Back to GetFilings.com
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 SEPTEMBER 30, 2003
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
INTERPLAY ENTERTAINMENT CORP.
(Exact name of the registrant as specified in its charter)
DELAWARE 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92606
(Address of principal executive offices)
(949) 553-6655
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
CLASS ISSUED AND OUTSTANDING AT SEPTEMBER 30, 2003
----- --------------------------------------------
Common Stock, $0.001 par value 93,855,634
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
SEPTEMBER 30, 2003
TABLE OF CONTENTS
--------------
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2003 (unaudited) and
December 31, 2002 ........................................ 3
Condensed Consolidated Statements of Operations
for the Three and Nine Months ended September
30, 2003 and 2002 (unaudited) ............................ 4
Condensed Consolidated Statements of Cash Flows
for the Nine Months ended September 30, 2003
and 2002 (unaudited) ..................................... 5
Notes to Condensed Consolidated Financial
Statements (unaudited) ................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ............ 15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk .............................................. 26
Item 4. Controls and Procedures .................................. 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................ 27
Item 3. Defaults Upon Senior Securities .......................... 27
Item 5. Other Information ........................................ 28
Item 6. Exhibits and Reports on Form 8-K ......................... 28
SIGNATURES ............................................................ 29
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2003 2002
--------- ---------
(unaudited)
ASSETS
Current Assets:
Cash ........................................ $ 7 $ 134
Trade receivables from related parties,
net of allowances of $3,702 and
$231, respectively ...................... 2,455 2,506
Trade receivables, net of allowances
of $695 and $855, respectively .......... 7 170
Inventories ................................. 922 2,029
Prepaid licenses and royalties .............. 1,189 5,129
Other current assets ........................ 731 1,200
--------- ---------
Total current assets .................... 5,311 11,168
Property and equipment, net ...................... 2,411 3,130
--------- ---------
$ 7,722 $ 14,298
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current debt ................................ $ 1,442 $ 2,082
Accounts payable ............................ 8,696 10,280
Accrued royalties ........................... 4,578 4,775
Advances from distributors and others ....... 579 101
Advances from related parties ............... 4,995 3,550
Payables to related parties ................. 3,350 7,440
--------- ---------
Total current liabilities .............. 23,640 28,228
Commitments and contingencies
Stockholders' Deficit:
Common stock ................................ 94 94
Paid-in capital ............................. 121,640 121,637
Accumulated deficit ......................... (137,782) (135,793)
Accumulated other comprehensive income ...... 130 132
--------- ---------
Total stockholders' deficit ............ (15,918) (13,930)
--------- ---------
$ 7,722 $ 14,298
========= =========
See accompanying notes.
3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share amounts)
Net revenues ................... $ 365 $ 1,152 $ 1,278 $ 14,860
Net revenues from related
party distributors .......... 4,362 8,525 23,480 22,181
-------- -------- -------- --------
Total net revenues .......... 4,727 9,677 24,758 37,041
Cost of goods sold ............. 1,849 5,675 9,948 20,754
-------- -------- -------- --------
Gross profit ................ 2,878 4,002 14,810 16,287
Operating expenses:
Marketing and sales ......... 496 965 962 5,328
General and administrative .. 928 1,010 4,587 5,816
Product development ......... 3,555 3,460 11,124 12,161
-------- -------- -------- --------
Total operating expenses . 4,979 5,435 16,673 23,305
-------- -------- -------- --------
Operating loss ................. (2,101) (1,433) (1,863) (7,018)
Other income (expense):
Interest expense ........... (36) (352) (119) (2,181)
Gain on sale of Shiny ...... -- -- -- 28,781
Other ...................... (52) (62) (7) 858
-------- -------- -------- --------
Income (loss) before benefit
for income taxes ............ (2,189) (1,847) (1,989) 20,440
Benefit for income taxes ....... -- -- -- 75
-------- -------- -------- --------
Net income (loss) .............. $ (2,189) $ (1,847) $ (1,989) $ 20,515
-------- -------- -------- --------
Cumulative dividend on
participating preferred
stock ....................... $ -- $ -- $ -- $ 133
-------- -------- -------- --------
Net income (loss) available
to common stockholders ...... $ (2,189) $ (1,847) $ (1,989) $ 20,382
======== ======== ======== ========
Net income (loss) per common
share:
Basic ...................... $ (0.02) $ (0.02) $ (0.02) $ 0.25
======== ======== ======== ========
Diluted .................... $ (0.02) $ (0.02) $ (0.02) $ 0.25
======== ======== ======== ========
Shares used in calculating net
income (loss) per common
share:
Basic ...................... 93,856 93,138 93,851 80,365
======== ======== ======== ========
Diluted .................... 93,856 93,138 93,851 80,365
======== ======== ======== ========
See accompanying notes.
4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
-------- --------
(In thousands)
Cash flows from operating activities:
Net (loss) income ............................... $ (1,989) $ 20,515
Adjustments to reconcile net (loss)
income to cash provided by
(used in) operating activities:
Depreciation and amortization ................ 1,050 1,236
Noncash expense for stock options ............ -- 33
Non-cash interest expense .................... 81 1,829
Write-off of prepaid licenses
and royalties ............................. 2,379 2,100
Gain on sale of Shiny ........................ -- (28,781)
Other ........................................ (2) (23)
Changes in operating assets and
liabilities:
Trade receivables from related
parties ................................ 51 (1,882)
Trade receivables, net .................... 163 2,162
Inventories ............................... 1,107 2,251
Prepaid licenses and royalties ............ 1,561 64
Other current assets ...................... 469 26
Accounts payable .......................... (545) (4,787)
Accrued royalties ......................... (197) (3,256)
Other accrued liabilities ................. (1,039) (797)
Payables to related parties ............... (4,095) 3,395
Advances .................................. 1,923 (21,951)
-------- --------
Net cash provided by (used in)
operating activities ................ 917 (27,866)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment .............. (331) (162)
Proceeds from sale of Shiny ..................... -- 33,102
-------- --------
Net cash (used in) provided by
investing activities ................ (331) 32,940
-------- --------
Cash flows from financing activities:
Net payment on line of credit ................... -- (1,576)
(Repayment) borrowings from former
Chairman ..................................... -- (3,218)
Net proceeds from issuance of common
stock ........................................ 3 3
Repayment of note payable ....................... (716)
Proceeds from exercise of stock options ......... -- 86
-------- --------
Net cash (used in) financing
activities .......................... (713) (4,705)
-------- --------
Net (decrease) increase in cash .............. (127) 369
Cash, beginning of period .......................... 134 119
-------- --------
Cash, end of period ................................ $ 7 $ 488
======== ========
Supplemental cash flow information:
Cash paid for:
Interest ............................... $ 35 $ 327
See accompanying notes.
5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2003
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Interplay Entertainment Corp. (the "Company") 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 generally accepted accounting principles in the United
States for complete financial statements. The results of operations for the
current interim period are not necessarily indicative of results to be expected
for the current year or any other period. The balance sheet at December 31, 2002
has been derived from the audited consolidated financial statements at that
date, but does not include all information and footnotes required by generally
accepted accounting principles in the United States for complete financial
statements.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002 as filed with the U.S. Securities and Exchange Commission.
FACTORS AFFECTING FUTURE PERFORMANCE AND GOING CONCERN
The Company's independent public accountants included a "going concern"
explanatory paragraph in their audit report attached to the December 31, 2002
consolidated financial statements which had been prepared assuming that the
Company will continue as a going concern.
The Company has incurred substantial historical operating losses through
September 30, 2003, and at that date, had a stockholders' deficit of $15.9
million and a working capital deficit of $18.3 million. The Company has
historically funded its ongoing operations primarily from existing operations,
through the use of lines of credit, royalty and distribution fee advances, cash
generated by the private sale of securities and the sale of assets.
To reduce its working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles which
management believes do not meet sufficient projected profit margins, and the
scaling back of certain marketing programs. Management will continue to pursue
various alternatives to improve future operating results, and further expense
reductions, some of which may have a long-term adverse impact on the Company's
ability to generate successful future business activities.
In addition, the Company continues to seek and expects to require external
sources of funding, including but not limited to, a sale or merger of the
Company, a private placement of the Company's capital stock, the sale of
selected assets, the licensing of certain product rights in selected
territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
the Company's long-term strategic objectives. In this regard, the Company
completed the sale of the Hunter franchise in February 2003, for $15.0 million.
In August 2003, the Company completed an agreement with Avalon Interactive Group
Ltd. ("Avalon"), which changed its name from Virgin Interactive Entertainment
Limited on July 1, 2003 and is a subsidiary of Titus Interactive SA ("Titus"),
the Company's largest stockholder. This agreement modified the terms of the
parties' distribution agreement relating to an upcoming title. Under the terms
of this agreement, the Company was paid a cash advance of approximately
$740,000. Upon delivery of the gold master to this title the Company will
receive approximately an additional $740,000.
If the Company's existing cash and operating revenues from future product
releases are not sufficient to fund the Company's operations, no assurance can
be given that alternative sources of funding could be obtained on acceptable
terms, or at all. These conditions, combined with the Company's historical
operating losses and its deficits in stockholders' equity and working capital,
raise substantial doubt about the Company's ability to continue as a going
concern. The accompanying condensed consolidated financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets and liabilities that may result from
the outcome of this uncertainty.
6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 restructuring activities and litigation.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Interplay Entertainment Corp. and its wholly-owned subsidiaries, Interplay
Productions Limited (U.K.), Interplay OEM, Inc., Interplay Productions Pty Ltd
(Australia), Interplay Co., Ltd., (Japan) and Games On-line. Shiny
Entertainment, Inc., which was sold by the Company in April 2002, is included in
the consolidated financial statements up to the date of the sale. All
significant intercompany accounts and transactions have been eliminated.
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 Universal Games, Inc.
("Vivendi") in August 2001, substantially all of the Company's sales are made by
two related party distributors: Vivendi, an affiliate of Universal Studios Inc.
which owns less than 5 percent of the outstanding shares of the Company's common
stock, and Avalon, a wholly owned subsidiary of Titus.
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 SFAS No. 48,
"Revenue Recognition when Right of Return Exists," revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The amount
of reserves ultimately required could differ materially in the near term from
the amounts included in the accompanying condensed consolidated financial
statements.
Customer support provided by the Company is limited to email and Internet
support. These costs are not significant and are charged to expenses as
incurred.
The Company also engages in the sale of licensing rights on certain
products. The terms of the licensing rights differ, but normally include the
right to develop and distribute a product on a specific video game platform. For
these activities, revenue is recognized when the rights have been transferred
and no other obligations exist.
7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
The Emerging Issues Task Force ("EITF") issued EITF 01-09 in November 2001.
The pronouncement codifies and reconciles the consensus reached on EITF 00-14,
00-22 and 00-25, which addresses the recognition, measurement and profit and
loss account classification of certain selling expenses. The adoption of this
issue has resulted in the reclassification of certain selling expenses including
sales incentives, slotting fees, buydowns and distributor payments from cost of
sales and administrative expenses to a reduction in sales. 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 to net income for any period.
STOCK-BASED COMPENSATION
At September 30, 2003, the Company has three stock-based employee
compensation plans. The Company accounts for these plans under the recognition
and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and related Interpretations. The Company did not incur any
stock-based employee compensation cost for the three and nine months ended
September 30, 2003 and 2002,. The following table illustrates the effect on net
income (loss) and earnings (loss) per common share if the Company had applied
the fair value recognition provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ----------
(Dollars in thousands, except per share amounts)
Net income (loss) available
to common stockholders,
as reported ............. $ (2,189) $ (1,847) $ (1,989) $ 20,382
Pro forma compensation
expense ................. 55 64 151 151
--------- --------- --------- ----------
Pro forma net income (loss)
available to common
stockholders ............ $ (2,244) $ (1,911) $ (2,140) $ 20,231
========= ========= ========= ==========
Earnings (loss) per share,
as reported
Basic ................... $ (0.02) $ (0.02) $ (0.02) $ 0.25
Diluted ................. $ (0.02) $ (0.02) $ (0.02) $ 0.25
Earnings (loss) per share,
pro forma
Basic ................... $ (0.02) $ (0.02) $ (0.02) $ 0.25
Diluted ................. $ (0.02) $ (0.02) $ (0.02) $ 0.25
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements discussed in the notes to the December 31,
2002 audited consolidated financial statements, filed previously with the U.S.
Securities and Exchange Commission in Form 10-K, that were required to be
adopted during the period ended September 30, 2003 did not have a significant
impact on the Company's financial statements.
NOTE 2. INVENTORIES
Inventories consist of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ ------------
(Dollars in thousands)
Packaged software ...................... $ 922 $ 2,029
=========== ============
8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
NOTE 3. PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------ ------
(Dollars in thousands)
Prepaid royalties for titles in
development ......................... $ 800 $4,644
Prepaid royalties for shipped
titles, net of amortization ......... 112 431
Prepaid licenses and trademarks,
net of amortization ................. 277 54
------ ------
$1,189 $5,129
====== ======
Amortization of prepaid licenses and royalties is included in cost of goods
sold and totaled $0.7 million and $0.8 million for the three months ended
September 30, 2003 and 2002, respectively. For the nine months ended September
30, 2003 and 2002, amortization of prepaid licenses and royalties was $6.6
million and $6.4, 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 zero for the three
months ended September 30, 2003 and 2002, and $2.4 million and $2.1 million for
the nine months ended September 30, 2003 and 2002, respectively.
NOTE 4. ADVANCES FROM DISTRIBUTORS AND OTHERS
Advances from distributors and OEMs consist of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------ ------
(Dollars in thousands)
Advances for other distribution rights ... $ 579 $ 101
====== ======
Net advance from Vivendi distribution
agreements ............................ $4,995 $3,550
====== ======
Other advances from distributors are repayable as products covered by those
agreements are sold.
In April 2002, the Company entered into an agreement with Titus, pursuant
to which, among other things, the Company sold to Titus all right, title and
interest in the games "EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter",
"Sacrifice", "MDK", "MDK II", and "Kingpin", and Titus licensed from the Company
the right to develop, publish, manufacture and distribute the games "Hunter I",
"Hunter II", "Icewind Dale I", "Icewind Dale II", and "BG: Dark Alliance II"
solely on the Nintendo Advance GameBoy game system for the life of the games. As
consideration for these rights, Titus issued to the Company a promissory note in
the principal amount of $3.5 million, which bears interest at 6 percent per
annum. The promissory note was due on August 31, 2002, and was to be paid, at
Titus' option, in cash or in shares of Titus common stock with a per share value
equal to 90 percent of the average trading price of Titus' common stock over the
5 days immediately preceding the payment date. The Company provided Titus with a
guarantee under this agreement, which provided that in the event Titus did not
achieve gross sales from the underlying properties of at least $3.5 million by
June 25, 2003, and the shortfall was not the result of Titus' failure to use
best commercial efforts, the Company was to pay to Titus the difference between
$3.5 million and the actual gross sales achieved by Titus, not to exceed $2.0
million. In April 2003, the Company entered into a rescission agreement with
Titus to repurchase these assets for a purchase price payable by canceling the
$3.5 million promissory note, and any unpaid accrued interest thereon.
Concurrently, the Company and Titus terminated all executory obligations
including, without limitation, the Company's obligation to pay Titus up to the
$2 million guarantee.
9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
NOTE 5. COMMITMENTS AND CONTINGENCIES
At September 30, 2003, the Company has an accrual of $180,000 for past due
payroll taxes, including penalties and interest due to the non-payment of the
Company's payroll tax liabilities. The Company expects this matter to be settled
and the related accrual paid by December 2003. As of the filing of this Form
10-Q, the Company has accrued an additional $540,000 of principal, penalties,
and interest related to the non-payment of payroll tax liabilities for the
period October 1, 2003 through October 31, 2003.
The Company is involved in various legal proceedings, claims and litigation
arising in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the opinion
of management, the outcome of known routine claims will not have a material
adverse effect on the Company's business, financial condition, results of
operations or cash flows.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and the Company's
subsidiary GamesOnline.com, Inc., alleging, among other things, breach of
contract, misappropriation of trade secrets, breach of fiduciary duties and
breach of the implied covenant of good faith in connection with an electronic
distribution agreement dated November 2001 between KBK and GamesOnline.com, Inc.
KBK has alleged that GamesOnline.com failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Infogrames. In August 2003, KBK amended its complaint to include the Company as
a defendant. The Company believes this complaint is without merit and continues
to vigorously defend its position.
In August 2003, the Company sent several notifications to Vivendi accusing
Vivendi of its failure to perform in accordance with the distribution agreement
but did not receive a response acceptable to the Company. In September 2003, the
Company decided to terminate the distribution agreement with Vivendi as a result
of its alleged breaches, including for the non-payment of money owed to the
Company under the terms of this distribution agreement. In October 2003, the
Company and Vivendi reached a settlement as to their dispute under this
distribution agreement whereby Vivendi will distribute the Company's Fallout:
Brotherhood of Steel in North America and Asia-Pacific (excluding Japan), and
Vivendi will retain exclusive distribution rights in these regions for all
future Company titles through August 2005.
On September 19, 2003, the Company filed a complaint against Atari, Inc. in
the Supreme Court of the State of New York. The complaint alleges that Atari,
Inc. wrongfully claims a termination of a multi-year license agreement between
the parties and seeks an injunction and declaratory relief preventing Atari,
Inc. from terminating this license agreement pending a determination on the
merits. In September 2003, the Company successfully obtained a preliminary
injunction in the Supreme Court of the State of New York preventing Atari, Inc.
from terminating this multi-year license agreement until such time as a decision
on the merits has been rendered. As of September 30, 2003, the parties remain in
litigation. The Company believes Atari, Inc.'s attempt to terminate the license
agreement is without merit and intends to vigorously prosecute its position.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. filed suit
against the Company in the Superior Court for the State of California, County of
Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of Two Million Dollars ($2,000,000). At the time the suit was filed, the
current remaining principal sum due under the note was One Million Three
Hundred, Thirty-Three Thousand Three Hundred Thirty-Three Dollars and
Thirty-Four cents ($1,333,333.34), plus interest. The Company settled this
litigation and entered into a payment plan with Warner Bros. to satisfy the
balance of the note by January 30, 2004.
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") filed a
motion for summary judgment in lieu of complaint against us in the amount of
$1.3 million, alleging, among other things, that we are liable to pay Special
Situations $1.3 million for our failure to timely register for resale with the
Securities and Exchange Commission certain shares of our common stock that
Special Situations purchased from us in April 2001. The court denied Special
Situation's motion for summary judgment in
10
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
lieu of complaint. Special Situations filed and served the Company with a
complaint, which the Company has answered. This case is currently in the
discovery phase and the Company is vigorously defending its position.
NOTE 6. NET EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed as net earnings (loss)
attributable to common stockholders divided by the weighted-average number of
common shares outstanding for the period and does not include the impact of any
potentially dilutive securities. Diluted earnings per share is computed by
dividing the net earnings attributable to the common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and common stock warrants.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
(In thousands, except per share amounts)
Net income (loss) available to
common stockholders ............. $ (2,189) $ (1,847) $ (1,989) $ 20,382
----------- ----------- ----------- -----------
Shares used to compute net income
(loss) per share:
Weighted-average common shares ... 93,856 3,138 93,851 80,365
Dilutive stock equivalents ....... - - - -
----------- ----------- ----------- -----------
Dilutive potential common shares . 93,856 93,138 93,851 80,365
=========== =========== =========== ===========
Net income (loss) per share:
Basic ............................ $ (0.02) $ (0.02) $ (0.02) $ 0.25
Diluted .......................... $ (0.02) $ (0.02) $ (0.02) $ 0.25
There were options and warrants outstanding to purchase 10,411,218 and
11,264,231 shares of common stock at September 30, 2003 and 2002, respectively,
which were excluded from the earnings per share computation for the three and
nine months ended September 30, 2003 and 2002, as the exercise price was greater
than the average market price of the common shares. The weighted average
exercise price of the outstanding stock options and common stock warrants at
September 30, 2003 and 2002 was $1.93 and $2.05, respectively.
11
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
NOTE 7. RELATED PARTIES
Amounts receivable from and payable to related parties are as follows:
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
(Dollars in thousands)
Receivables from related parties:
Avalon ....................... $ 4,689 $ 2,050
Vivendi ...................... 1,163 487
Titus ........................ 305 200
Return allowance ............. (3,702) (231)
----------------- ----------------
Total ........................ $ 2,455 $ 2,506
================= ================
Payables to related parties:
Avalon ....................... $ 491 $ 1,797
Vivendi ...................... 2,859 5,322
Titus ........................ - 321
----------------- ----------------
Total ........................ $ 3,350 $ 7,440
================= ================
DISTRIBUTION AND PUBLISHING AGREEMENTS
TITUS INTERACTIVE SA
In connection with the equity investments by Titus, the Company performs
distribution services on behalf of Titus for fees. In connection with such
distribution services, the Company recognized fee income of zero and $12,000 for
the three months ended September 30, 2003 and 2002 and $5,000 and $31,000 for
the nine months ended September 30, 2003 and 2002, respectively.
Amounts due to Titus at December 31, 2002 consisted primarily of trade
payables.
In March 2003, the Company entered into a note receivable with Titus
Software Corp. ("TSC"), a subsidiary of Titus, for $226,000. The note earns
interest at 8 percent per annum and is due in February 2004. In May 2003, the
Company's board of directors rescinded the note receivable and demanded
repayment of the $226,000 from TSC. The balance on the note receivable, with
accrued interest, at September 30, 2003 was $227,000.
In April 2003, the Company paid Europlay I, LLC ("Europlay"), a financial
advisor originally retained by Titus, and subsequently retained by the Company,
$448,000 in connection with services provided by Europlay to the Company.
In May 2003, the Company's Chief Executive Officer instructed the Company
to pay TSC $60,000 to cover legal fees in connection with a lawsuit against
Titus. As a result of the payment, the CEO requested that the Company credit the
$60,000 to amounts owed to him by the Company arising from expenses incurred in
connection with providing services to the Company. The Company's management is
in the process of investigating the details of the transaction, including
independent counsel review as appropriate, in order to properly record the
transaction.
TRANSACTIONS WITH TITUS JAPAN K.K.
In June 2003, the Company entered into 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 regards to
certain sales transactions in Japan. This representation agreement has not been
approved by our Board and is currently being reviewed by the Board. As of
September 30, 2003, the Company has received approximately $50,000 in income and
incurred approximately $10,000 in commission fees pursuant to this agreement.
12
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
AVALON INTERACTIVE GROUP LTD.
Under an International Distribution Agreement, Avalon provides for the
exclusive distribution of substantially all of the Company's products in Europe,
the Commonwealth of Independent States, Africa and the Middle East for a
seven-year period ending in February 2006, cancelable under certain conditions,
subject to termination penalties and costs. Under the Agreement, the Company
pays Avalon a distribution fee based on net sales, and Avalon provides certain
market preparation, warehousing, sales and fulfillment services on behalf of the
Company. In connection with the International Distribution Agreement, the
Company subleased office space from Avalon through March 2003. In September
2003, the Company amended this International Distribution Agreement to provide
Avalon with exclusive Australian distribution rights to a product.
In connection with the International Distribution Agreement, the Company
incurred distribution commission expense of $412,000 and $200,000 for the three
months ended September 30, 2003 and 2002, and $475,000 and $500,000 for the nine
months ended September 30, 2003 and 2002, respectively. In addition, the Company
recognized overhead fees of zero dollars and $500,000 for the nine months ended
September 30, 2003 and 2002, respectively.
Under a Product Publishing Agreement with Avalon, as amended, the Company
has an exclusive license to publish and distribute one future product release
within North America, Latin America and South America for a royalty based on net
sales. The Company does not anticipate releasing the title and does not
anticipate any further transactions under this agreement. In connection with the
Product Publishing Agreement with Avalon, the Company earned zero dollars and
$8,000 in connection with performing publishing and distribution services on
behalf of Avalon for the three months ended September 30, 2003 and 2002 and for
the nine months ended September 30, 2003 and 2002, the Company earned zero
dollars and $47,000, respectively.
In June 1997, the Company entered into a Development and Publishing
Agreement with Confounding Factor, a game developer, in which it agreed to
commission the development of the game "Galleon" in exchange for an exclusive
worldwide license to fully exploit the game and all derivatives including all
publishing and distribution rights. Subsequently, in March 2002, the Company
entered into a Term Sheet with Avalon, pursuant to which Avalon assumed all
responsibility for future milestone payments to Confounding Factor to complete
development of "Galleon" and Avalon acquired exclusive rights to ship the game
in certain territories. Avalon paid an initial $511,000 to Confounding Factor,
but then ceased making the required payments. While reserving its rights
vis-a-vis Avalon, the Company then resumed making payments to Confounding Factor
to protect its interests in "Galleon," and since that time has been providing
production assistance to the developer in order to finalize the Xbox version of
the game, which the Company expects to release in its fourth quarter. As of
March 2003, the Company met all of the remaining financial obligations to
Confounding Factor. The Company is currently negotiating a settlement with
Avalon regarding the publishing rights to "Galleon".
In January 2003, the Company entered into a waiver with Avalon related to
the distribution of a video game title in which it sold its European
distribution rights to Vivendi. In consideration for Avalon relinquishing its
rights, the Company paid Avalon $650,000 and will pay Avalon 50 percent of all
proceeds in excess of the advance received from Vivendi. As of September 30,
2003, Vivendi has not reported sales exceeding the minimum guarantee.
In February 2003, Avalon Interactive UK Ltd. (formerly named Virgin
Interactive Entertainment (Europe) Limited) ) ("Avalon Europe"), the operating
subsidiary of Avalon, filed for a Company Voluntary Arrangement, or CVA, a
process of reorganization in the United Kingdom. We are not creditors of Avalon
Europe. In May 2003, Avalon filed its own CVA 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 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 and of the approval of the CVA of
its operating subsidiary, Avalon Europe, on our ability to collect amounts due
from Avalon are uncertain (see note 7). As a result, we cannot guarantee our
ability to collect the debts we believe are due and owed to us from Avalon. If
Avalon is not able to operate under the new CVA, the Company expects Avalon to
cease operations and liquidate, in which event we will most likely not receive
any amounts presently due us by Avalon, and will not have a distributor for our
products in Europe and the other territories in which Avalon presently
distributes our products.
13
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 2003
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 license rights and to avoid potential third-party liability from various
licensors of its products. In connection with the settlement, the Company
incurred legal fees of $80,000. Consequently, Avalon owes the Company $400,000
pursuant to the indemnification provisions of the International Distribution
Agreement, which is included in trade receivables from related parties and which
the Company has fully reserved for.
In August 2003 the Company completed an agreement with Avalon which
modified the terms of the parties' distribution agreement relating to an
upcoming title. Under the terms of this agreement, the Company was paid a cash
advance of approximately $740,000. Upon delivery of the gold master to this
title the Company will receive approximately an additional $740,000.
VIVENDI UNIVERSAL GAMES, INC.
In February 2003, the Company sold to Vivendi Universal Games, Inc.
("Vivendi") all future interactive entertainment publishing rights to the
"Hunter: The Reckoning" franchise for $15 million, payable in installments,
which were fully paid at June 30, 2003. The Company retains the rights to the
previously published "Hunter: The Reckoning" titles on Microsoft Xbox and
Nintendo GameCube.
In connection with distribution agreements with Vivendi, the Company
incurred distribution commission expense of $1.8 million and $0.7 million for
the three months ended September 30, 2003 and 2002, and $5.8 million and $3.3
million for the nine months ended September 30, 2003 and 2002, respectively.
In September 2003, the Company decided to terminate the distribution
agreement with Vivendi as a result of its alleged breaches, including for the
non-payment of money owed to the Company under the terms of this distribution
agreement. In October 2003, the Company and Vivendi reached a settlement as to
their dispute under this distribution agreement, whereby Vivendi will distribute
the Company's Fallout: Brotherhood of Steel in North America and Asia-Pacific
(excluding Japan), and Vivendi will retain exclusive distribution rights in
these regions for all future Company titles through August 2005.
NOTE 8. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------- --------------------------------------------------
2003 2002 2003 2002
----------------------- ----------------------- ----------------------- ------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ---------- ---------- ---------- ----------- ---------- ------------ ----------
(Dollars in thousands)
North America $ 1,808 38% $ 7,985 82% $ 4,702 19% $ 20,845 56%
Europe 2,333 50 978 10 4,043 16 3,915 11
Rest of World 485 10 175 2 641 3 308 1
OEM, royalty and
licensing 101 2 539 6 15,372 62 11,973 32
----------- ---------- ---------- ---------- ----------- ---------- ------------ ----------
$ 4,727 100% $ 9,677 100% $ 24,758 100% $ 37,041 100%
=========== ========== ========== ========== =========== ========== ============ ==========
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
The information contained in this Form 10-Q is intended to update the
information contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 2002, previously filed with the U.S. Securities and Exchange
Commission, and presumes that readers have access to, and will have read, the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other information contained in such Form 10-K.
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934 and such forward-looking statements are
subject to the safe harbors created thereby. For this purpose, any statements
contained in this Form 10-Q, except for historical information, may be deemed to
be forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "should," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
financing activities, sales or mergers and cost reduction measures are
forward-looking statements and there can be no assurance that the Company will
achieve its operating plans or generate positive cash flow in the future,
arrange adequate financing or complete strategic transactions on satisfactory
terms, if at all, or that any cost reductions effected by the Company will be
sufficient to offset any negative cash flow from operations.
Additional risks and uncertainties include possible delays in the
completion of products, the possible lack of consumer appeal and acceptance of
products released by the Company, fluctuations in demand for the Company's
products, lost sales because of the rescheduling of products launched or orders
delivered, failure of the Company's markets to continue to grow, that the
Company's products will remain accepted within their respective markets, that
competitive conditions within the Company's markets will not change materially
or adversely, that the Company will retain key development and management
personnel, that the Company's forecasts will accurately anticipate market demand
and that there will be no material adverse change in the Company's operations or
business. Additional factors that may affect future operating results are
discussed in more detail in "Factors Affecting Future Performance" in the
Company's Annual Report on Form 10-K on file with the U.S. Securities and
Exchange Commission. Assumptions relating to the foregoing involve judgments
with respect to, among other things, future economic, competitive and market
conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, the business and operations of the
Company are subject to substantial risks that increase the uncertainty inherent
in the forward-looking statements, and the inclusion of such information should
not be regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved. In addition, risks,
uncertainties and assumptions change as events or circumstances change. The
Company disclaims any obligation to publicly release the results of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances occurring subsequent to the filing of this Form 10-Q
with the SEC or otherwise to revise or update any oral or written
forward-looking statement that may be made from time to time by or on behalf of
the Company.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these condensed consolidated
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to revenue recognition, prepaid
licenses and royalties and software development costs. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under
15
different assumptions or conditions. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
preparation of our consolidated financial statements.
REVENUE RECOGNITION
We record revenues when we deliver products to customers in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." and SEC
Staff Accounting Bulletin No. 101, Revenue Recognition. Commencing in August
2001, substantially all of our sales are made by two related party distributors:
Vivendi Universal Games, Inc. ("Vivendi") and Avalon Interactive Group Ltd.
("Avalon"), formerly named Virgin Interactive Entertainment Ltd. We recognize
revenue from sales by distributors, net of sales commissions, only as the
distributor recognizes sales of our products to unaffiliated third parties. For
those agreements that provide the customers the right to multiple copies of a
product in exchange for guaranteed amounts, we recognize revenue at the delivery
and acceptance of the product master. We recognize per copy royalties on sales
that exceed the guarantee as copies are duplicated.
We generally are not contractually obligated to accept returns, except for
defective, shelf-worn and damaged products. However, on a case-by-case
negotiated basis, we permit customers to return or exchange 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 condensed consolidated
financial statements.
We provide customer support only via email and the Internet. Customer
support costs are not significant and we charge such costs to expenses as we
incur them.
We also engage in the sale of licensing rights on certain products. The
terms of the licensing rights differ, but normally include the right to develop
and distribute a product on a specific video game platform. Revenue is
recognized when the rights have been transferred and no other obligations exist.
The Emerging Issues Task Force ("EITF") issued EITF 01-09 in November 2001.
The pronouncement codifies and reconciles the consensus reached on EITF 00-14,
00-22 and 00-25, which addresses the recognition, measurement and profit and
loss account classification of certain selling expenses. The adoption of this
issue has resulted in the reclassification of certain selling expenses including
sales incentives, slotting fees, buydowns and distributor payments from cost of
sales and administrative expenses to a reduction in sales. 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 to net income for any period.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under developer arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables. Royalty advances are recoupable against future
sales based upon the contractual royalty rate. We amortize the cost of licenses,
prepaid royalties and other outside production costs to cost of goods sold over
six months commencing with the initial shipment in each region of the related
title. We amortize these amounts at a rate based upon the actual number of units
shipped with a minimum amortization of 75 percent in the first month of release
and a minimum of 5 percent for each of the next five months after release. This
minimum amortization rate reflects our typical product life cycle. We evaluate
the future realization of such costs quarterly and charge to cost of goods sold
any amounts that we deem unlikely to be fully realized through future sales.
Such costs are classified as current and noncurrent assets based upon the
estimated product release date.
16
SOFTWARE DEVELOPMENT COSTS
Our internal research and development costs, which consist primarily of
software development costs, are expensed as incurred. Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed," provides for the
capitalization of certain software development costs incurred after
technological feasibility of the software is established or for development
costs that have alternative future uses. Under our current practice of
developing new products, the technological feasibility of the underlying
software is not established until substantially all of the product development
is complete. As a result, we have not capitalized any software development costs
on internal development projects, as the eligible costs were determined to be
insignificant.
OTHER SIGNIFICANT ACCOUNTING POLICIES
Other significant accounting policies not involving the same level of
measurement uncertainties as those discussed above are nevertheless important to
an understanding of the financial statements. The policies related to
consolidation, channel exposure and loss contingencies require difficult
judgments on complex matters that are often subject to multiple sources of
authoritative guidance. Certain of these matters are among topics currently
under reexamination by accounting standards setters and regulators. Although no
specific conclusions reached by these standard setters appear likely to cause a
material change in our accounting policies, outcomes cannot be predicted with
confidence.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements discussed in the notes to the December 31,
2002 audited financial statements, filed previously with the U.S. Securities and
Exchange Commission in Form 10-K, that were required to be adopted during the
period ending September 30, 2003 did not have a significant impact on our
condensed consolidated financial statements.
17
RESULTS OF OPERATIONS
The following table sets forth certain selected consolidated statements of
operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------- ---------------------------------------------
2003 2002 2003 2002
-------------------- -------------------- -------------------- --------------------
% OF NET % OF NET % OF NET % OF NET
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Net revenues .................. $ 4,727 100% $ 9,677 100% $ 24,758 100% $ 37,041 100%
Cost of goods sold ............ 1,849 39% 5,675 59% 9,948 40% 20,754 56%
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit .................. 2,878 61% 4,002 41% 14,810 60% 16,287 44%
-------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Marketing and sales ...... 496 11% 965 10% 962 4% 5,328 14%
General and administrative 928 20% 1,010 10% 4,587 19% 5,816 16%
Product development ...... 3,555 75% 3,460 36% 11,124 45% 12,161 33%
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses . 4,979 106% 5,435 56% 16,673 67% 23,305 63%
-------- -------- -------- -------- -------- -------- -------- --------
Operating income .............. (2,101) (45%) (1,433) (15%) (1,863) (7%) (7,018) (19%)
Gain on sale of Shiny ......... -- 0% -- 0% -- 0% 28,781 78%
Other expense ................. (88) (2%) (414) (4%) (126) (1%) (1,323) (4%)
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before income
taxes ...................... (2,189) (46%) (1,847) (19%) (1,989) (8%) 20,440 55%
Benefit for income taxes ...... -- 0% -- (0%) -- 0% (75) 0%
-------- -------- -------- -------- -------- -------- -------- --------
Net income .................... $ (2,189) (47%) $ (1,847) (19%) $ (1,989) (8%) $ 20,515 55%
======== ======== ======== ======== ======== ======== ======== ========
Net revenues by geographic
region:
North America ............ $ 1,808 38% $ 7,985 82% $ 4,702 19% $ 20,845 56%
International ............ 2,818 60% 1,153 12% 4,684 19% 4,223 12%
OEM, royalty and licensing 101 2% 539 6% 15,372 62% 11,973 32%
Net revenues by platform:
Personal computer ........ $ 3,009 64% $ 4,548 47% $ 4,633 19% $ 11,939 32%
Video game console ....... 1,617 34% 4,590 47% 4,753 19% 13,129 36%
OEM, royalty and licensing 101 2% 539 6% 15,372 62% 11,973 32%
NORTH AMERICAN, INTERNATIONAL AND ORIGINAL EQUIPMENT MANUFACTURER ("OEM"),
ROYALTY AND LICENSING NET REVENUES
Net revenues for the three months ended September 30, 2003 were $4.7
million, a decrease of 51% compared to the same period in 2002. This decrease
resulted from a 77% decrease in North American net revenues, an 81% decrease in
OEM, royalties and licensing revenues, offset by a 144% increase in
international net revenues.
North American net revenues for the three months ended September 30, 2003
were $1.8 million. The decrease in North American net revenues in the three
months ended September 30, 2003 was mainly due to a 65% decrease in back catalog
sales compared to the 2002 comparable period as a result of concluding sales
activity under the August 2001 distribution agreement with Vivendi and an 89%
decrease in new release gold master revenue. Furthermore, we delivered one gold
master in the three months ended September 30, 2003 compared to delivering three
gold masters in the same period in 2002, resulting in a decrease in North
American sales of $8.0 million and a decrease in product returns and price
concessions of $1.8 million as compared to the 2002 comparable period. In
addition, the decrease in back catalog sales is due to having fewer titles to
replace titles that have exhausted their useful commercial lives and we have
lost the rights to certain titles that were a part of our back catalog and have
not obtained new titles to replaces those titles. The decrease in product
returns and price concessions in the three months ended September 30, 2003 as
compared to the 2002 comparable period is due to decreased back catalog sales
under the terms of the August 2001 distribution agreement with Vivendi, whereby
the Company assumes all credit, product return and price concession risks, as
opposed to the August 2002 distribution agreement with Vivendi, whereby Vivendi
pays us a lower per unit rate and in return assumes all credit, product return
and price concession risks.
18
International net revenues for the three months ended September 30, 2003
were $2.8 million. The increase in international net revenues for the three
months ended September 30, 2003 was mainly due to a 110% increase in new release
sales due to releasing three new titles, two of which were previously released
in North America in the 2003 period as compared to one in the 2002 period,
offset by a decrease of 6% in back catalog sales. Our increase in sales is a
result of the acceptance of Avalon's Company Voluntary Arrangement, or CVA,
which gave Avalon new resources for them to dedicate to the sale of our
products. Overall, in the three months ended September 30, 2003, we had a $1.2
million increase in revenue and a decrease in product returns and price
concessions of $0.5 million compared to the comparable 2002 period.
OEM, royalty and licensing net revenues for the three months ended
September 30, 2003 were $0.1 million, a decrease of $0.4 million as compared to
the same period in 2002. OEM net revenues decreased by $0.4 million in the three
months ended September 30, 2003 as compared to the 2002 comparable period and
licensing net revenues remained constant as compared to the 2002 comparable
period. The decrease in OEM net revenues is a result of our efforts to focus on
our core business of developing and publishing video game titles for
distribution directly to the end users and our continued focus on video game
console titles, which typically are not bundled with other products.
Net revenues for the nine months ended September 30, 2003 were $24.8
million, a decrease of 33% compared to the same period in 2002. This decrease
resulted from a 77% decrease in North American net revenues, offset by a 11%
increase in international net revenues and a 29% increase in OEM, royalties and
licensing revenues.
North American net revenues for the nine months ended September 30, 2003
were $4.7 million. The decrease in North American net revenues in the nine
months ended September 30, 2003 was mainly due to a 79% decrease in back catalog
sales compared to the comparable 2002 period as a result of concluding sales
activity under the August 2001 distribution agreement with Vivendi and an 85%
decrease in new release gold master revenue. During the nine months ended
September 30, 2003 we delivered two gold masters compared to delivering four
gold masters in the comparable 2002 period, resulting in a decrease in North
American sales of $20.8 million and a decrease in product returns and price
concessions of $4.7 million in the nine months ended September 30, 2003, as
compared to the 2002 comparable period. Furthermore, our back catalog sales
decrease is due to having fewer titles to replace titles that have exhausted
their useful commercial lives and we have lost the rights to certain titles that
were a part of our back catalog and have not obtained new titles to replaces
those titles. The decrease in product returns and price concessions in the nine
months ended September 30, 2003 as compared to the 2002 comparable period is due
to decreased back catalog sales under the terms of the August 2001 distribution
agreement with Vivendi, whereby the Company assumes all credit, product return
and price concession risks, as opposed to the August 2002 distribution agreement
with Vivendi, whereby Vivendi pays us a lower per unit rate and in return
assumes all credit, product return and price concession risks.
We expect that our North American publishing net revenues will decrease in
fiscal 2003 compared to fiscal 2002, mainly due to decreased unit sales and our
release of all new titles under the terms of the August 2002 distribution
agreement with Vivendi.
International net revenues for the nine months ended September 30, 2003
were $4.7 million. The increase in international net revenues for the nine
months ended September 30, 2003 was mainly due to releasing three gold masters
to three titles, which were previously released in North America to Vivendi
under a one-time distribution agreement for the three titles in Europe with
terms similar to the distribution arrangement in North America. The Company also
released three new titles, two of which were previously released in North
America, through Avalon. Avalon remains our main distributor in Europe and will
distribute our future releases in Europe under the terms of our International
Distribution Agreement, as amended. In addition, the increase in international
net revenues was impacted by a 235% increase in new release sales mainly due to
releasing six new titles in the 2003 period as compared to one in the 2002
period. Additionally, our increase in sales is a result of the acceptance of
Avalon's Company Voluntary Arrangement, or CVA, which gave Avalon new resources
for them to dedicate to the sale of our products. Overall, in the nine months
ended September 30, 2003, we had a $0.7 million decrease in revenue and a
decrease in product returns and price concessions of $1.2 million compared to
the comparable 2002 period.
We expect that our international publishing net revenues will increase in
fiscal 2003 as compared to fiscal 2002, mainly due to increased unit sales.
However, if Avalon is not able to operate under the new CVA, we may need to
obtain a new European distributor in a short amount of time. If we are not able
to engage a new distributor, it could have a material negative impact on our
European sales.
19
OEM, royalty and licensing net revenues for the nine months ended September
30, 2003 were $15.4 million, an increase of $3.4 million as compared to the same
period in 2002. OEM net revenues decreased by $2.8 million in the nine months
ended September 30, 2003 as compared to the 2002 comparable period and licensing
net revenues increased by $6.2 million as compared to the 2002 period. The
decrease in OEM net revenues is a result of our efforts to focus on our core
business of developing and publishing video game titles for distribution
directly to end users and our continued focus on video game console titles,
which typically are not bundled with other products. The nine months ended
September 30, 2003 included revenue related to the sale of all future
interactive entertainment publishing rights to the "Hunter: The Reckoning"
franchise for $15 million. We retain the rights to the previously published
"Hunter: The Reckoning" titles on Microsoft Xbox and Nintendo GameCube. Our 2002
licensing net revenues included revenues related to the sale of publishing
rights for one of our products and the recognition of deferred revenue for a
licensing transaction. In January 2002, we sold the publishing rights to this
title to the distributor in connection with a settlement agreement entered into
with a third party developer. The settlement agreement provided, among other
things, that we assign our rights and obligations under the product agreement to
the third party distributor. As a result, we recorded net revenues of $5.6
million in the nine months ended September 30, 2002. In February 2002, a
licensing transaction we entered into in 1999 expired and we recognized revenue
of $1.2 million, the unearned portion of the minimum guarantee.
We expect that OEM, royalty and licensing net revenues in fiscal 2003 will
increase compared to fiscal 2002 as a result of recording the $15 million in
revenue resulting from the sale of the Hunter video game franchise in February
2003.
PLATFORM NET REVENUES
PC net revenues for the three months ended September 30, 2003 were $3.0
million, a decrease of 34% compared to the same period in 2002. The decrease in
PC net revenues in the three months ended September 30, 2003 was primarily due
to decreased net revenues from both back catalog and new releases. Video game
console net revenues were $1.6 million, a decrease of 65% for the three months
ended September 30, 2003 compared to the same period in 2002, due to not
delivering any gold masters for any titles to Vivendi in the 2003 period
compared to delivering two gold masters in 2002 and decreased back catalog
sales.
PC net revenues for the nine months ended September 30, 2003 were $4.6
million, a decrease of 61% compared to the same period in 2002. The decrease in
PC net revenues in the nine months ended September 30, 2003 was primarily due to
decreased net revenues from both back catalog and new releases. Video game
console net revenues were $4.8 million, a decrease of 64% for the nine months
ended September 30, 2003 compared to the same period in 2002, in part because of
the way in which we were responsible for production under our August 2001
distribution agreement with Vivendi. In the nine months ended September 30,
2003, we delivered the gold master for one console title, Run Like Hell (Xbox),
to Vivendi, under the terms of the August 2002 distribution agreement, in which
Vivendi is responsible for all manufacturing, marketing and distribution
expenditures, and bears all credit, price concessions and inventory risk,
including product returns and in return, pays us a lower per unit rate. In the
2002 period, we released one title under the terms of the August 2001 agreement
with Vivendi, whereby we were responsible for all marketing, manufacturing and
bore any price concession risks, in which we receive a higher per unit rate. In
addition, during 2002 we delivered gold masters for two titles under the terms
of the August 2002 distribution agreement, in which Vivendi is responsible for
all manufacturing, marketing and distribution expenditures, and bears all
credit, price concessions and inventory risk, including product returns and in
return, pays us a lower per unit rate.
We expect our PC net revenues to decrease in fiscal 2003 as compared to
fiscal 2002 as we expect to release no new PC titles during the rest of 2003 as
we continue to focus more on console products. We anticipate delivering the gold
masters to the following new console titles: Baldur's Gate: Dark Alliance 2
(Playstation 2 and Xbox) and Fallout: Brotherhood of Steel (PlayStation 2 and
Xbox) during the rest of 2003. We expect our console net revenues to decrease in
fiscal 2003 due to receiving a lower per unit rate on more of our titles as
compared with fiscal 2002 in exchange for not assuming any credit, price
concessions and inventory risk, including product returns.
COST OF GOODS SOLD; GROSS PROFIT MARGIN
Our cost of goods sold decreased 67% to $1.8 million in the three months
ended September 30, 2003 compared to the same period in 2002. The decrease was
due to lower back catalog sales under the August 2001 agreement with Vivendi.
Our gross margin increased to 61% for the 2003 period from 41% in the 2002
period.
20
This was primarily due to lower cost of goods in the 2003 period as the only
cost of goods we incur under the August 2002 distribution agreement with Vivendi
are expenses related to royalties due to third parties. The 2002 period was
negatively impacted by higher amortization of prepaid royalties on externally
developed products.
Our cost of goods sold decreased 52% to $9.9 million in the nine months
ended September 30, 2003 compared to the same period in 2002. The decrease was
due to lower back catalog sales in Europe due to the financial difficulties of
Avalon, lower back catalog sales under the August 2001 agreement with Vivendi
and not incurring any cost of goods expenditures under the August 2002 agreement
with Vivendi offset by $2.9 million in amortization of prepaid royalties
associated with the sale of the Hunter video game franchise. Our gross margin
increased to 60% for the nine months ended September 30, 2003 from 44% in the
2002 comparable period. This was primarily due to the gross profit margin
realized from the $15 million in revenue related to the sale of all future
interactive entertainment publishing rights to the "Hunter: The Reckoning"
franchise and lower cost of goods in the 2003 period as the only cost of goods
we incur under the August 2002 agreement with Vivendi are expenses related to
royalties due to third parties. Both periods were negatively impacted by higher
amortization of prepaid royalties on externally developed products, including
approximately $2.4 million in fiscal 2003 and $2.1 million in fiscal 2002 in
write-offs of canceled development projects or on titles that were not expected
to meet our desired profit requirements.
We expect our gross profit margin and gross profit to increase in fiscal
2003 as compared to fiscal 2002 due to lower cost of goods in fiscal 2003
resulting from our August 2002 distribution agreement with Vivendi, the absence
in fiscal 2003 of significant, unusual product returns and price concessions and
additional write-offs of prepaid royalties, and the sale of all future
interactive entertainment publishing rights to the "Hunter: The Reckoning"
franchise for $15 million.
MARKETING AND SALES
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses for the three months ended September 30, 2003 were $0.5 million, a 49%
decrease as compared to the 2002 comparable period. The decrease in marketing
and sales expenses is due to a $0.8 million decrease in personnel costs and
general expenses due in part to our shift from a direct sales force for North
America to a distribution arrangement with Vivendi offset by a $0.3 million
increase in advertising and retail marketing support expenditures in Europe to
support the increase in sales during the period.
Marketing and sales expenses for the nine months ended September 30, 2003
were $1.0 million, an 82% decrease as compared to the 2002 comparable period.
The decrease in marketing and sales expenses is due to a $2.1 million reduction
in advertising and retail marketing support expenditures and a $2.2 million
decrease in personnel costs and general expenses. The $2.1 million reduction in
advertising and retail marketing support expenditures is due to lower back
catalog and new release net revenues, as well as a $0.5 million decrease in
overhead fees paid to Avalon under our April 2001 settlement with Avalon. The
$2.2 million decrease in personnel costs and general expenses is due in part to
our shift from a direct sales force for North America to the distribution
arrangement with Vivendi.
We expect our marketing and sales expenses to decrease in fiscal 2003
compared to fiscal 2002, due to lower personnel costs from our reduced
headcount, a reduction in overhead fees paid to Avalon pursuant to the April
2001 settlement and the release of titles under the terms of the August 2002
distribution agreement whereby Vivendi pays us a lower per unit rate and in
return assumes all marketing expenditures.
GENERAL AND ADMINISTRATIVE
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
three months ended September 30, 2003 were $0.9 million, a 8% decrease as
compared to the same period in 2002. The decrease is due to a $0.1 million
decrease in personnel costs and general expenses.
General and administrative expenses for the nine months ended September 30,
2003 were $4.6 million, a 21% decrease as compared to the same period in 2002.
The decrease is due to a $1.2 million decrease in personnel costs and general
expenses.
21
We expect our general and administrative expenses to decrease in fiscal
2003 compared to fiscal 2002 due to a decrease in personnel costs and general
expenses.
PRODUCT DEVELOPMENT
Product development expenses for the three months ended September 30, 2003
were $3.6 million, a 3% increase as compared to the same period in 2002. This
increase is due to a $0.1 million increase in personnel costs and general
expenses.
Product development expenses for the nine months ended September 30, 2003
were $11.1 million, a 9% decrease as compared to the same period in 2002. This
decrease is due to a $1.1 million decrease in personnel costs and general
expenses as a result of a reduction in headcount and the sale of Shiny
Entertainment, Inc. in April 2002.
We expect our product development expenses to decrease in fiscal 2003
compared to fiscal 2002 due to a decrease in personnel costs and general
expenses.
LIQUIDITY AND CAPITAL RESOURCES
GENERALLY
We have funded our operations to date primarily through the use of royalty
and distribution fee advances, cash generated by the private sale of securities,
the sale of assets and from results of operations.
As of September 30, 2003, we had a working capital deficit of $18.3
million, and our cash balance was approximately $7,000. We anticipate our
current cash reserves, plus our expected generation of cash from existing
operations, will only be sufficient to fund our anticipated expenditures,
including payroll, into the fourth quarter of fiscal 2003. The Company expects
to receive certain funds in November 2003. However, if such funds are not
received, the Company will not be able to meet its current cash obligations. We
expect that we will need to substantially reduce our working capital needs
and/or raise additional funds. We entered into the August 2002 distribution
agreement with Vivendi, which accelerates cash collections through
non-refundable minimum guarantees. If we are unable to substantially reduce our
working capital needs, are unsuccessful in collecting amounts owed to us, fail
to adequately exploit our game assets, or otherwise do not receive sufficient
financing we may pursue a number of actions, including, but not limited to, (i)
liquidation of any or all of our assets, (ii) sale or merger of the Company
and/or (iii) seek protection from our creditors.
These conditions, combined with our historical operating losses and
deficits in stockholders' equity and working capital, raise substantial doubt
about our ability to continue as a going concern. The accompanying consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets and
liabilities that may result from the outcome of this uncertainty.
Our main source of capital is from the release of new titles. Historically,
we have had some delays in the release of new titles and we anticipate that we
may continue to incur delays in the release of future titles. These delays can
have a negative impact on our liquidity.
To reduce our working capital needs, we have implemented various measures
including a reduction of personnel, a reduction of fixed overhead commitments,
cancellation or suspension of development on future titles, which management
believes do not meet sufficient projected profit margins, and the scaling back
of certain marketing programs associated with the cancelled projects. Management
will continue to pursue various alternatives to improve future operating results
and further expense reductions, some of which may have a long-term adverse
impact on our ability to generate successful future business activities. In
addition, we continue to seek external sources of funding, including but not
limited to, a sale or merger of the Company, a private placement of our capital
stock, the sale of selected assets, the licensing of certain product rights in
selected territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
our long-term strategic objectives. In this regard, we completed the sale of the
Hunter franchise in February 2003, for $15.0 million.
22
In order to improve our cash flow, in August 2002, we entered into a new
distribution arrangement with Vivendi, whereby, Vivendi distributes
substantially all of our products in North America for a period of three years
as a whole and two years with respect to each product giving a potential maximum
term of five years. Under the August 2002 agreement, Vivendi pays us sales
proceeds less amounts for distribution fees, price concessions and returns.
Vivendi is responsible for all manufacturing, marketing and distribution
expenditures, and bears all credit, price concessions and inventory risk,
including product returns. Upon our delivery of a gold master to Vivendi,
Vivendi pays us, as a minimum guarantee, a specified percent of the projected
amount due to us based on projected initial shipment sales, which are
established by Vivendi in accordance with the terms of the agreement. The
remaining amounts are due upon shipment of the titles to Vivendi's customers.
Payments for future sales that exceed the projected initial shipment sales are
paid on a monthly basis. We expect this new arrangement to improve our
short-term liquidity, but should not impact our overall liquidity.
CURRENT DEVELOPMENTS
At September 30, 2003, the Company has an accrual of $180,000 for past due
payroll taxes, including penalties and interest due to the non-payment of the
Company's payroll tax liabilities. The Company expects this matter to be settled
and the related accrual paid by December 2003. As of the filing of this Form
10-Q, the Company has accrued an additional $540,000 of principal, penalties,
and interest related to the non-payment of payroll tax liabilities for the
period October 1, 2003 through October 31, 2003.
In August, 2003 the Company completed an agreement with Avalon which
modified the terms of the parties' distribution agreement relating to an
upcoming title. Under the terms of this agreement, the Company was paid a cash
advance of approximately $740,000. Upon delivery of the gold master to this
title the Company will receive approximately an additional $740,000.
Our primary capital needs have historically been to fund working capital
requirements necessary to fund our net losses, the development and introduction
of products and related technologies and the acquisition or lease of equipment
and other assets used in the product development process. Our operating
activities provided cash of $0.9 million during the nine months ended September
30, 2003, primarily attributable to reductions of inventory and prepaid
royalties and advances received from Vivendi. These cash proceeds from operating
activities were partially offset by decreases in payables to related parties and
accounts payables.
Net cash used by financing activities of $0.7 million for the nine months
ended September 30, 2003, consisted primarily of payments on a secured note
payable to Warner Bros. Entertainment Inc. Cash used in investing activities of
$0.3 million for the nine months ended September 30, 2003 consisted of normal
capital expenditures, primarily for office and computer equipment used in our
operations. We do not currently have any material commitments with respect to
any future capital expenditures.
The following summarizes our contractual obligations under non-cancelable
operating leases and other borrowings at September 30, 2003, and the effect such
obligations are expected to have on our liquidity and cash flow in future
periods.
Less Than 1 - 3 After
Total 1 Year Years 3 Years
------- ---------- ------- --------
(In thousands)
Contractual cash obligations -
Non-cancelable operating
lease obligations ............. $ 4,054 $ 1,496 $ 2,558 $ -
======= ========== ======= ========
ACTIVITIES WITH RELATED PARTIES
Our operations involve significant transactions with Titus, our majority
stockholder, Avalon, a wholly-owned subsidiary of Titus, and Vivendi, an
affiliate of Universal Studios, Inc. ("Universal") which owns less than 5% of
our common stock.
23
As of September 30, 2003, Universal's ownership decreased below 5%. As a
result, Universal will no longer be considered a 5% or more beneficial holder of
the Company's common stock and all future filings will no longer disclose
Universal as such. Consequently, all future filings involving disclosure of
Vivendi will no longer be made on the basis of disclosures of an affiliate of a
5% or more beneficial holder of the Company's common stock.
TRANSACTIONS WITH TITUS
In connection with the equity investments by Titus, we perform distribution
services on behalf of Titus for fees. In connection with such distribution
services, we recognized fee income of $5,000 and $19,000 for the nine months
ended September 30, 2003 and 2002, respectively.
In April 2002, we entered into an agreement with Titus, pursuant to which,
among other things, we sold to Titus all right, title and interest in the games
"EarthWorm Jim", "Messiah", "Wild 9", "R/C Stunt Copter", "Sacrifice", "MDK",
"MDK II", and "Kingpin", and Titus licensed from us the right to develop,
publish, manufacture and distribute the games "Hunter I", "Hunter II", "Icewind
Dale I", "Icewind Dale II", and "BG: Dark Alliance II" solely on Nintendo
Advance GameBoy game system for the life of the games. As consideration for
these rights, Titus issued to us a promissory note in the principal amount of
$3.5 million, which note bears interest at 6 percent per annum. The promissory
note was due on August 31, 2002, and was to be paid, at Titus' option, in cash
or in shares of Titus common stock with a per share value equal to 90% of the
average trading price of Titus' common stock over the 5 days immediately
preceding the payment date. Pursuant to an April 26, 2002 agreement with Titus,
on or before July 25, 2002, we had the right to solicit offers from and
negotiate with third parties to sell certain rights and licenses. The Company's
efforts to enter into a binding agreement with a third party were unsuccessful.
Moreover, we provided Titus with a guarantee under this agreement, which
provides that in the event Titus did not achieve gross sales of at least $3.5
million by June 25, 2003, and the shortfall was not the result of Titus' failure
to use best commercial efforts, we were to pay to Titus the difference between
$3.5 million and the actual gross sales achieved by Titus, not to exceed $2
million. We entered into a rescission agreement in April 2003 with Titus to
repurchase these assets for a purchase price payable by canceling the $3.5
million promissory note, and any unpaid accrued interest thereon. Concurrently,
we terminated any executory obligations remaining, including, without
limitation, our obligation to pay Titus up to the $2 million guarantee.
In March 2003, we entered into a note receivable with Titus Software Corp.
("TSC"), a subsidiary of Titus, for $226,000. The note earns interest at 8% per
annum and is due in February 2004. In May 2003, our board of directors rescinded
the note receivable and demanded repayment of the $226,000 from TSC. The balance
on the note receivable, with accrued interest, at September 30, 2003 was
$232,000.
In April 2003, we paid Europlay I, LLC ("Europlay"), a financial advisor
originally retained by Titus, and subsequently retained by us, $448,000 in
connection with prior services provided by Europlay to us.
In May 2003, our Chief Executive Officer instructed us to pay TSC $60,000
to cover legal fees in connection with a lawsuit against Titus. As a result of
the payment, our CEO requested that we credit the $60,000 to amounts owed to him
by the Company arising from expenses incurred in connection with providing
services to us. Our management is in the process of investigating the details of
the transaction, including independent counsel review as appropriate, in order
to properly record the transaction.
TRANSACTIONS WITH EDGE LLC
In September 2003, our Board of Directors ratified and approved the
Company's engagement of Edge LLC to provide recommendations regarding the
operation of our legal department and strategies as well as interim executive
functions. As of September 30, 2003, the Company has incurred an aggregate
expense of approximately $38,400 to Edge LLC. Mr. Vulpillat, a director of the
Company, is the owner and consultant for Edge LLC.
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
Under an International Distribution Agreement with Avalon, 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
September 2003, we amended this International Distribution Agreement to provide
Avalon with exclusive Australian rights to a product.
24
Under a Product Publishing Agreement with Avalon, as amended, we have an
exclusive license to publish and distribute one future product release within
North America, Latin America and South America for a royalty based on net sales.
We do not anticipate releasing the title and do not anticipate having any
further transactions under this agreement.
In June 1997, we entered into a Development and Publishing Agreement with
Confounding Factor, a game developer, in which we agreed to commission the
development of the game "Galleon" in exchange for an exclusive worldwide license
to fully exploit the game and all derivates including all publishing and
distribution rights. Subsequently, in March 2002, we entered into a Term Sheet
with Avalon, pursuant to which Avalon assumed all responsibility for future
milestone payments to Confounding Factor to complete development of "Galleon"
and Avalon acquired exclusive rights to ship the game in certain territories.
Avalon paid an initial $511,000 to Confounding Factor, but then ceased making
the required payments. While reserving our rights vis-a-vis Avalon, we then
resumed making payments to Confounding Factor to protect our interests in
"Galleon," and since that time have been providing production assistance to the
developer in order to finalize the Xbox version of the game, which we expect to
release in our fourth quarter. As of March 2003, we met all of the remaining
financial obligations to Confounding Factor. We are currently negotiating a
settlement with Avalon regarding the publishing rights to "Galleon".
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 $650,000 and will pay Avalon 50% of all proceeds in excess of the advance
received from Vivendi. As of September 30, 2003, Vivendi has not reported sales
exceeding the minimum guarantee.
In February 2003, Avalon Interactive (UK) Ltd. (formerly named Virgin
Interactive Entertainment (Europe) Limited ("Avalon Europe"), the operating
subsidiary of Avalon, filed for a Company Voluntary Arrangement, or CVA, a
process of reorganization in the United Kingdom. We are not creditors of Avalon
Europe. In May 2003, Avalon filed its own CVA in the United Kingdom in which we
participated in and approved as a creditor of Avalon. As part of the Avalon CVA
process, we submitted our creditor's claim. 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 and of the approval of the CVA of its
operating subsidiary, Avalon Europe, on our ability to collect amounts due from
Avalon is uncertain. As a result, we cannot guarantee our ability to collect the
debts we believe are due and owing to us from Avalon. If Avalon is not able to
operate under the new CVA, the Company expects Avalon to cease operations and
liquidate, in which event we will most likely not receive any amounts presently
due us by Avalon, and will not have a distributor for our products 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, which we have fully reserved for.
In August 2003 the Company completed an agreement with Avalon which
modified the terms of the parties' distribution agreement relating to an
upcoming title. Under the terms of this agreement, the Company was paid a cash
advance of approximately $740,000. Upon delivery of the gold master to this
title the Company will receive approximately an additional $740,000. We expect
to deliver the gold master by the end of fiscal 2003.
TRANSACTIONS WITH VIVENDI
In February 2003, we sold to Vivendi, all future interactive entertainment
publishing rights to the "Hunter: The Reckoning" franchise for $15.0 million,
payable in installments. We retain the rights to the previously published
"Hunter: The Reckoning" titles on Microsoft Xbox and Nintendo GameCube.
In September 2003, the Company decided to terminate the distribution
agreement with Vivendi as a result of its alleged breaches, including for the
non-payment of money owed to the Company under the terms of this distribution
agreement. In October 2003, the Company and Vivendi reached a settlement as to
their dispute under this distribution agreement, whereby Vivendi will distribute
the Company's Fallout: Brotherhood of Steel in North
25
America and Asia-Pacific (excluding Japan), and Vivendi will retain exclusive
distribution rights in these regions for all future Company titles through
August 2005.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of September 30,
2003. 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 risk associated with foreign currency
fluctuations.
INTEREST RATE RISK
Our interest rate risk is due to our working capital lines of credit
typically having an interest rate based on either the bank's prime rate or
LIBOR. Currently, we do not have a line of credit, but we anticipate
establishing a line of credit in the future. A change in interest rates would
not have an effect on our interest expense on the Secured Convertible Promissory
Note issued to Warner Bros. Entertainment Inc. because this instrument bears a
fixed rate of interest.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiarys functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, primarily from Avalon. We
recognized gains of $62,000 and $82,000 during the nine months ended September
30, 2003 and 2002, 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 September 30, 2003, the end of the period covered by this report, our
Chief Executive Officer and interim Chief Financial Officer, Herve Caen, with
the participation of our management, carried out an evaluation of the
effectiveness of our disclosure controls and procedures pursuant to Exchange Act
Rule 13a-145 and 15d-15. Based upon that evaluation, Mr. Caen believes that, as
of the date of the evaluation, our disclosure controls and procedures are
effective in causing material information to be recorded, processed, summarized
and reported by our management on a timely basis and to ensure that the quality
and timeliness of the Company's public disclosures complies with its U.S.
Securities and Exchange Commission disclosure obligation.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
As of September 30, 2003, there were no significant changes in our internal
controls or in other factors that could significantly affect internal controls,
known to Mr. Caen.
26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in various legal proceedings, claims and litigation arising
in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the opinion
of management, the outcome of known routine claims will not have a material
adverse effect on our business, financial condition or results of operations.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against both Infogrames, Inc. and our subsidiary
GamesOnline.com, Inc., alleging, among other things, breach of contract,
misappropriation of trade secrets, breach of fiduciary duties and breach of
implied covenant of good faith in connection with an electronic distribution
agreement dated November 2001 between KBK and GamesOnline.com, Inc. KBK has
alleged that GamesOnline.com, Inc. failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Infogrames. In August 2003, KBK amended its complaint to include us as a
defendant. We believe this complaint is without merit and continue to vigorously
defend our position.
In August 2003, the Company sent several notifications to Vivendi accusing
Vivendi of its failure to perform in accordance with the distribution agreement
but did not receive a response acceptable to the Company. In September 2003, the
Company decided to terminate the distribution agreement with Vivendi as a result
of its alleged breaches, including for the non-payment of money owed to the
Company under the terms of this distribution agreement. In September 2003,
Vivendi filed a complaint against the Company seeking, among other relief, a
determination of the parties' rights and obligations under this distribution
agreement. In October 2003, the Company and Vivendi reached a settlement as to
their dispute under this distribution agreement.
On September 19, 2003, the Company filed a complaint against Atari, Inc. in
the Supreme Court of the State of New York. The complaint alleges that Atari,
Inc. wrongfully claims a termination of a multi-year license agreement between
the parties and seeks an injunction and declaratory relief preventing Atari,
Inc. from terminating this license agreement pending a determination on the
merits. In September 2003, the Company successfully obtained a preliminary
injunction in the Supreme Court of the State of New York preventing Atari, Inc.
from terminating this multi-year license agreement until such time as a decision
on the merits has been rendered. As of September 30, 2003, the parties remain in
litigation. The Company believes Atari, Inc.'s attempt to terminate the license
agreement is without merit and intends to vigorously prosecute its position.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. filed suit
against the Company in the Superior Court for the State of California, County of
Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2,000,000. At the time the suit was filed, the current remaining
principal sum due under the note was $1,333,333.34, plus interest. The Company
settled this litigation and entered into a payment plan with Warner Bros. to
satisfy the balance of the note by January 30, 2004.
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") filed a
motion for summary judgment in lieu of complaint against the Company in the
amount of $1.3 million, alleging among other things, that the Company is liable
to pay Special Situations $1.3 million for its failure to timely register for
resale with the SEC certain shares of our common stock that Special Situations
purchased from us in April 2001. The court denied Special Situation's motion for
summary judgment in lieu of complaint. Special Situations subsequently filed and
served the Company with a complaint, which the Company has answered. This case
is currently in the discovery phase. The Company denies these claims and is
vigorously defending its position.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(a) The Company has 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. The Company and Warner Bros. Entertainment
Inc. have since
27
entered into a mutually agreed upon repayment plan to satisfy the balance of the
note by January 30, 2004. As of the date of this report, the Company owes
principal and interest of $1,262,725.93 under this note.
ITEM 5. OTHER INFORMATION
The Company held its 2002 annual stockholder meeting on October 10, 2002.
This year, the annual stockholder meeting of the Company is expected to be held
on December 18, 2003. Any stockholder who intends to present a proposal at the
2004 annual meeting of stockholders for inclusion in our proxy statement and
proxy form relating to such annual meeting must submit such proposal to us at
its principal executive offices by March 31, 2004. In the event a stockholder
proposal is not received by us by March 31, 2004, the proxy to be solicited by
the board of directors for the 2004 annual meeting will confer discretionary
authority on the holders of the proxy to vote the shares if the proposal is
presented at the 2004 annual stockholder meeting without any discussion of the
proposal in the proxy statement for such meeting.
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) of the Securities
and Exchange Act of 1934, as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) of the
Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer and Interim
Chief Financial Officer of Interplay Entertainment Corp. pursuant
to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as
amended.
(b) REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K on August 18,
2003, reporting that the Company issued a press release on August 14,
2003 regarding results of operations for the second quarter of 2003.
The Company filed a Current Report on Form 8-K on September 29,
2003, reporting that the Company issued a press release on September
26, 2003 regarding its termination of a distribution agreement with
Vivendi Universal Games.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: November 14, 2003 By: /S/ HERVE CAEN
---------------------------------------
Herve Caen,
Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
29
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) of the Securities
and Exchange Act of 1934, as amended.
31.2 Certificate of Herve Caen, Interim Chief Financial Officer of
Interplay Entertainment Corp. pursuant to Rule 13a-14(a) of the
Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Herve Caen, Chief Executive Officer and Interim
Chief Financial Officer of Interplay Entertainment Corp. pursuant
to Rule 13a-14(b) of the Securities and Exchange Act of 1934, as
amended.
30