UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
INTERPLAY ENTERTAINMENT CORP.
(Exact name of the registrant as specified in its charter)
DELAWARE 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 N. CRESCENT DRIVE, BEVERLY HILLS, CALIFORNIA 90210
(Address of principal executive offices)
(310) 432-1958
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]
Indicate by check mark whether the registrant is shell company ( as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
CLASS ISSUED AND OUTSTANDING AT APRIL 19, 2006
----- ----------------------------------------
Common Stock, $0.001 par value 89,197,418
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2006
TABLE OF CONTENTS
--------------
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2006
(unaudited) and December 31, 2005 3
Condensed Consolidated Statements of Operations for the Three
Months ended March 31, 2006 and 2005 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the Three
Months ended March 31, 2006 and 2005 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 1A. Risk Factors 17
Item 3. Defaults Upon Senior Securities 25
Item 6. Exhibits 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
ASSETS 2006 2005
------------- -------------
(unaudited)
Current Assets:
Cash ......................................................... $ 40,000 $ 122,000
Trade receivables from related parties, net of allowances
of $2,114,000 and $2,370,000 respectively ................ 23,000 17,000
Trade receivables, net of allowances
of $76,000 and $94,000 respectively ...................... 161,000 428,000
Inventories .................................................. 9,000 8,000
Deposits ..................................................... 6,000 8,000
Prepaid expenses ............................................. 21,000 60,000
Other receivables ............................................ -- 8,000
------------- -------------
Total current assets ........................................... 260,000 651,000
Property and equipment, net ....................................... 6,000 7,000
Other assets ...................................................... 61,000 15,000
------------- -------------
Total assets .............................................. $ 327,000 $ 673,000
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current debt ................................................. $ 1,585,000 $ 1,549,000
Accounts payable ............................................. 9,627,000 9,560,000
Accrued royalties ............................................ 952,000 949,000
Advances from distributors and others ........................ 173,000 105,000
------------- -------------
Total current liabilities ............................... 12,337,000 12,163,000
------------- -------------
Commitments and contingencies
Stockholders' Deficit:
Preferred stock, $0.001 par value 5,000,000 shares authorized;
no shares issued or outstanding, respectively,
Common stock, $0.001 par value 150,000,000 shares authorized;
93,855,634 shares issued and outstanding .................. 94,000 94,000
Paid-in capital .............................................. 121,640,000 121,640,000
Accumulated deficit .......................................... (133,813,000) (133,284,000)
Accumulated other comprehensive income ....................... 69,000 60,000
------------- -------------
Treasury stock of 4,658,216 .................................. 0 0
------------- -------------
Total stockholders' deficit ...................... (12,010,000) (11,490,000)
Total liabilities and stockholders' deficit ............. $ 327,000 $ 673,000
============= =============
See accompanying notes.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2006 2005
------------- -------------
Net revenue from licensing ..................... $ 38,000 $ 793,000
Net revenues from related and non related
distributors ................................. 68,000 --
------------ ------------
Total net revenues .......................... 106,000 793,000
Cost of goods sold ............................. 6,000 171,000
------------ ------------
Gross profit ................................ 100,000 622,000
Operating expenses:
Marketing and sales ......................... 147,000 103,000
General and administrative .................. 415,000 648,000
Product Development ......................... 0 81,000
------------ ------------
Total operating expenses ................. 562,000 832,000
------------ ------------
Operating (loss) income ........................ (462,000) (210,000)
------------ ------------
Other income (expense):
Interest expense ........................... (25,000) (6,000)
Other ...................................... (42,000) --
------------ ------------
Total other income (expense) ............. (67,000) (6,000)
Income before benefit for income taxes ......... (529,000) (216,000)
Benefit for income taxes ....................... -- --
------------ ------------
Net (loss) available to common stockholders .... $ (529,000) $ (216,000)
============ ============
Net (loss) income per common share:
Basic ...................................... $ (.006) $ (0.00)
============ ============
Diluted .................................... $ (.006) $ (0.00)
============ ============
Shares used in calculating (loss) net income
per common share:
Basic ...................................... 89,197,418 93,856,634
============ ============
Diluted .................................... 89,197,148 93,856,634
============ ============
See accompanying notes.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------
2006 2005
--------- ---------
Cash flows from operating activities:
Net (loss) income .......................................... $(529,000) $(216,000)
Adjustments to reconcile net (loss) income to
cash (used) provided by operating activities:
Depreciation and amortization ........................... 1,000 79,000
Abandonment of property and equipment .................. (1,000) --
Changes in operating assets and liabilities:
Trade receivables from related parties ............... (6,000) (10,000)
Trade receivables, net ............................... 267,000 (166,000)
Inventories .......................................... (1,000) (4,000)
Prepaid licenses and royalties ....................... -- (20,000)
Prepaid expenses ..................................... 39,000 --
Other current assets, net ............................ 8,000 101,000
Other assets ......................................... (46,000) --
Accounts payable ..................................... 106,000 265,000
Accrued royalties .................................... 3,000 --
Payables to former related parties ................... -- (15,000)
Advances from distributors ........................... 68,000 --
Accumulated other compensation income ................ 9,000 --
--------- ---------
Net cash provided by (used in) operating activities (82,000) 14,000
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment ......................... -- --
--------- ---------
Net cash used in investing activities ............. -- --
--------- ---------
Cash flows from financing activities:
Repayment of current debt .................................. -- --
--------- ---------
Net cash provided by (used in) financing activities -- --
--------- ---------
Effect of exchange rate changes on cash ................. -- --
Net increase (decrease) in cash ......................... (82,000) 14,000
Cash, beginning of period ..................................... 122,000 29,000
--------- ---------
Cash, end of period ........................................... $ 40,000 $ 43,000
========= =========
Supplemental cash flow information:
Cash paid for:
Interest .......................................... $ 0 $ 6,000
See accompanying notes.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2006
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Interplay Entertainment Corp. (which we refer to as the "Company" in these
Notes) and its subsidiaries reflect all adjustments (consisting only of normal
recurring adjustments) that, in the opinion of management, are necessary for a
fair presentation of the results for the interim period in accordance with
instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all information and footnotes required by accounting principles
generally accepted in the United States ("GAAP") for complete financial
statements. The results of operations for the current interim period are not
necessarily indicative of results to be expected for the current year or any
other period. The balance sheet at December 31, 2005 has been derived from the
audited consolidated financial statements at that date, but does not include all
information and footnotes required by GAAP for complete financial statements.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2005 as filed with the U.S. Securities and Exchange Commission ("SEC").
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN STATUS
The Company's independent public accountant included a "going concern"
explanatory paragraph in his audit report on the December 31, 2005 consolidated
financial statements which were prepared assuming that the Company will continue
as a going concern.
To reduce working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles. All
costs incurred and expected to be incurred associated with the restructuring
activities of the Company are considered insignificant. 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 securities, the sale of selected
assets, the licensing of certain product rights, selected distribution
agreements, and/or other strategic transactions sufficient to provide short-term
funding, and potentially achieve the Company's long-term strategic objectives.
The Company expects that it will need to substantially reduce its working
capital needs and/or raise additional capital. However, no assurance can be
given that alternative sources of funding could be obtained on acceptable terms,
or at all. These conditions, combined with the Company's historical operating
losses and its deficits in stockholders' equity and working capital, raise
substantial doubt about 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 might result from the outcome of
this uncertainty.
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the condensed consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Significant estimates made in preparing the
condensed consolidated financial statements include, among others, sales returns
and allowances, cash flows used to evaluate the recoverability of prepaid
licenses and royalties, channel exposure and long-lived assets, and certain
accrued liabilities related to litigation.
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2006
PRINCIPLES OF CONSOLIDATION
The accompanying condensed consolidated financial statements include the
accounts of Interplay Entertainment Corp. and its wholly-owned subsidiaries,
Interplay Productions Limited (U.K.), Interplay OEM, Inc., Interplay Co., Ltd.,
(Japan) and Games On-line.com, Inc. All significant intercompany transactions
have been eliminated.
NOTE 2. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings, claims, and
litigation arising in the ordinary course of Business, including disputes
arising over the ownership of intellectual property rights and collection
matters. In the opinion of management, the outcome of known routine claims will
not have a material adverse effect on the Company's business, financial
condition, or results of operations.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") initiated
legal proceedings against the Company seeking damages of approximately $1.3
million, alleging, among other things, that we failed to secure a timely
effective date for a Registration Statement for its shares purchased by Special
Situations under a common stock subscription agreement dated March 29, 2001 and
that the Company therefore, liable to pay Special Situations $1.3 million.
Special Situations entered into a settlement agreement with the Company in
December, 2003 contemplating payments over time, which the Company later
defaulted . In August, 2004 the Company entered into a stipulation of settlement
on which it later defaulted. On January 12, 2005 a judgment of approximately
$776,00 was entered in the State of New York and on February 4 ,2005 a judgment
reflecting the January 12, 2005 judgment was entered in the State of California.
On May 3, 2006 the Company entered into a Stipulation of Settlement. Under this
Stipulation of Settlement, the Company agreed to issue a total of 10,000,000
shares of its unregistered common stock and made a payment in the amount of
approximately $239,000. Following the issuance of such shares, and in
consideration of such issuance and such payment, satisfaction of judgments in
the amount of approximately $776,000 recorded against the Company will be filed.
Such shares will be issued in a private placement pursuant to section 4(2) of
the Securities Act of 1933 and will be issued prior to the satisfaction of
judgments which must occur within 10 business days following the Company making
a payment of approximately $239,000 and the issuance of such shares. Such shares
have now been issued.
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the Company for various claims related to a
breach of a distributorship agreement. Synnex obtained a $172,000 judgment
against the Company.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against the Company in the Superior Court for the State of
California, County of Orange, alleging default on an Amended and Restated
Secured Convertible Promissory Note held by Warner dated April 30, 2002, with an
original principal sum of $2.0 million. At the time the suit was filed, the
current remaining principal sum due under the note was $1.4 million in principal
including interest. The Company owes a remaining balance of approximately
$360,000 payable in one remaining installment. The Company is currently in
default of the settlement agreement.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $432,000. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has not accrued any amount for any remaining lease obligation,
should such obligation exist. The Company is currently in default of the
forbearance agreement.
7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2006
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,000 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000. If Monte Cristo executes the judgment, it
will negatively affect the Company's cash flow, which could further restrict the
Company's operations and cause material harm to its business.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company, for failure to pay development fees, in the Orange County Superior
Court, that was settled in July 2004. The Company was unable to make the
payments and Reflexive sought ,and obtained, judgment against the company for
approximately $110,000.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for failure to pay royalties. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further, the settlement was entered into with Interplay OEM only in the
amount of $170,000; however, KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment has not been made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $110,000 pursuant to section 166 and section 186 of the
Internal Revenue Code in payroll tax penalties, and interest for late filing and
late payment of payroll taxes. Approximately $110,000 has been accrued as of
December 31, 2005 but remains unpaid. The Company received notice from the
Employment Development Department (EDD) that it owes approximately $103,000 in
payroll taxes owed for the periods ending 2004 and 2003, which have been accrued
for December 31,2005.
The Company was unable to meet certain 2004 payroll obligations to its
employees; as a result, several employees filed claims with the State of
California Labor Board ("Labor Board"). The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and obtained
in August 2005 judgments totaling $118,000 in favor of former employees of the
Company. Since this time $44,000 of the claims have been settled, leaving a
balance of $74,000.
The Labor Board fined the Company approximately $79,000 for having lost
workers' compensation insurance for a period of time. The Company is appealing
the Labor Board fine.
The Company received notice from the California State Board of Equalization
of a balance due in the amount of $73,000 for a prior year audit. The Company is
in the process of appealing the prior year audit calculations.
On September 14, 2005, Network Commercial Service, Inc. ("NCS") filed an
action against the Company alleging breach of contract relating to the provision
of copying equipment and that the balance due is $140,000 to NCS. The Company is
evaluating the merit of the lawsuit.
On April 22, 2005, Mark Strecker filed a judgment to be entered against the
Company for various claims alleging unpaid services in the amount of $35,000.
The Company is evaluating the merit of the lawsuit.
On May 19, 2005 DZN, The Design Group, Inc. filed an action against the
Company for various advertising services in the amount of $38,000. The Company
is evaluating the merit of the lawsuit.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. The Company is evaluating the merit of the lawsuit.
On March 7, 2006 Parallax Software Corp. entered a judgment against the
Company for a material breach of a settlement agreement related to royalties
owed in the amount of $219,000. The Company is evaluating the merit of the
lawsuit.
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2006
The Company has recorded an estimate for the liabilities related to the
aforementioned litigation. If any of the creditors execute their judgments
against the Company, the results will negatively affect the Company's cash flow,
which could restrict the Company's operations and cause material restraints to
its business.
NOTE 3. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------
2006 2005
----------------------- -----------------------
AMOUNT PERCENT AMOUNT PERCENT
----------- ---------- ---------- ----------
(Dollars in thousands)
North America $ 44 42% $ 37 5%
Europe 0 0 457 58
Rest of World 15 14 240 31
OEM, royalty
and licensing 47 44 59 6
----------- ---------- ---------- ----------
$ 106 100% $ 793 100%
=========== ========== ========== ==========
SUBSEQUENT EVENT
10,000,000 shares of common stock of the Company have now been issued to various
Special Situations Funds.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
Interplay Entertainment Corp., which we refer to in this Report as
"we," "us," or "our," is a developer, publisher and licensor of interactive
entertainment software and intellectual properties for both core gamers and the
mass market. The information contained in this Form 10-Q is intended to update
the information contained in our Annual Report on Form 10-K for the year ended
December 31, 2005, as amended, and presumes that readers have access to, and
will have read, the "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other information contained in such
Form 10-K, as amended.
This Report on Form 10-Q contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 and such forward-looking statements are
subject to the safe harbors created thereby. For this purpose, any statements
contained in this Form 10-Q, except for historical information, may be deemed to
be forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "should," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to help identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
revenue or expense expectations, including those forward-looking statements in
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations", financing activities, future cash flows, cash constraints, sales
or mergers and cost reduction measures are forward-looking statements and there
can be no assurance that we will effect any or all of these objectives in the
future. Specifically, the forward-looking statements in this Item 2 assume that
we will continue as a going concern. Risks and Uncertainties that may affect our
future results are discussed in more detail in the section titled "Risk Factors"
in Item 1A of part II of this Form 10-Q. Assumptions relating to our
forward-looking statements involve judgments with respect to, among other
things, future economic, competitive and market conditions and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond our control. Although we believe that the assumptions
underlying the forward-looking statements are reasonable, our industry, business
and operations are subject to substantial risks, and the inclusion of such
information should not be regarded as a representation by management that any
particular objective or plans will be achieved. In addition, risks,
uncertainties and assumptions change as events or circumstances change. We
disclaim any obligation to publicly release the results of any revisions to
these forward-looking statements which may be made to reflect events or
circumstances occurring subsequent to the filing of this Form 10-Q with the SEC
or otherwise to revise or update any oral or written forward-looking statement
that may be made from time to time by us or on our behalf.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates, including, among others, those related to revenue recognition,
prepaid licenses and royalties and software development costs. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
10
RESULTS OF OPERATIONS
The following table sets forth certain selected consolidated statements
of operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2006 2005
----------------- -----------------
% OF NET % OF NET
AMOUNT REVENUES AMOUNT REVENUES
------ ------ ------ ------
(Dollars in thousands)
Net revenues .......................... $ 106 100% $ 793 100%
Cost of goods sold .................... 6 6% 171 22%
------ ------ ------ ------
Gross profit ..................... 100 94% 622 78%
------ ------ ------ ------
Operating expenses:
Marketing and sales .............. 147 138% 103 13%
General and administrative ....... 415 392% 648 82%
Product development .............. 0 0% 81 10%
------ ------ ------ ------
Total operating expenses ......... 562 530% 832 105%
------ ------ ------ ------
Operating income (loss) ............... (462) (436)% (210) (26)%
Other expense ......................... (67) (63)% (6) (1)%
------ ------ ------ ------
Net income (loss) ..................... $ (529) (499)% $ (216) (26%
====== ====== ====== ======
Net revenues by geographic region:
North America .................... $ 44 42% $ 37 5%
International .................... 15 14% 697 88%
OEM, royalty and licensing ....... 47 44% 59 7%
------ ------ ------ ------
106 100% 793 100%
====== ====== ====== ======
Net revenues by platform:
Personal computer ................ $ 21 20% $ 132 17%
Video game console ............... 38 36% 602 77%
OEM, royalty and licensing ....... 47 44% 59 6%
------ ------ ------ ------
106 100% 793 100%
====== ====== ====== ======
11
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Geographically, our net revenues for the three months ended March 31, 2006
and 2005 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
-------- -------- -------- --------
North America ................... $ 44 $ 37 $ 7 19%
International ................... 15 697 (682) (98)%
OEM, Royalty & Licensing ........ 47 59 (12) (59)%
Net Revenues .................... $ 106 $ 793 $ (687) (87)%
Net revenues for the three months ended March 31, 2006 were $106,000, a
decrease of 87% compared to the same period in 2005. This decrease resulted from
a 19% decrease in North American net revenues , a 59% decrease in OEM, royalty
and licensing net revenues, and a 98% decrease in International net revenues.
These decreases all substantially resulted from the expiring of the contracts
with Vivendi Universal Games.
North American net revenues for the three months ended March 31, 2006
were $44,000. The decrease in North American net revenues in 2006 was mainly due
to a 19% decrease in back catalog sales.
OEM, royalty and licensing net revenues for the three months ended
March 31, 2006 were $47,000, a decrease of $687,000 as compared to the same
period in 2005.
International net revenues for the three months ended March 31, 2006
were $15,000. The decrease in International net revenues for the three months
ended March 31, 2006 was mainly due to a 98% decrease in back catalog sales.
PLATFORM NET REVENUES
Our platform net revenues for the three months ended March 31, 2006 and
2005 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
-------- -------- -------- --------
Personal Computer ............... $ 21 $ 132 $ (111) (84)%
Video Game Console .............. 38 602 (564) (94)%
OEM, Royalty & Licensing ........ 47 59 (12) (20)%
Net Revenues .................... 106 793 (687) (86)%
PC net revenues for the three months ended March 31, 2006 were $21,000,
a decrease of 84% compared to the same period in 2005. The decrease in PC net
revenues in 2006 was primarily due to lower back catalog sales. Video game
console net revenues were $ 38,000, a decrease of 94 % for the three months
ended March 31, 2006 compared to the same period in 2005, due to lower back
catalog sales.
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our net revenues, cost of goods sold and gross margin for the three months
ended March 31, 2006 and 2005 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
-------- -------- -------- --------
Net Revenues .................... $ 106 $ 793 $ (687) (87)%
Cost of Goods Sold .............. 6 171 (165) (96)%
Gross Profit Margin ............. 100 622 (522) (83)%
Cost of goods sold related to PC and video game console net revenues
represents the manufacturing and related costs of interactive entertainment
software products, including costs of media, manuals, duplication, packaging
materials, assembly, freight and royalties paid to developers, licensors and
hardware manufacturers. Cost of goods sold related to royalty-based net revenues
primarily represents third party licensing fees and royalties paid by us.
Typically, cost of goods sold as a percentage of net revenues for video game
console products is higher than cost of goods sold as a percentage of net
revenues for PC based products due to the relatively higher manufacturing and
royalty costs associated with video game console and affiliate label products.
We also include in
12
the cost of goods sold the amortization of prepaid royalty and license fees paid
to third party software developers. We expense prepaid royalties over a period
of six months commencing with the initial shipment of the title at a rate based
upon the number of units shipped. We evaluate the likelihood of future
realization of prepaid royalties and license fees quarterly, on a
product-by-product basis, and charge the cost of goods sold for any amounts that
we deem unlikely to realize through future product sales.
Our cost of goods sold decreased 96% to $6,000 in the three months
ended March 31, 2006 compared to the same period in 2005. The decrease was due
to no amortization of prepaid royalties on externally developed products in the
three months ended March 31, 2006 as compared to the 2005 period, as revenue was
generated from non-licensed products or products with no unrecouped prepaid
royalties.
Our gross margin increased to 94% for the 2006 period from 79% in the
2005 period. This was primarily due to the 2006 period having a higher
percentage of licensing revenue compared to distribution revenue.
MARKETING AND SALES
Our marketing and sales expense for the three months ended March 31, 2006
and 2005 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
---- ---- ------ --------
Marketing and Sales $147 $103 $44 42%
Marketing and sales expenses primarily consist of advertising and
retail marketing support, sales commissions, marketing and sales personnel,
customer support services and other related operating expenses. Marketing and
sales expenses for the three months ended March 31, 2006 were $147,000 a 42%
increase compared to the 2005 period.
GENERAL AND ADMINISTRATIVE
Our general and administrative expense for the three months ended March 31,
2006 and 2005 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
---- ---- ------ --------
General and Administrative $415 $648 ($233) (36)%
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended March 31, 2006 were $415,000 a 36 % decrease as compared to
the same period in 2005. The decrease is mainly due to a $233,000 decrease in
personnel costs and general expenses.
PRODUCT DEVELOPMENT
Our product development expense for the three months ended March 31, 2005
and 2004 breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
---- ---- ------ --------
Product Development $ 0 $ 81 ($81) (100)%
Product development expenses for the three months ended March 31, 2006
were approximately $0, a 100% decrease as compared to the same period in 2005.
This decrease is due to a $81,000 decrease in personnel costs as a result of a
reduction in product development personnel during 2006 as compared to 2005.
13
OTHER EXPENSE (INCOME), NET
Our other expense for the three months ended March 31, 2006 and 2005
breakdown as follows: (in thousands)
2006 2005 CHANGE % CHANGE
---- ---- ------ --------
Other Expense (Income) $ 67 $ 6 $ 61 91%
Other expense consists primarily of interest expense on our debt and
foreign currency exchange transaction gains and losses. Other expense for the
three months ended March 31, 2006 was $67,000, a 91% increase as compared to the
same period in 2005.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2006, we had a working capital deficit of approximately
$12 million, and our cash balance was approximately $40,000. We currently have
no cash reserves and are unable to pay current liabilities. We cannot continue
in our current form without obtaining additional financing or income or reducing
expenditures.
We have substantially reduced our operating expenses. We need to reduce our
continuing liabilities. We have to raise additional capital or financing. If we
do not receive sufficient financing we may (i) liquidate assets, (ii) sell the
company (iii) seek protection from our creditors including the filing of
voluntary bankruptcy or being the subject of involuntary bankruptcy, and/or (iv)
continue operations, but incur material harm to our business, operations or
financial conditions. These conditions, combined with our historical operating
losses and our deficits in stockholders' equity and working capital, raise
substantial doubt about our ability to continue as a going concern.
Additionally, we have reduced our fixed overhead commitments, and cancelled
or suspended development on future titles. Management will continue to pursue
various alternatives to improve future operating results.
We continue to seek external sources of funding, including but not limited
to, incurring debt, the sale of assets or stock, the licensing of certain
product rights in selected territories, selected distribution agreements, and/or
other strategic transactions sufficient to provide short-term funding, and
potentially achieve our long-term strategic objectives.
We have been operating without a credit facility since October 2001, which
has adversely affected cash flow. We continue to face difficulties in paying our
vendors, and employees, and have pending lawsuits as a result of our continuing
cash flow difficulties. We expect these difficulties to continue during 2006.
Historically, we have funded our operations primarily through cash flow
from operations, including royalty and distribution fee advances.
Our primary capital needs have historically been working capital
requirements necessary to fund our operations. Our operating activities used
cash of $82,000 during the three months ended March 31, 2006.
The Company had approximately $173,000 in revenue from deferred income
recognition and approximately $106,000 in royalty and licensing revenue in the
three months ended March 31, 2006. However, the Company does not expect material
income from the recognition of deferred income or other income during the
remaining of 2006.
We entered into various licensing agreements during the three months ended
March 31,2006 under which we licensed others to exploit games that we have
intellectual property rights to. This included entering into an agreement with
Atari Inc. which resulted in a one time payment for this license. We expect in
subsequent quarters of 2006 to enter into similar license arrangements to
generate cash for the Company's operations.
Currently the Company has no internal development of new titles.
If operating revenues are not sufficient to fund our operations, no
assurance can be given that alternative sources of funding could be obtained on
acceptable terms, or at all. These conditions, combined with our deficits in
stockholders' equity and working capital, raise substantial doubt about our
ability to continue as a going concern. The accompanying condensed consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets and
liabilities that may result from the outcome of this
14
uncertainty. There can be no guarantee that we will be able to meet all
contractual obligations or liabilities in the future, including payroll
obligations.
OFF BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements under which we have
obligations under a guaranteed contract that has any of the characteristics
identified in paragraph 3 of FASB Interpretation No. 45 "Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". We do not have any retained or contingent interest in
assets transferred to an unconsolidated entity or similar arrangement that
serves as credit, liquidity or market risk support to such entity for such
assets. We also do not have any obligation, including a contingent obligation,
under a contract that would be accounted for as a derivative instrument. We have
no obligations, including a contingent obligation arising out of a variable
interest (as referenced in FASB Interpretation No. 46, Consolidation of Variable
Interest Entities, as amended) in an unconsolidated entity that is held by, and
material to, us, where such entity provides financing, liquidity, market risk or
credit risk support to, or engages in leasing, hedging or research and
development services with us.
CONTRACTUAL OBLIGATIONS
The following table summarizes certain of our contractual obligations under
non-cancelable contracts and other commitments at March 31, 2006, and the effect
such obligations are expected to have on our liquidity and cash flow in future
periods. (in thousands)
- --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 - 3 3 - 5 MORE THAN
1 YEAR YEARS YEARS 5 YEARS
- --------------------------------------------------------------------------------
Lease Commitments (1) 125 - 114 11 -
- --------------------------------------------------------------------------------
Total 125 - 114 11 -
- --------------------------------------------------------------------------------
Our current cash reserves plus our expected cash from existing operations
will only be sufficient to fund our anticipated expenditures to June 30, 2006.
We will need to substantially reduce our working capital needs, continue to
consummate certain sales of assets and/or raise additional financing to meet our
contractual obligations..
(1) We have a lease commitment at the Beverly Hills office through April 2008.
We have a monthly rental agreement in Irvine.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of March 31,
2006. However, we are exposed to certain market risks arising from transactions
in the normal course of business, principally the risk associated with foreign
currency fluctuations. We do not hedge our interest rate risk, or our risk
associated with foreign currency fluctuations.
INTEREST RATE RISK
Currently, we do not have a line of credit, but we anticipate we may
establish a line of credit in the future.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables.
We recognized gains of $2,500 and $0 during the three months ended
March 31, 2006 and 2005 respectively, primarily in connection with foreign
exchange fluctuations in the timing of payments received on accounts receivable
which have been from Interplay Productions Ltd .
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and interim Chief Financial Officer of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
this evaluation, our Chief Executive Officer and interim Chief Financial Officer
concluded that our disclosure controls and procedures are were effective, at the
reasonable assurance level, in ensuring that information required to be
disclosed is recorded, processed, summarized and reported within the time period
specified in the SEC's rules and forms and in timely alerting him to material
information required to be included in this report.
There were no changes made in our internal controls over financial
reporting that occurred during the quarter ended March 31, 2006 that have
materially affected or are reasonably likely to materially affect these
controls.
Our management, including the CEO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
necessarily prevent all fraud and material errors. An internal control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations on all internal
control systems, our internal control system can provide only reasonable
assurance of achieving its objectives and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within our Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, and/or by management override of the control. The design of any system
of internal control is also based in part upon certain assumptions about the
likelihood of future events, and there can be no can provide only reasonable,
not absolute assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may become
inadequate because of changes in circumstances, and/or the degree of compliance
with the policies and procedures may deteriorate.
16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required in this Item 1 is incorporated herein by
reference to the information in "Note 2. Commitments and Contingencies" to our
condensed consolidated financial statements located in Item 1, Part 1 of this
Report.
ITEM 1A. RISK FACTORS
RISK FACTORS
Our future operating results depend upon many factors and are subject
to various risks and uncertainties. These major risks and uncertainties are
discussed below. There may be additional risks and uncertainties which we do not
believe are currently material or are not yet known to us but which may become
such in the future. Some of the risks and uncertainties which may cause our
operating results to vary from anticipated results or which may materially and
adversely affect our operating results are as follows:
RISKS RELATED TO OUR FINANCIAL RESULTS
WE CURRENTLY HAVE A NUMBER OF OBLIGATIONS THAT WE ARE UNABLE TO MEET WITHOUT
GENERATING ADDITIONAL INCOME OR RAISING ADDITIONAL CAPITAL. IF WE CANNOT
GENERATE ADDITIONAL INCOME OR RAISE ADDITIONAL CAPITAL IN THE NEAR FUTURE, WE
MAY BECOME INSOLVENT AND/OR BE MADE BANKRUPT AND/OR OUR MAY BECOME ILLIQUID OR
WORTHLESS.
As of March 31, 2006, our cash balance was approximately $40,000 and
our outstanding accounts payable and current liabilities totaled approximately
$12.3 million. In particular, we have some significant creditors that comprise a
substantial proportion of outstanding obligations, including many that have
obtained judgments against us that we might not be able to satisfy. If we do not
receive sufficient financing or sufficient funds from our operations we may (i)
liquidate assets, (ii) seek or be forced into bankruptcy and/or (iii) continue
operations, but incur material harm to our business, operations or financial
condition. These measures could have a material adverse effect on our ability to
continue as a going concern. Additionally, because of our financial condition,
our Board of Directors has a duty to our creditors that may conflict with the
interests of our stockholders. When a Delaware corporation is operating in the
vicinity of insolvency, the Delaware courts have imposed upon the corporation's
directors a fiduciary duty to the corporation's creditors. Our Board of
Directors may be required to make decisions that favor the interests of
creditors at the expense of our stockholders to fulfill its fiduciary duty. For
instance, we may be required to preserve our assets to maximize the repayment of
debts versus employing the assets to further grow our business and increase
shareholder value. If we cannot generate enough income from our operations or
are unable to locate additional funds through financing, we will not have
sufficient resources to continue operations.
WE HAVE A HISTORY OF LOSSES, AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY
CURTAILING FUTURE OPERATIONS TO CONTINUE AS A BUSINESS.
For the three months ended ended March 31, 2006, our net loss from
operations was $529,000, and we have incurred significant net losses in previous
years. Although for the year ended December 31, 2005, our net income from
operations was $5.9 million, $7 million of our revenue was recognized from the
expiration of distribution contracts and other income, and we have incurred
significant net losses in previous years. As of March 31, 2006 we had an
accumulated deficit of $134 million. Our ability to fund our capital
requirements out of our available cash and cash generated from our operations
depends on a number of factors. Some of these factors include the progress of
our product distributions and licensing, the rate of growth of our business, and
our products' commercial success. If we cannot generate positive cash flow from
operations, we will have to continue to reduce our costs and raise working
capital from other sources. These measures could include selling or
consolidating certain operations or assets, and delaying, canceling or scaling
back product development and marketing programs. These measures could materially
and adversely affect our ability to publish successful titles, and may not be
enough to permit us to operate profitability, or at all.
OUR ABILITY TO EFFECT A FINANCING TRANSACTION TO FUND OUR OPERATIONS COULD
ADVERSELY AFFECT THE VALUE OF YOUR STOCK.
17
If we are not acquired by or merge with another entity or if we are not
able to raise additional capital by sale or license of certain of our assets, we
may need to consummate a financing transaction to receive additional liquidity.
This additional financing may take the form of raising additional capital
through public or private equity offerings or debt financing. To the extent we
raise additional capital by issuing equity securities, we cannot be certain that
additional capital will be available to us on favorable terms and our
stockholders will likely experience substantial dilution. Our certificate of
incorporation provides for the issuance of preferred stock however we currently
do not have any preferred stock issued and outstanding. Any new equity
securities issued may have greater rights, preferences or privileges than our
existing common stock. Material shortage of capital will require us to take
drastic steps such as reducing our level of operations, disposing of selected
assets, effecting financings on less than favorable terms or seeking protection
under federal bankruptcy laws.
RISKS RELATED TO OUR BUSINESS
TITUS INTERACTIVE SA (PLACED IN INVOLUNTARY BANKRUPTCY IN JANUARY, 2005)
CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A MAJORITY OF OUR BOARD OF
DIRECTORS AND PREVENT AN ACQUISITION OF US THAT IS FAVORABLE TO OUR OTHER
STOCKHOLDERS. ALTERNATIVELY, TITUS CAN ALSO CAUSE A SALE OF CONTROL OF OUR
COMPANY THAT MAY NOT BE FAVORABLE TO OUR OTHER STOCKHOLDERS.
Titus owns approximately 58 million shares of common stock. As a
consequence, Titus can control substantially all matters requiring stockholder
approval, including the election of directors, subject to our stockholders'
cumulative voting rights, and the approval of mergers or other business
combination transactions. At our 2003 and 2002 annual stockholders meetings,
Titus exercised its voting power to elect a majority of our Board of Directors.
Currently, our Chief Executive Officer and interim Chief Financial Officer Herve
Caen is a director of various Titus affiliates. This concentration of voting
power could discourage or prevent a change in control that otherwise could
result in a premium in the price of our common stock. Further, Titus' bankruptcy
could lead to a sale by its liquidator or other representative in bankruptcy, of
shares Titus holds in us, and/or a sale of Titus itself which would result in a
sale of control of our Company and such a sale may not be favorable to our other
stockholders . Such a sale, including if it involves a dispersion of shares to
multiple stockholders, further could have the effect of making any business
combination, or a sale of all of our shares as a whole, more difficult.
THE LACK OF ANY CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL REDUCTION IN THE
CASH AVAILABLE TO FINANCE OUR OPERATIONS.
We are currently operating without a credit agreement or credit
facility. The lack of a credit agreement or credit facility has significantly
impeded our ability to fund our operations and has caused material harm to our
business. There can be no assurance that we will be able to enter into a new
credit agreement or that if we do enter into a new credit agreement, it will be
on terms favorable to us.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES HISTORICALLY DEPENDED ON OUR
DISTRIBUTORS' DILIGENT SALES EFFORTS.
Avalon was the exclusive distributor for most of our products in Europe,
the Commonwealth of Independent States, Africa and the Middle East. Our
agreement with Avalon was terminated following the liquidation of Avalon in
February 2005. We subsequently appointed our wholly owned subsidiary Interplay
Productions Ltd as our distributor for Europe.
Vivendi had exclusive rights to distribute our products in North
America and selected International territories. Our agreement with Vivendi
expired in August 2005 and December 2005 for most of our products.
Our revenues and cash flows could fall significantly and our business
and financial results could suffer material harm if:
o We fail to replace Vivendi as our distributor; or
o Interplay Productions Ltd fails to effectively distribute our
products.
We typically sell to distributors and retailers on unsecured credit, with
terms that vary depending upon the customer and the nature of the product. We
confront the risk of non-payment from our customers, whether due to their
financial inability to pay us, or otherwise. In addition, while we maintain a
reserve for uncollectible receivables, the reserve may not be sufficient in
every circumstance. As a result, a payment default by a significant customer
could cause material harm to our business.
18
WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR
ABILITY TO MANAGE OUR FINANCIAL OPERATIONS.
We are presently without a CFO, and Mr. Caen has assumed the position
of interim-CFO and continues as CFO to date until a replacement can be found.
OUR BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL. IF WE FAIL TO DELIVER
OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER.
Our business is highly seasonal, with the highest levels of consumer
demand occurring in the fourth quarter. Our industry is also cyclical. The
timing of hardware platform introduction is often tied to the year-end season
and is not within our control. As new platforms are being introduced into our
industry, consumers often choose to defer game software purchases until such new
platforms are available, which would cause sales of our products on current
platforms to decline. This decline may not be offset by increased sales of
products for the new platform.
THE UNPREDICTABILITY OF FUTURE RESULTS MAY CAUSE OUR STOCK PRICE TO REMAIN
DEPRESSED OR TO DECLINE FURTHER.
Our operating results have fluctuated in the past and may fluctuate in
the future due to several factors, some of which are beyond our control. These
factors include:
o demand for our products and our competitors' products;
o the size and rate of growth of the market for interactive
entertainment software;
o changes in personal computer and video game console platforms;
o the timing of announcements of new products by us and our
competitors and the number of new products and product
enhancements released by us and our competitors;
o changes in our product mix;
o the number of our products that are returned; and
o the level of our international and original equipment
manufacturer royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in
which we will ship our products. Some of these factors include:
o the uncertainties associated with the interactive
entertainment software development process;
o approvals required from content and technology licensors; and
o the timing of the release and market penetration of new game
hardware platforms.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE INTRODUCTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
Although for the year ended December 31, 2005, our net income from
operations was $5.9 million, $7 million of our revenue was recognized from the
expiration of distribution contracts and other income, and we have incurred
significant net losses in previous. Our losses in the past stemmed partly from
the significant costs we incurred to develop our entertainment software
products, product returns and price concessions. Moreover, a significant portion
of our operating expenses is relatively fixed, with planned expenditures based
largely on sales forecasts. At the same time, most of our products have a
relatively short life cycle and sell for a limited period of time after their
initial release, usually less than one year.
Relatively fixed costs and short windows in which to earn revenues mean
that sales of new products are important in enabling us to recover our
development costs, to fund operations and to replace declining net revenues from
older products. Our failure to accurately assess the commercial success of our
new products, and our delays in releasing new products could reduce our net
revenues and our ability to recoup development and operational costs.
19
IF OUR PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, OUR BUSINESS COULD BE
HARMED SIGNIFICANTLY.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our new products will achieve significant market acceptance, or
that we will be able to sustain this acceptance for a significant length of time
if we achieve it.
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis. Because we introduce
a relatively limited number of new products in a given period, the failure of
one or more of these products to achieve market acceptance could cause material
harm to our business. Further, if our products do not achieve market acceptance,
we could be forced to accept substantial product returns or grant significant
pricing concessions to maintain our relationship with retailers and our access
to distribution channels. If we are forced to accept significant product returns
or grant significant pricing concessions, our business and financial results
could suffer material harm.
OUR RELIANCE ON THIRD PARTY SOFTWARE DEVELOPERS SUBJECTS US TO THE RISKS THAT
THESE DEVELOPERS WILL NOT SUPPLY US WITH HIGH QUALITY PRODUCTS IN A TIMELY
MANNER OR ON ACCEPTABLE TERMS.
Third party interactive entertainment software developers develop many
of our software products. Since we depend on these developers in the aggregate,
we remain subject to the following risks:
o limited financial resources may force developers out of
business prior to their completion of projects for us or
require us to fund additional costs; and
o the possibility that developers could demand that we
renegotiate our arrangements with them to include new terms
less favorable to us.
Increased competition for skilled third party software developers also
has compelled us to agree to make advance payments on royalties and to guarantee
minimum royalty payments to intellectual property licensors and game developers.
Moreover, if the products subject to these arrangements, are not delivered
timely, or with acceptable quality, or do not generate sufficient sales volumes
to recover these royalty advances and guaranteed payments, we would have to
write-off unrecovered portions of these payments, which could cause material
harm to our business and financial results. We compete with a number of
companies that have substantially greater financial, marketing and product
development resources than we do.
The greater resources of our competitors permit them to pay higher fees
than we can to licensors of desirable motion picture, television, sports and
character properties and to third party software developers.
We compete primarily with other publishers of personal computer and
video game console interactive entertainment software. Significant competitors
include Electronic Arts Inc. and Activision, Inc. Many of these competitors have
substantially greater financial, technical resources, larger customer bases,
longer operating histories, greater name recognition and more established
relationships in the industry than we do.
In addition, integrated video game console hardware/software companies
such as Sony Computer Entertainment, Nintendo, and Microsoft Corporation compete
directly with us in the development of software titles for their respective
platforms and they have generally discretionary approval authority over the
products we develop for their platforms. Large diversified entertainment
companies, such as The Walt Disney Company, and Time Warner Inc. many of which
own substantial libraries of available content and have substantially greater
financial resources, may decide to compete directly with us or to enter into
exclusive relationships with our competitors.
20
WE HAVE A LIMITED NUMBER OF KEY MANAGEMENT AND OTHER PERSONNEL. THE LOSS OF ANY
SINGLE MEMBER OF MANAGEMENT OR KEY PERSON OR THE FAILURE TO HIRE AND INTEGRATE
CAPABLE NEW KEY PERSONNEL COULD HARM OUR BUSINESS.
Our business requires extensive time and creative effort to produce and
market. Our future success also will depend upon our ability to attract,
motivate and retain qualified employees and contractors, particularly software
design and development personnel. Competition for highly skilled employees is
intense, and we may fail to attract and retain such personnel. Alternatively, we
may incur increased costs in order to attract and retain skilled employees. Our
executive management team currently consists of CEO and interim CFO Herve Caen.
Our failure to recruit or retain the services of key personnel, including
competent executive management, or to attract and retain additional qualified
employees could cause material harm to our business.
OUR INTERNATIONAL SALES EXPOSE US TO RISKS OF UNSTABLE FOREIGN ECONOMIES,
DIFFICULTIES IN COLLECTION OF REVENUES, INCREASED COSTS OF ADMINISTERING
INTERNATIONAL BUSINESS TRANSACTIONS AND FLUCTUATIONS IN EXCHANGE RATES.
Our net revenues from international sales accounted for approximately
57% and 75% of our total net revenues for years ended December 31, 2005 and
2004, respectively. Most of these revenues came from our distribution
relationship with Vivendi , pursuant to which Vivendi became the exclusive
distributor for most of our products in Europe, the Commonwealth of Independent
States, Africa and the Middle East and a recognition of revenue from
international expiration of contracts during 2005. To the extent our resources
allow, we intend to continue to expand our direct and indirect sales, marketing
and product localization activities worldwide.
Our international sales are subject to a number of inherent risks,
including the following:
o recessions in foreign economies may reduce purchases of our
products;
o translating and localizing products for international markets
is time consuming and expensive;
o accounts receivable are more difficult to collect and when
they are collectible, they may take longer to collect;
o regulatory requirements may change unexpectedly;
o it is difficult and costly to staff and manage foreign
operations;
o fluctuations in foreign currency exchange rates;
o political and economic instability; and
o delays in market penetration of new platforms in foreign
territories.
These factors may cause material declines in our future international
net revenues and, consequently, could cause material harm to our business. A
significant, continuing risk we face from our international sales and operations
stems from currency exchange rate fluctuations. Because we do not engage in
currency hedging activities, fluctuations in currency exchange rates have caused
significant reductions in our net revenues from international sales and
licensing due to the loss in value upon conversion into U.S. Dollars. We may
suffer similar losses in the future.
OUR CUSTOMERS HAVE THE ABILITY TO RETURN OUR PRODUCTS OR TO RECEIVE PRICING
CONCESSIONS AND SUCH RETURNS AND CONCESSIONS COULD REDUCE OUR NET REVENUES AND
RESULTS OF OPERATIONS.
We are exposed to the risk of product returns and pricing concessions
with respect to our distributors. Our distributors allow retailers to return
defective, shelf-worn and damaged products in accordance with negotiated terms,
and also offer a 90-day limited warranty to our end users that our products will
be free from manufacturing defects. In addition, our distributors provide
pricing concessions to our customers to manage our customers' inventory levels
in the distribution channel. Our distributors could be forced to accept
substantial product returns and provide pricing concessions to maintain our
relationships with retailers and their access to distribution channels. We have
mitigated this risk in North America under our current distribution arrangement
with Vivendi, as sales will be guaranteed with no offset for product returns and
price concessions.
21
WE DEPEND UPON THIRD PARTY LICENSES OF CONTENT FOR MANY OF OUR PRODUCTS.
Many of our current and planned products are lines based on original
ideas or intellectual properties licensed from other parties. From time to time
we may not be in compliance with certain terms of these license agreements, and
our ability to market products based on these licenses may be negatively
impacted. Moreover, disputes regarding these license agreements may also
negatively impact our ability to market products based on these licenses.
Additionally, we may not be able to obtain new licenses, or maintain or renew
existing licenses, on commercially reasonable terms, if at all. If we are unable
to maintain current licenses or obtain new licenses for the underlying content
that we believe offers the greatest consumer appeal, we would either have to
seek alternative, potentially less appealing licenses, or release products
without the desired underlying content, either of which could limit our
commercial success and cause material harm to our business.
OUR LICENSORS ARE ALSO OFTEN OUR COMPETITORS. WE MAY FAIL TO MAINTAIN EXISTING
LICENSES, OR OBTAIN NEW LICENSES FROM PLATFORM COMPANIES ON ACCEPTABLE TERMS OR
TO OBTAIN RENEWALS OF EXISTING OR FUTURE LICENSES FROM LICENSORS.
We are required to obtain a license to develop and distribute software
for each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo and Microsoft, who
are also our competitors. Each of these companies has the right to approve the
technical functionality and content of our products for their platforms prior to
distribution. Typically, such license agreements give broad control to the
licensor over the approval, manufacturing and shipment of products on their
platform. Due to the competitive nature of the approval process, we typically
must make significant product development expenditures on a particular product
prior to the time we seek these approvals. Our inability to obtain these
approvals or to obtain them on a timely basis could cause material harm to our
business.
OUR SALES VOLUME AND THE SUCCESS OF OUR PRODUCTS DEPEND IN PART UPON THE NUMBER
OF PRODUCT TITLES DISTRIBUTED BY HARDWARE COMPANIES FOR USE WITH THEIR VIDEO
GAME PLATFORMS.
Even after we have obtained licenses to develop and distribute
software, we depend upon hardware companies such as Sony Computer Entertainment,
Nintendo and Microsoft, or their designated licensees, to manufacture the CD-ROM
or DVD-ROM media discs that contain our software. These discs are then run on
the companies' video game consoles. This process subjects us to the following
risks:
o we are required to submit and pay for minimum numbers of discs
we want produced containing our software, regardless of
whether these discs are sold, shifting onto us the financial
risk associated with poor sales of the software developed by
us; and
o reorders of discs are expensive, reducing the gross margin we
receive from software releases that have stronger sales than
initially anticipated and that require the production of
additional discs.
As a result, video game console hardware licensors can shift onto us
the risk that if actual retailer and consumer demand for our interactive
entertainment software differs from our forecasts, we must either bear the loss
from overproduction or the lower per-unit revenues associated with producing
additional discs. Either situation could lead to material reductions in our net
revenues and operating results.
RISKS RELATED TO OUR INDUSTRY
Inadequate intellectual property protections could prevent us from
enforcing or defending our proprietary technology.
We regard our software as proprietary and rely on a combination of
patent, copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks, and hold the rights to one
patent application related to one of our titles. While we provide "shrink-wrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
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Policing unauthorized use of our products is difficult, and software
piracy can be a persistent problem, especially in some international markets.
Further, the laws of some countries where our products are or may be distributed
either do not protect our products and intellectual property rights to the same
extent as the laws of the United States, or are weakly enforced. Legal
protection of our rights may be ineffective in such countries, and as we
leverage our software products using emerging technologies such as the Internet
and online services, our ability to protect our intellectual property rights and
to avoid infringing others' intellectual property rights may diminish. We cannot
assure you that existing intellectual property laws will provide adequate
protection for our products in connection with these emerging technologies.
WE MAY UNINTENTIONALLY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
WHICH COULD EXPOSE US TO SUBSTANTIAL DAMAGES OR RESTRICT OUR OPERATIONS.
As the number of interactive entertainment software products increases
and the features and content of these products continue to overlap, software
developers increasingly may become subject to infringement claims. Although we
believe that we make reasonable efforts to ensure that our products do not
violate the intellectual property rights of others, it is possible that third
parties still may claim infringement. From time to time, we receive
communications from third parties regarding such claims. Existing or future
infringement claims against us, whether valid or not, may be time consuming and
expensive to defend. Intellectual property litigation or claims could force us
to do one or more of the following:
o cease selling, incorporating or using products or services
that incorporate the challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property, which license, if available at all, may not be
available on commercially favorable terms; or
o redesign our interactive entertainment software products,
possibly in a manner that reduces their commercial appeal.
Any of these actions may cause material harm to our business and
financial results.
OUR BUSINESS IS INTENSELY COMPETITIVE AND PROFITABILITY IS INCREASINGLY DRIVEN
BY A FEW KEY TITLE RELEASES. IF WE ARE UNABLE TO DELIVER KEY TITLES, OUR
BUSINESS MAY BE HARMED.
Competition in our industry is intense. New videogame products are
regularly introduced. Increasingly, profits and revenues in our industry are
dominated by certain key product releases and are increasingly produced in
conjunction with the latest consumer and media trends. Many of our competitors
may have more finances and other resources for the development of product titles
than we do. If our competitors develop more successful products, or if we do not
continue to develop consistently high-quality products, our revenue will
decline.
IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
o operating systems such as Microsoft Windows Longhorn;
o new media formats
o releases of new video game consoles;
o new video game systems by Sony, Microsoft, Nintendo and
others.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
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New interactive entertainment software platforms and technologies also
may undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
o anticipate future technologies and platforms and the rate of
market penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on
favorable terms; or
o create software for those new platforms on a timely basis.
OUR SOFTWARE MAY BE SUBJECT TO GOVERNMENTAL RESTRICTIONS OR RATING SYSTEMS.
Legislation is periodically introduced at the state and federal levels
in the United States and in foreign countries to establish a system for
providing consumers with information about graphic violence and sexually
explicit material contained in interactive entertainment software products. In
addition, many foreign countries have laws that permit governmental entities to
censor the content of interactive entertainment software. We believe that
mandatory government-run rating systems eventually will be adopted in many
countries that are significant markets or potential markets for our products. We
may be required to modify our products to comply with new regulations, which
could delay the release of our products in those countries.
Due to the uncertainties regarding such rating systems, confusion in
the marketplace may occur, and we are unable to predict what effect, if any,
such rating systems would have on our business. In addition to such regulations,
certain retailers have in the past declined to stock some of our products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. While to date these actions
have not caused material harm to our business, we cannot assure you that similar
actions by our distributors or retailers in the future would not cause material
harm to our business.
RISKS RELATED TO OUR STOCK
SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND INHIBIT OUR ABILITY TO RECEIVE A
PREMIUM PRICE FOR YOUR SHARES.
Our Certificate of Incorporation, as amended, provides for 5,000,000
authorized shares of Preferred Stock. Our Board of Directors has the authority,
without any action by the stockholders, to issue up to 4,280,576 shares of
preferred stock and to fix the rights and preferences of such shares. 719,424
shares of Series A Preferred Stock was issued to Titus in the past, which amount
has been fully converted into our common stock. In addition, our certificate of
incorporation and bylaws contain provisions that:
o eliminate the ability of stockholders to act by written
consent and to call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to
nominate directors or submit proposals for stockholder
approval.
These provisions may have the effect of delaying, deferring or
preventing a change in control, may discourage bids for our common stock at a
premium over its market price and may adversely affect the market price, and the
voting and other rights of the holders, of our common stock.
OUR COMMON STOCK MAY BE SUBJECT TO THE "PENNY STOCK" RULES WHICH COULD ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
"Penny stocks" generally include equity securities with a price of less
than $5.00 per share, which are not traded on a national stock exchange or on
Nasdaq, and are issued by a company that has tangible net assets of less than
$2,000,000 if the company has been operating for at least three years. The
"penny stock" rules require, among other things, broker dealers to satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving a purchaser's written consent prior to
any transaction. In addition, additional
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disclosure in connection with trades in the common stock are required, including
the delivery of a disclosure schedule prescribed by the SEC relating to the
"penny stock" market. These additional burdens imposed on broker-dealers may
discourage them from effecting transactions in our common stock, which may make
it more difficult for an investor to sell their shares and adversely affect the
market price of our common stock.
OUR STOCK IS VOLATILE
The trading price of our common stock has previously fluctuated and
could continue to fluctuate in response to factors that are largely beyond our
control, and which may not be directly related to the actual operating
performance of our business, including:
o general conditions in the computer, software, entertainment,
media or electronics industries;
o changes in earnings estimates or buy/sell recommendations by
analysts;
o investor perceptions and expectations regarding our products,
plans and strategic position and those of our competitors and
customers; and
o price and trading volume volatility of the broader public
markets, particularly the high technology sections of the
market.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
We have received several notices of default on payment on principal and
interest from Warner Bros. Entertainment Inc. on an Amended and Restated Secured
Convertible Promissory Note, dated April 30, 2002, with an original principal
sum of $2,000,000. Subsequently, we entered into a payment plan with Warner
Bros., of which we are currently in default. As of the date of this filing, the
balance of the amount due under the note by us is $0.34 million payable in one
remaining installment.
ITEM 6. EXHIBITS
(a) Exhibits - The following exhibits, other than exhibit 32.1 which is
being furnished herewith, are filed as part of this report:
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
31.1 Certificate of Herve Caen, Chief Executive Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a)
of the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial
Officer of Interplay Entertainment Corp. pursuant to
Rule 13a-14(a) of the Securities and Exchange Act of
1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer and
Interim Chief Financial Officer of Interplay
Entertainment Corp. pursuant to Rule 13a-14(b) of the
Securities and Exchange Act of 1934, as amended.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: June 15, 2006 By: /S/ HERVE CAEN
------------------------------------
Herve Caen,
Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
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