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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, 2004
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.)
1682 LANGLEY AVENUE, IRVINE, CALIFORNIA 92614
(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 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 September 29, 2004
- ------------------------------ --------------------------------------------
Common Stock, $0.001 par value 93,855,634
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2004
TABLE OF CONTENTS
------------
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2004 (unaudited) and December 31, 2003 3
Condensed Consolidated Statements of Operations
for the Three and Six Months ended June 30, 2004
and 2003 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
for the Six Months ended June 30, 2004 and 2003
(unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 29
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 32
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JUNE 30, DECEMBER 31,
ASSETS 2004 2003
------ ---------- ----------
(UNAUDITED)
Current Assets:
Cash $ 13 $ 1,171
Cash held in trust 500 --
Trade receivables from related parties, net of allowances 1,031 564
of $1215 and $ 691 respectively
Trade receivables, net of allowances 675 6
of $34 and $34, respectively
Inventories 199 146
Prepaid licenses and royalties 443 209
Other current assets 449 1,276
---------- ----------
Total current assets 3,310 3,372
Property and equipment, net 957 2,114
---------- ----------
$ 4,267 $ 5,486
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
Current Liabilities:
Current debt $ 330 $ 837
Accounts payable 11,370 7,093
Accrued royalties 5,249 5,067
Advances from distributors and others 2,798 5,125
Payables to related parties 15 --
---------- ----------
Total current liabilities 19,762 18,122
Commitments and contingencies
Stockholders' Deficit:
Common stock 94 94
Paid-in capital 121,640 121,640
Accumulated deficit (137,339) (134,481)
Accumulated other comprehensive income 110 111
---------- ----------
Total stockholders' deficit (15,495) (12,636)
---------- ----------
$ 4,267 $ 5,486
========== ==========
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,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net revenues $ 1,201 $ 341 $ 1,526 $ 913
Net revenues from related party distributors 1,941 928 10,025 19,118
--------- --------- --------- ---------
Total net revenues 3,142 1,269 11,551 20,031
Cost of goods sold 1,359 1,114 6,442 8,099
--------- --------- --------- ---------
Gross profit 1,783 155 5,109 11,932
Operating expenses:
Marketing and sales 386 354 1,374 475
General and administrative 1,147 1,269 2,356 3,632
Product development 1,433 3,910 3,441 7,588
--------- --------- --------- ---------
Total operating expenses 2,966 5,533 7,171 11,695
--------- --------- --------- ---------
Operating income (loss) (1,183) (5,378) (2,062) 237
Other income (expense):
Interest expense (15) (32) (30) (83)
Other (661) 34 (659) 46
--------- --------- --------- ---------
Income (loss) before benefit for income taxes (1,859) (5,376) (2,751) 200
Income taxes (95) -- (107)
--------- --------- --------- ---------
Net income (loss) $ (1,954) $ (5,376) $ (2,858) $ 200
========= ========= ========= =========
Net income (loss) per common share:
Basic $ (0.02) $ (0.06) $ (0.03) $ --
========= ========= ========= =========
Diluted $ (0.02) $ (0.06) $ (0.03) $ --
========= ========= ========= =========
Shares used in calculating net
income (loss) per common share:
Basic 93,855 93,849 93,855 93,849
========= ========= ========= =========
Diluted 93,855 93,849 93,855 93,849
========= ========= ========= =========
See accompanying notes.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
-------------------
2004 2003
-------- --------
(IN THOUSANDS)
Cash flows from operating activities:
Net income $(2,858) $ 200
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 507 696
Non-cash interest expense -- 60
Write-off of prepaid licenses and royalties -- 2,379
Write-off of fixed assets 636 --
Other (1) --
Changes in operating assets and liabilities:
Cash held in trust (500)
Trade receivables from related parties (467) 611
Trade receivables, net (669) 129
Inventories (53) 1,582
Prepaid licenses and royalties (234) 1,127
Other current assets 827 228
Accounts payable 4,277 (1,481)
Accrued royalties 182 (663)
Other accrued liabilities (693) (1,039)
Payables to related parties (1,619) (3,448)
Advances -- 1,190
-------- --------
Net cash provided (used) by operating activities (665) 1,571
-------- --------
Cash flows from investing activities:
Purchase and sale of property and equipment 14 (326)
-------- --------
Net cash used in investing activities 14 (326)
-------- --------
Cash flows from financing activities:
Net payment on line of credit -- --
(Repayment) borrowings from former Chairman -- --
Net proceeds from issuance of common stock -- 2
Repayment of note payable (507) (716)
Proceeds from exercise of stock options -- --
-------- --------
Net cash provided by (used in) financing activities (507) (714)
-------- --------
Net increase in cash (1,158) 531
Cash, beginning of period 1,171 134
-------- --------
Cash, end of period $ 13 $ 665
======== ========
Supplemental cash flow information:
Cash paid for:
Interest $ 6 $ 22
See accompanying notes.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2004
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, 2003 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, 2003 as filed with the Securities and Exchange Commission.
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN
The Company's independent registered public accounting firm included a
"going concern" explanatory paragraph in their audit report on the December 31,
2003 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 which
management believes do not meet sufficient projected profit margins. 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 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 August 2002, the Company entered into a new three-year North
American distribution agreement (the "2002 Agreement") with Vivendi Universal
Games, Inc. ("Vivendi"), which substantially replaces the August 2001 agreement
with Vivendi. Under the 2002 agreement, the Company receives cash payments from
Vivendi for distributed products sooner than under the Company's August 2001
agreement with Vivendi. The Company has amended its agreement with Vivendi to
increase the number of territories in which Vivendi can distribute the Company's
products. In return, the Company has received additional advances from Vivendi
for these additional rights.
The Company anticipates its current cash reserves, plus its expected
generation of cash from existing operations, will not be sufficient to fund its
anticipated expenditures through the fourth quarter of fiscal 2004.
Consequently, 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.
See Notes 5 and 7 for additional factors relating to the Company's
going concern status.
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
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.
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 a distribution agreement with Vivendi in August 2001,
substantially all of the Company's sales are made by two distributors: Vivendi
and Avalon Interactive Group Ltd. ("Avalon"), a wholly owned subsidiary of Titus
Interactive S.A., our majority stockholder ("Titus") which is a related party.
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 products and may provide markdown
allowances on products unsold by a customer. In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 48, "Revenue Recognition when Right
of Return Exists," revenue is recorded net of an allowance for estimated
returns, exchanges, markdowns, price concessions and warranty costs. Such
reserves are based upon management's evaluation of historical experience,
current industry trends and estimated costs. The amount of reserves ultimately
required could differ materially in the near term from the amounts included in
the accompanying condensed consolidated financial statements.
Customer support costs are not significant and are charged to expense
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 for the Company.
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 pronouncement has resulted in the reclassification of certain selling
expenses including sales incentives, slotting fees, buy downs and distributor
payments from cost of sales and administrative expenses to a reduction in sales.
These amounts, consisting principally of promotional allowances to the Company's
retail customers were previously recorded as sales and marketing expenses;
therefore, there was no impact on results of operations for any period.
7
STOCK-BASED COMPENSATION
At June 30, 2004, the Company has one stock-based employee compensation
plan. The Company accounts for this plan under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related Interpretations. The Company incurred stock-based employee
compensation expense for the six months ended June 30, 2004 and 2003. 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 SFAS No. 123, "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net income (loss) available to common stockholders, as reported $ (1,954) $ (5,376) $ (2,858) $ 200
Pro forma compensation expense 16 65 32 96
---------- ---------- ---------- ----------
Pro forma net income (loss) available to common stockholders $ (1,970) $ (5,441) $ (2,890) $ 104
========== ========== ========== ==========
Earnings (loss) per share, as reported
Basic $ (0.02) $ (0.06) $ (0.03) $ --
Diluted $ (0.02) $ (0.06) $ (0.03) $ --
Earnings (loss) per share, pro form
Basic $ (0.02) $ (0.06) $ (0.03) $ --
Diluted $ (0.02) $ (0.06) $ (0.03) $ --
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements discussed in the notes to the December
31, 2003 audited consolidated financial statements, filed previously with the
SEC in Form 10-K, that were required to be adopted during the period ending June
30, 2004 did not have a significant impact on the Company's financial
statements.
NOTE 2. INVENTORIES
Inventories consist of the following:
JUNE 30, DECEMBER 31,
2004 2003
------------- ------------
(DOLLARS IN THOUSANDS)
Packaged software $ 199 $ 146
============= ============
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
NOTE 3. PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
JUNE 30, DECEMBER 31,
2004 2003
------------- -------------
(DOLLARS IN THOUSANDS)
Prepaid royalties for titles in development $ 310 $ 100
Prepaid royalties for shipped titles, net of amortization -- --
Prepaid licenses and trademarks, net of amortization 133 109
------------- -------------
$ 443 $ 209
============= =============
Amortization of prepaid licenses and royalties is included in cost of
goods sold and totaled $0 million and $0.6 million for the three months ended
June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 and
2003, amortization of prepaid licenses and royalties was $0 million and $.6
million, 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 million and $0.6
million for the three months ended June 30, 2004 and 2003, and $0 million and
$2.4 million for the six months ended June 30, 2004 and 2003, respectively.
NOTE 4. ADVANCES FROM DISTRIBUTORS AND OTHERS
Advances from distributors and OEMs consist of the following:
JUNE 30, DECEMBER 31,
2004 2003
------------ ------------
(DOLLARS IN THOUSANDS)
Advances for other distribution rights $ 526 $ 629
============ ============
Net advance from Vivendi distribution agreements $ 2,272 $ 4,496
============ ============
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.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a
$98.8 million complaint for damages against Atari Interactive, Inc. (formerly
known as Infogrames Interactive, Inc.) and certain Atari Interactive affiliates
as well as the Company's subsidiary GamesOnline.com, Inc., ("GOL") alleging,
among other things, breach of contract, misappropriation of trade secrets,
breach of fiduciary duties and breach of implied covenant of good faith in
connection with an electronic distribution agreement dated November 2001 between
KBK and GOL, KBK has alleged that GOL failed to timely deliver to KBK assets to
a product, and that it improperly disclosed confidential information about KBK
to Atari. GOL counterclaimed against KBK for breach of contract as KBK owes GOL
$700,000 in guaranteed advanced fees under the terms of the agreement. In
addition, the Company filed an action against Atari Interactive for breach
indemnity, among other claims given the fact that it was Atari that was to
deliver the product to GOL for KBK, which Atari Interactive failed and refused
to do. The Company believes this complaint for KBK is without merit and it will
continue to pursue the claim against KBK for the amount due it under the terms
of the agreement.
On September 19, 2003, the Company commenced a wrongful termination and
breach of contract action against Atari Interactive, Inc. and Atari, Inc. in New
York State Supreme Court, New York County. The Company sought, among other
9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
things, a judgment declaring that a computer game license agreement between the
Company and Atari Interactive continues to be in full force and effect. On
September 23, 2003, the Company obtained a preliminary injunction that prevented
termination of the computer game license agreement. Atari Interactive answered
the complaint, denying all claims, asserting several affirmative defenses and
counterclaims for breach of contract and one counterclaim for a judgment
declaring the computer game license agreement terminated. Both sides sought
damages in an amount to be determined at trial. The Company, Atari Interactive
and Atari, Inc. reached an agreement with respect to the scope and terms of the
computer game license agreement. The parties filed with the court a Stipulation
of Dismissal, dated December 22, 2003. The court ordered dismissal of the matter
on January 6, 2004. Atari terminated the D&D agreement with us on April 23, 2004
and entered into tri-party agreements with us and Vivendi and Avalon that allows
Vivendi to resume North American distribution, and Avalon to resume
International distribution pursuant to their pre-existing agreements with us of
certain Dungeons & Dragons games, including BALDUR'S GATE: DARK ALLIANCE II. In
September 2004 Atari notified Vivendi that Vivendi is currently in breach of its
obligations to remit royalties to Atari pursuant to the terms of the agreement.
Atari Interactive notified Vivendi that if Vivendi did not cure the breach set
forth in the letter by September 30, 2004 that the letter shall be deemed notice
of termination of the agreement.
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 of $2.0 million. At the time the suit was filed, the amount
due under the note was $1.4 million including interest. Subsequently, the
Company entered into a settlement agreement with Warner. The Company is
currently in default of the settlement agreement with Warner and has entered
into a payment plan, of which the Company is in default, for the balance of
approximately $330,000 owed payable in one remaining installment.
In March 2004, the Company instituted litigation in the Superior Court
for the State of California, Los Angeles County, against Battleborne
Entertainment, Inc. ("Battleborne"). Battleborne was developing a console
product for the Company tentatively titled AIRBORNE: LIBERATION. The Company's
complaint alleges that Battleborne repudiated the Company's contract with it and
subsequently renamed the product and entered into a development agreement with a
different publisher. The Company is currently seeking a declaration from the
court that it retain rights to the product or receive damages.
On or about April 16, 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 $431,823. The Company was unable to pay the rent, and
vacated the office space during the month of June 2004. On June 3, 2004 our
lessor 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 $148,282.33, exclusive of interest. The
Company is in the process of negotiating a payment schedule on the judgment and
the other claim together. This suit could cause substantial harm to the
Company's business. The Company was evicted from it's office facilities in
Irvine, California and relocated to temporary office space during June 2004. The
Company has not determined the legal significance of any remaining lease
obligation to Arden. Such lease commitment approximated $2.8 million at time of
eviction.
On or about April 19, 2004, Bioware Corporation filed an action against
the Company in the Superior Court for the State of California, County of Orange,
alleging breach of contract for failure to pay royalties. At the time of filing,
Bioware alleged that it was owed approximately $156,000 under various agreements
for which it obtained a writ of attachment to secure payment of the alleged
obligation if it is successful at trial. Bioware also sought and obtained a
temporary restraining order prohibiting the Company from transferring assets up
to the amount sought in the writ of attachment. We successfully opposed the
preliminary injunction and vacated the temporary restraining order. We believe
that no royalties are owed to Bioware and will continue to defend the Company's
position.
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 $886,406 plus interest, in connection with an exclusive
10
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
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 our business.
Snowblind entered into a partial settlement agreement on June 23, 2004
following the suit filed by Snowblind on November 19, 2003. Snowblind filed a
second amended complaint against the Company on or about July 12, 2004 claiming
various causes of action including but not limited to, breach of contract,
account stated, open book account, and recission. Discovery is continuing and it
is difficult to determine at this stage the propriety of the claim, but the
Company believes this suit has no merit..
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 us seeking damages of approximately $1.3 million,
alleging, among other things, that the Company failed to secure a timely
effective date for a Registration Statement for shares purchased by Special
Situations under a common stock subscription agreement dated March 29, 2001 and
that the Company is therefore liable to pay Special Situations $1.3 million.
This matter was settled and the case dismissed in December 2003. Special
Situations had entered into a settlement agreement with us contemplating
payments over time.
Reflexive Entertainment, Inc. filed an action against the Company in
the Orange County Superior Court that was settled. The Company was unable to
make the payments and Reflexive sought judgment in an amount in excess of the
judgment. The Company is in the process of filing a motion to set aside the
judgment, which the Company believes will be successful.
On March 27, 2003, KDG France SAS ("KDG") filed an action against
Interplay OEM, Inc. and Herve Caen for various claims. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further the settlement was entered into with Interplay OEM only in the
amount of $170,000, however KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment was not made. The Company believes that it has valid defenses to the
claim.
The Company received notice from the Internal Revenue Service ("IRS")
that it owes approximately $95,000 in payroll tax penalties. The Company
estimates that it owes an additional amount of approximately $50,000, which it
has accrued at June 30, 2004 for late payment penalties on payroll taxes.
The Company was unable to meet its May 15, May 31, and June 15, 2004
payroll obligations to its employees, as a result several employees filed claims
with the State of California Labor Board ("Labor Board"). The Company has since
paid the May 15, May 31, and June 15 payrolls and associated payroll taxes. The
Labor Board has fined the Company approximately $10,000 for failure to meet its
payroll obligations. Such amount has been accrued by the Company at June 30,
2004.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled.
The Company subsequently entered into a new workers compensation insurance plan.
The Labor Board fined the Company approximately $79,000 for having lost workers
compensation insurance for a period of time. Such amount has been accrued by the
Company at June 30, 2004. The Company's health insurance was also cancelled but
the Company had the policy reinstated.
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
11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
dilutive stock options and common stock warrants. Since the Company has losses
for all reporting periods, basic and dilutive per share amounts are equal, since
the effect of dilutive items would be antidilutive.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
--------- --------- --------- ---------
Net income (loss) available to common stockholders $ (1,954) $ (5,376) $ (2,859) $ 200
--------- --------- --------- ---------
Shares used to compute net income (loss) per share:
Weighted-average common shares 93,855 93,849 93,855 93,849
Dilutive stock equivalents -- -- -- --
--------- --------- --------- ---------
Dilutive potential common shares 93,855 93,849 93,855 93,849
========= ========= ========= =========
Net income (loss) per share:
Basic $ (0.02) $ (0.06) $ (0.03) $ --
Diluted $ (0.02) $ (0.06) $ (0.03) $ --
--------- --------- --------- ---------
There were options and warrants outstanding to purchase 9,962,718 and
10,411,218 shares of common stock at June 30, 2004 and 2003, respectively, which
were excluded from the earnings per share computation for the three and six
months ended June 30, 2004 and 2003, 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, 2004 and
2003 was $1.84 and $1.93, respectively.
12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
NOTE 7. RELATED PARTIES
Amounts receivable from and payable to related parties are as follows:
JUNE 30, 2004 DECEMBER 31, 2003
-------------- -----------------
(DOLLARS IN THOUSANDS)
Receivables from related parties:
Titus TSC $ 322 $ 313
Titus KK -- 6
Titus SARL 43 43
Avalon 1,881 893
Less Reserves (1,215) (691)
-------------- --------------
Total $ 1,031 $ 564
============== ==============
Payables to related parties:
Titus GIE $ 15 $ --
-------------- --------------
Total $ 15 $ --
============== ==============
DISTRIBUTION AND PUBLISHING AGREEMENTS
ACTIVITIES WITH RELATED PARTIES
It is the Company's policy that related party transactions shall be
reviewed and approved by a majority of the Company's disinterested directors or
its Independent Committee.
The Company's operations involve significant transactions with its
majority stockholder Titus and its affiliates. The Company has a major
distribution agreement with Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus presently owns approximately 58 million shares of common stock,
which represents approximately 62% of the Company's outstanding common stock,
its only voting security.
The Company performs certain distribution services on behalf of Titus
for a fee. In connection with such distribution services, the Company recognized
fee income of $0 and $5,000 for the three months ended June 30, 2004, and 2003,
respectively.
As of June 30, 2004 and December 31, 2003, Titus and its affiliates
excluding Avalon owed the Company $364,000 and $362,000, respectively. The
Company owed Titus and its affiliates excluding Avalon $15,000 and $0.00 as of
June 30, 2004 and December 31, 2003 respectively. Amounts the Company owed to
Titus and its affiliates excluding Avalon at June 30, 2004 consisted primarily
of trade payables.
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
The Company has an International Distribution Agreement with Avalon, a
wholly owned subsidiary of Titus. Pursuant to this distribution agreement,
Avalon provides for the exclusive distribution of substantially all of the
Company's 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, the Company pays Avalon a distribution fee based on net
sales, and Avalon provides certain market preparation, warehousing, sales and
fulfillment services on its behalf. In connection with the International
Distribution Agreement with Avalon, the Company incurred distribution commission
13
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
expense of $402,000 and $15,000, for the three months ended June 30, 2004, and
2003, and $1,755,000 and $300,000 for the six months ended June 30,2004 and 2003
respectively. In addition, the Company recognized no overhead fees for the three
months ended June 30, 2004, and 2003 and no overhead fees for the six months
ended June 30, 2004 and 2003 respectively. Also in connection with this
International Distribution Agreement, the Company subleased office space from
Avalon. There was no rent paid to Avalon for the three months ended June 30,
2004, and 2003. The Company paid $27,000 to Avalon for rent for the six months
ended June 30, 2003.. As of April 2003, the Company no longer subleased office
space from Avalon.
In January 2003, the Company entered into a waiver with Avalon related
to the distribution of a video game title in which the Company sold the European
distribution rights to Vivendi. In consideration for Avalon relinquishing its
rights, the Company paid Avalon a $650,000 cash consideration and will pay
Avalon 50% of all proceeds in excess of the advance received from Vivendi. As of
June 30, 2004, Vivendi has not reported sales exceeding the minimum guarantee.
In May 2003, Avalon filed for a CVA, a process of reorganization in the
United Kingdom, in which the Company participated in, and was approved as a
creditor of Avalon. As part of the Avalon CVA process, the Company submitted its
creditor's claim. The Company has received approximately $555,000 due to it as a
creditor under the terms of the Avalon CVA plan. The Company continues to
evaluate and adjust as appropriate its claims against Avalon in the CVA process.
However, the effects of the approval of the Avalon CVA on its ability to collect
amounts due from Avalon are uncertain. As a result, the Company cannot guarantee
its ability to collect fully the debts it believes are due and owed to it from
Avalon.. If Avalon is not able to continue to operate under the new CVA, the
Company expects Avalon to cease operations and liquidate, in which event the
Company will most likely not receive in full the amounts presently due it by
Avalon. The Company may also have to appoint another distributor or become its
own distributor in Europe and the other territories in which Avalon presently
distributes its products.
In March 2003, the Company made a settlement payment of approximately
$320,000 to a third-party on behalf of Avalon Europe to protect the validity of
certain of its license rights and to avoid potential third-party liability from
various licensors of its products, and incurred legal fees in the amount of
approximately $80,000 in connection therewith. Consequently, Avalon owes the
Company $400,000 pursuant to the indemnification provisions of the International
Distribution Agreement. This amount was included in the Company's claims against
Avalon in the Avalon CVA process. The Company has also entered into a Product
Publishing Agreement with Avalon, which provides it with an exclusive license to
publish and distribute substantially all of Avalon's products within North
America, Latin America and South America for a royalty based on net sales. As
part of terms of an April 2001 settlement between Avalon and the Company, the
Product Publishing Agreement was amended to provide for the Company to publish
only one future title developed by Avalon. In connection with this Product
Publishing Agreement with Avalon, the Company did not perform any publishing and
distribution services on behalf of Avalon for the six months ended June 30, 2004
and 2003.
In August 2004, we reached an understanding with Avalon under which it
is anticipated that Avalon will make four payments totaling 750,000 English
pounds between September 13, 2004, and November 15, 2004 to pay off the balance
owed on their post CVA balance.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, the Company entered into a note receivable with Titus
Software Corp., ("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The
note earns interest at 8% per annum and was due in February 2004. In May 2003,
the Company's Board of Directors rescinded the note receivable and demanded
repayment of the $226,000 from TSC. As of the date of this filing the balance on
the note with accrued interest has not been paid. The balance on the note
receivable, with accrued interest, at June 30, 2004 was approximately $250,000.
The total receivable due from TSC is approximately $322,000 as of June 30, 2004.
The majority of the additional $72,000 was due to TSC subletting office space
and miscellaneous other items.
In May 2003, the Company paid TSC $60,000 to cover legal fees in
connection with a lawsuit against Titus. As a result of the payment, the
Company's CEO requested that the Company credit the $60,000 to amounts it owed
14
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
to him arising from expenses incurred in connection with providing services to
the Company. The Company's Board of Directors is in the process of investigating
the details of the transaction, including independent counsel review as
appropriate, in order to properly record the transaction.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, the Company began operating under a representation
agreement with Titus Japan K.K. ("Titus Japan"), a majority-controlled
subsidiary of Titus, pursuant to which Titus Japan represents the Company as an
agent in regard to certain sales transactions in Japan. This representation
agreement has not yet been approved by the Company's Board of Directors and is
currently being reviewed by them. The Company's Board of Directors has approved
the payments of certain amounts to Titus Japan in connection with certain
services already performed by them on the Company's behalf. As of June 30, 2004
the Company had a zero balance with Titus Japan.
TRANSACTIONS WITH TITUS INTERACTIVE STUDIO
In September 2003, the Company engaged the translation services of
Titus Interactive Studio, pursuant to which (i) the Company will first request a
quote from Titus Interactive Studio for each service needed and only if such
quote compares favorably with quotes from other companies for identical work
will Titus Interactive Studio be used, (ii) such services shall be based on work
orders submitted by the Company and (iii) each work order cannot have a rate
exceeding $0.20/word (excluding voice over) without receiving additional prior
Board of Director's approval. The Company has paid approximately $11,000 to date
under this agreement. The Company has a $0 balance with Titus Interactive Studio
as of the date of this filing.
TRANSACTIONS WITH TITUS SARL
As of June 30, 2004 the Company has a receivable of approximately
$43,000 for product development services that the Company provided.
TRANSACTIONS WITH TITUS GIE
In February 2004, the Company engaged the services of GIE Titus
Interactive Group, a wholly owned subsidiary of Titus, for a three-month
agreement pursuant to which GIE Titus or its agents shall provide to the Company
certain foreign administrative and legal services at a rate of $5,000 per month.
For the three months ended June 30, 2004 the Company had a payable of $15,000.
TRANSACTIONS WITH EDGE LLC
In September 2003, the Company's Board of Directors approved the
engagement of Edge LLC to provide recommendations regarding the operation of the
Company's legal department and strategies as well as interim executive
functions. Mr. Michel Vulpillat, a former member of the Company's Board of
Directors, is a managing member of Edge LLC. Michel Vulpillat resigned from the
Board of Directors on June 23, 2004. As of June 30, 2004, the Company has
incurred an aggregate expense of approximately $184,000 and had a payable of
approximately $84,400 to Edge LLC.
In April 2004, the Company entered into a Bridge Financing Agreement
with Edge LLC pursuant to which Edge LLC loaned the Company $60,000 at an
interest rate of 10% per annum and is due as soon as sufficient funds other than
the funds received pursuant to this agreement become available, but in no event
later than May 31, 2004. The Company also incurred a $2,000 transaction fee as a
part of this financing. As of the date of this filing the Company has paid Edge
LLC $35,000 pursuant to this agreement and consequently still owes approximately
$25,000 plus the transaction fee and interest. This balance due is in addition
to the approximately $84,400 in payables due to Edge LLC described above.
15
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
JUNE 30, 2004
NOTE 8. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is
managed primarily from the Company's Irvine, California offices.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------------------- -----------------------------------------------
2004 2003 2004 2003
--------------------- --------------------- --------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
North America $ 333 10% $ 1,015 80% $ 684 6% $ 2,895 15%
International 1,626 52% 158 12% 9,490 82% 1,864 9%
OEM, royalty and 1,183 38% 96 8% 1,377 12% 15,272 76%
licensing
-------- -------- -------- -------- -------- -------- -------- --------
$ 3,142 100% $ 1,269 100% $11,551 100% $20,031 100%
======== ======== ======== ======== ======== ======== ======== ========
16
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 and publisher of interactive entertainment
software 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, 2003, 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, sales or mergers and cost reduction
measures are forward-looking statements and there can be no assurance that we
will affect any or all of these objectives in the future. Specifically, the
forward-looking statements in this Item 2 assumes 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 7 of our
Form 10-K for the year ended December 31, 2003 filed with the U.S. Securities
and Exchange Commission (the "SEC"). 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. We believe the
following critical accounting policies affect our more significant judgments and
estimates used in preparation of our condensed consolidated financial
statements.
REVENUE RECOGNITION
17
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 distributors, Vivendi, and Avalon, an affiliate of our majority shareholder
Titus. We recognize revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of our products to
unaffiliated third parties. For those agreements that provide the customers the
right to multiple copies of a product in exchange for guaranteed amounts, we
recognize revenue at the delivery and acceptance of the product gold master. We
recognize per copy royalties on sales that exceed the guarantee as copies are
sold.
We generally are not contractually obligated to accept returns, except
for defective, shelf-worn and damaged products. However, on a case-by-case
negotiated basis, we permit customers to return or exchange products and may
provide price concessions to our retail distribution customers on unsold or slow
moving products. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 48, "Revenue Recognition when Right of Return Exists," we record
revenue net of a provision for estimated returns, exchanges, markdowns, price
concessions, and warranty costs. We record such reserves based upon management's
evaluation of historical experience, current industry trends and estimated
costs. The amount of reserves ultimately required could differ materially in the
near term from the amounts provided in the accompanying consolidated financial
statements.
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. We recognize revenue
when the rights have been transferred and no other obligations exist for the
Company.
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 and 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% in the first month of
release and a minimum of 5% for each of the next five months after release. This
minimum amortization rate reflects our typical product life cycle. Our
management relies on forecasted revenue to evaluate the future realization of
prepaid royalties and charges to cost of goods sold any amounts they deem
unlikely to be fully realized through future sales. Such costs are classified as
current and non current assets based upon estimated product release date. If
actual revenue, or revised sales forecasts, fall below the initial forecasted
sales, the charge may be larger than anticipated in any given quarter.
We evaluate the recoverability of prepaid licenses and royalties on a
product-by-product basis. Prepaid royalties for products that are cancelled are
expensed in the period of cancellation to cost of goods sold. In addition, a
charge to cost of sales is recorded when our forecast for a particular game
indicates that un-amortized capitalized costs exceed the net realizable value of
that asset. The net realizable value is the estimated net future proceeds from
our distributors that are reduced by previously capitalized cost and the
estimated future cost of completing the game. If a revised game sales forecast
is less than our current game sales forecast, or if actual game sales are less
than management's forecast, it is possible we could accelerate the amortization
of prepaid licenses and royalties previously capitalized. Once the charge has
been taken, that amount is not expensed in future quarters when the product
ships.
During the six months ended June 30, 2004 and 2003, we recorded prepaid
licenses and royalties impairment charges to cost of goods sold of $0 million
and $2.1 million respectively. Our prepaid royalty balances at June 30, 2004
were $.56 million, net of reserves of $.31 million
18
SOFTWARE DEVELOPMENT COSTS
Our internal research and development costs, which consist primarily of
software development costs, are expensed as incurred. 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. We have not capitalized any software development costs on internal
development projects, as the eligible costs were determined to be insignificant.
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 Company's 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.
RESULTS OF OPERATIONS
NORTH AMERICA, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Geographically, our net revenues for the three and six months ended
June 30, 2004 and 2003 break down as follows: (in thousands)
- ---------------------------- -------- --------- ----------- -----------
Three Months Ended June 30 2004 2003 Change % Change
- ---------------------------- -------- --------- ----------- -----------
North America $333 $1,015 ($682) (67%)
- ---------------------------- -------- --------- ----------- -----------
International 1,626 158 1,468 929%
- ---------------------------- -------- --------- ----------- -----------
OEM, Royalty & Licensing 1,183 96 1,087 1132%
- ---------------------------- -------- --------- ----------- -----------
Net Revenues 3,142 1,269 1,873 147%
- ---------------------------- -------- --------- ----------- -----------
- ---------------------------- -------- --------- ----------- -----------
Six Months Ended June 30 2004 2003 Change % Change
- ---------------------------- -------- --------- ----------- -----------
North America $684 $2,895 $(2,211) (76%)
- ---------------------------- -------- --------- ----------- -----------
International 9,490 1,864 7,626 409%
- ---------------------------- -------- --------- ----------- -----------
OEM, Royalty & Licensing 1,377 15,272 (13,895) (90%)
- ---------------------------- -------- --------- ----------- -----------
Net Revenues 11,551 20,031 (8,480) (42%)
- ---------------------------- -------- --------- ----------- -----------
Net revenues for the three months ended June 30, 2004 were $3.1
million, an increase of 147% compared to the same period in 2003. This increase
resulted from a 67% decrease in North America net revenues and a 1132% increase
in OEM, royalties and licensing revenues and by a 929% increase in international
net revenues. Furthermore we did not deliver any gold masters to any titles in
the three months ended June 30, 2003 or 2004. We did have continuing sales in
the second quarter from the first quarter releases of BALDUR'S GATE: DARK
ALLIANCE II and FALLOUT: BROTHERHOOD OF STEEL in Europe in the three months
ended June 30, 2004. The three months ended June 30, 2003 did not have sales of
comparable titles. We also had $1.175 million in revenue from the sale of the
rights to develop FALLOUT 3 on all platforms other than massively multiplayer
and did not have a comparable sale for the three months ended June 2003.
Net revenues for the six months ended June 30, 2004 were $11.6 million,
a decrease of 42% compared to the same period in 2003. This decrease resulted
from a 76% decrease in North America net revenues and a 90% decrease in OEM,
Royalty and licensing revenues offset by a 409% increase in International net
revenues.
North America net revenues for the three months ended June 30, 2004
were $0.3 million, a decrease of 67% compared to the same period in 2003. The
decrease in North America net revenues in 2004 was mainly due to delivering one
product gold master to one title in 2003 compared to delivering zero product
gold masters in 2004, resulting in a decrease in North America sales of $.7
million.
19
North America net revenues for the six months ended June 30, 2004 were
$.7 million a decrease of 76% compared to the same period in 2003. The decrease
in North America net revenues in 2004 was mainly due to delivering one product
gold master to one title in 2003 compared to delivering zero product gold
masters in 2004, resulting in a decrease in North America sales of $2.2 million.
International net revenues for the three months ended June 30, 2004
were $1.6 million, a 929% increase compared to the same period in 2003. The
increase in International net revenues for the three months ended June 30, 2004
was mainly due to continuing sales in the second quarter from the first quarter
releases of BALDUR'S GATE: DARK ALLIANCE II and FALLOUT: BROTHERHOOD OF STEEL in
Europe. Overall, we had a $1.5 million increase in net revenue compared to the
2003 period.
International net revenues for the six months ended June 30, 2004 were
$9.5 million, a 409% increase compared to the same period in 2003. The increase
in International net revenues for the six months ended June 30, 2004 was mainly
due to releasing BALDUR'S GATE: DARK ALLIANCE II AND FALLOUT: BROTHERHOOD OF
STEEL in Europe during the first six months of 2004.
Avalon, our primary international distributor is not current on their
post-CVA payments to us. (please see Note 7. Related Parties to our Condensed
Consolidated Financial Statements). If Avalon is not able to continue its
reorganization 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 International sales.
OEM, royalty and licensing net revenues for the three months ended June
30, 2004 were $1.2 million, an increase of 1,132% compared to the same period in
2003. The increase in licensing net revenues in 2004 was due to the fact that in
2004, we recorded $1.175 million in revenue related to the sale of the rights to
develop FALLOUT 3 and did not have a comparable transaction in the second
quarter of 2003. Overall we had a $1.1 million increase as compared to the same
period in 2003.
OEM, royalty and licensing net revenues for the six months ended June
30, 2004 were $1.4 million, a decrease of 90% compared to the same period in
2003. The $13.8 million decrease as compared to the same period in 2003 was
mainly due to the fact that in 2003 we recorded $15.0 million in revenue related
to the sale of the HUNTER: THE RECKONING video game license offset by the $1.175
million sale of the rights to develop FALLOUT 3 in 2004. PLATFORM NET REVENUES
Our platform net revenues for the three and six months ended June 30,
2004 and 2003 break down as follows: (in thousands)
- ---------------------------- ------- --------- ---------- ----------
Three Months Ended June 30 2004 2003 Change % Change
- ---------------------------- ------- --------- ---------- ----------
Personal Computer $311 $976 ($665) (68%)
- ---------------------------- ------- --------- ---------- ----------
Video Game Console 1,648 197 1,451 736%
- ---------------------------- ------- --------- ---------- ----------
OEM, Royalty & Licensing 1,183 96 1,087 1132%
- ---------------------------- ------- --------- ---------- ----------
Net Revenues 3,142 1,269 1,873 148%
- ---------------------------- ------- --------- ---------- ----------
- ---------------------------- ------- --------- ---------- ----------
Six Months Ended June 30 2004 2003 Change % Change
- ---------------------------- ------- --------- ---------- ----------
Personal Computer $1,017 $1,624 ($607) (37%)
- ---------------------------- ------- --------- ---------- ----------
Video Game Console 9,157 3,135 6,022 192%
- ---------------------------- ------- --------- ---------- ----------
OEM, Royalty & Licensing 1,377 15,272 (13,895) (90%)
- ---------------------------- ------- --------- ---------- ----------
Net Revenues 11,551 20,031 (8,480) (42%)
- ---------------------------- ------- --------- ---------- ----------
PC net revenues for the three months ended June 30, 2004 were $.3
million, a decrease of 68% compared to the same period in 2003. The decrease in
PC net revenues in 2004 was primarily due to lower back catalog sales. Video
game console net revenues were $1.6 million, an increase of 736% for the three
months ended June 30, 2004 compared to the same period in 2003, mainly due to
continuing sales in the second quarter from the first quarter releases of
BALDUR'S GATE: DARK ALLIANCE II and FALLOUT: BROTHERHOOD OF STEEL in Europe.
PC net revenues for the six months ended June 30, 2004 were $1.0
million, a decrease of 37% compared to the same period in 2003. The decrease in
PC net revenues in the three months ended June 30, 2004 was primarily due to
20
lower back catalog sales. Video Game console net revenues were $9.1 million, an
increase of 192% for the six months ended June 30, 2004 compared to the same
period in 2003, due to releasing BALDUR'S GATE: DARK ALLIANCE II and FALLOUT:
BROTHERHOOD OF STEEL in Europe in 2004, offset by delivering one product gold
master, RUN LIKE HELL (Xbox), in 2003 to Vivendi in North America.
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our net revenues, cost of goods sold and gross margin for the three and
six months ended June 30, 2004 and 2003 break down as follows: (in thousands)
- ---------------------------- -------- ------------- ------------- ----------
Three Months Ended June 30 2004 2003 Change % Change
- ---------------------------- -------- ------------- ------------- ----------
Net Revenues $3,142 $1,269 $1,873 147%
- ---------------------------- -------- ------------- ------------- ----------
Cost of Goods Sold 1,359 1,114 245 22%
- ---------------------------- -------- ------------- ------------- ----------
Gross Profit Margin 1,783 155 1,628 1,050%
- ---------------------------- -------- ------------- ------------- ----------
- ---------------------------- -------- ------------- ------------- ----------
Six Months Ended June 30 2004 2003 Change % Change
- ---------------------------- -------- ------------- ------------- ----------
Net Revenues $11,551 $20,031 ($8,480) (42%)
- ---------------------------- -------- ------------- ------------- ----------
Cost of Goods Sold 6,442 8,099 (1,657) (21%)
- ---------------------------- -------- ------------- ------------- ----------
Gross Profit Margin 5,109 11,932 (6,823) (57%)
- ---------------------------- -------- ------------- ------------- ----------
- ---------------------------- -------- ------------- ------------
Three Months Ended June 30 2004 2003 Change
- ---------------------------- -------- ------------- ------------
Net Revenues 100% 100% 0%
- ---------------------------- -------- ------------- ------------
Cost of Goods Sold 43% 88% (45%)
- ---------------------------- -------- ------------- ------------
Gross Profit Margin 57% 12% 45%
- ---------------------------- -------- ------------- ------------
- ---------------------------- -------- ------------- ------------
Six Months Ended June 30 2004 2003 Change
- ---------------------------- -------- ------------- ------------
Net Revenues 100% 100% 0%
- ---------------------------- -------- ------------- ------------
Cost of Goods Sold 56% 40% 16%
- ---------------------------- -------- ------------- ------------
Gross Profit Margin 44% 60% (16%)
- ---------------------------- -------- ------------- ------------
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. For sales of titles under the new 2002 distribution
arrangement with Vivendi, our cost of goods consists of royalties paid to
developers. Cost of goods sold related to royalty-based net revenues primarily
represents third party licensing fees and royalties paid by us. Typically, cost
of goods sold as a percentage of net revenues for video game console products is
higher than cost of goods sold as a percentage of net revenues for PC based
products due to the relatively higher manufacturing and royalty costs associated
with video game console and affiliate label products. We also include in the
cost of goods sold the amortization of prepaid royalty 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 increased 22% to $1.3 million in the three
months ended June 30, 2004 compared to the same period in 2003. The increase was
due to higher shipments mainly due to continuing sales in the second quarter
from the first quarter releases of BALDUR'S GATE: DARK ALLIANCE II and FALLOUT:
BROTHERHOOD OF STEEL in Europe.
Our cost of goods sold decreased 21% to $6.4 million in the six months
ended June 30, 2004 compared to the same period in 2003. In 2003, we incurred
$2.9 million in amortization of prepaid royalties associated with the sale of
the HUNTER: THE RECKONING license and approximately $2.4 million in write-offs
of development projects that were impaired because these titles were not
expected to meet our desired profit requirements. The decrease in cost of goods
sold was partially offset by an increase in manufacturing costs due to higher
unit sales in Europe in 2004.
21
Our gross margin increased to 57% for the three months ended June 30,
2004 from 12% in the comparable period in 2003. 2003 was negatively impacted by
higher amortization of prepaid royalties on externally developed products
including approximately $.6 million in fiscal 2003 in write-offs of cancelled
development projects or on titles that were not expected to meet our desired
profit requirements. 2004 did not have a comparable write-off. 2004 had sale of
the rights to develop FALLOUT 3 which yielded approximately an 100% profit
margin 2003 did not have a comparable sale.
Our gross margin decreased to 44% for the six months ended June 30,
2004 period from 60% in the comparable 2003 period. This was primarily due to
the sale of the HUNTER: THE RECKONING license, which yielded approximately an
80% profit margin in 2003 partially offset by the sale of the rights to develop
FALLOUT 3 in 2004.
MARKETING AND SALES
Our marketing and sales expense for the three months ended June 30,
2004 and 2003 break down as follows: (in thousands)
- ----------------------------- ----------- ----------- ------------ ----------
Marketing and Sales 2004 2003 Change % Change
- ----------------------------- ----------- ----------- ------------ ----------
Three Months Ended June 30 $386 $354 $32 9%
- ----------------------------- ----------- ----------- ------------ ----------
Six Months Ended June 30 1,374 475 899 189%
- ----------------------------- ----------- ----------- ------------ ----------
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, 2004 were $.4 million, a 9%
increase as compared to the 2003 period. Marketing and sales expenses for the
six months ended June 30, 2004 were $1.4 million a 189% increase as compared to
the same period during 2003. The increases for the three and six months ended
June 30, 2004 as compared to the same periods in 2003 are due primarily to
increased advertising costs for BALDUR'S GATE DARK ALLIANCE 2 on the PS2 and
Xbox platforms in Europe.
GENERAL AND ADMINISTRATIVE
Our general and administrative expense for the three and six months
ended June 30, 2004 and 2003 break down as follows: (in thousands)
- ----------------------------- ----------- ----------- ------------ ----------
General and Administrative 2004 2003 Change % Change
- ----------------------------- ----------- ----------- ------------ ----------
Three Months Ended June 30 $1,147 $1,269 ($122) (9%)
- ----------------------------- ----------- ----------- ------------ ----------
Six Months Ended June 30 2,356 3,632 (1,276) (35%)
- ----------------------------- ----------- ----------- ------------ ----------
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, 2004 were $1.1 million, a 9% decrease as compared to
the same period in 2003. The decrease is mainly due to a $.1 million decrease in
personnel costs and general expenses. General and administrative expenses for
the six months ended June 30, 2004 were $2.4 million a 35% decrease as compared
to the same period in 2003. The decrease is mainly due to a $1.3 million
decrease in personnel costs and general expenses as a result of a reduction in
administrative personnel during 2004.
PRODUCT DEVELOPMENT
Our product development expense for the three and six months ended June
30, 2004 and 2003 break down as follows: (in thousands)
- ----------------------------- ----------- ----------- ------------ ----------
Product Development 2004 2003 Change % Change
- ----------------------------- ----------- ----------- ------------ ----------
Three Months Ended June 30 $1,433 $3,910 ($2,477) (63%)
- ----------------------------- ----------- ----------- ------------ ----------
Six Months Ended June 30 3,441 7,588 (4,147) (55%)
- ----------------------------- ----------- ----------- ------------ ----------
22
Product development expenses for the three months ended June 30, 2004
were $1.4 million, a 63% decrease as compared to the same period in 2003. This
decrease is due to a $2.5 million decrease in personnel costs and general
expenses as a result of a reduction in product development personnel during
2004. Product development expenses for the six months ended June 30, 2004 were
$3.4 million, a 55% decrease as compared to the same period in 2003. The
decrease is mainly due to a $4.2 million decrease in personnel costs and general
expenses as a result of a reduction in product development personnel during
2004.
OTHER EXPENSE, NET
Our other expense for the three months ended June 30, 2004 and 2003
break down as follows: (in thousands)
- ------------------------ -------- ---------- ---------- -----------
Other (Expenses) Income 2004 2003 Change % Change
- ------------------------ -------- ---------- ---------- -----------
Three Months Ended $676 $2 ($674) 33,700%
- ------------------------ -------- ---------- ---------- -----------
Six Months Ended (689) (37) (652) 1762%
- ------------------------ -------- ---------- ---------- -----------
Other expense consists primarily of interest expense on our debt and
foreign currency exchange transaction gains and losses, and write off of fixed
assets. Other expense for the three months ended June 30, 2004 was $.68 million,
as compared to $.002 million in other income in the same period in 2003. This
increase is due to a write down of fixed assets.
Other Expenses for the six months ended June 30, 2004 was $.69 million,
a 1,762% increase. This increase is due to a write off of fixed assets.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, we had a working capital deficit of approximately
$13 million, and our cash balance was $13,000. We currently have no cash
reserves and are unable to pay current liabilities. The Company cannot continue
in its current form without at this time obtaining additional financing.
On April 16, 2004, our lessor filed an unlawful detainer action against
us alleging unpaid rent of approximately $432,000. We were unable to pay our
rent, and vacated the office space during the month of June 2004. On June 3,
2004 our lessor obtained a judgment of approximately $588,000 thereof exclusive
of interest. We also owe an additional approximately $148,000 on a prior
settlement with the landlord. We are in the process of negotiating a payment
plan on the approximately $738,000 that we owe. The Company has not determined
if the lessor has any right to recover amounts on the remaining lease commitment
at time of eviction of approximately $2.8 million. In early August we leased
approximately 500 square foot office space at 1682 Langley Ave in Irvine,
California.
We have received notice from the Internal Revenue Service ("IRS") that
we owe approximately $95,000 in payroll tax penalties for late payment of
payroll taxes in the 3rd and 4th quarters of 2003 and the 1st quarter of 2004.
We have accrued an additional $50,000 in penalties for the second quarter of
2004. At the end of the first quarter 2004, we owed $100,000, $102,000 and
$99,000 in Federal and State payroll taxes, which were due on April 30, April
15, and March 31, 2004, respectively, and were still owed at June 30, 2004.
These payroll taxes were subsequently paid in July and August 2004. We are
current on our payroll tax obligations although we still owe the penalties
associated with the late payments.
We were unable to meet our May 15, May 31, and June 15, 2004 payroll
obligations to our employees. The State of California Labor Board ("Labor
Board") fined us approximately $10,000 for failure to meet our payroll
obligations. We subsequently paid the May 15, May 31, and June 15, 2004 payrolls
and the associated payroll taxes. All Labor Board pending disputes with former
employees have been paid off and the labor board fines still need to be settled.
We need to have met our payroll obligations otherwise there will be additional
penalties.
Since we were having difficulty meeting our payroll obligations on a
timely basis to our employees a large number of our employees stopped reporting
to work in late May and early June 2004. We were subsequently evicted from our
building at 16815 Von Karman Avenue in Irvine, California in mid June 2004. We
have a core group of approximately 20 employees on payroll, of which
approximately 8 are actively working from the new company location in Irvine,
California. Substantially all employees have not been paid for the period July 1
23
through September 30, 2004. There may be some liability to us arising from
employees who have left. Our property, general liability, auto, fiduciary
liability, workers compensation, and employment practices liability insurance
policies, have been cancelled. We obtained a new workers' compensation insurance
policy. The Labor Board fined us approximately $79,000 for not having worker's
compensation coverage for a period of time. Our health insurance was also
cancelled but was subsequently reinstated. We are appealing the labor board
fines.
On July 2, 2004,we granted an option to Vivendi to purchase the Redneck
Rampage intellectual property rights for $300,000. On July 19, 2004, Vivendi
exercised the option and paid the $300,000 on July 23, 2004.
We entered into tri-party agreements with Atari Interactive, Inc. and
Vivendi and Avalon that allows Vivendi to resume North American distribution,
and Avalon to resume International distribution pursuant to their pre-existing
agreements with usof certain Dungeons & Dragons games, including BALDUR'S GATE:
DARK ALLIANCE II. In September 2004 Atari notified Vivendi that Vivendi is
currently in breach of its obligations to remit royalties to Atari pursuant to
the terms of the agreement. Atari Interactive notified Vivendi that if Vivendi
did not cure the breach set forth in the letter by September 30, 2004 that the
letter shall be deemed notice of termination of the agreement.
Interplay sold to Bethesda Softworks LLC, "Bethesda" the rights to
develop FALLOUT 3 on all platforms for $1.175 million minimum guaranteed advance
against royalties. Bethesda also has an option to develop two sequels, FALLOUT
4, and FALLOUT 5 for $1.0 million minimum guaranteed advance against royalties
per sequel. Interplay retained the rights to develop a massively multiplayer
online game ("MMORPG") using the Fallout Trademark.
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. In April 2004, we engaged an investment bank to assist us
in locating and evaluating strategic transactions. However, no assurance can be
given that any strategic transaction will be consummated or any alternative
sources of funding can be obtained on acceptable terms, or at all. 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.
During 2003, we continued to operate under limited cash flow from
operations. To improve our operating results, we have reduced our personnel by
96, from 203 in March 2003 to 107 in March 2004 by both involuntary termination
and attrition. We have a core group of approximately 20 employees on payroll of
which approximately 8 are actively working from the new company location in
Irvine. The number of employees continues to reduce through voluntary
termination and attrition. Operations are continuing at a substantially reduced
basis. We have also reviewed other operational costs and have made reductions in
expenditures in areas throughout the company.
Additionally, we have reduced our fixed overhead commitments, and
cancelled or suspended development on future titles which management believes do
not meet sufficient projected profit margins, and scaled back certain marketing
programs associated with the cancelled projects. Management will continue to
pursue various alternatives to improve future operating results and further
expense reductions.
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 the balance of 2004.
Historically, we have funded our operations primarily through the use
of lines of credit, cash flow from operations, including royalty and
distribution fee advances, cash generated by the sale of securities, and the
sale of assets.
24
Our primary capital needs have historically been working capital
requirements necessary to fund our operations, 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 used cash of $644,000 during the six months ended June 30, 2004,
primarily attributable to fees incurred for lawsuits, and other liabilities, and
recoupment of advances received by distributors.
Cash used by investing activities of $5,000 for the six months ended
June 30, 2004 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. Net cash used by
financing activities of $507,000 for the six months ended June 30, 2004,
consisted primarily of repayments of our note payable to Warner Brothers
Entertainment, Inc.
In May 2003, Avalon filed for a CVA, a process of reorganization in the
United Kingdom. As part of the Avalon CVA process, we submitted our creditor's
claim.. We continue to operate under a distribution agreement with Avalon.
Avalon distributes substantially all of our titles in Europe, the Commonwealth
of Independent States, Africa, the Middle East, and certain other select
countries. Avalon is not current on their post-CVA payments to us. Our
distribution agreement with Avalon ends in February 2006. We continue to
evaluate and adjust as appropriate our claims against Avalon in the CVA process.
However, the effects of the approval of the Avalon CVA on our ability to collect
amounts due from Avalon are uncertain. As a result, we cannot guarantee our
ability to collect fully the debts we believe are due and owed to us from
Avalon. If Avalon is not able to continue to operate under the new CVA, we
expect Avalon to cease operations and liquidate, in which event we will most
likely not receive in full the amounts presently due us by Avalon. We may also
have to appoint another distributor or become our own distributor in Europe and
the other territories in which Avalon presently distributes our products. In
August 2004 we reached an understanding with Avalon under which it is
anticipated that Avalon will make four payments totaling 750,000 English pounds
between September 13, 2004, and November 15, 2004 to pay off the balance owed on
their post CVA balance. This is our anticipated main source of short-term
cashflow. There is no assurance that these payments will be received given the
financial condition of Avalon and the first payment has not been received.
In April 2002, we entered into a settlement agreement with the landlord
of an office facility in the United Kingdom, whereby we returned the property to
the landlord and were released from any further lease obligations. This
settlement reduced our total contractual cash obligations by $1.3 million
through fiscal 2005.
Currently there is no internal development of new titles going on.
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.
If operating revenues from product releases are not sufficient to fund
our operations, no assurance can be given that alternative sources of funding
could be obtained on acceptable terms, or at all. These conditions, combined
with our deficits in stockholders' equity and working capital, raise substantial
doubt about our ability to continue as a going concern. The accompanying
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets and
liabilities that may result from the outcome of this uncertainty. There can be
no guarantee that we will be able to meet all contractual obligations or
liabilities in the future, including payroll obligations.
OFF BALANCE SHEET ARRANGEMENTS
We do not have any off balance sheet arrangements under which we have
obligations under a guaranteed contract that has any of the characteristics
identified in paragraph 3 of FASB Interpretation No. 45 "Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". We do not have any retained or contingent interest in
assets transferred to an unconsolidated entity or similar arrangement that
serves as credit, liquidity or market risk support to such entity for such
assets. We also do not have any obligation, including a contingent obligation,
under a contract that would be accounted for as a derivative instrument. We have
no obligations, including a contingent obligation arising out of a variable
interest (as referenced in FASB Interpretation No. 46, Consolidation of Variable
Interest Entities, as amended) in an unconsolidated entity that is held by, and
25
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 June 30, 2004, and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods: (in thousands)
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Less Than More Than
Contractual Obligations Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Developer License $4,394 $2,751 $1,643
Commitments (1)
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Lease Commitments (2) 738 738
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Payroll Taxes (3) 1,210 1,210
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Current Debt 330 330
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Other Commitments (5) 1,476 970 506
- ------------------------ ----------- ------------- ------------ ------------ ----------------
Total 8,148 5,999 2,149
- ------------------------ ----------- ------------- ------------ ------------ ----------------
We currently have no cash reserves. 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. As
discussed previously, the Company is uncertain as to its remaining lease
obligation to Arden Realty on its former office space. The remaining lease
obligation at time of eviction approximated $2.8 million.
(1) Developer/Licensee Commitments: The products produced by us are
designed and created by our employee designers and artists and by non-employee
software developers ("independent developers"). We typically advance development
funds to the independent developers during development of our games, usually in
installment payments made upon the completion of specified development
milestones, which payments are considered advances against subsequent royalties
based on the sales of the products. These terms are typically set forth in
written agreements entered into with the independent developers. In addition, we
have content license contracts that contain minimum guarantee payments and
marketing commitments that are not dependent on any deliverables. These
developer and content license commitments represent the sum of (a) minimum
marketing commitments under royalty bearing licensing agreements, and (b)
minimum payments and advances against royalties due under royalty-bearing
licenses and developer agreements.
(2) Lease Commitments: We lease certain of our current facilities and
equipment under non-cancelable operating lease agreements. We are required to
pay property taxes, insurance and normal maintenance costs for certain of our
facilities and will be required to pay any increases over the base year of these
expenses on the remainder of our facilities.
Our headquarters were located in Irvine, California where we leased
approximately 81,000 square feet of office space. This lease would have expired
in June 2006. On or about April 16, 2004, Arden Realty Finance IV LLC 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 $431,823. The Company was unable to satisfy this
obligation and reach an agreement with its landlord, the Company subsequently
forfeited its lease and vacated the building. Arden Realty obtained a judgment
for approximately $588,000 exclusive of interest. We then signed a monthly
rental agreement beginning in August 2004 at 1682 Langley Ave in Irvine, CA for
our operations. The monthly payments are approximately $2,000 per month. This
suit and interruption of our operations could cause substantial harm to our
business.
(3) Payroll Taxes: At June 30, 2004, we have an accrual of
approximately $140,000 for past due interest and penalties on late payment of
our Federal and state payroll taxes. We also have accrued approximately $1.1
26
million in wages and Federal and State payroll taxes, which were paid subsequent
to June 30, 2004.
(4) Other Commitments: Consist of payment plans and amounts owed to
various creditors.
ACTIVITIES WITH RELATED PARTIES
It is our policy that related party transactions will be reviewed and
approved by a majority of our disinterested directors or our Independent
Committee.
Our operations involve significant transactions with our majority
stockholder Titus and its affiliates. We have a major distribution agreement
with Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus presently owns approximately 58 million shares of common stock,
which represents approximately 62% of our outstanding common stock, our only
voting security.
We perform certain distribution services on behalf of Titus for a fee.
In connection with such distribution services, we recognized fee income of $0
and $5,000 for the three months ended June 30, 2004, and 2003, respectively.
As of June 30, 2004 and December 31, 2003, Titus and its affiliates
excluding Avalon owed us $364,000 and $362,000, respectively. We owed Titus and
its affiliates excluding Avalon $15,000 and $0.00 as of June 30, 2004 and
December 31, 2003 respectively. Amounts we owed to Titus and its affiliates
excluding Avalon at June 30, 2004, consisted primarily of trade payables.
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
We have an International Distribution Agreement with Avalon, a wholly
owned subsidiary of Titus. Pursuant to this distribution agreement, Avalon
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 Avalon a distribution fee based on net sales, and Avalon provides certain
market preparation, warehousing, sales and fulfillment services on our behalf.
In connection with the International Distribution Agreement with Avalon, we
incurred distribution commission expense of $402,000 and $15,000, for the three
months ended June 30, 2004, and 2003, and $1,755,000 and $300,00 for the six
months ended June 30, 2004, and 2003 respectively In addition, we recognized no
overhead fees for the three months ended June 30, 2004, and 2003 and no overhead
fees for the six months ended June 30, 2004 and 2003 respectively. Also in
connection with this International Distribution Agreement, we subleased office
space from Avalon. Rent expense paid to Avalon was $0 and $0 for the three
months ended June 30, 2004, and 2003 and $0 and $27,000 for the six months ended
June 30, 2004 and 2003 respectively. As of April 2003, we no longer subleased
office space from Avalon.
In January 2003, we entered into a waiver with Avalon related to the
distribution of a video game title in which we sold the European distribution
rights to Vivendi. In consideration for Avalon relinquishing its rights, we paid
Avalon a $650,000 cash consideration and will pay Avalon 50% of all proceeds in
excess of the advance received from Vivendi. As of June 30, 2004 Vivendi has not
reported sales exceeding the minimum guarantee.
In May 2003, Avalon filed for a CVA, a process of reorganization in the
United Kingdom, in which we participated in, and were approved as a creditor of
Avalon. As part of the Avalon CVA process, we submitted our creditor's claim. We
have received the payments of approximately $555,000 due to us as a creditor
under the terms of the Avalon CVA plan. We continue to evaluate and adjust as
appropriate our claims against Avalon in the CVA process. However, the effects
of the approval of the Avalon CVA on our ability to collect amounts due from
Avalon are uncertain. As a result, we cannot guarantee our ability to collect
fully the debts we believe are due and owed to us from Avalon. If Avalon is not
able to continue to operate under the new CVA, we expect Avalon to cease
27
operations and liquidate, in which event we will most likely not receive in full
the amounts presently due us by Avalon. We may also have to appoint another
distributor or become our own distributor in Europe and the other territories in
which Avalon presently distributes our products.
In March 2003, we made a settlement payment of approximately $320,000
to a third-party on behalf of Avalon 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, Avalon owes us
$400,000 pursuant to the indemnification provisions of the International
Distribution Agreement. This amount was included in our claims against Avalon in
the Avalon CVA process. We have also entered into a Product Publishing Agreement
with Avalon, which provides us with an exclusive license to publish and
distribute substantially all of Avalon's products within North America, Latin
America and South America for a royalty based on net sales. As part of terms of
an April 2001 settlement between Avalon and us, the Product Publishing Agreement
was amended to provide for us to publish only one future title developed by
Avalon. In connection with this Product Publishing Agreement with Avalon, we did
not perform any publishing and distribution services on behalf of Avalon for the
six months ended June 30, 2004 and 2003 respectively.
In August 2004, we reached an understanding with Avalon under which it
is anticipated that Avalon will make four payments totaling 750,000 English
pounds between September 13, 2004, and November 15, 2004 to pay off the balance
owed on their post CVA balance.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software
Corp., ("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at June 30, 2004 was approximately $250,000. The total receivable due
from TSC is approximately $322,000 as of June 30, 2004. The majority of the
additional approximately $72,000 was due to TSC subletting office space and
miscellaneous other items.
In May 2003, we paid 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 we owed to him arising from expenses incurred in
connection with providing services to us. Our Board of Directors is in the
process of investigating the details of the transaction, including independent
counsel review as appropriate, in order to properly record the transaction.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. This representation agreement has not yet been
approved by our Board of Directors and is currently being reviewed by them. Our
Board of Directors has approved the payments of certain amounts to Titus Japan
in connection with certain services already performed by them on our behalf. As
of June 30, 2004 we had a zero balance with Titus Japan.
TRANSACTIONS WITH TITUS INTERACTIVE STUDIO
In September 2003, we engaged the translation services of Titus
Interactive Studio, pursuant to which (i) we will first request a quote from
Titus Interactive Studio for each service needed and only if such quote compares
favorably with quotes from other companies for identical work will Titus
Interactive Studio be used, (ii) such services shall be based on work orders
submitted by us and (iii) each work order cannot have a rate exceeding
$0.20/word (excluding voice over) without receiving additional prior Board of
Directors' approval. We have paid approximately $11,000 to date under this
agreement. We have a $0.00 balance with Titus Interactive Studio as of the date
of this filing.
TRANSACTIONS WITH TITUS SARL
As of June 30, 2004, we have a receivable of $43,000 for product
development services that we provided.
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TRANSACTIONS WITH TITUS GIE
In February 2004, we engaged the services of GIE Titus Interactive
Group, a wholly owned subsidiary of Titus, for a three-month service agreement
pursuant to which GIE Titus or its agents shall provide to us certain foreign
administrative and legal services at a rate of $5,000 per month for three
months. As of June 30, 2004 we had a payable of $15,000,
TRANSACTIONS WITH EDGE LLC
In September 2003, our Board of Directors ratified and approved our
engagement of Edge LLC to provide recommendations regarding the operation of our
legal department and strategies as well as interim executive functions. Mr.
Michel Vulpillat, a former member of our Board of Directors, is a managing
member for Edge LLC. Michel Vulpillat resigned from the Board of Directors on
June 23, 2004. As of June 30, 2004, we have incurred an aggregate expense of
approximately $184,000 and had a payable of approximately $84,400 to Edge LLC.
In April 2004, we entered into a Bridge Financing Agreement with Edge
LLC pursuant to which Edge LLC loaned us $60,000 at an interest rate of 10% per
annum and is due as soon as sufficient funds other than the funds received
pursuant to this agreement become available, but in no event later than May 31,
2004. We also incurred a $2,000 transaction fee as a part of this financing. As
of the date of this filing we have paid Edge LLC $35,000 pursuant to this
agreement and consequently still owe approximately $25,000 plus the transaction
fee and 10% interest. This balance due is in addition to the approximately
$84,400 in payables due to Edge LLC above.
WE DO NOT PAY DIVIDENDS ON OUR COMMON STOCK.
While we have never paid dividends in the past, we may decide to do in the
foreseeable future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of June 30,
2004. 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 or significant risk due to
fluctuations in interest rates.
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 Avalon. We
recognized loss of $33,000 and a gain of $5,000 during the six months ended June
30, 2004 and 2003, respectively, primarily in connection with foreign exchange
fluctuations in the timing of payments received on accounts receivable from
Avalon.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and interim Chief Financial Officer of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
this evaluation, our Chief Executive Officer and interim Chief Financial Officer
concluded that our disclosure controls and procedures were of limited
effectiveness, at the reasonable assurance level, in timely alerting him to
material information required to be included in this report.
Due to the departure of numerous key employees during June 2004, there
was significant change in our internal controls over financial reporting that
occurred during the quarter ended June 30, 2004 that have materially affected or
are reasonably likely to materially affect these controls.
29
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, 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 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.
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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 5. Commitments and Contingencies" to our
condensed consolidated financial statements located in Item 1, Part 1 of this
Report.
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 $0.33 million payable in one
remaining installment.
ITEM 5. OTHER INFORMATION
Prior to August 23, 2004 Nathan Peck, Michel Vulpillat, and Gerald
DeCiccio resigned as board members. Robert Stefanovich resigned as a board
member on October 11, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(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) 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 14, 2004,
giving information on Fourth quarter and Year end 2003 operating results and
attaching a press release.
The Company filed a Current Report on Form 8-K on April 21, 2004
attached a press release announcing the engagement of SG capital.
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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: October 13, 2004 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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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.