<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999 Commission File No. 0-27338
GT INTERACTIVE SOFTWARE CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3689915
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
417 FIFTH AVENUE, NEW YORK, NY 10016
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 726-6500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
As of November 12, 1999, there were 74,633,940 shares of the
registrant's Common Stock outstanding.
<PAGE> 2
GT INTERACTIVE SOFTWARE CORP.
SEPTEMBER 30, 1999 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Item 1. Financial Statements (Unaudited):
Consolidated Condensed Balance Sheets as of March 31, 1999 (audited)
and September 30, 1999 3
Consolidated Statements of Operations for the Three and Six Months Ended
September 30, 1998 and 1999 4
Consolidated Statements of Comprehensive Income for the Three and Six Months
Ended September 30, 1998 and 1999 5
Consolidated Statements of Cash Flows for the Six Months Ended September 30,
1998 and 1999 6
Notes to the Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 14
PART II - OTHER INFORMATION
Item 1. Litigation 22
Item 2. Changes in Securities and Use of Proceeds
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
</TABLE>
1
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, SEPTEMBER 30,
1999 1999
----------- -------------
(AUDITED) (UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 13,512 $ 4,435
Receivables, net 125,935 116,343
Inventories, net 138,208 117,988
Income taxes receivable 1,973 2,250
Other current assets 58,284 31,035
--------- ---------
Total current assets 337,912 272,051
Property and equipment, net 36,808 38,334
Goodwill, net 34,194 32,682
Deferred income taxes 12,664 28,924
Other assets 13,249 12,266
--------- ---------
Total assets $ 434,827 $ 384,257
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 132,556 $ 97,251
Accrued liabilities 51,417 56,442
Revolving credit facility -- 109,000
Notes payable -- 26,706
Royalties payable 18,515 15,003
Income taxes payable 2,569 520
Other current liabilities 1,085 439
--------- ---------
Total current liabilities 206,142 305,361
Long-term debt 98,750 --
Other long-term liabilities 2,802 1,410
--------- ---------
Total liabilities 307,694 306,771
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par, 5,000,000 shares authorized, 600,000 shares
of Series A Convertible Preferred Stock issued and outstanding, stated at
liquidation preference of $50.00 per share 30,000 30,000
Common stock, $0.01 par 150,000,000 shares authorized, 72,775,868 and 73,922,659
shares issued and outstanding, respectively 727 739
Additional paid-in capital 161,073 171,609
Accumulated deficit (64,667) (124,862)
--------- ---------
Total stockholders' equity 127,133 77,486
--------- ---------
Total liabilities and stockholders' equity $ 434,827 $ 384,257
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
<PAGE> 4
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -------------------------
1998 1999 1998 1999
---------- --------- --------- ----------
<S> <C> <C> <C> <C>
Net revenues $ 116,151 $ 91,426 $ 232,542 $ 212,751
Cost of goods sold 55,957 64,620 111,855 126,763
Selling and distribution expenses 29,108 37,588 55,568 71,464
General and administrative expenses 11,411 15,173 23,864 26,935
Research and development 15,965 25,229 32,562 41,595
Amortization of goodwill 676 928 1,547 1,816
--------- --------- --------- ---------
Operating income (loss) 3,034 (52,112) 7,146 (55,822)
Interest and other expense, net 789 5,562 1,965 7,815
--------- --------- --------- ---------
Income (loss) before provision for (benefit from)
income taxes 2,245 (57,674) 5,181 (63,637)
Provision for (benefit from) income taxes 876 (1,614) 2,009 (3,723)
--------- --------- --------- ---------
Net income (loss) from continuing operations 1,369 (56,060) 3,172 (59,914)
--------- --------- --------- ---------
Loss from discontinued operations -- 477 -- 477
--------- --------- --------- ---------
Net income (loss) before dividends on preferred stock 1,369 (56,537) 3,172 (60,391)
Less dividends on preferred stock -- 600 -- 1,200
--------- --------- --------- ---------
Net income (loss) attributable to common stockholders $ 1,369 $ (57,137) $ 3,172 $ (61,591)
========= ========= ========= =========
Basic net income (loss) per share from continuing operations $ 0.02 $ (0.76) $ 0.05 $ (0.82)
Basic net loss per share from discontinued operations $ -- $ (0.01) $ -- $ (0.01)
--------- --------- --------- ---------
Basis net income (loss) per share $ 0.02 $ (0.77) $ 0.05 $ (0.84)
========= ========= ========= =========
Weighed average number of shares outstanding 68,088 73,859 68,072 73,366
========= ========= ========= =========
Diluted net income (loss) per share from continuing operations $ 0.02 $ (0.76) $ 0.05 $ (0.82)
Diluted net loss per share from discontinued operations $ -- $ (0.01) $ -- $ (0.01)
--------- --------- --------- ---------
Diluted net income (loss) per share $ 0.02 $ (0.76) $ 0.05 $ (0.83)
========= ========= ========= =========
Weighted average number of shares outstanding 68,567 73,859 68,785 73,366
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 4
<PAGE> 5
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1999 1998 1999
<S> <C> <C> <C> <C>
Net income (loss) before dividends on preferred stock $ 1,369 $(56,537) $ 3,172 $(60,391)
Other comprehensive income (loss):
Foreign currency translation adjustments 376 832 752 196
-------- -------- -------- --------
Comprehensive income (loss) $ 1,745 $(55,705) $ 3,924 $(60,195)
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 5
<PAGE> 6
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
1998 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before dividends on preferred stock $ 3,172 $(60,391)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 6,437 8,120
Deferred income taxes 589 2,897
Deferred income 28 (118)
Issuance of Common Stock in lieu of partial royalty payment -- 2,300
Issuance of Common Stock pursuant to Employee Stock Purchase Plan -- 416
Changes in operating assets and liabilities:
Receivables, net (39,811) 10,243
Inventories, net (15,153) 20,560
Income taxes receivable 8,016 (277)
Other current assets (3,527) 10,583
Accounts payable (3,778) (35,062)
Accrued liabilities (1,979) 6,574
Royalties payable (10,687) (3,511)
Income taxes payable 1,790 (2,194)
Long-term liabilities 1,746 (1,389)
Other (1,559) 462
-------- --------
Net cash used in operating activities (54,716) (40,787)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (9,626) (7,574)
-------- --------
Net cash used in investing activities (9,626) (7,574)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings, net 52,250 10,250
Notes payable -- 30,000
Proceeds from exercise of stock options 355 115
-------- --------
Net cash provided by financing activities 52,605 40,365
-------- --------
Effect of exchange rates on cash and cash equivalents (268) (1,081)
-------- --------
Net decrease in cash and cash equivalents (12,006) (9,077)
Cash and cash equivalents - beginning of period 17,224 13,407
-------- --------
Cash and cash equivalents - end of period $ 5,218 $ 4,330
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 6
<PAGE> 7
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying interim consolidated financial statements of GT
Interactive Software Corp. and Subsidiaries (the "Company") are unaudited, but
in the opinion of management, reflect all adjustments consisting of normal
recurring accruals necessary for a fair presentation of the results for the
interim period in accordance with instructions for Form 10-Q. Accordingly, they
do not include all information and notes required by generally accepted
accounting principles for complete financial statements. These interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1999.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years'
consolidated financial statements to conform to classifications used in the
current period.
NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 requires dual presentation of basic earnings per share ("EPS")
and diluted EPS on the face of all statements of earnings for all entities with
complex capital structures. Basic EPS is computed as net earnings divided by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock-based compensation plans including stock options, restricted stock
awards, warrants and other convertible securities using the treasury stock
method.
Goodwill
Goodwill is amortized using the straight-line method over periods not
exceeding 20 years. Management reassesses quarterly the appropriateness of both
the carrying value and remaining life of goodwill, principally based on
forecasts of future undiscounted cash flows of businesses acquired.
NOTE 2 - ACQUISITIONS
In October 1997, the Company acquired SingleTrac Entertainment
Technologies, Inc. ("SingleTrac"), a software developer, for cash and stock.
Total consideration, including acquisition costs, was approximately $14.7
million, of which approximately $5.4 million was cash and the balance of the
purchase price was the issuance of 0.7 million newly issued shares of the
Company's common stock, par value $.01 per share ("Common Stock"), and the
assumption of approximately 0.3 million stock options. The acquisition was
accounted for as a purchase. The purchase price was allocated to net assets
acquired, purchased in-process research and development ("R&D"), and goodwill
and other intangibles. Purchased in-process R&D includes the value of products
in the development stage and not considered to have reached technological
feasibility. In accordance with the applicable accounting rules, purchased
in-process R&D is required to be expensed. Accordingly, approximately $11
million of acquisition cost was expensed in the fourth quarter of 1997. In
connection with the reorganization of the Company's Frontline business, the
Company wrote off approximately $3.3 million of goodwill relating to SingleTrac
in the quarter ended March 31, 1999.
Page 7
<PAGE> 8
NOTE 2 - ACQUISITIONS (CONTINUED)
In November 1998, the Company acquired One Zero Media, Inc. ("OZM"), an
Internet entertainment content company, in exchange for approximately 2.3
million newly issued shares of the Company's Common Stock and approximately 0.6
million stock options to purchase the Company's Common Stock. Total
consideration, including acquisition costs, was approximately $17.2 million,
which was allocated to net assets acquired and goodwill. The acquisition was
accounted for as a purchase, because it was the Company's intention to sell an
ownership interest in OZM. At March 31, 1999, the Company decided to sell OZM
and therefore OZM was accounted for as a discontinued operation. OZM was sold on
July 28, 1999 for $5.2 million in cash. This resulted in an additional loss for
the three months ended September 30, 1999 from discontinued operations of $0.5
million.
In December 1998, the Company acquired Reflections Interactive Limited
("Reflections"), a developer of interactive entertainment software for computer
games, in exchange for approximately 2.3 million newly issued shares of the
Company's Common Stock. Total consideration, including acquisition costs, was
approximately $13.5 million. The acquisition was accounted for as a purchase.
The purchase price was allocated to net assets acquired, purchased in-process
R&D and goodwill. Accordingly, $5.0 million of acquisition cost was expensed in
the quarter ended December 31, 1998. Additionally, the Company acquired Prism
Leisure Tontragervertriebs GmbH ("Prism"), a distributor of value-priced
software based in Germany, for nominal consideration. The acquisition was
accounted for as a purchase. The purchase price was allocated to net assets
acquired and goodwill.
In December 1998, the Company formed GT Interactive European Holdings
B.V., a European holding company, which acquired all of the outstanding capital
stock of Home Software Benelux B.V. ("Homesoft"), a distributor of entertainment
software, for approximately $1.0 million in cash. The acquisition was accounted
for as a purchase.
In December 1998, the Company purchased the assets of Legend
Entertainment Company ("Legend"), a developer of entertainment software. Total
consideration, including acquisition costs, was approximately $2.0 million. The
purchase price was allocated to goodwill.
NOTE 3 - INVENTORIES, NET
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, SEPTEMBER 30,
1999 1999
(IN THOUSANDS)
<S> <C> <C>
Finished goods $134,014 $110,429
Raw materials 4,194 7,559
-------- --------
$138,208 $117,988
======== ========
</TABLE>
NOTE 4 - COMMITMENTS AND CONTINGENCIES
On January 21, 1997, the Company entered into a revolving credit
agreement (as amended, the "Old Credit Agreement") with certain banks, expiring
on December 31, 1998. On September 11, 1998, the borrowings under the Old Credit
Agreement were repaid and the Old Credit Agreement was terminated.
Simultaneously, on September 11, 1998, the Company entered with First
Union National Bank, as agent for a syndicate of banks, into a new revolving
credit agreement (the "New Credit Agreement") expiring on September 11, 2001.
Under the New Credit Agreement, the Company can borrow up to $125 million (the
"Line"). These borrowings have been used to refinance indebtedness under the Old
Credit Agreement and will be used for ongoing working capital requirements,
letters of credit and other general corporate purposes, including permitted
acquisitions. Borrowing is limited to a percentage of domestic
<PAGE> 9
accounts receivable and inventory, and is secured by these and certain other
assets.
On February 23, 1999, certain partnerships affiliated with General
Atlantic Partners (together with its affiliates, "General Atlantic") purchased
from the Company 0.6 million shares of the Company's Series A Convertible
Preferred Stock (the "Preferred Stock") for an aggregate purchase price of
$30.0 million. These shares of Preferred Stock are convertible into 6.0 million
shares of the Company's Common Stock at a conversion price of $5 per share.
On June 29, 1999, the Company and the banks amended the New Credit
Agreement to increase the Company's borrowing base by an additional $20 million
until March 31, 2000, and to remove certain financial covenants under the New
Credit Agreement. The Company anticipates that under the New Credit Agreement,
as amended, substantially all of the Line should be available to the Company
through March 31, 2000. The termination date of the New Credit Agreement, as
amended, was changed to June 30, 2000. Under the New Credit Agreement, as
amended, the borrowings bear interest at either the bank's reference rate (which
is generally equivalent to the published prime rate) plus 2.5% or LIBOR plus 4%
and the Company pays, on the unused portion of the Line, a commitment fee of
0.50% per annum. The amended New Credit Agreement also requires maintenance of
certain EBITDA levels and limits on capital expenditure amounts. To induce the
banks to amend the New Credit Agreement, the Company paid the banks an amendment
fee of 1.75% on the existing Line, as well as certain arrangement fees and
annual agent fees. As an additional inducement, the Company issued to the banks
warrants to purchase, at an exercise price of $0.01 per share, an aggregate of
850,000 shares of the Company's Common Stock with varying vesting schedules for
exercisability. Of these, warrants to purchase 375,000 shares of Common Stock
were immediately exercisable, warrants to purchase 250,000 shares of Common
Stock became exercisable on October 31, 1999, and warrants to purchase the
remaining 225,000 shares of Common Stock will become exercisable only upon the
occurrence of certain events. At September 30, 1999, the Company had outstanding
debt of $109.0 million, representing borrowings under the New Credit Agreement,
and letters of credit amounting to approximately $3.8 million.
On June 29, 1999, as a further condition to the banks' agreement to
amend the New Credit Agreement, the Company received commitments from General
Atlantic and certain members of the Cayre family (together with General
Atlantic, the "Junior Debtholders") to loan to the Company an aggregate of $30.0
million (the "Junior Debt"). Certain members of the Cayre family and affiliates
of General Atlantic own, in the aggregate, a significant percentage of the
Company's Common Stock. Of the $30.0 million of Junior Debt, $20.0 million was
funded by General Atlantic and $10.0 million was funded by the Cayre family on
or before July 29, 1999. The Junior Debt is evidenced by promissory notes (the
"Notes") from the Company to the Junior Debtholders. The Company used the
borrowings under the Notes to prepay a portion of the Line, which may be
reborrowed.
To induce General Atlantic to enter into the commitments, the Company
has amended the terms of the Certificate of Designation designating its Series A
Convertible Preferred Stock to provide that in the event of a change of control,
the holders of the Preferred Stock will receive, before any payment or
distribution is made on any other equity securities of the Company, an amount
equal to the liquidation preference set forth in the Certificate of Designation
plus all accrued and unpaid dividends thereon to the date fixed for such change
of control. Further, the Company issued to General Atlantic warrants (the
"Commitment Warrants") to purchase, at an exercise price equal to $0.01 per
share, an aggregate of 500,000 shares (subject to anti-dilution adjustments) of
the Company's Common Stock.
In addition, the Company has amended the Registration Rights Agreement,
dated February 22, 1999 (the "Registration Rights Agreement"), between the
Company and General Atlantic, to extend those registration rights to the shares
of Common Stock issuable upon exercise of the Commitment Warrants and any
additional warrants issued to General Atlantic, as described below. The Notes
will mature no later than July 29, 2000 (the "Maturity Date") and will bear
cumulative interest, compounding quarterly, at the rate of 9% per year until
January 1, 2000, on which date the rate will increase to 12% per year. All
accrued and unpaid interest will be due and payable in cash on the earlier of
(i) the Maturity Date and (ii) the first business day after the Line has been
repaid in full. In the event of a change in control of the Company, the Company
is required to prepay the aggregate unpaid principal amount of the Notes plus
all accrued and unpaid interest thereon. After the Line has been repaid in full,
the Company may prepay the Notes in whole or in part. The Notes, including all
unpaid principal of and
<PAGE> 10
interest thereunder, will be subordinate and junior in right of payment to all
amounts owed under the New Credit Agreement, as amended. Concurrently with the
issuance of the Notes, the Company issued to the Junior Debtholders warrants to
purchase, at an exercise price of $0.01 per share, an aggregate of 1,500,000
shares of the Company's Common Stock. On November 1, 1999, the Company issued
additional warrants to purchase, at an exercise price equal to $0.01 per share,
an aggregate of 2,500,000 shares of the Company's Common Stock to the Junior
Debtholders. The Cayre family assigned their pro-rata share of the warrants to
General Atlantic. Under certain circumstances, the Company may be obligated to
issue additional warrants to the Junior Debtholders.
On September 18, 1997, Scavenger, Inc. ("Scavenger"), a software
developer, filed a lawsuit against the Company in New York Supreme Court
claiming that the Company breached a software development contract between the
parties dated November 28, 1995. Scavenger alleges that the Company, after
paying $2.5 million in advances and accepting delivery of gold master disks for
two computer games, refused to pay any more advances, including advances
relating to the development of two additional games under the agreement.
Scavenger is suing for the remaining advances ($4.3 million) and for future
royalties ($5 million), and also seeks consequential damages for allegedly being
forced out of business ($100 million) and losing contracts with unspecified
third parties ($4 million) as a result of the Company's alleged breach. The
Company filed an answer and counterclaim, in which it denies any liability to
Scavenger and alleges, among other things, that the contract was lawfully
terminated when Scavenger failed to deliver the two remaining games after
receiving from the Company written notice to cure its material breaches. By its
counterclaim, the Company seeks damages and restitution for at least $5 million
on grounds of breach of contract and unjust enrichment. Pursuant to a
preliminary conference order dated February 11, 1998, the parties had until year
end 1998 to conduct discovery. On September 17, 1998, however, Scavenger's
counsel filed a motion seeking to be relieved as counsel, which the Court
granted on October 6, 1998. At a November 12, 1998 preliminary conference,
another attorney appeared as Scavenger's prospective new counsel, subject to
further discussions with Scavenger. New counsel thereafter filed a notice of
appearance in the case. At a December 1, 1998 compliance conference, the Court
reissued a discovery order, whereby discovery was to be completed by July 30,
1999. At a June 30, 1999 conference, the Court extended the discovery deadline
until September 15, 1999. At an August 5, 1999 conference the Court maintained
those deadlines but scheduled another compliance conference for September 7,
1999 at which time those deadlines might be reconsidered. Scavenger has now
moved for partial summary judgment on its first two causes of action for
remaining advances ($4.3 million), and the Company has opposed that motion and
asked the court to dismiss those two claims with prejudice. Scavenger has moved
to amend the complaint adding claims of fraud and prima facie tort seeking
punitive damages; the proposed amended complaint seeks $60 million and $100
million on the fraud claims and $10 million in punitive damages on the prima
facie tort claim. The Company has, at once, opposed the motion to amend and
cross moved to dismiss the additional claims if leave to amend is granted. At
the September 1999 conference, the Court extended the discovery deadline through
October 13, 1999 and, except for certain discrete items being pursued with the
Court's permission, discovery has been completed. The Company has now served a
motion for partial summary judgment, seeking dismissal of the third, fourth and
fifth causes of action which, respectively, seek $5 million in claimed
additional royalty payments, $100 million in claimed consequential damages and
$4 million for alleged tortious interference with contract. The motion is
expected to be fully briefed and submitted by the middle of December 1999. The
Company intends to vigorously defend this action and pursue its counterclaim.
In January, February, and March 1998, ten substantially similar
complaints were filed against the Company, its former Chairman and its former
Chief Executive Officer, and in certain actions, its former Chief Financial
Officer, in the United States District Court for the Southern District of New
York. The plaintiffs, in general, purport to sue on behalf of a class of persons
who purchased shares (and as to certain complaints, purchased call options or
sold put options) of the Company during the period from August 1, 1996 through
December 12, 1997. The plaintiffs allege that the Company violated the federal
securities laws by making misrepresentations and omissions of material facts
that allegedly artificially inflated the market price of the Company's common
stock during the class period. The plaintiffs further allege that the Company
failed to expense properly certain prepaid royalties for software products that
had been terminated or had failed to achieve technological feasibility, which
misstatements purportedly had the effect of overstating the Company's net income
and net assets. Motions were made by certain groups of plaintiffs for their
appointment as lead plaintiffs in the actions. On October 7, 1998, the Court
appointed lead plaintiffs and lead counsel to the plaintiffs in the actions. The
plaintiffs' consolidated and amended complaint was filed and served in early
January 1999. By order dated January 23, 1999, the plaintiffs were granted leave
to file a second consolidated and amended complaint, which added claims under
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against the
Company's independent auditor, Arthur Andersen LLP. The Company and Arthur
Andersen LLP have each filed motions to dismiss the second consolidated and
amended complaint. The Company believes that these complaints are without merit
and intends to defend itself vigorously against these actions.
<PAGE> 11
On April 12, 1999, an action was commenced by the administrators for
three children who were murdered on December 1, 1997 by Michael Carneal at the
Heath High School in McCracken County, Kentucky. The action was brought against
25 defendants, including the Company and other corporations in the videogame
business; companies that produced or distributed the movie "The Basketball
Diaries;" and companies that allegedly provide obscene internet content. The
complaint alleges, with respect to the Company and other videogame corporations,
that Carneal was influenced by the allegedly violent content of certain
videogames and that the videogame manufacturers are liable for Carneal's
conduct. The complaint seeks $10 million in compensatory damages and $100
million in punitive damages. The Company and approximately ten other videogame
corporations have entered into a joint defense agreement, and have retained
counsel. The Court has stayed all discovery pending the briefing of motions to
discuss the complaint; reply briefs are due November 23, 1999. The Company
intends to vigorously defend this action.
Additionally, the Company is involved in various claims and legal
actions, the ultimate resolution of which management believes will not be
material to the Company's results of operations or financial condition.
NOTE 5 - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------
1998 1999
---- ----
(IN THOUSANDS)
<S> <C> <C>
Warrants issued in connection with New Credit
Agreement, as amended $ -- $3,188
Warrants issued in connection with Junior Debt -- 4,530
Common Stock issued in lieu of partial royalty payment -- 2,300
Cash paid for income taxes 6,118 2,611
Cash paid for interest 2,305 4,771
</TABLE>
NOTE 6 - RESTRUCTURING RESERVES
Restructuring charges of approximately $17.5 million, recorded in the
fourth quarter of fiscal 1999, relate to a reorganization of the Company's
frontline publishing business, contemplated relocation of corporate headquarters
to California and outsourcing of the Company's distribution function. The
Company has closed down certain internal development studios as part of its
frontline reorganization. As a result of the planned sale, recapitalization or
merger of the Company, plans to relocate corporate headquarters have been placed
on hold. The outsourcing of the distribution function is still in progress.
Management expects to complete the reorganization by March 31, 2000. The
following table sets forth adjustments to the restructuring reserve:
<TABLE>
<CAPTION>
BALANCE, BALANCE,
MARCH 31, SEPTEMBER 30,
1999 PAYMENTS 1999
-------- -------- ---------
<S> <C> <C> <C>
Severance $ 8,357 $(1,107) $ 7,250
Transition rent 635 (155) 480
------- ------- -------
$ 8,992 $(1,262) $ 7,730
======= ======= =======
</TABLE>
<PAGE> 12
On November 15, 1999, the Company and Infogrames Entertainment S.A., a
societe anonyme organized under the laws of France, together with its
wholly-owned U.S. subsidiary ("Infogrames"), entered into a securities purchase
agreement (the "GT Purchase Agreement") pursuant to which the Company agreed to
issue and Infogrames agreed to purchase from the Company: (i) 28,571,429 shares
of the Company's Common Stock at a purchase price of $1.75 per share and (ii) 5%
Subordinated Convertible Notes in the aggregate principal amount of
approximately $60.5 million (the "Infogrames Notes"), at a conversion price of
$1.85 per share. Concurrently with the execution of the GT Purchase Agreement,
Infogrames purchased from the Company a Short-Term Senior Secured Note in the
aggregate principal amount of $25 million (the "Short-Term Note"), with interest
at the per annum rate of either the Base Rate (as defined in the Short-Term
Note) plus 2.5% or LIBOR plus 4%. On the closing date of the GT Purchase
Agreement, the outstanding principal of and interest on the Short-Term Note
shall be applied toward the payment by Infogrames for the Infogrames Notes.
Concurrently with the execution of the GT Purchase Agreement, Infogrames
entered into equity purchase and voting agreements (the "Selling Stockholder
Agreements") with the Cayre family and General Atlantic, pursuant to which
Infogrames will purchase (a) from the Cayre family, (i) an aggregate of
33,789,000 shares of Common Stock for an aggregate purchase price of $25 million
(which represents a purchase price of $0.74 per share) and (ii) the Cayre
family's Notes in the aggregate principal amount of $10 million plus accrued
interest, and (b) from General Atlantic, warrants to purchase 4,500,000 shares
of Common Stock for nominal consideration.
In addition, concurrently with and as a condition of Infogrames' execution
of the GT Purchase Agreement, the Company entered into a securities exchange
agreement (the "Securities Exchange Agreement") with General Atlantic pursuant
to which the Company agreed to issue to General Atlantic convertible
non-interest bearing subordinated notes in the aggregate principal amount of $50
million (the "GAP Notes"), convertible at $4.00 per share, and General Atlantic
agreed to transfer to the Company, in exchange for and in consideration of the
issuance of the GAP Notes, subordinated notes of the Company held by General
Atlantic in the aggregate principal amount of $20 million and 600,000 shares of
Preferred Stock held by General Atlantic with a liquidation preference of $30
million.
<PAGE> 13
The consummation of the transactions contemplated by the GT Purchase
Agreement, the Selling Stockholder Agreements and the Securities Exchange
Agreement is contingent upon the expiration or early termination of the waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended, and any applicable corresponding non-United States laws, and the
completion of all filings required pursuant to the rules and regulations of The
Nasdaq Stock Market, as well as certain other customary conditions set forth
in the GT Purchase Agreement.
On November 15, 1999, the Company and its banks amended the New Credit
Agreement to waive the covenant requiring minimal levels of EBITDA, to increase
the Company's receivables and inventory advance rates to 60% and 50%
respectively, and to increase the borrowing base availability by the amount of
cash held by the Company from time to time. The $20 million additional borrowing
base availability agreed in June 1999 will remain until the consummation or
termination of the Infogrames transactions described above (collectively, the
"Transaction"). The covenant requiring the Company to permanently reduce the
aggregate commitment under the New Credit Agreement with net proceeds from the
Transaction has also been waived by the banks. The termination date of the New
Credit Agreement, as amended, was changed to March 31, 2000 from June 30, 2000.
Under the New Credit Agreement, as amended, the banks consented to the Company
entering into the Transaction and the Infogrames Short-Term Note, and the
granting to Infogrames of a junior lien on the Company's collateral. The amended
New Credit Agreement also requires that upon consummation of the Transaction the
aggregate commitment is to be reduced by $50 million, to $75 million and that
the borrowings will bear interest at the reduced rate of either the bank's
reference rate plus 1.0% or LIBOR plus 2.5%. To induce the banks to amend the
New Credit Agreement, the Company has agreed to pay the banks an amendment fee
of $500,000 on the termination of the New Credit Agreement, however this fee is
subject to reduction or elimination if the Transaction is closed and the
remaining balance refinanced or repaid within a certain time period. In
addition, following the closing of the Transaction, the Company will pay the
banks a monthly usage fee of $100,000. In the event that the Transaction is
terminated, or is not consummated by January 1, 2000 (or, in certain limited
circumstances, if the Closing is extended under the terms of the Infogrames
Agreement), an event of default will occur under the New Credit Agreement (as
well as under the Short-Term Note), and amounts due thereunder may be
accelerated by the banks.
If the Transaction is consummated, the Company anticipates that substantial
additional restructuring and other changes could be incurred. Management
believes that funds from operations, together with the proceeds from the
Short-Term Note, will be sufficient to fund operations through March 31, 2000.
If the Transaction is consummated, management believes that the capital received
therefrom, together with funds from operations, will be sufficient to fund
operations for the foreseeable future. In the event the Transaction is
terminated, amounts under the New Credit Agreement and the Short-Term Note will
be in default and may be accelerated. In such event, the Company would be
required to immediately replace these facilities and/or raise additional
capital. The failure to do so could have a material adverse effect on the
Company and its operations. There is no assurance that such funding could be
raised in such event.
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements which
involve risks and uncertainties. The Company's actual results or future events
could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to,
world-wide business and industry conditions, adoption of new hardware systems,
product delays, software development requirements and their impact on product
launches, company customer relations, failure to consumate with Infogrames
described below, and other risks and factors detailed, from time to time, in the
Company's filings with the Securities and Exchange Commission including, but not
limited to, the factors described on pages 9 through 15 of the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 1999.
OVERVIEW
The Company develops, publishes and distributes interactive
entertainment software for the children's education ("edutainment"), leisure
entertainment and gaming enthusiast's markets for a variety of platforms. The
Company employs a portfolio approach to achieve a broad base of published
products across most major consumer software categories. Since it commenced
operations in February 1993, the Company has experienced rapid growth and its
product and customer mix has changed substantially.
Publishing and distribution are the two major activities of the
Company. Publishing is divided into frontline, leisure and children's
publishing. Because each of these product categories has different associated
costs, the Company's margins have depended and will depend, in part, on the
percentage of net revenues attributable to each category. In addition, a
particular product's margin may depend on whether it has been internally or
externally developed and on what platforms it is published. Further, the
Company's margins may vary significantly from quarter to quarter depending on
the timing of its new published product releases. To the extent that mass
merchants require greater proportions of third-party software products, some of
which may yield lower margins, the Company's operating results may be impacted
accordingly.
The worldwide interactive entertainment software market is comprised
primarily of software for two distinct platforms: PCs and dedicated game
consoles. The market has grown dramatically in recent years with its growth
driven by the increasing installed base of multimedia PCs and current generation
game console systems. In addition, the development of enabling multimedia
technologies, the proliferation of software titles, the development of new and
expanding distribution channels and the emergence of a strong international
market for interactive entertainment software have spurred the rapid expansion
of the interactive entertainment market.
The consumer software industry is seasonal. Net revenues are typically
highest during the fourth calendar quarter. This seasonality is primarily a
result of the increased demand for consumer software during the year-end holiday
buying season.
There has been an increased rate of change and complexity in the
technological innovations affecting the Company's products, coupled with
increased competitiveness for shelf space and buyer selectivity. The market for
frontline titles has become increasingly hit-driven, which has led to higher
production budgets, more complex development processes, longer development
cycles and generally shorter product life cycles. The importance of the timely
release of hit titles, as well as the increased scope and complexity of the
product development and production process, have increased the need for
disciplined product development processes that limit cost and schedule overruns.
This in turn has increased the importance of leveraging the technologies,
characters or story-lines of such hit titles into additional interactive
entertainment software products in order to spread development costs among
multiple products. In this environment, the Company is determined to achieve a
balance between internal and external development, alliances and acquisitions,
and to reduce its relative dependence on third-party developers.
<PAGE> 15
Consumer software is sold through specialty retailers such as
Electronics Boutique and CompUSA, mass merchants and warehouse clubs such as
Wal-Mart, Sam's Club, Price-Costco and Target, and major retailers including
Best Buy. The Internet and on-line networks also present a new channel through
which publishers and distributors can make their products available to
end-users.
Sales are recorded net of expected future returns. Higher than
anticipated returns were experienced in the first six months of the fiscal year.
As a result of such a review at the end of the third quarter, management has
taken a substantial provision for returns and price protection in the current
quarter as described below. Management continuously assesses and re-evaluates
the rate of returns based on business conditions and market factors.
In 1998, the Company acquired OZM, Reflections, Legend and Homesoft.
Financial results of these companies have been included in the Company's
Consolidated Financial Statements on a purchase basis for the period since the
acquisition. At March 31, 1999, OZM is accounted for as a discontinued
operation, as it was the Company's intention to sell OZM. OZM was sold on July
28, 1999 for $5.2 million in cash. This resulted in an additional loss for the
three months ended September 30, 1999 from discontinued operations of $0.5
million. The initial loss recorded in the prior fiscal year of $19.0 million
included a provision of $5.0 million for operating losses during the phase-out
period.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1999 1998 1999
<S> <C> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 48.2 70.7 48.1 59.6
Selling and distribution expenses 25.1 41.1 23.9 33.6
General and administrative expenses 9.8 16.6 10.3 12.7
Research and development 13.7 27.6 14.0 19.6
Amortization of goodwill 0.6 1.0 0.7 0.9
------ ------ ------ ------
Operating income (loss) 2.6 (57.0) 3.1 (26.2)
Interest and other expense, net 0.7 6.1 0.8 3.7
------ ------ ------ ------
Income (loss) before provision for (benefit from)
income taxes 1.9 (63.1) 2.2 (29.9)
Provision for (benefit from) income taxes 0.8 (1.8) 0.9 (1.7)
------ ------ ------ ------
Net income (loss) from continuing operations 1.2 (61.3) 1.4 (28.2)
Loss from discontinued operations -- 0.5 -- 0.2
------ ------ ------ ------
Net income (loss) before dividends on preferred stock 1.2 (61.8) 1.4 (28.4)
Less dividends on preferred stock -- 0.7 -- 0.6
------ ------ ------ ------
Net income (loss) attributable to common stockholders 1.2% (62.5)% 1.4% (28.9)%
====== ====== ====== ======
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
Net revenues for the three months ended September 30, 1999 decreased
approximately $24.7 million, or 21.3%, to $91.4 million from $116.2 million, as
compared to the comparable period of the prior year. Net revenues for the six
months ended September 30, 1999 decreased approximately $19.8 million, or 8.5%,
to $212.8 million from $232.5 million, as compared to the comparable period of
the prior year. Such decrease in net revenues is attributable primarily to
reduced volume in the distribution business. During the quarter, particularly
during the last half of the quarter, the Company's perceived financial condition
significantly constrained its ability to acquire inventory for its third party
distribution business. As a result, the Company was forced to substantially
downsize its distribution business in the second quarter. Management expects net
revenues from the distribution business to significantly under-perform its
original projections for the remainder of the fiscal year, as the Company
continues to downsize that business and focus its resources on its core
publishing business.
<PAGE> 16
While the consumer software business is seasonal, as has been
previously stated, and the granting of price protection and returns of products
are expected to be substantially higher in the first and second calendar
quarters compared to the second half of the calendar year, actual returns in the
first two fiscal quarters exceeded expectations. As consumer pricing has become
more competitive, the Company is finding more frequently that it is necessary to
offer mark-downs for products which have not yet sold through to the consumer,
or to accept a higher level of returns of product that are not selling at
retail, or both. In anticipation of a further reduction in net revenues and as a
reflection of the higher than expected returns, management has increased
substantially its provision for price protection and returns in the current
fiscal quarter.
Absent the foregoing, the growth in net revenues for the three and six
months ended September 30, 1999 was primarily attributable to an increase in
frontline publishing revenues, which includes both domestic and international
frontline. This is due to the release of Driver, Duke Nukum Zero Hour for
Nintendo 64 ("N64") and Total Annihilation: Kingdoms for the PC, as well as
continued strong reorders for Driver for Sony Playstation ("PSX"). Domestic
frontline publishing revenues increased for the three and six months ended
September 30, 1999, as compared to the comparable period of the prior year.
International frontline publishing revenues decreased for the three months ended
September 30, 1999 and increased for the six months ended September 30, 1999, as
compared to the comparable periods of the prior year. Leisure publishing
revenues, as a percentage of total net revenues, remained flat over the relative
periods. Children's publishing revenues decreased for the three months ended
September 30, 1999 compared to the three months ended September 30, 1998 when
the initial release of Blue's Clues titles significantly aided revenues.
Children's publishing revenues increased for the six months ended September 30,
1999 due to the continued strong sales of Blues Clues titles and sales of deluxe
packaging of existing titles such as Freddi Fish, Putt-Putt and Pajama Sam.
Due to the downsizing of the Company's distribution business,
distribution net revenues decreased 64% from $50.0 million to $17.9 million for
the three months ended September 30, 1999, compared to the prior year period.
Distribution net revenues decreased 33% from $109.6 million to $73.4 million for
the six months ended September 30, 1999 as compared to the comparable period of
the prior year. In addition, the negative comparison is amplified by the strong
sales of Windows '98 in the six months ended September 30, 1998. Further, some
of the Company's larger retail customers continue to purchase consumer software
direct from several larger publishers whose software was previously sold through
the Company.
Cost of goods sold for the three months ended September 30, 1999
increased approximately $8.7 million, or 15.5%, to $64.6 million from $55.9
million, as compared to the comparable period of the prior year. Cost of goods
sold for the six months ended September 30, 1999 increased approximately $14.9
million, or 13.3%, to $126.8 million from $111.9 million, as compared to the
comparable period of the prior year. Cost of goods sold as a percentage of net
revenues for the three and six months ended September 30, 1999 increased to
70.7% and 59.6% from 48.2% and 48.1%, respectively, as compared to the
comparable periods of the prior year. The increase for the three and six months
ended September 30, 1999, as a percentage of net revenues, was due primarily to
a supplemental $8.0 million increase in the inventory valuation reserve to
reconcile the perpetual physical inventory records with those of the accounting
records of the Company. This need for reconciliation arose because of the
Company's continuing efforts to return to vendors, sometimes at negotiated
values, excess and unsaleable inventory returned from the Company's customers.
During the second quarter and through October 31, 1999, approximately $25.0
million of such inventory was so returned to vendors. The need for an increase
in inventory valuation reserves was further supported as a result of
transitioning physical distribution functions to a third party vendor.
Additionally, the increase in cost of goods was due to the increased sale of
console products, which generally have a higher overall cost than PC products.
Selling and distribution expenses primarily include shipping expenses,
sales and distribution labor expenses, advertising and promotion expenses and
distribution facilities costs. These expenses for the three months ended
September 30, 1999 increased approximately $8.5 million, or 29.1%, to $37.6
million from $29.1 million, as compared to the comparable period of the prior
year. Selling and distribution expenses
<PAGE> 17
for the six months ended September 30, 1999 increased approximately $15.9
million, or 28.6%, to $71.5 million from $55.6 million, as compared to the
comparable period of the prior year. Selling and distribution expenses as a
percentage of net revenues for the three and six months ended September 30, 1999
increased to 41.1% and 33.6% from 25.1% and 23.9%, respectively, as compared to
the comparable period of the prior year. The increase, as a percentage of net
revenues, was primarily attributable to the increase of advertising worldwide to
support existing and upcoming releases of the Company's frontline publishing
products and to continued inefficiencies in the Company's warehousing
operations.
General and administrative expenses primarily include personnel
expenses, facilities costs, professional expenses and other overhead charges.
These expenses for the three months ended September 30, 1999 increased
approximately $3.8 million, or 33.0%, to $15.2 million from $11.4 million, as
compared to the comparable period of the prior year. General and administrative
expenses for the six months ended September 30, 1999 increased approximately
$3.1 million, or 12.9%, to $26.9 million from $23.9 million, as compared to the
comparable period of the prior year. General and administrative expenses as a
percentage of net revenues for the three and six months ended September 30, 1999
increased to 16.6% and 12.7% from 9.8% and 10.3%, respectively, as compared to
the comparable periods of the prior year. The increase was primarily due to
increased costs associated with the Company's previously announced
restructuring, depreciation associated with the expansion of the Company's
worldwide facilities and the implementation of enterprise software to enhance
the Company's management information systems worldwide.
Research and development expenses ("R&D") primarily includes payment of
royalty advances to third-party developers on products that are currently in
development and direct costs of internally developing and producing a title such
as salaries and related costs. These expenses for the three months ended
September 30, 1999 increased approximately $9.3 million, or 58.0%, to $25.2
million from $16.0 million, as compared to the comparable period of the prior
year. R&D expenses for the six months ended September 30, 1999 increased
approximately $9.0 million, or 27.7%, to $41.6 million from $32.6 million, as
compared to the comparable period of the prior year. Research and development as
a percentage of net revenues for the three and six months ended September 30,
1999 increased to 27.6% and 19.6% from 13.7% and 14.0%, respectively, as
compared to the comparable periods of the prior year. The increase is primarily
due to a $7.8 million earned-out royalty payment to Reflections Interactive for
Driver, which was paid in cash and Common Stock. This was partially offset by
the Company entering into fewer new contracts with external developers. Research
and development expenses of the Company's internal development studios, which
primarily include Cavedog Entertainment, Humongous, Legend Entertainment and
Reflections increased to $16.4 and $27.2 million for the three and six months
ended September 30, 1999 from $7.3 million and $14.4 million, respectively, in
the comparable periods of the prior year.
Interest and other expense, net, increased approximately $4.8 million
and $5.9 million for the three and six months ended September 30, 1999,
respectively, as compared to the comparable periods of the prior year. The
increase was primarily attributable to the increase in interest costs associated
with increased borrowings under the Old Credit Agreement and New Credit
Agreement. The amortization of deferred financing costs relating to the New
Credit Agreement also contributed to the increase in interest and other expense,
net (See Note 4).
The Company's effective tax rate for the three and six months ended
September 30, 1999 was 3% and 6%, respectively, compared to 39% for the
three and six months ended September 30, 1998. The Company does not anticipate
earnings in the near future sufficient to offset an increasing tax benefit.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $4.3 million at September 30, 1999
compared to $13.4 million at March 31, 1999. As of September 30, 1999, the
Company had a working capital deficit of $33.3 million compared to $131.8
million in working capital at March 31, 1999.
During the six months ended September 30, 1999, $40.4 million of cash
and cash equivalents was provided by financing activities. The Company utilized
$10.3 million of its revolving line of credit and issued $30 million of notes
payable to shareholders (see "Junior Debt" described below). The cash flow from
financing activities was primarily used to fund $40.8 million for net cash used
in operating activities
<PAGE> 18
which resulted from operating losses, and a reduction in the accounts payable
balance (for past due accounts). This was partially offset by a decline in
receivables and a decline in inventory.
Approximately $7.6 million in cash was used in investing activities to
purchase property and equipment, primarily additional computer hardware and
software for the development of internal systems.
On January 21, 1997, the Company entered into a revolving Credit
Agreement (as amended, the "Old Credit Agreement") with certain banks expiring
on December 31, 1998. On September 11, 1998, the borrowings under the Old Credit
Agreement were repaid and the Old Credit Agreement was terminated.
Simultaneously, on September 11, 1998, the Company entered with First
Union National Bank, as agent for a syndicate of banks, into a new revolving
Credit Agreement (the "New Credit Agreement") expiring on September 11, 2001.
Under the New Credit Agreement, the Company can borrow up to $125 million (the
"Line"), depending on the borrowing base. Borrowing is limited to a percentage
of domestic accounts receivable and inventory, and is secured by these and
certain other assets.
On February 23, 1999, certain partnerships affiliated with General
Atlantic Partners, LLC (together with its affiliates, "General Atlantic")
purchased from the Company 0.6 million shares of the Company's Series A
Convertible Preferred Stock (the "Preferred Stock") for an aggregate purchase
price of $30.0 million. These shares of Preferred Stock are convertible into 6.0
million shares of the Company's Common Stock at a conversion price of $5 per
share.
On June 29, 1999, the Company and the banks amended the New Credit
Agreement to increase the Company's borrowing base by an additional $20 million
until March 31, 2000 and to remove certain financial covenants under the New
Credit Agreement. The termination date of the New Credit Agreement, as amended,
was changed to June 30, 2000. Under the New Credit Agreement, as amended, the
borrowings bear interest at either the bank's reference rate (which is generally
equivalent to the published prime rate) plus 2.5% or LIBOR plus 4% and the
Company pays, on the unused portion of the Line, a commitment fee of 0.50% per
annum. The amended New Credit Agreement also requires maintenance of certain
EBITDA levels and limits on capital expenditure amounts. To induce the banks to
amend the New Credit Agreement, the Company paid the banks an amendment fee of
1.75% on the existing Line, as well as certain arrangement fees and annual agent
fees. As an additional inducement, the Company issued the banks warrants to
purchase, at an exercise price of $0.01 per share, an aggregate of 850,000
shares of the Company's Common Stock with varying vesting schedules for
exercisability. Of these, warrants to purchase 375,000 shares of Common Stock
were immediately exercisable and warrants to purchase 250,000 shares of Common
Stock became exercisable on October 31, 1999. The remaining warrants to purchase
225,000 shares of Common Stock will become exercisable only upon the occurrence
of certain events. At September 30, 1999, the Company had outstanding debt of
approximately $109 million, representing borrowings under the New Credit
Agreement, and letters of credit amounting to approximately $3.8 million. (See
Note 7).
On June 29, 1999, as a further condition to the banks' agreement to
amend the New Credit Agreement, the Company received commitments from General
Atlantic and certain members of the Cayre family (together with General
Atlantic, the "Junior Debtholders") to loan to the Company an aggregate of $30.0
million (the "Junior Debt"). Certain members of the Cayre family and
<PAGE> 19
affiliates of General Atlantic own, in the aggregate, approximately 58% of the
Company's Common Stock as of September 30, 1999. Of the $30.0 million of Junior
Debt, $20.0 million was funded by General Atlantic and $10.0 million was funded
by the Cayre family on or before July 29, 1999. The Junior Debt is evidenced by
promissory notes (the "Notes") from the Company to the Junior Debtholders. The
Company used the borrowings under the Notes to prepay a portion of the Line,
which may be reborrowed.
To induce General Atlantic to enter into the commitments, the Company has
amended the terms of the Certificate of Designation designating its Series A
Convertible Preferred Stock to provide that in the event of a change of control,
the holders of the Preferred Stock will receive, before any payment or
distribution is made on any other equity securities of the Company, an amount
equal to the liquidation preference set forth in the Certificate of Designation
plus all accrued and unpaid dividends thereon to the date fixed for such change
of control. Further, the Company issued to General Atlantic warrants (the
"Commitment Warrants") to purchase, at an exercise price equal to $0.01 per
share, an aggregate of 500,000 shares (subject to anti-dilution adjustments) of
the Company's Common Stock.
The Company amended the Registration Rights Agreement, dated February 22,
1999 (the "Registration Rights Agreement"), between the Company and General
Atlantic, to extend those registration rights to the shares of Common Stock
issuable upon exercise of the Commitment Warrants and any additional warrants
issued to General Atlantic, as described below. The Notes will mature no later
than July 29, 2000 (the "Maturity Date") and will bear cumulative interest,
compounding quarterly, at the rate of 9% per year until January 1, 2000, on
which date the rate will increase to 12% per year. All accrued and unpaid
interest will be due and payable in cash on the earlier of (i) the Maturity Date
and (ii) the first business day after the Line has been repaid in full. In the
event of a change in control of the Company, the Company is required to prepay
the aggregate unpaid principal amount of the Notes plus all accrued and unpaid
interest thereon. After the Line has been repaid in full, the Company may prepay
the Notes in whole or in part. The Notes, including all unpaid principal of and
interest thereunder, will be subordinate and junior in right of payment to all
amounts owed under the New Credit Agreement, as amended. Concurrently with the
issuance of the Notes, the Company issued to the Junior Debtholders warrants to
purchase, at an exercise price of $0.01 per share, an aggregate of 1,500,000
shares of the Company's Common Stock. On November 1, 1999, the Company issued
additional warrants to purchase, at an exercise price of $0.01 per share, an
aggregate of 2,500,000 shares of the Company's Common Stock to the Junior
Debtholders. The Cayre family assigned their pro-rata share of the warrants to
General Atlantic. Under certain circumstances, the Company may be obligated to
issue additional warrants to the Junior Debtholders.
On November 15, 1999, the Company and Infogrames Entertainment S.A., a
societe anonyme organized under the laws of France, together with its U.S.
wholly-owned subsidiary ("Infogrames"), entered into a securities purchase
agreement (the "GT Purchase Agreement") pursuant to which the Company agreed to
issue and Infogrames agreed to purchase from the Company: (i) 28,571,429 shares
of the Company's Common Stock at a purchase price of $1.75 per share and (ii) 5%
Subordinated Convertible Notes in the aggregate principal amount of
approximately $60.5 million (the "Infogrames Notes"), at a conversion price of
$1.85 per share. Concurrently with the execution of the GT Purchase Agreement,
Infogrames purchased from the Company a Short-Term Senior Secured Note in the
aggregate principal amount of $25 million (the "Short-Term Note"), with interest
at the per annum rate of either the Base Rate (as defined in the Short-Term
Note) plus 2.5% or LIBOR plus 4%. On the closing date of the GT Purchase
Agreement, the outstanding principal of and interest on the Short-Term Note
shall be applied toward the payment by Infogrames for the Infogrames Notes.
Concurrently with the execution of the GT Purchase Agreement, Infogrames
entered into equity purchase and voting agreements (the "Selling Stockholder
Agreements") with the Cayre family and General Atlantic, pursuant to which
Infogrames will purchase (a) from the Cayre family, (i) an aggregate of
33,789,000 shares of Common Stock for an aggregate purchase price of $25 million
(which represents a purchase price of $0.74 per share) and (ii) the Cayre
family's Notes in the aggregate principal amount of $10 million plus accrued
interest, and (b) from General Atlantic, warrants to purchase 4,500,000 shares
of Common Stock for nominal consideration.
<PAGE> 20
In addition, concurrently with and as a condition of Infogrames'
execution of the GT Purchase Agreement, the Company entered into a securities
exchange agreement (the "Securities Exchange Agreement") with General Atlantic
pursuant to which the Company agreed to issue to General Atlantic convertible
non-interest bearing subordinated notes in the aggregate principal amount of $50
million (the "GAP Notes"), convertible at $4.00 per share, and General Atlantic
agreed to transfer to the Company, in exchange for and in consideration of the
issuance of the GAP Notes, subordinated notes of the Company held by General
Atlantic in the aggregate principal amount of $20 million and 600,000 shares
of Preferred Stock held by General Atlantic with a liquidation preference of $30
million.
The consummation of the transactions contemplated by the GT Purchase
Agreement, the Selling Stockholder Agreements and the Securities Exchange
Agreement is contingent upon the expiration or early termination of the waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended, and any applicable corresponding non-United States laws, and the
completion of all filings required pursuant to the rules and regulations of The
Nasdaq Stock Market, as well as certain other customary conditions set forth
in the GT Purchase Agreement.
On November 15, 1999, the Company and its banks amended the New Credit
Agreement to waive the covenant requiring minimal levels of EBITDA, to increase
the Company's receivables and inventory advance rates to 60% and 50%
respectively, and to increase the borrowing base availability by the amount of
cash held by the Company from time to time. The $20 million additional borrowing
base availability agreed in June 1999 will remain until the consummation or
termination of the Infogrames transactions described above (collectively, the
"Transaction"). The covenant requiring the Company to permanently reduce the
aggregate commitment under the New Credit Agreement with net proceeds from the
Transaction has also been waived by the banks. The termination date of the New
Credit Agreement, as amended, was changed to March 31, 2000 from June 30, 2000.
Under the New Credit Agreement, as amended, the banks consented to the Company
entering into the Transaction and the Infogrames Short-Term Note, and the
granting to Infogrames of a junior lien on the Company's collateral. The amended
New Credit Agreement also requires that upon consummation of the Transaction the
aggregate commitment is to be reduced by $50 million, to $75 million and that
the borrowings will bear interest at the reduced rate of either the bank's
reference rate plus 1.0% or LIBOR plus 2.5%. To induce the banks to amend the
New Credit Agreement, the Company has agreed to pay the banks an amendment fee
of $500,000 on the termination of the New Credit Agreement, however this fee is
subject to reduction or elimination if the Transaction is closed and the
remaining balance refinanced or repaid within a certain time period. In
addition, following the closing of the Transaction, the Company will pay the
banks a monthly usage fee of $100,000. In the event that the Transaction is
terminated, or is not consummated by January 1, 2000 (or, in certain limited
circumstances, if the Closing is extended under the terms of the Infogrames
Agreement, an event of default will occur under the New Credit Agreement (as
well as under the Short-Term Note), and amounts due thereunder may be
accelerated by the banks.
If the Transaction is consummated, the Company anticipates that substantial
additional restructuring and other changes could be incurred. Management
believes that funds from operations, together with the proceeds from the
Short-Term Note, will be sufficient to fund operations through March 31, 2000.
If the Transaction is consummated, management believes that the capital received
therefrom, together with funds from operations, will be sufficient to fund
operations for the foreseeable future. In the event the Transaction is
terminated, amounts under the New Credit Agreement and the Short-Term Note will
be in default and may be accelerated. In such event, the Company would be
required to immediately replace these facilities and/or raise additional
capital. The failure to do so could have a material adverse effect on the
Company and its operations. There is no assurance that such funding could be
raised in such event.
The Company expects continued volatility in the use of cash due to
varying seasonal, receivable payment cycles and quarterly working capital needs
to finance its growing publishing businesses, and the scale-back in its
distribution business.
<PAGE> 21
YEAR 2000 COMPLIANCE
Many currently installed operating systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields need additional digits to distinguish dates after the year 1999. As a
result, computer systems and/or software used by many companies may need to be
upgraded to comply with such "Year 2000" requirements. Failure to correct
systems to become "Year 2000 compliant" may result in systems failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities. The Year 2000 issue also may affect the
Company's products.
The Company's review of its Year 2000 compliance issues encompasses
three principal areas: critical information systems (including information
technology) ("IT"), such as financial and order entry systems, and
non-information technology ("Non-IT") systems, such as facilities; third party
customers, vendors and others with whom the Company does business; and the
Company's products. The Company has conducted a comprehensive review of its
critical information systems, created a plan for reviewing its products for Year
2000 compliance and begun implementing that plan. A plan has also been
developed, and is now being implemented, to remedy any deficiencies in the
Company's critical information systems. The Company is resolving Year 2000
compliance issues primarily through normal upgrades of its software or, when
necessary, through replacement of existing software or affected non-IT systems
with Year 2000 compliant applications or systems.
Presently, the Company is in the process of testing the enhancements to
its critical information systems and is developing and implementing a plan to
identify time sensitive components in its products currently under development.
In addition, the Company is in the process of asking vendors and other third
parties with whom the Company has relevant relationships to certify that they
are Year 2000 compliant or, if they are not yet so compliant, to provide a
description of their plans to become so. The Company expects to complete its
programs for Year 2000 compliance with respect to critical information systems
and vendor and other third parties by December 15, 1999 and intends to complete
such process with respect to its products in advance of January 1, 2000. There
can be no assurance that such upgrades and replacements can be completed on
schedule or within estimated costs or can successfully address the Year 2000
compliance issues. If the Company's present efforts to address the Year 2000
compliance issues are not successful, or if vendors and other third parties with
which the Company conducts business do not successfully address such issues, the
Company's business, operating results and financial position could be materially
and adversely affected. For example, failure to achieve Year 2000 compliance for
the Company's internal critical information systems could delay its ability to
manufacture and ship products, disrupt customer service and technical support
facilities, or interrupt customer access to online products and services.
The Company also relies heavily on third parties such as vendors,
suppliers, service providers and a large retail distribution channel. If these
or other third parties experience Year 2000 failures or malfunctions, there
could be a material adverse impact on the Company's ability to conduct ongoing
operations. For example, the ability to manufacture and ship products (both the
Company's and third parties' for which the Company acts as distributor) into the
retail channel, to receive retail sales information necessary to maintain proper
inventory levels, or to complete online transactions dependent upon third party
service providers could be affected. Moreover, should third party products
distributed by the Company fail to be Year 2000 compliant, retail customers of
the Company might return such products or seek redress from the Company, which
in turn would require the Company to seek redress from the publisher of the
product. In addition, because of the number of products sold by the Company
currently and in the past, the Company could face litigation relating to Year
2000 compliance of products that the Company no longer sells and/or supports,
although the Company believes that any such exposure should not be material.
The Company has budgeted $0.8 million for the cost of upgrading,
replacing, testing and implementing its Year 2000 compliance, and has currently
spent approximately $0.75 million to date. Additionally, the Company has not yet
established a contingency plan and will continue to evaluate whether one is
necessary, depending upon its progress in implementing its Year 2000 compliance
measures as set forth above. The above discussion regarding costs, risks and
estimated completion dates for the Year 2000 is based on the Company's best
estimates given information that is currently available, and is subject to
change. Actual results may differ materially from these estimates.
<PAGE> 22
PART II. OTHER INFORMATION
ITEM 1. LITIGATION
With respect to the action brought against the Company by Scavenger, Inc.,
previously described in the Company's Annual Report on Form 10-K for the fiscal
year ended March 31, 1999 (the "1999 Annual Report"), at the September 1999
conference, the Court extended the discovery deadline through October 13, 1999
and, except for certain discrete items being pursued with the Court's
permission, discovery has been completed. The Company has now served a motion
for partial summary judgment, seeking dismissal of the third, fourth and fifth
causes of action which, respectively seek $5 million in claimed additional
royalty payments, $100 million in claimed consequential damages and $4 million
for alleged tortious interference with contract. The motion is expected to be
fully briefed and submitted by the middle of December 1999.
With respect to the litigations between Midway Games, Inc. and related
entities and the Company, previously described in the 1999 Annual Report, as
announced on August 16, 1999, the parties have entered into a settlement
agreement to resolve all claims and counterclaims between the parties.
Additionally, the Company is involved in various claims and legal actions,
the ultimate resolution of which management believes will not be material to
the Company's results of operations or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
Pursuant to the Notes from the Company to the Junior Debtholders, the
Company, on November 1, 1999, issued warrants to purchase an additional
2,500,000 shares of Common Stock to General Atlantic. In connection with the
Transaction, Infogrames will be purchasing such warrants from General Atlantic.
Pursuant to the Development and Publishing Agreement entered into between
the Company and Martin Edmondson in the December 23, 1998 acquisition of
Reflections Interactive Limited, on September 30, 1999 and October 29, 1999,
the Company issued 791,306 and 693,828 shares of Common Stock, respectively.
<PAGE> 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
3.1 Amended and Restated Certificate of Incorporation, as amended
(incorporated herein by reference to the exhibit with the
corresponding number filed as part of the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998).
3.2 Amended and Restated By-laws, as amended (incorporated herein
by reference to the exhibit with the corresponding number
filed as part of the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998).
27.1 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K
During the quarter ended September 30, 1998, the Company filed a
Current Report on Form 8-K on August 5, 1999, to report the amendment to the New
Credit Agreement and the funding of the Junior Debt by General Atlantic and the
Cayre family.
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GT INTERACTIVE SOFTWARE CORP.
By: /s/ JOHN T. BAKER IV
-----------------------
John T. Baker IV
President and Chief Operating Officer
Date: November 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 4,330
<SECURITIES> 105
<RECEIVABLES> 175,754
<ALLOWANCES> 10,668
<INVENTORY> 137,988
<CURRENT-ASSETS> 292,051
<PP&E> 64,271
<DEPRECIATION> 25,937
<TOTAL-ASSETS> 404,257
<CURRENT-LIABILITIES> 325,361
<BONDS> 109,000
0
30,000
<COMMON> 739
<OTHER-SE> 46,747
<TOTAL-LIABILITY-AND-EQUITY> 404,257
<SALES> 212,751
<TOTAL-REVENUES> 212,751
<CGS> 126,763
<TOTAL-COSTS> 126,763
<OTHER-EXPENSES> 114,875
<LOSS-PROVISION> (790)
<INTEREST-EXPENSE> 7,815
<INCOME-PRETAX> (63,637)
<INCOME-TAX> (3,723)
<INCOME-CONTINUING> (59,914)
<DISCONTINUED> (477)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (60,391)
<EPS-BASIC> (0.84)
<EPS-DILUTED> (0.84)
</TABLE>
