UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Class Issued and Outstanding at August 8, 2003
----- ----------------------------------------
Common Stock, $0.001 par value 93,849,176
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2003
TABLE OF CONTENTS
--------------
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2003 (unaudited) and December 31, 2002 3
Condensed Consolidated Statements of Operations
for the Three and Six Months ended June 30, 2003
and 2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
for the Three and Six Months ended June 30, 2003
and 2002 (unaudited) 5
Notes to Condensed Consolidated Financial
Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
JUNE 30, DECEMBER 31,
2003 2002
--------- ---------
(Unaudited)
ASSETS
Current Assets:
Cash ........................................ $ 665 $ 134
Trade receivables from related parties,
net of allowances of $2,531 and
$231, respectively ...................... 1,895 2,506
Trade receivables, net of allowances
of $683 and $855, respectively .......... 41 170
Inventories ................................. 447 2,029
Prepaid licenses and royalties .............. 1,623 5,129
Other current assets ........................ 972 1,200
--------- ---------
Total current assets .................... 5,643 11,168
Property and equipment, net ...................... 2,760 3,130
--------- ---------
$ 8,403 $ 14,298
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current debt ................................ $ 1,426 $ 2,082
Accounts payable ............................ 7,760 9,241
Accrued royalties ........................... 4,112 4,775
Other accrued liabilities ................... -- 1,039
Advances from distributors and others ....... 111 101
Advances from related parties ............... 4,730 3,550
Payables to related parties ................. 3,992 7,440
--------- ---------
Total current liabilities .............. 22,131 28,228
Commitments and contingencies
Stockholders' Deficit:
Common stock ................................ 94 94
Paid-in capital ............................. 121,639 121,637
Accumulated deficit ......................... (135,593) (135,793)
Accumulated other comprehensive income ...... 132 132
--------- ---------
Total stockholders' deficit ............ (13,728) (13,930)
--------- ---------
$ 8,403 $ 14,298
========= =========
See accompanying notes.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share amounts)
Net revenues .................... $ 341 $ 1,812 $ 913 $ 11,193
Net revenues from related party
distributors .................. 928 10,030 19,118 16,024
-------- -------- -------- --------
Total net revenues ........... 1,269 11,842 20,031 27,217
Cost of goods sold .............. 1,114 10,602 8,099 15,079
-------- -------- -------- --------
Gross profit ................. 155 1,240 11,932 12,138
Operating expenses:
Marketing and sales .......... 354 2,688 475 4,342
General and administrative ... 1,269 1,819 3,632 4,835
Product development .......... 3,910 3,848 7,588 8,546
-------- -------- -------- --------
Total operating expenses .. 5,533 8,355 11,695 17,723
-------- -------- -------- --------
Operating income (loss) ......... (5,378) (7,115) 237 (5,585)
Other income (expense):
Interest expense ............ (32) (887) (83) (1,829)
Gain on sale of Shiny ....... -- 28,781 -- 28,781
Other ....................... 34 14 46 921
-------- -------- -------- --------
Income (loss) before benefit
for income taxes .............. (5,376) 20,793 200 22,288
Benefit for income taxes ........ -- 75 -- 75
-------- -------- -------- --------
Net income (loss) ............... $ (5,376) $ 20,868 $ 200 $ 22,363
-------- -------- -------- --------
Cumulative dividend on
participating preferred stock . $ -- $ -- $ -- $ 133
-------- -------- -------- --------
Net income (loss) available to
common stockholders ........... $ (5,376) $ 20,868 $ 200 $ 22,230
======== ======== ======== ========
Net income (loss) per common
share:
Basic ....................... $ (0.06) $ 0.22 $ -- $ 0.30
======== ======== ======== ========
Diluted ..................... $ (0.06) $ 0.22 $ -- $ 0.30
======== ======== ======== ========
Shares used in calculating net
income (loss) per common share:
Basic ....................... 93,849 93,095 93,849 73,873
======== ======== ======== ========
Diluted ..................... 93,849 93,095 93,849 73,873
======== ======== ======== ========
See accompanying notes.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
----------------------
2003 2002
-------- --------
Cash flows from operating activities: (In thousands)
Net income ...................................... $ 200 $ 22,363
Adjustments to reconcile net income to
cash provided by operating
activities:
Depreciation and amortization ................ 696 880
Noncash expense for stock options ............ -- 33
Non-cash interest expense .................... 60 1,544
Write-off of prepaid licenses and
royalties ................................. 2,379 2,100
Gain on sale of Shiny ........................ -- (28,781)
Other ........................................ -- (53)
Changes in operating assets and
liabilities:
Trade receivables from related
parties ................................ 611 (888)
Trade receivables, net .................... 129 1,495
Inventories ............................... 1,582 299
Prepaid licenses and royalties ............ 1,127 1,119
Other current assets ...................... 228 603
Accounts payable .......................... (1,481) (1,326)
Accrued royalties ......................... (663) (4,497)
Other accrued liabilities ................. (1,039) 321
Payables to related parties ............... (3,448) 1,852
Advances .................................. 1,190 (19,719)
-------- --------
Net cash provided by operating
activities .......................... 1,571 (22,655)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment .............. (326) (22)
Proceeds from sale of Shiny ..................... -- 27,420
-------- --------
Net cash used in investing
activities .......................... (326) 27,398
-------- --------
Cash flows from financing activities:
Net payment on line of credit ................... -- (1,576)
(Repayment) borrowings from former
Chairman ..................................... -- (3,218)
Net proceeds from issuance of common
stock ........................................ 2 3
Repayment of note payable ....................... (716) --
Proceeds from exercise of stock options ......... -- 86
-------- --------
Net cash provided by (used in)
financing activities ................ (714) (4,705)
-------- --------
Net increase in cash ......................... 531 38
Cash, beginning of period .......................... 134 119
-------- --------
Cash, end of period ................................ $ 665 $ 157
======== ========
Supplemental cash flow information:
Cash paid for:
Interest ............................... $ 22 $ 278
See accompanying notes.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2003
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Interplay Entertainment Corp. and its subsidiaries (the "Company") 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. The balance sheet at December 31, 2002
has been derived from the audited consolidated financial statements at that
date, but does not include all information and footnotes required by generally
accepted accounting principles in the United States for complete financial
statements.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002 as filed with the Securities and Exchange Commission.
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN
The Company's independent public accountants included a "going concern"
explanatory paragraph in their audit report attached to the December 31, 2002
financial statements which had been prepared assuming that the Company will
continue as a going concern.
The Company has incurred substantial historical operating losses through
June 30, 2003, and at that date, had a stockholders' deficit of $13.7 million
and a working capital deficit of $16.5 million. The Company has historically
funded its ongoing operations primarily from existing operations, through the
use of lines of credit, royalty and distribution fee advances, cash generated by
the private sale of securities, and proceeds of its initial public offering.
To reduce its working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles which
management believes do not meet sufficient projected profit margins, and the
scaling back of certain marketing programs. Management will continue to pursue
various alternatives to improve future operating results, and further expense
reductions, some of which may have a long-term adverse impact on the Company's
ability to generate successful future business activities.
In addition, the Company continues to seek and expects to require external
sources of funding, including but not limited to, a sale or merger of the
Company, a private placement of the Company's capital stock, the sale of
selected assets, the licensing of certain product rights in selected
territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
the Company's long-term strategic objectives. In this regard, the Company
completed the sale of the Hunter franchise in February 2003, for $15.0 million.
Furthermore, the Company is currently in negotiations with Virgin to modify the
terms of its distribution agreement relating to an upcoming title. Upon
consummation of the agreement, Virgin would provide the Company with a cash
advance of approximately $750,000. However, there can be no assurance that the
Company will be able to complete this transaction and therefore obtain any
potential cash advance. Additionally, in August 2002, the Company's Board of
Directors established a Special Committee comprised of directors that are
independent of the Company's largest stockholder, Titus Interactive S.A.
("Titus"), to investigate strategic options, including raising capital from the
sale of debt or equity securities and a sale of the Company.
If the Company's existing cash and operating revenues from future product
releases are not sufficient to fund the Company's operations, no assurance can
be given that alternative sources of funding could be obtained on acceptable
terms, or at all. These conditions, combined with the Company's historical
operating losses and its deficits in stockholders' equity and working capital,
raise substantial doubt about the Company's ability to continue as a going
concern. The accompanying condensed consolidated financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets and liabilities that may result from
the outcome of this uncertainty.
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the condensed consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant estimates made in preparing the condensed
consolidated financial statements include, among others, sales returns and
allowances, cash flows used to evaluate the recoverability of prepaid licenses
and royalties and long-lived assets, and certain accrued liabilities related to
restructuring activities and litigation.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period's condensed
consolidated 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" and SEC Staff Accounting Bulletin No. 101, Revenue Recognition.
With the signing of the Vivendi distribution agreement in August 2001,
substantially all of the Company's sales are made by two related party
distributors, Vivendi, which owns approximately 5 percent of the outstanding
shares of the Company's common stock, and Virgin Interactive Entertainment
Limited ("Virgin"), which changed its name to Avalon Interactive on July 1, 2003
and is a subsidiary of Titus, the Company's largest stockholder.
The Company recognizes revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of the Company's products
to unaffiliated third parties. For those agreements that provide the customers
the right to multiple copies of a product in exchange for guaranteed amounts,
revenue is recognized at the delivery and acceptance of the product master. Per
copy royalties on sales that exceed the guarantee are recognized as earned.
Guaranteed minimum royalties on sales, where the guarantee is not recognizable
upon delivery, are recognized as the minimum payments come due.
The Company is generally not contractually obligated to accept returns,
except for defective, shelf-worn and damaged products in accordance with
negotiated terms. However, on a case by case negotiated basis, the Company
permits customers to return or exchange product and may provide markdown
allowances on products unsold by a customer. In accordance with SFAS No. 48,
"Revenue Recognition when Right of Return Exists," revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The amount
of reserves ultimately required could differ materially in the near term from
the amounts included in the accompanying condensed consolidated financial
statements.
Customer support provided by the Company is limited to telephone and
Internet support. These costs are not significant and are charged to expenses as
incurred.
The Company also engages in the sale of licensing rights on certain
products. The terms of the licensing rights differ, but normally include the
right to develop and distribute a product on a specific video game platform. For
these activities, revenue is recognized when the rights have been transferred
and no other obligations exist.
The Emerging Issues Task Force ("EITF") issued EITF 01-09 in November 2001.
The pronouncement codifies and reconciles the consensus reached on EITF 00-14,
00-22 and 00-25, which addresses the recognition, measurement and profit and
loss account classification of certain selling expenses. The adoption of this
issue has resulted in the reclassification of certain selling expenses including
sales incentives, slotting fees, buydowns and distributor payments from cost of
sales and administrative expenses to a reduction in sales. Additionally, prior
period amounts were reclassified to conform to the new requirements. The impact
of this pronouncement did not result in a material reduction of net sales for
the six months ended June 30, 2003 and 2002, respectively. These amounts,
7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
consisting principally of promotional allowances to the Company's retail
customers were previously recorded as sales and marketing expenses; therefore,
there was no impact to net income for any period.
STOCK-BASED COMPENSATION
At June 30, 2003, the Company has three stock-based employee compensation
plans. The Company accounts for those plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. The Company did not incur any
stock-based employee compensation cost for the three and six months ended June
30, 2003 and 2002, respectively. The following table illustrates the effect on
net income (loss) and earnings (loss) per common share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2003 2002 2003 2002
-------- -------- -------- --------
(Dollars in thousands, except per share amounts)
Net income (loss) available
to common stockholders, as
reported $ (5,376) $ 20,868 $ 200 $ 22,230
Pro forma compensation expense 65 111 96 87
-------- -------- -------- --------
Pro forma net income (loss)
available to common
stockholders $ (5,441) $ 20,757 $ 104 $ 22,143
======== ======== ======== ========
Earnings (loss) per share, as
reported
Basic $ (0.06) $ 0.22 $ -- $ 0.30
Diluted $ (0.06) $ 0.22 $ -- $ 0.30
Earnings (loss) per share, pro
forma
Basic $ (0.06) $ 0.22 $ -- $ 0.30
Diluted $ (0.06) $ 0.22 $ -- $ 0.30
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements discussed in the notes to the December 31,
2002 audited consolidated financial statements, filed previously with the
Securities and Exchange Commission in Form 10-K, that were required to be
adopted during the period ending June 30, 2003 did not have a significant impact
on the Company's financial statements.
NOTE 2. INVENTORIES
Inventories consist of the following:
JUNE 30, DECEMBER 31,
2003 2002
------ ------
(Dollars in thousands)
Packaged software .................... $ 447 $2,029
====== ======
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
NOTE 3. PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
JUNE 30, DECEMBER 31,
2003 2002
------ ------
(Dollars in thousands)
Prepaid royalties for titles in
development ............................... $1,323 $4,644
Prepaid royalties for shipped titles,
net of amortization ....................... -- 431
Prepaid licenses and trademarks,
net of amortization ....................... 300 54
------ ------
$1,623 $5,129
====== ======
Amortization of prepaid licenses and royalties is included in cost of goods
sold and totaled $0.6 million and $4.5 million for the three months ended June
30, 2003 and 2002, respectively. For the six months ended June 30, 2003 and
2002, amortization of prepaid licenses and royalties was $6.0 million and $5.6,
respectively, and included amounts amortized in connection with the sale of the
Company's Hunter franchise to Vivendi (Note 7). Included in the amortization of
prepaid licenses and royalties are write-offs of development projects that were
cancelled because they were not expected to meet the Company's desired profit
requirements. These amounts totaled $0.6 million and $2.1 million for the three
months ended June 30, 2003 and 2002, and $2.4 million and $2.1 million for the
six months ended June 30, 2003 and 2002, respectively.
NOTE 4. ADVANCES FROM DISTRIBUTORS AND OTHERS
Advances from distributors and OEMs consist of the following:
JUNE 30, DECEMBER 31,
2003 2002
------ ------
(Dollars in thousands)
Advances for other distribution
rights .................................... $ 111 $ 101
====== ======
Net advance from Vivendi distribution
agreements ................................ $4,730 $3,550
====== ======
Other advances from distributors are repayable as products covered by those
agreements are sold.
In April 2002, the Company entered into an agreement with Titus, pursuant
to which, among other things, the Company sold to Titus all right, title and
interest in the games "EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter",
"Sacrifice", "MDK", "MDK II", and "Kingpin", and Titus licensed from the Company
the right to develop, publish, manufacture and distribute the games "Hunter I",
"Hunter II", "Icewind Dale I", "Icewind Dale II", and "BG: Dark Alliance II"
solely on the Nintendo Advance GameBoy game system for the life of the games. As
consideration for these rights, Titus issued to the Company a promissory note in
the principal amount of $3.5 million, which note bears interest at 6 percent per
annum. The promissory note was due on August 31, 2002, and was to be paid, at
Titus' option, in cash or in shares of Titus common stock with a per share value
equal to 90 percent of the average trading price of Titus' common stock over the
5 days immediately preceding the payment date. The Company provided Titus with a
guarantee under this agreement, which provided that in the event Titus did not
achieve gross sales from the underlying properties of at least $3.5 million by
June 25, 2003, and the shortfall was not the result of Titus' failure to use
best commercial efforts, the Company was to pay to Titus the difference between
$3.5 million and the actual gross sales achieved by Titus, not to exceed $2.0
million. In April 2003, the Company entered into a rescission agreement with
Titus to repurchase these assets for a purchase price payable by canceling the
$3.5 million promissory note, and any unpaid accrued interest thereon.
Concurrently, the Company and Titus terminated all executory obligations
including, without limitation, the Company's obligation to pay Titus up to the
$2 million guarantee.
9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings, claims and litigation
arising in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. 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, results of
operations or cash flows.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and the Company's
subsidiary GamesOnline.com, Inc., alleging, among other things, breach of
contract, misappropriation of trade secrets, breach of fiduciary duties and
breach of the implied covenant of good faith in connection with an electronic
distribution agreement dated November 2001 between KBK and GamesOnline.com, Inc.
KBK has alleged that GamesOnline.com failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Infogrames. In August 2003, KBK amended its complaint to include the Company as
a defendant. The Company believes this complaint is without merit and continues
to vigorously defend its position.
NOTE 6. NET EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed as net earnings (loss)
attributable to common stockholders divided by the weighted-average number of
common shares outstanding for the period and does not include the impact of any
potentially dilutive securities. Diluted earnings per share is computed by
dividing the net earnings attributable to the common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and common stock warrants.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share amounts)
Net income (loss) available to
common stockholders ............ $ (5,376) $ 20,868 $ 200 $ 22,230
-------- -------- -------- --------
Shares used to compute net
income (loss) per share:
Weighted-average common shares . 93,849 93,095 93,849 73,873
Dilutive stock equivalents ..... -- -- -- --
-------- -------- -------- --------
Dilutive potential common
shares ...................... 93,849 93,095 93,849 73,873
======== ======== ======== ========
Net income (loss) per share:
Basic .......................... $ (0.06) $ 0.22 $ -- $ 0.30
Diluted ........................ $ (0.06) $ 0.22 $ -- $ 0.30
-------- -------- -------- --------
There were options and warrants outstanding to purchase 10,411,218 and
11,268,933 shares of common stock at June 30, 2003 and 2002, respectively, which
were excluded from the earnings per share computation for the three and six
months ended June 30, 2003 and 2002, as the exercise price was greater than the
average market price of the common shares. The weighted average exercise price
of the outstanding stock options and common stock warrants at June 30, 2003 and
2002 was $1.93 and $2.05, respectively.
10
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
NOTE 7. RELATED PARTIES
Amounts receivable from and payable to related parties are as follows:
JUNE 30, DECEMBER 31,
2003 2002
------- -------
(Dollars in thousands)
Receivables from related parties:
Virgin ................................. $ 3,029 $ 2,050
Vivendi ................................ 936 487
Titus .................................. 461 200
Return allowance ....................... (2,531) (231)
------- -------
Total .................................. $ 1,895 $ 2,506
======= =======
Payables to related parties:
Virgin ................................. $ 498 $ 1,797
Vivendi ................................ 3,315 5,322
Titus .................................. 179 321
------- -------
Total .................................. $ 3,992 $ 7,440
======= =======
DISTRIBUTION AND PUBLISHING AGREEMENTS
TITUS INTERACTIVE S.A.
In connection with the equity investments by Titus, the Company performs
distribution services on behalf of Titus for a fee. In connection with such
distribution services, the Company recognized fee income of zero and $19,000 for
the three months ended June 30, 2003 and 2002 and $5,000 and $19,000 for the six
months ended June 30, 2003 and 2002, respectively.
Amounts due to Titus at June 30, 2003 and December 31, 2002 consisted
primarily of trade payables.
In March 2003, the Company entered into a note receivable with Titus
Software Corp. ("TSC"), a subsidiary of Titus, for $226,000. The note earns
interest at 8 percent per annum and is due in February 2004. The note is secured
by (i) 4 million shares of our common stock held by Titus, (ii) TSC's rights in
and to a note receivable due from the President of Interplay and (iii) rights in
and to TSC's most current video game title releases during 2003 and 2004. In May
2003, the Company's board of directors rescinded the note receivable and
demanded repayment of the $226,000 from TSC. The balance on the note receivable,
with accrued interest, at June 30, 2003 was $227,000.
In April 2003, the Company paid Europlay I, LLC ("Europlay"), a financial
advisor originally retained by Titus, and subsequently retained by the Company,
$448,000 in connection with services provided by Europlay to the Company.
In May 2003, the Company's Chief Executive Officer instructed the Company
to pay TSC $60,000 to cover legal fees in connection with a lawsuit against
Titus. As a result of the payment, the CEO requested that the Company credit the
$60,000 to amounts owed to him by the Company arising from expenses incurred in
connection with providing services to the Company. The Company's management is
in the process of investigating the details of the transaction, including
independent counsel review, in order to properly record the transaction.
11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
VIRGIN INTERACTIVE ENTERTAINMENT LIMITED
Under an International Distribution Agreement with Virgin, Virgin provides
for the exclusive distribution of substantially all of the Company's products in
Europe, the Commonwealth of Independent States, Africa and the Middle East for a
seven-year period ending in February 2006, cancelable under certain conditions,
subject to termination penalties and costs. Under the Agreement, the Company
pays Virgin a distribution fee based on net sales, and Virgin provides certain
market preparation, warehousing, sales and fulfillment services on behalf of the
Company. In connection with the International Distribution Agreement, the
Company subleased office space from Virgin through March 2003.
In connection with the International Distribution Agreement, the Company
incurred distribution commission expense of $15,000 and $200,000 for the three
months ended June 30, 2003 and 2002,and $63,000 and $300,000 for the six months
ended June 30, 2003 and 2002, respectively. In addition, the Company recognized
overhead fees of zero dollars and $300,000 for the three months ended June 30,
2003 and 2002, and zero dollars and $500,000 for the six months ended June 30,
2003 and 2002, respectively.
Under a Product Publishing Agreement with Virgin, as amended, the Company
has an exclusive license to publish and distribute one future product release
within North America, Latin America and South America for a royalty based on net
sales. The Company does not anticipate releasing the title and does not
anticipate any further transactions under this agreement. In connection with the
Product Publishing Agreement with Virgin, the Company earned zero dollars and
$39,000 in connection with performing publishing and distribution services on
behalf of Virgin for the three months ended June 30, 2003 and 2002 and for the
six months ended June 30, 2003 and 2002, the Company earned zero dollars and
$39,000, respectively.
In June 1997, the Company entered into a Development and Publishing
Agreement with Confounding Factor, a game developer, in which it agreed to
commission the development of the game "Galleon" in exchange for an exclusive
worldwide license to fully exploit the game and all derivates including all
publishing and distribution rights. Subsequently, in March 2002, the Company
entered into a Term Sheet with Virgin, pursuant to which Virgin assumed all
responsibility for future milestone payments to Confounding Factor to complete
development of "Galleon" and Virgin acquired exclusive rights to ship the game
in certain territories. Virgin paid an initial $511,000 to Confounding Factor,
but then ceased making the required payments. Subsequently, Virgin proposed that
the Company refund the $511,000 to Virgin and void the Term Sheet (except with
respect to Virgin's rights to publish Galleon in Japan), which the Independent
Committee of the Company's Board of Directors rejected. While reserving its
rights vis-a-vis Virgin, the Company then resumed making payments to Confounding
Factor to protect its interests in "Galleon," and since that time has been
providing production assistance to the developer in order to finalize the Xbox
version of the game, which the Company expects to release in its fourth quarter.
As of March 2003, the Company met all of the remaining financial obligations to
Confounding Factor. The Company is currently negotiating a settlement with
Virgin regarding the publishing rights to "Galleon".
In January 2003, the Company entered into a waiver with Virgin related to
the distribution of a video game title in which it sold its European
distribution rights to Vivendi. In consideration for Virgin relinquishing its
rights, the Company paid Virgin $650,000 and will pay Virgin 50 percent of all
proceeds in excess of the advance received from Vivendi. As of June 30, 2003,
Vivendi has not reported sales exceeding the minimum guarantee.
In February 2003, Virgin Interactive Entertainment (Europe) Limited
("Virgin Europe"), the operating subsidiary of Virgin filed for a Company
Voluntary Arrangement, or CVA, a process of reorganization in the United Kingdom
which must be approved by Virgin's creditors. Included in amounts owed, Virgin
reported it owed the Company approximately $1.8 million under the International
Distribution Agreement, which the Company has fully reserved for. Virgin
Europe's creditors rejected the CVA. On May 9, 2003, the Company received a new
proposed CVA to vote on for approval by Virgin Europe's creditors on May 19,
2003. The revised CVA was approved and under the CVA, Virgin will pay the
Company approximately $241,000 per quarter beginning in January 2004. The
Company does not know what affect the approval of the CVA will have on its
ability to collect amounts owed from Virgin. If Virgin is not able to operate
under the new CVA, the Company expects Virgin to cease operations and liquidate,
in which event it will most likely not receive any amounts presently due it by
Virgin, and will not have a distributor for its products in Europe and the other
territories in which Virgin presently distributes its products. On July 1, 2003,
Virgin changed its name to Avalon Interactive.
12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2003
In March 2003, the Company made a settlement payment of approximately
$320,000 to a third-party on behalf of Virgin Europe to protect the validity of
certain license rights and to avoid potential third-party liability from various
licensors of its products. In connection with the settlement, the Company
incurred legal fees of $80,000. Consequently, Virgin owes the Company $400,000
pursuant to the indemnification provisions of the International Distribution
Agreement, which the Company has fully reserved for.
VIVENDI UNIVERSAL GAMES, INC.
In February 2003, the Company sold to Vivendi Universal Games, Inc.
("Vivendi") all future interactive entertainment publishing rights to the
"Hunter: The Reckoning" franchise for $15 million, payable in installments,
which were fully paid at June 30, 2003. The Company retains the rights to the
previously published "Hunter: The Reckoning" titles on Microsoft Xbox and
Nintendo GameCube.
In order to improve the Company's cash flow, in August 2002, the Company
entered into a new distribution arrangement with Vivendi, whereby, Vivendi will
distribute substantially all of its products in North America for a period of
three years as a whole and two years with respect to each product giving a
potential maximum term of five years. The August 2002 agreement amended and
superceded the August 2001 distribution agreement with Vivendi. Under the August
2002 agreement, Vivendi will pay sales proceeds less amounts for distribution
fees, price concessions and returns. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon delivery
of a gold master to Vivendi, Vivendi will pay, as a minimum guarantee, a
specified percent of the projected amount due, based on projected initial
shipment sales, which are established by Vivendi in accordance with the terms of
the agreement. The remaining amounts are due upon shipment of the titles to
Vivendi's customers. Payments for future sales that exceed the projected initial
shipment sales are paid on a monthly basis.
In connection with the distribution agreements with Vivendi, the Company
incurred distribution commission expense of $2.6 million and $1.7 million for
the three months ended June 30, 2003 and June 30, 2002, and $3.9 million and
$2.6 million for the six months ended June 30, 2003 and June 30, 2002,
respectively.
NOTE 8. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------------------------------- --------------------------------------------------
2003 2002 2003 2002
----------------------- ----------------------- ----------------------- ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ---------- ---------- ---------- ----------- ---------- ------------ ----------
(Dollars in thousands)
North America $ 1,015 80 % $ 8,103 68 % $ 2,895 14 % $ 12,569 46 %
Europe 88 7 1,643 14 1,708 9 2,946 11
Rest of World 70 5 121 1 156 1 268 1
OEM, royalty
and licensing 96 8 1,975 17 15,272 76 11,434 42
----------- ---------- ---------- ---------- ----------- ---------- ------------ ----------
$ 1,269 100 % $ 11,842 100 % $ 20,031 100 % $ 27,217 100 %
=========== ========== ========== ========== =========== ========== ============ ==========
13
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, 2002, previously filed with the Securities and Exchange
Commission, 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 and cost reduction measures are forward-looking statements
and there can be no assurance that the Company will achieve its operating plans
or generate positive cash flow in the future, arrange adequate financing or
complete strategic transactions on satisfactory terms, if at all, or that any
cost reductions effected by the Company will be sufficient to offset any
negative cash flow from operations. Additional risks and uncertainties include
possible delays in the completion of products, the possible lack of consumer
appeal and acceptance of products released by the Company, fluctuations in
demand for the Company's products, lost sales because of the rescheduling of
products launched or orders delivered, failure of the Company's markets to
continue to grow, that the Company's products will remain accepted within their
respective markets, that competitive conditions within the Company's markets
will not change materially or adversely, that the Company will retain key
development and management personnel, that the Company's forecasts will
accurately anticipate market demand and that there will be no material adverse
change in the Company's operations or business. Additional factors that may
affect future operating results are discussed in more detail in "Factors
Affecting Future Performance" in 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.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including those related to revenue recognition, prepaid licenses and
royalties and software development costs. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under
14
different assumptions or conditions. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
preparation of our consolidated financial statements.
REVENUE RECOGNITION
We record revenues when we deliver products to customers in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." and SEC
Staff Accounting Bulletin No. 101, Revenue Recognition. Commencing in August
2001, substantially all of our sales are made by two related party distributors,
Vivendi Universal Games, Inc. and Avalon Interactive, formerly known as Virgin
Interactive Entertainment Ltd. We recognize revenue from sales by distributors,
net of sales commissions, only as the distributor recognizes sales of our
products to unaffiliated third parties. For those agreements that provide the
customers the right to multiple copies of a product in exchange for guaranteed
amounts, we recognize revenue at the delivery and acceptance of the product
master. We recognize per copy royalties on sales that exceed the guarantee as
copies are duplicated.
We generally are not contractually obligated to accept returns, except for
defective, shelf-worn and damaged products. However, on a case-by-case
negotiated basis, we permit customers to return or exchange product and may
provide price concessions to our retail distribution customers on unsold or slow
moving products. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 48, "Revenue Recognition when Right of Return Exists," we record
revenue net of a provision for estimated returns, exchanges, markdowns, price
concessions, and warranty costs. We record such reserves based upon management's
evaluation of historical experience, current industry trends and estimated
costs. The amount of reserves ultimately required could differ materially in the
near term from the amounts provided in the accompanying condensed consolidated
financial statements.
We provide customer support only via telephone and the Internet. Customer
support costs are not significant and we charge such costs to expenses as we
incur them.
We also engage in the sale of licensing rights on certain products. The
terms of the licensing rights differ, but normally include the right to develop
and distribute a product on a specific video game platform. Revenue is
recognized when the rights have been transferred and no other obligations exist.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under developer arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables. Royalty advances are recoupable against future
sales based upon the contractual royalty rate. We amortize the cost of licenses,
prepaid royalties and other outside production costs to cost of goods sold over
six months commencing with the initial shipment in each region of the related
title. We amortize these amounts at a rate based upon the actual number of units
shipped with a minimum amortization of 75 percent in the first month of release
and a minimum of 5 percent for each of the next five months after release. This
minimum amortization rate reflects our typical product life cycle. We evaluate
the future realization of such costs quarterly and charge to cost of goods sold
any amounts that we deem unlikely to be fully realized through future sales.
Such costs are classified as current and noncurrent assets based upon the
estimated product release date.
SOFTWARE DEVELOPMENT COSTS
Our internal research and development costs, which consist primarily of
software development costs, are expensed as incurred. Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed," provides for the
capitalization of certain software development costs incurred after
technological feasibility of the software is established or for development
costs that have alternative future uses. Under our current practice of
developing new products, the technological feasibility of the underlying
software is not established until substantially all of the product development
is complete. As a result, we have not capitalized any software development costs
on internal development projects, as the eligible costs were determined to be
insignificant.
15
OTHER SIGNIFICANT ACCOUNTING POLICIES
Other significant accounting policies not involving the same level of
measurement uncertainties as those discussed above are nevertheless important to
an understanding of the financial statements. The policies related to
consolidation and loss contingencies require difficult judgments on complex
matters that are often subject to multiple sources of authoritative guidance.
Certain of these matters are among topics currently under reexamination by
accounting standards setters and regulators. Although no specific conclusions
reached by these standard setters appear likely to cause a material change in
our accounting policies, outcomes cannot be predicted with confidence.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements discussed in the notes to the December 31,
2002 audited financial statements, filed previously with the Securities and
Exchange Commission in Form 10-K, that were required to be adopted during the
year ending December 31, 2003 did not have a significant impact on our financial
statements.
RESULTS OF OPERATIONS
The following table sets forth certain selected consolidated statements of
operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------- ---------------------------------------------
2003 2002 2003 2002
-------------------- -------------------- -------------------- --------------------
% OF NET % OF NET % OF NET % OF NET
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Net revenues .................. $ 1,269 100% $ 11,842 100% $ 20,031 100% $ 27,217 100%
Cost of goods sold ............ 1,114 88% 10,602 90% 8,099 40% 15,079 55%
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit .................. 155 12% 1,240 10% 11,932 60% 12,138 45%
-------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Marketing and sales ...... 354 28% 2,688 23% 475 2% 4,342 16%
General and administrative 1,269 100% 1,819 15% 3,632 18% 4,835 18%
Product development ...... 3,910 308% 3,848 31% 7,588 38% 8,546 31%
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses . 5,533 436% 8,355 69% 11,695 58% 17,723 65%
-------- -------- -------- -------- -------- -------- -------- --------
Operating income .............. (5,378) (425%) (7,115) (60%) 237 2% (5,585) (21%)
Gain on sale of Shiny ......... -- 0% 28,781 243% -- 0% 28,781 106%
Other expense ................. 2 0% (873) (7%) (37) (0%) (908) (3%)
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before income
taxes ...................... (5,376) (424%) 20,793 176% 200 -- 22,288 82%
Benefit for income taxes ...... -- 0% (75) (1%) -- 0% (75) 0%
-------- -------- -------- -------- -------- -------- -------- --------
Net income .................... $ (5,376) (425%) $ 20,868 176% $ 200 0% $ 22,363 82%
======== ======== ======== ======== ======== ======== ======== ========
Net revenues by geographic
region:
North America ............ $ 1,015 80% $ 8,103 68% $ 2,895 15% $ 12,569 46%
International ............ 158 12% 1,764 15% 1,864 9% 3,214 12%
OEM, royalty and licensing 96 8% 1,975 17% 15,272 76% 11,434 42%
Net revenues by platform:
Personal computer ........ $ 976 77% $ 2,664 22% $ 1,624 8% $ 6,945 26%
Video game console ....... 197 15% 7,203 61% 3,135 16% 8,838 33%
OEM, royalty and licensing 96 8% 1,975 17% 15,272 76% 11,434 42%
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the three months ended June 30, 2003 were $1.3 million, a
decrease of 89 percent compared to the same period in 2002. This decrease
resulted from a 88 percent decrease in North American net revenues, a 91 percent
decrease in International net revenues and a 95 percent decrease in OEM,
royalties and licensing revenues.
16
North American net revenues for the three months ended June 30, 2003 were
$1.0 million. The decrease in North American net revenues in the three months
ended June 30, 2003 was mainly due to a 76 percent decrease in back catalog
sales compared to the 2002 comparable period as a result of concluding sales
activity under the August 2001 distribution agreement with Vivendi. Furthermore,
we did not deliver any gold masters to any titles in the three months ended June
30, 2003 compared to releasing one title in the same period in 2002, resulting
in a decrease in North American sales of $9.0 million and a decrease in product
returns and price concessions of $1.9 million as compared to the 2002 comparable
period. In addition, the decrease in back catalog sales is due to having fewer
titles to replace titles that have exhausted their useful commercial lives and
we have lost the rights to certain titles that were a part of our back catalog
and have not obtained new titles to replaces those titles. The decrease in
product returns and price concessions in the three months ended June 30, 2003 as
compared to the 2002 comparable period is due to the terms of the August 2002
distribution agreement with Vivendi, whereby Vivendi pays us a lower per unit
rate and in return assumes all credit, product return and price concession
risks.
International net revenues for the three months ended June 30, 2003 were
$0.2 million. The decrease in International net revenues for the three months
ended June 31, 2003 was mainly due to a 75 percent reduction in back catalog
sales. Our back catalog sales decrease is due to having fewer titles to replace
titles that have exhausted their useful commercial lives. Furthermore, our
titles distributed by Virgin, which changed its name to Avalon Interactive on
July 1, 2003, had lower sales due to Virgin's financial difficulties, which
resulted in Virgin filing a Company Voluntary Arrangement or CVA, a process of
reorganization in the United Kingdom, which was accepted by Virgin's creditors
in May 2003. Overall, in the three months ended June 30, 2003, we had a $1.8
million decrease in revenue and an increase in product returns and price
concessions of $0.2 million compared to the comparable 2002 period.
OEM, royalty and licensing net revenues for the three months ended June 30,
2003 were $0.1 million, a decrease of $1.8 million as compared to the same
period in 2002. OEM net revenues decreased by $1.1 million in the three months
ended June 30, 2003 as compared to the 2002 comparable period and licensing net
revenues decreased by $0.7 million as compared to the 2002 comparable period.
The decrease in OEM net revenues is a result of our efforts to focus on our core
business of developing and publishing video game titles for distribution
directly to the end users and our continued focus on video game console titles,
which typically are not bundled with other products. The decrease in licensing
is due to a decrease in licensing activity during the three months ended June
30, 2003.
Net revenues for the six months ended June 30, 2003 were $20.0 million, a
decrease of 26 percent compared to the same period in 2002. This decrease
resulted from a 77 percent decrease in North American net revenues and a 42
percent decrease in International net revenues offset by a 34 percent increase
in OEM, royalties and licensing revenues.
North American net revenues for the six months ended June 30, 2003 were
$2.9 million. The decrease in North American net revenues in the six months
ended June 30, 2003 was mainly due to a 76 percent decrease in back catalog
sales compared to the comparable 2002 period as a result of concluding sales
activity under the August 2001 distribution agreement with Vivendi. During the
six months ended June 30, 2003 we delivered one gold master compared to
releasing one title in the comparable 2002 period, resulting in a decrease in
North American sales of $12.8 million and a decrease in product returns and
price concessions of $3.2 million in the six months ended June 30, 2003, as
compared to the 2002 comparable period. Furthermore, our back catalog sales
decrease is due to having fewer titles to replace titles that have exhausted
their useful commercial lives and we have lost the rights to certain titles that
were a part of our back catalog and have not obtained new titles to replaces
those titles. The decrease in product returns and price concessions in the six
months ended June 30, 2003 as compared to the 2002 comparable period is due to
the terms of the August 2002 distribution agreement, whereby Vivendi pays us a
lower per unit rate and in return assumes all credit, product return and price
concession risks.
We expect that our North American publishing net revenues will decrease in
fiscal 2003 compared to fiscal 2002, mainly due to decreased unit sales and our
release of all new titles under the terms of the August 2002 distribution
agreement with Vivendi.
International net revenues for the six months ended June 30, 2003 were $1.9
million. The decrease in International net revenues for the six months ended
June 30, 2003 was mainly due to releasing three gold masters to three titles to
Vivendi under a one-time distribution agreement for the three titles in Europe
with terms similar to the distribution arrangement in North America. Virgin,
which changed its name to Avalon Interactive on July 1, 2003, remains our main
distributor in Europe and will distribute our future releases in Europe under
the terms of our
17
International Distribution Agreement, as amended. In addition, the decrease in
International net revenues was impacted by a 75 percent reduction in back
catalog sales. Our back catalog sales decrease is due to having fewer titles to
replace titles that have exhausted their useful commercial lives. Furthermore,
our titles distributed by Virgin had lower sales due to Virgin's financial
difficulties, which resulted in Virgin filing a Company Voluntary Arrangement or
CVA, a process of reorganization in the United Kingdom. Overall, we had a $1.9
million decrease in revenue offset by a decrease in product returns and price
concessions of $0.6 million in the six months ended June 30, 2003, as compared
to the 2002 comparable period.
We expect that our International publishing net revenues will increase in
fiscal 2003 as compared to fiscal 2002, mainly due to increased unit sales.
However, if Virgin is not able to reorganize and liquidates, we may need to
obtain a new European distributor in a short amount of time. If we are not able
to engage a new distributor, it could have a material negative impact on our
European sales.
OEM, royalty and licensing net revenues for the six months ended June 30,
2003 were $15.2 million, an increase of $3.9 million as compared to the same
period in 2002. OEM net revenues decreased by $2.0 million in the six months
ended June 30, 2003 as compared to the 2002 comparable period and licensing net
revenues increased by $6.2 million as compared to the 2002 period. The decrease
in OEM net revenues is a result of our efforts to focus on our core business of
developing and publishing video game titles for distribution directly to end
users and our continued focus on video game console titles, which typically are
not bundled with other products. The six months ended June 30, 2003 included
revenue related to the sale of all future interactive entertainment publishing
rights to the "Hunter: The Reckoning" franchise for $15 million. We retain the
rights to the previously published "Hunter: The Reckoning" titles on Microsoft
Xbox and Nintendo GameCube. Our 2002 licensing net revenues included revenues
related to the sale of publishing rights for one of our products and the
recognition of deferred revenue for a licensing transaction. In January 2002, we
sold the publishing rights to this title to the distributor in connection with a
settlement agreement entered into with a third party developer. The settlement
agreement provided, among other things, that we assign our rights and
obligations under the product agreement to the third party distributor. As a
result, we recorded net revenues of $5.6 million in the six months ended June
30, 2002. In February 2002, a licensing transaction we entered into in 1999
expired and we recognized revenue of $1.2 million, the unearned portion of the
minimum guarantee.
We expect that OEM, royalty and licensing net revenues in fiscal 2003 will
increase compared to fiscal 2002 as a result of recording the $15 million in
revenue resulting from the sale of the Hunter video game franchise in February
2003.
PLATFORM NET REVENUES
PC net revenues for the three months ended June 30, 2003 were $1.0 million,
a decrease of 63 percent compared to the same period in 2002. The decrease in PC
net revenues in the three months ended June 30, 2003 was primarily due to lower
back catalog sales. Video game console net revenues were $0.2 million, a
decrease of 97 percent for the three months ended June 30, 2003 compared to the
same period in 2002, due to not delivering any gold masters for any titles to
Vivendi, and lower sales of previously released console titles in the three
months ended June 30, 2003 as compared to releasing one new title in 2002.
PC net revenues for the six months ended June 30, 2003 were $1.6 million, a
decrease of 77 percent compared to the same period in 2002. The decrease in PC
net revenues in the six months ended June 30, 2003 was primarily due to lower
back catalog sales. Video game console net revenues were $3.1 million, a
decrease of 65 percent for the six months ended June 30, 2003 compared to the
same period in 2002, in part because of the way in which we were responsible for
production under our August 2001 distribution agreement with Vivendi. In the six
months ended June 30, 2003, we delivered the gold master for one title, Run Like
Hell (Xbox), to Vivendi, under the terms of the August 2002 distribution
agreement, in which Vivendi is responsible for all manufacturing, marketing and
distribution expenditures, and bears all credit, price concessions and inventory
risk, including product returns and in return, pays us a lower per unit rate. In
the 2002 period, we released one title under the terms of the August 2001
agreement with Vivendi, whereby we were responsible for all marketing,
manufacturing and bore any price concession risks, in which we receive a higher
per unit rate.
We expect our PC net revenues to decrease in fiscal 2003 as compared to
fiscal 2002 as we expect to release one new title, Lionheart, during the rest of
2003 as we continue to focus more on console products. We anticipate releasing
the following new console titles: Baldur's Gate, Dark Alliance 2 (Play Station 2
and XBox); Fallout, Brotherhood of Steel (Play Station 2 and Xbox); and Galleon
(Xbox), during the rest of 2003 and accordingly, expect net revenues to increase
in fiscal 2003.
18
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our cost of goods sold decreased 90 percent to $1.1 million in the three
months ended June 30, 2003 compared to the same period in 2002. The decrease was
due to lower sales of products in Europe due to the financial difficulties of
Virgin, lower back catalog sales under the August 2001 agreement with Vivendi
and not incurring any cost of goods expenditures under the August 2002 agreement
with Vivendi. Under the August 2002 agreement, Vivendi pays us a lower per unit
rate and in return is responsible for all manufacturing, marketing and
distribution expenditures. Our gross margin increased to 12 percent for the 2003
period from 10 percent in the 2002 period. This was primarily due to lower cost
of goods in the 2003 period as the only cost of goods we incur under the August
2002 distribution agreement with Vivendi are expenses related to royalties due
to third parties. Both periods were negatively impacted by higher amortization
of prepaid royalties on externally developed products, including approximately
$0.6 million in fiscal 2003 and $2.1 million in fiscal 2002 in write-offs of
canceled development projects or on titles that were not expected to meet our
desired profit requirements.
Our cost of goods sold decreased 46 percent to $8.1 million in the six
months ended June 30, 2003 compared to the same period in 2002. The decrease was
due to lower sales of products in Europe due to the financial difficulties of
Virgin, lower back catalog sales under the August 2001 agreement with Vivendi
and not incurring any cost of goods expenditures under the August 2002 agreement
with Vivendi offset by $2.9 million in amortization of prepaid royalties
associated with the sale of the Hunter video game franchise. Our gross margin
increased to 60 percent for the six months ended June 30 2003 from 45 percent in
the 2002 comparable period. This was primarily due to lower cost of goods in the
2003 period as the only cost of goods we incur under the August 2002 agreement
with Vivendi are expenses related to royalties due to third parties. Both
periods were negatively impacted by higher amortization of prepaid royalties on
externally developed products, including approximately $2.4 million in fiscal
2003 and $2.1 million in fiscal 2002 in write-offs of canceled development
projects or on titles that were not expected to meet our desired profit
requirements.
We expect our gross profit margin and gross profit to increase in fiscal
2003 as compared to fiscal 2002 due to lower cost of goods in fiscal 2003
resulting from our 2002 North American distribution agreement with Vivendi, and
the absence in fiscal 2003 of significant, unusual product returns and price
concessions and additional write-offs of prepaid royalties.
MARKETING AND SALES
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses for the three months ended June 30, 2003 were $0.4 million, a 87
percent decrease as compared to the 2002 comparable period. The decrease in
marketing and sales expenses is due to a $1.5 million reduction in advertising
and retail marketing support expenditures due to releasing one title in the 2003
period under the terms of the new distribution agreement whereby Vivendi pays us
a lower per unit rate and in return assumes all marketing expenditures, and a
$0.8 million decrease in personnel costs and general expenses due in part to our
shift from a direct sales force for North America to a distribution arrangement
with Vivendi. The decrease in marketing and sales expenses also reflected a $0.3
million decrease in overhead fees paid to Virgin under our April 2001 settlement
with Virgin.
Marketing and sales expenses for the six months ended June 30, 2003 were
$0.5 million, a 89 percent decrease as compared to the 2002 comparable period.
The decrease in marketing and sales expenses is due to a $2.3 million reduction
in advertising and retail marketing support expenditures due to releasing one
title in the 2003 period under the terms of the 2002 distribution agreement
whereby Vivendi pays us a lower per unit rate and in return assumes all
marketing expenditures, and a $1.6 million decrease in personnel costs and
general expenses due in part to our shift from a direct sales force for North
America to the distribution arrangement with Vivendi. The decrease in marketing
and sales expenses also reflected a $0.5 million decrease in overhead fees paid
to Virgin under our April 2001 settlement with Virgin.
We expect our marketing and sales expenses to decrease in fiscal 2003
compared to fiscal 2002, due to lower personnel costs from our reduced
headcount, a reduction in overhead fees paid to Virgin pursuant to the April
2001 settlement and the release of titles under the terms of the 2002
distribution agreement whereby Vivendi pays us a lower per unit rate and in
return assumes all marketing expenditures.
19
GENERAL AND ADMINISTRATIVE
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended June 30, 2003 were $1.3 million, a 30 percent decrease as
compared to the same period in 2002. The decrease is due to a $0.5 million
decrease in personnel costs and general expenses.
General and administrative expenses for the six months ended June 30, 2003
were $3.6 million, a 25 percent decrease as compared to the same period in 2002.
The decrease is due to a $1.2 million decrease in personnel costs and general
expenses.
We expect our general and administrative expenses to remain relatively
constant in fiscal 2003 compared to fiscal 2002.
PRODUCT DEVELOPMENT
Product development expenses for the three months ended June 30, 2003 were
$3.9 million, a 2 percent increase as compared to the same period in 2002. This
increase is due to a $0.1 million increase in personnel costs and general
expenses.
Product development expenses for the six months ended June 30, 2003 were
$7.6 million, a 11 percent decrease as compared to the same period in 2002. This
decrease is due to a $1.2 million decrease in personnel costs as a result of a
reduction in headcount and the sale of Shiny Entertainment, Inc. in April 2002
offset by a $0.2 million increase in general expenses.
We expect our product development expenses to remain relatively constant in
fiscal 2003 compared to fiscal 2002.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date primarily through the use of
borrowings, royalty and distribution fee advances, cash generated by the private
sale of securities, proceeds of our initial public offering, the sale of assets
and from results of operations.
As of June 30, 2003, we had a working capital deficit of $16.5 million, and
our cash balance was approximately $0.7 million. We anticipate our current cash
reserves, plus our expected generation of cash from existing operations, will
only be sufficient to fund our anticipated expenditures, including payroll, into
the third quarter of fiscal 2003. Consequently, we expect that we will need to
substantially reduce our working capital needs and/or raise additional
financing. Along these lines, we entered into the 2002 distribution agreement
with Vivendi, which accelerates cash collections through non-refundable minimum
guarantees. If we do not receive sufficient financing we may (i) liquidate
assets, (ii) sell the company (iii) seek protection from our creditors, and/or
(iv) continue operations, but incur material harm to our business, operations or
financial conditions.
Our primary capital needs have historically been to fund working capital
requirements necessary to fund our net losses, the development and introduction
of products and related technologies and the acquisition or lease of equipment
and other assets used in the product development process. Our operating
activities provided cash of $1.6 million during the six months ended June 30,
2003, primarily attributable to reductions of inventory and prepaid royalties
and advances received from Vivendi. These cash proceeds from operating
activities were partially offset by decreases in payables to related parties and
accounts payables.
Net cash used by financing activities of $0.7 million for the six months
ended June 30, 2003, consisted primarily of payments on the note payable to
Warner Brothers. Cash used in investing activities of $0.3 million for the six
months ended June 30, 2003 consisted of normal capital expenditures, primarily
for office and computer equipment used in our operations. We do not currently
have any material commitments with respect to any future capital expenditures.
20
The following summarizes our contractual obligations under non-cancelable
operating leases and other borrowings at June 30, 2003, and the effect such
obligations are expected to have on our liquidity and cash flow in future
periods.
Less Than 1 - 3 After
Total 1 Year Years 3 Years
------ ------ ------ ------
(In thousands)
Contractual cash obligations -
Non-cancelable operating lease
obligations ..................... $4,523 $1,460 $3,063 $ --
====== ====== ====== ======
Our main source of capital is from the release of new titles. Historically,
we have had some delays in the release of new titles and we anticipate that we
may continue to incur delays in the release of future titles. These delays can
have a negative impact on our short-term liquidity, but should not affect our
overall liquidity.
To reduce our working capital needs, we have implemented various measures
including a reduction of personnel, a reduction of fixed overhead commitments,
cancellation or suspension of development on future titles, which management
believes do not meet sufficient projected profit margins, and the scaling back
of certain marketing programs associated with the cancelled projects. Management
will continue to pursue various alternatives to improve future operating results
and further expense reductions, some of which may have a long-term adverse
impact on our ability to generate successful future business activities. In
addition, we continue to seek external sources of funding, including but not
limited to, a sale or merger of the company, a private placement of our capital
stock, the sale of selected assets, the licensing of certain product rights in
selected territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
our long-term strategic objectives. In this regard, we completed the sale of the
Hunter franchise in February 2003, for $15.0 million. Additionally, in August
2002, our Board of Directors established a Special Committee comprised of
directors that are independent of our largest stockholder, Titus Interactive
S.A., to investigate strategic options, including raising capital from the sale
of debt or equity securities and a sale of the company.
In order to improve our cash flow, in August 2002, we entered into a new
distribution arrangement with Vivendi, whereby, Vivendi will distribute
substantially all of our products in North America for a period of three years
as a whole and two years with respect to each product giving a potential maximum
term of five years. Under the August 2002 agreement, Vivendi will pay us sales
proceeds less amounts for distribution fees, price concessions and returns.
Vivendi is responsible for all manufacturing, marketing and distribution
expenditures, and bears all credit, price concessions and inventory risk,
including product returns. Upon our delivery of a gold master to Vivendi,
Vivendi will pay us, as a minimum guarantee, a specified percent of the
projected amount due to us based on projected initial shipment sales, which are
established by Vivendi in accordance with the terms of the agreement. The
remaining amounts are due upon shipment of the titles to Vivendi's customers.
Payments for future sales that exceed the projected initial shipment sales are
paid on a monthly basis. We expect this new arrangement to improve our
short-term liquidity, but should not impact our overall liquidity.
We are currently in negotiations with Virgin to modify the terms of the
distribution agreement relating to an upcoming title. Upon consummation of the
agreement, Virgin would provide us with a cash advance of approximately
$750,000. However, there can be no assurance that we will be able to complete
this transaction and therefore obtain any potential cash advance.
If operating revenues from product releases are not sufficient to fund our
operations, no assurance can be given that alternative sources of funding could
be obtained on acceptable terms, or at all. These conditions, combined with our
historical operating losses and deficits in stockholders' equity and working
capital, raise substantial doubt about our ability to continue as a going
concern. The accompanying consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets and liabilities that may result from the outcome of
this uncertainty.
21
ACTIVITIES WITH RELATED PARTIES
Our operations involve significant transactions with Titus, our majority
stockholder, Virgin, a wholly-owned subsidiary of Titus, and Vivendi, an
indirect owner of 5 percent of our common stock.
TRANSACTIONS WITH TITUS
In connection with the equity investments by Titus, we perform distribution
services on behalf of Titus for a fee. In connection with such distribution
services, we recognized fee income of $5,000 and $19,000 for the six months
ended June 30, 2003 and 2002, respectively.
In April 2002, we entered into an agreement with Titus, pursuant to which,
among other things, we sold to Titus all right, title and interest in the games
"EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter", "Sacrifice", "MDK",
"MDK II", and "Kingpin", and Titus licensed from us the right to develop,
publish, manufacture and distribute the games "Hunter I", "Hunter II", "Icewind
Dale I", "Icewind Dale II", and "BG: Dark Alliance II" solely on Nintendo
Advance GameBoy game system for the life of the games. As consideration for
these rights, Titus issued to us a promissory note in the principal amount of
$3.5 million, which note bears interest at 6 percent per annum. The promissory
note was due on August 31, 2002, and was to be paid, at Titus' option, in cash
or in shares of Titus common stock with a per share value equal to 90 percent of
the average trading price of Titus' common stock over the 5 days immediately
preceding the payment date. Pursuant to our April 26, 2002 agreement with Titus,
on or before July 25, 2002, we had the right to solicit offers from and
negotiate with third parties to sell the rights and licenses granted under the
April 26, 2002 agreement. If we had entered into a binding agreement with a
third party to sell these rights and licenses for an amount in excess $3.5
million, we would have rescinded the April 26, 2002 agreement with Titus and
recovered all rights granted and released Titus from all obligations thereunder.
The Company's efforts to enter into a binding agreement with a third party were
unsuccessful. Moreover, we provided Titus with a guarantee under this agreement,
which provides that in the event Titus did not achieve gross sales of at least
$3.5 million by June 25, 2003, and the shortfall was not the result of Titus'
failure to use best commercial efforts, we were to pay to Titus the difference
between $3.5 million and the actual gross sales achieved by Titus, not to exceed
$2 million. We entered into a rescission agreement in April 2003 with Titus to
repurchase these assets for a purchase price payable by canceling the $3.5
million promissory note, and any unpaid accrued interest thereon. Concurrently,
we terminated any executory obligations remaining, including, without
limitation, our obligation to pay Titus up to the $2 million guarantee.
In March 2003, we entered into a note receivable with Titus Software Corp.,
or "TSC", a subsidiary of Titus, for $226,000. The note earns interest at 8
percent per annum and is due in February 2004. The note is secured by (i) 4
million shares of our common stock held by Titus, (ii) TSC's rights in and to a
note receivable due from the President of Interplay and (iii) rights in and to
TSC's most current video game title releases during 2003 and 2004. In May 2003,
our board of directors rescinded the note receivable and demanded repayment of
the $226,000 from TSC. The balance on the note receivable, with accrued
interest, at June 30, 2003 was $227,000.
In April 2003, we paid Europlay I, LLC ("Europlay"), a financial advisor
originally retained by Titus, and subsequently retained by us, $448,000 in
connection with prior services provided by Europlay to us.
In May 2003, our Chief Executive Officer instructed us to pay TSC $60,000
to cover legal fees in connection with a lawsuit against Titus. As a result of
the payment, our CEO requested that we credit the $60,000 to amounts owed to him
by the company arising from expenses incurred in connection with providing
services to us. Our management is in the process of investigating the details of
the transaction, including independent counsel review, in order to properly
record the transaction.
TRANSACTIONS WITH VIRGIN, A WHOLLY OWNED SUBSIDIARY OF TITUS
Under an International Distribution Agreement with Virgin, Virgin provides
for the exclusive distribution of substantially all of our products in Europe,
Commonwealth of Independent States, Africa and the Middle East for a seven-year
period ending February 2006, cancelable under certain conditions, subject to
termination penalties and costs. Under this agreement, as amended, we pay Virgin
a distribution fee based on net sales, and Virgin provides
22
certain market preparation, warehousing, sales and fulfillment services on our
behalf. In connection with the International Distribution Agreement, we
subleased office space from Virgin through March 31, 2003.
Under a Product Publishing Agreement with Virgin, as amended, we have an
exclusive license to publish and distribute one future product release within
North America, Latin America and South America for a royalty based on net sales.
We do not anticipate releasing the title and do not anticipate having any
further transactions under this agreement. In connection with the Product
Publishing Agreement with Virgin, we performed publishing and distribution
services on behalf of.
In June 1997, we entered into a Development and Publishing Agreement with
Confounding Factor, a game developer, in which we agreed to commission the
development of the game "Galleon" in exchange for an exclusive worldwide license
to fully exploit the game and all derivates including all publishing and
distribution rights. Subsequently, in March 2002, we entered into a Term Sheet
with Virgin, pursuant to which Virgin assumed all responsibility for future
milestone payments to Confounding Factor to complete development of "Galleon"
and Virgin acquired exclusive rights to ship the game in certain territories.
Virgin paid an initial $511,000 to Confounding Factor, but then ceased making
the required payments. Subsequently, Virgin proposed that Interplay refund the
$511,000 to Virgin and void the Term Sheet (except with respect to Virgin's
rights to publish Galleon in Japan), which the Independent Committee of our
Board of Directors rejected. While reserving our rights vis-a-vis Virgin, we
then resumed making payments to Confounding Factor to protect our interests in
"Galleon," and since that time have been providing production assistance to the
developer in order to finalize the Xbox version of the game, which we expect to
release in our fourth quarter. As of March 2003, we met all of the remaining
financial obligations to Confounding Factor. We are currently negotiating a
settlement with Virgin regarding the publishing rights to "Galleon".
In January 2003, we entered into a waiver with Virgin related to the
distribution of a video game title in which we sold the European distribution
rights to Vivendi. In consideration for Virgin relinquishing its rights, we paid
Virgin $650,000 and will pay Virgin 50 percent of all proceeds in excess of the
advance received from Vivendi. As of June 30, 2003, Vivendi has not reported
sales exceeding the minimum guarantee.
In February 2003, Virgin Interactive Entertainment (Europe) Limited
("Virgin Europe"), the operating subsidiary of Virgin filed for a Company
Voluntary Arrangement, or CVA, a process of reorganization in the United Kingdom
which must be approved by Virgin's creditors. Included in amounts owed, Virgin
reported owed us approximately $1.8 million under our International Distribution
Agreement, which we have fully reserved for. The CVA was rejected by Virgin
Europe's creditors. On May 9, 2003, we received a new proposed CVA to voted on
for approval by Virgin Europe's creditors on May 19, 2003. The revised CVA was
approved and under the CVA, Virgin will pay us $241,000 per quarter beginning in
January 2004. We do not know what affect the approval of the CVA will have on
our ability to collect amounts Virgin owes us. If Virgin is not able to operate
under the new CVA, we expect Virgin to cease operations and liquidate, in which
event we will most likely not receive any amounts presently due us by Virgin,
and will not have a distributor for our products in Europe and the other
territories in which Virgin presently distributes our products. On July 1, 2003,
Virgin changed its name to Avalon Interactive.
In March 2003, we made a settlement payment of approximately $320,000 to a
third-party on behalf of Virgin Europe to protect the validity of certain of our
license rights and to avoid potential third-party liability from various
licensors of our products, and incurred legal fees in the amount of
approximately $80,000 in connection therewith. Consequently, Virgin owes us
$400,000 pursuant to the indemnification provisions of the International
Distribution Agreement, which we have fully reserved for.
TRANSACTIONS WITH VIVENDI
In February 2003, we sold to Vivendi, all future interactive entertainment
publishing rights to the "Hunter: The Reckoning" franchise for $15.0 million,
payable in installments. We retain the rights to the previously published
"Hunter: The Reckoning" titles on Microsoft Xbox and Nintendo GameCube.
In order to improve our cash flow, in August 2002, we entered into a new
distribution arrangement with Vivendi, whereby, Vivendi will distribute
substantially all of our products in North America for a period of three years
as a whole and two years with respect to each product giving a potential maximum
term of five years. The August 2002 agreement amended and superceded our August
2001 distribution agreement with Vivendi. Under the August 2002 agreement,
Vivendi will pay us sales proceeds less amounts for distribution fees, price
concessions and returns. Vivendi is responsible for all manufacturing, marketing
and distribution expenditures, and bears all credit, price concessions and
inventory risk, including product returns. Upon our delivery of a gold master to
Vivendi, Vivendi will pay us, as a minimum guarantee, a specified percent of the
projected amount due to us based on
23
projected initial shipment sales, which are established by Vivendi in accordance
with the terms of the agreement. The remaining amounts are due upon shipment of
the titles to Vivendi's customers. Payments for future sales that exceed the
projected initial shipment sales are paid on a monthly basis.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of June 30, 2003.
However, we are exposed to certain market risks arising from transactions in the
normal course of business, principally the risk associated with interest rate
fluctuations on any revolving line of credit agreement we maintain, and the risk
associated with foreign currency fluctuations. We do not hedge our interest rate
risk, or our risk associated with foreign currency fluctuations.
INTEREST RATE RISK
Our interest rate risk is due to our working capital lines of credit
typically having an interest rate based on either the bank's prime rate or
LIBOR. Currently, we do not have a line of credit, but we anticipate
establishing a line of credit in the future. A change in interest rates would
not have an effect on our interest expense on the Secured Convertible Promissory
Note issued to Warner Bros. because this instrument bears a fixed rate of
interest.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, primarily from Virgin. We
recognized gains of $5,000 and $68,000 during the six months ended June 30, 2003
and 2002, respectively, primarily in connection with foreign exchange
fluctuations in the timing of payments received on accounts receivable from
Virgin.
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2003, the end of the period covered by this report, our
Chief Executive Officer and interim Chief Financial Officer, Herve Caen, with
the participation of our management, carried out an evaluation of the
effectiveness of our disclosure controls and procedures pursuant to Exchange Act
Rule 13a-14. Based upon that evaluation, Mr. Caen believes that, as of the date
of the evaluation, our disclosure controls and procedures are effective in
causing material information to be recorded, processed, summarized and reported
by our management on a timely basis and to ensure that the quality and
timeliness of the Company's public disclosures complies with its Securities and
Exchange Commission disclosure obligation.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There were no significant changes in our internal controls or in other
factors that could significantly affect internal controls, known to Mr. Caen,
subsequent to the date of the evaluation.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are 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 our business, financial condition or results of operations.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and our subsidiary
GamesOnline.com, Inc., alleging, among other things, breach of contract,
misappropriation of trade secrets, breach of fiduciary duties and breach of
implied covenant of good faith in
24
connection with an electronic distribution agreement dated November 2001 between
KBK and GamesOnline.com, Inc. KBK has alleged that GamesOnline.com, Inc. failed
to timely deliver to KBK assets to a product, and that it improperly disclosed
confidential information about KBK to Infogrames. In August 2003, KBK amended
its complaint to include us as a defendant. We believe this complaint is without
merit and continue to vigorously defend our position.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The following exhibits are filed as part of this
report:
Exhibit
Number Exhibit Title
------- -------------
31.1 Certificate of Herve Caen, Chief Executive Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) under
the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) under
the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer and Interim
Chief Financial Officer of Interplay Entertainment Corp.
pursuant to Rule 13a-14(b) under the Securities and Exchange
Act of 1934, as amended.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on April 7,
2003, reporting that the Company issued a press release on
April 1, 2003 regarding results of operations for the fourth
quarter and year-ended December 31, 2002.
The Company filed a Current Report on Form 8-K on May 20,
2003, reporting that the Company issued a press release on May
20, 2003 regarding results of operations for the first quarter
of 2003.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: August 14, 2003 By: /s/ HERVE CAEN
------------------------------------
Herve Caen,
Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
26
EXHIBIT INDEX
Exhibit
Number Exhibit Title
------- -------------
31.1 Certificate of Herve Caen, Chief Executive Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) under
the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) under
the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer and Interim
Chief Financial Officer of Interplay Entertainment Corp.
pursuant to Rule 13a-14(b) under the Securities and Exchange
Act of 1934, as amended.
27