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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
INTERPLAY ENTERTAINMENT CORP.
(Exact name of the registrant as specified in its charter)
DELAWARE 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1682 LANGLEY AVENUE, IRVINE, CALIFORNIA 92606
(Address of principal executive offices)
(310) 432-1958
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
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 [_] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
As of December 31, 2004, the aggregate market value of voting common stock held
by non-affiliates was approximately $270,000 based upon the closing price of the
Common Stock on that date.
As of May 19, 2005, 93,855,634 shares of Common Stock of the Registrant were
issued and outstanding.
INTERPLAY ENTERTAINMENT CORP.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2004
PAGE
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PART I
Item 1. Business 4
Item 2. Properties 9
Item 3. Legal Proceedings 9
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 11
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 7A. Quantitative and Qualitative Disclosure about
Market Risk 37
Item 8. Consolidated Financial Statements and Supplementary
Data 37
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 38
Item 9A Controls and Procedures 38
PART III
Item 10. Directors and Executive Officers of the Registrant 38
Item 11. Executive Compensation 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 44
Item 13. Certain Relationships and Related Transactions 45
Item 14. Principal Accountant Fees and Services 47
PART IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 48
Signatures 49
Exhibit Index 50
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THIS REPORT 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
REPORT EXCEPT FOR HISTORICAL INFORMATION MAY BE DEEMED TO BE FORWARD-LOOKING
STATEMENTS. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, OUR USE OF WORDS
SUCH AS "PLAN," "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND,"
"COULD," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR
COMPARABLE TERMINOLOGY ARE INTENDED TO HELP IDENTIFY FORWARD-LOOKING STATEMENTS.
IN ADDITION, ANY STATEMENTS THAT REFER TO EXPECTATIONS, PROJECTIONS OR OTHER
CHARACTERIZATIONS OF FUTURE EVENTS OR CIRCUMSTANCES ARE FORWARD-LOOKING
STATEMENTS.
THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON CURRENT
EXPECTATIONS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AS WELL AS
CERTAIN ASSUMPTIONS. FOR EXAMPLE, ANY STATEMENTS REGARDING FUTURE CASH FLOW,
CASH CONSTRAINTS, FINANCING ACTIVITIES, COST REDUCTION MEASURES, REPLACEMENT OF
OUR LINE OF CREDIT AND MERGERS, SALES OR ACQUISITIONS ARE FORWARD-LOOKING
STATEMENTS AND THERE CAN BE NO ASSURANCE THAT WE WILL AFFECT ANY OR ALL OF THESE
OBJECTIVES IN THE FUTURE. ADDITIONAL RISKS AND UNCERTAINTIES THAT MAY AFFECT OUR
FUTURE RESULTS ARE DISCUSSED IN MORE DETAIL IN THE SECTION TITLED "RISK FACTORS"
IN "ITEM 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS."
ASSUMPTIONS RELATING TO OUR FORWARD-LOOKING STATEMENTS INVOLVE JUDGMENTS
WITH RESPECT TO, AMONG OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET
CONDITIONS, AND FUTURE BUSINESS DECISIONS, ALL OF WHICH ARE DIFFICULT OR
IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH ARE BEYOND OUR CONTROL.
ALTHOUGH WE BELIEVE THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING
STATEMENTS ARE REASONABLE, OUR INDUSTRY, BUSINESS AND OPERATIONS ARE SUBJECT TO
SUBSTANTIAL RISKS, AND THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED
AS A REPRESENTATION BY MANAGEMENT THAT ANY PARTICULAR OBJECTIVE OR PLANS WILL BE
ACHIEVED. IN ADDITION, RISKS, UNCERTAINTIES AND ASSUMPTIONS CHANGE AS EVENTS OR
CIRCUMSTANCES CHANGE. WE DISCLAIM ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS
OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO
REFLECT EVENTS OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS
REPORT WITH THE SEC OR OTHERWISE TO REVISE OR UPDATE ANY ORAL OR WRITTEN
FORWARD-LOOKING STATEMENT THAT MAY BE MADE FROM TIME TO TIME BY US OR ON OUR
BEHALF.
INTERPLAY(R), INTERPLAY PRODUCTIONS(R), GAMES ON LINE(R) AND CERTAIN OF OUR
OTHER PRODUCT NAMES AND PUBLISHING LABELS REFERRED TO IN THIS REPORT ARE THE
COMPANY'S TRADEMARKS. THIS REPORT ALSO CONTAINS TRADEMARKS BELONGING TO OTHERS.
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PART I
ITEM 1. BUSINESS
OVERVIEW AND RECENT DEVELOPMENTS
Interplay Entertainment Corp., which we refer to in this Report as "we,"
"us," or "our," is a developer, publisher and licensor of interactive
entertainment software for both core gamers and the mass market. We were
incorporated in the State of California in 1982 and were reincorporated in the
State of Delaware in May 1998. We are most widely known for our titles in the
action/arcade, adventure/role playing game (RPG), and strategy/puzzle
categories. We have produced titles for many of the most popular interactive
entertainment software platforms, and currently are focusing our publishing and
distribution business by developing interactive entertainment software for the
On Line Massively Multiplayer market.
We seek to publish or license out interactive entertainment software titles
that are, or have the potential to become, franchise software titles that can be
leveraged across several releases and/or platforms, and have published many such
successful franchise titles to date.
Our business and industry has certain risks and uncertainties. During 2004
we continued to operate under limited cash flow from operations. We expect to
operate under similar cash constraints during 2005. For a fuller discussion of
the risk and uncertainties relating to our financial results, our business and
our industry, please see the section titled "Risk Factors" in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The majority of our sales and distribution is handled by Vivendi Universal
Games, Inc. ("Vivendi") in North America and selected rest-of-world countries
and was handled by Avalon Interactive Group Ltd. ("Avalon") in Europe the
Commonwealth of Independent States, Africa and the Middle East until the
liquidation of Avalon in February of 2005, and through licensing strategies
elsewhere. Subsequently Avalon ceased operations following its involuntary
liquidation in February 2005. We will most likely not receive the amounts
presently due us by Avalon. Following the liquidation of Avalon, we appointed in
March 2005 our wholly owned subsidiary, Interplay Productions Ltd, as our
distributor in Europe and other selected territories.
In June 2004, we licensed to Bethesda Softworks LLC ("Bethesda") the rights
to develop Fallout 3 on all platforms for a non refundable advance against
royalties of $1.175 million. Bethesda also has an option to develop two sequels,
Fallout 4 and Fallout 5 for $1.0 million minimum guaranteed advance against
royalties per sequel. Interplay retained the right to develop massively
multiplayer online games (MMOLG) using the Fallout trademark.
In July 2004, we sold the Redneck Rampage intellectual property rights to
Vivendi for $300,000.
In December 2004, we licensed from Majorem the exclusive worldwide, outside
of Taiwan, publishing and distribution rights to the MMOLG, Ballerium.
In January 2005, our majority shareholder, Titus Interactive SA, who holds
approximately 58 million shares of our common stock, representing approximately
62% of our outstanding common stock, was placed into involuntary liquidation.
PRODUCTS
We publish and distribute interactive entertainment software titles that
provide immersive game experiences by combining advanced technology with
engaging content, vivid graphics and rich sound. We utilize the experience and
judgment of the experienced gamers in our production group to select and produce
the products we publish.
Our strategy is to invest in products for those platforms, whether PC or
video game console, that have or will have sufficient installed bases or a large
enough number of potential subscribers for the investment to be economically
viable. We do not currently internally develop new products. As we anticipate
continued substantial growth in the use of high-speed Internet access, which
could provide significantly expanded market potential for online products, we
are focusing our efforts to launching an online service, entitled GamesOnLine,
allowing consumers to become part of a unique online community of gamers and
access selected content. We currently have one online game in development,
Ballerium.
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INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
We regard our software as proprietary and rely primarily on a combination
of patent, copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks. We hold copyrights on our
products, product literature and advertising and other materials, and hold
trademark rights in our name and certain of our product names and publishing
labels. We have licensed certain products to third parties for distribution in
particular geographic markets or for particular platforms, and receive royalties
on such licenses. We also outsource some of our product development activities
to third party developers. We contractually retain all intellectual property
rights related to such projects. We also license certain products developed by
third parties and pay royalties on such products.
While we provide "shrink wrap" license agreements or limitations on use
with our software, the enforceability of such agreements or limitations is
uncertain. We are aware that unauthorized copying occurs, and if a significantly
greater amount of unauthorized copying of our interactive entertainment software
products were to occur, our operating results could be materially adversely
affected. We use copy protection on selected products and do not provide source
code to third parties unless they have signed nondisclosure agreements.
We rely on existing copyright laws to prevent the unauthorized distribution
of our software. Existing copyright laws afford only limited protection.
Policing unauthorized use of our products is difficult, and we expect software
piracy to be a persistent problem, especially in certain international markets.
Further, the laws of certain countries in which our products are or may be
distributed either do not protect our products and intellectual property rights
to the same extent as the laws of the U.S. or are weakly enforced. Legal
protection of our rights may be ineffective in such countries, and as we
leverage our software products using emerging technologies, such as the Internet
and on-line services, our ability to protect our intellectual property rights,
and to avoid infringing the intellectual property rights of others, becomes more
difficult. In addition, the intellectual property laws are less clear with
respect to such emerging technologies. There can be no assurance that existing
intellectual property laws will provide our products with adequate protection in
connection with such emerging technologies.
As the number of software products in the interactive entertainment
software industry increases and the features and content of these products
further overlap, interactive entertainment software developers may increasingly
become subject to infringement claims. Although we take reasonable efforts to
ensure that our products do not violate the intellectual property rights of
others, there can be no assurance that claims of infringement will not be made.
Any such claims, with or without merit, can be time consuming and expensive to
defend. From time to time, we have received communications from third parties
asserting that features or content of certain of our products may infringe upon
such party's intellectual property rights. In some instances, we may need to
engage in litigation in the ordinary course of our business to defend against
such claims. There can be no assurance that existing or future infringement
claims against us will not result in costly litigation or require that we
license the intellectual property rights of third parties, either of which could
have a material adverse effect on our business, operating results and financial
condition.
PRODUCT DEVELOPMENT
We develop or acquire our products from publishing relationships with
leading independent developers.
THE DEVELOPMENT PROCESS. We develop original products externally, using
third party software developers working under contract with us. Producers on our
internal staff monitor the work of third party development teams through design
review, progress evaluation, milestone review, and quality assurance. In
particular, each milestone submission is thoroughly evaluated by our product
development staff to ensure compliance with the product's design specifications
and our quality standards. We enter into consulting or development agreements
with third party developers, generally on a flat-fee, work-for-hire basis or on
a royalty basis, whereby we pay development fees or royalty advances based on
the achievement of milestones. In royalty arrangements, we ultimately pay
continuation royalties to developers once our advances have been recouped. In
addition, in certain cases, we will utilize third party developers to convert
products for use with new platforms.
Our products typically have short life cycles, and we therefore depend on
the timely introduction of successful new products, including enhancements of or
sequels to existing products and conversions of previously released products to
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additional platforms, to generate revenues to fund operations and to replace
declining revenues from existing products. The development cycle of new products
is difficult to predict, and involves a number of risks.
During the years ended December 31, 2004, 2003, and 2002, we spent $2.6
million, $13.7 million, and $16.2 million, respectively, on product research and
development activities. Those amounts represented 20%, 38%, and 37%
respectively, of net revenues in each of those periods.
INTERNAL PRODUCT DEVELOPMENT
In May 2004, we had to close down our internal development studio as a
result of our inability to meet our payroll obligations on a timely basis. All
internal projects were discontinued at that time and we currently do not have
any product under development internally.
EXTERNAL PRODUCT DEVELOPMENT
To expand our product offerings to include hit titles created by third
party developers and to leverage our publishing capabilities, we enter into
publishing arrangements with third party developers. In the years ended December
31, 2004, 2003, and 2002, approximately 0%, 0%, and 67%, respectively, of new
products we released and which we believe are or will become franchise titles
were developed by third party developers. We expect that the proportion of our
new products which are developed externally may vary significantly from period
to period as different products are released. In selecting external titles to
publish, we seek titles that combine advanced technologies with creative game
design. Our publishing agreements usually provide us with the exclusive right to
distribute, or license another party to distribute, a product on a worldwide
basis (although, in certain instances our rights are limited to a specified
territory). We typically fund external development through the payment of
advances upon the completion of milestones, which advances are credited against
royalties based on sales of the products. Further, our publishing arrangements
typically provide us with ownership of the trademarks relating to the product as
well as exclusive rights to sequels to the product. We manage the production of
external development projects by appointing a producer from our internal
production team to oversee the development process and work with the third party
developer to design, develop and test the game. At December 31, 2004, we had one
title, Ballerium, being developed by a third party developer.
We believe this strategy of cultivating relationships with talented third
party developers can be cost-effective and can provide an excellent source of
quality products. A number of our commercially successful products have been
developed under this strategy. However, our reliance on third party software
developers for the development of a significant number of our interactive
software entertainment products involves a number of risks. Our reliance on
third party software developers subjects us to the risks that these developers
will not supply us with high quality products in a timely manner or on
acceptable terms.
SEGMENT INFORMATION
We operate primarily in one industry segment, the development, publishing
and distribution of interactive entertainment software. For information
regarding the revenues and assets associated with our geographic segments, see
Note 14 of the Notes to our Consolidated Financial Statements included elsewhere
in this Report.
We had during 2004 two distributors as our two main customers: Vivendi and
Avalon. Vivendi and Avalon accounted for 19.8% and 79.6% of our net revenues in
2004. Vivendi have and Avalon had exclusive rights to distribute our product in
substantial parts of the world. Avalon was liquidated in February 2005 and as a
result, we took over distribution of our products in Europe. If Vivendi fails to
deliver the proceeds owed us from distribution or fails to effectively
distribute our products or perform under their distribution agreements, our
business and financial results could suffer material harm.
SALES AND DISTRIBUTION
NORTH AMERICA. In August 2002, we entered into a 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 providing for a potential maximum term of five years. Under this
distribution agreement, Vivendi
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pays us sales proceeds less amounts for distribution fees. 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 product gold master to Vivendi, Vivendi pays us,
as a non-refundable minimum guarantee and which is a specified percent of the
projected amount due to us based on projected initial shipment sales. Payments
for sales that exceed the projected initial shipment sales are paid on a monthly
basis as sales occur. Other than for products covered by the tri-party agreement
with Atari, the Vivendi distribution agreement expires in August 2005.
Vivendi provides terms of sale comparable to competitors in our industry.
In addition, we provide a 90-day limited warranty to end-users that our products
will be free from manufacturing defects. While to date we have not experienced
any material warranty claims, there can be no assurance that we will not
experience material warranty claims in the future.
INTERNATIONAL. We were operating during 2004 under a distribution agreement
with Avalon, pursuant to which Avalon distributed substantially all of our
titles in Europe, the Commonwealth of Independent States, Africa and the Middle
East for a seven-year period. Under this agreement, Avalon earned a distribution
fee for its marketing and distribution of our products, and we reimbursed Avalon
for certain direct costs and expenses.
Following the liquidation of Avalon, in March 2005 we appointed our wholly
owned subsidiary, Interplay Productions Ltd, as our distributor in Europe and
other selected territories.
In January 2003, we entered into an agreement with Vivendi to distribute
substantially all of our products in select rest-of-world countries. This
agreement expires in August 2005.
INTERPLAY OEM. Our wholly owned subsidiary, Interplay OEM, distributes our
interactive entertainment software titles, as well as those of other software
publishers, to computer and peripheral device manufacturers for use in bundling
arrangements. As a result of changes in market conditions for bundling
arrangements and the limited amount of resources we have available, we no longer
have any personnel applying their efforts towards bundling arrangements. In
December 2002, we assigned our original equipment manufacturer, or OEM
distribution rights to Vivendi and will utilize Vivendi's resources in our
future OEM business. Under OEM arrangements, one or more software titles, which
are either limited-feature versions or the retail version of a game, are bundled
with computer or peripheral devices and are sold by an original equipment
manufacturer so that the purchaser of the hardware device obtains the software
as part of the hardware purchase. Although it is customary for OEM customers to
pay a lower per unit price on sales through OEM bundling contracts, such
arrangements involve a high unit volume commitment. Interplay OEM net revenues
generally are incremental net revenues and do not have significant additional
product development or sales and marketing costs. The OEM distribution agreement
with Vivendi expires in August 2005.
MARKETING
We assist our distributors in the development and implementation of
marketing programs and campaigns for each of our titles and product groups. Our
distributors' marketing activities in preparation for a product launch include
print advertising, game reviews in consumer and trade publications, retail
in-store promotions, attendance at trade shows and public relations. Our
distributors also send direct and electronic mail promotional materials to our
database of gamers, and may selectively use radio and television advertisements
in connection with the introduction of certain of our products. Our distributors
budget a portion of each product's sales for cooperative advertising and market
development funds with retailers. Every title and brand is to be launched with a
multi-tiered marketing campaign that is developed on an individual basis to
promote product awareness and customer pre-orders.
Our distributors engage in on-line marketing through Internet advertising.
We maintained several Internet web sites and discontinued all web sites in June
of 2004. These web sites provided news and information of interest to our
customers through free demonstration versions of games, contests, games,
tournaments and promotions. We expect to resume online activities as part of our
upcoming GamesOnLine service. To generate interest in new product introductions,
we will provide demonstration versions of upcoming titles through magazines and
will provide game samples that consumers will be able to download from
GamesOnline.com. In addition, we will host on-line events and maintain various
message boards to keep customers informed on shipped and upcoming titles.
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COMPETITION
The interactive entertainment software industry is intensely competitive
and is characterized by the frequent introduction of new hardware systems and
software products. Our competitors vary in size from small companies to very
large corporations with significantly greater financial, marketing and product
development resources than ours. Due to these greater resources, certain of our
competitors are able to undertake more extensive marketing campaigns, adopt more
aggressive pricing policies, pay higher fees to licensors of desirable motion
picture, television, sports and character properties and pay more to third party
software developers than us. We believe that the principal competitive factors
in the interactive entertainment software industry include product features,
brand name recognition, access to distribution channels, quality, ease of use,
price, marketing support and quality of customer service.
We compete primarily with other publishers of PC and video game console
interactive entertainment software. Significant competitors include Activision,
Atari, Capcom, Eidos, Electronic Arts, Konami, Lucas Arts, Midway, Namco, Sega,
Take-Two Interactive, THQ, Ubi Soft. and Vivendi. In addition, integrated video
game console hardware/software companies such as Sony Computer Entertainment,
Microsoft Corporation, and Nintendo compete directly with us in the development
of software titles for their respective platforms. Large diversified
entertainment companies, such as The Walt Disney Company, and Time Warner Inc.,
many of which own substantial libraries of available content and have
substantially greater financial resources than us, may decide to compete
directly with us or to enter into exclusive relationships with our competitors.
Retailers of our products typically have a limited amount of shelf space
and promotional resources. Consequently, there is intense competition among
consumer software producers, and in particular interactive entertainment
software producers, for high quality retail shelf space and promotional support
from retailers. If the number of consumer software products and computer
platforms increase, competition for shelf space will intensify which may require
us to increase our marketing expenditures. This increased demand for limited
shelf space, places retailers and distributors in an increasingly better
position to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return policies. As our
products constitute a relatively small percentage of any retailer's sales
volume, there can be no assurance that retailers will continue to purchase our
products or provide our products with adequate shelf space and promotional
support. A prolonged failure by retailers to provide shelf space and promotional
support would have a material adverse effect on our business, operating results
and financial condition
SEASONALITY
The interactive entertainment software industry is highly seasonal as a
whole, with the highest levels of consumer demand occurring during the year-end
holiday buying season. As a result, our net revenues, gross profits and
operating income have historically been highest during the second half of the
year. Our business and financial results may therefore be affected by the timing
of our introduction of new releases.
MANUFACTURING
Our PC-based products consist primarily of CD-ROMs and DVDs, manuals, and
packaging materials. Substantially all of our CD-ROM and DVD duplication is
performed by third parties. Printing of manuals and packaging materials,
manufacturing of related materials and assembly of completed packages are
performed to our specifications by third parties. To date, we have not
experienced any material difficulties or delays in the manufacture and assembly
of our CD-ROM and DVD based products, and we have not experienced significant
returns due to manufacturing defects.
Sony Computer Entertainment, Microsoft Corporation and Nintendo manufacture
and ship finished products that are compatible with their video game consoles to
our distributors for distribution. PlayStation 2, Xbox and GameCube products
consist of the game disks and include manuals and packaging and are typically
delivered within a relatively short lead-time.
If we experience unanticipated delays in the delivery of manufactured
software products by our third party manufacturers, our net sales and operating
results could be materially adversely affected.
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BACKLOG
We typically do not carry large inventories because most of our sales and
distribution efforts have been handled by Vivendi and International distributors
under the terms of our respective distribution agreements with them. To the
extent we ship items, we typically ship orders immediately upon receipt. To the
extent we have any backlog orders, we do not believe they would have a material
adverse effect on our business.
EMPLOYEES
As of December 31, 2004, we had 12 employees, including 2 in product
development, 1 in sales and marketing and 9 in finance, general and
administrative. We also retain independent contractors to provide certain
services, primarily in connection with our product development activities.
Neither we nor our full time employees are subject to any collective bargaining
agreements and we believe that our relations with our employees are good.
From time to time, we have retained actors and/or "voice over" talent to
perform in certain of our products, and we may continue this practice in the
future. These performers are typically members of the Screen Actors Guild or
other performers' guilds, which guilds have established collective bargaining
agreements governing their members' participation in interactive media projects.
We may be required to become subject to one or more of these collective
bargaining agreements in order to engage the services of these performers in
connection with future development projects.
ADDITIONAL INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the U.S. Securities and Exchange Commission or SEC. You may
obtain copies of these reports via the Internet at the SEC's homepage located at
www.sec.gov. Our Website is currently unavailable and when available you may
also go to our Internet address located at www.interplay.com and go to "Investor
Relations" which will link you to the SEC's homepage for our filed reports. In
addition, copies of the reports we file with the SEC may also be obtained at the
SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You
may obtain information on the operation of the Public Reference Room by Calling
the SEC at 1-800-SEC-0330.
ITEM 2. PROPERTIES
Our headquarters are located in Irvine, California, where we leased
approximately 81,000 square feet of office space. We were evicted from our
building by our Landlord in early June 2004 and subsequently leased
approximately 500 square feet of office space to relocate our operations. We
also lease on a short term basis approximately 1,200 square feet in Beverly
Hills, California, for GamesOnLine.
ITEM 3. LEGAL PROCEEDINGS
We are occasionally 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. We do not believe the outcome of such routine claims will have a
material adverse effect on the Company's business, financial condition or
results of operations. From time to time, we may also be engaged in legal
proceedings arising outside of the ordinary course of our business.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against Atari Interactive, Inc. (formerly known as
Infogrames Interactive, Inc.) and other Atari Interactive affiliates as well as
our subsidiary GamesOnline.com, Inc., ("GOL") alleging, among other things,
breach of contract, misappropriation of trade secrets, breach of fiduciary
duties and breach of implied covenant of good faith in connection with an
electronic distribution agreement dated November 2001 between KBK and GOL. KBK
has alleged that GOL failed to timely deliver to KBK assets to a product, and
that it improperly disclosed confidential information about KBK to Atari. KBK
amended its complaint to add us as a separate defendant. GOL counterclaimed
against KBK for breach of contract as KBK owes GOL $700,000 in guaranteed
advanced fees under the term of the agreement. In addition, the Company filed an
action against Atari Interactive for breach indemnity, among other claims. In
October 2004, the
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California Superior court dismissed the legal action of KBK against the Company
and its subsidiary GOL and granted a judgment to GOL in the cross complaint from
GOL against KBK for $890,730. GOL dismissed its action against Atari Interactive
in April 2005.
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the company for various claims. The
Company's attorney's have filed and obtained a motion to be relieved as counsel
on August 10, 2004. The company has not yet retained replacement counsel in this
action.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") initiated
legal proceedings against us seeking damages of approximately $1.3 million,
alleging, among other things, that we failed to secure a timely effective date
for a Registration Statement for our shares purchased by Special Situations
under a common stock subscription agreement dated March 29, 2002 and that we are
therefore liable to pay Special Situations $1.3 million. This matter was settled
and the case dismissed in December 2003. Special Situations had entered into a
settlement agreement with us contemplating payments over time. We are currently
in default of the settlement agreement.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against us in the Superior Court for the State of California, County
of Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal including
interest. Subsequently the company entered into a settlement agreement with
Warner. The Company is currently in default of the settlement agreement.
In March 2004, we instituted litigation in the Superior Court for the State
of California, Los Angeles County, against Battleborne Entertainment, Inc.
("Battleborne") Battleborne was developing a console product for us tentatively
titled "Airborne: Liberation". Our complaint alleges that Battleborne repudiated
the contract with us and subsequently renamed the product and entered into a
development agreement with a different publisher. We seek a declaration from the
court that we retain rights to the product, or damages.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $431,823. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden has agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has not accrued any amount for any remaining lease obligation,
should such obligation exist. We are currently in default of the forbearance
agreement.
In April 2004, Bioware Corporation filed an action against the Company in
the Superior Court for the State of California, County of Orange, alleging
breach of contract for failure to pay royalties. At the time of filing, Bioware
alleged that it was owed approximately $156,000 under various agreements for
which it obtained a writ of attachment to secure payment of the alleged
obligation if it is successful at trial. Bioware also sought and obtained a
temporary restraining order prohibiting the Company from transferring assets up
to the amount sought in the writ of attachment. We successfully opposed the
preliminary injunction and vacated the temporary restraining order. Bioware
subsequently dismissed their action.
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,406 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000. If Monte Cristo executes the judgment, it
will negatively affect the Company's cash flow, which could further restrict the
Company's operations and cause material harm to our business.
Snowblind entered into a partial settlement agreement on June 23, 2004
following the suit filed by Snowblind on November 19, 2003. Snowblind filed a
second amended complaint against the Company on or about July 12, 2004 claiming
various causes of action including but not limited to, breach of contract,
account stated, open book account, and recission. The action was settled in
April 2005 and we granted Snowblind the exclusive license to develop games using
10
the DARK ALLIANCE Trademark under certain conditions. We retained the right to
develop massively multiplayer online games using the DARK ALLIANCE trademark.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company in the Orange County Superior Court that was settled in July 2004. The
Company was unable to make the payments and Reflexive sought and obtained
judgment against the company.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for various claims. On December 29, 2003 a settlement
agreement was entered into whereby Herve Caen was dismissed from the action.
Further the settlement was entered into with Interplay OEM only in the amount of
$170,000, however KDG reserved its rights to proceed against the Company if the
settlement payment was not made. As of this date the settlement payment was not
made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $117,000 in payroll tax penalties which it has accrued for
at December 31, 2004.
The Company was unable to meet certain 2004 payroll obligations to its
employees; as a result several employees filed claims with the State of
California Labor Board ("Labor Board"). The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and set trial
dates for August 2005.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled.
The Company subsequently entered into a new workers compensation insurance plan.
The Labor Board fined the Company approximately $79,000 for having lost workers
compensation insurance for a period of time. The Company is appealing the Labor
Board fines.
On December 29, 2004, Piper Rudnick LLP ("Piper Rudnick") filed an action
against Interplay Entertainment Corp. for various claims for unpaid services. We
are currently evaluating the merit of this lawsuit.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 16, 2002, the listing of our common stock was moved from the Nasdaq
National Market System to the Nasdaq SmallCap Market System. On October 9, 2002,
our common stock was delisted and began trading on the NASD-operated
Over-the-Counter Bulletin Board. Our common stock is currently traded on the
NASD-operated Over-the-Counter Bulletin Board under the symbol "IPLY" or while
non-compliant "IPLYE". At May 27, 2005, there were 144 holders of record of our
common stock.
The following table sets forth the range of high and low sales prices for
our common stock for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31, 2004 HIGH LOW
- ------------------------------------ ------- -------
First Quarter ........................ $ .14 $ .10
Second Quarter ....................... .14 .03
Third Quarter ........................ .05 .02
Fourth Quarter ....................... .03 .01
FOR THE YEAR ENDED DECEMBER 31, 2003 HIGH LOW
- ------------------------------------ ------- -------
First Quarter ........................ $ .08 $ .05
Second Quarter ....................... .14 .05
Third Quarter ........................ .14 .09
Fourth Quarter ....................... .12 .07
11
DIVIDEND POLICY
It is not currently our policy to pay dividends.
SECURITIES ISSUANCES
No new shares were issued during FY 2004
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2004:
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under equity
be issued upon exercise exercise price of compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- ----------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 211,150 2.02 7,609,447
approved by security
holders
Equity compensation plans - - -
not approved by security
holders
----------------------------------------------------------------------------
Total 211,150 2.02 7,609,447
============================================================================
We have one stock option plan currently outstanding. Under the 1997 Stock
Incentive Plan, as amended (the "1997 Plan"), we may grant options to our
employees, consultants and directors, which generally vest from three to five
years. At our 2002 annual stockholders' meeting, our stockholders voted to
approve an amendment to the 1997 Plan to increase the number of authorized
shares of common stock available for issuance under the 1997 Plan from four
million to 10 million. Our Incentive Stock Option, Nonqualified Stock Option and
Restricted Stock Purchase Plan- 1991, as amended (the "1991 Plan"), and our
Incentive Stock Option and Nonqualified Stock Option Plan-1994, as amended (the
"1994 Plan"), have terminated. An aggregate of 9,050 stock options that remain
outstanding under the 1991 Plan and 1994 Plan have been transferred to our 1997
Plan.
We have treated the difference, if any, between the exercise price and the
estimated fair market value as compensation expense for financial reporting
purposes, pursuant to APB 25. Compensation expense for the vested portion
aggregated $0, $0 and $44,000 for the years 2004, 2003 and 2002 respectively.
12
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for the years ended
December 31, 2004, 2003 and 2002 and the selected consolidated balance sheets
data as of December 31, 2004 and 2003 are derived from our audited consolidated
financial statements included elsewhere in this Report. The selected
consolidated statements of operations data for the years ended December 31, 2001
and 2000 and the selected consolidated balance sheets data as of December 31,
2002, 2001, and 2000 are derived from our audited consolidated financial
statements not included in this Report. Our historical results are not
necessarily indicative of the results that may be achieved for any other period.
The following data should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements included elsewhere in this Report.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(Unaudited)
(Dollars in thousands, except share and per share amounts)
STATEMENTS OF OPERATIONS DATA:
Net revenues ........................ $ 13,197 $ 36,301 $ 43,999 $ 56,448 $ 101,426
Cost of goods sold .................. 6,826 13,120 26,706 45,816 54,061
--------- --------- --------- --------- ---------
Gross profit ........................ 6,371 23,181 17,293 10,632 47,365
Operating expenses .................. 8,853 21,787 29,653 51,922 55,751
--------- --------- --------- --------- ---------
Operating (income) loss ............. (2,482) 1,394 (12,360) (41,290) (8,386)
Sale of Shiny ....................... -- -- 28,813 -- --
Other income (expense) .............. (2,094) (82) (1,531) (4,526) (3,689)
--------- --------- --------- --------- ---------
Income (loss) before income taxes ... (4,576) 1,312 14,922 (45,816) (12,075)
Provision (benefit) for income taxes 154 -- (225) 500 --
--------- --------- --------- --------- ---------
Net income (loss) ................... $ (4,730) $ 1,312 $ 15,147 $ (46,316) $ (12,075)
========= ========= ========= ========= =========
Cumulative dividend on participating
preferred stock .................. $ -- $ -- $ 133 $ 966 $ 870
Accretion of warrant ................ -- -- -- 266 532
--------- --------- --------- --------- ---------
Net income (loss) available to common
stockholders ..................... $ (4,730) $ 1,312 $ 15,014 $ (47,548) $ (13,477)
========= ========= ========= ========= =========
Net income (loss) per common share:
Basic .......................... $ (0.05) $ 0.01 $ 0.18 $ (1.23) $ (0.45)
Diluted ........................ $ (0.05) $ 0.01 $ 0.16 $ (1.23) $ (0.45)
Shares used in calculating net income
(loss) per common share - basic .. 93,856 93,852 83,585 38,670 30,047
Shares used in calculating net income
(loss) per common share - diluted 93,856 104,314 96,070 38,670 30,047
SELECTED OPERATING DATA:
Net revenues by geographic region:
North America .................. $ 1,544 $ 13,541 $ 26,184 $ 34,998 $ 53,298
International .................. 9,934 6,484 5,674 15,451 35,077
OEM, royalty and licensing ..... 1,720 16,276 12,141 5,999 13,051
Net revenues by platform:
Personal computer .............. $ 1,817 $ 7,671 $ 15,802 $ 34,912 $ 73,730
Video game console ............. 9,660 12,354 16,056 15,537 14,645
OEM, royalty and licensing ..... 1,720 16,276 12,141 5,999 13,051
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(Unaudited)
BALANCE SHEETS DATA: (Dollars in thousands)
Working capital (deficiency) $ (17,852) $ (14,750) $ (17,060) $ (34,169) $ 123
Total assets 834 5,486 14,298 31,106 59,081
Total debt 1,575 837 2,082 4,794 25,433
Stockholders' equity (deficit) (17,362) (12,636) (13,930) (28,150) 6,398
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Consolidated Financial Statements and notes thereto and other information
included or incorporated by reference herein.
EXECUTIVE OVERVIEW AND SUMMARY
Interplay Entertainment Corp. is a developer, publisher and licensor of
interactive entertainment software for both core gamers and the mass market. We
are most widely known for our titles in the action/arcade, adventure/role
playing game (RPG), and strategy/puzzle categories. We have produced titles for
many of the most popular interactive entertainment software platforms, and
currently are focusing our publishing and distribution business by developing
interactive entertainment software for the On Line Massively Multiplayer market.
During 2004 we continued to operate under limited cash flow from
operations. We expect to operate under similar cash constraints during 2005.
On or about February 23, 2004, we received correspondence from Atari
Interactive, Inc, the holder of the D&D license, alleging that we had failed to
pay royalties due under the D&D license as of February 15, 2004. Our rights to
distribute titles under the D&D license were terminated by Atari on April 23,
2004.
In June 2004 we licensed to Bethesda Softworks LLC, the rights to develop
FALLOUT 3 on all platforms for $1.175 million minimum guaranteed advance against
royalties. Bethesda also has an option to develop two sequels, FALLOUT 4, and
FALLOUT 5 for $1.0 million minimum guaranteed advance against royalties per
sequel. Interplay retained the rights to develop a massively multiplayer online
game ("MMORPG") using the Fallout Trademark.
In July 2004, we granted an option to Vivendi to purchase the REDNECK
RAMPAGE intellectual property rights for $300,000. Later that month, Vivendi
exercised the option.
In July 2004, we entered into a tri-party agreement with Atari Interactive,
Inc and Vivendi that allows Vivendi to resume North American and international
distribution pursuant to their pre-existing agreements with us of certain
Dungeons & Dragons games, including Baldur's Gate Dark Alliance II. The
agreement provided for proceeds due us to be paid directly to Atari by Vivendi,
up to an amount of $1.0 million of which approximately $.3 million was still
oustanding as of December 31, 2004. As a result we did not receive any proceeds
from Vivendi since July 2004 and will most likely not receive any proceeds
during 2005.
In August 2004, we entered into a tri-party agreement with Atari
Interactive, Inc and Avalon that allows Avalon to resume European distribution
pursuant to their pre-existing agreements with us of certain Dungeons & Dragons
games, including Baldur's Gate Dark Alliance II. The agreement provided for
proceeds due us to be paid directly to Atari by Avalon, as a result we did not
receive any proceeds from this agreement in 2004. This agreement was terminated
following Avalon's liquidation in February 2005.
We also continued to significantly reduce our operational costs and
personnel in 2004. We reduced our personnel by 101, from 113 in December 2003 to
12 in December 2004 by both involuntary termination and attrition. We also made
reductions in expenditures in other areas. As a result of these cost-cutting
measures, our ongoing cash needs to fund operations has been greatly reduced for
2005.
We continue to face difficulties in paying our vendors and have pending
lawsuits as a result of our continuing cash flow difficulties. We expect to
continue to operate under cash constraints during 2005.
The accompanying consolidated financial statements have been prepared
assuming that we will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The carrying amounts of assets and liabilities presented in the
financial statements do not purport to represent realizable or settlement
values. The Report of our Independent Auditors for the December 31, 2004
consolidated financial
14
statements includes an explanatory paragraph expressing substantial doubt about
our ability to continue as a going concern.
We derived net revenues primarily from sales of software products to our
two main distributors, Vivendi and Avalon. Vivendi distributes our products in
North America and select rest-of-world countries. Vivendi also handles our OEM
distribution. Our distribution agreement with Vivendi expires in August 2005
except for certain products subject to a tri-party agreement with Atari
Interactive Inc which expires in December 2006. Upon expiration of the Vivendi
distribution agreements we will need to either renew the distribution
agreements, find new distribution partners, or resume distribution ourselves.
Avalon distributed our products in Europe, the commonwealth of Independent
States, Africa and the Middle East. Our distribution agreement with Avalon was
terminated following Avalon's involuntary judicial liquidation in February 2005.
In March 2005 we appointed our wholly owned subsidiary, Interplay Productions
Ltd, as our distributor in Europe and other selected territories.
In addition, we derive royalty-based revenues from licensing arrangements
of intellectual property and products to third parties for distribution in
markets and through channels that are outside of our primary focus. We no longer
distribute products through our Games Online subsidiary and this subsidiary will
host our online gaming service.
Our products are either designed and created by our employees or by
external software developers. When we use external developers, we typically
advance development funds to the developers in installment payments based upon
the completion of certain milestones. These advances are typically considered
advances against future royalties, which are to be recouped against these
advances. We currently have one product in development with external developers.
We plan on creating additional products through external developers.
Our wholly owned subsidiary, Interplay OEM, distributed our interactive
entertainment software titles, as well as those of other software publishers, to
computer and peripheral device manufacturers for use in bundling arrangements.
As a result of changes in the market conditions for bundling arrangements and
the limited amount of resources we have available, we no longer have any
personnel applying their efforts towards bundling arrangements. In December
2002, we licensed our OEM distribution rights to Vivendi and may utilize
Vivendi's resources in our future OEM business. This agreement expires in August
2005.
Our operating results will continue to be impacted by economic, industry
and business trends affecting the interactive entertainment industry. Our
industry is highly seasonal, with the highest levels of consumer demand
occurring during the year-end holiday buying season. We expect that with the
upcoming release of new console systems by Sony, Nintendo and Microsoft, our
industry has entered into a transition period that could affect marketability of
new products.
Our operating results have fluctuated significantly in the past and likely
will fluctuate significantly in the future, both on a quarterly and an annual
basis. A number of factors may cause or contribute to such fluctuations, and
many of such factors are beyond our control.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these 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 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.
15
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. 104, Revenue Recognition.
Substantially all of our sales were made by two distributors, Vivendi
Universal Games, Inc. and Avalon Interactive Group Ltd, an affiliate of our
majority shareholder Titus Interactive S.A. We recognize revenue from sales by
distributors, net of sales commissions, only as the distributor recognizes sales
of our products to unaffiliated third parties. For those agreements that provide
the customers the right to multiple copies of a product in exchange for
guaranteed amounts, we recognize revenue at the delivery and acceptance of the
product gold master. We recognize per copy royalties on sales that exceed the
guarantee as copies are 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 consolidated financial
statements.
We provide customer support only via telephone and the Internet. Customer
support costs are not significant and we charge such costs to expenses as we
incur them.
We also engage in the sale of licensing rights on certain products. The
terms of the licensing rights differ, but normally include the right to develop
and distribute a product on a specific video game platform. We recognize revenue
when the rights have been transferred and no other obligations exist.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under developer arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables. Royalty advances are recoupable against future
sales based upon the contractual royalty rate. We amortize the cost of licenses,
prepaid royalties and other outside production costs to cost of goods sold over
six months commencing with the initial shipment in each region of the related
title. We amortize these amounts at a rate based upon the actual number of units
shipped with a minimum amortization of 75% in the first month of release and a
minimum of 5% for each of the next five months after release. This minimum
amortization rate reflects our typical product life cycle. Our management relies
on forecasted revenue to evaluate the future realization of prepaid royalties
and charges to cost of goods sold any amounts they deem unlikely to be fully
realized through future sales. Such costs are classified as current and non
current assets based upon estimated product release date. If actual revenue, or
revised sales forecasts, fall below the initial forecasted sales, the charge may
be larger than anticipated in any given quarter. Once the charge has been taken,
that amount will not be expensed in future quarters when the product has
shipped.
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.
16
OTHER SIGNIFICANT ACCOUNTING POLICIES
Other significant accounting policies not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. The policies related to
consolidation and loss contingencies require difficult judgments on complex
matters that are often subject to multiple sources of authoritative guidance.
Certain of these matters are among topics currently under reexamination by
accounting standards setters and regulators. Although no specific conclusions
reached by these standard setters appear likely to cause a material change in
our accounting policies, outcomes cannot be predicted with confidence. Please
see Note 2 of Notes to Consolidated Financial Statements, Summary of Significant
Accounting Policies, which discusses accounting policies that must be selected
by management when there are acceptable alternatives.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data and segment and platform data for the periods indicated
expressed as a percentage of net revenues:
YEARS ENDED DECEMBER 31,
-------------------------
2004 2003 2002
----- ----- -----
STATEMENTS OF OPERATIONS DATA:
Net revenues .................................... 100 % 100 % 100 %
Cost of goods sold .............................. 52 36 61
----- ----- -----
Gross margin .................................... 48 64 39
Operating expenses:
Marketing and sales ........................ 13 4 13
General and administrative ................. 34 18 17
Product development ........................ 20 38 37
Other ...................................... -- -- --
----- ----- -----
Total operating expenses ................... 67 60 67
----- ----- -----
Operating income (loss) ......................... (19) 4 (28)
Other income (expense) .......................... (16) -- 62
----- ----- -----
Income (loss) before provision
for income taxes ........................... (35) 4 34
Provision for income taxes ...................... 1 -- --
----- ----- -----
Net income (loss) ............................... (36)% 4 % 34 %
===== ===== =====
SELECTED OPERATING DATA:
Net revenues by segment:
North America .............................. 12 % 38 % 60 %
International .............................. 75 18 13
OEM, royalty and licensing ................. 13 44 27
----- ----- -----
100 % 100 % 100 %
===== ===== =====
Net revenues by platform:
Personal computer .......................... 14 % 21 % 36 %
Video game console ......................... 73 35 37
OEM, royalty and licensing ................. 13 44 27
----- ----- -----
100 % 100 % 100 %
===== ===== =====
17
Geographically, our net revenues for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
North America 1,544 13,541 (11,997) (88.6%)
International 9,934 6,484 3,450 53.2%
OEM, Royalty & Licensing 1,720 16,276 (14,306) (89.2%)
Net Revenues 13,197 36,301 (22,854) (63.9%)
Geographically, our net revenues for the years ended December 31, 2003 and
2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
North America 13,541 26,184 (12,643) (48%)
International 6,484 5,674 810 14%
OEM, Royalty & Licensing 16,276 12,141 3,885 32%
Net Revenues 36,301 43,999 (7,948) (18%)
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the year ended December 31, 2004 were $13.2 million, a
decrease of 63.9% compared to the same period in 2003. This decrease resulted
from a 88% decrease in North American net revenues and a 89% decrease in OEM,
royalties and licensing revenues, offset by a 53% increase in International net
revenues. Net revenues for the year ended December 31, 2003 were $36.1 million,
a decrease of 18% compared to the same period in 2002. This decrease resulted
from a 48% decrease in North American net revenues, offset by a 14% increase in
International net revenues and a 32% increase in OEM, royalties and licensing
revenues.
North American net revenues for the year ended December 31, 2004 were $1.5
million as compared to $13.5 million for the year ended December 31, 2003. The
decrease in North American net revenues in 2004 was mainly due to releasing zero
product gold masters in 2004 as compared to delivering six product gold masters
in 2003.
We expect that our North American publishing net revenues will decrease in
2005 compared to 2004, mainly due to decreased catalog sales.
The decrease in North American net revenues in 2003 was mainly due to lower
total unit sales of both new release and catalog titles. Although we released
six titles in each of 2003 and 2002, all six titles in 2003 were released by
Vivendi, as compared to five in 2002, under the terms of the 2002 distribution
agreement, whereby Vivendi pays us a lower per unit rate and in return assumes
all credit, product return and price concession risks, as well as being
responsible for all manufacturing, marketing and distribution expenditures. This
resulted in a decrease in North American sales of $19.4 million in 2003,
partially offset by a decrease in product returns and price concessions of $6.7
million as compared to the 2002 period. Our product returns were also lower in
2003 due primarily to the reduction in price concessions we made in connection
with our decreased catalog sales under our prior North American Distribution
Agreement we entered into with Vivendi in 2001.
International net revenues for the year ended December 31, 2004 were $9.9
million an increase of 3.4 million as compared to International net revenues for
the year ended December 31, 2003. The increase in International net revenues
compared to the year ended December 31, 2003 was mainly due to releasing
BALDUR'S GATE DARK ALLIANCE II and FALLOUT: BROTHERHOOD OF STEEL during the
twelve months ended December 31, 2004 and not having comparable titles during
2003.
We expect that our International publishing net revenues will decrease in
2005 as compared to 2004, mainly due to decreased unit sales.
International net revenues for the year ended December 31, 2003 were $6.5
million. The increase in International net revenues for the year ended December
31, 2002 was mainly due to a decrease in product returns and price
18
concessions of $3.1 million compared to the 2002 period and the recognition of
$0.6 million in revenues related to Avalon's CVA, offset by a decrease of both
new release and catalog sales.
OEM, royalty and licensing net revenues for the year ended December 31,
2004 were $1.7 million, a decrease of $14.3 million as compared to the same
period in 2003. The OEM business decreased $14.3 million as a consequence of our
reorganization.
OEM, royalty and licensing net revenues for the year ended December 31,
2003 were $16.0 million, an increase of $3.9 million as compared to the same
period in 2002. The OEM business decreased $2.8 million as a result of our
efforts to focus on our core business of developing and publishing video game
titles for distribution directly to the end users and our continued focus on
video game console titles, which typically are not bundled with other products.
The year ended December 31, 2003 also included $15.0 million in revenues for the
sale of the HUNTER: THE RECKONING video game franchise in the first quarter of
2003 and $0.5 million in net revenues related to the sale of the GALLEON video
game in the fourth quarter of 2003.
PLATFORM NET REVENUES
Our platform net revenues for the years ended December 31, 2004 and 2003
breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Personal Computer 1,817 7,671 (5,854) (76.3%)
Video Game Console 9,660 12,354 (2,694) (21.8%)
OEM, Royalty & Licensing 1,720 16,276 (14,306) (89.2%)
Net Revenues 13,197 36,301 (22,854) (63.4%)
PC net revenues for the year ended December 31, 2004 were $1.8 million, a
decrease of 76.3% compared to the same period in 2003. The decrease in PC net
revenues in 2004 was primarily due to no new releases. We expect our PC net
revenues to decrease in 2005 as compared to 2004 as we continue to reorganize
the company.
Our video game console net revenues for the year ended December 31, 2004
were $9.6 million a decrease of 21.8% compared to the same period in 2003. The
decrease in video game console net revenues was partially attributed to our
releasing or delivering no gold masters to Vivendi. Our catalog sales also
decreased in 2004 as compared to 2003. Since we anticipate releasing no new
console titles in 2005, we expect our video game console net revenues to
decrease in 2005.
Our platform net revenues for the years ended December 31, 2003 and 2002
breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Personal Computer 7,671 15,802 (8,131) (52%)
Video Game Console 12,354 16,056 (3,702) (23%)
OEM, Royalty & Licensing 16,276 12,141 3,885 31%
Net Revenues 36,301 43,999 (7,948) (18%)
PC net revenues for the year ended December 31, 2003 were $7.7 million, a
decrease of 52% compared to the same period in 2002. The decrease in PC net
revenues in 2003 was primarily due to the lower sales of our title LIONHEART in
2003 as compared to our 2002 release of ICEWIND DALE II. The decrease in PC net
revenues were further affected by a decrease in catalog sales.
Our video game console net revenues decreased 23% for the year ended
December 31, 2003 compared to the same period in 2002. The decrease in video
game console net revenues was partially attributed to our releasing or
delivering five gold masters to Vivendi, all under our 2002 distribution
agreement with them, whereby, we received a lower per unit rate in return for
Vivendi being responsible for all manufacturing, marketing, and distribution
expenditures. These five titles were: RLH (XBOX), BALDUR'S GATE: DARK ALLIANCE
II (PLAYSTATION 2), BALDUR'S GATE: DARK ALLIANCE II (XBOX), FALLOUT: BROTHERHOOD
OF STEEL (PLAYSTATION 2) AND FALLOUT: BROTHERHOOD OF STEEL (XBOX). We also
released five titles in 2002 to Vivendi; however, only four were under the 2002
distribution agreement. Furthermore, our video game console
19
net revenues were reduced in 2003 by not releasing BALDUR'S GATE: DARK ALLIANCE
II (PLAYSTATION 2), BALDUR'S GATE: DARK ALLIANCE II (XBOX), FALLOUT: BROTHERHOOD
OF STEEL (PLAYSTATION 2) and FALLOUT: BROTHERHOOD OF STEEL (XBOX) in Europe. Our
catalog sales also decreased in 2003 as compared to 2002.
COST OF GOODS SOLD; GROSS MARGIN
Cost of goods sold related to PC and video game console net revenues
represents the manufacturing and related costs of interactive entertainment
software products, including costs of media, manuals, duplication, packaging
materials, assembly, freight and royalties paid to developers, licensors and
hardware manufacturers. For sales of titles under the new distribution
arrangement with Vivendi, our cost of goods consists of royalties paid to
developers. Cost of goods sold related to royalty-based net revenues primarily
represents third party licensing fees and royalties paid by us. Typically, cost
of goods sold as a percentage of net revenues for video game console products
are higher than cost of goods sold as a percentage of net revenues for PC based
products due to the relatively higher manufacturing and royalty costs associated
with video game console and affiliate label products. We also include in the
cost of goods sold the amortization of prepaid royalty and license fees we pay
to third party software developers. We expense prepaid royalties over a period
of six months commencing with the initial shipment of the title at a rate based
upon the numbers of units shipped. We evaluate the likelihood of future
realization of prepaid royalties and license fees quarterly, on a
product-by-product basis, and charge the cost of goods sold for any amounts that
we deem unlikely to realize through future product sales.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2004 and 2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Net Revenues 13,197 36,301 (23,104) (63.6%)
Cost of Goods Sold 6,826 13,120 (6,294) (48%)
Gross Margin 6,371 23,181 (16,810) (72.5%)
Our cost of goods sold decreased 48% to $6.8 million in the year ended
December 31, 2004 compared to $12.9 million in the same period in 2003.
Furthermore, in 2003 we incurred $2.9 million in amortization of prepaid
royalties associated with the sale of the HUNTER: THE RECKONING license and
approximately $2.9 million in write-offs of development projects that were
impaired because the titles were not expected to meet our desired profit
requirements. In addition, the decrease was mainly a result of lower product
cost of goods associated with lower overall product sales. We expect our cost of
goods sold to decrease in 2005 as compared to 2004 because we anticipate lower
overall product sales.
Our gross margin decreased to 48.3% for the twelve months ended December
31, 2004 from 63.9% in the comparable period in 2003. This was primarily due to
the sale of the HUNTER: THE RECKONING license, which yielded approximately an
80% profit margin in 2003 partially offset by the sale of the rights to develop
FALLOUT 3 and the sale of REDNECK RAMPAGE in 2004.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2003 and 2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Net Revenues 36,301 43,999 (7,948) (18%)
Cost of Goods Sold 13,120 26,706 (13,786) (52%)
Gross Margin 23,181 17,293 5,838 34%
Our cost of goods sold decreased 52% to $12.9 million in the year ended
December 31, 2003 compared to the same period in 2002. Furthermore, we incurred
$2.9 million of non-recurring charges related to the write-off of prepaid
royalties on titles that were cancelled or not expected to meet our desired
profit requirements as compared to $4.1 million in the 2002 period. In addition,
the decrease was mainly a result of lower product cost of goods associated with
lower overall product sales.
20
Our gross margin increased to 64% in 2003 from 39% in 2002. This was due to
a decrease in our royalty expense as a result of a decrease of $1.2 million in
write-off of prepaid royalties, a decrease in our product cost of goods, a
decrease in product returns and price concessions as compared to the 2002 period
due to distributing all of our new releases in North America under the 2002
distribution agreement with Vivendi and the sale of the HUNTER: THE RECKONING
franchise in February 2003.
MARKETING AND SALES
Our marketing and sales expenses for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Marketing and Sales 1,703 1,415 288 20.4%
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 twelve months ended December 31, 2004 were $1.7 million, a
20.4% increase as compared to the 2003 period. The increase in marketing and
sales expenses is due primarily to increased advertising costs for Baldur's Gate
DARK ALLIANCE 2 on the PS2 and Xbox platforms in Europe. We expect our marketing
and sales expenses to decrease in 2005 compared to 2004, as we expect to ship
release fewer titles in 2005 as compared to 2004.
Our marketing and sales expenses for the years ended December 31, 2003 and
2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Marketing and Sales 1,415 5,814 (4,399) (76%)
Marketing and sales expenses for the year ended December 31, 2003 were $1.4
million, a 76% decrease as compared to the 2002 period. The decrease in
marketing and sales expenses is due to a $2.3 million reduction in advertising
and retail marketing support expenditures and a decrease of $2.1 million in
personnel costs and general expenses.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses for the years ended December 31,
2004 and 2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
General and Administrative 4,514 6,692 (2,178) (32.6%)
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
year ended December 31, 2004 were $4.5 million, a 32.6% decrease as compared to
the same period in 2003. The decrease is mainly due to decreases in personnel
costs and general expenses as a result of a reduction in administrative
personnel during 2004. We expect our general and administrative expenses to
decrease in 2005 compared to 2004.
Our general and administrative expenses for the years ended December 31,
2003 and 2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
General and Administrative 6,692 7,655 (963) (13%)
General and administrative expenses for the year ended December 31, 2003
were $6.7 million, a 13% decrease as compared to the same period in 2002. The
decrease is due to a $1.0 million decrease in personnel costs and general
expenses in 2003. In the 2002 period, we incurred significant charges of $0.4
million in loan termination fees associated
21
with the termination of our line of credit and $0.5 million in consulting
expenses payable to Europlay 1, LLC, ("Europlay") an outside consulting firm
hired in 2002 to assist us with the restructuring of the company and the sale of
Shiny Entertainment, Inc.
PRODUCT DEVELOPMENT
Our product development expenses for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Product Development 2,636 13,680 (11,044) (80.7%)
We charge internal product development expenses, which consist primarily of
personnel and support costs, to operations in the period incurred. Product
development expenses for the year ended December 31, 2004 were $2.6 million, a
80.7% decrease as compared to the same period in 2003. This decrease was mainly
due to a $11 million decrease in personnel costs and general expenses as a
result of a reduction in headcount and the closure of our internal development
studio during the year. We expect our product development expenses to decrease
in 2005 compared to 2004 as a result of reductions of development personnel
during 2004.
Our product development expenses for the years ended December 31, 2003 and
2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Product Development 13,680 16,184 (2,504) (16%)
Product development expenses for the year ended December 31, 2003 were
$13.7 million, a 16% decrease as compared to the same period in 2002. This
decrease was due to a $2.5 million decrease in personnel costs as a result of a
reduction in headcount and the sale of Shiny Entertainment, Inc. in April 2002.
OTHER EXPENSE, NET
Our other expense for the years ended December 31, 2004 and 2003 breakdown
as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Other Expense 2,248 82 (2,166) (278%)
Other expense consists primarily of interest expense, bad debt expense,
payroll tax penalties, write-off of fixed assets and foreign currency exchange
transaction losses. Other expense for the year ended December 31, 2004 was $2.2
million, a 278% decrease as compared to the same period in 2003. This increase
is due primarily to a write-off of fixed assets and a write down of the Avalon
accounts receivable balance.
Our other expense for the years ended December 31, 2003 and 2002 breakdown
as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Other Expense 82 1,531 (1,449) (95%)
Other expense for the year ended December 31, 2003 was $0.1 million, a 95%
decrease as compared to the same period in 2002. The 2002 period included higher
interest expense related to higher net borrowings, a $1.8 million provision due
to a delay in the effectiveness of a registration statement in connection with
our private placement of 8,126,770 shares of Common Stock and a $0.9 million
gain in the settlement and termination of a building lease in the United
Kingdom.
22
PROVISION (BENEFIT) FOR INCOME TAXES
Our provision/(benefit) for income taxes for the years ended December 31,
2004 and 2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------- -------
Provision (Benefit) 0 (0) 0 0%
We recorded no tax provision for the years ended December 31, 2004 and
2003.
Our provision/(benefit) for income taxes for the years ended December 31,
2003 and 2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------- -------
Provision (Benefit) 0 (225) 225 100%
We recorded no tax provision for the year ended December 31, 2003,
compared with a tax benefit of $225,000 for the year ended December 31, 2002. In
June 2002, the Internal Revenue Service ("IRS") concluded their examination of
our consolidated federal income tax returns for the years ended April 30, 1992
through 1997. In fiscal 2001, we established a reserve of $500,000, representing
management's best estimate of amounts to be paid in settlement of the IRS
claims. With the executed settlement, the actual amount owed was only $275,000.
Accordingly, we adjusted our reserve and, as a result, recognized an income tax
benefit of $225,000. We have a deferred tax asset of approximately $54.3 million
that has been fully reserved at December 31, 2003. This tax asset would reduce
future provisions for income taxes and related tax liabilities when realized,
subject to limitations.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2004, we had a working capital deficit of approximately
$18 million, and our cash balance was approximately $29,000. We currently have
no cash reserves and are unable to pay current liabilities. The Company cannot
continue in its current form without obtaining additional financing or income.
On April 16, 2004, Arden Realty, our landlord filed an unlawful detainer
action against us alleging unpaid rent of approximately $432,000. We were unable
to pay our rent, and vacated the office space during the month of June 2004. On
June 3, 2004, our Landlord obtained a judgment of approximately $588,000
exclusive of interest. We also owe an additional approximately $148,000 on a
prior settlement with the Landlord. We negotiated a forbearance agreement
whereby Arden has agreed to accept payments commencing in January 2005 in the
amount of $60,000 per month until the full amount is paid. We are currently in
default of this agreement.
We have received notice from the Internal Revenue Service ("IRS") that we
owe approximately $117,000 in payroll tax penalties for late payment of payroll
taxes in the 3rd and 4th quarters of 2003 and the 1st and 2nd quarters of 2004.
Such amount has been accrued at December 31, 2004. We have received notice from
the California Employment Development Department that we owe payroll taxes and
penalties of approximately $101,000. We have received notice from the State
Board of Equalization that we owe approximately $64,000 in State Use Tax. We
have also received notice from the Orange County Treasurer that we owe
approximately $28,000 in property taxes. Such amounts have been accrued at
December 31, 2004.
We were unable to meet certain 2004 payroll obligations to our employees,
as a result several employees filed claims with the State of California Labor
Board ("Labor Board"). The Labor Board has fined us approximately $10,000 for
failure to meet our payroll obligations and set trial dates for August 2005.
Since we were having difficulty meeting our payroll obligations on a timely
basis to our employees a large number of our employees stopped reporting to work
in late May and early June 2004. We were subsequently evicted from our building
at 16815 Von Karman Avenue in Irvine, California in mid June 2004. We had a core
group of approximately 12 employees on payroll on December 31, 2004, some of
whom are actively working from the new company locations in
23
Irvine and Beverly Hills, California and some have subsequently left the
Company. Substantially all employees have not been paid for the period August
through December 31, 2004. Since we have been unable to pay the employees we
have continuing liability to them and there is a high probability that some or
all of them will seek employment elsewhere. There may be some liability to us
arising from employees, including those who have left.
Our property, general liability, auto, fiduciary liability, workers
compensation, directors and officers, and employment practices liability
insurance policies, have been cancelled. We obtained a new workers' compensation
insurance policy. The Labor Board fined us approximately $79,000 for not having
worker's compensation coverage for a period of time. Our health insurance was
also cancelled but was subsequently reinstated. We are appealing the Labor Board
fines.
On July 2, 2004,we granted an option to Vivendi to purchase the REDNECK
RAMPAGE intellectual property rights for $300,000. On July 19, 2004, Vivendi
exercised the option and paid the $300,000 on July 23, 2004.
We entered into tri-party agreements with Atari Interactive, Inc. and
Vivendi and Avalon that allows Vivendi to resume North American distribution,
and Avalon to resume International distribution pursuant to their pre-existing
agreements with us of certain Dungeons & Dragons games, including BALDUR'S GATE:
DARK ALLIANCE II. In September 2004 Atari notified Vivendi that Vivendi is
currently in breach of its obligations to remit royalties to Atari pursuant to
the terms of the agreement. Atari Interactive notified Vivendi that if Vivendi
did not cure the breach set forth in the letter by September 30, 2004 that the
letter shall be deemed notice of termination of the agreement. According to
reports we received from Vivendi we believe Atari was paid by Vivendi
approximately $742,000 as of December 31, 2004. We will most likely not receive
any proceeds from Vivendi during 2005.
Interplay licensed to Bethesda Softworks LLC, "Bethesda" the rights to
develop FALLOUT 3 on all platforms for $1.175 million minimum guaranteed advance
against royalties. Bethesda also has an option to develop two sequels, FALLOUT
4, and FALLOUT 5 for $1.0 million minimum guaranteed advance against royalties
per sequel. Interplay retained the rights to develop a massively multiplayer
online game using the Fallout Trademark.
We have substantially reduced our operating expenses. We need to reduce our
continuing liabilities. We have to raise additional capital or financing. If we
do not receive sufficient financing we may (i) liquidate assets, (ii) sell the
company (iii) seek protection from our creditors including the filing of
voluntary bankruptcy or being the subject of involuntary bankruptcy, and/or (iv)
continue operations, but incur material harm to our business, operations or
financial conditions. These conditions, combined with our historical operating
losses and our deficits in stockholders' equity and working capital, raise
substantial doubt about our ability to continue as a going concern.
Additionally, we have reduced our fixed overhead commitments, and cancelled
or suspended development on future titles which management believes do not meet
sufficient projected profit margins, and scaled back certain marketing programs
associated with the cancelled projects. Management will continue to pursue
various alternatives to improve future operating results.
We continue to seek external sources of funding, including but not limited
to, incurring debt, the sale of assets or stock, the licensing of certain
product rights in selected territories, selected distribution agreements, and/or
other strategic transactions sufficient to provide short-term funding, and
potentially achieve our long-term strategic objectives.
We have been operating without a credit facility since October 2001, which
has adversely affected cash flow. We continue to face difficulties in paying our
vendors, and employees, and have pending lawsuits as a result of our continuing
cash flow difficulties. We expect these difficulties to continue during 2005.
Historically, we have funded our operations primarily through the use of
lines of credit, cash flow from operations, including royalty and distribution
fee advances, cash generated by the sale of securities, and the sale of assets.
Our primary capital needs have historically been working capital
requirements necessary to fund our operations, the development and introduction
of products and related technologies and the acquisition or lease of equipment
and other assets used in the product development process. Our operating
activities used cash of $2.9 million during the twelve months ended December 31,
2004, primarily attributable to fees incurred for lawsuits, and other
liabilities, and
24
recoupment of advances received by distributors.
Cash provided by investing activities of $28,000 for the twelve months
ended December 31, 2004 consisted of normal capital expenditures and sales,
primarily for office and computer equipment used in our operations. We do not
currently have any material commitments with respect to any future capital
expenditures. Net cash provided by financing activities of $738,000 for the
twelve months ended December 31, 2004, consisted primarily of repayments of our
notes payable.
Avalon distributed our products in Europe, the commonwealth of Independent
States, Africa and the Middle East. Our distribution agreement with Avalon was
terminated following Avalon's involuntary judicial liquidation in February 2005.
In March 2005 we appointed our wholly owned subsidiary, Interplay Productions
Ltd, as our distributor in Europe and other selected territories. As a result,
we cannot guarantee our ability to collect fully the debts we believe are due
and owed to us from Avalon. We subsequently fully reserved the Avalon
receivable.
Currently there is no internal development of new titles going on.
If operating revenues from product releases are not sufficient to fund our
operations, no assurance can be given that alternative sources of funding could
be obtained on acceptable terms, or at all. These conditions, combined with our
deficits in stockholders' equity and working capital, raise substantial doubt
about our ability to continue as a going concern. The accompanying 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. There can be
no guarantee that we will be able to meet all contractual obligations or
liabilities in the future, including payroll obligations.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements under which we have
obligations under a guaranteed contract that has any of the characteristics
identified in paragraph 3 of FASB Interpretation 3 of FASB Interpretation No. 45
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. We do not have any retained or
contingent interest in assets transferred to an unconsolidated entity or similar
arrangement that serves as credit, liquidity or market risk support to such
entity for such assets. We also do not have any obligation, including a
contingent obligation, under a contract that would be accounted for as a
derivative instrument. We have no obligations, including a contingent obligation
arising out of a variable interest (as referenced in FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (January 2003), as may be modified
or supplemented) in an unconsolidated entity that is held by, and material to,
the registrant, where such entity provides financing, liquidity, market risk or
credit risk support to, or engages in leasing, hedging or research and
development services with the registrant.
CONTRACTUAL OBLIGATIONS
The following table summarizes certain of our contractual obligations under
non-cancelable contracts and other commitments at December 31, 2004, and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods. (in thousands)
LESS THAN 1 - 3 3 - 5 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
- -----------------------------------------------------------------------------------------
Developer Licensee Commitments (1) 4,694 3,051 1,643 -- --
Lease Commitments (2) ............ 737 737 -- -- --
Taxes (3) ........................ 310 310 -- -- --
Other Commitments (4) ............ 1,476 970 506 -- --
- -----------------------------------------------------------------------------------------
Total ........................... 7,217 5,068 2,149 -- --
Our current cash reserves plus our expected cash from existing operations
will only be sufficient to fund our anticipated expenditures into the second
quarter of fiscal 2005. We will need to substantially reduce our working capital
25
needs, continue to consummate certain sales of assets and/or raise additional
financing to meet our contractual obligations.
(1) Developer/Licensee Commitments: The products produced by us are
designed and created by our employee designers and artists and by non-employee
software developers ("independent developers"). We typically advance development
funds to the independent developers during development of our games, usually in
installment payments made upon the completion of specified development
milestones, which payments are considered advances against subsequent royalties
based on the sales of the products. These terms are typically set forth-in
written agreements entered into with the independent developers. In addition we
have content license contracts that contain minimum guarantee payments and
marketing commitments that are not dependent on any deliverables. These
developer and content license commitments represent the sum of (1) minimum
marketing commitments under royalty bearing licensing agreements, and (2)
minimum payments and advances against royalties due under royalty-bearing
licenses and developer agreements.
(2) Lease Commitments: The company's headquarters were located in Irvine,
California where the Company leased approximately 81,000 square feet of office
space. This lease would have expired in June 2006. On or about April 16, 2004,
Arden Realty Finance IV LLC filed an unlawful detainer action against the
Company in the Superior Court for the State of California, County of Orange,
alleging the Company's default under its corporate lease agreement. At the time
the suit was filed, the alleged outstanding rent totaled $431,823. The Company
was unable to satisfy this obligation and reach an agreement with its landlord,
the Company subsequently forfeited its lease and vacated the building. Arden
Realty obtained a judgment for approximately $588,000 exclusive of interest. The
Company also owes an additional approximately $149,000 making a total owed to
Arden by the Company of approximately $737,000. The Company negotiated a
forbearance agreement whereby Arden has agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has been unable to make any of the $60,000 per month payments. We
have monthly rental agreements in Irvine, CA and Beverly Hills, California for
our operations.
(3) We have received notice from the Internal Revenue Service ("IRS") that
we owe approximately $117,000 in payroll tax penalties for late payment of
payroll taxes in the 3rd and 4th quarters of 2003 and the 1st and 2nd quarters
of 2004. Such amount has been accrued at December 31, 2004. We have received
notice from the California Unemployment Development Department that we owe
payroll taxes and penalties of approximately $101,000. We have received notice
from the State Board of Equalization that we owe approximately $64,000 in State
Use Tax. We have also received notice from the Orange County Treasurer that we
owe approximately $28,000 in property taxes. Such amounts have been accrued at
December 31, 2004.
(4) Other Commitments: Consist of payment plans entered into with various
creditors.
ACTIVITIES WITH RELATED PARTIES
It is our policy that related party transactions are to be reviewed and
approved by a majority of our disinterested directors or our Independent
Committee.
Our operations involve significant transactions with our majority
stockholder Titus and its affiliates. We had a major distribution agreement with
Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus presently owns approximately 58 million shares of common stock, which
represents approximately 62% of our outstanding common stock, our only voting
security.
We performed certain distribution services on behalf of Titus for a fee. In
connection with such distribution services, we recognized fee income of $0 and
$5,000 for the twelve months ended December 31, 2004, and 2003, respectively.
As of December 31, 2004 and December 31, 2003, Titus and its affiliates
excluding Avalon owed us $370,000 and $362,000, respectively. We owed Titus and
its affiliates excluding Avalon $30,000 and $0 as of December 31, 2004 and
December 31, 2003 respectively.
26
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
We had an International Distribution Agreement with Avalon, a wholly owned
subsidiary of Titus. Pursuant to this distribution agreement, Avalon provided
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 paid
Avalon a distribution fee based on net sales, and Avalon provides certain market
preparation, warehousing, sales and fulfillment services on our behalf. In
connection with the International Distribution Agreement with Avalon, we
incurred distribution commission expense of $62,000 and $.9 million, for the
twelve months ended December 31, 2004, and 2003 respectively. This agreement was
terminated as a result of Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software Corp.,
("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at September 30, 2004 was approximately $254,000. The total receivable
due from TSC is approximately $327,000 as of September 30, 2004. The majority of
the additional approximately $73,000 was due to TSC subletting office space and
miscellaneous other items.
In May 2003, we paid TSC $60,000 to cover legal fees in connection with a
lawsuit against Titus. As a result of the payment, our CEO requested that we
credit the $60,000 to amounts we owed to him arising from expenses incurred in
connection with providing services to us. Our Board of Directors is in the
process of investigating the details of the transaction, including independent
counsel review as appropriate, in order to properly record the transaction.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. This representation agreement has not yet been
approved by our Board of Directors and is currently being reviewed by them. Our
Board of Directors has approved the payments of certain amounts to Titus Japan
in connection with certain services already performed by them on our behalf. As
of December 31, 2004 we had a zero balance with Titus Japan. During the twelve
months ending December 31, 2004 our Japanese subsidiary paid to Titus Japan
approximately $209,000 in commissions, marketing and publishing staff services.
Our Japanese subsidiary had approximately $369,000 in revenue in the twelve
months ending December 31, 2004.
TRANSACTIONS WITH TITUS SARL
As of December 31, 2004, we have a receivable of $18,000 and $43,000
respectively for product development services that we provided. Titus SARL was
placed into involuntary liquidation in January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, we engaged the services of GIE Titus Interactive Group, a
wholly owned subsidiary of Titus, for a three-month service agreement pursuant
to which GIE Titus or its agents shall provide to us certain foreign
administrative and legal services at a rate of $5,000 per month for three
months. As of December 31, 2004, we had a zero balance with Titus GIE
Interactive Group. Titus GIE was placed into involuntary liquidation in January
2005.
27
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4." This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
United States and accounting principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment," a
revision to SFAS 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123R establishes standards for the accounting
for transactions in which an entity exchanges instruments for goods or services.
It also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity-based compensation issued to
employees. SFAS 123R requires the Company to value the share-based compensation
based on the classification of the share-based award. If the share-based award
is to be classified as a liability, the Company must re-measure the award at
each balance sheet date until the award is settled. If the share-based award is
to be classified as equity, the Company will measure the value of the
share-based award on the date of grant but the award will not be re-measured at
each balance sheet date. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for public
companies with calendar year ends no later than the beginning of the next fiscal
year. All public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS 123 except that the amounts must be
recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS 123 amounts
in the statement of operations. Management is in the process of determining the
effect SFAS 123R will have upon the Company's financial position and statement
of operations and the method of transition adoption.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
RISK FACTORS
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. These major risks and uncertainties are
discussed below. There may be additional risks and uncertainties which we do not
believe are currently material or are not yet known to us but which may become
such in the future. Some of the risks and uncertainties which may cause our
operating results to vary from anticipated results or which may materially and
adversely affect our operating results are as follows:
28
RISKS RELATED TO OUR FINANCIAL RESULTS
WE CURRENTLY HAVE A NUMBER OF OBLIGATIONS THAT WE ARE UNABLE TO MEET WITHOUT
GENERATING ADDITIONAL INCOME OR RAISING ADDITIONAL CAPITAL. IF WE CANNOT
GENERATE ADDITIONAL INCOME OR RAISE ADDITIONAL CAPITAL IN THE NEAR FUTURE, WE
MAY BECOME INSOLVENT AND/OR OUR STOCK WOULD BECOME ILLIQUID OR WORTHLESS.
As of December 31, 2004, our cash balance was approximately $29,000 and our
outstanding accounts payable and current liabilities totaled approximately $13.2
million. In particular we have some significant creditors that comprise a
substantial proportion of outstanding obligations that we might not be able to
satisfy. If we do not receive sufficient financing or sufficient funds from our
operations we may (i) liquidate assets, (ii) seek or be forced into bankruptcy
and/or (iii) continue operations, but incur material harm to our business,
operations or financial condition. These measures could have a material adverse
effect on our ability to continue as a going concern. Additionally, because of
our financial condition, our Board of Directors has a duty to our creditors that
may conflict with the interests of our stockholders. When a Delaware corporation
is operating in the vicinity of insolvency, the Delaware courts have imposed
upon the corporation's directors a fiduciary duty to the corporation's
creditors. Our Board of Directors may be required to make decisions that favor
the interests of creditors at the expense of our stockholders to fulfill its
fiduciary duty. For instance, we may be required to preserve our assets to
maximize the repayment of debts versus employing the assets to further grow our
business and increase shareholder value. If we cannot generate enough income
from our operations or are unable to locate additional funds through financing,
we will not have sufficient resources to continue operations.
WE HAVE A HISTORY OF LOSSES, AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY
CURTAILING FUTURE OPERATIONS TO CONTINUE AS A BUSINESS.
For the year ended December 31, 2004, our net loss from operations was $2.5
million and for the year ended December 31, 2003, our net loss from operations
was $1.3 million. Since inception, we have incurred significant losses and
negative cash flow, and as of December 31, 2004 we had an accumulated deficit of
$139 million. Our ability to fund our capital requirements out of our available
cash and cash generated from our operations depends on a number of factors. Some
of these factors include the progress of our product development programs, the
rate of growth of our business, and our products' commercial success. If we
cannot generate positive cash flow from operations, we will have to continue to
reduce our costs and raise working capital from other sources. These measures
could include selling or consolidating certain operations or assets, and
delaying, canceling or scaling back product development and marketing programs.
These measures could materially and adversely affect our ability to publish
successful titles, and may not be enough to permit us to operate profitability,
or at all.
OUR ABILITY TO EFFECT A FINANCING TRANSACTION TO FUND OUR OPERATIONS COULD
ADVERSELY AFFECT THE VALUE OF YOUR STOCK.
If we are not acquired by or merge with another entity or if we are not
able to raise additional capital by sale or license of certain of our assets, we
may need to consummate a financing transaction to receive additional liquidity.
This additional financing may take the form of raising additional capital
through public or private equity offerings or debt financing. To the extent we
raise additional capital by issuing equity securities, we cannot be certain that
additional capital will be available to us on favorable terms and our
stockholders will likely experience substantial dilution. Our certificate of
incorporation provides for the issuance of preferred stock however we currently
do not have any preferred stock issued and outstanding. Any new equity
securities issued may have greater rights, preferences or privileges than our
existing common stock. Material shortage of capital will require us to take
drastic steps such as reducing our level of operations, disposing of selected
assets, effecting financings on less than favorable terms or seeking protection
under federal bankruptcy laws.
RISKS RELATED TO OUR BUSINESS
TITUS INTERACTIVE SA CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A
MAJORITY OF OUR BOARD OF DIRECTORS AND PREVENT AN ACQUISITION OF US THAT IS
FAVORABLE TO OUR OTHER STOCKHOLDERS. ALTERNATIVELY, TITUS CAN ALSO CAUSE A SALE
OF CONTROL OF OUR COMPANY THAT MAY NOT BE FAVORABLE TO OUR OTHER STOCKHOLDERS.
Titus owns approximately 58 million shares of common stock, which
represents approximately 62% of our outstanding common stock, our only voting
security. As a consequence, Titus can control substantially all matters
29
requiring stockholder approval, including the election of directors, subject to
our stockholders' cumulative voting rights, and the approval of mergers or other
business combination transactions. At our 2003 and 2002 annual stockholders
meetings, Titus exercised its voting power to elect a majority of our Board of
Directors. Currently, our Chief Executive Officer and interim Chief Financial
Officer Herve Caen is a director of various Titus affiliates. This concentration
of voting power could discourage or prevent a change in control that otherwise
could result in a premium in the price of our common stock. Further, Titus'
bankruptcy could lead to a sale by its liquidator or other representative in
bankruptcy, of shares Titus holds in us, thereby potentially reducing the value
of our shares and market capitalization. Such a sale and dispersion of shares to
multiple stockholders further could have the effect of making any business
combination, or a sale of all of our shares as a whole, more difficult.
THE LACK OF ANY CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL REDUCTION IN THE
CASH AVAILABLE TO FINANCE OUR OPERATIONS.
We are currently operating without a credit agreement or credit facility.
The lack of a credit agreement or credit facility has significantly impeded our
ability to fund our operations and has caused material harm to our business.
There can be no assurance that we will be able to enter into a new credit
agreement or that if we do enter into a new credit agreement, it will be on
terms favorable to us.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES HISTORICALLY DEPENDED ON OUR
DISTRIBUTORS' DILIGENT SALES EFFORTS.
Avalon was the exclusive distributor for most of our products in Europe,
the Commonwealth of Independent States, Africa and the Middle East. Our
agreement with Avalon was terminated following the liquidation of Avalon in
February 2005. We subsequently appointed our wholly owned subsidiary Interplay
Productions Ltd as our distributor for Europe.
Vivendi has exclusive rights to distribute our products in North America
and selected International territories. Our agreement with Vivendi will expire
in August 2005 for most of our products.
Our revenues and cash flows could fall significantly and our business and
financial results could suffer material harm if: o We fail to replace Vivendi as
our distributor; or o Interplay Productions Ltd fails to effectively distribute
our products.
We typically sell to distributors and retailers on unsecured credit, with
terms that vary depending upon the customer and the nature of the product. We
confront the risk of non-payment from our customers, whether due to their
financial inability to pay us, or otherwise. In addition, while we maintain a
reserve for uncollectible receivables, the reserve may not be sufficient in
every circumstance. As a result, a payment default by a significant customer
could cause material harm to our business.
WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR
ABILITY TO MANAGE OUR FINANCIAL OPERATIONS.
We are presently without a CFO, and Mr. Caen has assumed the position of
interim-CFO and continues as CFO to date until a replacement can be found.
OUR BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL. IF WE FAIL TO DELIVER
OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER.
Our business is highly seasonal, with the highest levels of consumer demand
occurring in the fourth quarter. Our industry is also cyclical. The timing of
hardware platform introduction is often tied to the year-end season and is not
within our control. As new platforms are being introduced into our industry,
consumers often choose to defer game software purchases until such new platforms
are available, which would cause sales of our products on current platforms to
decline. This decline may not be offset by increased sales of products for the
new platform.
30
THE UNPREDICTABILITY OF FUTURE RESULTS MAY CAUSE OUR STOCK PRICE TO REMAIN
DEPRESSED OR TO DECLINE FURTHER.
Our operating results have fluctuated in the past and may fluctuate in the
future due to several factors, some of which are beyond our control. These
factors include:
o demand for our products and our competitors' products;
o the size and rate of growth of the market for interactive
entertainment software;
o changes in personal computer and video game console platforms;
o the timing of announcements of new products by us and our competitors
and the number of new products and product enhancements released by us
and our competitors;
o changes in our product mix;
o the number of our products that are returned; and
o the level of our international and original equipment manufacturer
royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which
we will ship our products. Some of these factors include:
o the uncertainties associated with the interactive entertainment
software development process;
o approvals required from content and technology licensors; and
o the timing of the release and market penetration of new game hardware
platforms.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE INTRODUCTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
For the year ended December 31, 2004, our net loss from operations was $2.5
million. We have incurred significant net losses in previous years periods. Our
losses in the past stemmed partly from the significant costs we incured to
develop our entertainment software products, product returns and price
concessions. Moreover, a significant portion of our operating expenses is
relatively fixed, with planned expenditures based largely on sales forecasts. At
the same time, most of our products have a relatively short life cycle and sell
for a limited period of time after their initial release, usually less than one
year.
Relatively fixed costs and short windows in which to earn revenues mean
that sales of new products are important in enabling us to recover our
development costs, to fund operations and to replace declining net revenues from
older products. Our failure to accurately assess the commercial success of our
new products, and our delays in releasing new products could reduce our net
revenues and our ability to recoup development and operational costs.
IF OUR PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, OUR BUSINESS COULD BE
HARMED SIGNIFICANTLY.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles
31
to increase in the future. We cannot assure you that our new products will
achieve significant market acceptance, or that we will be able to sustain this
acceptance for a significant length of time if we achieve it.
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis. Because we introduce
a relatively limited number of new products in a given period, the failure of
one or more of these products to achieve market acceptance could cause material
harm to our business. Further, if our products do not achieve market acceptance,
we could be forced to accept substantial product returns or grant significant
pricing concessions to maintain our relationship with retailers and our access
to distribution channels. If we are forced to accept significant product returns
or grant significant pricing concessions, our business and financial results
could suffer material harm.
OUR RELIANCE ON THIRD PARTY SOFTWARE DEVELOPERS SUBJECTS US TO THE RISKS THAT
THESE DEVELOPERS WILL NOT SUPPLY US WITH HIGH QUALITY PRODUCTS IN A TIMELY
MANNER OR ON ACCEPTABLE TERMS.
Third party interactive entertainment software developers develop many of
our software products. Since we depend on these developers in the aggregate, we
remain subject to the following risks:
o limited financial resources may force developers out of business prior
to their completion of projects for us or require us to fund
additional costs; and
o the possibility that developers could demand that we renegotiate our
arrangements with them to include new terms less favorable to us.
INCREASED COMPETITION FOR SKILLED THIRD PARTY SOFTWARE DEVELOPERS ALSO HAS
COMPELLED US TO AGREE TO MAKE ADVANCE PAYMENTS ON ROYALTIES AND TO GUARANTEE
MINIMUM ROYALTY PAYMENTS TO INTELLECTUAL PROPERTY LICENSORS AND GAME DEVELOPERS.
MOREOVER, IF THE PRODUCTS SUBJECT TO THESE ARRANGEMENTS, ARE NOT DELIVERED
TIMELY, OR WITH ACCEPTABLE QUALITY, OR DO NOT GENERATE SUFFICIENT SALES VOLUMES
TO RECOVER THESE ROYALTY ADVANCES AND GUARANTEED PAYMENTS, WE WOULD HAVE TO
WRITE-OFF UNRECOVERED PORTIONS OF THESE PAYMENTS, WHICH COULD CAUSE MATERIAL
HARM TO OUR BUSINESS AND FINANCIAL RESULTS. WE COMPETE WITH A NUMBER OF
COMPANIES THAT HAVE SUBSTANTIALLY GREATER FINANCIAL, MARKETING AND PRODUCT
DEVELOPMENT RESOURCES THAN WE DO.
The greater resources of our competitors permit them to pay higher fees
than we can to licensors of desirable motion picture, television, sports and
character properties and to third party software developers.
We compete primarily with other publishers of personal computer and video
game console interactive entertainment software. Significant competitors include
Electronic Arts Inc. and Activision, Inc. Many of these competitors have
substantially greater financial, technical resources, larger customer bases,
longer operating histories, greater name recognition and more established
relationships in the industry than we do.
In addition, integrated video game console hardware/software companies such
as Sony Computer Entertainment, Nintendo, and Microsoft Corporation compete
directly with us in the development of software titles for their respective
platforms and they have generally discretionary approval authority over the
products we develop for their platforms. Large diversified entertainment
companies, such as The Walt Disney Company, and Time Warner Inc. many of which
own substantial libraries of available content and have substantially greater
financial resources, may decide to compete directly with us or to enter into
exclusive relationships with our competitors.
WE HAVE A LIMITED NUMBER OF KEY MANAGEMENT AND OTHER PERSONNEL. THE LOSS OF ANY
SINGLE MEMBER OF MANAGEMENT OR KEY PERSON OR THE FAILURE TO HIRE AND INTEGRATE
CAPABLE NEW KEY PERSONNEL COULD HARM OUR BUSINESS.
Our business requires extensive time and creative effort to produce and
market. Our future success also will depend upon our ability to attract,
motivate and retain qualified employees and contractors, particularly software
design and development personnel. Competition for highly skilled employees is
intense, and we may fail to attract and retain such personnel. Alternatively, we
may incur increased costs in order to attract and retain skilled employees. Our
executive management team currently consists of CEO and interim CFO Herve Caen.
Our failure to recruit or retain the services of
32
key personnel, including competent executive management, or to attract and
retain additional qualified employees could cause material harm to our business.
OUR INTERNATIONAL SALES EXPOSE US TO RISKS OF UNSTABLE FOREIGN ECONOMIES,
DIFFICULTIES IN COLLECTION OF REVENUES, INCREASED COSTS OF ADMINISTERING
INTERNATIONAL BUSINESS TRANSACTIONS AND FLUCTUATIONS IN EXCHANGE RATES.
Our net revenues from international sales accounted for approximately 75%
and 18% of our total net revenues for years ended December 31, 2004 and 2003,
respectively. Most of these revenues came from our distribution relationship
with Avalon, pursuant to which Avalon became the exclusive distributor for most
of our products in Europe, the Commonwealth of Independent States, Africa and
the Middle East. To the extent our resources allow, we intend to continue to
expand our direct and indirect sales, marketing and product localization
activities worldwide.
Our international sales are subject to a number of inherent risks,
including the following:
o recessions in foreign economies may reduce purchases of our products;
o translating and localizing products for international markets is time
consuming and expensive;
o accounts receivable are more difficult to collect and when they are
collectible, they may take longer to collect;
o regulatory requirements may change unexpectedly;
o it is difficult and costly to staff and manage foreign operations;
o fluctuations in foreign currency exchange rates;
o political and economic instability; and
o delays in market penetration of new platforms in foreign territories.
These factors may cause material declines in our future international net
revenues and, consequently, could cause material harm to our business.
A significant, continuing risk we face from our international sales and
operations stems from currency exchange rate fluctuations. Because we do not
engage in currency hedging activities, fluctuations in currency exchange rates
have caused significant reductions in our net revenues from international sales
and licensing due to the loss in value upon conversion into U.S. Dollars. We may
suffer similar losses in the future.
OUR CUSTOMERS HAVE THE ABILITY TO RETURN OUR PRODUCTS OR TO RECEIVE PRICING
CONCESSIONS AND SUCH RETURNS AND CONCESSIONS COULD REDUCE OUR NET REVENUES AND
RESULTS OF OPERATIONS.
We are exposed to the risk of product returns and pricing concessions with
respect to our distributors. Our distributors allow retailers to return
defective, shelf-worn and damaged products in accordance with negotiated terms,
and also offer a 90-day limited warranty to our end users that our products will
be free from manufacturing defects. In addition, our distributors provide
pricing concessions to our customers to manage our customers' inventory levels
in the distribution channel. Our distributors could be forced to accept
substantial product returns and provide pricing concessions to maintain our
relationships with retailers and their access to distribution channels. We have
mitigated this risk in North America under our current distribution arrangement
with Vivendi, as sales will be guaranteed with no offset for product returns and
price concessions.
WE DEPEND UPON THIRD PARTY LICENSES OF CONTENT FOR MANY OF OUR PRODUCTS.
Many of our current and planned products, are lines based on original ideas
or intellectual properties licensed from other parties. From time to time we may
not be in compliance with certain terms of these license agreements, and our
ability to market products based on these licenses may be negatively impacted.
Moreover, disputes regarding these license agreements may also negatively impact
our ability to market products based on these licenses. Additionally, we
33
may not be able to obtain new licenses, or maintain or renew existing licenses,
on commercially reasonable terms, if at all. If we are unable to maintain
current licenses or obtain new licenses for the underlying content that we
believe offers the greatest consumer appeal, we would either have to seek
alternative, potentially less appealing licenses, or release products without
the desired underlying content, either of which could limit our commercial
success and cause material harm to our business.
IF DISTRIBUTION CONTRACT CLAIMS CONTINUE TO BE ASSERTED AGAINST US, WE MAY BE
UNABLE TO SUSTAIN OUR BUSINESS OR MEET OUR CURRENT OBLIGATIONS.
During calendar year 2004, we were involved in disputes with our key
distributor Vivendi Universal Games. While we have since reached an amicable
settlement with Vivendi, other distribution-related contract claims may be
asserted against us in the future. Such claims can harm our business by
consuming our limited human and financial resources, regardless of the merits of
the claims. We incur substantial expenses in evaluating and defending against
such claims. In the event that there is a determination against us on any these
types of claims, we could incur significant monetary liability and there could
be a negative impact on product release.
OUR LICENSORS ARE ALSO OFTEN OUR COMPETITORS. WE MAY FAIL TO MAINTAIN EXISTING
LICENSES, OR OBTAIN NEW LICENSES FROM PLATFORM COMPANIES ON ACCEPTABLE TERMS OR
TO OBTAIN RENEWALS OF EXISTING OR FUTURE LICENSES FROM LICENSORS.
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo and Microsoft, who
are also our competitors. Each of these companies has the right to approve the
technical functionality and content of our products for their platforms prior to
distribution. Typically, such license agreements give broad control to the
licensor over the approval, manufacturing and shipment of products on their
platform. Due to the competitive nature of the approval process, we typically
must make significant product development expenditures on a particular product
prior to the time we seek these approvals. Our inability to obtain these
approvals or to obtain them on a timely basis could cause material harm to our
business.
OUR SALES VOLUME AND THE SUCCESS OF OUR PRODUCTS DEPEND IN PART UPON THE NUMBER
OF PRODUCT TITLES DISTRIBUTED BY HARDWARE COMPANIES FOR USE WITH THEIR VIDEO
GAME PLATFORMS.
Even after we have obtained licenses to develop and distribute software, we
depend upon hardware companies such as Sony Computer Entertainment, Nintendo and
Microsoft, or their designated licensees, to manufacture the CD-ROM or DVD-ROM
media discs that contain our software. These discs are then run on the
companies' video game consoles. This process subjects us to the following risks:
o we are required to submit and pay for minimum numbers of discs we want
produced containing our software, regardless of whether these discs
are sold, shifting onto us the financial risk associated with poor
sales of the software developed by us; and
o reorders of discs are expensive, reducing the gross margin we receive
from software releases that have stronger sales than initially
anticipated and that require the production of additional discs.
As a result, video game console hardware licensors can shift onto us the
risk that if actual retailer and consumer demand for our interactive
entertainment software differs from our forecasts, we must either bear the loss
from overproduction or the lower per-unit revenues associated with producing
additional discs. Either situation could lead to material reductions in our net
revenues and operating results.
RISKS RELATED TO OUR INDUSTRY
INADEQUATE INTELLECTUAL PROPERTY PROTECTIONS COULD PREVENT US FROM ENFORCING OR
DEFENDING OUR PROPRIETARY TECHNOLOGY.
34
We regard our software as proprietary and rely on a combination of patent,
copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks, and hold the rights to one
patent application related to one of our titles. While we provide "shrink-wrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy
can be a persistent problem, especially in some international markets. Further,
the laws of some countries where our products are or may be distributed either
do not protect our products and intellectual property rights to the same extent
as the laws of the United States, or are weakly enforced. Legal protection of
our rights may be ineffective in such countries, and as we leverage our software
products using emerging technologies such as the Internet and online services,
our ability to protect our intellectual property rights and to avoid infringing
others' intellectual property rights may diminish. We cannot assure you that
existing intellectual property laws will provide adequate protection for our
products in connection with these emerging technologies.
WE MAY UNINTENTIONALLY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
WHICH COULD EXPOSE US TO SUBSTANTIAL DAMAGES OR RESTRICT OUR OPERATIONS.
As the number of interactive entertainment software products increases and
the features and content of these products continue to overlap, software
developers increasingly may become subject to infringement claims. Although we
believe that we make reasonable efforts to ensure that our products do not
violate the intellectual property rights of others, it is possible that third
parties still may claim infringement. From time to time, we receive
communications from third parties regarding such claims. Existing or future
infringement claims against us, whether valid or not, may be time consuming and
expensive to defend. Intellectual property litigation or claims could force us
to do one or more of the following:
o cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property, which license, if available at all, may not be available on
commercially favorable terms; or
o redesign our interactive entertainment software products, possibly in
a manner that reduces their commercial appeal.
Any of these actions may cause material harm to our business and financial
results.
OUR BUSINESS IS INTENSELY COMPETITIVE AND PROFITABILITY IS INCREASINGLY DRIVEN
BY A FEW KEY TITLE RELEASES. IF WE ARE UNABLE TO DELIVER KEY TITLES, OUR
BUSINESS MAY BE HARMED.
Competition in our industry is intense. New videogame products are
regularly introduced. Increasingly, profits and revenues in our industry are
dominated by certain key product releases and are increasingly produced in
conjunction with the latest consumer and media trends. Many of our competitors
may have more finances and other resources for the development of product titles
than we do. If our competitors develop more successful products, or if we do not
continue to develop consistently high-quality products, our revenue will
decline.
IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
o operating systems such as Microsoft Windows Longhorn;
o new media formats
35
o releases of new video game consoles;
o new video game systems by Sony, Microsoft, Nintendo and others.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
New interactive entertainment software platforms and technologies also may
undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
o anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on favorable
terms; or
o create software for those new platforms on a timely basis.
OUR SOFTWARE MAY BE SUBJECT TO GOVERNMENTAL RESTRICTIONS OR RATING SYSTEMS.
Legislation is periodically introduced at the state and federal levels in
the United States and in foreign countries to establish a system for providing
consumers with information about graphic violence and sexually explicit material
contained in interactive entertainment software products. In addition, many
foreign countries have laws that permit governmental entities to censor the
content of interactive entertainment software. We believe that mandatory
government-run rating systems eventually will be adopted in many countries that
are significant markets or potential markets for our products. We may be
required to modify our products to comply with new regulations, which could
delay the release of our products in those countries.
Due to the uncertainties regarding such rating systems, confusion in the
marketplace may occur, and we are unable to predict what effect, if any, such
rating systems would have on our business. In addition to such regulations,
certain retailers have in the past declined to stock some of our products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. While to date these actions
have not caused material harm to our business, we cannot assure you that similar
actions by our distributors or retailers in the future would not cause material
harm to our business.
RISKS RELATED TO OUR STOCK
SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND INHIBIT OUR ABILITY TO RECEIVE A
PREMIUM PRICE FOR YOUR SHARES.
Our Certificate of Incorporation, as amended, provides for 5,000,000
authorized shares of Preferred Stock. Our Board of Directors has the authority,
without any action by the stockholders, to issue up to 4,280,576 shares of
preferred stock and to fix the rights and preferences of such shares. 719,424
shares of Series A Preferred Stock was issued to Titus in the past, which amount
has been fully converted into our common stock. In addition, our certificate of
incorporation and bylaws contain provisions that:
o eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to nominate
directors or submit proposals for stockholder approval.
36
These provisions may have the effect of delaying, deferring or preventing a
change in control, may discourage bids for our common stock at a premium over
its market price and may adversely affect the market price, and the voting and
other rights of the holders, of our common stock.
OUR COMMON STOCK MAY BE SUBJECT TO THE "PENNY STOCK" RULES WHICH COULD ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
"Penny stocks" generally include equity securities with a price of less
than $5.00 per share, which are not traded on a national stock exchange or on
Nasdaq, and are issued by a company that has tangible net assets of less than
$2,000,000 if the company has been operating for at least three years. The
"penny stock" rules require, among other things, broker dealers to satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving a purchaser's written consent prior to
any transaction. In addition, additional disclosure in connection with trades in
the common stock are required, including the delivery of a disclosure schedule
prescribed by the SEC relating to the "penny stock" market. These additional
burdens imposed on broker-dealers may discourage them from effecting
transactions in our common stock, which may make it more difficult for an
investor to sell their shares and adversely affect the market price of our
common stock.
OUR STOCK IS VOLATILE
The trading price of our common stock has previously fluctuated and could
continue to fluctuate in response to factors that are largely beyond our
control, and which may not be directly related to the actual operating
performance of our business, including:
o general conditions in the computer, software, entertainment, media or
electronics industries;
o changes in earnings estimates or buy/sell recommendations by analysts;
o investor perceptions and expectations regarding our products, plans
and strategic position and those of our competitors and customers; and
o price and trading volume volatility of the broader public markets,
particularly the high technology sections of the market.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of December 31,
2004. However, we are exposed to certain market risks arising from transactions
in the normal course of business, principally the risk associated with foreign
currency fluctuations. We do not hedge our risk associated with foreign currency
fluctuations.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, which primarily have been from
Avalon.
We recognized a $33,000 loss, $58,000 gain and $104,000 loss during the
years ended December 31, 2004, 2003 and 2002, respectively, primarily in
connection with foreign exchange fluctuations in the timing of payments received
on accounts receivable from Avalon.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements begin on page F-1 of this report.
37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information required by this Item 9 has been previously furnished and
is incorporated herein by reference to our forms 8-K filed on (i) February 25,
2003, and amendment to such form 8-K filed on February 27, 2003, and (ii) March
30, 2005.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and interim Chief Financial Officer of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
this evaluation, our Chief Executive Officer and interim Chief Financial Officer
concluded that our disclosure controls and procedures were of limited
effectiveness, at the reasonable assurance level, in timely alerting him to
material information required to be included in this report.
Due to the departure of numerous key employees during June 2004, there was
significant change in our internal controls over financial reporting that
occurred during the quarter ended September 30, 2004 and the quarter ended
December 31, 2004 that have materially affected or are reasonably likely to
materially affect these controls.
Our management, including the CEO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
necessarily prevent all fraud and material errors. An internal control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations on all internal
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, and/or by management
override of the control. The design of any system of internal control is also
based in part upon certain assumptions about the likelihood of future events,
and there can be no absolute assurance that any design will succeed in achieving
its stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in circumstances, and/or the degree of
compliance with the policies and procedures may deteriorate.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
SUMMARY INFORMATION CONCERNING DIRECTORS, EXECUTIVE OFFICERS AND CERTAIN
SIGNIFICANT EMPLOYEES
The following table sets forth certain information regarding our
directors and executive officers and their ages as of May 27, 2005:
DIRECTORS AGE PRESENT POSITION
Herve Caen 43 Chairman of the Board of Directors,
Chief Executive Officer and Interim
Chief Financial Officer
Eric Caen 39 Director
Michel Welter (1)(2)(3) 46 Director
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
(3) Member of the Independent Committee of the Board of Directors.
38
Herve Caen and Eric Caen are brothers. There are no other family
relationships between any director and/or any executive officer. The Board of
Directors has determined that there are no other significant employees for
purposes of this Item 10.
BACKGROUND INFORMATION CONCERNING DIRECTORS AND EXECUTIVE OFFICERS
HERVE CAEN joined us as President and as a director in November 1999. Mr.
Caen was appointed interim Chief Executive Officer in January 2002 and currently
serves as our Chief Executive Officer and interim Chief Financial Officer to
date. Mr. Caen has served as Chairman of our Board of Directors since September
2001. Mr. Caen has served as Chairman of the Board of Directors of Titus
Interactive S.A., an interactive entertainment software company since 1991. Mr.
Caen was also Chief Executive Officer of Titus Interactive S.A. from 1991
through December 31, 2002. Mr. Caen also serves as Managing Director of Titus
Interactive Studio, Titus SARL and Digital Integration Services, which positions
he has held since 1985, 1991 and 1998, respectively. Mr. Caen also serves as
Chief Executive Officer of Titus Software Corporation, Chairman of Titus
Software UK Limited and Representative Director of Titus Japan K.K., which
positions he has held since 1988, 1991 and 1998, respectively.
ERIC CAEN has served as a director since November 1999. Mr. Caen has served
as a Director and as President of Titus Interactive S.A. since 1991. Mr. Caen is
also currently the Chief Executive Officer of Titus Interactive S.A. Mr. Caen
also serves as Vice President of Titus Software Corporation, Secretary and
Director of Titus Software UK Limited and Director of Titus Japan K.K. and
Digital Integration Limited, which positions he has held since 1988, 1991, 1998
and 1998, respectively. Mr. Caen has also served as Managing Director of Total
Fun 2, a French record production company, since 1998. Mr. Caen served as
Managing director of Titus SARL from 1988 to 1991.
MICHEL WELTER joined our Board of Directors in September 2001. Mr. Welter,
together with his company Weltertainment, is involved in the trading and
exploitation of animated TV series. From 2000 to 2002 he served as President of
CineGroupe International, a Canadian company, which develops, produces and
distributes animated television series and movies. From 1990 to the end of 2000,
Mr. Welter served as President of Saban Enterprises where he launched the
international merchandising for the hit series "Power Rangers" and was in charge
of international business development where he put together numerous
co-productions with companies in Europe and Asia.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our executive officers, directors, and persons who own more than 10% of a
registered class of our equity securities to file reports of ownership and
changes in ownership with the SEC. Executive officers, directors and greater
than 10% stockholders are required by SEC rules and regulations to furnish us
with all Section 16(a) forms they file. Based solely on our review of the copies
of the forms received by us and representations from certain reporting persons
that they have complied with the relevant filing requirements, we believe that,
during the year ended December 31, 2004, all our executive officers, directors
and greater than 10% stockholders complied with all Section 16(a) filing
requirements.
AUDIT COMMITTEE INDEPENDENCE AND AUDIT COMMITTEE FINANCIAL EXPERT.
The Audit Committee currently consists of Michel Welter. The Board has
determined that since October 2004 when Mr. Stefanovich resigned from the board,
who was until that time the "audit committee financial expert", as that term is
defined in Section 407 of the Sarbanes-Oxley Act of 2002 and pursuant to the
rules and regulations of the SEC, the Audit Committee no longer has such an
expert. The Board determined that Mr. Stefanovich was, and has also determined
that Mr. Welter is, "independent", as that term is defined under the rules of
the National Association of Securities Dealers, Inc.
CODE OF ETHICS
We have adopted a Code of Ethics for all of our employees, including our
principal executive officer, principal financial officer, principal accounting
officer or controller and any person performing similar functions. The Code of
Ethics was filed as an exhibit to the Amendment No. 1 to the 10K for the period
ended December 31, 2003.
39
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
earned during the last three fiscal years ended December 31, 2004, by our Chief
Executive Officer and President whose total salary and bonus during the year
ended December 31, 2004 exceeded $100,000 (collectively, the "Named Executive
Officers"). No other executive officer serving at December 31, 2004, received
total salary and bonus during 2004 in excess of $100,000.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
------------
ANNUAL COMPENSATION SECURITIES
------------------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS(#) COMPENSATION
- -------------------------------- ---- --------- ----- ------------ ------------
Herve Caen (1).................. 2004 $ 260,330 (2) -- -- $ --
Chairman of the Board of 2003 487,147 -- -- (3)
Directors, Chief Executive 2002 250,000 -- -- --
Officer and Interim Chief
Financial Officer
Phillip Adam.................... 2004 116,276 (4) -- -- 2,000 (5)
President 2003 200,000 -- -- 12,000 (5)
2002 168,000 -- -- 5,331 (5)
- ----------
(1) Mr. Caen joined us as President in November 1999. Mr. Caen was
appointed Chief Executive Officer in January 2002 and currently serves
as our Chief Executive Officer and interim Chief Financial Officer. Mr.
Caen has served as Chairman of our Board of Directors since September
2001. In March 2003, our Compensation Committee approved an annual base
salary of $360,000 as Chief Executive officer and $100,000 per year
while serving as interim Chief Financial Officer.
(2) Mr. Caen was only paid a portion of his salary during FY 2004 due to
the limited cash available. We accrued the balance due Mr. Caen of
$199,670 as of December 31, 2004.
(3) Mr. Caen received 2,000 shares of our common stock pursuant to a
non-discretionary grant made under the terms of our Employee Stock
Purchase Program.
(4) Mr. Adam was only paid a portion of his salary during FY 2004 due to
the limited cash available. We accrued the balance due Mr. Adam of
$75,391 as of December 31, 2004. Mr. Adam resigned on January 15th,
2005.
(5) Mr. Adam's other compensation consists of matching payments made under
our 401(k) plan.
40
STOCK OPTION GRANTS IN FISCAL 2004
There were no stock options or stock appreciation rights granted to the
Named Executive Officers during the year ended December 31, 2004.
AGGREGATE OPTION/ SAR EXERCISES
AND 2004 YEAR-END OPTION VALUES
There were no exercises of stock options or stock appreciation rights
during the year ended December 31, 2004 for any of the Named Executive Officers.
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN-THE-
UNEXERCISED OPTIONS MONEY OPTIONS AT
AT YEAR-END YEAR-END
SHARES ACQUIRED (EXERCISABLE/ (EXERCISABLE/
NAME ON EXERCISE VALUE REALIZED UNEXERCISABLE) UNEXERCISABLE) (1)
---- ----------- -------------- -------------- ------------------
Herve Caen -- -- -- --
Phillip Adam -- -- 10,000/0 $0/$0
- ----------
(1) Represents an amount equal to the difference between the closing sale
price for our common stock ($0.08) on the Over-The-Counter Bulletin
Board on December 31, 2003, and the option exercise price, multiplied
by the number of unexercised in-the-money options. None of the options
held by the Named Executive Officers were in-the-money at year-end.
DIRECTOR COMPENSATION
Currently, we accrue for payment to each of our non-employee directors'
compensation as follows:
o $5,000 in cash compensation per quarter for attendance at Board of
Directors meetings.
o $5,000 in cash compensation per annum for each Board committee a
director is a member of and participates in.
o Upon election and appointment to the Board, or upon loss of employee
status of an employee director, an option to purchase up to 25,000
shares of our common stock under the Third Amended and Restated 1997
Stock Incentive Plan. These director options are each for a term of
ten years and vest over the first three years.
o An option to purchase 5,000 shares of our common stock under the Third
Amended and Restated 1997 Stock Incentive Plan for each subsequent
year of director service. These director options are each for a term
of ten years and vest over the first three years.
EMPLOYMENT AGREEMENTS
Mr. Herve Caen currently serves as our Chief Executive Officer and interim
Chief Financial Officer. We previously entered into an employment agreement with
Mr. Herve Caen for a term of three years through November 2002, pursuant to
which he currently serves as our Chairman of the Board of Directors and Chief
Executive Officer. The employment agreement provided for an annual base salary
of $250,000, with such annual raises as may be approved by the Board of
Directors, plus annual bonuses at the discretion of the Board of Directors. Mr.
Caen is also entitled to participate in the incentive compensation and other
employee benefit plans established by us from time to time. In March 2003, our
Compensation Committee approved an annual base salary increase for Mr. Caen from
$250,000 to $360,000. The Compensation Committee is currently negotiating a new
employment agreement with Mr. Caen.
Mr. Phillip Adam served as our President during 2004. In March 2003, our
Compensation Committee approved a three-year employment agreement with Mr. Adam
as President for an annual base salary of $200,000. Mr. Adam resigned from the
company on January 15, 2005.
41
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee currently consists of Michel Welter. From
January to August 2004, the Compensation Committee was comprised of Michel
Welter, Jerry DeCiccio and Robert Stefanovich. Mr. DeCiccio resigned as a
director in August 2004. From August 2004 to Ortober 2004, Mr Welter and Mr
Stefanovich served on our Compensation Committee. Mr. Stefanovich resigned as a
director in October 2004. During 2004, decisions regarding executive
compensation were made by our Compensation Committee. None of the current 2004
members of our Compensation Committee nor any of our 2004 executive officers or
directors had a relationship that would constitute an interlocking relationship
with executive officers and directors of another entity.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The following is the Report of the Compensation Committee describing the
compensation policies applicable to the Company's executive officers. This
information shall not be deemed to be "soliciting material" or to be "filed"
with the SEC nor shall this information be incorporated by reference into any
future filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, except to the extent that the company
specifically incorporates it by reference into a filing.
Compensation Policies and Objectives
The Compensation Committee reviews and approves the annual salary, bonus
and other benefits, including incentive compensation awards, of our executive
officers, including the Chief Executive Officer. The Compensation Committee also
reviews the employee benefit plans and recommends changes to the existing plans
to the Board of Directors. The executive compensation policy is designed to
attract and retain exceptional executives by offering compensation for superior
performance that is competitive with other well-managed organizations. The
Compensation Committee measures executive performance on an individual and
corporate basis.
There are three components to the executive compensation program, as
follows:
Base Salary. Base salaries for executives and other key employees
are determined by individual financial and non-financial performance and general
economic conditions of the company and of the industry. In recommending salaries
for executive officers, the Compensation Committee (i) reviews the historical
performance of the executives, and (ii) reviews specific information provided by
its accountants and other consultants, as necessary, with respect to the
competitiveness of salaries paid to the our executives.
Annual Bonus. Annual bonuses for executives and other key employees
are tied directly to the company's financial performance as well as individual
performance. The purpose of annual cash bonuses is to reward executives for
achievements of corporate, financial and operational goals. Annual cash bonuses
are intended to reward the achievement of outstanding performance. If certain
objective and subjective performance goals are not met, annual bonuses are
reduced or not paid.
Long-Term Incentives. The purpose of these plans is to create an
opportunity for executives and other key employees to share in the enhancement
of stockholder value through stock options. The overall goal of this component
of pay is to create a strong link between the management of the company and its
stockholders through management stock ownership and the achievement of specific
corporate financial measures that result in the appreciation of our share price.
Stock options are awarded in order to tie the executive officers' interests to
the company's performance and align those interests closely with those of our
stockholders. The Compensation Committee generally has followed the practice of
granting options on terms that provide that the options become exercisable in
installments over a two to five year period. The Compensation Committee believes
that this feature not only provides an employee retention factor but also makes
longer-term growth in share prices important for those receiving options.
No stock options were granted to our executive officers in 2004. The
Compensation Committee continues to review the desirability of issuing stock
options to its executive officers in any given fiscal year to provide incentives
in connection with our corporate objectives.
42
Fiscal Year 2004 Chief Executive Officer Compensation
The salary, annual raises and annual bonus of Herve Caen, our Chief
Executive Officer and interim Chief Financial Officer, are determined in
accordance with Mr. Caen's employment agreement with us. Mr. Caen's employment
agreement provides for a base salary of $360,000 per year, with annual raises
and bonuses as may be approved at the discretion of our Board of Directors and
$100,000 per year while serving as interim Chief Financial Officer. The amounts
of any annual raises or bonuses are determined in accordance with the policies
and objectives set forth above. For the fiscal year ended December 31, 2004, Mr.
Caen received $260,330 in compensation as Chief Executive Officer and interim
Chief Financial Officer. The Compensation Committee did not award Mr. Caen any
options during 2004. The Compensation Committee is currently negotiating a new
employment agreement with Mr. Herve Caen.
Tax Law Implications for Executive Compensation
Section 162(m) of the Internal Revenue Code limits us to a deduction for
federal income tax purposes of no more than $1 million of compensation paid to
certain Named Executive Officers in a taxable year. Compensation above $1
million may be deducted if it is "performance-based compensation" within the
meaning of the Code. The Compensation Committee believes that at present the
compensation paid to each Named Executive Officer in a taxable year will not
exceed the deduction limit of $1 million under Section 162(m). However, the
Compensation Committee has determined that stock awards granted under the
long-term incentive plans with an exercise price at least equal to the fair
market value of our common stock on the date of grant will be treated as
"performance-based compensation."
The Compensation Committee*
Michel Welter
* From January to August 2004, the Compensation Committee was
comprised of Michel Welter, Jerry DeCiccio and Robert
Stefanovich. Mr. DeCiccio resigned as a director in August 2004.
Mr. Stefanovich resigned as a director in October 2004.
PERFORMANCE GRAPH
The following graph sets forth the percentage change in cumulative total
stockholder return of our common stock during the period from December 31, 1999
to December 31, 2004, compared with the cumulative returns of the NASDAQ Stock
Market (U.S. Companies) Index and the Media General Index 820*. The comparison
assumes $100 was invested on December 31, 1999 in our common stock and in each
of the foregoing indices. Information presented below is as of the end of the
fiscal year ended December 31, 2004.
This performance graph and the data related thereto shall not be deemed to
be "soliciting material" or "filed" with the SEC nor shall this information be
incorporated by reference into any future filing under the Securities Act of
1933, as amended, or the Securities Exchange Act of 1934, as amended, except to
the extent that we specifically incorporate it by reference into a filing.
[PERFORMANCE GRAPH OMITTED]
Cumulative Total Return
--------------------------------------------------------------------------------------
12/99 3/00 6/00 9/00 12/00 3/01 6/01 9/01 12/01 3/02 6/02
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
INTERPLAY ENTERTAINMENT CORP 100.00 119.13 89.35 129.78 87.24 53.20 74.88 14.30 15.66 10.89 12.93
NASDAQ STOCK MARKET (U.S.) .. 100.00 106.34 91.13 76.62 58.64 50.19 51.16 33.34 45.16 44.30 34.32
MEDIA GENERAL INDEX 820 ..... 100.00 97.40 96.44 112.07 89.88 81.82 99.20 71.03 92.37 93.67 87.36
Cumulative Total Return
-----------------------------------------------------------------------------
9/02 12/02 3/03 6/03 9/03 12/03 3/04 6/04 9/04 12/04
----- ----- ----- ----- ----- ----- ----- ----- ----- ------
INTERPLAY ENTERTAINMENT CORP 4.08 2.04 2.38 4.42 3.74 2.55 4.08 0.99 0.75 0.48
NASDAQ STOCK MARKET (U.S.) .. 28.13 26.34 23.80 29.32 35.67 38.12 41.12 39.67 37.83 40.57
MEDIA GENERAL INDEX 820 ..... 79.27 62.83 69.73 91.72 107.97 111.75 128.21 128.73 110.12 148.02
43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of March 31, 2005, unless otherwise
indicated, certain information relating to the ownership of our common stock by
(i) each person known by us to be the beneficial owner of more than 5% of the
outstanding shares of our common stock, (ii) each of our directors, (iii) each
of the Named Executive Officers, and (iv) all of our executive officers and
directors as a group. Except as may be indicated in the footnotes to the table
and subject to applicable community property laws, each such person has the sole
voting and investment power with respect to the shares owned. The address of
each person listed is in care of us, 1682 Langley Avenue, Irvine, California
92606, unless otherwise set forth below such person's name.
NUMBER OF SHARES
OF COMMON STOCK
NAME AND ADDRESS BENEFICIALLY OWNED (1) PERCENT (2)
- ---------------- ---------------------- -----------
DIRECTORS:
Herve Caen.............................. 8,681,306 (4) 9.2%
Eric Caen............................... 30,001 (5) *
Michel Welter........................... 60,001 (6) *
NON-DIRECTOR NAMED EXECUTIVE OFFICERS:
Phillip Adam 208,779 (7) *
5% HOLDERS:
Titus Interactive SA.................... 58,426,293 (3) 62.3%
Parc de l'Esplanade
12, rue Enrico Fermi
St-Thibault-des-Vignes
77462 Lagny-sur-Marne Cedex
France
Directors and Executive Officers
as a Group (4 persons)............... 8,961,754 9.5%
- ----------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules and
regulations of the SEC and generally includes voting or investment power
with respect to securities. Shares of common stock subject to options
currently exercisable, or exercisable within 60 days of March 31, 2005 are
deemed outstanding for computing the percentage of the person holding such
options but are not deemed outstanding for computing the percentage of any
other person. Except as indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole
voting and investment power with respect to all shares of common stock
shown as beneficially owned by them. The information as to shares
beneficially owned has been individually furnished by the respective
directors, Named Executive Officers, and other stockholders, or taken from
documents filed with the SEC.
(2) Based on 93,855,634 shares of common stock outstanding as of March 31,
2005. Percentages are rounded to the nearest tenth of a percent.
(3) Includes 460,298 shares subject to warrants exercisable within 60 days of
March 31, 2005. (4) Includes 8,681,306 shares of our common stock held
directly by Mr. Herve Caen. (5) Includes 30,001 shares subject to stock
options exercisable within 60 days of March 31, 2005. (6) Includes 20,001
shares subject to stock options exercisable within 60 days of March 31,
2005. (7) Includes 10,000 shares subject to stock options exercisable
within 60 days of March 31, 2005.
44
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2004:
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under equity
be issued upon exercise exercise price of compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- --------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 211,150 2.02 7,609,447
approved by security
holders
Equity compensation plans -- -- --
not approved by
security holders
-----------------------------------------------------------------------------
Total 211,150 2.02 7,609,447
=============================================================================
We have one stock option plan currently outstanding. Under the 1997 Stock
Incentive Plan, as amended (the "1997 Plan"), we may grant options to our
employees, consultants and directors, which generally vest from three to five
years. At our 2002 annual stockholders' meeting, our stockholders voted to
approve an amendment to the 1997 Plan to increase the number of authorized
shares of common stock available for issuance under the 1997 Plan from four
million to 10 million. Our Incentive Stock Option, Nonqualified Stock Option and
Restricted Stock Purchase Plan- 1991, as amended (the "1991 Plan"), and our
Incentive Stock Option and Nonqualified Stock Option Plan-1994, as amended (the
"1994 Plan"), have terminated. Our employee stock purchase plan has been
terminated. An aggregate of 9,050 stock options that remain outstanding under
the 1991 Plan and 1994 Plan have been transferred to our 1997 Plan.
We have treated the difference, if any, between the exercise price and the
estimated fair market value as compensation expense for financial reporting
purposes, pursuant to APB 25. Compensation expense for the vested portion
aggregated $0, $0 and $0 for the years ended December 31, 2004, 2003 and 2002,
respectively.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
It is our policy that related party transactions are to be reviewed and
approved by a majority of our disinterested directors or our Independent
Committee.
Our operations involve significant transactions with our majority
stockholder Titus and its affiliates. We had a major distribution agreement with
Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus presently owns approximately 58 million shares of common stock, which
represents approximately 62% of our outstanding common stock, our only voting
security.
We performed certain distribution services on behalf of Titus for a fee. In
connection with such distribution services, we recognized fee income of $0 and
$5,000 for the twelve months ended December 31, 2004, and 2003, respectively.
As of December 31, 2004 and December 31, 2003, Titus and its affiliates
excluding Avalon owed us $370,000 and $362,000, respectively. We owed Titus and
its affiliates excluding Avalon $30,000 and $0 as of December 31, 2004 and
December 31, 2003 respectively.
45
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
We had an International Distribution Agreement with Avalon, a wholly owned
subsidiary of Titus. Pursuant to this distribution agreement, Avalon provided
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 paid
Avalon a distribution fee based on net sales, and Avalon provides certain market
preparation, warehousing, sales and fulfillment services on our behalf. In
connection with the International Distribution Agreement with Avalon, we
incurred distribution commission expense of $62,000 and $.9 million, for the
twelve months ended December 31, 2004, and 2003 respectively. This agreement was
terminated as a result of Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software Corp.,
("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at September 30, 2004 was approximately $254,000. The total receivable
due from TSC is approximately $327,000 as of September 30, 2004. The majority of
the additional approximately $73,000 was due to TSC subletting office space and
miscellaneous other items.
In May 2003, we paid TSC $60,000 to cover legal fees in connection with a
lawsuit against Titus. As a result of the payment, our CEO requested that we
credit the $60,000 to amounts we owed to him arising from expenses incurred in
connection with providing services to us. Our Board of Directors is in the
process of investigating the details of the transaction, including independent
counsel review as appropriate, in order to properly record the transaction.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. This representation agreement has not yet been
approved by our Board of Directors and is currently being reviewed by them. Our
Board of Directors has approved the payments of certain amounts to Titus Japan
in connection with certain services already performed by them on our behalf. As
of December 31, 2004 we had a zerobalance with Titus Japan. During the twelve
months ending December 31, 2004 our Japanese subsidiary paid to Titus Japan
approximately $209,000 in commissions, marketing and publishing staff services.
Our Japanese subsidiary had approximately $369,000 in revenue in the twelve
months ending December 31, 2004.
TRANSACTIONS WITH TITUS SARL
As of December 31, 2004, we have a receivable of $18,000 and $43,000
respectively for product development services that we provided. Titus SARL was
placed into involuntary liquidation in January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, we engaged the services of GIE Titus Interactive Group, a
wholly owned subsidiary of Titus, for a three-month service agreement pursuant
to which GIE Titus or its agents shall provide to us certain foreign
administrative and legal services at a rate of $5,000 per month for three
months. As of December 31, 2004, we had a zero balance with Titus GIE
Interactive Group. Titus GIE was placed into involuntary liquidation in January
2005.
46
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Rose, Snyder & Jacobs ("RSJ") served as our independent auditors for fiscal
year 2004. For fiscal year 2003, Squar, Milner, Reehl & Williamson LLP ("SMRW")
served as our independent auditors.
Aggregate fees billed by our independent auditors for professional services
rendered for the audit of fiscal years 2004 and 2003 and for other professional
services billed in fiscal years 2004 and 2003 are as follows:
YEAR ENDED
------------------------------------------------
DESCRIPTION OF FEES DECEMBER 31, 2004 DECEMBER 31, 2003
- ------------------- ----------------- -----------------
Audit Fees $16,097 (1)(4) $100,860 (3)
Audit-Related Fees -- 56,000 (2)
Tax Fees (3) -- --
All Other Fees -- --
- --------------------------------------------------------------------------------
TOTAL: $16,097 $227,372
======
(1) This entire amount was paid to SMRW.
(2) We paid SMRW $45,000 for a 12-month audit ending June 30, 2003 in
connection with the audit requirements of our majority stockholder Titus
Interactive S.A. ("Titus"), of which $37,500 was reimbursed to us by Titus.
The $7,500 balance was determined by SMRW to be savings applied towards our
regular annual company audit. This semi-annual audit and the related
reimbursement amount was pre-approved and authorized by our Audit
Committee.
(3) Of this amount, $85,000 was paid to SMRW and $96,972 was paid to Ernst &
Young.
(4) We expect to incur additional fees in connection with the review of this
form 10-K for the year ended December 31, 2004.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
Our Audit Committee has a policy that all audit and non-audit related
services provided by our independent auditor is to be approved by our Audit
Committee. Specifically, the Audit Committee requires that prior to the
engagement of our independent auditor for any specified service, the approval of
the Audit Committee must be received. All such matters are to be approved in a
scheduled meeting of the Audit Committee consisting of a quorum of the Audit
Committee. All of the above aggregate fees billed by our independent auditors
have been approved pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation
S-X.
47
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents, except for exhibit 32.1 which is being furnished
herewith, are filed as part of this report:
(1) Financial Statements
The list of financial statements contained in the accompanying Index
to Consolidated Financial Statements covered by the Reports of Independent
Auditors is herein incorporated by reference.
(2) Financial Statement Schedules
The list of financial statement schedules contained in the
accompanying Index to Consolidated Financial Statements covered by the Reports
of Independent Auditors is herein incorporated by reference.
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or the
Notes thereto.
(3) Exhibits
The list of exhibits on the accompanying Exhibit Index is herein
incorporated by reference.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized, at Irvine, California
this 3rd day of June 2005.
INTERPLAY ENTERTAINMENT CORP.
/s/ Herve Caen
By:_________________________________
Herve Caen
Its: Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
POWER OF ATTORNEY
The undersigned directors and officers of Interplay Entertainment Corp. do
hereby constitute and appoint Herve Caen with full power of substitution and
resubstitution, as their true and lawful attorneys and agents, to do any and all
acts and things in our name and behalf in our capacities as directors and
officers and to execute any and all instruments for us and in our names in the
capacities indicated below, which said attorney and agent, may deem necessary or
advisable to enable said corporation to comply with the Securities Exchange Act
of 1934, as amended and any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with this Annual Report on
Form 10-K, including specifically but without limitation, power and authority to
sign for us or any of us in our names in the capacities indicated below, any and
all amendments (including post-effective amendments) hereto, and we do hereby
ratify and confirm all that said attorneys and agents, or either of them, shall
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Annual Report and Form 10-K has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Herve Caen
____________________ Chief Executive Officer, Interim Chief June 3, 2005
Herve Caen Financial Officer and Director
(Principal Executive and Financial and
Accounting Officer)
/s/ Eric Caen
____________________ Director June 3, 2005
Eric Caen
/s/ Michel Welter
____________________ Director June 3, 2005
Michel Welter
49
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ------- -----------------------------------------------------------------------
2.1 Agreement and Plan of Reorganization and Merger, dated May 29, 1998,
between the Company and Interplay Productions; (incorporated herein by
reference to Exhibit 2.1 to the Company's Registration Statement on
Form S-1, No. 333-48473 (the "Form S-1")).
2.2 Stock Purchase Agreement by and between Infogrames, Inc., Shiny
Entertainment Inc., David Perry, Shiny Group, Inc., and the Company
dated April 23, 2002; (incorporated herein by reference to Exhibit 2.1
to the Company's Form 8-K filed May 6, 2002).
2.3 Amendment Number 1 to the Stock Purchase Agreement by and between the
Company, Infogrames, Inc., Shiny Entertainment, Inc., David Perry, and
Shiny Group, Inc. dated April 30, 2002; (incorporated herein by
reference to Exhibit 2.2 to the Company's Form 8-K filed May 6, 2002).
3.1 Amended and Restated Certificate of Incorporation of the Company;
(incorporated herein by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003).
3.2 Certificate of Designation of Preferences of Series A Preferred Stock,
as filed with the Delaware Secretary of State on April 14, 2000;
(incorporated herein by reference to Exhibit 10.32 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999).
3.3 Certificate of Amendment of Certificate of Designation of Rights,
Preferences, Privileges and Restrictions of Series A Preferred Stock,
as filed with the Delaware Secretary of State on October 30, 2000;
(incorporated herein by reference to Exhibit 3.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003).
3.4 Certificate of Amendment of Amended and Restated Certificate of
Incorporation of the Company, as filed with the Delaware Secretary of
State on November 2, 2000; (incorporated herein by reference to Exhibit
3.4 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
3.5 Certificate of Amendment of Amended and Restated Certificate of
Incorporation of the Company, as filed with the Delaware Secretary of
State on January 21, 2004; (incorporated herein by reference to Exhibit
3.5 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
3.6 Amended and Restated Bylaws of the Company; (incorporated herein by
reference to Exhibit 3.6 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2003).
3.7 Amendment to the Amended and Restated Bylaws of the Company dated March
9, 2004; (incorporated herein by reference to Exhibit 3.7 to the
Company's Annual Report on Form 10-K for the year ended December 31,
2003).
4.1 Specimen form of stock certificate for Common Stock; (incorporated
herein by reference to Exhibit 4.1 to the Form S-1)
4.2 Shareholders' Agreement among MCA Inc., the Company, and Brian Fargo,
dated March 30, 1994, as amended; (incorporated herein by reference to
Exhibit 4.2 to the Form S-1).
4.3 Investors' Rights Agreement dated October 10, 1996, as amended, among
the Company and holders of its Subordinated Secured Promissory Notes
and Warrants to purchase Common Stock.; (incorporated herein by
reference to Exhibit 4.3 to the Form S-1).
10.01 Third Amended and Restated 1997 Stock Incentive Plan (the "1997 Plan");
(incorporated herein by reference to Appendix A of the Definitive Proxy
Statement filed on August 20, 2002).
50
10.02 Form of Stock Option Agreement pertaining to the 1997 Plan. 10.03 Form
of Restricted Stock Purchase Agreement pertaining to the 1997 Plan;
(incorporated herein by reference to Exhibit 10.3 to the Form S-1).
10.04 Employee Stock Purchase Plan; (incorporated herein by reference to
Exhibit 10.10 to the Form S-1).
10.05 Form of Indemnification Agreement for Officers and Directors of the
Company; (incorporated herein by reference to Exhibit 10.11 to the Form
S-1).
10.06 Von Karman Corporate Center Office Building Lease between the Company
and Aetna Life Insurance Company of Illinois dated September 8, 1995,
together with amendments thereto; (incorporated herein by reference to
Exhibit 10.14 to the Form S-1).
10.07 Heads of Agreement concerning Sales and Distribution between the
Company and Activision, Inc., dated November 19, 1998, as amended;
(incorporated herein by reference to Exhibit 10.23 to The Company's
Annual Report on Form 10-K for the year ended December 31, 1998).
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment).
10.08 Stock Purchase Agreement between the Company and Titus Interactive SA,
dated March 18, 1999; (incorporated herein by reference to Exhibit
10.24 to The Company's Annual Report on Form 10-K for the year ended
December 31, 1998).
10.09 International Distribution Agreement between the Company and Virgin
Interactive Entertainment Limited, dated February 10, 1999;
(incorporated herein by reference to Exhibit 10.26 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1998).
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment).
10.10 Termination Agreement among the Company, Virgin Interactive
Entertainment Limited, VIE Acquisition Group, LLC and VIE Acquisition
Holdings, LLC, dated February 10, 1999; (incorporated herein by
reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998). Portions omitted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment).
10.11 Fifth Amendment to Lease for Von Karman Corporate Center Office
Building between the Company and Arden Realty Finance IV, L.L.C., dated
December 4, 1998; (incorporated herein by reference to Exhibit 10.29 to
the Company's Annual Report on Form 10-K for the year ended December
31, 1998).
10.12 Stock Purchase Agreement dated July 20, 1999, by and among the Company,
Titus Interactive S.A., and Brian Fargo; (incorporated herein by
reference to Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999).
10.13 Exchange Agreement dated July 20, 1999, by and among Titus Interactive
S.A., Brian Fargo, Herve Caen and Eric Caen; (incorporated herein by
reference to Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999).
10.14 Employment Agreement between the Company and Herve Caen dated November
9, 1999; (incorporated herein by reference to Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1999).
10.15 Warrant (350,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000; (incorporated herein by
reference to Exhibit 10.33 to The Company's Annual Report on Form 10-K
for the year ended December 31, 1999).
10.16 Warrant (50,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000; (incorporated herein by
reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999).
51
10.17 Warrant (100,000 shares) for Common Stock between the Company and Titus
Interactive S.A., dated April 14, 2000; (incorporated herein by
reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999).
10.18 Amendment Number 1 to International Distribution Agreement between the
Company and Virgin Interactive Entertainment Limited, dated July 1,
1999; (incorporated herein by reference to Exhibit 10.39 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1999).
10.19 Common Stock Subscription Agreement of the Company, dated March 29,
2001; (incorporated herein by reference to Exhibit 4.1 to the Form S-3
filed on April 17, 2001).
10.20 Common Stock Purchase Warrant of the Company; (incorporated herein by
reference to Exhibit 4.2 to the Form S-3 filed on April 17, 2001).
10.21 Warrant to Purchase Common Stock of the Company, dated April 25, 2001;
(incorporated herein by reference to Exhibit 10.4 to the Form S-3 filed
on May 4, 2001).
10.22 Agreement between the Company, Brian Fargo, Titus Interactive S.A., and
Herve Caen, dated May 15, 2001; (incorporated herein by reference to
Exhibit 99 to Form SCD 13D/A).
10.23 Distribution Agreement, dated August 23, 2001. (Portions omitted and
filed separately with the Securities and Exchange Commission pursuant
to a request for confidential treatment); (incorporated herein by
reference to Exhibit 10.1 to the Form 10-Q for the quarter ending
September 30, 2001).
10.24 Letter Agreement re: Amendment #1 to Distribution Agreement dated
August 23, 2001, dated September 14, 2001. (Portions omitted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment); (incorporated herein by reference
to Exhibit 10.2 to the Form 10-Q for the quarter ending September 30,
2001).
10.25 Letter Agreement re: Secured Advance and Amendment #2 to Distribution
Agreement, dated November 20, 2001 by and between the Company, and
Vivendi Universal Interactive Publishing North America, Inc.;
(incorporated herein by reference to Exhibit 10.47 to the Form 10-K for
the year ended December 31, 2001).
10.26 Letter Agreement re: Secured Advance and Amendment #3 to Distribution
Agreement, dated December 13, 2001 by and between the Company, and
Vivendi Universal Interactive Publishing North America, Inc.;
(incorporated herein by reference to Exhibit 10.48 to the Form 10-K for
the year ended December 31, 2001).
10.27 Third Amendment to Computer License Agreement, dated July 25, 2001 by
and between the Company, and Infogrames, Inc.; (incorporated herein by
reference to Exhibit 10.49 to the Form 10-K for the year ended December
31, 2001).
10.28 Letter Agreement and Amendment Number 4 to Distribution Agreement by
and between Vivendi Universal Games, Inc. and the Company, dated
January 18, 2002; (incorporated herein by reference to Exhibit 10.1 to
Form 10-Q filed on May 15, 2002).
10.29 Fourth Amendment To Computer License Agreement by and between the
Company, and Infogrames Interactive, Inc. dated January 23, 2002.
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to request for confidential treatment);
(incorporated herein by reference to Exhibit 10.2 to Form 10-Q filed on
May 15, 2002).
10.30 Amendment Number Four to the Product Agreement by and between the
Company, Infogrames Interactive, Inc., and Bioware Corp. dated January
24, 2002; (incorporated herein by reference to Exhibit 10.3 to Form
10-Q filed on May 15, 2002).
52
10.31 Amended and Restated Amendment Number 1 to Product Agreement by and
between the Company, and High Voltage Software, Inc. dated March 5,
2002. (Portions omitted and filed separately with the Securities and
Exchange Commission pursuant to request for confidential treatment);
(incorporated herein by reference to Exhibit 10.4 to Form 10-Q filed on
May 15, 2002).
10.32 Settlement Agreement and Release by and between Brian Fargo, the
Company, Interplay OEM, Inc., Gamesonline.com, Inc., Shiny
Entertainment, Inc., and Titus Interactive S.A. dated March 13, 2002;
(incorporated herein by reference to Exhibit 10.6 to Form 10-Q filed on
May 15, 2002).
10.33 Agreement by and between Vivendi Universal Games Inc., the Company, and
Shiny Entertainment, Inc. dated April of 2002; (incorporated herein by
reference to Exhibit 10.7 to Form 10-Q filed on May 15, 2002).
10.34 Term Sheet by and between Titus Interactive S.A., and the Company,
dated April 26, 2002; (incorporated herein by reference to Exhibit 10.8
to Form 10-Q filed on May 15, 2002).
10.35 Promissory Note by Titus Interactive S.A. in favor of the Company,
dated April 26, 2002; (incorporated herein by reference to Exhibit 10.9
to Form 10-Q filed on May 15, 2002).
10.36 Amended and Restated Secured Convertible Promissory Note, dated April
30, 2002, in favor of Warner Bros., a division of Time Warner
Entertainment Company, L.P.; (incorporated herein by reference to
Exhibit 10.10 to Form 10-Q filed on May 15, 2002).
10.37 Video Game Distribution Agreement by and between Vivendi Universal
Games, Inc. and the Company, dated August 9, 2002. (Portions omitted
and filed separately with the Securities and Exchange Commission
pursuant to a request for confidential treatment); (incorporated herein
by reference to Exhibit 10.1 to Form 10-Q filed on November 19, 2002).
10.38 Letter of Intent by and between Vivendi Universal Games, Inc. and the
Company, dated August 9, 2002. (Portions omitted and filed separately
with the Securities and Exchange Commission pursuant to a request for
confidential treatment); (incorporated herein by reference to Exhibit
10.2 to Form 10-Q filed on November 19, 2002).
10.39 Letter Agreement and Amendment #2 by and between Vivendi Universal
Games, Inc. and the Company, dated August 29, 2002. (Portions omitted
and filed separately with the Securities and Exchange Commission
pursuant to a request for confidential treatment); (incorporated herein
by reference to Exhibit 10.3 to Form 10-Q filed on November 19, 2002).
10.40 Letter Agreement and Amendment #3 by and between Vivendi Universal
Games, Inc. and the Company, dated September 12, 2002. (Portions
omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment);
(incorporated herein by reference to Exhibit 10.4 to Form 10-Q filed on
November 19, 2002).
10.41 Letter Agreement and Amendment # 4 (OEM & Back-Catalog) to Video Game
Distribution Agreement dated August 9, 2002 by and between Vivendi
Universal Games, Inc. and the Company, dated December 20, 2002.
(Portions omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment);
(incorporated herein by reference to Exhibit 10.64 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2002).
10.42 Letter Agreement and Amendment # 5 (Asia Pacific & Australia) to Video
Game Distribution Agreement dated August 9, 2002 by and between Vivendi
Universal Games, Inc. and the Company dated January 13, 2003. (Portions
omitted and filed separately with the Securities and Exchange
Commission pursuant to a request for confidential treatment);
(incorporated herein by reference to Exhibit 10.65 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2002).
53
10.43 Purchase & Sale Agreement by and between Vivendi Universal Games, Inc.
and the Company dated February 26, 2003. (Portions omitted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment); (incorporated herein by reference
to Exhibit 10.1 to the Form 10-Q for the quarter ending March 31,
2003).
10.44 Amendment Number 2 of International Distribution Agreement by and
between Virgin Interactive Entertainment Limited (renamed Avalon
Interactive Group Ltd.) and the Company, dated January 1, 2000;
(incorporated herein by reference to Exhibit 10.44 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2003).
10.45 Amendment to International Distribution Agreement, by and between
Virgin Interactive Entertainment Limited (renamed Avalon Interactive
Group Ltd.) and the Company, dated April 2001; (incorporated herein by
reference to Exhibit 10.45 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2003).
10.46 Avalon Amendment Number 4 of International Distribution Agreement, by
and between Avalon Interactive Group Limited and the Company, dated
August 6, 2003; (incorporated herein by reference to Exhibit 10.46 to
the Company's Annual Report on Form 10-K for the year ended December
31, 2003).
10.47 Mutual Release Settlement Agreement by and between Warner Bros.
Entertainment, Inc. and the Company, dated October 13, 2003. 21.1
Subsidiaries of the Company; (incorporated herein by reference to
Exhibit 10.47 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003).
10.48 Letter Agreement by and between Majorem Ltd and the Company, dated
December 21, 2004.
14.1 Code of Ethics of the Company; (incorporated herein by reference to
Exhibit 14.1 to Amendment No. 1 to the Company's Annual Report on Form
10-K for the year ended December 31, 2003).
21.1 Subsidiaries of the Company
23.1 Consent of Squar, Milner LLP, Independent Registered Public Accounting
Firm.
23.2 Consent of Rose, Snyder & Jacobs, Independent Registered Public
Accounting Firm.
24.1 Power of Attorney (included on signature page to this Form 10-K)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and
Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1 Certification of Chief Executive Officer and interim Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 by Herve Caen.
99.1 Press Release dated August 15, 2002; (incorporated herein by reference
to Exhibit 99.2 to Form 10-Q filed August 19, 2002).
54
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORTS OF INDEPENDENT AUDITORS
PAGE
----
Reports of Independent Registered Public Accounting Firms F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at December 31, 2004 and 2003 F-4
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003 and 2002 F-5
Consolidated Statements of Stockholder's Equity (Deficit)
for the years ended December 31, 2004, 2003, 2002 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002 F-7
Notes to Consolidated Financial Statements F-9
Schedule II - Valuation and Qualifying Accounts S-1
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated balance sheet of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive S.A.), and
subsidiaries (the "Company"), as of December 31, 2004, and the related
consolidated statement of operations, shareholders' equity (deficit) and other
comprehensive income (loss) and cash flows for the year then ended. Our audit
also included the schedule of valuation and qualifying accounts for the year
ended December 31, 2004. These consolidated financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and schedule based
on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Interplay
Entertainment Corp. and subsidiaries as of December 31, 2004, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule for the year ended
December 31, 2004, when considered in relation to the basic financial
statements, taken as a whole, presents fairly in all material respects the
information set forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has negative working capital of $17.8 million and a stockholders'
deficit of $17.3 million at December 31, 2004. These factors, among others,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are described in Note 1.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Rose, Snyder & Jacobs, A Corporation of Public Accountants
Encino, California
May 31, 2005
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated balance sheet of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive S.A.), and
subsidiaries (the "Company"), as of December 31, 2003, and the related
consolidated statements of operations, shareholders' equity (deficit) and other
comprehensive income and cash flows for each of the years in the two year period
then ended. Our audit also included the financial statement schedule listed in
the Index at Item 15(a) (2) for the years ended December 31, 2003 and 2002.
These consolidated financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Interplay
Entertainment Corp. and subsidiaries as of December 31, 2003, and the results of
their operations and their cash flows for each of the years in the two year
period then ended in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, the related financial
statement schedule for the years ended December 31, 2003 and 2002, when
considered in relation to the basic financial statements, taken as a whole,
present fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has negative working capital of $14.8 million and a stockholders'
deficit of $12.7 million at December 31, 2003, losses from operations through
December 31, 2003 and negative operating cash flow for the year then ended.
These factors, among others, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Squar Milner Reehl & Williamson, LLP
Newport Beach, California
March 25, 2004
F-3
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
DECEMBER 31,
-------------------------
ASSETS 2004 2003
--------- ---------
Current Assets:
Cash ...................................... $ 29 $ 1,171
Restricted Cash ........................... 2 --
Trade receivables from related parties,
net of allowances of $2,370 and $691,
respectively .......................... 10 564
Trade receivables, net of allowances
of $36 and $34, respectively .......... 139 6
Inventories ............................... 26 146
Prepaid licenses and royalties ............ -- 209
Deposits .................................. -- 600
Prepaid expenses .......................... -- 673
Other receivables ......................... 137 3
--------- ---------
Total current assets ................... 343 3,372
Property and equipment, net .................... 490 2,114
--------- ---------
$ 833 $ 5,486
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current debt .............................. $ 1,575 $ 837
Accounts payable .......................... 8,772 7,093
Accrued royalties ......................... 3,501 5,067
Advances from distributors and others ..... 883 629
Advances from related party distributors .. 2,989 2,862
Deferred Income ........................... 475 1,634
--------- ---------
Total current liabilities ............ 18,195 18,122
========= =========
Commitments and contingencies
Stockholders' Equity (Deficit):
Preferred stock, $0.001 par value
5,000,000 shares authorized;
no shares issued or outstanding,
respectively,
Common stock, $0.001 par value
150,000,000 shares authorized;
93,855,634 shares issued and
outstanding, respectively .............. 94 94
Paid-in capital ........................... 121,640 121,640
Accumulated deficit ....................... (139,211) (134,481)
Accumulated other comprehensive income .... 115 111
--------- ---------
Total stockholders' equity (deficit)
(17,362) (12,636)
--------- ---------
$ 833 $ 5,486
========= =========
See accompanying notes.
F-4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
YEARS ENDED DECEMBER 31,
--------------------------------------
2004 2003 2002
-------- -------- --------
Net revenues ....................................... $ 1,932 $ 2,286 $ 15,021
Net revenues from related party distributors ....... 11,265 34,015 28,978
-------- -------- --------
Total net revenues .............................. 13,197 36,301 43,999
Cost of goods sold ................................. 6,826 13,120 26,706
-------- -------- --------
Gross profit .................................... 6,371 23,181 17,293
-------- -------- --------
Operating expenses:
Marketing and sales ............................. 1,703 1,415 5,814
General and administrative ...................... 4,514 6,692 7,655
Product development ............................. 2,636 13,680 16,184
-------- -------- --------
Total operating expenses ..................... 8,853 21,787 29,653
-------- -------- --------
Operating income (loss) ..................... (2,482) 1,394 (12,360)
-------- -------- --------
Other income (expense):
Interest expense
(249) (218) (2,214)
Gain on sale of Shiny ........................... -- -- 28,813
Other ........................................... (1,999) 136 683
-------- -------- --------
Total other income (expense) ................ (2,248) (82) 27,282
-------- -------- --------
Income (loss) before provision (benefit) for
income taxes .................................. (4,730) 1,312 14,922
Provision (benefit) for income taxes ............... -- -- (225)
-------- -------- --------
Net income (loss) .................................. $ (4,730) $ 1,312 $ 15,147
-------- -------- --------
Cumulative dividend on participating preferred stock $ -- $ -- $ 133
Accretion of warrant ............................... -- -- --
-------- -------- --------
Net income (loss) available to common stockholders . $ (4,730) $ 1,312 $ 15,014
======== ======== ========
Net income (loss) per common share:
Basic .............................................. $ (0.05) $ 0.01 $ 0.18
======== ======== ========
Diluted ............................................ $ (0.05) $ 0.01 $ 0.16
======== ======== ========
Weighted average number of shares used in
calculating net income (loss) per
common share:
Basic 93,856 93,852 83,585
======== ======== ========
Diluted 93,856 104,314 96,070
======== ======== ========
See accompanying notes.
F-5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPRESENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands)
PREFERRED STOCK COMMON STOCK
--------------------------- -------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
---------- ---------- ---------- ---------- ----------
Balance, December 31, 2001 (Unaudited) .. 383,354 11,753 44,995,821 45 110,701
Issuance of common stock,
net of issuance costs ............. -- -- 721,652 1 208
Accumulated accrued dividend on
Series A preferred stock .......... -- 133 -- -- --
Conversion of Series A preferred stock
into common stock ................. (383,354) (10,657) 47,492,162 47 10,610
Dividend payable in connection with
preferred stock conversion ........ -- (1,229) -- -- --
Issuance of warrants ................. -- -- -- -- 33
Exercise of stock options ............ -- -- 639,541 1 85
Net income ........................... -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- -- -- -- --
Comprehensive income ......
---------- ---------- ---------- ---------- ----------
Balance, December 31, 2002 .............. -- -- 93,849,176 94 121,637
Issuance of common stock,
net of issuance costs ............. -- -- 6,458 -- 3
Net Income ........................... -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- -- -- -- --
Comprehensive income ......
---------- ---------- ---------- ---------- ----------
Balance, December 31, 2003 .............. -- $ -- 93,855,634 $ 94 $ 121,640
========== ========== ========== ========== ==========
Issuance of common stock,
net of issuance costs ............ -- -- -- -- --
Net Income ........................... -- -- -- -- --
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- -- -- -- --
Other comprehensive income ... -- -- -- -- --
Comprehensive income ......
---------- ---------- ---------- ---------- ----------
Balance, December 31, 2004 .............. -- $ -- 93,855,634 $ 94 $ 121,640
========== ========== ========== ========== ==========
OTHER OTHER
ACCUMULATED COMPREHENSIVE COMPREHENSIVE
DEFICIT INCOME (LOSS) INCOME (LOSS) TOTAL
---------- ---------- ---------- ----------
Balance, December 31, 2001 (Unaudited) .. (150,807) 158 (28,150)
Issuance of common stock,
net of issuance costs ............. -- -- 209
Accumulated accrued dividend on
Series A preferred stock .......... (133) -- --
Conversion of Series A preferred stock
into common stock ................. -- -- --
Dividend payable in connection with
preferred stock conversion ........ -- -- (1,229)
Issuance of warrants ................. -- -- 33
Exercise of stock options ............ -- -- 86
Net income ........................... 15,147 -- 15,147 15,147
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- (26) (26) (26)
----------
Comprehensive income ...... 15,121
---------- ---------- ========== ----------
Balance, December 31, 2002 .............. (135,793) 132 (13,930)
Issuance of common stock,
net of issuance costs ............. -- -- 3
Net Income ........................... 1,312 -- 1,312 1,312
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- (21) (21) (21)
----------
Comprehensive income ...... $ 1,291
---------- ---------- ========== ----------
Balance, December 31, 2003 .............. $ (134,481) $ 111 $ (12,636)
========== ========== ==========
Issuance of common stock,
net of issuance costs ............ -- -- --
Net Income ........................... (4,730) -- -- (4,730)
Other comprehensive income,
net of income taxes:
Foreign currency translation
adjustment .................. -- 4 -- 4
----------
Other comprehensive income ... -- --
----------
Comprehensive income ...... $ --
---------- ---------- ========== ----------
Balance, December 31, 2004 .............. $ (139,211) $ 115 $ (17,362)
========== ========== ==========
See accompanying notes.
F-6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
YEARS ENDED DECEMBER 31,
--------------------------------------
2004 2003 2002
-------- -------- --------
Cash flows from operating activities:
Net income (loss) ........................................... $ (4,730) $ 1,312 $ 15,147
Adjustments to reconcile net income (loss) to
cash provided by (used in) operating activities--
Depreciation and amortization ............................ 734 1,353 1,671
Noncash expense for stock compensation ................... -- -- 238
Deposit .................................................. 600 -- --
Noncash interest expense ................................. -- 6 1,860
Amortization of prepaid licenses and royalties ........... -- 5,163 5,095
Writeoff of prepaid licenses and royalties ............... 209 2,857 4,100
Gain on sale of Shiny .................................... -- -- (28,813)
Other .................................................... -- (21) (26)
Changes in assets and liabilities:
Trade receivables, net ................................ (133) 164 3,139
Trade receivables from related parties ................ 554 1,942 3,669
Inventories ........................................... 120 1,883 1,949
Prepaid licenses and royalties ........................ -- (3,100) (5,628)
Prepaid expenses ...................................... 673 -- --
Loss on sale of assets ................................ 28 -- --
Loss on abandonment of assets ......................... 862 -- --
Other current assets/receivables ...................... (134) (76) (51)
Accounts payable ...................................... 1,704 (2,148) (5,777)
Accrued current debt .................................. -- 292 (2,887)
Accrued royalties ..................................... (1,566) -- --
Other accrued liabilities ............................. -- (1,039) (1,806)
Payables to related parties ........................... -- (5,806) (887)
Advances from distributors and others ................. -- (160) (19,201)
Advances - Vivendi .................................... 996 -- --
Deferred revenue - Vivendi ............................ 1,385 -- --
Deferred income ....................................... (1,923) -- --
Accumulated other comprehensive income ................ 4 -- --
-------- -------- --------
Net cash provided by (used in) operating activities (617) 2,622 (28,208)
-------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment ......................... -- (337) (207)
Proceeds from sale of Shiny ................................. -- -- 33,134
-------- -------- --------
Net cash (used in) provided by investing activities ... -- (337) 32,927
-------- -------- --------
Cash flows from financing activities:
Net borrowings (payments) on line of credit ................. -- -- (1,576)
(Repayment) borrowings from former Chairman ................. -- -- (3,218)
Net proceeds from issuance of common stock .................. -- 3 4
Repayment of note payable ................................... -- (1,251) --
Repayment of debt ........................................... 61 -- --
Proceeds from debt .......................................... (586) -- --
Proceeds from exercise of stock options ..................... -- -- 86
Other financing activities .................................. -- -- --
-------- -------- --------
Net cash used in financing activities ................. (525) (1,248) (4,704)
-------- -------- --------
Net increase (decrease) in cash ................................ (1,142) 1,037 15
Cash, beginning of year ........................................ 1,171 134 119
-------- -------- --------
Cash, end of year .............................................. $ 29 $ 1,171 $ 134
======== ======== ========
See accompanying notes.
F-7
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2004 2003 2002
------ ------ ------
Supplemental cash flow information:
Cash paid during the year for interest ........................... $ -- $ 212 $ 344
Suplemental disclosure of non-cash investing and financing activities:
Dividend payable on partial conversion of preferred stock ........ -- -- 1,229
Accrued dividend on participating preferred stock ................ -- -- 133
Common stock issued under Product Agreement ...................... -- -- 205
See accompanying notes.
F-8
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Interplay Entertainment Corp., a Delaware corporation, and its subsidiaries
(the "Company"), develop, publish and license out interactive entertainment
software. The Company's software is developed for use on various interactive
entertainment software platforms, including personal computers and video game
consoles, such as the Sony PlayStation 2, Microsoft Xbox and Nintendo GameCube.
As of December 31, 2004, Titus Interactive, S.A. ("Titus"), a France-based
developer, publisher and distributor of interactive entertainment software,
owned 62% of the Company's common stock. The Company's common stock is quoted on
the NASDAQ OTC Bulletin Board under the symbol "IPLY" or while non-compliant
"IPLYE".
GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern, which contemplates, among
other things, the realization of assets and satisfaction of liabilities in the
normal course of business. The Company had a net operating loss of $4.7 million
in 2004. Also at December 31, 2004, the Company had a stockholders' deficit of
$17.4 million and a working capital deficit of $17.3 million. The Company has
historically funded its operations primarily through the use of lines of credit
(although the Company has not had the availability of such lines since October
2001), licensing fees, royalty and distribution fee advances, cash generated by
the private sale of securities, and proceeds of its initial public offering.
To reduce working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments, cancellation or suspension of development on future titles.
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
licensed to Bethesda Softworks LLC ("Bethesda") the rights to develop Fallout 3
on all platforms for a non refundable advance against royalties of $1.175
million and sold the Redneck Rampage intellectual property rights to Vivendi for
$300,000.
The Company anticipates its current cash reserves plus its expected
generation of cash from existing operations, will only be sufficient to fund its
anticipated expenditures into the second quarter of fiscal 2005. Consequently,
the Company expects that it will need to substantially reduce its working
capital needs and/or raise additional financing. However, no assurance can be
given that alternative sources of funding could be obtained on acceptable terms,
or at all. These conditions, combined with the Company's historical operating
losses and its deficits in stockholders' equity and working capital, raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets and liabilities that might result from the outcome of
this uncertainty.
AUTHORIZED COMMON STOCK
The Company has a total of 150,000,000 authorized shares of common stock.
F-9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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. All significant
inter-company accounts and transactions have been eliminated.
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 consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates made in
preparing the consolidated financial statements include, among others, sales
returns and allowances, allowances for uncollectible receivables, cash flows
used to evaluate the recoverability of prepaid licenses and royalties and
long-lived assets, and certain accrued liabilities related to restructuring
activities and litigation. Actual results could differ from those estimates.
RISKS AND UNCERTAINTIES
The Company operates in a highly competitive industry that is subject to
intense competition, potential government regulation and rapid technological
change. The Company's operations are subject to significant risks and
uncertainties including financial, operational, technological, regulatory and
other business risks associated with such a company.
INVENTORIES
Inventories consist of packaged software ready for shipment, including
video game console software. Inventories are valued at the lower of cost
(first-in, first-out) or market. The Company regularly monitors inventory for
excess or obsolete items and makes any valuation corrections when such
adjustments are known. Based on management's evaluation, the Company has
established a reserve at December 31, 2004 and 2003 of approximately $0 and
$30,000 respectively.
Net realizable value is based on management's forecast for sales of the
Company's products in the ensuing years. The industry in which the Company
operates is characterized by technological advancement and changes. Should
demand for the Company's products prove to be significantly less than
anticipated, the ultimate realizable value of the Company's inventories could be
substantially less than the amount shown on the accompanying consolidated
balance sheets.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of 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 development 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. The Company amortizes 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. The Company amortizes these amounts at a rate based upon the
actual number of units shipped with a minimum amortization of 75% in the first
month of release and a minimum of 5% for each of the next five months after
release. This minimum amortization rate reflects the Company's typical product
life cycle. Management evaluates the
F-10
future realization of such costs quarterly and charges to cost of goods sold any
amounts that management deems unlikely to be fully realized through future
sales. Such costs are classified as current and noncurrent assets based upon
estimated product release date.
SOFTWARE DEVELOPMENT COSTS
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 the Company's current practice of developing new products, the
technological feasibility of the underlying software is not established until
substantially all product development is complete, which generally includes the
development of a working model. The Company has not capitalized any software
development costs on internal development projects, as the eligible costs were
determined to be insignificant.
ACCRUED ROYALTIES
Accrued royalties consist of amounts due to outside developers and
licensors based on contractual royalty rates for sales of shipped titles. The
Company records a royalty expense based upon a contractual royalty rate after it
has fully recouped the royalty advances paid to the outside developer, if any,
prior to shipping a title.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of computers,
equipment and furniture and fixtures is provided using the straight-line method
over a period of five to seven years. Leasehold improvements are amortized on a
straight-line basis over the lesser of the estimated useful life or the
remaining lease term. Upon the sale or retirement of property and equipment, the
accounts are relieved of the cost and the related accumulated depreciation, with
any resulting gain or loss included in the consolidated statements of
operations.
LONG-LIVED ASSETS
On January 1, 2002, the Company adopted Financial Accounting Statements
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." SFAS 144 requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. If the cost basis of a long-lived asset
is greater than the estimated fair value, based on many models, including
projected future undiscounted net cash flows from such asset (excluding
interest) and replacement value, an impairment loss is recognized. Impairment
losses are calculated as the difference between the cost basis of an asset and
its estimated fair value. SFAS 144, which supercedes SFAS 121, also requires
companies to separately report discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
abandonment, or in a distribution to shareholders) or is classified as held for
sale. Assets to be disposed are reported at the lower of the carrying amount or
fair value less costs to sell. The adoption of SFAS 144 did not have a material
impact on the Company's financial position or results of operations. Management
has determined that no impairment exists and therefore, no adjustments have been
made to the carrying values of long-lived assets. There can be no assurance,
however, that market conditions will not change or demand for the Company's
products or services will continue which could result in impairment of
long-lived assets in the future.
GOODWILL AND INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS," which addresses how intangible assets that are acquired
individually or with a group of other assets should be accounted for in the
financial statements upon their acquisition and after they have been initially
recognized in the financial statements. SFAS 142 requires that goodwill and
identifiable intangible assets that have indefinite useful lives not be
amortized but rather be tested at least annually for impairment, and
identifiable intangible assets that have finite useful lives be amortized over
their useful lives. SFAS 142 provides specific guidance for testing goodwill and
identifiable intangible assets that will
F-11
not be amortized for impairment. In addition, SFAS 142 expands the disclosure
requirements about goodwill and other intangible assets in the years subsequent
to their acquisition. At December 31, 2004, the Company had no goodwill or
intangible items subject to amortization.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable and accounts payable
approximates the fair value. In addition, the carrying value of all borrowings
approximates fair value based on interest rates currently available to the
Company. The fair value of trade receivable from related parties, advances from
related party distributor, loans to/from related parties and payables to related
parties are not determinable as these transactions are with related parties.
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. 104, Revenue Recognition.
With the signing of the new Vivendi distribution agreement in August 2002,
substantially all of the Company's sales are made by two related party
distributors (Notes 6 and 12), Vivendi, which owns less than 5% of the
outstanding shares of the Company's common stock at December 31, 2004, and
Avalon Interactive Group Ltd. ("Avalon"), formerly Virgin Interactive
Entertainment Limited, a wholly owned subsidiary of Titus, the Company's largest
stockholder.
The Company recognizes revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of the Company's products
to unaffiliated third parties. For those agreements that provide the customers
the right to multiple copies of a product in exchange for guaranteed amounts,
revenue is recognized at the delivery and acceptance of the product gold 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 basis, the Company may permit
customers to return or exchange product and may provide markdown allowances on
products unsold by a customer. In accordance with SFAS No. 48, "Revenue
Recognition when Right of Return Exists," revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. The reserve
for estimated returns, exchanges, markdowns, price concessions and warranty
costs was $0 and $0.4 million at December 31, 2004 and 2003, respectively. The
amount of reserves ultimately required could differ materially in the near term
from the amounts included in the accompanying consolidated financial statements.
Customer support provided by the Company is limited to telephone and
Internet support. These costs are not 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.
In November 2001, the Emerging Issues Task Force (EITF) issued EITF 01-09,
"Accounting for Consideration given by a Vendor to a Customer". 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, buy downs and distributor payments from cost of sales
and administrative expenses to a reduction in sales. Additionally, prior period
amounts were reclassified to conform to the new requirements. The impact of this
pronouncement resulted in a reduction of net sales of $0, $0, and $0.1 million
for the years ended December 31, 2004, 2003 and 2002, respectively. 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.
F-12
ADVERTISING COSTS
The Company generally expenses advertising costs as incurred, except for
production costs associated with media campaigns that are deferred and charged
to expense at the first run of the ad. Cooperative advertising with distributors
and retailers is accrued when revenue is recognized. Cooperative advertising
credits are reimbursed when qualifying claims are submitted. Advertising costs
approximated $1.2 million, $0.6 million and $3.0 million for the years ended
December 31, 2004, 2003 and 2002, respectively.
INCOME TAXES
The Company accounts for income taxes using the liability method as
prescribed by the SFAS No. 109, "Accounting for Income Taxes." The statement
requires an asset and liability approach for financial accounting and reporting
of income taxes. Deferred income taxes are provided for temporary differences in
the recognition of certain income and expense items for financial reporting and
tax purposes given the provisions of the enacted tax laws. A valuation allowance
is provided for significant deferred tax assets when it is more likely than not
those assets will not be recovered.
FOREIGN CURRENCY
The Company follows the principles of SFAS No. 52, "Foreign Currency
Translation," using the local currency of its operating subsidiaries as the
functional currency. Accordingly, all assets and liabilities outside the United
States are translated into U.S. dollars at the rate of exchange in effect at the
balance sheet date. Income and expense items are translated at the weighted
average exchange rate prevailing during the period. Gains or losses arising from
the translation of the foreign subsidiaries' financial statements are included
in the accompanying consolidated financial statements as a component of other
comprehensive loss. Gains and Losses resulting from foreign currency
transactions amounted to a $33,000 loss, $58,000 gain and $104,000 loss during
the years ended December 31, 2004, 2003 and 2002, respectively, and are included
in other income (expense) in the consolidated statements of operations.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per common share is computed by dividing income
(loss) attributable to common stockholders by the weighted average number of
common shares outstanding. Diluted net income (loss) per common share is
computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding plus the effect of any
convertible debt, dilutive stock options and common stock warrants. For the
years ended December 31, 2004, 2003 and 2002, all options and warrants
outstanding to purchase common stock were excluded from the earnings per share
computation as the exercise price was greater than the average market price of
the common shares.
The Company discloses information regarding segments in accordance with
SFAS No. 131 DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.
SFAS No. 131 establishes standards for reporting of financial information about
operating segments in annual financial statements and requires reporting
selected information about operating segments in interim financial reports. The
Company is managed, and financial information is developed on a geographical
basis, rather than a product line basis. Thus, the Company has provided segment
information on a geographical basis (see Note 14).
Management establishes an allowance for doubtful accounts based on
qualitative and quantitative review of credit profiles of our customers,
contractual terms and conditions, current economic trends and historical
payment, return and discount experience. Management reassesses the allowance for
doubtful accounts each period. If management made different judgments or
utilized different estimates for any period material differences in the amount
and timing of revenue recognized could result. Accounts receivable are written
off when all collection attempts have failed.
Cost of software revenue primarily reflects the manufacture expense and
royalties to third party developers, which are recognized upon delivery of the
product. Cost of support includes (i) sales commissions and salaries paid to
employees who provide support to clients and (ii) fees paid to consultants,
which are recognized as the services are performed. Sales commissions are
expensed as incurred.
F-13
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) of the Company includes net income (loss)
adjusted for the change in foreign currency translation adjustments. The net
effect of income taxes on comprehensive income (loss) is immaterial.
STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with the
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and related Interpretations and makes the necessary pro forma
disclosures mandated by SFAS No. 123 "Accounting for Stock-based Compensation".
In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation - an
Interpretation of APB 25". This Interpretation clarifies (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a non-compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 became effective July 1, 2000, but
certain conclusions in FIN 44 cover specific events that occur after either
December 15, 1998, or January 12, 2000. Management believes that the Company
accounts for its employee stock based compensation in accordance with FIN 44.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123". SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income and earnings per share and the entity's accounting policy decisions with
respect to stock-based employee compensation. Certain of the disclosure
requirements are required for all companies, regardless of whether the fair
value method or intrinsic value method is used to account for stock-based
employee compensation arrangements. The Company continues to account for its
employee incentive stock option plans using the intrinsic value method in
accordance with the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
SFAS 148 is effective for financial statements for fiscal years ended after
December 15, 2002 and for interim periods beginning after December 15, 2002. The
Company adopted the disclosure provisions of this statement during the year
ended December 31, 2002.
At December 31, 2004, the Company has one stock-based employee compensation
plan, which is described more fully in Note 11. The Company accounts for this
plan under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations.
Stock-based employee compensation cost reflected in net income was $0, $0, and
$0 for the years ended December 31, 2004, 2003 and 2002, respectively. The
following table illustrates the effect on net income and earnings 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.
YEARS ENDED DECEMBER 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
(Dollars in thousands, except
per share amounts)
Net income (loss) available to common stockholders, as reported $ (4,730) $ 1,404 $ 15,014
Pro forma estimated fair value compensation expense ........... -- (177) (232)
---------- ---------- ----------
Pro forma net income (loss) available to common stockholders .. $ (4,730) $ 1,227 $ 14,782
========== ========== ==========
Basic net income (loss) per common share as reported .......... $ (0.05) $ 0.01 $ 0.18
Diluted net income (loss) per common share as reported ........ $ (0.05) $ 0.01 $ 0.16
Basic pro forma net income (loss) per common share ............ $ (0.05) $ 0.01 $ 0.16
Diluted pro forma net income (loss) per common share .......... $ (0.05) $ 0.01 $ 0.15
F-14
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4." This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
United States and accounting principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment," a
revision to SFAS 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123R establishes standards for the accounting
for transactions in which an entity exchanges instruments for goods or services.
It also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity-based compensation issued to
employees. SFAS 123R requires the Company to value the share-based compensation
based on the classification of the share-based award. If the share-based award
is to be classified as a liability, the Company must re-measure the award at
each balance sheet date until the award is settled. If the share-based award is
to be classified as equity, the Company will measure the value of the
share-based award on the date of grant but the award will not be re-measured at
each balance sheet date. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for public
companies with calendar year ends no later than the beginning of the next fiscal
year. All public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS 123 except that the amounts must be
recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS 123 amounts
in the statement of operations. Management is in the process of determining the
effect SFAS 123R will have upon the Company's financial position and statement
of operations and the method of transition adoption.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
3. SHINY ENTERTAINMENT, INC
In 1995, the Company acquired a 91% interest in Shiny Entertainment, Inc.
("Shiny") for $3.6 million in cash and stock. The acquisition was accounted for
using the purchase method. The allocation of purchase price included $3 million
of goodwill. The purchase agreement required the Company to pay the former owner
of Shiny additional cash payments of up to $5.6 million upon the delivery and
acceptance of five future Shiny interactive entertainment software titles (the
"earnout payments"). In March 2001, the Company entered into an amendment to the
Shiny purchase agreement, which, among other things, settled all outstanding
claims under the earnout payments, and resulted in the Company acquiring the
remaining 9% equity interest in Shiny for $600,000, payable in installments of
cash and options on common stock. The amendment also provided for additional
cash payments to the former owner of Shiny for two interactive entertainment
software titles to be delivered in the future. The former owner of Shiny would
have earned royalties after the future
F-15
delivery of the two titles to the Company. At December 31, 2001, the Company
owed the former owner of Shiny $200,000 related to this amendment, which is
recorded under accounts payable in the accompanying consolidated balance sheets.
On April 30, 2002, the Company consummated the sale of Shiny, pursuant to
the terms of a Stock Purchase Agreement, dated April 23, 2002, as amended, among
the Company, Infogrames, Inc., Shiny, Shiny's president and Shiny Group, Inc.
Pursuant to the purchase agreement, Infogrames acquired all of the outstanding
common stock of Shiny for approximately $47.2 million, which was paid to or for
the benefit of the Company as follows:
o $3.0 million in cash paid to the Company at closing;
o $10.8 million to be paid to the Company pursuant to a promissory note
from Infogrames providing for scheduled payments with the final
payment due July 31, 2002;
o $26.1 million paid directly to third party creditors of the Company;
and
o $7.3 million paid to Shiny's president and Shiny Group for Shiny
common stock that was issued to such parties to settle claims relating
to the Company's original acquisition of Shiny.
The promissory note receivable from Infogrames was paid in full in August
2002.
The Company recognized a gain of $28.8 million on the sale of Shiny. The
details of the sale are as follows:
(In millions)
Sale price of Shiny ............................................. $ 47.2
Net assets of Shiny at April 30, 2002 ........................... 2.3
Transaction related costs:
Cash payment to Warner Brothers Entertainment,
Inc. for consent to transfer Matrix license ................ 2.2
Note payable issued to Warner Brothers
Entertainment, Inc. for consent
to transfer Matrix license (Note 5) ........................ 2.0
Payment to Shiny's President & Shiny Group, Inc. ............. 7.1
Commission fees to Europlay I, LLC ........................... 3.9
Legal fees ................................................... 0.9
-------
Gain on sale .................................................... $ 28.8
=======
In addition, the Company recorded a tax provision of $150,000 in connection
with the sale of Shiny.
Concurrently with the closing of the sale, the Company settled a legal
dispute with Vivendi, relating to the parties' August 2001 distribution
agreement. The Company also settled legal disputes with its former bank and its
former Chairman, relating to the Company's April 2001 credit facility with its
former bank that was partially guaranteed by its former Chairman. The disputes
with Vivendi, the bank and the former Chairman were settled and dismissed, with
prejudice, following consummation of the sale.
F-16
4. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of the following:
DECEMBER 31,
-----------------
2004 2003
------ ------
(Dollars in thousands)
Prepaid royalties for titles in development .. $ -- $ 100
Prepaid royalties for shipped titles ......... -- --
Prepaid licenses and trademarks .............. -- 109
------ ------
$ -- $ 209
====== ======
Amortization of prepaid licenses and royalties is included in cost of goods
sold and totaled $2, $5.2 million and $5.7 million for the years ended December
31, 2004, 2003 and 2002, respectively.
During the years ended December 31, 2004, 2003 and 2002, the Company
wrote-off $.2 million, $2.9 million and $4.1 million, respectively, of prepaid
royalties for titles in development that were impaired due to the cancellation
of certain development projects, which the Company has recorded under cost of
goods sold in the accompanying consolidated statements of operations.
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
------------------------
2004 2003
------- -------
(Dollars in thousands)
Computers and equipment ...................... $ 1,463 $ 6,071
Furniture and fixtures ....................... 8 48
Leasehold improvements ....................... -- 102
------- -------
1,471 6,221
Less: Accumulated depreciation
and amortization .......................... (981) (4,107)
------- -------
$ 490 $ 2,114
======= =======
For the years ended December 31, 2004, 2003 and 2002, the Company incurred
depreciation and amortization expense of $.8 million, $1.4 million and $1.7
million, respectively. During the years ended December 31, 2004, 2003 and 2002,
the Company disposed of fully depreciated equipment having an original cost of
$4.7 million, $4.6 and $0 million, respectively. Disposition of assets in 2004
generated a loss of $.9 million.
5. PROMISSORY NOTES
The Company issued to Warner Brothers Entertainment, Inc. ("Warner") a
Secured Convertible Promissory Note bearing interest at 6% per annum, due April
30, 2003, in the principal amount of $2.0 million in connection with the sale of
Shiny (Note 3). The note was issued in partial payment of amounts due Warner
under the parties' license agreement for the video game based on the motion
picture THE MATRIX, which was being developed by Shiny. The note is secured by
all of the Company's assets, and may be converted by the holder thereof into
shares of the Company's common stock on the maturity date or, to the extent
there is any proposed prepayment, within the 30day period prior to such
prepayment. The conversion price is equal to the lower of (a) $0.304 or (b) an
amount equal to the average closing price of a share of
F-17
the Company's common stock for the five business days ending on the day prior to
the conversion date, provided that in no event can the note be converted into
more than 18,600,000 shares. If any amount remains due following conversion of
the note into 18,600,000 shares, the remaining amount will be payable in cash.
The Company agrees to register with the Securities and Exchange Commission the
shares of common stock to be issued in the event Warner exercises its conversion
option. At December 31, 2004, the balance owed to Warner, including accrued
interest, is $0.34 million. On or about October 9, 2003, Warner filed suit
against the Company in the Superior Court for the State of California, County of
Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal and interest. The
Company entered into a settlement agreement on this litigation and entered into
a payment plan with Warner to satisfy the balance of the note by January 30,
2004. The Company is currently in default of the settlement agreement with
Warner and has entered into a payment plan, of which the Company is in default,
for the remaining balance of $0.34 million payable in one remaining installment.
The Company issued to Atari Interactive, Inc. ("Atari") a Promissory Note
bearing no interest, due December 31, 2006, in the principal amount of $2.0
million in connection with Atari entering into tri-party agreements with the
Company and its main distributors, Vivendi and Avalon. The note was issued in
payment of all outstanding accrued royalties due Atari under the D&D license
agreement which license was terminated by Atari on April 23, 2004. At December
31, 2004, the balance owed to Atari, is $1.3 million as a result of payments
made by Vivendi and Avalon on the Company's behalf to Atari.
6. ADVANCES FROM DISTRIBUTORS, RELATED PARTIES AND OTHERS
Advances from distributors and OEMs consist of the following:
DECEMBER 31,
---------------------
2004 2003
------ -------
(Dollars in thousands)
Advances for other distribution rights ............. $ 476 $ 629
====== ======
Net advance from Vivendi distribution
agreement (related party) ....................... $2,989 $2,862
====== ======
In April 2002, the Company entered into an agreement with Titus, pursuant
to which, among other things, the Company sold to Titus all right, title and
interest in the games EARTHWORM JIM, MESSIAH, WILD 9, R/C STUNT Copter,
SACRIFICE, MDK, MDK II, and KINGPIN, and Titus licensed from the Company the
right to develop, publish, manufacture and distribute the games HUNTER I, HUNTER
II, ICEWIND DALE I, ICEWIND DALE II, and BG: DARK ALLIANCE II solely on the
Nintendo Advance GameBoy game system for the life of the games. As consideration
for these rights, Titus issued to the Company a promissory note in the principal
amount of $3.5 million, which note bears interest at 6% per annum. The
promissory note was due on August 31, 2002, and may 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. The Company has provided Titus with a guarantee
under this agreement, which provides that in the event Titus does not achieve
gross sales of at least $3.5 million by June 25, 2003, and the shortfall is not
the result of Titus' failure to use best commercial efforts, the Company will
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.
In August 2001, the Company entered into a distribution agreement with
Vivendi providing for Vivendi to become the Company's distributor in North
America through December 31, 2002, as amended, for substantially all of its
products, with the exception of products with pre-existing distribution
agreements. Under the terms of the agreement, as amended, Vivendi earned a
distribution fee based on the net sales of the titles distributed. The agreement
provided for advance payments from Vivendi totaling $10.0 million. In amendments
to the agreement, Vivendi agreed to advance the Company an additional $3.5
million. The distribution agreement, as amended, provides for the acceleration
of the
F-18
recoupment of the advances made to the Company, as defined. During the three
months ended March 31, 2002, Vivendi advanced the Company an additional $3.0
million bringing the total amounts advanced to the Company under the
distribution agreement with Vivendi to $16.5 million. In April 2002, the
distribution agreement was further amended to provide for Vivendi to distribute
substantially all of the Company's products through December 31, 2002, except
certain future products, which Vivendi would have the right to distribute for
one year from the date of release. As of August 1, 2002, all distribution
advances relating to the August 2001 agreement from Vivendi were fully earned or
repaid. As of December 31, 2003 this agreement has expired.
In August 2002, the Company entered into a new distribution agreement with
Vivendi whereby Vivendi will distribute substantially all of the Company
products in North America for a period of three years as a whole and two years
with respect to each product giving a potential maximum term of five years.
Under the August 2002 agreement, Vivendi will pay the Company sales proceeds
less amounts for distribution fees. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon the
Company's delivery of a gold master to Vivendi, Vivendi will pay the Company as
a non-refundable minimum guarantee, a specified percent of the projected amount
due the Company based on projected initial shipment sales, which are established
by Vivendi in accordance with the terms of the agreement. The remaining amounts
are due upon shipment of the titles to Vivendi's customers. Payments for future
sales that exceed the projected initial shipment sales are paid on a monthly
basis. In December 2002, the Company granted OEM rights and selected back
catalog titles in North America to Vivendi. In January 2003, the Company granted
Vivendi the right to distribute substantially all of our products in select
rest-of-world countries. As of December 31, 2004, Vivendi had $2.9 million of
its advance remaining to recoup under the rest-of-world countries and OEM back
catalog agreements. As of December 2004, the Company earned $0.7 million of the
$3.6 million advance related to future minimum guarantees on undelivered
products.
In February 2003, the Company sold to Vivendi all future interactive
entertainment-publishing rights to the HUNTER: THE RECKONING license for $15
million, payable in installments, which were fully paid at June 30, 2003. The
Company retained the rights to the previously published HUNTER: THE RECKONING
titles on Microsoft Xbox and Nintendo GameCube.
In February 2003, Vivendi advanced the Company $1.0 million pursuant to a
letter of intent. As of December 31, 2003, the advance was discharged and
recouped in full by Vivendi under the terms of the Vivendi settlement.
In September 2003, the Company terminated its distribution agreement with
Vivendi as a result of their alleged breaches, including for non-payment of
money owed to the Company under the terms of this distribution agreement. In
October 2003, Vivendi and the Company reached a mutually agreed upon settlement
and agreed to reinstate the 2002 distribution agreement. . Vivendi distributed
the Company's games FALLOUT: BROTHERHOOD OF STEEL and BALDURS GATE: DARK
ALLIANCE II in North America and Asia-Pacific (excluding Japan), and retained
exclusive distribution rights in these regions for all of the Company's future
titles through August 2005.
Based on recent sales and royalty statements received in April 2004 from
Vivendi, the Company believes that Vivendi incorrectly reported gross sales of
its products under the 2002 Agreement as a result of its taking improper
deductions for price protections it offered its customers. Vivendi has
acknowledged this error. The Company currently believes the minimum amount due
in additional proceeds is approximately $66,000, which we are currently
investigating. .
During 2003, the Company entered into two distribution agreements granting
the distribution rights to certain titles for a total of $0.8 million in cash
advance payments. As of December 31, 2004, approximately $0.2 of the advance has
been earned.
In March 2001, the Company entered into a supplement to a licensing
agreement with a console hardware and software manufacturer under which it
received an advance of $5.0 million. This advance was repaid with proceeds from
the sale of Shiny.
In July 2001, the Company entered into a distribution agreement with a
distributor whereby the distributor would have the North American distribution
rights to a future title. In return, the distributor paid the Company an advance
of $4.0 million to be recouped against future amounts due to the Company based
on net sales of the future title. In January
F-19
2002, the Company sold the publishing rights to this title to the distributor in
connection with a settlement agreement entered into with the thrid party
developer. The settlement agreement provided, among other things, that the
Company assign its rights and obligations under the product agreement to the
third party distributor. In consideration for assigning the product agreement to
the distributor, the Company was not required to repay the $4.0 million advance
nor repay $1.6 million related to past royalties and interest owed to the
distributor. In addition, the Company agreed to forgive $0.6 million in advances
previously paid to the developer. As a result, the Company recorded net revenues
of $5.6 million and a related cost of $0.6 million in the year ended December
31, 2002.
7. INCOME TAXES
Income (loss) before provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
----------------------------------------------
2004 2003 2002
------- ------- -------
(Dollars in thousands)
Domestic ............. $(4,574) $ 1,289 $14,922
Foreign .............. (3) 23 --
------- ------- -------
Total ................ $(4,577) $ 1,312 $14,922
======= ======= =======
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
------------------------------------------
2004 2003 2002
------ ------ ------
(Dollars in thousands)
Current:
Federal ............... $ -- $ -- $ (225)
State ................. -- -- --
Foreign ............... -- -- --
------ ------ ------
-- -- (225)
Deferred:
Federal ............... -- -- --
State ................. -- -- --
------ ------ ------
-- -- --
------ ------ ------
$ -- $ -- $ (225)
====== ====== ======
The Company files a consolidated U.S. Federal income tax return, which
includes all of its domestic operations. The Company files separate tax returns
for each of its foreign subsidiaries in the countries in which they reside. The
Company's available net operating loss ("NOL") carryforward for Federal tax
reporting purposes approximates $135 million and expires through the year 2023.
The Company's NOL's for State tax reporting purposes approximate $70 million and
expires through the year 2013. The utilization of the federal and state net
operating losses may be limited by Internal Revenue Code Section 382. Further,
utilization of the Company's state NOLs for tax years beginning in 2002 and
2003, were suspended under provisions of California law.
A reconciliation of the statutory Federal income tax rate and the effective
tax rate as a percentage of pretax loss is as follows:
F-20
2004 2003 2002
------ ------ ------
Statutory income tax rate ............. 34.0 % 34.0 % 34.0 %
State and local income taxes, net of
Federal income tax benefit ......... -- -- 2.0
Valuation allowance ................ (39.5) (39.5) (36.0)
Other ................................. 5.5 5.5
(1.5)
------ ------ ------
-- % -- % (1.5)%
====== ====== ======
The components of the Company's net deferred income tax asset (liability)
are as follows:
DECEMBER 31,
---------------------
2004 2003
-------- --------
(Dollars in thousands)
Current deferred tax asset (liability):
Prepaid royalties ............................... $ -- $ (1,343)
Nondeductible reserves .......................... 938 1,843
Reserve for advances ............................ (789) (1,685)
Accrued expenses ................................ 870 1,089
Foreign loss and credit carryforward ............ 2,556 2,556
Federal and state net operating losses .......... 51,753 49,735
Research and development credit carryforward .... 2,374 2,374
Other ........................................... -- (119)
-------- --------
57,712 54,450
-------- --------
Non-current deferred tax asset (liability):
Depreciation expense ............................ (117) (117)
Nondeductible reserves .......................... -- --
-------- --------
(117) (117)
-------- --------
Net deferred tax asset before
valuation allowance ............................. 57,712 54,334
Valuation allowance .................................. (57,712) (54,334)
-------- --------
Net deferred tax asset ............................... $ -- $ --
======== ========
The Company maintains a valuation allowance against its deferred tax
assets due to the uncertainty regarding future realization. In assessing the
realizability of its deferred tax assets, management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies. The valuation allowance on deferred tax assets increased
$3.4 million during the year ending December 31, 2004 and decreased $0.05
million during the year ending December 31, 2003.
8. COMMITMENTS AND CONTINGENCIES
ATARI TERMINATION
On or about February 23, 2004, the Company received correspondence from
Atari Interactive, Inc, the holder of the D&D license, alleging that the Company
had failed to pay royalties due under the D&D license as of February 15, 2004.
The company's rights to distribute titles under the D&D license were terminated
by Atari on April 23, 2004.
F-21
In July 2004, we entered into a tri-party agreement with Atari Interactive,
Inc and Vivendi that allows Vivendi to resume North American and international
distribution pursuant to their pre-existing agreements with us of certain
Dungeons & Dragons games, including Baldur's Gate Dark Alliance II. The
agreement provided for proceeds due us to be paid directly to Atari by Vivendi,
up to an amount of $1.0 million of which approximately $.3 million was still
oustanding as of December 31, 2004. As a result we did not receive any proceeds
from Vivendi since July 2004 and will most likely not receive any proceeds
during 2005.
In August 2004, we entered into a tri-party agreement with Atari
Interactive, Inc and Avalon that allows Avalon to resume European distribution
pursuant to their pre-existing agreements with us of certain Dungeons & Dragons
games, including Baldur's Gate Dark Alliance II. The agreement provided for
proceeds due us to be paid directly to Atari by Avalon, as a result we did not
receive any proceeds from this agreement in 2004. This agreement was terminated
following Avalon's liquidation in February 2005.
PAYROLL TAXES
At December 31, 2004, the Company had accrued approximately $117,000 for
past due interest and penalties on the late payment of federal payroll taxes.
The Company owes approximately $20,000 in past due Federal payroll taxes. As of
December 31, 2004, the Company owes approximately $101,000 in past due payroll
tax principal, penalties, or interest to the State of California. The Company
owes approximately $64,000 in State Use tax. The Company also owes approximately
$28,000 in property tax.
INSURANCE
The Company's property, general liability, auto, workers compensation,
fiduciary liability, Directors and Officers, and employment practices liability
have been cancelled during the year ending December 31, 2004. The Company is
current on its workers comp and employee health insurance premiums.
LEASES
The Company has a month to month rental agreement for the office space it
occupies including its corporate offices in Irvine, California.
Total rent expense was $.4 million, $1.8 million, and $2.1 million for the
years ended December 31, 2004, 2003 and 2002, respectively.
The company's headquarters were located in Irvine, California where the
Company leased approximately 81,000 square feet of office space. This lease
would have expired in June 2006. On or about April 16, 2004, Arden Realty
Finance IV LLC filed an unlawful detainer action against the Company in the
Superior Court for the State of California, County of Orange, alleging the
Company's default under its corporate lease agreement. At the time the suit was
filed, the alleged outstanding rent totaled $431,823. The Company was unable to
satisfy this obligation and reach an agreement with its landlord, the Company
subsequently forfeited its lease and vacated the building. Arden Realty obtained
a judgment for approximately $588,000 exclusive of interest. The Company also
owes an additional approximately $149,000 making a total owed to Arden by the
Company of approximately $737,000. The Company negotiated a forbearance
agreement whereby Arden has agreed to accept payments commencing in January 2005
in the amount of $60,000 per month until the full amount is paid. The Company
has been unable to make any of the $60,000 per month payments. The Company
signed a monthly rental agreement beginning in August 2004 at 1682 Langley Ave
in Irvine, CA for its operations. The monthly payments are approximately $1,300
per month.
LITIGATION
The Company is involved in various legal proceedings, claims and litigation
arising in the ordinary course of business, including disputes arising over the
ownership of intellectual property rights and collection matters. In the opinion
of management, the outcome of known routine claims will not have a material
adverse effect on the Company's business, financial condition or results of
operations.
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against Atari Interactive, Inc. (formerly known as
Infogrames Interactive, Inc.) and other Atari Interactive affiliates as well as
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 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
F-22
confidential information about KBK to Atari. KBK amended its complaint to add
the Company as a separate defendant. The Company counterclaimed against KBK and
also against Atari Interactive for breach of contract, among other claims. GOL
counterclaimed against KBK for breach of contract as KBK owes GOL $700,000 in
guaranteed advanced fees under the term of the agreement. In addition, the
Company filed an action against Atari Interactive for breach indemnity, among
other claims. In October 2004, the California Superior court dismissed the legal
action of KBK against the Company and its subsidiary GOL and granted a judgment
to GOL in the cross complaint from GOL against KBK for $890,730. GOL dismissed
its action against Atari Interactive in April 2005.
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the company for various claims. The
Company's attorney's have filed and obtained a motion to be relieved as counsel
on August 10, 2004. The company has not yet retained replacement counsel in this
action.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") initiated
legal proceedings against the Company seeking damages of approximately $1.3
million, alleging, among other things, that the Company failed to secure a
timely effective date for a Registration Statement for the Company's shares
purchased by Special Situations under a common stock subscription agreement
dated March 29, 2002 and that the Company is therefore liable to pay Special
Situations $1.3 million. This matter was settled and the case dismissed in
December 2003. Special Situations had entered into a settlement agreement with
the Company contemplating payments over time. We are currently in default of the
settlement agreement.
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 $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal and interest. The
Company stipulated to a judgment in favor of Warner Brothers and are in the
process of satisfying the judgment, of which approximately $837,000 remained to
be paid as of December 31, 2004. The Company is currently in default of the
settlement agreement with Warner and has entered into a payment plan, of which
the Company is in default, for the remaining balance of $0.34 million payable in
one remaining installment.
In March 2004, the Company instituted litigation in the Superior Court for
the State of California, Los Angeles County, against Battleborne Entertainment,
Inc. ("Battleborne"). Battleborne was developing a console product for us
tentatively titled "Airborne: Liberation." The Company's complaint alleges that
Battleborne repudiated the contract with the Company and subsequently renamed
the product and entered into a development agreement with a different publisher.
The Company seeks a declaration from the court that it retain rights to the
product, or damages.
On or about April 16, 2004, Arden Realty Finance IV LLC filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $431,823. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden has agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has not accrued any amount for any remaining lease obligation,
should such obligation exist. The Company is currently in default of the
forbearance agreement.
On or about April 19, 2004, Bioware Corporation filed a breach of contract
action against the Company in the Superior Court for the State of California,
County of Orange, alleging failure to pay royalties when due. At the time of
filing, Bioware alleged that it was owed approximately $156,000 under various
agreements for which it obtained a writ of attachment to secure payment of the
alleged obligation if it is successful at trial. Bioware also sought and
obtained a temporary restraining order prohibiting the Company from transferring
assets up to the amount sought in the writ of attachment. The Company
successfully opposed the preliminary injunction and vacated the temporary
restraining order. Bioware subsequently dismissed their action.
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,406 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and
F-23
consequently, Monte Cristo has filed a stipulated judgment against the Company
in the amount of $100,000. If Monte Cristo executes the judgment, it will
negatively affect the Company's cash flow, which could further restrict the
Company's operations and cause material harm to its business.
Snowblind entered into a partial settlement agreement on June 23, 2004
following the suit filed by Snowblind on November 19, 2003. Snowblind filed a
second amended complaint against the Company on or about July 12, 2004 claiming
various causes of action including but not limited to, breach of contract,
account stated, open book account, and recission. The action was settled in
April 2005 and the Company granted Snowblind the exclusive license to develop
games using the DARK ALLIANCE Trademark under certain conditions. The Company
retained the right to develop massively multiplayer online games using the DARK
ALLIANCE trademark.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company in the Orange County Superior Court that was settled in July 2004. The
Company was unable to make the payments and Reflexive sought and obtained
judgment against the company.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for various claims. On December 29, 2003 a settlement
agreement was entered into whereby Herve Caen was dismissed from the action.
Further the settlement was entered into with Interplay OEM only in the amount of
$170,000, however KDG reserved its rights to proceed against the Company if the
settlement payment was not made. As of this date the settlement payment was not
made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $90,000 in payroll tax penalties which it has accrued for
at December 31, 2004. The Company has requested the abatement by the IRS of such
penalties.
The Company was unable to meet certain 2004 payroll obligations to its
employees, as a result several employees filed claims with the State of
California Labor Board ("Labor Board"). The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and set trial
dates for August 2005.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled.
The Company subsequently entered into a new workers compensation insurance plan.
The Labor Board fined the Company approximately $79,000 for having lost workers
compensation insurance for a period of time. The Company is appealing the Labor
Board fines.
On December 29, 2004, Piper Rudnick LLP ("Piper Rudnick") filed an action
against Interplay Entertainment Corp. for various claims for unpaid services.
The Company is currently evaluating the merit of this lawsuit.
EMPLOYMENT AGREEMENTS
The Company has entered into various employment agreements with certain key
employees providing for, among other things, salary, bonuses and the right to
participate in certain incentive compensation and other employee benefit plans
established by the Company. Under these agreements, upon termination without
cause or resignation for good reason, the employees may be entitled to certain
severance benefits, as defined. These agreements expire through 2006.
9. STOCKHOLDERS' EQUITY
PREFERRED STOCK AND COMMON STOCK
The Company's articles of incorporation authorize up to 5,000,000 shares of
$0.001 par value preferred stock. Shares of preferred stock may be issued in one
or more classes or series at such time as the Board of Directors determine. As
of December 31, 2004, there were no shares of preferred stock outstanding.
In April 2001, the Company completed a private placement of 8,126,770 units
at $1.5625 per unit for total proceeds of $12.7 million, and net proceeds of
approximately $11.7 million. Each unit consisted of one share of common stock
and a warrant to purchase one share of common stock at $1.75 per share, which
are currently exercisable. If the
F-24
Company issues additional shares of common stock at a per share price below the
exercise price of the warrants, then the warrants are to be repriced, as
defined, subject to stockholder approval. The warrants expire in March 2006. In
addition to the warrants issued in the private placement, the Company granted
the investment banker associated with the transaction a warrant for 500,000
shares of the Company's common stock. The warrant has an exercise price of
$1.5625 per share and vests one year after the registration statement for the
shares of common stock issued under the private placement becomes effective. The
warrant expires four years after it vests. The registration statement was not
declared effective by May 31, 2001 and in accordance with the terms of the
agreement, the Company incurred a penalty of approximately $254,000 per month,
payable in cash, until June 2002, when the registration statement was declared
effective. During 2003, the Company settled with certain of these investors with
respect to payment. During the years ended December 31, 2004, 2003, and 2002,
the Company accrued a provision of $0, $0 million and $1.8 million,
respectively, payable to these stockholders, which was charged to results of
operations and classified as interest expense. The total amount accrued at
December 31, 2004 and 2003 is $3.1 million and $3.1 million, respectively, which
is included in accounts payable in the accompanying consolidated balance sheet.
In April 2000, the Company completed a $20 million transaction with Titus
under a Stock Purchase Agreement and issued 719,424 shares of newly designated
Series A Preferred Stock ("Preferred Stock") and a warrant for 350,000 shares of
the Company's Common Stock, which had preferences under certain events, as
defined. The Preferred Stock was convertible by Titus, redeemable by the
Company, and accrued a 6% cumulative dividend per annum payable in cash or, at
the option of Titus, in shares of the Company's Common Stock as declared by the
Company's Board of Directors. The Company held rights to redeem the Preferred
Stock shares at the original issue price plus all accrued but unpaid dividends.
Titus was entitled to convert the Preferred Stock shares into shares of Common
Stock at any time after May 2001. The conversion rate was the lesser of $2.78
(7,194,240 shares of Common Stock) or 85% of the market price per share at the
time of conversion, as defined. The Preferred Stock was entitled to the same
voting rights as if it had been converted to Common Stock shares subject to a
maximum of 7,619,047 votes. In October 2000, the Company's stockholders approved
the issuance of the Preferred Stock to Titus. In connection with this
transaction, Titus received a warrant for 350,000 shares of the Company's Common
Stock exercisable at $3.79 per share at anytime. The fair value of the warrant
was estimated on the date of the grant using the Black-Scholes pricing model.
This resulted in the Company allocating $19,202,000 to the Preferred Stock and
$798,000 to the warrant, which is included in paid in capital. The discount on
the Preferred Stock was accreted over a one-year period as a dividend to the
Preferred Stock in the amount of $532,000 and $266,000 during the year ended
December 31, 2001 and 2000, respectively. As of December 31, 2001, the Company
had accreted the full amount. In addition, Titus received a warrant for 50,000
shares of the Company's Common Stock exercisable at $3.79 per share, because the
Company did not meet certain financial operating performance targets for the
year ended December 31, 2000. The fair value of this warrant was recorded as
additional interest expense. Both warrants expire in April 2010.
In August 2001, Titus converted 336,070 shares of Series A Preferred Stock
into 6,679,306 shares of Common Stock. This conversion did not include
accumulated dividends of $740,000 on the Preferred Stock, these were
reclassified as an accrued liability as Titus had elected to receive the
dividends in cash. In March 2002, Titus converted its remaining 383,354 shares
of Series A Preferred Stock into 47,492,162 shares of Common Stock. This
conversion did not include accumulated dividends of $1.2 million on the
Preferred Stock, these were reclassified as an accrued liability as Titus had
elected to receive the dividends in cash. Collectively, Titus has 62% of the
total voting power of the Company's capital stock at December 31, 2004. There
were no accrued dividends as of December 31, 2004.
EMPLOYEE STOCK PURCHASE PLAN
Under this plan, eligible employees may purchase shares of the Company's
Common Stock at 85% of fair market value at specific, predetermined dates. In
2000, the Board of Directors increased the number of shares authorized to
300,000. Of the 300,000 shares authorized for issuance under the plan,
approximately 84,877 shares remained available for issuance at December 31,
2003. Employees purchased zero, 6,458, and 21,652 shares in 2004, 2003 and 2002
for $0, $323 and $4,000, respectively. In 2003 the employee stock purchase plan
was terminated.
F-25
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock reserved for future issuance at December 31, 2004 is as
follows:
Stock option plans:
Outstanding ........................................ 211,150
Available for future grants ........................ 7,829,282
Employee Stock Purchase Plan .............................. --
Warrants .................................................. 9,587,068
----------
Total .................................................... 17,627,500
==========
10. NET EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed as net earnings (loss)
available 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 common share is computed
by dividing the net earnings available 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 and the conversion of
outstanding convertible debentures.
YEARS ENDED DECEMBER 31,
-------------------------------
2004 2003 2002
-------- -------- --------
(Amounts in thousands,
except per share amounts)
Net income (loss) available to common stockholders ........... $ (4,730) $ 1,312 $ 15,014
Interest related to conversion of secured convertible
promissory note ........................................ -- 92 82
-------- -------- --------
Dilutive net income (loss) available to common stockholders $ (4,730) $ 1,404 $ 15,096
-------- -------- --------
Shares used to compute net income (loss) per common share:
Weighted-average common shares ............................ 93,856 93,852 83,585
Dilutive stock equivalents ................................ -- 10,462 12,485
-------- -------- --------
Dilutive potential common shares .......................... 93,856 104,314 96,070
======== ======== ========
Net income (loss) per common share:
Basic ..................................................... $ (0.05) $ 0.01 $ 0.18
Diluted ................................................... $ (0.05) $ 0.01 $ 0.16
There were options and warrants outstanding to purchase 9,798,218 shares of
common stock at December 31, 2004, which were excluded from the earnings per
common share computation as the exercise price was greater than the average
market price of the common shares. The dilutive stock equivalents in the above
calculation related to the outstanding convertible debentures at December 31,
2004, which the Company utilized the "if converted" method pursuant to SFAS 128.
Due to the net loss attributable for the year ended December 31, 2004, on a
diluted basis to common stockholders, stock options and warrants have been
excluded from the diluted earnings per share calculation as their inclusion
would have been antidilutive. Had net income been reported for the year ended
December 31, 2004, an additional 13,694,739 shares would have been added to
dilutive potential common shares. The weighted average exercise price at
December 31, 2004, 2003 and 2002 was $1.84, $1.84 and $1.99, respectively, for
the options and warrants outstanding.
In August 2000, the Company issued a warrant to purchase up to 100,000
shares of the Company's Common Stock. The warrant vested at certain dates over a
one year period and had exercise prices between $3.00 per share and $6.00 per
share. The warrant expired in August 2003 unexercised.
F-26
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------
2004 2003 2002
---------------------------- ---------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------------------------- ---------------------------- ------------- ---------
Warrants outstanding at
beginning of year 9,587,068 $1.84 9,687,068 $1.99 9,687,068 $1.99
Granted -- -- -- -- -- --
Exercised -- -- -- -- -- --
Canceled -- -- (100,000) 4.50 -- --
------------- -------------- -------------
Warrants outstanding
at end of year 9,587,068 $1.84 9,587,068 $1.84 9,687,068 $1.99
============= ============== =============
Warrants exercisable 9,587,068 9,587,068 9,187,068
============= ============== =============
There were no warrants granted in 2004, 2003, and 2002 respectively.
A detail of the warrants outstanding and exercisable as of December 31,
2004 is as follows:
WARRANTS OUTSTANDING AND EXERCISABLE
-------------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACT EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE
- -------------------------------- --------- --------- ---------
$1.56 - $1.56 .................. 500,000 2.50 $ 1.56
$1.75 - $1.75 .................. 8,626,770 1.47 1.75
$3.79 - $3.79 .................. 460,298 5.29 3.79
$3.00 - $6.00
--------- --------- ---------
$1.56 - $6.00 .................. 9,587,068 3.09 $ 1.84
========= ========= =========
11. EMPLOYEE BENEFIT PLANS
STOCK OPTION PLANS
The Company has one stock option plan currently outstanding. Under the 1997
Stock Incentive Plan, as amended (the "1997 Plan"), the Company may grant
options to its employees, consultants and directors, which generally vest from
three to five years. At the Company's 2002 annual stockholders' meeting, its
stockholders voted to approve an amendment to the 1997 Plan to increase the
number of authorized shares of common stock available for issuance under the
1997 Plan from four million to 10 million. The Company's Incentive Stock Option,
Nonqualified Stock Option and Restricted Stock Purchase Plan- 1991, as amended
(the "1991 Plan"), and the Company's Incentive Stock Option and Nonqualified
Stock Option Plan-1994, as amended (the "1994 Plan"), have terminated.
The Company has treated the difference, if any, between the exercise price
and the estimated fair market value as compensation expense for financial
reporting purposes, pursuant to APB 25. Compensation expense for the vested
portion aggregated $0, $0 and $0 for the years ended December 31, 2004, 2003 and
2002, respectively.
F-27
The following is a summary of option activity pursuant to the Company's
stock option plans:
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------
2004 2003 2002
---------------------------- ---------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------------------------- ---------------------------- ------------- ---------
Options outstanding at
beginning of year 425,985 $1.95 1,091,697 $3.10 4,007,969 $2.57
Granted 5,000 0.08 130,000 0.09 -- --
Exercised -- -- -- -- (639,541) 0.14
Canceled (219,835) 1.85 (795,712) 3.22 (2,276,731) 3.44
------------ ------------ -----------
Options outstanding
at end of year 211,150 $2.02 425,985 $1.95 1,091,697 $3.10
============ ============ ===========
Options exercisable 171,686 243,890 744,892
============ ============ ===========
The following outlines the significant assumptions used to estimate the
fair value information presented utilizing the Black-Scholes Single Option
approach with ratable amortization. There were 5,000 and 130,000 options granted
in 2004 and 2003, respectively. The 2004 grants of stock options were granted to
a member of the Board of Directors at the time and have since been canceled.
YEAR ENDED DECEMBER 31,
-----------------------
2004 2003
-------- --------
Risk free rate ................................. 4.0% 4.0%
Expected life .................................. 10 7.2 years
Expected volatility ............................ 160% 164%
Expected dividends ............................. -- --
Weighted- average grant-date fair value
of options granted .......................... $ 0.08 $ 0.09
A detail of the options outstanding and exercisable as of December 31, 2004
is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACT EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
- ---------------------- ------- ------- ------- ------- -------
$0.09 - $0.09 ........ 70,000 8.86 $ 0.09 43,336 $ 0.09
$0.68 - $2.69 ........ 100,500 5.23 2.06 89,700 2.22
$3.25 - $4.94 ........ 28,500 4.81 4.02 26,500 4.06
$8.00 - $8.00 ........ 12,150 1.91 8.00 12,150 8.00
------- ------- ------- ------- -------
$0.09 - $8.00 ........ 211,150 6.19 $ 2.02 171,686 $ 2.37
======= ======= ======= ======= =======
F-28
PROFIT SHARING 401(K) PLAN
The Company sponsors a 401(k) plan ("the Plan") for most full-time
employees. The Company matches 50% of the participant's contributions up to 6%
of the participant's base compensation. The profit sharing contribution amount
is at the sole discretion of the Company's Board of Directors. Current year
contributions were zero. Participants vest at a rate of 20% per year after the
first year of service for profit sharing contributions and 20% per year after
the first two years of service for matching contributions. Participants become
100% vested upon death, permanent disability or termination of the Plan. Benefit
expense for the years ended December 31, 2004, 2003 and 2002 was $29,000,
$150,000 and $79,000, respectively. The 401(k) plan was cancelled during 2004.
12. RELATED PARTY TRANSACTIONS
Amounts receivable from and payable to related parties are as follows:
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
(Dollars in thousands)
Receivables from related parties:
Titus TSC ..................... $ 327 $ 313
Titus KK ...................... -- $ 6
Titus SARL .................... 18 43
VIE Acquisition group ......... 10 --
Avalon ........................ 2,025 893
Less Reserves ................. (2,370) (691)
------------ ------------
Total ......................... $ 10 $ 564
============ ============
Payables to related parties:
Vivendi ....................... $ -- $ 1,634
------------ ------------
Total ......................... $ -- $ 1,634
============ ============
ACTIVITIES WITH RELATED PARTIES
It is the Company's policy that related party transactions shall be
reviewed and approved by a majority of the Company's disinterested directors or
its Independent Committee.
The Company's operations involve significant transactions with its majority
stockholder Titus and its affiliates. The Company has a major distribution
agreement with Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus presently owns approximately 58 million shares of Company common
stock, which represents approximately 62% of the Company's outstanding common
stock, its only voting security.
The Company performed certain distribution services on behalf of Titus for
a fee. In connection with such distribution services, the Company recognized fee
income of $0, $5,000, and $22,000 for the years ended December 31, 2004, 2003,
and 2002.
As of December 31, 2004 and December 31, 2003, Titus and its affiliates
excluding Avalon owed the Company $370,000 and $362,000, respectively. The
Company owed Titus and its affiliates excluding Avalon $30,000 and $0 as of
December 31, 2004 and December 31, 2003 respectively.
F-29
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
The Company has an International Distribution Agreement with Avalon, a
wholly owned subsidiary of Titus. Pursuant to this distribution agreement,
Avalon provides for the exclusive distribution of substantially all of the
Company's products in Europe, Commonwealth of Independent States, Africa and the
Middle East for a seven-year period ending February 2006, cancelable under
certain conditions, subject to termination penalties and costs. Under this
agreement, as amended, the Company pays Avalon a distribution fee based on net
sales, and Avalon provides certain market preparation, warehousing, sales and
fulfillment services on its behalf. In connection with the International
Distribution Agreement with Avalon, the Company incurred distribution commission
expense of $62,000 and $.9 million, and $.9 million, for the twelve months ended
December 31, 2004, 2003, and 2002 respectively. In addition, the Company
recognized overhead fees of $0, $0 and $.5 million for the twelve months ended
December 31, 2004, 2003, and 2002 respectively. Also in connection with this
International Distribution Agreement, the Company subleased office space from
Avalon. Rent expense paid to Avalon was $0, $27,000 and $104,000 for the years
ended December 31, 2004, 2003, and 2002. This agreement was terminated as a
result of Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, the Company entered into a note receivable with Titus
Software Corp., ("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The
note earns interest at 8% per annum and was due in February 2004. In May 2003,
the Company's Board of Directors rescinded the note receivable and demanded
repayment of the $226,000 from TSC. As of the date of this filing the balance on
the note with accrued interest has not been paid. The balance on the note
receivable, with accrued interest, at December 31, 2004 was approximately
$254,000. The total receivable due from TSC is approximately $327,000 as of
December 31, 2004. The majority of the additional $73,000 was due to TSC
subletting office space and miscellaneous other items.
In May 2003, the Company paid TSC $60,000 to cover legal fees in connection
with a lawsuit against Titus. As a result of the payment, the Company's CEO
requested that the Company credit the $60,000 to amounts it owed to him arising
from expenses incurred in connection with providing services to the Company. The
Company's Board of Directors is in the process of investigating the details of
the transaction, including independent counsel review as appropriate, in order
to properly record the transaction.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, the Company began operating under a representation agreement
with Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of
Titus, pursuant to which Titus Japan represents the Company as an agent in
regard to certain sales transactions in Japan. This representation agreement has
not yet been approved by the Company's Board of Directors and is currently being
reviewed by them. The Company's Board of Directors has approved the payments of
certain amounts to Titus Japan in connection with certain services already
performed by them on the Company's behalf. As of December 31, 2004 the Company
had a zero balance with Titus Japan. During the twelve months ending December
31, 2004 the Company's Japan subsidiary paid to Titus Japan approximately
$209,000 in commissions and publishing and staff services. The Company's Japan
subsidiary had approximately $369,000 in revenue in the twelve months ending
December 31, 2004.
TRANSACTIONS WITH TITUS SARL
As of December 31, 2004 and 2003 the Company has a receivable of
approximately $18,000 and $43,000 respectively for product development services
that the Company provided. Titus SARL was placed into involuntary liquidation in
January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, the Company engaged the services of GIE Titus Interactive
Group, a wholly owned subsidiary of Titus, for a three-month agreement pursuant
to which GIE Titus or its agents shall provide to the Company certain
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foreign administrative and legal services at a rate of $5,000 per month. At
December 31, 2004 the Company had payables and receivables of $0 to GIE Titus
Interactive Group. The agreement was terminated in the fourth quarter of 2004.
Titus GIE was placed into involuntary liquidation in January 2005
TRANSACTIONS WITH VIE ACQUISITION GROUP
Approximately $42,000 and $0 was paid to VIE Acquisition Group for
management services provided during the twelve months ended December 31, 2004
and 2003.
13. CONCENTRATION OF CREDIT RISK
Avalon was the exclusive distributor for most of the Company's products in
Europe, the Commonwealth of Independent States, Africa and the Middle East. The
Company's agreement with Avalon was terminated following the liquidation of
Avalon in February 2005. The Company subsequently appointed its wholly owned
subsidiary Interplay Productions Ltd as its distributor for Europe.
Vivendi has exclusive rights to distribute the Company's products in North
America and selected International territories. The Company's agreement with
Vivendi will expire in August 2005 for most of its products.
The Company's revenues and cash flows could fall significantly and its
business and financial results could suffer material harm if:
o The Company fail to replace Vivendi as our distributor; or
o Interplay Productions Ltd fails to effectively distribute the
Company's products.
The Company typically sells to distributors and retailers on unsecured
credit, with terms that vary depending upon the customer and the nature of the
product. The Company confronts the risk of non-payment from its customers,
whether due to their financial inability to pay, or otherwise. In addition,
while the Company's maintains a reserve for uncollectible receivables, the
reserve may not be sufficient in every circumstance. As a result, a payment
default by a significant customer could cause material harm to the Company's
business.
For the years ended December 31, 2004, 2003 and 2002, Avalon accounted for
approximately 70%, 12% and 11%, respectively, of net revenues in connection with
the International Distribution Agreement (Note 12). Vivendi accounted for 21%,
82%, and 71% of net revenues in the years ended December 31, 2004, 2003 and
2002, respectively.
14. 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:
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
2004 2003 2002
--------------------- -------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- -------
(Dollars in thousands) (Dollars in thousands) (Dollars in thousands)
North America .. $ 1,544 100% $13,541 37% $26,184 60%
Europe ......... 8,706 -- 5,682 16 4,988 11
Rest of World .. 1,228 -- 802 2 686 2
OEM, royalty and
licensing ... 1,720 -- 16,276 45 12,141 27
------- ------- ------- ------- ------- -------
$13,198 100% $36,301 100% $43,999 100%
======= ======= ======= ======= ======= =======
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15. QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's summarized quarterly financial data is as follow:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
Year ended December 31, 2004:
Net revenues ............................. $ 6,917 $ 1,201 $ 268 $ 4,811
=========== =========== =========== ===========
Gross profit ............................. $ 3,326 $ 1,783 $ 679 $ 583
=========== =========== =========== ===========
Net income (loss) ........................ $ (903) $ (1,954) $ (1,467) $ (406)
=========== =========== =========== ===========
Net income (loss) per common share basic . $ (0.01) $ (0.02) $ (0.02) $ (0.00)
=========== =========== =========== ===========
Net income (loss) per common share diluted $ (0.01) $ (0.02) $ (0.02) $ (0.00)
=========== =========== =========== ===========
Year ended December 31, 2003:
Net revenues ............................. $ 18,762 $ 1,269 $ 4,727 $ 11,543
=========== =========== =========== ===========
Gross profit ............................. $ 11,777 $ 155 $ 2,878 $ 8,371
=========== =========== =========== ===========
Net income (loss) ........................ $ 5,576 $ (5,376) $ (2,189) $ 3,301
=========== =========== =========== ===========
Net income (loss) per common share basic . $ 0.06 $ 0.06 $ (0.02) $ 0.04
=========== =========== =========== ===========
Net income (loss) per common share diluted $ 0.06 $ 0.06 $ (0.02) $ 0.04
=========== =========== =========== ===========
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
TRADE RECEIVABLES ALLOWANCE
---------------------------------------------------------
BALANCE AT PROVISIONS FOR BALANCE AT
BEGINNING OF RETURNS RETURNS AND END OF
PERIOD PERIOD AND DISCOUNTS DISCOUNTS PERIOD
------ ------------ ------------ ---------- ----------
Year ended December 31, 2002 $ 7,541 $ 2,586 $ (9,041) $ 1,086
========== ========== ========== =========
Year ended December 31, 2003 $ 1,086 $ 864 $ (1,225) $ 725
========== ========== ========== =========
Year ended December 31, 2004 $ 725 $ 1,681 $ -- $ 2,406
========== ========== ========== =========
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