least through March 31, 2002. See "Factors Affecting
Future Performance--We may need to raise additional capital in the future."
16
FACTORS AFFECTING FUTURE PERFORMANCE
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. Some of the risks and uncertainties which may
cause our operating results to vary from anticipated results or which may
materially and adversely affect its operating results are as follows:
We may need to raise additional capital in the future.
We used net cash in operations of $1.4 million and $23.2 million during the
three months ended March 31, 2001 and the year ended December 31, 2000,
respectively. At March 31, 2001, we have negative working capital of $8.9
million. We cannot assure you that we will ever generate positive cash flow from
operations. Our ability to fund our capital requirements out of our available
cash, lines of credit and cash generated from our operations depends on a number
of factors. Some of these factors include the progress of our product
development programs, the rate of growth of our business, and our products'
commercial success. If we issue additional equity securities, our existing
stockholders could suffer a large amount of dilution in their ownership. In the
event we have to raise additional working capital from other sources, we cannot
assure you that we will be able to raise additional working capital on
acceptable terms, if at all. In the event we cannot raise additional working
capital, we would have to take additional actions to continue to reduce our
costs, including selling or consolidating certain operations, delaying,
canceling or scaling back product development and marketing programs and other
actions. These measures could materially and adversely affect our ability to
publish successful titles, and these measures may not be enough to generate
operating profits. We might have to get the approval of other parties, including
our senior lender and/or Titus, for some of these measures, and we cannot assure
you that we would be able to obtain those approvals. In addition, there is a
risk that our Common Stock may be delisted from the Nasdaq National Market (see
"If we are unable to maintain our listing on the Nasdaq National Market, our
stock price could be harmed significantly," below). If such delisting were to
occur, our ability to raise equity capital could be significantly impaired.
Our business is highly seasonal, and our operating results may fluctuate
significantly in future periods.
Our operating results have fluctuated a great deal in the past and will
probably continue to fluctuate significantly in the future, both on a quarterly
and an annual basis. Many factors may cause or contribute to these
fluctuations, and many of these factors are beyond our control. Some of these
factors include the following:
. delays in shipping our products
. demand for our products
. demand for our competitors' products
. the size and rate of growth of the market for interactive entertainment
software
. changes in PC and video game console platforms
. the number of new products and product enhancements released by us and our
competitors
. changes in our product mix
. the number of our products that are returned
. the timing of orders placed by our distributors and dealers
. the timing of our development and marketing expenditures
. price competition
. the level of our international and OEM, royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which we
will ship our products. Some of these factors include:
. the uncertainties associated with the interactive entertainment software
development process
. long manufacturing lead times for Nintendo-compatible products
. possible production delays
. the approval process for products compatible with video game consoles such
as those from Sony Computer Entertainment, Nintendo, Sega and Microsoft
. approvals required from content and technology licensors
. the timing of the release and market penetration of new game hardware
platforms.
17
Because of the limited number of products we introduce in any particular
quarter, a delay in the introduction of a product may materially and adversely
affect our operating results for that quarter, and may not be recaptured in
later quarters. Such delays have had a significant adverse effect on our
operating results in certain past quarters. A significant portion of our
operating expenses is relatively fixed, and planned expenditures are based
largely on sales forecasts. If net revenues do not meet our expectations in any
given quarter, operating results may be materially adversely affected. The
interactive entertainment software industry is highly seasonal, with the highest
levels of consumer demand occurring during the year-end holiday buying season.
As a result, our net revenues, gross profits and operating income have
historically been highest during the second half of the year. The impact of
this seasonality will increase as we rely more heavily on game console net
revenues in the future. Revenues are also materially affected by new product
releases. Our failure or inability to introduce products on a timely basis to
meet these seasonal increases in demand may have a material adverse effect on
our business, operating results and financial condition.
We may over time become increasingly affected by the industry's seasonal
patterns. Although we seek to reduce the effect of such seasonal patterns on
our business by distributing our product release dates more evenly throughout
the year, we cannot assure you that these efforts will be successful. We cannot
assure you that we will be profitable in any particular period given the
uncertainties associated with software development, manufacturing, distribution
and the impact of the industry's seasonal patterns on our net revenues.
As a result of the foregoing factors it is possible that our operating results
in one or more future periods will fail to meet or exceed the expectations of
securities analysts or investors. In that event, the trading price of our
Common Stock would likely be materially adversely affected.
We have incurred significant net losses in recent periods, which may continue in
the future.
We have experienced significant net losses in recent periods, including losses
of $8.4 million and $12.1 million for the three months ended March 31, 2001 and
the year ended December 31, 2000, respectively. These losses resulted largely
from lower than expected worldwide sales of certain title releases, as well as
from operating expense levels that were high relative to our revenue level. We
may experience similar problems in current or future periods and we may not be
able to generate sufficient net revenues or adequate working capital, or bring
our costs into line with revenues, so as to attain or sustain profitability in
the future.
If we fail to introduce new products on a timely basis, or if our products
contain defects, our business could be harmed significantly.
Our products typically have short life cycles, and we depend on the timely
introduction of successful new products to generate net revenues, to fund
operations and to replace declining net revenues from older products. These new
products include enhancements of or sequels to our existing products and
conversions of previously released products to additional platforms. If in the
future, for any reason, net revenues from new products fail to replace declining
net revenues from existing products, our business, operating results and
financial condition could be materially adversely affected. The timing and
success of new interactive entertainment software product releases remains
unpredictable due to the complexity of product development, including the
uncertainty associated with new technology. The development cycle of new
products is difficult to predict but typically ranges from 12 to 24 months with
six to 12 months for adapting a product to a different technology platform. The
success of any particular software product can also be negatively impacted by
delays in the introduction, manufacture or distribution of the platform for
which the product was developed (see "If we fail to anticipate changes in video
game platforms and technology, our business will be harmed."). In the past, we
have frequently experienced significant delays in the introduction of new
products, including certain products currently under development. Because net
revenues associated with the initial shipments of a new product generally
constitute a high percentage of the total net revenues associated with a
product, any delay in the introduction of, or the presence of a defect in, one
or more new products expected in a period could have a material adverse effect
on the ultimate success of these products and on our business, operating results
and financial condition. The cost of developing and marketing new interactive
entertainment software has increased in recent years due to such factors as the
increasing complexity and content of interactive entertainment software, the
increasing sophistication of hardware technology and consumer tastes and the
increasing costs of obtaining licenses for intellectual properties. We expect
this trend to continue. We cannot assure you that our new products will be
introduced on schedule, if at all, or that, if introduced, these products will
achieve significant market acceptance or generate significant net revenues for
us. In addition, software products as complex
18
as the ones we offer may contain undetected errors when first introduced or when
new versions are released. We cannot assure you that, despite testing prior to
release, errors will not be found in new products or releases after shipment,
resulting in loss of or delay in market acceptance. This loss or delay could
have a material adverse effect on our business, operating results and financial
condition.
If our products do not achieve broad market acceptance, our business could be
harmed significantly.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our new products will achieve significant market acceptance, or
that we will be able to sustain this acceptance for a significant length of time
if we achieve it. We also cannot assure you that product life cycles will be
sufficient to permit us to recover product development and other associated
costs. 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.
We believe that these trends will continue in our industry and that our future
revenue will continue to be dependent 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 have a material adverse effect on our business,
operating results and financial condition. Further, if we do not achieve market
acceptance, we could be forced to accept substantial product returns or grant
significant markdown allowances to maintain our relationship with retailers and
our access to distribution channels. We cannot assure you that higher than
expected product returns and markdowns will not occur in the future. In the
event that we are forced to accept significant product returns or grant
significant markdown allowances, our business, operating results and financial
condition could be materially adversely affected.
Titus Interactive SA may exert a high degree of control over our management.
Titus currently owns 12,817,255 shares, or approximately 34 percent, of our
outstanding Common Stock, and 719,424 shares of our Series A Preferred Stock
that have voting power equivalent to up to 7,619,047 shares of Common Stock. As
such, Titus currently holds approximately 45 percent of the total voting power
of our stock. Commencing June 1, 2001, Titus may convert each such share, to the
extent not previously redeemed by us, into a number of shares of our Common
Stock determined by dividing $27.80 by the lesser of (a) $2.78 and (b) eighty-
five percent (85%) of the average closing price per share as reported by Nasdaq
for the twenty (20) trading days preceding the date of conversion. If converted
on May 1, 2001, the Series A Preferred Stock would be convertible into an
aggregate of approximately 14.9 million shares of our Common Stock. Titus also
holds warrants for up to 460,000 shares of our Common Stock, exercisable at
$3.79 per share, expiring in April 2010. In connection with Titus' investment,
Herve Caen, Titus' chairman and chief executive officer, serves as our president
and as a member of our Board of Directors, and Herve Caen's brother Eric Caen,
who is president and a director of Titus, also serves on our Board of Directors.
As a consequence, Titus holds significant voting power with respect to the
election of our Board of Directors and the right of approval of certain
significant corporate actions, and Herve Caen and Eric Caen have substantial
authority over our operations. Titus may, under certain circumstances, be able
to elect as many as four of the seven members of the Board of Directors. As
such, Titus may be able to exercise a high degree of control over our
management. This control could prevent or hinder a sale of the Company on terms
that are not acceptable to Titus. Moreover, Titus holds interests that may vary
from those of the Company and its other stockholders, and Titus may exercise its
control of the Company in the furtherance of such outside interests.
If we are unable to maintain our listing on the Nasdaq National Market, our
stock price could be harmed significantly.
Our Common Stock is currently quoted on the Nasdaq National Market under the
symbol "IPLY." For continued inclusion on the Nasdaq National Market, a company
must meet certain tests, including a minimum bid price of $1.00 and net tangible
assets of at least $4 million. As of December 31, 1999, we were not in
compliance with the minimum net tangible assets requirement, and did not return
to compliance with that requirement until April 14, 2000. We were subject to a
hearing before a Nasdaq Listing Qualifications Panel, which determined to
continue the listing of our Common Stock on the Nasdaq National Market subject
to certain conditions, all of which we have fulfilled. As of March 31, 2001, we
were not in compliance with the minimum net tangible assets requirement, and
19
did not return to compliance with that requirement until April 10, 2001. If we
fail to satisfy the listing standards on a continuous basis, our Common Stock
may be removed from listing on the Nasdaq National Market. If our Common Stock
were delisted from the Nasdaq National Market, trading of our Common Stock, if
any, would be conducted on the Nasdaq Small Cap Market, in the over-the-counter
market on the so-called "pink sheets" or, if available, the NASD's "Electronic
Bulletin Board." In any of those cases, investors could find it more difficult
to buy or sell, or to obtain accurate quotations as to the value of, our Common
Stock. The trading price per share of our Common Stock would most likely be
reduced as a result.
In addition, Nasdaq requires that a company's Audit Committee have two
members, and beginning June 14, 2001 will require three. Our Audit Committee
currently has two members. As such, we will have to identify and secure the
services of an additional suitable candidate for our Audit Committee in order to
maintain compliance with this listing requirement. Any failure to do so could
lead to our Common Stock being delisted from the Nasdaq National Market.
Our Distribution Agreement with Virgin subjects us to certain risks.
In connection with our acquisition of a 43.9 percent membership interest in
VIE Acquisition Group LLC ("VIE"), the parent entity of Virgin Interactive
Entertainment Limited ("Virgin"), in February 1999, we signed an International
Distribution Agreement with Virgin. Under this Agreement, we appointed Virgin
as our exclusive distributor for substantially all of our products in Europe,
the CIS, Africa and the Middle East, subject to certain reserved rights, for a
seven-year period. We pay Virgin a distribution fee for marketing and
distributing our products, as well as certain direct costs and expenses. Virgin
has been inconsistent in meeting its obligations to deliver to us the proceeds
obtained from their distribution of our products. Because of the exclusive
nature of the Agreement, if Virgin were to continue to be inconsistent in
meeting its obligations to deliver to us proceeds from distribution, or were to
experience problems with its business, or otherwise to fail to perform under the
Agreement, our business, operating results and financial condition could be
materially and adversely affected.
In the April 2001 settlement between Virgin and us, VIE fully redeemed our
membership interest in VIE. In addition, Virgin paid us $3.1 million owed to us,
dismissed its claim for past overhead fees, reduced the minimum monthly overhead
fee payable to Virgin to $111,000 per month for the nine month period beginning
April 2001, and $83,000 per month for the six month period beginning January
2002, and eliminated the minimum overhead commitment commencing July 2002 and
for the remaining term of the International Distribution Agreement.
We are dependent on Third Party Software Developers, which subjects us to
certain risks.
We rely on third party interactive entertainment software developers for the
development of a significant number of our interactive entertainment software
products. As there continues to be high demand for reputable and competent
third party developers, we cannot assure you that third party software
developers that have developed products for us in the past will continue to be
available to develop products for us in the future. Many third party software
developers have limited financial resources, which could expose us to the risk
that such developers may go out of business prior to completing a project. In
addition, due to our limited control over third party software developers, we
cannot assure you that such developers will complete products for us on a timely
basis or within acceptable quality standards, if at all. Due to increased
competition for skilled third party software developers, we have had to agree to
make advance payments on royalties and guaranteed minimum royalty payments to
intellectual property licensors and game developers, and we expect to continue
to enter into these kinds of arrangements. If the products subject to these
arrangements do not have sufficient sales volumes to recover these royalty
advances and guaranteed payments, we would have to write-off unrecovered
portions of these payments, which could have a material adverse effect on our
business, operating results and financial condition. Further, we cannot assure
you that third party developers will not demand renegotiation of their
arrangements with us.
If we fail to anticipate changes in video game platforms and technology, our
business could be harmed.
The interactive entertainment software industry is subject to rapid
technological change. New technologies, including operating systems such as
Microsoft Windows 2000, technologies that support multi-player games, new media
formats such as on-line delivery and digital video disks ("DVDs") and recent
releases or planned releases in the near future of new video game platforms such
as the Sony Playstation 2, the Nintendo Gamecube and the Microsoft Xbox could
render our current products or products in development obsolete or unmarketable.
We must
20
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 software are not released on a
timely basis or do not attain significant market penetration, our business,
operating results and financial condition could be materially adversely
affected. Alternatively, if we fail to develop products for a platform that does
achieve significant market penetration, then our business, operating results and
financial condition could also be materially adversely affected.
The emergence of new interactive entertainment software platforms and
technologies and the increased popularity of new products and technologies may
materially and adversely affect the demand for products based on older
technologies. The broad range of competing and incompatible emerging
technologies may lead consumers to postpone buying decisions with respect to
products until one or more emerging technologies gain widespread acceptance.
This postponement could have a material adverse effect on our business,
operating results and financial condition. We are currently developing products
for Microsoft Windows, Sony PlayStation 2 and new platforms expected to be
introduced in 2001 by Microsoft and Nintendo. Our success will depend in part
on our ability to anticipate technological changes and to adapt our products to
emerging game platforms. We cannot assure you that we will be able to
anticipate future technological changes, to obtain licenses to develop products
for those platforms on favorable terms or to create software for those new
platforms. Any failure to do so could have a material adverse effect on our
business, operating results and financial condition.
Our industry is intensely competitive.
The interactive entertainment software industry is intensely competitive and
new interactive entertainment software programs and software platforms are
regularly introduced. Our competitors vary in size from small companies to very
large corporations with significantly greater financial, marketing and product
development resources than ours do. Due to these greater resources, certain of
our competitors can 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 we can. We believe that the main competitive factors
in the interactive entertainment software industry include:
. product features
. brand name recognition
. access to distribution channels
. quality
. ease of use, price, marketing support and quality of customer service.
We compete primarily with other publishers of PC and video game console
interactive entertainment software. Significant competitors include:
. Electronic Arts Inc.
. Activision, Inc.
. Infogrames Entertainment
. Microsoft Corporation
. LucasArts Entertainment Company
. Midway Games Inc.
. Acclaim Entertainment, Inc.
. Vivendi Universal Interactive Publishing
. Ubi Soft Entertainment Publishing
. The 3DO Company
. Take Two Interactive Software, Inc.
. Eidos PLC
. THQ Inc.
In addition, integrated video game console hardware/software companies such as
Sony Computer Entertainment, Nintendo, Microsoft Corporation and Sega compete
directly with us in the development of software titles for their respective
platforms. Large diversified entertainment companies, such as The Walt Disney
Company, many of
21
which own substantial libraries of available content and have substantially
greater financial resources, may decide to compete directly with us or to enter
into exclusive relationships with our competitors. We also believe that the
overall growth in the use of the Internet and on-line services by consumers may
pose a competitive threat if customers and potential customers spend less of
their available home PC time using interactive entertainment software and more
using the Internet and on-line services.
Retailers of our products typically have a limited amount of shelf space and
promotional resources, and there is intense competition among consumer software
producers, and in particular interactive entertainment software products, for
high quality retail shelf space and promotional support from retailers. To the
extent that the number of consumer software products and computer platforms
increases, competition for shelf space may intensify and may require us to
increase our marketing expenditures. Due to increased competition for limited
shelf space, retailers and distributors are in an increasingly better position
to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return policies. Our
products constitute a relatively small percentage of any retailer's sale volume,
and we cannot assure you that retailers will continue to purchase our products
or to provide our products with adequate levels of shelf space and promotional
support. A prolonged failure in this regard may have a material adverse effect
on our business, operating results and financial condition.
Our dependence on our distribution channels exposes us to certain risks.
We currently sell our products directly through our own sales force to mass
merchants, warehouse club stores, large computer and software specialty chains
through catalogs in the U.S. and Canada, as well as to certain distributors.
Outside North America, we generally sell products to third party distributors.
Our sales are made primarily on a purchase order basis, without long-term
agreements. The loss of, or significant reduction in sales to, any of our
principal retail customers or distributors could materially adversely affect our
business, operating results and financial condition.
The distribution channels through which publishers sell consumer software
products evolve continuously through a variety of means, including
consolidation, financial difficulties of certain distributors and retailers, and
the emergence of new distributors and new retailers such as warehouse chains,
mass merchants and computer superstores. As more consumers own PCs, the
distribution channels for interactive entertainment software will likely
continue to change. Mass merchants have become the most important distribution
channels for retail sales of interactive entertainment software. A number of
these mass merchants have entered into exclusive buying arrangements with other
software developers or distributors, which arrangements could prevent us from
selling certain of our products directly to that mass merchant. If the number
of mass merchants entering into exclusive buying arrangements with our
competitors were to increase, our ability to sell to such merchants would be
restricted to selling through the exclusive distributor. Because sales to
distributors typically have a lower gross profit than sales to retailers, this
would have the effect of lowering our gross profit. This trend could have a
material adverse impact on our business, operating results and financial
condition. In addition, emerging methods of distribution, such as the Internet
and on-line services, may become more important in the future, and it will be
important for us to maintain access to these channels of distribution. We
cannot assure you that we will maintain access or that our access will allow us
to maintain our historical sales volume levels.
Distributors and retailers in the computer industry have from time to time
experienced significant fluctuations in their businesses, and a number have
failed. The insolvency or business failure of any significant distributor or
retailer of our products could have a material adverse effect on our business,
operating results and financial condition. We typically make sales to
distributors and retailers on unsecured credit, with terms that vary depending
upon the customer and the nature of the product. Although we have insolvency
risk insurance to protect against our customers' bankruptcy, insolvency or
liquidation, this insurance contains a significant deductible and a co-payment
obligation, and the policy does not cover all instances of non-payment. In
addition, while we maintain a reserve for uncollectible receivables, the reserve
may not be sufficient in every circumstance. As a result, a payment default by
a significant customer could have a material adverse effect on our business,
operating results and financial condition.
We are exposed to the risk of product returns and markdown allowances with
respect to our distributors and retailers. We allow distributors and retailers
to return defective, shelf-worn and damaged products in accordance with
negotiated terms, and also offer a 90-day limited warranty to our end users that
our products will be free from manufacturing defects. In addition, we provide
markdown allowances to our customers to manage our customers' inventory levels
in the distribution channel. Although we maintain a reserve for returns and
markdown allowances,
22
and although our agreements with certain of our customers place certain limits
on product returns and markdown allowances, we could be forced to accept
substantial product returns and provide markdown allowances to maintain our
relationships with retailers and our access to distribution channels. Product
return and markdown allowances that exceed our reserves could have a material
adverse effect on our business, operating results and financial condition. We
could experience such high levels of product returns and markdown allowances in
future periods, which could have a material adverse effect on our business,
operating results and financial condition.
Sales of our Common Stock by our existing stockholders may harm the market for
our stock.
Universal Studios, Inc. currently holds 4,658,216 shares, or 12 percent, of
our outstanding Common Stock, all of which are in the process of being
registered for resale.
In 1999, we entered into two Stock Purchase Agreements with Titus, pursuant to
which Titus purchased 10,795,455 shares of our Common Stock from us for an
aggregate purchase price of $35 million. As part of the agreements, Titus'
chairman and chief executive officer became our president, and our chairman and
chief executive officer exchanged 2 million personal shares of our Common Stock
for an agreed upon number of Titus shares. As a result of these transactions,
Titus currently owns approximately 34 percent of our outstanding Common Stock.
In addition, Titus purchased 719,424 shares of Preferred Stock from us in
April 2000. The Preferred Stock is convertible by Titus, redeemable by us at
the purchase price under certain circumstances and accrues a six percent
dividend per year. Titus may convert each such share, to the extent not
previously redeemed by us, into a number of our Common Stock determined by
dividing $27.80 by the lesser of (a) $2.78 and (b) 85 percent of the average
closing price per share as reported by Nasdaq for the 20 trading days preceding
the date of conversion. If converted on May 1, 2001, the Series A Preferred
Stock would be convertible into an aggregate of approximately 14.9 million
shares of our Common Stock. Titus also holds warrants to purchase up to 460,000
shares of our Common Stock.
In April 2001, the Company completed a private placement of 8,126,770 shares
of Common Stock for $12.7 million, and received net proceeds of approximately
$11.5 million. The shares were issued at $1.5625 per share, and included
warrants to purchase one share of Common Stock for each share sold. The warrants
are exercisable at $1.75 per share, and one-half of the warrants can be
exercised immediately with the other half exercisable after June 27, 2001, if
(and only if) the closing price of the Company's Common Stock as reported on
Nasdaq does not equal or exceed $2.75 for 20 consecutive trading days prior to
June 27, 2001. The Company may also require the holder to exercise the warrants
if the closing price of the Company's Common Stock as reported on Nasdaq does
not equal or exceed $3.00 for 20 consecutive trading days prior to June 27,
2001. The warrants expire in April 2006. The transaction provides for a
registration statement covering the shares sold or issuable upon exercise of
such warrants to be filed by April 16, 2001 and become effective by May 31,
2001. In the event that the filing and effective dates of the registration
statement are not met, the Company is subject to a two percent penalty per
month, payable in cash or stock, until the filing and effective dates are met.
The funds available from this transaction have been used to retire current debt
under the Loan Agreement existing at March 31, 2001, and to fund future
operations.
Employees and directors (who are not deemed affiliates) hold options to buy
3,545,128 shares of Common Stock and warrants to buy 960,000 shares of Common
Stock, substantially all of which are eligible for immediate resale. In
addition, we may issue options to purchase up to an additional 1,280,027 shares
of Common Stock under our stock option plans, which we anticipate will be fully
saleable when issued.
In November 2000, we filed a registration statement to register 11,256,511
shares of Common Stock, and in April 2001, we filed registration statements to
register 37,053,316 shares of Common Stock. Sales of substantial amounts of
Common Stock into the public market could lower the market price of the Common
Stock significantly. Titus, our largest stockholder and the holder of Series A
Preferred Stock, and Company officers and directors may under certain
circumstances hold more than 60 percent of our outstanding Common Stock.
Although such persons are subject to certain restrictions on the transfer of
their Interplay stock, future sales by them could depress the market price of
the Common Stock. In addition, such sales could also negatively affect our
ability to raise capital through the sale of our equity securities, and could
increase the dilution to our stockholders resulting from any such sale.
We are subject to certain risks associated with the potential introduction of a
majority of Titus' Common Stock into the market.
We filed a registration statement covering the resale of 10,795,445 shares of
Common Stock held by Titus, which will give Titus the ability to sell such
shares on the public market. This number of shares represents approximately 28
percent of the outstanding shares of our Common Stock and all of the shares
issuable to Titus upon the exercise of its warrants. We have also filed a
registration statement to register for resale all of the shares of Common Stock
issuable to Titus upon conversion of the Series A Preferred Stock and all of
the shares issuable to Titus upon the exercise of its warrants. In the event
Titus sells these shares in the public market, such sales could lead to a
significant decrease in the public trading price of shares of our Common Stock.
Such a decrease in value would affect the price at which you could resell your
shares. Such an offering by Titus could also negatively affect our ability to
raise
23
capital through the sale of our equity securities, and could increase the
dilution to our stockholders resulting from any such sale. Further, because any
such sale would be made by our largest single stockholder, such sale might
create a negative perception of us and our securities. This perception may
heighten any negative effect on the trading price of our Common Stock and our
ability to raise capital through the sale of our equity securities.
We are dependent upon third party licenses of content for many of our products.
Many of our current and planned products, such as our Star Trek, Advanced
Dungeons and Dragons, Matrix and the Caesars Palace titles, are based on
original ideas or intellectual properties licensed from other parties. We
cannot assure you that we will be able to obtain new licenses, or renew existing
licenses, on commercially reasonable terms, if at all. For example, Viacom
Consumer Products, Inc. has granted the Star Trek license to another party upon
the expiration of our rights in 2002. If we are unable to obtain licenses for
the underlying content that we believe offers the greatest consumer appeal, we
would either have to seek alternative, potentially less appealing licenses, or
release the products without the desired underlying content, either of which
could have a material adverse effect on our business, operating results and
financial condition. We cannot assure you that acquired properties will enhance
the market acceptance of our products based on those properties. We also cannot
assure you that our new product offerings will generate net revenues in excess
of their costs of development and marketing or minimum royalty obligations, or
that net revenues from new product sales will meet or exceed net revenues from
existing product sales.
We are dependent on licenses from and manufacturing by hardware companies.
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo, Microsoft and
Sega. We cannot assure you that we will be able to obtain licenses from
hardware companies on acceptable terms or that any existing or future licenses
will be renewed by the licensors. In addition, Sony Computer Entertainment,
Nintendo, Microsoft and Sega each have the right to approve the technical
functionality and content of the Company's products for their respective
platforms prior to distribution. Due to the nature of the approval process, we
must make significant product development expenditures on a particular product
prior to the time we seek these approvals. Our inability to obtain these
approvals could have a material adverse effect on our business, operating
results and financial condition.
Hardware companies such as Sony Computer Entertainment, Nintendo, Sega and
Microsoft may impose upon their licensees a restrictive selection and product
approval process, such that those licensees are restricted in the number of
titles that will be approved for distribution on the particular platform. While
we have prepared our future product release plans taking this competitive
approval process into consideration, if we incorrectly predict its impact or
otherwise fail to obtain approvals for all products in our development plans,
this failure could have a material adverse effect on our business, operating
results and financial condition. We depend upon Sony Computer Entertainment,
Nintendo and Sega for the manufacture of our products that are compatible with
their respective video game consoles. As a result, Sony Computer Entertainment,
Nintendo, Sega and Microsoft have the ability to raise prices for supplying
these products at any time and effectively control the timing of our release of
new titles for those platforms. PlayStation and Dreamcast products consist of
CD-ROMs and are typically delivered by Sony Computer Entertainment and Sega,
respectively, within a relatively short lead time. Other media may entail
longer lead times depending on the manufacturer. If we experience unanticipated
delays in the delivery of video game console products from Sony Computer
Entertainment, Sega, Nintendo or Microsoft, or if actual retailer and consumer
demand for our interactive entertainment software differs from our forecast, our
business, operating results and financial condition could be materially
adversely affected.
We depend on our key personnel.
Our success depends to a significant extent on the continued service of our
key product design, development, sales, marketing and management personnel, and
in particular on the leadership, strategic vision and industry reputation of our
founder and Chief Executive Officer, Brian Fargo. Our future success will also
depend upon our ability to continue to attract, motivate and retain highly
qualified employees and contractors, particularly key software design and
development personnel. Competition for highly skilled employees is intense, and
we cannot assure you that we will be successful in attracting and retaining such
personnel. Specifically, we may experience
24
increased costs in order to attract and retain skilled employees. Our failure to
retain the services of Brian Fargo or other key personnel or to attract and
retain additional qualified employees could have a material adverse effect on
our business, operating results and financial condition.
Our significant international sales expose us to certain risks.
Our international net revenues accounted for 25 and 33 percent of our total
net revenues for the three months ended March 31, 2001 and 2000, respectively.
In February 1999, we entered into an International Distribution Agreement with
Virgin for the exclusive distribution of our products in selected international
territories. We intend to continue to expand our direct and indirect sales,
marketing and product localization activities worldwide. This expansion will
require a great deal of management time and attention and financial resources in
order to develop improved international sales and support channels. We cannot
assure you, however, that we will be able to maintain or increase international
market demand for our products. Our international sales and operations are
subject to a number of inherent risks, including the following:
. the impact of recessions in foreign economies
. the time and financial costs associated with translating and localizing
products for international markets
. longer accounts receivable collection periods
. greater difficulty in accounts receivable collection
. unexpected changes in regulatory requirements
. difficulties and costs of staffing and managing foreign operations
. foreign currency exchange rate fluctuations
. political and economic instability
. dependence on Virgin as an exclusive distributor for Europe.
These factors may have a material adverse effect on our future international
net revenues and, consequently, on our business, operating results and financial
condition. We currently do not engage in currency hedging activities and for
the three months ended March 31, 2001 and the year ended December 31, 2000, our
results were negatively impacted by $102,000 and $935,000, respectively due to
fluctuations in currency exchange rates. We cannot assure you that fluctuations
in currency exchange rates in the future will not have a material adverse effect
on net revenues from international sales and licensing, and thus on our
business, operating results and financial condition.
In addition, on January 1, 1999, eleven of the fifteen member countries of the
European Union established fixed conversion rates between their existing
sovereign currencies and a new European currency, the euro. These eleven
countries adopted the euro as the common legal currency on that date. We make a
significant portion of our sales to these countries. Consequently, we
anticipate that the euro conversion will, among other things, create technical
challenges to adapt information technology and other systems to accommodate
euro-denominated transactions. The euro conversion may also limit our ability
to charge different prices for our products in different markets. While we
anticipate that the conversion will not cause major disruption of our business,
the conversion may have a material effect on our business or financial
condition.
We may not be able to protect our proprietary rights.
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 the software engine for one of our titles. While
we provide "shrinkwrap" license agreements or limitations on use with our
software, it is uncertain to what extent these agreements and limitations are
enforceable. We are aware that some unauthorized copying occurs within the
computer software industry, and if a significantly greater amount of
unauthorized copying of our interactive entertainment software products were to
occur, our operating results could be materially adversely affected. While we
use copy protection on some of our products, we do not provide source code to
third parties unless they have signed nondisclosure agreements with respect to
that source code.
We rely on existing copyright laws to prevent unauthorized distribution of our
software. Existing copyright laws afford only limited protection. Policing
unauthorized use of our products is difficult, and software piracy can be a
persistent problem, especially in certain international markets. Further, the
laws of certain countries where our products are or may be distributed either do
not protect our products and intellectual property rights to the same
25
extent as the laws of the U.S. or are weakly enforced. Legal protection of our
rights may be ineffective in such countries, and as we leverage our software
products using emerging technologies, such as the Internet and on-line services,
our ability to protect our intellectual property rights and to avoid infringing
others' intellectual property rights may be diminished. We cannot assure you
that existing intellectual property laws will provide adequate protection for
our products in connection with these emerging technologies.
As the number of interactive entertainment software products in the industry
increases and the features and content of these products continues to overlap,
software developers may increasingly become subject to infringement claims.
Although we make reasonable efforts to ensure that our products do not violate
the intellectual property rights of others, we cannot assure you 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 receive
communications from third parties regarding such claims. We cannot assure you
that existing or future infringement claims against us will not result in costly
litigation or require us to 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.
Our software may be subject to governmental restrictions or rating systems.
Legislation is periodically introduced at the state and federal levels in the
U.S. 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. Such a system would include
procedures for interactive entertainment software publishers to identify
particular products within defined rating categories and communicate these
ratings to consumers through appropriate package labeling and through
advertising and marketing presentations. In addition, many foreign countries
have laws that permit governmental entities to censor the content of certain
works, including interactive entertainment software. In certain instances, we
may be required to modify our products to comply with the requirements of these
governmental entities, which could delay the release of those products in those
countries. Those delays could have a material adverse effect on our business,
operating results and financial condition. While we currently voluntarily
submit our products to industry-created review boards and publish their ratings
on our game packaging, we believe that mandatory government-run interactive
entertainment software products rating systems eventually will be adopted in
many countries that represent significant markets or potential markets for our
products. Due to the uncertainties inherent in the implementation of 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
certain 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 had a material adverse effect on our
business, operating results or financial condition, we cannot assure you that
similar actions by our distributors or retailers in the future would not have a
material adverse effect on our business, operating results and financial
condition.
Our directors and officers control a high percentage of our voting stock.
Including Titus, our directors and executive officers beneficially own voting
stock with total of approximately 45 percent of the aggregate Common Stock
voting power in the Company. In addition, Titus holds Preferred Stock entitled
to 7,619,047 votes, or approximately 20 percent of overall voting power, and in
the event Titus converts such shares into Common Stock, the resulting shares
could substantially increase Titus' voting power. These stockholders can
control substantially all matters requiring our stockholders' approval,
including the election of directors (subject to our stockholders' cumulative
voting rights) and the approval of mergers or other business combination
transactions. This concentration of voting power could discourage or prevent a
change in control.
We may not be able to successfully implement Internet-based product offerings.
We seek to establish an on-line presence by creating and supporting sites on
the Internet. Our future plans envision conducting and supporting on-line
product offerings through these sites or others. Our ability to successfully
establish an on-line presence and to offer online products will depend on
several factors outside our control. These factors include the emergence of a
robust online industry and infrastructure and the development and implementation
of technological advancements to the Internet to increase bandwidth to the point
that will allow us to conduct and support on-line product offerings. Because
global commerce and the exchange of information on the Internet and other
similar open, wide area networks are relatively new and evolving, we cannot
assure you that a viable commercial marketplace on the Internet will emerge from
the developing industry infrastructure or that the
26
appropriate complementary products for providing and carrying Internet traffic
and commerce will be developed. We also cannot assure you that we will be able
to create or develop a sustainable or profitable on-line presence or that we
will be able to generate any significant revenue from on-line product offerings
in the near future, if at all. If the Internet does not become a viable
commercial marketplace, or if this development occurs but is insufficient to
meet our needs or if such development is delayed beyond the point where we plan
to have established an on-line service, our business, operating results and
financial condition could be materially adversely affected.
Acquisitions may adversely affect our business.
As part of our strategy to enhance distribution and product development
capabilities, we intend to review potential acquisitions of complementary
businesses, products and technologies. Some of these acquisitions could be
material in size and scope. While we will continue to search for appropriate
acquisition opportunities, we cannot assure you that the Company will be
successful in identifying suitable acquisition opportunities. If we do identify
any potential acquisition opportunity, we cannot assure you that we will
consummate the acquisition, and if the acquisition does occur, we cannot assure
you that it will be successful in enhancing our business or will increase our
earnings. As the interactive entertainment software industry continues to
consolidate, we may face increased competition for acquisition opportunities,
which may inhibit our ability to complete suitable transactions or increase
their cost. Future acquisitions could also divert substantial management time,
result in short term reductions in earnings or special transactions or other
charges and may be difficult to integrate with existing operations or assets.
We may, in the future, issue additional shares of Common Stock in connection
with one or more acquisitions, which may dilute our stockholders. Additionally,
with respect to future acquisitions, our stockholders may not have an
opportunity to review the financial statements of the entity being acquired or
to vote on these acquisitions.
Provisions of our charter documents and Delaware law may prevent a change in
control.
Our Certificate of Incorporation and Bylaws, as well as Delaware corporate
law, contain certain provisions that could delay, defer or prevent a change in
control and could materially adversely affect the prevailing market price of our
Common Stock. Certain of these provisions impose various procedural and other
requirements that could make it more difficult for stockholders to take certain
corporate actions.
Our stock price is highly volatile.
The trading price of our Common Stock has been and could continue to be
subject to wide fluctuations in response certain factors, including:
. quarter to quarter variations in results of operations
. our announcements of new products
. our competitors' announcements of new products
. our product development or release schedule
. general conditions in the computer, software, entertainment, media or
electronics industries
. changes in earnings estimates or buy/sell recommendations by analysts
. investor perceptions and expectations regarding our products, plans and
. strategic position and those of our competitors and customers
. other events or factors
In addition, the public stock markets experience extreme price and trading
volume volatility, particularly in high technology sectors of the market. This
volatility has significantly affected the market prices of securities of many
technology companies for reasons often unrelated to the operating performance of
the specific companies. These broad market fluctuations may adversely affect
the market price of our Common Stock.
We do not pay dividends on our Common Stock.
We have not paid any cash dividends on our Common Stock and do not anticipate
paying dividends in the near future.
27
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of March 31, 2001.
However, we are exposed to certain market risks arising from transactions in the
normal course of business, principally the risk associated with interest rate
fluctuations on our revolving line of credit agreement, and the risk associated
with foreign currency fluctuations. We do not hedge our interest rate risk, or
our risk associated with foreign currency fluctuations.
Interest Rate Risk
Our working capital line of credit bears interest at either the bank's prime
rate or LIBOR, at our option. We have no fixed rate debt. As such, if interest
rates increase in the future, our operating results and cashflows could be
materially and adversely affected.
Foreign Currency Risk
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, primarily from Virgin. We have
recognized losses of $102,000 and $89,000 for the three months ended March 31,
2001 and 2000, respectively, and could recognize losses in the future in
connection with foreign exchange fluctuations in the timing of payments received
on accounts receivable from Virgin.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in various legal proceedings, claims and
litigation arising in the ordinary course of business, including
disputes arising over the ownership of intellectual property rights
and collection matters. In the opinion of management, the outcome of
known routine claims will not have a material adverse effect on the
Company's business, financial condition or results of operations.
28
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 14, 2001 By: /s/ BRIAN FARGO
-----------------------
Brian Fargo,
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: May 14, 2001 By: /s/ MANUEL MARRERO
---------------------
Manuel Marrero,
Chief Financial Officer
(Principal Financial and Accounting Officer)
29