<PAGE>
PROSPECTUS FILED PURSUANT TO RULE 424(b)(4)
dated June 19, 1998 REGISTRATION NUMBER 333-48473
5,000,000 Shares
[LOGO OF INTERPLAY APPEARS HERE]
Common Stock
All of the 5,000,000 shares of Common Stock offered hereby (the "Offering")
are being issued and sold by Interplay Entertainment Corp. ("Interplay" or the
"Company"). A non-management stockholder of the Company (the "Selling
Stockholder") has granted the Underwriters a 30-day option to purchase up to
an additional 750,000 shares of Common Stock. The Company will not receive any
proceeds from the sale of stock by the Selling Stockholder.
Prior to the Offering, there has been no public market for the Common Stock of
the Company. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price. The Company's Common Stock has
been approved for quotation on the Nasdaq National Market under the symbol
"IPLY."
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
================================================================================
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share.............................. $5.50 $0.385 $5.115
- -------------------------------------------------------------------------------
Total(3)............................... $27,500,000 $1,886,500 $25,613,500
</TABLE>
================================================================================
(1) The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting offering expenses payable by the Company estimated at
$1,038,500.
(3) The Underwriters will not receive any Underwriting Discount in connection
with the purchase of 100,000 shares of Common Stock in the Offering by the
Company's Chief Executive Officer. The Selling Stockholder has granted the
Underwriters a 30-day option to purchase up to an additional 750,000
shares of Common Stock solely to cover over-allotments, if any, at the
Price to Public less the Underwriting Discount. If all such shares are
purchased, the total Price to Public and Underwriting Discount will be
$31,625,000 and $2,175,250, respectively, and the Selling Stockholder will
receive proceeds of $3,836,250. See "Underwriting."
The shares of Common Stock are offered by the several Underwriters subject to
prior sale, when, as and if delivered to and accepted by the Underwriters and
subject to their right to reject orders in whole or in part. It is expected
that delivery of the certificates representing shares of the Common Stock will
be made at the offices of Piper Jaffray Inc. in Minneapolis, Minnesota on or
about June 24, 1998.
Piper Jaffray inc.
Bear, Stearns & Co. Inc.
UBS Securities
<PAGE>
INTERPLAY
PRODUCTIONS
[ANIMATED DEPICTIONS OF CHARACTERS AND ARTWORK
FROM THE COMPANY'S STAR TREK, REDNECK RAMPAGE,
EARTHWORM JIM, CLAY FIGHTER AND VR SPORTS
POWERBOAT RACING TITLES]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF THE
COMPANY, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS
IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, DURING AND AFTER THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
BY GAMERS.
[Title names interspersed with animated
FOR GAMERS. product artwork and pictures of product
packaging]
STRATEGY
--------
FLAT CAT
ACTION M.A.X.
- ------
TANTRUM CONQUEST OF THE NEW WORLD
DESCENT CAESARS PALACE
DESCENT II BRIDGE DELUXE II WITH OMAR SHARIF
STAR TREK: STARFLEET ACADEMY BATTLE CHESS
CARMAGEDDON USCF CHESS
REDNECK RAMPAGE BEAT THE HOUSE
CLAY FIGHTER 63 1/3
ROLE PLAYING
------------
BLACK ISLE STUDIOS
FALLOUT
STONEKEEP
<PAGE>
SHINY
-----
EARTHWORM JIM
MDK
ADVENTURE
---------
TRIBAL DREAMS
OF LIGHT AND DARKNESS -- THE PROPHECY
SPORTS
------
VR SPORTS
VIRTUAL POOL
VIRTUAL POOL 2
VR BASEBALL '97
VR SPORTS POWERBOAT RACING
JIMMY JOHNSON'S VR FOOTBALL '98
[Wording interspersed with animated product artwork and pictures of product
packaging]
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and Consolidated Financial
Statements and Notes thereto (the "Consolidated Financial Statements") included
elsewhere in this Prospectus. Except as otherwise noted, all information in
this Prospectus, including financial information, share and per share data,
assumes no exercise of the Underwriters' over-allotment option. See
"Underwriting." Investors should carefully consider the information set forth
under the heading "Risk Factors."
THE COMPANY
Interplay Entertainment Corp. ("Interplay" or the "Company") is a leading
developer, publisher and distributor of interactive entertainment software for
both core gamers and the mass market. The Company, which commenced operations
in 1983, is most widely known for its titles in the action/arcade,
adventure/role-playing game ("RPG"), strategy/puzzle and sports categories, and
has published such hit titles as Descent, Fallout, Stonekeep, Battle Chess and
Virtual Pool. The Company has produced titles for many of the most popular
interactive entertainment software platforms, and currently balances its
development efforts by publishing interactive entertainment software for
personal computers ("PCs") and current generation video game consoles, such as
the PlayStation(R) manufactured by Sony Computer Entertainment ("PlayStation")
and Nintendo 64. Interplay was named Publisher of the Year in 1996 by Computer
& Net Player magazine.
The worldwide market for interactive entertainment software has grown
significantly in recent years. According to the International Development Group
("IDG"), a market research firm, the worldwide market for interactive
entertainment software generated sales of more than 220 million retail units in
1997 and is projected to generate more than 437 million retail units in 1999,
representing a 41% compound annual growth rate. The interactive entertainment
software market is composed primarily of software for PCs and current
generation video game consoles.
The Company seeks to publish interactive entertainment software titles that
are, or have the potential to become, franchise titles that can be leveraged
across several releases and/or platforms, and has published many such
successful franchise titles to date. In addition, the Company secures licenses
to use popular intellectual properties, such as Star Trek, Caesars Palace and
Major League Baseball, for incorporation into certain of its products. Of the
more than 40 titles currently in development by the Company, more than half are
sequels to successful titles or incorporate licensed intellectual properties.
In addition to developing products through its internal product development
group of approximately 290 employees worldwide, the Company seeks to publish
titles from leading third party interactive entertainment software developers.
Through relationships with such developers, the Company believes that it is
able to supplement its internally developed product line with products
developed by talented third party developers while reducing its exposure to
certain of the financial risks associated with internal product development.
The Company believes that one of its core strengths is its developer-friendly
management culture, which the Company believes provides it with a competitive
advantage in forging strategic relationships with successful third party
interactive entertainment software developers. The Company's internal software
producers manage external product development efforts to ensure that externally
developed titles satisfy the Company's product development standards. The
Company also seeks to leverage its investments in existing gameplay
technologies into new titles, while internally and externally developing new
technologies which can be used in multiple future title releases.
The Company has developed a worldwide sales and distribution capability. In
North America, Interplay sells and distributes its products primarily through
its direct sales force and, to a lesser extent, through third party
distribution arrangements. In certain international markets, the Company has
established direct sales and distribution capabilities, while in the majority
of international markets the Company utilizes third party distribution
arrangements. The Company's wholly owned subsidiary, Interplay OEM, Inc.,
distributes both Company-published and third party-published titles to computer
hardware and peripheral device manufacturers for use in bundling arrangements.
In addition, the Company sells its games directly through its web site and
generates royalty-based revenues from use of its games by providers of on-line
gameplay who distribute through popular on-line services, such as America
Online.
The Company was incorporated in the State of California in 1982 and was
reincorporated in the State of Delaware in May 1998, and conducts business
under the trade name "Interplay Productions." The principal executive offices
of the Company are located at 16815 Von Karman Avenue, Irvine, California
92606, and its telephone number at that location is (949) 553-6655.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by
the Company............ 5,000,000 shares
Common Stock to be
outstanding after the
Offering............... 18,225,446 shares(1)
Use of Proceeds......... For repayment of indebtedness. See "Use of Proceeds."
Nasdaq National Market
symbol................. IPLY
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
EIGHT MONTHS THREE MONTHS
YEAR ENDED APRIL 30, ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------- ------------------- ----------------
1993 1994 1995 1996 1997 1996 1997 1997 1998
------- ------- ------- ------- -------- ----------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
STATEMENTS OF OPERATIONS DATA(2):
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues........... $25,355 $52,668 $79,546 $96,952 $ 83,262 $ 50,364 $85,961 $22,410 $40,996
Gross profit........... 11,981 21,445 34,055 47,013 20,782 14,639 41,097 8,902 21,775
Operating income
(loss)................ 3,917 5,296 6,047 (417) (34,684) (22,302) (2,786) (6,850) 4,512
Net income (loss)...... 2,623 3,203 4,249 (744) (27,219) (17,469) (5,059) (5,443) 2,849
Net income (loss) per share(3):
Basic.................. $ 0.32 $ 0.37 $ 0.40 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.26
Diluted................ $ 0.29 $ 0.32 $ 0.35 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.23
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1997 1997 1997 1997 1998
--------- -------- --------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
QUARTERLY STATEMENTS OF OP-
ERATIONS DATA:
Net revenues.............. $ 22,410 $ 20,502 $ 23,833 $ 53,308 $ 40,996
Gross profit.............. 8,902 6,561 9,680 26,557 21,775
Operating income (loss)... (6,850) (9,327) (4,431) 8,045 4,512
Net income (loss)......... (5,443) (9,990) (5,481) 6,493 2,849
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------
ACTUAL AS ADJUSTED(4)
-------- --------------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Working capital........................................ $ 17,442 $ 33,903
Total assets........................................... 78,327 78,327
Total long-term debt (including current portion)....... 38,680 7,250
Stockholders' equity................................... 1,669 34,905
</TABLE>
- -------
(1) Based on shares outstanding at March 31, 1998. Includes 2,272,418 shares of
Common Stock issuable upon the closing of the Offering upon the exercise of
Common Stock Warrants by the cancellation of Subordinated Secured
Promissory Notes at an exercise price of $3.85 per share (based on the
initial public offering price of $5.50 per share). Excludes (i) 2,053,206
shares of Common Stock issuable upon exercise of stock options outstanding
at March 31, 1998, which had a weighted average exercise price of $4.80 per
share, (ii) 1,680,541 shares of Common Stock reserved for issuance under
the Company's 1997 Stock Incentive Plan and (iii) 200,000 shares of Common
Stock reserved for issuance under the Company's Employee Stock Purchase
Plan. See "Management--Employee Benefit Plans--Stock Incentive Plans,"
"Description of Capital Stock--Common Stock Warrants" and Notes 6 and 13 of
Notes to Consolidated Financial Statements.
(2) Effective May 1, 1997, the Company changed its fiscal year end from April
30 to December 31.
(3) See Note 2 of Notes to Consolidated Financial Statements for an explanation
of the number of shares used in computing net income per share.
(4) As adjusted to reflect the sale by the Company of 5,000,000 shares of
Common Stock offered hereby at the initial public offering price of $5.50
per share and the application of the estimated net proceeds therefrom, and
the exercise of Common Stock Warrants having an aggregate purchase price of
$87,488 by the cancellation of Subordinated Secured Promissory Notes in the
aggregate principal amount of $8,661,320. See "Use of Proceeds,"
"Description of Capital Stock--Common Stock Warrants" and Notes 6 and 13 of
Notes to Consolidated Financial Statements.
As used in this Prospectus, references to Interplay or the Company refer to
Interplay Entertainment Corp., a Delaware corporation, its California
predecessor, and its wholly and majority owned subsidiaries. Interplay(TM),
Interplay Productions(R), the Interplay logo(R), By Gamers. For Gamers.(TM),
and certain of the Company's product names and publishing labels referred to
herein are trademarks of the Company. This Prospectus also includes trademarks
of other companies.
4
<PAGE>
RISK FACTORS
An investment in the shares of Common Stock offered hereby involves a high
degree of risk. In addition to the other information in this Prospectus, the
following factors should be considered carefully in evaluating the Company and
its business before purchasing shares of Common Stock offered by this
Prospectus. This Prospectus contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. The
cautionary statements made in this Prospectus should be read as being
applicable to all related forward-looking statements wherever they appear in
this Prospectus. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed below, as
well as those discussed elsewhere in this Prospectus.
FLUCTUATIONS IN OPERATING RESULTS; UNCERTAINTY OF FUTURE RESULTS; SEASONALITY
The Company's operating results have fluctuated significantly in the past
and will likely 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 the Company's control. Such
factors include, but are not limited to, demand for the Company's and its
competitors' products, the size and rate of growth of the market for
interactive entertainment software, changes in computing platforms, the number
of new products and product enhancements released by the Company and its
competitors during the period, changes in product mix, product returns, the
timing of orders placed by distributors and dealers, delays in shipment, the
timing of development and marketing expenditures, price competition and the
level of the Company's international and OEM, royalty and licensing net
revenues. The uncertainties associated with the interactive entertainment
software development process, lengthy manufacturing lead times for Nintendo-
compatible products, possible production delays, and the approval process for
products compatible with the Sony Computer Entertainment, Nintendo and Sega
video game consoles, as well as approvals required from other licensors, make
it difficult to accurately predict the quarter in which shipments will occur.
Because of the limited number of products introduced by the Company in any
particular quarter, a delay in the introduction of a product may materially
adversely affect the Company's operating results for that quarter. A
significant portion of the Company's operating expenses is relatively fixed,
and planned expenditures are based primarily on sales forecasts. If net
revenues do not meet the Company's expectations in any given quarter,
operating results may be materially adversely affected. The interactive
entertainment software industry is highly seasonal, with the highest levels of
consumer demand occurring during the year-end holiday buying season, followed
by demand during the first calendar quarter resulting both from demand for
interactive entertainment software for PCs and video game consoles purchased
during the holidays and from continuing demand for titles released in the
preceding fourth calendar quarter. As a result, net revenues, gross profits
and operating income for the Company have historically been highest during the
fourth and the following first calendar quarters, and have declined from those
levels in the subsequent second and third calendar quarters.
The failure or inability of the Company to introduce products on a timely
basis to meet such seasonal increases in demand may have a material adverse
effect on the Company's business, operating results and financial condition.
The Company may over time become increasingly affected by the industry's
seasonal patterns. Although the Company seeks to reduce the effect of such
seasonal patterns on its business by distributing its product release dates
more evenly throughout the year, there can be no assurance that such efforts
will be successful. There can be no assurance that the Company will be
profitable in any particular period given the uncertainties associated with
software development, manufacturing, distribution and the impact of the
industry's seasonal patterns on the Company's net revenues.
As a result of the foregoing factors and the other factors discussed in
"Risk Factors," it is likely that the Company's operating results in one or
more future periods will fail to meet or exceed the expectations of securities
analysts or investors. In such event, the trading price of the Common Stock
would likely be materially adversely affected. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
5
<PAGE>
RECENT LOSSES
The Company has experienced significant losses in recent periods, including
losses of $5.1 million and $27.2 million, respectively, in the eight months
ended December 31, 1997 and in the Company's former fiscal year ended April
30, 1997. The losses resulted primarily from delays in the completion of
certain products, which led the Company to release alternative titles
developed by third parties which did not achieve broad market acceptance, and
the sharp decline in the market for titles for the Macintosh and Sega Saturn
platforms, both of which resulted in a high level of product returns and
markdowns which reduced net revenues. Operating results for the year ended
April 30, 1997, were also negatively affected by the Company's decision to
write-off $5.9 million in prepayments to third party developers relating to
titles or platform versions of titles which had been cancelled or which were
expected to achieve lower unit sales than were originally forecast, an
excessive reliance on development projects utilizing new technologies in the
face of increasing development costs, slower than expected growth in sales in
the Japanese market, and investments in new product lines in the sports and
edutainment categories. There can be no assurance that the Company will not
experience similar problems in current or future periods or that the Company
will be able to generate sufficient net revenues to attain or sustain
profitability in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; RISK OF PRODUCT DELAYS AND PRODUCT
DEFECTS
The Company's products typically have short life cycles, and the Company
depends on the timely introduction of successful new products, including
enhancements of or sequels to existing products and conversions of previously
released products to additional platforms, to generate net revenues to fund
operations and to replace declining net revenues from older products. In the
Company's former fiscal year ended April 30, 1997, the Company's results of
operations were adversely affected by a number of factors, including delays in
the completion of certain new products which led the Company to release
alternative titles developed by third parties that did not achieve broad
market acceptance. If in the future for any reason net revenues from new
products were to fail to replace declining net revenues from existing
products, the Company's business, operating results and financial condition
could be materially adversely affected. The timing and success of new
interactive entertainment software product releases remains unpredictable due
to the complexity of product development, including the uncertainty associated
with new technology. The development cycle of new products is difficult to
predict but typically ranges from 12 to 24 months and another six to 12 months
for the porting of a product to a different technology platform. In the past,
the Company has repeatedly experienced significant delays in the introduction
of certain new products, and the Company anticipates that it will experience
delays in the introduction of new products, including certain products
currently under development, in the future. Because net revenues associated
with the initial shipments of a new product generally constitute a high
percentage of the total net revenues associated with a product, any delay in
the introduction of, or the presence of a defect in, one or more new products
expected in a period could have a material adverse effect on the ultimate
success of such products and on the Company's business, operating results and
financial condition. The costs of developing and marketing new interactive
entertainment software have increased in recent years due to such factors as
the increasing complexity and content of interactive entertainment software,
increasing sophistication of hardware technology and consumer tastes and
increasing costs of obtaining licenses for intellectual properties, and the
Company expects this trend to continue. There can be no assurance that new
products will be introduced on schedule, if at all, or that, if introduced,
they will achieve significant market acceptance or generate significant net
revenues. In addition, software products as complex as those offered by the
Company may contain undetected errors when first introduced or when new
versions are released. There can be no assurance that, despite testing by the
Company, errors will not be found in new products or releases after
commencement of commercial shipments, resulting in loss of or delay in market
acceptance, which could have a material adverse effect on the Company's
business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
UNCERTAINTY OF MARKET ACCEPTANCE; DEPENDENCE ON HIT TITLES
Consumer preferences for interactive entertainment software are continually
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved sustained market acceptance.
Rather, a limited number of releases have become "hits" and have accounted for
a substantial
6
<PAGE>
portion of revenues in the industry. Further, publishers with a history of
producing hit titles have enjoyed a significant marketing advantage because of
their heightened brand recognition and customer loyalty. The Company expects
the importance of introducing hit titles to increase in the future. There can
be no assurance that new products introduced by the Company will achieve
significant market acceptance, that such acceptance, if achieved, will be
sustainable for any significant period, or that product life cycles will be
sufficient to permit the Company to recover development and other associated
costs. Most of the Company's products have a relatively short life cycle and
sell for a limited period of time after their initial release, usually less
than one year. The Company believes that these trends will continue and that
the Company's future revenue will continue to be dependent on the successful
production of hit titles on a continuous basis. Because the Company introduces
a relatively limited number of new products in a given period, the failure of
one or more of such products to achieve market acceptance could have a
material adverse effect on the Company's business, operating results and
financial condition. Further, if market acceptance is not achieved, the
Company could be forced to accept substantial product returns or grant
significant markdown allowances to maintain its relationship with retailers
and its access to distribution channels. In the event that the Company is
forced to accept significant product returns or grant significant markdown
allowances, its business, operating results and financial condition could be
materially adversely affected.
DEPENDENCE ON THIRD PARTY SOFTWARE DEVELOPERS
The Company relies on third party interactive entertainment software
developers for the development of a significant number of its interactive
entertainment software products. As reputable and competent third party
developers continue to be in high demand, there can be no assurance that third
party software developers that have developed products for the Company in the
past will continue to be available to develop products for the Company in the
future. Many third party software developers have limited financial resources,
which could expose the Company to the risk that such developers may go out of
business prior to completing a project. In addition, due to the limited
control that the Company exercises over third party software developers, there
can be no assurance that such developers will complete products for the
Company on a timely basis or within acceptable quality standards, if at all.
Increased competition for skilled third party software developers has required
the Company to enter into agreements with licensors of intellectual property
and developers of games that involve advance payments by the Company of
royalties and guaranteed minimum royalty payments, and the Company expects to
continue to enter into such arrangements. If the sales volumes of products
subject to such arrangements are not sufficient to recover such royalty
advances and guarantees, the Company would be required to write-off
unrecovered portions of such payments, which could have a material adverse
effect on its business, operating results and financial condition. Further,
there can be no assurance that third party developers will not demand
renegotiation of their agreements with the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business--Product Development."
RAPIDLY CHANGING TECHNOLOGY; PLATFORM RISKS
The interactive entertainment software industry is subject to rapid
technological change. The introduction of new technologies, including
operating systems such as Microsoft Windows 95, technologies that support
multi-player games, new media formats such as on-line delivery and digital
video disks ("DVDs") and as yet unreleased video game platforms could render
the Company's current products or products in development obsolete or
unmarketable. The Company 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, the Company is required
to make substantial product development and other investments in a particular
platform well in advance of introduction of the platform. If the platforms for
which the Company develops software are not released on a timely basis or do
not attain significant market penetration, the Company's business, operating
results and financial condition could be materially adversely affected.
Alternatively, if the Company fails to develop products for a platform that
does achieve significant market penetration, then the Company's business,
operating results and financial condition could also be materially adversely
affected.
7
<PAGE>
The emergence of new interactive entertainment software platforms and
technologies and the increased popularity of new products and technologies may
materially and adversely affect the demand for products based on older
technologies. In this regard, the Company's results of operations in its
former fiscal year ended April 30, 1997 were adversely affected by a sharp
decline in the market for titles for the Macintosh and Sega Saturn platforms,
which declines resulted in a high level of product returns and markdown
allowances. The broad range of competing and incompatible emerging
technologies may lead consumers to postpone buying decisions with respect to
products until one or more of such technologies gain widespread acceptance.
Such postponement could have a material adverse effect on the Company's
business, operating results and financial condition. The Company is currently
actively developing products for the Microsoft Windows 95, PlayStation and
Nintendo 64 platforms. The Company's success will depend in part on its
ability to anticipate technological changes and to adapt its products to
emerging game platforms. There can be no assurance that the Company will be
able to anticipate future technological changes, to obtain licenses to develop
products for those platforms on terms favorable to the Company or to create
software for those new platforms, and any failure to do so could have a
material adverse effect on the Company's business, operating results and
financial condition.
INDUSTRY COMPETITION; COMPETITION FOR SHELF SPACE
The interactive entertainment software industry is intensely competitive and
is characterized by the frequent introduction of new interactive entertainment
software platforms and software products. The Company's competitors vary in
size from small companies to very large corporations with significantly
greater financial, marketing and product development resources than those of
the Company. Due to these greater resources, certain of the Company's
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 the Company. The Company believes 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.
The Company competes primarily with other publishers of PC and video game
console interactive entertainment software. Significant competitors include
Electronic Arts, GT Interactive Software Corp., Cendant Corporation,
Activision, Inc., Microsoft Corporation, LucasArts Entertainment Company,
Midway Games Inc., Acclaim Entertainment Inc., Microprose (Spectrum Holobyte),
Virgin Interactive Entertainment, Inc. and Hasbro Inc. In addition, integrated
video game console hardware/software companies such as Sony Computer
Entertainment, Nintendo and Sega compete directly with the Company in the
development of software titles for their respective platforms. Large
diversified entertainment companies, such as The Walt Disney Company, many of
which own substantial libraries of available content and have substantially
greater financial resources than the Company, may decide to compete directly
with the Company or to enter into exclusive relationships with competitors of
the Company. The Company also believes that the overall growth in the use of
the Internet and on-line services by consumers may pose a competitive threat
if customers and potential customers spend less of their available home PC
time using interactive entertainment software and more on the Internet and on-
line services.
Retailers of the Company's products typically have a limited amount of shelf
space and promotional resources, and there is intense competition among
consumer software producers, and in particular interactive entertainment
software products, for high quality retail shelf space and promotional support
from retailers. To the extent that the number of consumer software products
and computer platforms increases, competition for shelf space may intensify
and may require the Company to increase its marketing expenditures. Due to
increased competition for limited shelf space, retailers and distributors are
in an increasingly better position to negotiate favorable terms of sale,
including price discounts, price protection, marketing and display fees and
product return policies. The Company's products constitute a relatively small
percentage of any retailer's sales volume, and there can be no assurance that
retailers will continue to purchase the Company's products or to provide the
Company's products with adequate levels of shelf space and promotional
support, and a prolonged failure in this regard may have a material adverse
effect on the Company's business, operating results and financial condition.
8
<PAGE>
DEPENDENCE UPON THIRD PARTY LICENSES
Many of the Company's products, such as its Star Trek, Major League Baseball
and Caesars Palace titles, are based on original ideas or intellectual
properties licensed from third parties. There can be no assurance that the
Company will be able to obtain new licenses, or renew existing licenses, on
commercially reasonable terms, if at all. Should the Company be unable to
obtain licenses for the underlying content that it believes offers the
greatest consumer appeal, the Company would either have to seek alternative,
potentially less appealing licenses, or release the products without the
desired underlying content, either of which events could have a material
adverse effect on the Company's business, operating results and financial
condition. There can be no assurance that acquired properties will enhance the
market acceptance of the Company's products based on such properties, that the
Company's new product offerings will generate net revenues in excess of their
costs of development and marketing or minimum royalty obligations, or that net
revenues from new product sales will meet or exceed net revenues from existing
product sales. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business--Products."
DEPENDENCE ON DISTRIBUTION CHANNELS; RISK OF CUSTOMER BUSINESS FAILURES;
PRODUCT RETURNS
The Company currently sells its products directly through its own sales
force to mass merchants, warehouse club stores, large computer and software
specialty chains and through catalogs in the U.S. and Canada, as well as to
certain distributors. Outside North America, the Company generally sells to
third party distributors. The Company's sales are made primarily on a purchase
order basis, without long-term agreements. The loss of, or significant
reduction in sales to, any of the Company's principal retail customers or
distributors could materially adversely affect the Company's business,
operating results and financial condition.
The distribution channels through which consumer software products are sold
are characterized by continuous change, including consolidation, financial
difficulties of certain distributors and retailers, and the emergence of new
distributors and new retailers such as warehouse chains, mass merchants and
computer superstores. As more consumers own PCs, the distribution channels for
interactive entertainment software have changed and are expected to continue
to change. Mass merchants have become the most important distribution channels
for retail sales of interactive entertainment software. A number of these mass
merchants, includingWal-Mart, have entered into exclusive buying arrangements
with other software developers or distributors, which arrangements prevent the
Company from selling certain of its products directly to that mass merchant.
If the number of mass merchants entering into exclusive buying arrangements
with software distributors other than the Company were to increase, the
Company's ability to sell to such merchants would be restricted to selling
through the exclusive distributor. Because sales to distributors typically
have a lower gross margin than sales to retailers, this would have the effect
of lowering the Company's gross margin. In addition, this trend could increase
the Company's exposure to product returns and expose the Company to greater
risks, any of which could have a material adverse impact on the Company's
business, operating results and financial condition. In addition, emerging
methods of distribution, such as the Internet and on-line services, may become
important in the future, and it will be important for the Company to maintain
access to these channels of distribution. There can be no assurance that the
Company will maintain such access or that the Company's access will allow the
Company to maintain its historical levels of sales volume.
Distributors and retailers in the computer industry have from time to time
experienced significant fluctuations in their businesses, and there have been
a number of business failures among these entities. The insolvency or business
failure of any significant distributor or retailer of the Company's products
could have a material adverse effect on the Company's business, operating
results and financial condition. Sales are typically made on unsecured credit,
with terms that vary depending upon the customer and the nature of the
product. Although the Company has obtained insolvency risk insurance to
protect against any bankruptcy, insolvency or liquidation that may occur
involving its customers, such insurance contains a significant deductible and
a co-payment obligation, and the policy does not cover all instances of non-
payment. In addition, while the Company maintains a reserve for uncollectable
receivables, the actual reserve may not be sufficient in every circumstance.
As a result, a payment default by a significant customer could have a material
adverse effect on the Company's business, operating results and financial
condition.
9
<PAGE>
The Company is exposed to the risk of product returns and markdown
allowances with respect to its distributors and retailers. The Company allows
distributors and retailers to return defective, shelf-worn and damaged
products in accordance with negotiated terms, and also offers a 90-day limited
warranty to its end users that its products will be free from manufacturing
defects. In addition, the Company provides markdown allowances to its
customers to manage its customers' inventory levels in the distribution
channel. Although the Company maintains a reserve for returns and markdown
allowances, and although the Company's agreements with certain of its
customers place certain limits on product returns and markdown allowances, the
Company could be forced to accept substantial product returns and provide
markdown allowances to maintain its relationships with retailers and its
access to distribution channels. Product returns and markdown allowances that
exceed the Company's reserves could have a material adverse effect on the
Company's business, operating results and financial condition. In this regard,
the Company's results of operations for the former fiscal year ended April 30,
1997 were adversely affected by a sharp decline in the market for titles for
the Macintosh and Sega Saturn platforms, which resulted in a higher than
expected level of product returns and markdown allowances and consequently
reduced net revenues. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--General."
DEPENDENCE ON LICENSES FROM AND MANUFACTURING BY HARDWARE COMPANIES
The Company is required to obtain a license to develop and distribute
software for each of the video game console platforms for which the Company
develops products, including a separate license for each of North America,
Japan and Europe. The Company has obtained licenses to develop software for
the PlayStation in North America and Japan and is currently negotiating
agreements covering additional territories. In addition, the Company has
obtained a license to develop software for the Nintendo 64 in North America
and is currently negotiating with Nintendo for licenses covering additional
territories. There can be no assurance that the Company will be able to obtain
licenses from hardware companies on acceptable terms or that any existing or
future licenses will be renewed by the licensors. In addition, each of Sony
Computer Entertainment, Nintendo and Sega have the right to approve the
technical functionality and content of the Company's products for such
platform prior to distribution. Due to the nature of the approval process, the
Company must make significant product development expenditures on a particular
product prior to the time it seeks such approvals. The inability of the
Company to obtain such approvals could have a material adverse effect on the
Company's business, operating results and financial condition.
Hardware companies such as Sony Computer Entertainment, Nintendo and Sega
may impose upon their licensees a restrictive selection and product approval
process, such that licensees are restricted in the number of titles that will
be approved for distribution on the particular platform. While the Company has
prepared its future product release plans taking this competitive approval
process into consideration, if the Company has incorrectly predicted the
impact of this restrictive approval process, and as a result the Company fails
to obtain approvals for all products in the Company's development plans, such
failure could have a material adverse effect on the Company's business,
operating results and financial condition. The Company depends upon Sony
Computer Entertainment and Nintendo for the manufacture of the Company's
products that are compatible with their respective video game consoles. As a
result, Sony and Nintendo have the ability to raise prices for supplying such
products at any time and effectively control the timing of the Company's
release of new titles for those platforms. PlayStation products consist of CD-
ROMs and are typically delivered by Sony Computer Entertainment within a
relatively short lead time. Manufacturers of Nintendo and other video game
cartridges typically deliver software to the Company within 45 to 60 days
after receipt of a purchase order. If the Company experiences unanticipated
delays in the delivery of video game console products from Sony Computer
Entertainment or Nintendo, or if actual retailer and consumer demand for its
interactive entertainment software differs from that forecast by the Company,
its business, operating results and financial condition could be materially
adversely affected.
FUTURE CAPITAL REQUIREMENTS
The Company expects that its capital requirements will increase
significantly in the future. The Company did not generate cash flow from
operations in the three months ended March 31, 1998, the eight months ended
10
<PAGE>
December 31, 1997 and the former fiscal year ended April 30, 1997. There can
be no assurance that the Company will ever generate cash flow from operations.
The Company's ability to fund its capital requirements out of available cash,
its bank line of credit and cash generated from operations will depend on
numerous factors, including the progress of the Company's product development
programs, the rate of growth of the Company's business, and the commercial
success of the Company's products. The Company will likely be required to seek
additional funds through debt or equity financing. The issuance of additional
equity securities by the Company could result in substantial dilution to
stockholders. If adequate funds are not available on acceptable terms, the
Company would be required to delay or scale back its product development and
marketing programs, which could have a material adverse effect on the
Company's business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant extent on the continued
service of its key product design, development, sales, marketing and
management personnel, and in particular on the leadership, strategic vision
and industry reputation of its founder and Chief Executive Officer, Brian
Fargo. The Company's future success will also depend upon the Company's
ability to continue to attract, motivate and retain highly qualified employees
and contractors, particularly key software design and development personnel.
Competition for highly skilled employees is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. Specifically, the Company may experience increased costs in order
to attract and retain skilled employees. The Company's failure to retain the
services of Brian Fargo or its other key personnel or to attract and retain
additional qualified employees could have a material adverse effect on the
Company's business, operating results and financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS
International net revenues accounted for 27.4%, 28.7%, 38.4% and 25.4% of
the Company's total net revenues in the three months ended March 31, 1998, the
eight months ended December 31, 1997 and the former fiscal years ended April
30, 1997 and 1996, respectively. The Company intends to continue to expand its
direct and indirect sales, marketing and product localization activities
worldwide. Such expansion will require significant management time and
attention and financial resources in order to develop improved international
sales and support channels. There can be no assurance, however, that the
Company will be able to maintain or increase international market demand for
its products. International sales and operations are subject to a number of
inherent risks, including the impact of possible recessionary environments in
economies outside the U.S., the time and financial costs associated with
translating and localizing products for foreign markets, longer accounts
receivable collection periods and greater difficulty in accounts receivable
collection, unexpected changes in regulatory requirements, difficulties and
costs of staffing and managing foreign operations, and political and economic
instability. For example, the Company has recently experienced difficulties
selling products in certain Asian countries as a result of economic
instability in such countries, and there can be no assurance that such
difficulties will not continue or occur in other countries in the future.
There can be no assurance that the foregoing factors will not have a material
adverse effect on the Company's future international net revenues and,
consequently, on the Company's business, operating results and financial
condition. The Company currently does not engage in currency hedging
activities. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in currency
exchange rates in the future will not have a material adverse effect on net
revenues from international sales and licensing, and thus on the Company's
business, operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
MANAGEMENT OF GROWTH
The Company has recently undergone a period of rapid growth that has placed
a significant strain on the Company's financial, management and other
resources. The Company's ability to manage its growth effectively,
11
<PAGE>
should it continue, will require it to continue to improve its operational,
financial and management information systems and to attract, train, motivate,
manage and retain key employees. If the Company's executives are unable to
manage growth effectively, the Company's business, operating results and
financial condition could be materially adversely affected.
PROTECTION OF PROPRIETARY RIGHTS
The Company regards its software as proprietary and relies primarily on a
combination of copyright, trademark and trade secret laws, employee and third
party nondisclosure agreements and other methods to protect its proprietary
rights. The Company owns or licenses various copyrights and trademarks. While
the Company provides "shrinkwrap" license agreements or limitations on use
with its software, the enforceability of such agreements or limitations is
uncertain. The Company is aware that unauthorized copying occurs within the
computer software industry, and if a significantly greater amount of
unauthorized copying of the Company's interactive entertainment software
products were to occur, the Company's operating results could be materially
adversely affected. While the Company does not copy protect its products, it
does not provide source code to third parties unless they have signed
nondisclosure agreements with respect thereto.
The Company relies on existing copyright laws to prevent unauthorized
distribution of its software. Existing copyright laws afford only limited
protection. Policing unauthorized use of the Company's products is difficult,
and software piracy can be expected to be a persistent problem, especially in
certain international markets. Further, the laws of certain countries in which
the Company's products are or may be distributed either do not protect the
Company's products and intellectual property rights to the same extent as the
laws of the U.S. or are weakly enforced. Legal protection of the Company's
rights may be ineffective in such countries, and as the Company leverages its
software products using emerging technologies, such as the Internet and on-
line services, the ability of the Company to protect its 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 adequate protection to
the Company's products in connection with such emerging technologies.
As the number of interactive entertainment software products in the industry
increases and the features and content of these products further overlap,
software developers may increasingly become subject to infringement claims.
Although the Company makes reasonable efforts to ensure that its 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, the Company has received communication from third parties asserting that
features or content of certain of its products may infringe upon the
intellectual property rights of such parties. There can be no assurance that
existing or future infringement claims against the Company will not result in
costly litigation or require the Company to license the intellectual property
rights of third parties, either of which could have a material adverse effect
on the Company's business, operating results and financial condition. See
"Business--Intellectual Property and Proprietary Rights."
ENTERTAINMENT SOFTWARE RATING SYSTEM; GOVERNMENTAL RESTRICTIONS
Legislation is periodically introduced at the state and federal levels in
the U.S. 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. Such a
system would include procedures with which interactive entertainment software
publishers would be expected to comply by identifying particular products
within defined rating categories and communicating such ratings to consumers
through appropriate package labeling and through advertising and marketing
presentations consistent with each product's rating. In addition, many foreign
countries have laws which permit governmental entities to censor the content
of certain works, including interactive entertainment software. In certain
instances, the Company may be required to modify its products to comply with
the requirements of such governmental entities, which could delay the release
of those products in such countries. Such delays could have a material adverse
effect on the Company's business, operating results and financial condition.
While the Company currently voluntarily
12
<PAGE>
submits its products to industry-created review boards and publishes their
ratings on its game packaging, the Company believes that mandatory government-
run interactive entertainment software products rating systems eventually will
be adopted in many countries which represent significant markets or potential
markets for the Company. Due to the uncertainties inherent in the
implementation of such a rating system, confusion in the marketplace may
occur, and the Company is unable to predict what effect, if any, such a rating
system would have on the Company's business. In addition to such regulations,
certain retailers have in the past declined to stock certain of the Company's
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
such actions have not had a material adverse effect on the Company's business,
operating results or financial condition, there can be no assurance that
similar actions by the Company's distributors or retailers in the future would
not have a material adverse effect on the Company's business, operating
results or financial condition.
DEVELOPMENT OF INTERNET/ON-LINE SERVICES OR PRODUCTS
The Company seeks to establish an on-line presence by creating and
supporting sites on the Internet. The Company's future plans envision
conducting and supporting on-line product offerings through these sites or
others. The ability of the Company to successfully establish an on-line
presence and to offer on-line products will depend on several factors that are
outside the Company's control, including the emergence of a robust on-line
industry and infrastructure and the development and implementation of
technological advancements to the Internet to increase bandwidth and the speed
of responsiveness to the point that will allow the Company to conduct and
support on-line product offerings. Because global commerce and the exchange of
information on the Internet and other similar open, wide area networks are
relatively new and evolving, there can be no assurance that a viable
commercial marketplace on the Internet will emerge from the developing
industry infrastructure, that the appropriate complementary products for
providing and carrying Internet traffic and commerce will be developed, that
the Company will be able to create or develop a sustainable or profitable on-
line presence or that the Company will be able to generate any significant
revenue from on-line product offerings in the near future, or at all. If the
Internet does not become a viable commercial marketplace, or if such
development occurs but is insufficient to meet the Company's needs or if such
development is delayed beyond the point when the Company plans to have
established an on-line service, the Company's business, operating results and
financial condition could be materially adversely affected.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, in less than two years, computer systems and
software used by many companies may need to be upgraded to comply with such
Year 2000 requirements. The Company believes that its products, which are
self-contained software programs that run independently of external
chronology, will not be significantly affected by Year 2000 problems. The
Company is currently in the process of investigating whether its internal
accounting systems and other operational systems are Year 2000 compliant. The
Company has been informed by the vendor of its internal accounting software
that upgrades that will bring such software into Year 2000 compliance will be
provided to the Company under its existing software maintenance agreement in
the third quarter of 1998. The Company expects to effect the conversion of its
internal accounting system to such upgraded software by the end of 1998. There
can be no assurance that such upgrades will be provided on a timely basis or
will be free of errors. In addition, there can be no assurance that certain of
the Company's products or the Company's internal computer systems and networks
or those of its key vendors, developers and distributors will not be adversely
affected by Year 2000 issues, which could have a material adverse effect on
the Company's business, operating results and financial condition.
RISKS ASSOCIATED WITH ACQUISITIONS
As part of its strategy to enhance distribution and product development
capabilities, the Company intends to pursue acquisitions of complementary
businesses, products and technologies. Some of these acquisitions could be
13
<PAGE>
material in size and scope. While the Company will continue to search for
appropriate acquisition opportunities, there can be no assurance that the
Company will be successful in identifying suitable acquisition opportunities.
If any potential acquisition opportunity is identified, there can be no
assurance that the Company will consummate such acquisition, and if such
acquisition does occur, there can be no assurance that it will be successful
in enhancing the Company's business or will be accretive to the Company's
earnings. As the interactive entertainment software industry continues to
consolidate, the Company may face increased competition for acquisition
opportunities, which may inhibit its ability to complete suitable transactions
or increase the cost thereof. Future acquisitions could also divert
substantial management time, could result in short term reductions in earnings
or special transaction or other charges and may be difficult to integrate with
existing operations or assets.
The Company may, in the future, issue additional shares of Common Stock in
connection with one or more acquisitions, which may dilute its stockholders,
including investors in the Offering. Additionally, with respect to future
acquisitions, the Company's stockholders may not have an opportunity to review
the financial statements of the entity being acquired or to vote on such
acquisitions.
CONTROL BY DIRECTORS AND OFFICERS
The Company's directors and officers and Universal Studios, Inc.
("Universal"), which currently has two representatives on the Company's Board
of Directors, will, in the aggregate, beneficially own approximately 62.2% of
the Company's outstanding Common Stock following the completion of the
Offering, assuming that the Underwriters' over-allotment option is not
exercised. These stockholders, if acting together, would be able to control
substantially all matters requiring approval by the stockholders of the
Company, including the election of directors (subject to the cumulative voting
rights of the Company's stockholders) and the approval of mergers or other
business combination transactions. Such concentration of ownership could
discourage or prevent a change in control of the Company. See "Principal
Stockholders." Certain directors, officers and other affiliates of the Company
will receive a material benefit as a result of the Offering. See "Use of
Proceeds."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of Common Stock, including Common Stock issued upon the exercise of
outstanding options, in the public market after the Offering could materially
adversely affect the market price of the Common Stock. Such sales also might
make it more difficult for the Company to sell equity or equity-related
securities in the future at a time and price that the Company deems
acceptable, or at all. Upon the completion of the Offering, the Company will
have 18,225,446 shares of Common Stock outstanding. Of these shares, the
5,000,000 shares sold in the Offering (5,750,000 shares if the Underwriters'
over-allotment option is exercised in full) will be freely tradable without
restriction under the Securities Act of 1933, as amended (the "Securities
Act"), unless purchased by "affiliates" of the Company, as that term is
defined in Rule 144 under the Securities Act ("Rule 144"). The remaining
13,225,446 shares of Common Stock held by existing stockholders
(12,475,446 shares if the Underwriters' over-allotment option is exercised in
full) are "restricted securities," as that term is defined in Rule 144 and
were issued and sold by the Company in reliance on exemptions from the
registration requirements of the Securities Act. These restricted shares may
be sold in the public market only if registered or pursuant to an exemption
from registration, such as Rule 144. Holders of an aggregate of 7,781,868
shares of Common Stock following the Offering (7,031,868 shares if the
Underwriters' over-allotment option is exercised in full) and holders of
options to purchase an aggregate of 1,580,188 shares of Common Stock have
agreed, pursuant to certain lock-up agreements with the Representatives (the
"180-Day Lock-Up Agreements") that they will not offer, sell, contract to
sell, grant any option to sell or otherwise dispose of, directly or
indirectly, any shares of Common Stock owned by them or that could be
purchased by them through the exercise of options to purchase Common Stock of
the Company for a period of 180 days after the date of this Prospectus without
prior written consent of Piper Jaffray Inc. Such lock-up agreements will not
apply to the sale of Common Stock by the Selling Stockholder pursuant to the
exercise of the Underwriters' over-allotment option. Upon expiration of the
180-Day Lock-Up Agreements, 5,925,357 shares held by existing stockholders
(5,175,357 shares if the Underwriters' over-allotment option is exercised in
full) will be eligible for sale subject to the volume and other
14
<PAGE>
restrictions of Rule 144, and 1,856,511 shares will be eligible for sale
without restriction under Rule 144(k). In addition, Brian Fargo, the Company's
Chairman and Chief Executive Officer, has agreed, pursuant to a lock-up
agreement with the Representatives (the "Fargo Lock-Up"), that he will not
offer, sell, contract to sell, grant any option to sell or otherwise dispose
of, directly or indirectly, any shares of Common Stock owned by him or that
could be purchased by him through the exercise of options for a period of one
year following the date of this Prospectus without the prior written consent
of Piper Jaffray Inc. Upon expiration of the Fargo Lock-Up, the 5,542,378
shares owned by Mr. Fargo following the Offering will be eligible for sale
subject to the volume and other restrictions of Rule 144. As of March 31,
1998, 2,053,206 shares were subject to outstanding options to purchase Common
Stock, of which 1,580,188 shares are subject to the 180-Day Lock-Up Agreements
and 150,000 shares are subject to the Fargo Lock-Up. Following completion of
the Offering, holders of 12,586,843 shares (11,836,843 shares if the
Underwriters' over-allotment option is exercised in full) will be entitled to
certain demand and piggyback registration rights upon termination of lock-up
agreements. Any exercise of these registration rights could impair the
Company's ability to raise capital through the sale of its equity securities
and, if such registered shares are sold, could have a material adverse effect
on the market price of the Common Stock. See "Description of Capital Stock--
Registration Rights" and "Shares Eligible for Future Sale."
ANTI-TAKEOVER EFFECTS; DELAWARE LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS;
PREFERRED STOCK
The Company's Certificate of Incorporation and Bylaws, as well as Delaware
corporate law, contain certain provisions that could have the effect of
delaying, deferring or preventing a change in control of the Company and could
materially adversely affect the prevailing market price of the Common Stock.
Certain of such provisions impose various procedural and other requirements
that could make it more difficult for stockholders to effect certain corporate
actions. See "Description of Capital Stock."
DILUTION
The initial public offering price is substantially higher than the net
tangible book value per share of Common Stock. Investors purchasing shares of
Common Stock in the Offering will incur immediate and substantial net tangible
book value dilution of $3.69 per share, based on the initial public offering
price of $5.50 per share. To the extent that options to purchase the Company's
Common Stock are exercised, there will be further dilution. In addition, the
Company may issue additional shares in connection with compensation of
employees, acquisitions of complementary products, technologies or businesses
or strategic relationships. To the extent that such pool is increased or
additional shares are issued, there will be additional dilution. See
"Dilution," "Capitalization" and "Description of Capital Stock."
15
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 5,000,000 shares of
Common Stock offered by the Company hereby are estimated to be approximately
$24,575,000 at the initial public offering price of $5.50 per share and after
deducting the underwriting discount and estimated offering expenses. The
Company expects to use approximately $16.8 million of the net proceeds to
repay amounts outstanding under the Company's current bank line of credit,
which terminates in May 1999 and which bears interest at a rate per annum
equal to the London Interbank Offered Rate plus 4.87% (10.56% at March 31,
1998). As of May 31, 1998, the outstanding balance on the line of credit was
approximately $33.2 million. In addition, the Company expects to use
approximately $6.3 million of the net proceeds to repay Subordinated Secured
Promissory Notes, which bear interest at the rate of 12% per annum and are
payable upon the closing of the Offering, and accrued interest thereon. See
"Description of Capital Stock--Common Stock Warrants." The Company expects to
use approximately $1.5 million of the net proceeds to pay certain amounts due
to Universal Interactive Studios under the terms of an existing distribution
agreement. See "Certain Transactions." Pending such uses, the Company intends
to invest the net proceeds of the Offering in short-term, interest bearing,
investment-grade securities.
DIVIDEND POLICY
The Company anticipates that all future earnings will be retained to finance
future growth, and the Company does not anticipate paying any dividends on its
Common Stock in the foreseeable future. The Company's bank line of credit
agreement currently restricts the Company from paying cash dividends without
the prior written consent of the bank. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
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<PAGE>
DILUTION
The net tangible book value (deficit) of the Company as of March 31, 1998
was $(328,000) or $(0.03) per share. "Net tangible book value (deficit) per
share" is determined by dividing the number of shares of Common Stock
outstanding into the net tangible book value of the Company (tangible assets
less liabilities). After giving effect to the Offering and use of net proceeds
described herein, and the exercise of certain Common Stock Warrants by the
cancellation of certain Subordinated Secured Promissory Notes, the pro forma
net tangible book value of the Company at March 31, 1998 would have been
approximately $32,908,000 or $1.81 per share based on the initial public
offering price of $5.50 per share. This represents an immediate increase in
the net tangible book value of approximately $1.84 to present stockholders and
an immediate dilution of $3.69 per share to new investors purchasing shares of
Common Stock at the initial public offering price. The following table sets
forth this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share: $5.50
Net tangible book value (deficit) before the Offering...... $(0.03)
Increase resulting from the Offering....................... 1.84
------
Pro forma net tangible book value per share after the Offer-
ing......................................................... 1.81
-----
Dilution per share to new investors.......................... $3.69
=====
</TABLE>
The following table summarizes the difference between existing stockholders
and new investors with respect to the number of shares of Common Stock
purchased from the Company, the total cash consideration paid and the average
price paid per share (before deducting the underwriting discount and estimated
offering expenses):
<TABLE>
<CAPTION>
SHARES OF COMMON AVERAGE
STOCK PURCHASED TOTAL CONSIDERATION PRICE
------------------ ------------------- PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- -------
<S> <C> <C> <C> <C> <C>
Existing Stockholders(1)........ 13,225,446 72.6% $24,393,000 47.0% $1.84
New Investors................... 5,000,000 27.4 27,500,000 53.0 5.50
---------- ----- ----------- -----
Total......................... 18,225,446 100.0% $51,893,000 100.0%
========== ===== =========== =====
</TABLE>
- --------
(1) Based on shares outstanding at March 31, 1998. Includes 2,272,418 shares
of Common Stock issuable upon the closing of the Offering upon the
exercise of Common Stock Warrants by the cancellation of Subordinated
Secured Promissory Notes at an exercise price of $3.85 per share (based on
the initial public offering price of $5.50 per share). Excludes (i)
2,053,206 shares of Common Stock issuable upon exercise of stock options
outstanding at March 31, 1998, which had a weighted average exercise price
of $4.80 per share, (ii) 1,680,541 shares reserved for issuance pursuant
to future option grants under the Company's 1997 Stock Incentive Plan and
(iii) 200,000 shares of Common Stock reserved for issuance under the
Company's Employee Stock Purchase Plan. See "Management--Employee Benefit
Plans--Stock Incentive Plans," "Description of Capital Stock--Common Stock
Warrants" and Notes 6 and 13 of Notes to Consolidated Financial
Statements.
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1998, and as adjusted to give effect to (i) the sale of 5,000,000 shares
of Common Stock offered by the Company hereby at the initial public offering
price of $5.50 per share and the application of the net proceeds after
deducting the underwriting discount and estimated offering expenses payable by
the Company, and (ii) the issuance of 2,272,418 shares of Common Stock upon
the closing of the Offering upon the exercise of Common Stock Warrants at an
exercise price of $3.85 per share by the cancellation of Subordinated Secured
Promissory Notes. This table should be read in conjunction with "Use of
Proceeds," "Selected Consolidated Financial Information" and the Consolidated
Financial Statements included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
---------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Current Portion of Long-Term Debt......................... $ 14,825 $ 170
======== ========
Accrued Expenses.......................................... $ 22,231 $ 20,425
======== ========
Long-Term Debt:
Bank line of credit..................................... $ 23,820 $ 7,045
Other long-term debt.................................... 35 35
-------- --------
Total long-term debt, net of current portion.......... 23,855 7,080
-------- --------
Stockholders' Equity:
Preferred Stock, $.001 par value, 5,000,000 shares
authorized; no shares issued and outstanding, actual
and as adjusted........................................ -- --
Common Stock, $.001 par value, 50,000,000 shares autho-
rized; 10,953,028 and 18,225,446 shares issued and out-
standing, actual and as adjusted(1).................... 11 18
Paid-in capital......................................... 18,494 51,723
Accumulated deficit..................................... (17,028) (17,028)
Cumulative translation adjustment....................... 192 192
-------- --------
Total stockholders' equity.............................. 1,669 34,905
-------- --------
Total capitalization (including long-term debt)......... $ 25,524 $ 41,985
======== ========
</TABLE>
- --------
(1) Based on shares outstanding at March 31, 1998. Includes 2,272,418 shares
of Common Stock issuable upon the closing of the Offering upon the
exercise of Common Stock Warrants by the cancellation of Subordinated
Secured Promissory Notes at an exercise price of $3.85 per share (based on
the initial public offering price of $5.50 per share). Excludes (i)
2,053,206 shares of Common Stock issuable upon exercise of stock options
outstanding at such date, which had a weighted average exercise price of
$4.80 per share, (ii) 1,680,541 shares reserved for issuance pursuant to
future option grants under the Company's 1997 Stock Incentive Plan and
(iii) 200,000 shares of Common Stock reserved for issuance under the
Company's Employee Stock Purchase Plan. See "Management--Employee Benefit
Plans--Stock Incentive Plans" and "Description of Capital Stock--Common
Stock Warrants" and Notes 6 and 13 of Notes to Consolidated Financial
Statements.
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected consolidated statements of operations data for the former
fiscal years ended April 30, 1995, 1996 and 1997 and the eight months ended
December 31, 1997, and the selected consolidated balance sheets data as of
April 30, 1996 and 1997 and as of December 31, 1997 are derived from the
Company's audited consolidated financial statements included elsewhere in this
Prospectus. The selected consolidated statements of operations data for the
three months ended March 31, 1998 and 1997 and the consolidated balance sheets
data as of March 31, 1998 are unaudited and are derived from the Company's
consolidated financial statements included elsewhere in this Prospectus. The
selected consolidated statements of operations data for the years ended
April 30, 1993 and 1994, and the selected consolidated balance sheets data as
of April 30, 1993, 1994, and 1995 are derived from the Company's audited
consolidated financial statements not included in this Prospectus. The
selected consolidated statements of operations data for the eight months ended
December 31, 1996 is derived from the Company's unaudited consolidated
financial statements. The unaudited pro forma income (loss) per share is
derived from the unaudited pro forma data included elsewhere in this
Prospectus. The Company's 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 "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
EIGHT MONTHS ENDED THREE MONTHS ENDED
YEAR ENDED APRIL 30, DECEMBER 31, MARCH 31,
----------------------------------------- -------------------- --------------------
1993 1994 1995 1996 1997 1996 1997 1997 1998
------- ------- ------- ------- -------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA(1):
Net revenues............ $25,355 $52,668 $79,546 $96,952 $ 83,262 $ 50,364 $ 85,961 $ 22,410 $ 40,996
Cost of goods sold...... 13,374 31,223 45,491 49,939 62,480 35,725 44,864 13,508 19,221
------- ------- ------- ------- -------- --------- -------- --------- ---------
Gross profit............ 11,981 21,445 34,055 47,013 20,782 14,639 41,097 8,902 21,775
------- ------- ------- ------- -------- --------- -------- --------- ---------
Operating expenses:
Marketing and sales.... 4,421 7,698 14,280 23,285 24,627 15,747 20,603 7,280 8,589
General and administra-
tive.................. 1,589 4,805 5,528 9,025 9,408 8,730 8,989 3,088 2,855
Product development.... 2,054 3,646 8,200 15,120 21,431 12,464 14,291 5,384 5,819
------- ------- ------- ------- -------- --------- -------- --------- ---------
Total operating ex-
penses................ 8,064 16,149 28,008 47,430 55,466 36,941 43,883 15,752 17,263
------- ------- ------- ------- -------- --------- -------- --------- ---------
Operating income
(loss)................. 3,917 5,296 6,047 (417) (34,684) (22,302) (2,786) (6,850) 4,512
Other income (expense).. 112 68 1,046 (807) (1,600) (1,085) (2,273) (375) (1,418)
------- ------- ------- ------- -------- --------- -------- --------- ---------
Income (loss) before in-
come taxes............. 4,029 5,364 7,093 (1,224) (36,284) (23,387) (5,059) (7,225) 3,094
Provision (benefit) for
income taxes........... 1,406 2,161 2,844 (480) (9,065) (5,918) -- (1,782) 245
------- ------- ------- ------- -------- --------- -------- --------- ---------
Net income (loss)....... $ 2,623 $ 3,203 $ 4,249 $ (744) $(27,219) $ (17,469) $ (5,059) $ (5,443) $ 2,849
======= ======= ======= ======= ======== ========= ======== ========= =========
Net income (loss) per
share(2):
Basic.................. $ 0.32 $ 0.37 $ 0.40 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.26
======= ======= ======= ======= ======== ========= ======== ========= =========
Diluted................ $ 0.29 $ 0.32 $ 0.35 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.23
======= ======= ======= ======= ======== ========= ======== ========= =========
Pro forma (unaudited).. $ (1.55) $ (0.15) $ 0.22
======== ======== =========
SELECTED OPERATING DATA:
Net revenues by segment:
North America.......... $19,436 $40,094 $51,892 $54,702 $ 38,606 $ 27,735 $ 51,833 $ 9,562 $ 23,516
International.......... 2,919 2,227 13,829 24,579 32,006 13,955 24,642 10,333 11,223
OEM, royalty and
licensing............. 3,000 10,347 13,825 17,671 12,650 8,674 9,486 2,515 6,257
Net revenues by
platform:
Personal computer...... $14,978 $20,314 $36,804 $60,254 $ 45,192 $ 25,639 $ 42,520 $ 14,623 $ 21,191
Video game console..... 7,377 22,007 28,917 19,027 25,420 16,051 33,955 5,272 13,548
<CAPTION>
APRIL 30,
----------------------------------------- DECEMBER 31, MARCH 31,
1993 1994 1995 1996 1997 1997 1998
------- ------- ------- ------- -------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEETS DATA:
Working capital......... $ 5,546 $22,775 $25,227 $18,485 $ 7,890 $13,616 $17,442
Total assets............ 10,073 35,450 44,226 68,511 69,005 77,821 78,327
Total long-term debt
(including current
portion)............... 469 384 262 108 14,970 38,154 38,680
Stockholders' equity
(deficit).............. 5,953 25,053 30,069 30,195 3,401 (1,267) 1,669
</TABLE>
- --------
(1) Effective May 1, 1997, the Company changed its fiscal year end from April
30 to December 31.
(2) See Note 2 of Notes to Consolidated Financial Statements for an
explanation of the number of shares used in computing net income (loss)
per share.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company commenced operations in 1983, and operated as an independent
development studio until 1988, creating interactive entertainment software
games for publishers such as Electronic Arts and Activision. In 1988, the
Company began publishing software through an affiliate label relationship with
Activision, pursuant to which Activision distributed the Company's software in
North America. The Company began publishing and distributing its own
interactive entertainment software for both PCs and video game consoles in
1992 and has continued to build its publishing and distribution infrastructure
since that date. In addition to developing products through its internal
product development group, the Company publishes titles developed by third
party interactive entertainment software developers.
The Company derives net revenues primarily from direct sales of interactive
entertainment software for PCs and video game consoles to retailers and mass
merchants, from indirect sales to software distributors in North America and
internationally, from the distribution by the Company on an affiliate label
basis of titles published by third parties, and from direct sales to end-users
through the Company's catalogs and the Internet. The Company also derives
royalty-based revenues from licensing arrangements, from the sale of products
by third party distributors in international markets, and from OEM bundling
transactions.
The Company recognizes net revenues from the sale of its products upon
shipment. Subject to certain limitations, the Company permits customers to
obtain exchanges within certain specified periods and provides price
protection on certain unsold merchandise. Net revenues from product sales are
reflected after deducting an allowance for returns and price protection. With
respect to license agreements which provide customers the right to multiple
copies in exchange for guaranteed amounts, net revenues are recognized upon
delivery of the product master or the first copy. Per copy royalties on sales
which exceed the guarantee are recognized as earned.
In order to expand the Company's distribution channels and engage in
software development in overseas markets, in 1995 the Company established
operations in the United Kingdom and in Japan. In July 1997, the Company
initiated a licensing strategy in Japan and terminated its operations there.
International net revenues accounted for approximately 27.4%, 28.7%, 38.4% and
25.4% of the Company's net revenues during the three months ended March 31,
1998, the eight months ended December 31, 1997 and the former fiscal years
ended April 30, 1997 and April 30, 1996, respectively.
In January 1997, the Company formed a wholly owned subsidiary, Interplay
OEM, Inc. ("Interplay OEM"), which had previously operated as a division of
the Company. Interplay OEM distributes the Company's interactive entertainment
software titles, as well as those of other software publishers, to computer
hardware and peripheral device manufacturers for use in bundling arrangements.
The Company also derives net revenues from the licensing of certain of its
intellectual properties and certain of its products to third parties for
distribution in markets and through channels which are outside the Company's
primary focus. OEM, royalty and licensing net revenues accounted for 15.2%,
11.0% and 15.2% of the Company's total net revenues for the three months ended
March 31, 1998, the eight months ended December 31, 1997 and the former fiscal
year ended April 30, 1997, respectively. OEM, royalty and licensing net
revenues generally are incremental net revenues and do not have significant
additional product development or sales and marketing costs, and accordingly
have a more significant impact on the Company's operating results. The Company
expects that OEM, royalty and licensing net revenues may decline, both in
dollars and as a percentage of net revenues, as a larger proportion of OEM,
royalty and licensing net revenues are generated from royalty-based licensing
transactions, as opposed to the shipment of finished goods, and as the OEM
channel of distribution becomes more competitive.
Cost of goods sold related to PC and video game console net revenues
represents the manufacturing and related costs of interactive entertainment
software products, including costs of media, manuals, duplication, packaging
materials, assembly, freight and royalties paid to developers, licensors and
hardware manufacturers. Cost
20
<PAGE>
of goods sold related to royalty-based net revenues primarily represents third
party licensing fees and royalties paid by the Company. Typically, cost of
goods sold as a percentage of net revenues for video game console products and
affiliate label 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 these products. Also included in the cost of
goods sold is the amortization of prepaid royalty and license fees paid to
third party software developers. Prepaid royalties are expensed over a period
of six months from initial shipment. The Company evaluates the likelihood of
future realization of prepaid royalties quarterly, on a product by product
basis, and charges cost of goods sold for any amounts that it deems unlikely
to be realized through future product sales.
The Company's net loss for the former fiscal year ended April 30, 1997
increased to $27.2 million from $0.7 million in the comparable 1996 period.
The Company's results of operations for the former fiscal year ended April 30,
1997 were adversely affected by a number of factors, including delays in the
completion of certain products, which led the Company to release alternative
titles developed by third parties which did not achieve broad market
acceptance, and a sharp decline in the market for titles for the Macintosh and
Sega Saturn platforms, both of which resulted in a higher than expected level
of product returns and markdown allowances. The Company increased its reserves
by approximately $5.4 million during fiscal 1997 in response to these
increased returns and markdown allowances. According to PC Data, a market
research firm, from 1996 to 1997, the U.S. market for Macintosh titles
declined approximately 66% and Sega Saturn's share of the U.S. market for
interactive entertainment software declined from 14.9% to 9.3% during such
period, according to The TRST Report, published by NPD Group, a market
research firm. Operating results for the period were also negatively affected
by (i) the Company's decision to write-off $5.9 million in prepayments to
third party developers relating to titles or platform versions of titles which
had been cancelled or which were expected to achieve lower unit sales than
were originally forecast, (ii) an excessive reliance on development projects
utilizing new technologies in the face of increasing development costs (total
development costs were $21.4 million in fiscal 1997 as compared with $15.1
million in fiscal 1996) , (iii) slower than expected growth in sales in the
Japanese market, and (iv) investments in new product lines in the sports and
edutainment categories. The Company has taken a number of steps to address
these issues, both strategically and operationally. During the second half of
1997, the Company restructured its internal development organization into five
divisions, each of which is dedicated to the production and development of
products for a particular product category. The Company believes that this
divisional approach will enable the Company to better manage its internal and
external development processes and to obtain greater efficiency and
predictability in its product development process. The Company is also in the
process of restructuring its product development pipeline such that a
significant number of the products under development will be utilizing
existing core technologies or other game content in order to reduce the
development costs and development time for such products. In addition, in July
1997 the Company closed its Japanese office, and initiated a licensing
strategy in Japan in order to avoid the high costs of conducting operations
there. The Company also discontinued and absorbed the cost of approximately 20
Macintosh and Sega Saturn development projects, and, due to lower than
expected sales growth and intense competition in the edutainment product
category, the Company suspended its product development plans for its
edutainment product line. In March 1998, the Company granted a third party
exclusive distribution rights for certain titles in such product line.
Effective May 1, 1997, the Company changed its fiscal year end from April 30
to December 31. Accordingly, the discussion of financial results set forth
below compares the three months ended March 31, 1997 to the comparable 1996
period, the eight months ending December 31, 1997 to the comparable 1996
period, and compares the Company's previous fiscal years ended April 30, 1997,
1996 and 1995.
The Company's operating results have fluctuated significantly in the past
and will likely 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 the Company's control. There
can be no assurance that the Company will be profitable in any particular
period. It is likely that the Company's operating results in one or more
future periods will fail to meet or exceed the expectations of securities
analysts or investors. See "Risk Factors--Fluctuations in Operating Results;
Uncertainty of Future Results; Seasonality."
21
<PAGE>
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:
<TABLE>
<CAPTION>
EIGHT MONTHS ENDED THREE MONTHS ENDED
YEAR ENDED APRIL 30, DECEMBER 31, MARCH 31,
----------------------- --------------------- ---------------------
1995 1996 1997 1996 1997 1997 1998
------ ------ ------ --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Net revenues............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold...... 57.2 51.5 75.0 70.9 52.2 60.3 46.9
------ ------ ------ --------- --------- --------- ---------
Gross profit........ 42.8 48.5 25.0 29.1 47.8 39.7 53.1
------ ------ ------ --------- --------- --------- ---------
Operating expenses:
Marketing and sales... 18.0 24.0 29.6 31.3 24.0 32.5 21.0
General and adminis-
trative.............. 6.9 9.3 11.3 17.3 10.5 13.8 7.0
Product development... 10.3 15.6 25.7 24.8 16.6 24.0 14.2
------ ------ ------ --------- --------- --------- ---------
Total operating
expenses........... 35.2 48.9 66.6 73.4 51.1 70.3 42.2
------ ------ ------ --------- --------- --------- ---------
Operating income
(loss)................. 7.6 (0.4) (41.6) (44.3) (3.3) (30.6) 10.9
Other income (expense).. 1.3 (0.9) (1.9) (2.2) (2.6) (1.7) (3.4)
------ ------ ------ --------- --------- --------- ---------
Income (loss) before
income taxes........... 8.9 (1.3) (43.5) (46.5) (5.9) (32.3) 7.5
Provision (benefit) for
income taxes........... 3.6 (0.5) (10.9) (11.8) -- (8.0) 0.6
------ ------ ------ --------- --------- --------- ---------
Net income (loss)... 5.3% (0.8)% (32.6)% (34.7)% (5.9)% (24.3)% 6.9%
====== ====== ====== ========= ========= ========= =========
SELECTED OPERATING DATA:
Net revenues by segment:
North America......... 65.2% 56.4% 46.4% 55.1% 60.3% 42.7% 57.4%
International......... 17.4 25.4 38.4 27.7 28.7 46.1 27.4
OEM, royalty and
licensing............ 17.4 18.2 15.2 17.2 11.0 11.2 15.2
------ ------ ------ --------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ========= ========= ========= =========
Net revenues by
platform:
Personal computer..... 46.3% 62.2% 54.3% 50.9% 49.5% 65.3% 51.7%
Video game console.... 36.3 19.6 30.5 31.9 39.5 23.5 33.1
OEM, royalty and li-
censing.............. 17.4 18.2 15.2 17.2 11.0 11.2 15.2
------ ------ ------ --------- --------- --------- ---------
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ========= ========= ========= =========
</TABLE>
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
1997
Net Revenues
Net revenues for the three months ended March 31, 1998 increased 82.9% to
$41.0 million from $22.4 million in the comparable 1997 period. North American
net revenues increased to $23.5 million from $9.6 million in the 1997 period,
and international net revenues increased to $11.2 million from $10.3 million
in the 1997 period. The increase in net revenues in the 1998 period was
primarily due to increased title releases and unit sales volumes, including
significant new title releases, such as VR Sports Powerboat Racing and Die By
The Sword and a higher than expected level of product returns and markdowns
recorded during the 1997 period. OEM, royalty and licensing net revenues
increased to $6.3 million, or 15.2% of net revenues, in the 1998 period from
$2.5 million, or 11.2% of net revenues, in the 1997 period, primarily
attributable to increased OEM bundling transactions and licensing revenues on
edutainment products. The Company expects that OEM, royalty and licensing
revenues may decline, both in dollars and as a percentage of net revenues, on
a comparative quarterly basis during the remainder of 1998 as a larger
proportion of OEM, royalty and licensing net revenues are generated from
royalty-based licensing transactions, as opposed to the shipment of finished
goods, and as such distribution channels become more competitive.
22
<PAGE>
Cost of Goods Sold; Gross Margin
Cost of goods sold increased 42.3% in the three months ended March 31, 1998
to $19.2 million, or 46.9% of net revenues, from $13.5 million, or 60.3% of
net revenues in the comparable 1997 period. Gross margin increased to 53.1% of
net revenues from 39.7% of net revenues in the 1997 period. The increase in
gross margin was primarily attributable to lower costs of PC product sales
offset in part by greater manufacturing costs attributable to an increased
number of video game console products sold during the 1998 period. The
improvement in gross margin was also attributable to changes in the product
mix of internally and externally developed products, reductions in costs of
increased affiliate product revenues and increased OEM, royalty and licensing
net revenues. The 1997 period also included the effects of additional write-
offs of prepaid royalties relating to titles or platform versions of titles
which had been cancelled or which were expected to achieve lower unit sales
than were originally anticipated.
Operating Expenses
Total operating expenses increased 9.6% to $17.3 million, or 42.2% of net
revenues, in the three months ended March 31, 1998 from $15.8 million, or
70.3% of net revenues, for the comparable 1997 period.
Marketing and Sales. Marketing and sales expenses primarily include
advertising and retail marketing support, sales commissions, marketing and
sales personnel, customer support services, fulfillment and other costs.
Marketing and sales expenses increased 18.0% to $8.6 million, or 21.0% of net
revenues, for the three months ended March 31, 1998 from $7.3 million, or
32.5% of net revenues for the comparable 1997 period. The increase in absolute
dollars was primarily attributable to increased advertising and other
marketing costs associated with the increase in titles launched and products
sold during the 1998 period. The decrease as a percentage of net revenues was
primarily attributable to operating efficiencies achieved as a result of the
increased net revenues base. The Company expects that marketing and sales
expense in future periods may increase both in absolute dollars and as a
percentage of net revenues from the levels experienced in the three months
ended March 31, 1998 as the Company increases its marketing and sales
operations.
General and Administrative. General and administrative expenses primarily
include administrative personnel expenses, facilities costs, professional
expenses and other overhead charges. General and administrative expenses
decreased 7.5% to $2.9 million, or 7.0% of net revenues, in the three months
ended March 31, 1998 from $3.1 million, or 13.8% of net revenues in the
comparable 1997 period. The decrease in absolute dollars was primarily
attributable to lower overhead costs offset in part by increased personnel and
operations costs and facilities charges in North America and Europe in support
of increased net revenues. The decrease as a percentage of net revenues was
primarily attributable to operating efficiencies gained as a result of an
increased net revenue base. The Company expects that in future periods general
and administrative expenses will increase in absolute dollars, but may vary as
a percentage of net revenues.
Product Development. Product development expenses, which primarily include
personnel and support costs, are charged to operations in the period incurred.
Product development expenses increased 8.1% to $5.8 million, or 14.2% of net
revenues, in the three month period ended March 31, 1998 from $5.4 million or
24.0% of net revenues in the comparable 1997 period. The increase in absolute
dollars was primarily due to the increase in the number of products under
development, offset in part by cost efficiencies achieved as a result of the
reorganization of the development process. The decrease as a percentage of net
revenues primarily reflected cost savings and operating efficiencies gained as
a result of increased net revenues. The Company expects that in future periods
product development expenses will increase in absolute dollars, but may vary
as a percentage of net revenues.
Other Income (Expense)
Other income (expense) primarily includes interest expense on the Company's
bank line of credit and Subordinated Secured Promissory Notes. Other expense
increased to $1.4 million in the three months ended
23
<PAGE>
March 31, 1998 from $0.4 million in the comparable 1997 period. This increase
was primarily due to increased borrowings under the Company's line of credit
to support increased working capital requirements in the 1998 period and
interest on the Subordinated Secured Promissory Notes, which were issued from
October 1996 through February 1997 and were outstanding throughout the 1998
period.
Provision (Benefit) for Income Taxes
The Company recorded a tax provision of $0.2 million in the three months
ended March 31, 1998 compared to a tax benefit of $1.8 million for the
comparable 1997 period. No tax benefit was recorded in the 1998 period due to
the uncertainty of realization in future periods.
EIGHT MONTHS ENDED DECEMBER 31, 1997 COMPARED TO THE EIGHT MONTHS ENDED
DECEMBER 31, 1996
Net Revenues
Net revenues for the eight months ended December 31, 1997 increased 70.7% to
$86.0 million from $50.4 million in the comparable 1996 period. North American
net revenues increased to $51.8 million from $27.7 million in the 1996 period,
and international net revenues increased to $24.6 million from $14.0 million
in the 1996 period. The increase in net revenues in the 1997 period was
primarily due to increased title releases across multiple platforms in the
eight months ended December 31, 1997 as compared with the eight months ended
December 31, 1996, including significant title releases, such as Clay Fighter
63 1/3 and Star Trek: Starfleet Academy, in the calendar fourth quarter of
1997, and a higher than expected level of product returns and markdowns
recorded during the 1996 period. OEM, royalty and licensing net revenues
decreased to 11.0% of net revenues in the 1997 period from 17.2% in the 1996
period.
Cost of Goods Sold; Gross Margin
Cost of goods sold increased 25.6% in the eight months ended December 31,
1997 to $44.9 million, or 52.2% of net revenues, from $35.7 million, or 70.9%
of net revenues, in the comparable 1996 period. Gross margin increased to
47.8% in the 1997 period from 29.1% in the 1996 period. The increase in gross
margin was primarily due to reductions in sales by the Company on an affiliate
label basis of titles published by third parties, reductions in OEM royalty
expenses as a percentage of net revenues, and changes in the product mix of
externally developed products released during the periods, offset in part by
greater manufacturing costs attributable to an increased number of video game
console products released during the 1997 period. The 1996 period also
included the effects of additional write-offs of prepaid royalties relating to
titles or platform versions of titles which had been cancelled or which were
expected to achieve lower unit sales than were originally forecast.
Operating Expenses
Total operating expenses increased 18.8% to $43.9 million, or 51.1% of net
revenues, in the eight months ended December 31, 1997 from $36.9 million, or
73.4% of net revenues, for the comparable 1996 period.
Marketing and Sales. Marketing and sales expenses increased 30.8% to $20.6
million, or 24.0% of net revenues, for the eight months ended December 31,
1997 from $15.7 million, or 31.3% of net revenues, for the comparable 1996
period. The increase in absolute dollars was primarily due to advertising and
other marketing costs associated with the increase in products launched during
the period. The decrease as a percentage of net revenues was primarily
attributable to operating efficiencies gained as a result of an increased net
revenues base.
General and Administrative. General and administrative expenses increased
3.0% to $9.0 million, or 10.5% of net revenues, in the eight months ended
December 31, 1997 from $8.7 million, or 17.3% of net revenues, in the
comparable 1996 period. The increase in absolute dollars was primarily
attributable to increased personnel and operations and facilities costs both
in North America and Europe in support of increased net revenues. The decrease
as a percentage of net revenues was primarily attributable to operating
efficiencies gained as a result of an increased net revenues base.
24
<PAGE>
Product Development. Product development expenses increased 14.7% to
$14.3 million, or 16.6% of net revenues, in the eight months ended December
31, 1997 from $12.5 million, or 24.8% of net revenues, in the comparable 1996
period. The increase in absolute dollars was primarily due to the addition of
personnel in the Company's product development group, an increase in the
number of products under development and the initiation of European and OEM
product development in the 1997 period. The decrease as a percentage of net
revenues primarily reflected operating efficiencies gained as a result of
increased net revenues.
Other Income (Expense)
Other expense increased to $2.3 million in the eight months ended December
31, 1997 from $1.1 million in the comparable 1996 period. This increase was
primarily due to increased borrowings under the Company's line of credit to
support increased working capital requirements in the 1997 period and interest
on the Subordinated Secured Promissory Notes, which were issued from October
1996 through February 1997 and were outstanding throughout the 1997 period.
Provision (Benefit) for Income Taxes
The Company recorded no tax provision in the eight months ended December 31,
1997, compared to a tax benefit of $5.9 million in the comparable 1996 period.
No tax benefit was recorded in the 1997 period due to the uncertainty of
realization in future periods.
YEAR ENDED APRIL 30, 1997 COMPARED TO THE YEAR ENDED APRIL 30, 1996
Net Revenues
Net revenues in the year ended April 30, 1997 decreased 14.1% to $83.3
million from $97.0 million in the comparable 1996 period. North American net
revenues decreased to $38.6 million in the 1997 period from $54.7 million in
the 1996 period and international net revenues increased to $32.0 million in
the 1997 period from $24.6 million in the 1996 period. OEM, royalty and
licensing net revenues accounted for 15.2% of total net revenues for the 1997
period, compared to 18.2% for the 1996 period. The decrease in net revenues
for the 1997 period was primarily due to a decreased number of title releases
resulting from certain product delays across multiple platforms, lower unit
sales of the titles released during the period and a higher than expected
level of product returns and markdowns recorded during the period.
Cost of Goods Sold; Gross Margin
Cost of goods sold increased 25.1% to $62.5 million, or 75.0% of net
revenues, in the year ended April 30, 1997 from $49.9 million, or 51.5% of net
revenues, in the comparable 1996 period. Gross margin decreased to 25.0% in
the 1997 period from 48.5% in the 1996 period. The decrease in gross margin in
the 1997 period was primarily due to an increase in royalty expenses
attributable to the write-off of $5.9 million in prepaid royalties relating to
titles or platform versions of titles which had been cancelled or which were
expected to achieve lower unit sales than originally forecast, increased sales
of video game console titles and affiliate label products and disproportionate
returns and markdowns in the 1997 period, offset in part by increased OEM
volumes.
Operating Expenses
Total operating expenses increased 16.9% to $55.5 million, or 66.6% of net
revenues, in the year ended April 30, 1997 from $47.4 million, or 48.9% of net
revenues, in the comparable 1996 period.
Marketing and Sales. Marketing and sales expenses increased 5.8% to $24.6
million, or 29.6% of net revenues, in the 1997 period from $23.3 million, or
24.0% of net revenues, in the 1996 period. The increase in absolute dollars
was primarily due to increased commissions expense on European sales offset in
part by lower marketing and advertising expenses due to a decrease in titles
released during the period.
25
<PAGE>
General and Administrative. General and administrative expenses increased
4.2% to $9.4 million, or 11.3% of net revenues, in the 1997 period from $9.0
million, or 9.3% of net revenues, in the 1996 period. The increase in absolute
dollars was primarily attributable to increased personnel and facilities costs
in North America, Europe and Japan.
Product Development. Product development expenses increased 41.7% to $21.4
million, or 25.7% of net revenues, in the 1997 period from $15.1 million, or
15.6% of net revenues, in the 1996 period. The increase in absolute dollars
was primarily attributable to an increase in the number of products under
development, the inclusion of a full year of operations of Shiny, an
interactive entertainment software developer in which the Company acquired a
91% interest in 1995, localization and development costs in Japan, initiation
of European and OEM product development and increased product development
personnel and facilities costs.
Other Income (Expense)
Other expense increased to $1.6 million in the 1997 period from $0.8 million
in the 1996 period. The increase was primarily due to interest expense related
to borrowings under the Company's bank line of credit to support increased
working capital requirements and interest on the Subordinated Secured
Promissory Notes which were issued from October 1996 through February 1997.
Provision (Benefit) for Income Taxes
The Company's income tax benefit in the 1997 period was $9.1 million,
compared to an income tax benefit of $0.5 million in the 1996 period. The
benefit for income taxes as a percentage of pre-tax income declined from 39.2%
to 25.0% due to the recording of a valuation allowance of $2.9 million in the
1997 period.
YEAR ENDED APRIL 30, 1996 COMPARED TO THE YEAR ENDED APRIL 30, 1995
Net Revenues
Net revenues in the year ended April 30, 1996 increased 21.9% to $97.0
million from $79.5 million in the comparable 1995 period. North American net
revenues increased to $54.7 million and international net revenues increased
to $24.6 million in the 1996 period from $51.9 million and $13.8 million,
respectively, in the 1995 period. OEM, royalty and licensing net revenues were
18.2% of net revenues for the 1996 period, compared to 17.4% for the 1995
period. The increase in net revenues in the 1996 period was primarily due to
an increase in the number of title releases across multiple platforms with
increased individual title successes, including Stonekeep and Descent II,
which resulted in increased international net revenues, particularly in
Europe, and increased net revenues from retailers and resellers. The increase
was also due to increases in OEM, royalty and licensing net revenues. These
increases were offset in part by reduced affiliate label sales and increased
product returns and markdowns.
Cost of Goods Sold; Gross Margin
Cost of goods sold increased 9.8% to $49.9 million, or 51.5% of net
revenues, in the year ended April 30, 1996 from $45.5 million, or 57.2% of net
revenues, in the comparable 1995 period. Gross margin was 48.5% in the 1996
period, as compared to 42.8% in the 1995 period. The increase in gross margin
was primarily attributable to the increase in overall product sales, a product
mix emphasizing higher margin PC titles and reductions in affiliate label net
revenues.
Operating Expenses
Total operating expenses increased 69.3% to $47.4 million, or 48.9% of net
revenues, in the year ended April 30, 1996 from $28.0 million, or 35.2% of net
revenues, in the comparable 1995 period.
Marketing and Sales. Marketing and sales expenses increased 63.1% to $23.3
million, or 24.0% of net revenues, in the 1996 period from $14.3 million, or
18.0% of net revenues, in the comparable 1995 period. The
26
<PAGE>
increase for the 1996 period both in absolute dollars and as a percentage of
net revenues was primarily attributable to increased advertising and marketing
costs in support of increased product releases, promotional programs,
commissions on international sales and personnel and overhead.
General and Administrative. General and administrative expenses increased
63.3% to $9.0 million, or 9.3% of net revenues, in the 1996 period from $5.5
million, or 6.9% of net revenues in the 1995 period. The increase in both
absolute dollars and as a percentage of net revenues was primarily
attributable to increased personnel and operating and facilities costs in
North America, Europe and Japan.
Product Development. Product development expenses increased 84.4% to $15.1
million, or 15.6% of net revenues, in the 1996 period from $8.2 million, or
10.3% of net revenues, in the 1995 period. The increase in product development
expenses in both absolute dollars and as a percentage of net revenues was
primarily attributable to an increase in the number and complexity of products
in development, the expansion of the Company's internal development
capabilities (including the acquisition of Shiny), the initiation of
localization and development in Japan and increased facilities costs and
overhead requirements.
Other Income (Expense)
Other expense increased $1.8 million to $0.8 million in the year ended April
30, 1996, compared to other income of $1.0 million in the comparable 1995
period. The increase was primarily due to interest expense in the 1996 period
related to borrowings under the Company's bank line of credit to support
operations, while the Company earned income on cash balances during the 1995
period.
Provision (Benefit) for Income Taxes
The Company's income tax benefit in the year ended April 30, 1996 was $0.5
million, compared to an income tax provision of $2.8 million in the comparable
1995 period.
27
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated statements of
operations data for each of the eight calendar quarters in the period ended
March 31, 1998, as well as the percentage of the Company's net revenues
represented by each item. This information was derived from the Company's
unaudited consolidated financial statements that include, in the opinion of
the Company, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation when read in conjunction with the
Consolidated Financial Statements included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1996 1996 1996 1997 1997 1997 1997 1998
-------- --------- -------- --------- -------- --------- -------- ---------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Net revenues............ $18,574 $13,669 $29,038 $22,410 $20,502 $23,833 $53,308 $40,996
Cost of goods sold...... 10,210 10,459 20,952 13,508 13,941 14,153 26,751 19,221
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 8,364 3,210 8,086 8,902 6,561 9,680 26,557 21,775
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Marketing and sales.... 4,898 4,744 8,052 7,280 5,954 5,851 9,358 8,589
General and administra-
tive.................. 3,311 2,766 3,395 3,088 4,014 2,948 3,453 2,855
Product development.... 4,353 4,648 4,851 5,384 5,920 5,312 5,701 5,819
------- ------- ------- ------- ------- ------- ------- -------
Total operating ex-
penses................ 12,562 12,158 16,298 15,752 15,888 14,111 18,512 17,263
------- ------- ------- ------- ------- ------- ------- -------
Operating income
(loss)................. (4,198) (8,948) (8,212) (6,850) (9,327) (4,431) 8,045 4,512
Other income (expense).. (260) (294) (875) (375) (663) (1,050) (1,552) (1,418)
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before in-
come taxes............. (4,458) (9,242) (9,087) (7,225) (9,990) (5,481) 6,493 3,094
Provision (benefit) for
income taxes........... (1,739) (2,311) (2,272) (1,782) 0 0 0 245
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)....... $(2,719) $(6,931) $(6,815) $(5,443) $(9,990) $(5,481) $ 6,493 $ 2,849
======= ======= ======= ======= ======= ======= ======= =======
Net income (loss) per
share:
Basic.................. $ (0.25) $ (0.62) $ (0.61) $ (0.49) $ (0.90) $ (0.49) $ 0.65 $ 0.26
======= ======= ======= ======= ======= ======= ======= =======
Diluted................ $ (0.25) $ (0.62) $ (0.61) $ (0.49) $ (0.90) $ (0.49) $ 0.54 $ 0.23
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1996 1996 1996 1997 1997 1997 1997 1998
-------- --------- -------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PERCENTAGE OF NET REVE-
NUES:
Net revenues............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold...... 55.0 76.5 72.2 60.3 68.0 59.4 50.2 46.9
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............ 45.0 23.5 27.8 39.7 32.0 40.6 49.8 53.1
Operating expenses:
Marketing and sales.... 26.4 34.7 27.7 32.5 29.0 24.5 17.6 21.0
General and administra-
tive.................. 17.8 20.2 11.7 13.8 19.6 12.4 6.5 7.0
Product development.... 23.4 34.0 16.7 24.0 28.9 22.3 10.7 14.2
----- ----- ----- ----- ----- ----- ----- -----
Total operating ex-
penses................ 67.6 88.9 56.1 70.3 77.5 59.2 34.8 42.2
----- ----- ----- ----- ----- ----- ----- -----
Operating income
(loss)................. (22.6) (65.4) (28.3) (30.6) (45.5) (18.6) 15.0 10.9
Other income (expense).. (1.4) (2.2) (3.0) (1.7) (3.2) (4.4) (2.9) (3.4)
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before in-
come taxes............. (24.0) (67.6) (31.3) (32.3) (48.7) (23.0) 12.1 7.5
Provision (benefit) for
income taxes........... (9.4) (16.9) (7.8) (8.0) 0.0 0.0 0.0 0.6
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)....... (14.6)% (50.7)% (23.5)% (24.3)% (48.7)% (23.0)% 12.1% 6.9%
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
Net revenues for the three months ended December 31, 1997 and March 31, 1998
were $53.3 million and $41.0 million, respectively. The increase for such
three month periods reflected the market's seasonality, together with the
Company's successful introduction of a number of new product titles. Net
revenues of $18.6 million, $13.7 million and $29.0 million for the three
months ended June 30, 1996, September 30, 1996 and December 31, 1996,
respectively, reflected lower net revenues arising from product delays during
those periods and the resulting introduction of fewer titles than in other
periods and a higher than expected level of product returns and markdown
allowances.
28
<PAGE>
Cost of goods sold for the three month periods ended September 30, 1996,
December 31, 1996, March 31, 1997 and June 30, 1997 included the effects of
additional write-offs of prepaid royalties relating to titles or platform
versions of titles which had been cancelled or which were expected to achieve
lower unit sales than were originally forecast, which, combined with the lower
net revenues, resulted in lower gross margin during such periods.
Interest expense has increased on a comparative basis over the periods
presented, reflecting debt service on the Company's $14.7 million in
Subordinated Secured Promissory Notes issued from October 1996 through
February 1997 together with increased borrowings on the Company's bank line of
credit.
The Company's operating results have fluctuated significantly in the past
and will likely 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 the Company's control. Such
factors include, but are not limited to, demand for the Company's and its
competitors' products, the size and rate of growth of the market for
interactive entertainment software, changes in computing platforms, the number
of new products and product enhancements released by the Company and its
competitors during the period, changes in product mix, product returns, the
timing of orders placed by distributors and dealers, delays in shipment, the
timing of development and marketing expenditures, price competition and the
level of the Company's international net revenues. The uncertainties
associated with the interactive entertainment software development process,
lengthy manufacturing lead times for Nintendo-compatible products, possible
production delays, and the approval process for products compatible with the
Sony Computer Entertainment, Nintendo and Sega video game consoles, as well as
approvals required from other licensors, make it difficult to accurately
predict the quarter in which shipments will occur. Because of the limited
number of products introduced by the Company in any particular quarter, a
delay in the introduction of a product may materially adversely affect the
Company's operating results for that quarter. A significant portion of the
Company's operating expenses is relatively fixed, and planned expenditures are
based primarily on sales forecasts. If net revenues do not meet the Company's
expectations in any given quarter, operating results may be materially
adversely affected.
The interactive entertainment software industry is generally highly
seasonal, with the highest levels of consumer demand occurring during the
year-end holiday buying season, followed by demand during the calendar first
quarter resulting both from demand for interactive entertainment software for
PC's and video game consoles acquired during the holidays and from continuing
demand for titles released in the preceding fourth quarter. As a result, net
revenues, gross profits and operating income for the Company have historically
been highest during the fourth and the following first calendar quarters, and
have declined from these levels in the subsequent second and third calendar
quarters. The failure or inability of the Company to introduce products on a
timely basis to meet such seasonal increases in demand may have a material
adverse effect on the Company's business, operating results and financial
condition. The Company may over time become increasingly affected by the
industry's seasonal patterns. Although the Company seeks to reduce the effect
of such seasonal patterns on its business by distributing its product release
dates throughout the year, particularly during the quarters ending June 30 and
September 30, there can be no assurance that such efforts will be successful.
There can be no assurance that the Company will be profitable in any
particular period given the uncertainties associated with software
development, manufacturing, distribution and the impact of the industry's
seasonal patterns on the Company's net revenues. As a result of the foregoing
factors and the other factors discussed in "Risk Factors," it is likely that
the Company's operating results in one or more future periods will fail to
meet or exceed the expectations of securities analysts or investors. In such
event, the trading price of the Common Stock would likely be materially
adversely affected. See "Risk Factors--Fluctuations in Operating Results;
Uncertainty of Future Results; Seasonality."
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through the use of
bank lines of credit and equipment leases, and through cash generated by the
sale of securities. As of March 31, 1998, the Company's principal sources of
liquidity included cash and short term investments of approximately $1.9
million and the
29
<PAGE>
Company's bank line of credit bearing interest at the London Interbank Offered
Rate plus 4.87% (10.56% at March 31, 1998), expiring May 31, 1999. The
Company's bank line of credit balance was $33.2 million at May 31, 1998. The
Company expects to use approximately $16.8 million of the net proceeds of the
Offering to repay certain amounts outstanding under the bank line of credit.
Under the terms of the bank line of credit, the Company has available
borrowings up to $35.0 million through August 30, 1998, $30.0 million through
December 30, 1998 and $25.0 million through May 31, 1999, based in part on
qualifying receivables and inventory. Within the overall credit limit of
$35.0 million is the Company's ability to draw down up to $10.0 million in
excess of its borrowing base through August 30, 1998, and up to $5.0 million
in excess of its borrowing base through December 30, 1998. The Company is
currently in compliance with all terms of its credit agreement.
The Company's primary capital needs have historically been to fund working
capital requirements necessitated by its sales growth, 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. The
Company's operating activities used cash of $0.2 million during the three
months ended March 31, 1998, used cash of $15.3 million during the eight
months ended December 31, 1997, used cash of $17.0 million during the year
ended April 30, 1997, provided cash of $2.5 million in the year ended April
30, 1996 and used cash of $8.7 million in the year ended April 30, 1995. The
cash used by operating activities in the three months ended March 31, 1998 was
primarily attributable to increased trade receivables, offset in part by net
income during the period and increased accounts payable and accrued expenses.
The cash used by operating activities in the eight months ended December 31,
1997 was primarily attributable to increased trade receivables, particularly
in the year-end holiday selling season, together with a net loss of $5.1
million. The increase in cash used by operating activities in the year ended
April 30, 1997 was primarily due to a net loss of $27.2 million, offset in
part by increased liabilities and accrued expenses. Cash provided by
operations in the year ended April 30, 1996 primarily resulted from increases
in liabilities, and the use of operating cash in the year ended April 30, 1995
primarily resulted from increased royalty advances and receivables, offset by
net income during the period.
Cash provided by financing activities of $0.9 million in the three months
ended March 31, 1998 and $12.2 million in the eight months ended December 31,
1997, resulted primarily from borrowings under the Company's bank line of
credit. Cash provided by financing activities of $20.7 million in the year
ended April 30, 1997, resulted primarily from the issuance of Subordinated
Secured Promissory Notes and borrowings under the Company's bank line of
credit. Cash provided by financing activities of $5.5 million in the year
ended April 30, 1996, resulted primarily from borrowings under the Company's
bank line of credit, and cash provided by financing activities of $0.6 million
in the year ended April 30, 1995 resulted primarily from a tax benefit due to
the exercise of stock options.
Cash used in investing activities was $0.3 million, $0.8 million and $3.5
million in the three months ended March 31, 1998, the eight months ended
December 31, 1997 and the year ended April 30, 1997, respectively, which
consisted of capital expenditures, primarily for office and computer equipment
used in Company operations. Cash used in investing activities of $7.5 million
in the year ended April 30, 1996 resulted primarily from $4.6 million in
capital expenditures and $3.2 million used in the acquisition of Shiny
Entertainment. Cash provided by investing activities of $11.7 million in the
year ended April 30, 1995 resulted primarily from $15.0 million in proceeds
from the sale of marketable securities, offset in part by $3.3 million in
capital expenditures. The Company does not currently have any material
commitments with respect to any capital expenditures.
The Company expects that its capital requirements will increase
significantly in the future as it increases its product development and sales
and marketing programs, primarily due to increased headcount in these areas,
increased advance royalty payments to third party developers and increased
sales and marketing expenses. The Company has not yet definitively determined
such capital uses. The Company believes that funds available under its bank
line of credit and anticipated funds from operations will be sufficient to
satisfy the Company's projected working capital, capital expenditure
requirements and debt obligations in the normal course of business for at
30
<PAGE>
least the next twelve months. See "Use of Proceeds." There can be no
assurances, however, that the Company will not be required to raise additional
debt or equity financing during such period, nor that if the Company is
required to raise additional financing during such period it will be able to
do so on commercially reasonable terms. See "Risk Factors--Future Capital
Requirements."
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." In addition, the American Institute of
Certified Public Accountants issued Statement of Position ("SOP") 97-2,
"Software Revenue Recognition" and SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SFAS Nos. 130 and
131 and SOP 97-2 are effective for fiscal years beginning after December 15,
1997. SOP 98-1 is effective for fiscal years beginning after December 15,
1998. The Company does not believe that adoption of these standards will have
a material impact on the Company's results of operations.
YEAR 2000 ISSUE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. This inability to recognize or properly treat the Year
2000 may cause the Company's systems and applications to process critical
financial and operational information incorrectly. The Company continues to
assess the impact of the Year 2000 issue on its reporting systems and
operations.
The Company is currently in the process of investigating whether its
internal accounting systems and other operational systems are Year 2000
compliant. The Company has been informed by the vendor of its internal
accounting software that upgrades that will bring such software into Year 2000
compliance will be provided to the Company under its existing software
maintenance agreement in the third quarter of 1998. The Company expects to
effect the conversion of its internal accounting system to such upgraded
software by the end of 1998. The Company believes that necessary conversions
of other operational systems can also be accomplished through vendor upgrades
and enhancements as provided under its system maintenance agreements currently
in effect. The Company does not anticipate significant costs associated with
any necessary conversions. However, there can be no assurance that certain of
the Company's internal computer systems or networks or those of its key
vendors and distributors will not be adversely affected by such Year 2000
issues, which could have a material adverse effect on the Company's business,
operating results or financial condition. See "Risk Factors--Year 2000
Compliance."
31
<PAGE>
BUSINESS
Interplay is a leading developer, publisher and distributor of interactive
entertainment software for both core gamers and the mass market. The Company,
which commenced operations in 1983, is most widely known for its titles in the
action/arcade, adventure/RPG, strategy/puzzle and sports categories, and has
published such hit titles as Descent, Fallout, Stonekeep, Battle Chess and
Virtual Pool. The Company has produced titles for many of the most popular
interactive entertainment software platforms, and currently balances its
development efforts by publishing interactive entertainment software for PCs
and current generation video game consoles, such as the PlayStation and
Nintendo 64. Interplay was named Publisher of the Year in 1996 by Computer &
Net Player magazine.
The Company seeks to publish 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 has published many
such successful franchise titles to date. In addition, the Company secures
licenses to use popular intellectual properties, such as Star Trek, Caesars
Palace and Major League Baseball, for incorporation into certain of its
products. Of the more than 40 titles currently in development by the Company,
more than half are sequels to successful titles or incorporate licensed
intellectual properties.
INDUSTRY BACKGROUND
The worldwide market for interactive entertainment software has grown
significantly in recent years. According to IDG, the worldwide market for
interactive entertainment software generated sales of more than 220 million
retail units in 1997, and is projected to generate more than 437 million
retail units in 1999, representing a 41% compound annual growth rate. The
interactive entertainment software market is composed primarily of software
for PC platforms and video game consoles.
This market growth has been driven by the significant growth in the
worldwide installed base of PCs and video game consoles, the emergence of a
strong international market for interactive entertainment software,
particularly in Western Europe, and the emergence of powerful software
distribution channels capable of reaching a broad consumer base.
According to IDG, U.S. retail sales of PC interactive entertainment software
exceeded 45 million units in 1997 and are projected to grow 27% annually to
more than 73 million units in 1999. Also, according to IDG, approximately 43
million units of interactive entertainment software for PlayStation and
Nintendo 64 video game consoles were sold in the U.S. in 1997, and these unit
sales are expected to grow 56% annually to approximately 106 million in 1999.
The international market for PC interactive entertainment software is
growing rapidly as well. According to IDG, international sales of interactive
entertainment software for PCs were 53 million units in 1997 and are projected
to grow 27% annually to 85 million units in 1999. Similarly, growth in the
video game console installed base outside of the U.S. has driven an increase
in international sales of interactive entertainment software for video game
consoles, with 77 million units sold outside of the U.S. in 1997 and 171
million units projected to be sold in 1999, representing a compound annual
growth rate of 48%, according to IDG.
The distribution channels for interactive entertainment software have
changed significantly in recent years and have become increasingly
competitive. During the 1980s, consumer software was typically sold through
specialty stores. Today, mass merchants and consumer electronics stores such
as Wal-Mart, Best Buy, Price-Costco, Kmart, CompUSA and Target are the most
important distribution channels for retail sales of consumer software.
Competition for shelf space has intensified due to the fact that these high
volume retailers generally only stock a limited number of titles which are
expected to sell large numbers of units. This trend has increased the
importance of developing well-known brands and publishing labels with a
history of successful sales.
32
<PAGE>
Today, a limited number of titles capture a majority of the sales in the
interactive entertainment software market. According to PC Data, in 1997 the
top 100 PC titles released (approximately nine percent of the titles released)
generated 67% of the industry's overall revenues. This hit-driven market has
led to higher production budgets for titles as well as more complex
development and production processes and longer development cycles. Publishers
with a history of producing hit titles have enjoyed a significant marketing
advantage because of their heightened brand recognition and customer loyalty.
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 storylines of such hit titles into
additional interactive entertainment software products in order to spread
development costs among multiple products.
The Internet and on-line services represent an emerging segment of the
interactive entertainment software market. While competing with interactive
entertainment software as an alternative use of the home PC, the Internet and
on-line services also present a new platform on which publishers and
distributors can market, advertise and distribute their products, whether
through direct sales from web sites or through sponsoring multi-player on-line
tournaments featuring their games. The ability for users to compete on-line
provides an additional product feature which may increase demand for
interactive entertainment software products.
As interactive entertainment software continues to gain mass market
acceptance, it will become increasingly important for publishers of such
software (i) to achieve brand name recognition for their products among both
core gamers and the mass market by offering innovative products with
captivating gameplay across multiple platforms, (ii) to secure relationships
with third party interactive entertainment software developers with proven
track records of developing hit titles, (iii) to identify and address the
technical, creative and marketing risks before committing significant
development resources to a title, (iv) to aggressively market and sell these
products through traditional and emerging distribution channels and (v) to
leverage their existing software technology, and the brand recognition
associated with it, by producing sequel and add-on titles.
BUSINESS STRATEGY
The Company's objective is to enhance its position as a leading developer,
publisher and distributor of interactive entertainment software for both core
gamers and the mass market. The key elements of the Company's business
strategy are as follows:
Maximize Franchise and Brand Value. The Company seeks to publish hit titles
whose strong consumer appeal and resulting consumer loyalty create franchise
titles for the Company. Further, the Company seeks to leverage its franchise
titles into recurring sources of revenue by publishing sequels and add-ons and
by pursuing merchandising opportunities as they arise. To date, the Company
has published many successful franchise titles, including Descent, Virtual
Pool, Clay Fighter and Stonekeep, and believes that many of its products
slated for release in 1998 may become additional franchise titles. In
addition, the Company has developed or is developing products based on popular
intellectual properties licensed to the Company, such as Star Trek, Caesars
Palace and Major League Baseball. The Company believes that the exposure and
name recognition of these properties, combined with well-designed gameplay,
may create franchise titles for the Company. The Company currently publishes
titles under the Interplay, Shiny, VR Sports and Signature Series labels. To
create franchise value within specific product genres, the Company plans to
introduce genre-specific labels over time, including its Tantrum, Tribal
Dreams, Flat Cat and Black Isle Studios labels.
Secure Relationships with Proven Hit Developers. In order to maintain its
competitive position in its hit-driven industry, the Company devotes
significant resources to securing relationships with third party interactive
entertainment software developers with proven track records of developing hit
titles. The Company believes that its developer-friendly culture, distribution
capability and success as a publisher of well-known titles has enabled it to
attract and retain proven hit developers. Relationships such as these have led
to the release of such franchise titles as the Descent series, Virtual Pool
and Redneck Rampage. In furtherance of this strategy, in 1995 the Company
acquired a 91% interest in Shiny Entertainment, Inc. ("Shiny"), the developer
of the hit Earthworm Jim title.
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Manage Product Development Process. In order to limit cost and schedule
overruns while maintaining a creative and entrepreneurial environment for its
development group, the Company has implemented a divisional product
development and production process, based on product genres. The Company
believes that breaking down the development function into divisions enables it
to improve its software design capabilities, to better manage its internal and
external development processes and to enhance its software development tools
and techniques, thereby allowing for greater efficiency and improved
predictability in the software development process.
Leverage and Expand Distribution Channels. The Company seeks to leverage and
expand its channels of distribution in order to reach a larger number of
consumers in the retail, direct, budget and on-line markets, both domestically
and internationally. The Company has also established Interplay OEM, which
distributes the Company's interactive entertainment software titles, as well
as those of other software publishers, to computer hardware and peripheral
device manufacturers for use in bundling arrangements. In 1995, the Company
established a European subsidiary ("Interplay Europe") to focus on
distribution to the European markets, both directly and through third-party
distributors and joint ventures. The Company also plans to increase its
presence in other international markets by licensing its titles to publishers
in such markets, by entering into distribution arrangements and by
establishing direct distribution capabilities. Finally, the Company seeks to
leverage and expand its capabilities to distribute its products over the
Internet both through direct on-line marketing and sales efforts and through
the use of certain of its games by providers of on-line gameplay who
distribute through popular on-line services, such as America Online.
Develop and Leverage Advanced Technology. The Company seeks to leverage its
investments in existing game technologies while internally and externally
developing new technologies which can be used in multiple future titles. The
Company develops proprietary engines, development tools and related technology
which enable it to develop advanced 3D games on a timely and cost-effective
basis and with reduced technology risk. For example, the Company is
incorporating the advanced proprietary human motion and depth perception
technology developed by Shiny into certain of the Company's sports titles.
PRODUCTS
The Company develops, publishes and distributes interactive entertainment
software titles that provide immersive game experiences by combining advanced
technology with engaging content, vivid graphics and rich sound. The Company
utilizes the experience and judgment of the avid gamers in its product
development group to select and produce the products it publishes. This has
resulted in the publication of a wide variety of games that have received
numerous awards, including the Academy of Interactive Arts & Sciences' Best
Title, Computer Game Review's Gold and Platinum Triads and PC Entertainment's
Editor's Choice Awards.
The Company's strategy is to develop products for those platforms, whether
PC or video game console, that have or will have sufficient installed bases
for such development to be economically viable. The Company currently
publishes products for multiple PC platforms, including Windows 95, and for
the current generation of video game consoles, including the PlayStation and
Nintendo 64. The Company assesses the potential acceptance and success of
emerging platforms and the anticipated continued viability of existing
platforms based on many factors, including the number of competing titles, the
ratio of software sales to hardware sales with respect to such platform, the
installed base of the platform, the change in the rate of sales of the
platform and the cost and timing of development for the platform. The Company
has entered into license agreements with Sony Computer Entertainment and
Nintendo pursuant to which the Company is granted the right to develop,
sublicense and distribute products for such platforms in specified
territories, which products are manufactured by the licensor for the Company.
The Company pays the licensor a royalty and/or manufacturing fee in exchange
for such license and manufacturing services. Such agreements grant the
licensor certain approval rights over the products developed for such
platforms, as well as over the packaging and marketing materials for such
products. There can be no assurance that the Company will be able to obtain
future licenses from hardware companies on acceptable terms or that any
existing or future licenses will be renewed by the licensors. The inability of
the Company to obtain such approvals could have a material adverse effect on
the Company's business, operating results and financial condition. See "Risk
Factors--Dependence on Licenses from and Manufacturing by Hardware Companies."
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The interactive entertainment software market can generally be divided into
five major categories or product genres: action/arcade, adventure/RPG,
strategy/puzzle, sports and simulation. From January 1, 1995 to March 31,
1998, the Company released 65 titles, and currently has more than 40 titles in
various stages of development. Below are two tables, the first highlighting
selected Company releases since 1995 which the Company believes are, or will
become, franchise titles, and the second listing selected titles currently
scheduled for release in the next twelve months which are either sequels to
franchise titles or which the Company believes present franchise title
opportunities.
SELECTED TITLES RELEASED SINCE 1995
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
TITLE GENRE PLATFORM DEVELOPER
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Carmageddon Action/Arcade PC Third party
- -------------------------------------------------------------------------------
Clay Fighter 63 1/3 Action/Arcade N64 Interplay
- -------------------------------------------------------------------------------
Descent Action/Arcade PC, PlayStation, Mac Third party
- -------------------------------------------------------------------------------
Descent II Action/Arcade PC, PlayStation, Mac Third party
- -------------------------------------------------------------------------------
Descent: Freespace The Great
War Action/Arcade PC Third party
- -------------------------------------------------------------------------------
Die By the Sword Action/Arcade PC Third party
- -------------------------------------------------------------------------------
MDK Action/Arcade PC, PlayStation Shiny
- -------------------------------------------------------------------------------
Redneck Rampage Action/Arcade PC Third party
- -------------------------------------------------------------------------------
Star Trek: Starfleet Academy Action/Arcade PC, Mac Interplay
- -------------------------------------------------------------------------------
Fallout Adventure/RPG PC, Mac Interplay
- -------------------------------------------------------------------------------
Stonekeep Adventure/RPG PC Interplay
- -------------------------------------------------------------------------------
Caesars Palace Strategy/Puzzle PC, PlayStation Third party
- -------------------------------------------------------------------------------
M.A.X. Strategy/Puzzle PC Interplay
- -------------------------------------------------------------------------------
Jimmy Johnson's VR Football
'98 Sports PlayStation Third party
- -------------------------------------------------------------------------------
Virtual Pool Sports PC, PlayStation, Mac Third party
- -------------------------------------------------------------------------------
Virtual Pool 2 Sports PC Third party
- -------------------------------------------------------------------------------
VR Baseball '97 Sports PC, PlayStation Interplay
- -------------------------------------------------------------------------------
VR Sports Powerboat Racing Sports PC, PlayStation Third party
<CAPTION>
SELECTED TITLES SCHEDULED TO BE RELEASED IN THE NEXT TWELVE MONTHS
- --------------------------------------------------------------------------------
TITLE GENRE PLATFORM DEVELOPER
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Crime Killer Action/Arcade PlayStation Third party
- -------------------------------------------------------------------------------
Descent III Action/Arcade PC Third party
- -------------------------------------------------------------------------------
Earthworm Jim 3D Action/Arcade PC, PlayStation, N64 Third party
- -------------------------------------------------------------------------------
Messiah Action/Arcade PC, PlayStation Shiny
- -------------------------------------------------------------------------------
Wild 9 Action/Arcade PlayStation Shiny
- -------------------------------------------------------------------------------
Baldur's Gate Adventure/RPG PC Third party
- -------------------------------------------------------------------------------
Fallout 2 Adventure/RPG PC Interplay
- -------------------------------------------------------------------------------
Star Trek: Secret of Vulcan
Fury Adventure/RPG PC Interplay
- -------------------------------------------------------------------------------
Caesars Palace VIP Series Strategy/Puzzle PC Third party
- -------------------------------------------------------------------------------
M.A.X. 2 Strategy/Puzzle PC Interplay
- -------------------------------------------------------------------------------
VR Football '99 Sports PlayStation Third party
- -------------------------------------------------------------------------------
VR Baseball '99 Sports PC, PlayStation Interplay
</TABLE>
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Although the Company anticipates that it will release the titles listed in
the table immediately above in the next twelve months, the timing and success
of new interactive entertainment software product releases remains
unpredictable due to the complexity of product development, including the
uncertainty associated with new technology. The development cycle of new
products is difficult to predict but can typically range from 12 to 24 months,
and there can be no assurance that such titles will be released in the next
twelve months or at all. There also can be no assurance that, if introduced,
such new titles will become franchise titles, achieve market acceptance or
generate any significant revenues. While the level of sales required for a
title to be profitable varies depending on the costs associated with such
title, in general, the Company considers titles to be hit titles if they sell
more than 100,000 units. A significant delay in the introduction of, or the
presence of a defect in, one or more of such titles or other new products, or
the failure of one or more of such titles to generate significant net
revenues, could have a material adverse effect on the success of such products
and on the Company's business, operating results and financial condition. See
"Risk Factors--Dependence on New Product Introductions; Risk of Product Delays
and Product Defects" and "--Uncertainty of Market Acceptance; Dependence on
Hit Titles."
The Company has the right to distribute certain of the titles listed in the
above tables only in specified territories. For example, the Company only has
the right to distribute Carmageddon in North America. In addition, the
Company's right to distribute certain of its sports titles, such as VR
Baseball '99, in a given international territory varies depending upon the
relevant sports league's approvals obtained by the Company.
As part of its strategy to develop franchises, the Company has recently
adopted a separate publishing label for each of its five major product
categories: Tantrum, for the action/arcade division; Tribal Dreams, for the
adventure division; Black Isle Studios, for the RPG division; Flat Cat, for
the strategy/puzzle division, and VR Sports, for the sports division. The
Company also releases titles under the Shiny label. The length of time
required to attract consumer awareness of each of these product labels will
vary based on a number of factors, including the number of commercially
successful titles released by the particular development group. Below is a
partial summary of the Company's internally and externally developed titles
that have been released previously or are being developed for release in the
next twelve months in the various product categories. The only titles that
have individually contributed more than 10% of the Company's net revenues in
any fiscal year since the Company's former 1995 fiscal year have been
Stonekeep, which was developed internally by the Company, and Descent II,
which was developed by a third party developer, and each of which accounted
for more than 10% of the Company's net revenues in the Company's former fiscal
year ended April 30, 1996, and Clay Fighter 63 1/3 and Star Trek: Starfleet
Academy, both of which were developed internally by the Company, and each of
which accounted for more than 10% of the Company's net revenues in the eight
month period ended December 31, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The fact that
these titles accounted for more than 10% of the Company's net revenues in a
particular period is not an indication that these or any other titles will do
so in future periods. See "Risk Factors--Uncertainty of Market Acceptance;
Dependence on Hit Titles."
TANTRUM--ACTION/ARCADE TITLES
The Descent Series. Developed by Parallax and originally published in
February 1995, Descent and its sequel have sold more than 1.1 million retail
units worldwide. Descent has also earned critical acclaim, winning Best
Computer Game of 1995 and Best Title of 1995 from the Academy of Interactive
Arts and Sciences and Golden Triad honors from Computer Game Review. Descent:
FreeSpace The Great War, developed by Parallax and released in June 1998, is a
3D space simulator featuring large-scale dog-fights and huge capital ships as
"landscapes" for the environments, and includes an on-line, multi-player
option which allows up to 12 users to join a game. Parallax is also currently
developing Descent III, which incorporates a new advanced proprietary engine,
for release by the Company in the next twelve months.
Star Trek: Starfleet Academy. Developed internally by the Company and based
on Paramount's original Star Trek television and motion picture series, Star
Trek: Starfleet Academy combines real-time 3D action with strategic game play.
The game includes full motion video of actors, including three members of the
original cast, William Shatner as Captain Kirk, Walter Koenig as Ensign Chekov
and George Takei as Lieutenant Sulu. Released in September 1997, the game has
sold in excess of 350,000 retail units worldwide.
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Die By The Sword. Developed for the Company by Treyarch Invention, Die By
The Sword includes advanced technology that allows full motion control of the
game's characters, which engage in hand-to-hand combat. The proprietary
graphics engine includes a four person multi-player mode and allows players to
attack and defend themselves in a 360(degrees) environment featuring realistic
combat graphics and gameplay.
TRIBAL DREAMS--ADVENTURE TITLES
Star Trek: Secret of Vulcan Fury (under development). Star Trek: Secret of
Vulcan Fury is the third in a series of original Star Trek adventure games
developed internally by the Company. The game is expected to combine
proprietary motion-capture animation technology with original Star Trek
episodes written by one of the original Star Trek television writers. The game
will feature the voices of certain members of the original cast, challenging
story-based puzzles and the opportunity for players to assume the roles of six
Star Trek characters: Captain Kirk, Mr. Spock, Doctor McCoy, Lieutenant Sulu,
Ensign Chekov and Chief Engineer Scott.
BLACK ISLE STUDIOS--RPG TITLES
Stonekeep. The Company internally developed Stonekeep, an RPG that takes
place in a subterranean labyrinth and features 3D rendered dungeons and
creatures, a rich soundtrack and vivid special effects. Stonekeep has sold in
excess of 300,000 retail units worldwide since its release in November 1995.
Stonekeep was named Best RPG of 1995 by Computer Player and Editor's Choice
for Best RPG by PC Entertainment. The Company is currently developing a sequel
to Stonekeep.
Fallout 2 (under development). The Company is currently developing Fallout 2
as the sequel to Fallout: A Post Nuclear Role Playing Game, an RPG set in the
aftermath of a catastrophic nuclear war, which has sold in excess of 100,000
retail units worldwide since its release in October 1997. The original Fallout
won numerous industry awards including the Editor's Choice Award and RPG of
the Year 1997 by PC Gamer and the CG Choice Award and RPG of the Year 1997 by
Computer Gaming World. Fallout 2 will combine the original Fallout's gameplay
with new scenarios and characters.
FLAT CAT--STRATEGY/PUZZLE TITLES
M.A.X. Mechanized Assault & Exploration ("M.A.X."). Developed internally by
the Company, M.A.X., which allows players to lead a modern military unit into
various combat scenarios, has sold in excess of 150,000 retail units worldwide
since its release in January 1997. M.A.X. includes both real-time and turn-
based strategy elements. The Company is currently developing M.A.X. 2, which
will include three gameplay modes including real-time gameplay, simultaneous
turn-based gameplay and classic turn-based gameplay.
The Caesars Palace VIP Series. The Company is internally developing a series
of simulated gambling products based on its license to use the Caesars Palace
brand. The Company is releasing Caesars Palace VIP Series, which includes
individual products for blackjack, craps and video poker and will include a
slot machine product currently under development, each of which include casino
sound effects, official tutorials and authenticated odds. In 1997 the Company
released Caesars Palace for the PC and PlayStation.
VR SPORTS--SPORTS TITLES
VR Baseball. Developed internally by the Company, VR Baseball '97 is
licensed by the Major League Baseball Players Association and Major League
Baseball Properties, Inc. and delivers real-time, 360(degrees), 3D
professional baseball that allows players to view and play from any angle or
position. VR Baseball '97 has sold more than 100,000 retail units worldwide
since its release in March 1997. The Company recently released the PlayStation
version of VR Baseball '99, and is currently developing the PC version of such
title, which incorporates the advanced proprietary human motion and depth
perception technology developed by Shiny.
Virtual Pool. Developed by Celeris, Virtual Pool, the Company's first sports
title, is a realistic billiards simulation that has sold more than 250,000
retail units worldwide and has won a number of awards, including
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<PAGE>
Best Simulation of 1995 from the Academy of Interactive Arts & Sciences, Best
Sports Game of 1995 from PC Gamer magazine and Best VR Game of 1995 from
Computer Player magazine. The Company has also published Celeris' Virtual
Snooker and Virtual Pool 2 titles.
VR Sports Powerboat Racing. Developed by East Point for the PC and
PlayStation, VR Sports Powerboat Racing allows the user to race powerboats on
up to eight different watertracks against computer opponents or up to eight
Internet or networked players. The player's perspective can be either from the
driver's seat or from behind the boat, and races can take place during the day
or at night.
SHINY
Shiny development teams have created games in the action/arcade and
adventure categories. Shiny titles include the following:
MDK. MDK, a futuristic 3D fighting game released in March 1997, was the
first title released by Shiny after its acquisition by Interplay in 1995 and
has sold in excess of 400,000 retail units worldwide. The game was published
by Shiny and Interplay internationally and by Playmates Interactive
Entertainment, Inc. in North America. The Company is currently developing a
sequel to MDK for which it will have worldwide distribution rights.
Messiah (under development). Messiah will be a surrealistic 3D action game
centered on the player's ability to invade the bodies of game characters and
take possession of their actions. The game includes advanced proprietary human
motion and depth perception technology that creates realistic skin texture and
movement. Though still under development, the game has received significant
market exposure, including an appearance on the cover of Next Generation
magazine.
PRODUCT DEVELOPMENT
The Company develops or acquires its products from a variety of sources,
including its five internal development divisions, Shiny, Interplay Europe and
publishing relationships with leading independent developers.
The Development Process. The Company develops original products both
internally, using its in-house development staff, and externally, using third
party software developers working under contract with the Company. Producers
on the Company's internal staff monitor the work of both inside and third
party development teams through design review, progress evaluation, milestone
review and quality assurance. In particular, each milestone submission is
thoroughly evaluated by the Company's product development staff to ensure
compliance with the product's design specifications. The Company enters into
consulting or development agreements with third party developers which are
generally on a flat-fee, work-for-hire basis or on a royalty basis, whereby
advances are paid based on the achievement of milestones. In royalty
arrangements, the Company ultimately pays continuation royalties to developers
once the Company's advances have been recouped. In addition, in certain cases,
the Company will utilize third party developers to port products to new
platforms.
The Company's products typically have short life cycles, and the Company
depends on the timely introduction of successful new products, including
enhancements of or sequels to existing products and conversions of previously
released products to additional platforms, to generate net revenues to fund
operations and to replace declining net revenues from existing products. The
development cycle of new products is difficult to predict, and involves a
number of risks. See "Risk Factors--Dependence on New Product Introductions;
Risk of Product Delays and Product Defects."
INTERNAL PRODUCT DEVELOPMENT
U.S. Product Development. The Company's U.S. internal product development
group (excluding Shiny's development group) presently consists of
approximately 250 people. Once a design is selected by the Company,
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<PAGE>
a production team, development schedule and budget are established. The
Company's internal development process includes initial design and concept
layout, computer graphic design, 2D and 3D artwork, programming, prototype
testing, sound engineering and quality control. The development process for an
original, internally developed product typically takes from 12 to 24 months,
and another six to 12 months for the porting of a product to a different
technology platform. The Company utilizes a variety of advanced hardware and
software development tools, including animation, sound compression utilities,
clay modeling and video compression for the production and development of its
interactive entertainment software titles. The Company recently restructured
its internal development organization into five divisions, each dedicated to
the production and development of products for a particular product category.
Within each division, development teams are assigned to a particular project.
These teams are generally led by a producer or associate producer and include
game designers, software programmers, artists, product managers and sound
technicians. The Company believes that this divisional approach promotes the
creative and entrepreneurial environment necessary to develop innovative and
successful titles. In addition, the Company believes that breaking down the
development function into divisions enables it to improve its software design
capabilities, to better manage its internal and external development processes
and to create and enhance its software development tools and techniques,
thereby enabling the Company to obtain greater efficiency and improved
predictability in the software development process.
Shiny. In 1995, in order to supplement its development capabilities and to
obtain innovative software development talent, particularly in the development
of software for video game consoles, the Company acquired a 91% interest in
Shiny. Prior to the acquisition, David Perry, Shiny's President and founder,
produced a number of highly successful interactive entertainment software
titles, including CoolSpot, Aladdin, Earthworm Jim and Earthworm Jim II. Shiny
recently completed MDK and currently has three original titles under
development including Wild 9 and Messiah, which will be distributed worldwide
by the Company under the Shiny label. Shiny's development group presently
consists of approximately 25 people.
International Development. The Company is building international development
resources through Interplay Europe, whose software producers manage the
efforts of local third party developers in European countries. Historically,
the Company's international product development efforts have consisted
primarily of the localization of existing Company products. The Company
currently has several original products, including Earthworm Jim 3D and Crime
Killer, under development through Interplay Europe. Interplay Europe's
development group presently consists of approximately 20 people.
EXTERNAL PRODUCT DEVELOPMENT
In order to expand its product offerings to include hit titles created by
third party developers, and to leverage its sales and distribution
capabilities, the Company enters into publishing arrangements with third party
developers, including foreign developers and publishers who wish to utilize
the Company's sales and distribution network in North America. In the eight
months ended December 31, 1997, and the former fiscal years ended April 30,
1997 and 1996, approximately 50%, 33% and 67%, respectively, of new products
released by the Company which the Company believes are or will become
franchise titles were developed by third party developers. In the three months
ended March 31, 1998, six of the Company's seven new products released were
developed by third party developers. The Company expects that the proportion
of its new products which are developed externally may vary significantly from
period to period as different products are released. The Company's focus in
obtaining publishing products is to select titles that combine advanced
technologies with creative game design. The publishing agreements usually
provide the Company with the exclusive right to distribute a product on a
worldwide basis (however, in certain instances the agreement provides for a
specified territory). The Company typically funds 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, the
Company's publishing arrangements typically provide the Company with ownership
of the trademarks relating to the product as well as exclusive rights to
sequels to the product. The Company manages the production of external
development projects by appointing a producer from one of its internal product
development divisions to oversee the product's development and work with the
third party developer to design, develop and test the game.
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The Company believes this strategy of cultivating relationships with talented
third party developers, such as the developers of Descent and TombRaider,
provides an excellent source of quality products, and a number of the
Company's commercially successful products have been developed under this
strategy. However, the Company's reliance on third party software developers
for the development of a significant number of its interactive software
entertainment products involves a number of risks. See "Risk Factors--
Dependence on Third Party Software Developers."
SALES AND DISTRIBUTION
The Company's sales and distribution efforts are designed to broaden product
distribution and to increase the penetration of the Company's products in
domestic and international markets. The Company supplements its direct
distribution efforts in North America with third party distributors and
affiliate label relationships. Over the past several years, the Company has
increased its sales and distribution efforts in international markets through
the formation of Interplay Europe and through licensing and third party
distribution strategies elsewhere. The Company also distributes its software
products through Interplay OEM in bundling transactions with hardware and
peripheral companies and through on-line services.
North America. In North America, the Company sells its products primarily to
mass merchants, warehouse club stores, large computer and software specialty
retail chains and through catalogs. A majority of the Company's North American
retail sales are to direct accounts, and a lesser percentage are to third
party distributors. The Company's principal direct retail accounts include
CompUSA, Best Buy, Electronics Boutique, Toys "R" Us, Wal-Mart and Kmart. The
Company's principal distributors in North America include GT Interactive,
Ingram Micro, Beam Scope and Merisel. The Company also distributes product
catalogs and related promotional material to end-users who can order products
by direct mail, by using a toll-free number, or by accessing the Company's web
site. See "Risk Factors--Dependence on Distribution Channels; Risk of Customer
Business Failures; Product Returns."
The Company sells to retailers and distributors through its North American
sales organization. The Company's North American sales force is largely
responsible for generating retail demand for the Company's products by
presenting new products to the Company's retail customers in advance of the
products' scheduled release dates, by providing technical advice with respect
to the Company's products and by working closely with retailers and
distributors to sell the Company's products. The Company typically ships its
products within a short period of time after acceptance of purchase orders
from distributors and other customers. Accordingly, the Company typically does
not have a material backlog of unfilled orders, and net sales in any quarter
are substantially dependent on orders booked in that quarter. Any significant
weakening in customer demand would therefore have a material adverse impact on
the Company's operating results and on the Company's ability to maintain
profitability. See "Risk Factors--Fluctuations in Operating Results;
Uncertainty of Future Results; Seasonality."
The Company seeks to extend the life cycle and financial return of many of
its products by marketing those products differently along the product's sales
life. Although the product life cycle for each title varies based on a number
of factors, including the quality of the title, the number and quality of
competing titles, and in certain instances seasonality, the Company typically
considers a title as "back catalog" six months after its initial release. The
Company utilizes marketing programs appropriate for the particular title,
which generally include progressive price reductions over time to increase the
product's longevity in the retail channel as the Company shifts its
advertising support to newer releases. The Company introduced its Signature
Series product line in 1996 to market its older titles in the under $15.00
price category.
The Company has acquired the right to distribute certain products on an
affiliate label basis whereby it distributes products that are produced and
published by a third party and are marketed under the third party's name with
the package bearing a notation that the product is being distributed by the
Company. The Company's focus in obtaining affiliate label products is to
select titles that complement the Company's product families. Products that
are distributed through the Company's affiliate label program are generally
purchased directly from the third party and sold based on a distribution mark-
up. These products generally have a lower gross margin than internally and
externally developed products.
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The Company provides terms of sale comparable to competitors in its
industry. In addition, the Company provides technical support in North America
for its products through its customer support department and a 90-day limited
warranty to end-users that its products will be free from manufacturing
defects. While to date the Company has not experienced any material warranty
claims, there can be no assurance that the Company will not experience
material warranty claims in the future. See "Risk Factors--Dependence on
Distribution Channels; Risk of Customer Business Failures; Product Returns."
International. The Company, through Interplay Europe, employs approximately
15 persons dedicated to sales to the European market. Interplay Europe
maintains relationships with distributors and retailers throughout the
continent. For example, Interplay Europe has entered into an agreement with
Infogrames U.K. and Virgin Interactive Entertainment Limited to pool resources
in order to distribute PC and video game console software to independent
software retailers in the United Kingdom, and has entered into distribution
agreements with Acclaim Entertainment pursuant to which Acclaim Entertainment
distributes certain of the Company's titles in selected European countries.
Net revenues from such distribution agreements with Acclaim Entertainment
represented 6.5%, 7.4%, 14.9% and 7.0% of the Company's net revenues in the
three months ended March 31, 1998, the eight months ended December 31, 1997
and the Company's former fiscal years ended April 30, 1997 and 1996,
respectively. In addition, Interplay Europe manages sales and distribution
efforts in Central and Eastern Europe, the Near East, the Middle East, and
Africa. The Company seeks to localize its products for the various
international markets and intends to release localized versions of many of its
products simultaneously with the commercial release of these titles in North
America.
The Company has built a distribution capability in certain of the developed
markets in Asia and the Americas utilizing third party distribution
arrangements for specified products and platforms. In 1995 the Company
established operations in Japan in order to expand its Japanese sales. In July
1997, the Company initiated a licensing strategy in Japan and terminated its
operations there. For example, the Company recently licensed a number of its
titles to Sony Computer Entertainment to publish in Japan on the PlayStation.
The Company has recently entered into an agreement with Electronic Arts Pty.
Ltd. pursuant to which Electronic Arts has the exclusive right to market and
distribute the Company's PC products in Australia and New Zealand, and an
agreement with Roadshow Entertainment Pty. Ltd., pursuant to which Roadshow
Entertainment Pty. Ltd. has the exclusive right to market and distribute the
Company's video game console products in those countries.
OEM. Interplay OEM employs approximately 20 people focused on the
distribution of interactive entertainment software in bundling transactions to
hardware and peripheral companies. Under these arrangements, one or more
software titles, which are typically limited feature versions of the retail
version of a game, are bundled with hardware or peripheral devices and are
sold by the OEM so that the purchaser of the hardware device obtains the
software on a discounted basis as part of the hardware purchase. In addition,
Interplay OEM has established a development capability in order to create
modified versions of titles which support its customers' technologies.
Although it is customary for OEM customers to pay the Company a lower per unit
price on sales through OEM bundling arrangements, such arrangements typically
involve a high unit volume commitment to the Company. OEM net revenues
generally are incremental net revenues and do not have significant additional
product development or sales and marketing costs, and accordingly have a more
significant impact on the Company's operating results. There can be no
assurance, however, that OEM sales will continue to generate consistent
profits for the Company, and a decrease in OEM sales or margins could have a
material adverse effect on the Company's business, operating results and
financial condition. In addition to distributing the Company's titles,
Interplay OEM serves as the exclusive OEM distributor for a number of
interactive entertainment software publishers, including LucasArts
Entertainment Company, Microprose (Spectrum Holobyte) and Sales Curve
Interactive Ltd. Interplay OEM's hardware customers include many of the
industry's largest computer and peripheral manufacturers including IBM,
Hewlett-Packard, Compaq, Apple Computer, NEC, Diamond Multimedia, Packard
Bell, Creative Labs and Rockwell. The Company currently devotes seven
employees to modifying existing Company products into suitable OEM products.
On-Line Services. The Company has entered into an agreement with Games On-
Line, Inc., doing business as Engage Games Online ("Engage"), an Internet/on-
line games and entertainment company, pursuant to which
41
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Engage modifies the Company's games to enable them to be offered as multi-
player games on on-line services, such as America Online, and through a number
of Internet access providers. Engage performs certain services which include
modifying the Company's games, managing the on-line game site and chat areas
and organizing activities and tournaments to promote the games. The agreement
obligates Engage to pay the Company royalty fees based upon the revenue
generated by the Company's games through subscriber fees, player use fees,
advertising revenue, bounty fees and transaction fees. See "Certain
Transactions--Engage Transactions."
The Company's North American and international distribution channels are
characterized by continuous change, including consolidation, financial
difficulties of certain distributors and retailers, and the emergence of new
distributors and new retailers such as warehouse chains, mass merchants and
computer superstores. The Company is exposed to the risk of product returns
and markdown allowances with respect to its distributors and retailers. The
Company allows distributors and retailers to return defective, shelf-worn and
damaged products in accordance with negotiated terms. The Company considers
return requests on a case-by-case basis, taking into consideration factors
such as the products involved, the customer's historical sales volume and the
customer's credit status. The Company also offers a 90-day limited warranty to
its end users that its products will be free from manufacturing defects. In
addition, the Company provides markdown allowances, which consist of credits
given to customers to lower the sales price of certain products in an effort
to increase sales to its customers to help manage its customers' inventory
levels in the distribution channel. Although the Company maintains a reserve
for returns and markdown allowances, and although the Company manages its
returns and markdown allowances through its authorization procedure, the
Company could be forced to accept substantial product returns and provide
markdown allowances to maintain its relationships with retailers and its
access to distribution channels. The Company's reserve for returns and
doubtful accounts was $14.5 million, $14.9 million and $9.1 million for the
eight months ended December 31, 1997 and the Company's former fiscal years
ended April 30, 1997 and 1996, respectively. Product returns and markdown
allowances that exceed the Company's reserves could have a material adverse
effect on the Company's business, operating results and financial condition.
See "Risk Factors--Dependence on Distribution Channels; Risk of Customer
Business Failures; Product Returns."
MARKETING
The Company's marketing department is organized into five product groups,
mirroring the Company's five product development groups, to promote a focused
marketing strategy and brand image for each product group. In addition, the
marketing department has three functional groups (public relations, creative
services and direct sales) that support the five product groups.
The Company's marketing department develops and implements marketing
programs and campaigns for each of the Company's titles and product groups.
The Company's 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. The Company
sends direct and electronic mail promotional materials to its large database
of gamers. The Company has also selectively used radio advertisements in
connection with the introduction of certain of its products. The Company
budgets a portion of each product's sales for cooperative advertising and
market development funds with retailers. Every title and brand is launched
with a multi-tiered marketing campaign that is developed on an individual
basis to promote product awareness and customer pre-orders. The Company
anticipates that over time, as the market for its products matures and
competition becomes more intense, it will become necessary to devote more
resources to marketing its products and the marketing costs for its products
will increase accordingly.
The Company uses on-line marketing primarily through the maintenance of
several web sites. These sites provide news and information of interest to its
customers through free demonstration versions, contests, games, tournaments
and promotions. Also, to generate interest in new product introductions, the
Company provides free demonstration versions of upcoming titles both through
magazine cover mounts and through game samples that consumers can download
from the Company's web site.
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<PAGE>
COMPETITION
The interactive entertainment software industry is intensely competitive and
is characterized by the frequent introduction of new hardware systems and
software products. The Company's competitors vary in size from small companies
to very large corporations with significantly greater financial, marketing and
product development resources than those of the Company. Due to these greater
resources, certain of the Company's 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 the
Company. The Company believes 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.
The Company competes primarily with other publishers of PC and video game
console interactive entertainment software. Significant competitors include
Electronic Arts, GT Interactive Software Corp., Cendant Corporation,
Activision, Inc., Microsoft Corporation, LucasArts Entertainment Company,
Midway Games Inc., Acclaim Entertainment Inc., Microprose (Spectrum Holobyte),
Virgin Interactive Entertainment, Inc. and Hasbro Inc. In addition, integrated
video game console hardware/software companies such as Sony Computer
Entertainment, Nintendo and Sega compete directly with the Company in the
development of software titles for their respective platforms. Large
diversified entertainment companies, such as The Walt Disney Company, many of
which own substantial libraries of available content and have substantially
greater financial resources than the Company, may decide to compete directly
with the Company or to enter into exclusive relationships with competitors of
the Company. The Company also believes that the overall growth in the use of
the Internet and on-line services by consumers may pose a competitive threat
if customers and potential customers spend less of their available home PC
time using interactive entertainment software and more on the Internet and on-
line services.
Retailers of the Company's products typically have a limited amount of shelf
space and promotional resources, and there is intense competition among
consumer software producers, and in particular interactive entertainment
software products, for high quality retail shelf space and promotional support
from retailers. To the extent that the number of consumer software products
and computer platforms increases, competition for shelf space may intensify
and may require the Company to increase its marketing expenditures. Due to
increased competition for limited shelf space, retailers and distributors are
in an increasingly better position to negotiate favorable terms of sale,
including price discounts, price protection, marketing and display fees and
product return policies. The Company's products constitute a relatively small
percentage of any retailer's sales volume, and there can be no assurance that
retailers will continue to purchase the Company's products or to provide the
Company's products with adequate levels of shelf space and promotional
support, and a prolonged failure in this regard may have a material adverse
effect on the Company's business, operating results and financial condition.
See "Risk Factors--Industry Competition; Competition for Shelf Space."
MANUFACTURING
The Company's PC-based products consist primarily of CD-ROMs, user manuals
and packaging. Substantially all of the Company's CD-ROM duplication is
performed by unaffiliated third parties. Printing of the user manual and
packaging, manufacturing of related materials and assembly of completed
packages are performed to the Company's specifications by unaffiliated third
parties. To date, the Company has not experienced any material difficulties or
delays in the manufacture and assembly of its CD-ROM-based products, and has
not experienced significant returns due to manufacturing defects.
Sony Computer Entertainment and Nintendo manufacture the Company's products
that are compatible with their respective video game consoles, as well as the
manuals and packaging for such products, and ship finished products to the
Company for distribution. PlayStation products consist of CD-ROMs and are
typically delivered by Sony Computer Entertainment within a relatively short
lead time. Manufacturers of Nintendo and other video game cartridges typically
deliver software to the Company within 45 to 60 days after receipt of a
purchase order. If the Company experiences unanticipated delays in the
delivery of manufactured software products, its net sales and operating
results could be materially adversely affected. Furthermore, the long
manufacturing cycle
43
<PAGE>
associated with video game cartridges requires that the Company forecast
retailer and consumer demands for its manufactured titles further in advance
of shipment than for PC-based products or PlayStation CD-ROMs. See "Risk
Factors--Dependence on Licenses from and Manufacturing by Hardware Companies."
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The Company holds copyrights on its products, product literature and
advertising and other materials, and holds trademark rights in the Company's
name, the Interplay logo, its "By Gamers. For Gamers.(TM)" slogan and certain
of its product names and publishing labels. The Company does not currently
hold any patents. The Company has licensed certain products to third parties
for distribution in particular geographic markets or for particular platforms,
and receives royalties on such licenses. The Company also outsources some of
its product development to third party developers, contractually retaining all
intellectual property rights related to such projects. The Company also
licenses certain products developed by third parties and pays royalties on
such products. See "--Product Development."
The Company regards its software as proprietary and relies primarily on a
combination of copyright, trademark and trade secret laws, employee and third
party nondisclosure agreements and other methods to protect its proprietary
rights. The Company owns or licenses various copyrights and trademarks. While
the Company provides "shrinkwrap" license agreements or limitations on use
with its software, the enforceability of such agreements or limitations is
uncertain. The Company is aware that unauthorized copying occurs within the
computer software industry, and if a significantly greater amount of
unauthorized copying of the Company's interactive entertainment software
products were to occur, the Company's operating results could be materially
adversely affected. While the Company does not copy protect its products, it
does not provide source code to third parties, unless they have signed
nondisclosure agreements with respect thereto.
The Company relies on existing copyright laws to prevent unauthorized
distribution of its software. Existing copyright laws afford only limited
protection. Policing unauthorized use of the Company's products is difficult,
and software piracy can be expected to be a persistent problem, especially in
certain international markets. Further, the laws of certain countries in which
the Company's products are or may be distributed either do not protect the
Company's products and intellectual property rights to the same extent as the
laws of the U.S. or are weakly enforced. Legal protection of the Company's
rights may be ineffective in such countries, and as the Company leverages its
software products using emerging technologies, such as the Internet and on-
line services, the ability of the Company to protect its 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 adequate protection to
the Company's products 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 the Company makes reasonable efforts
to ensure that its 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, the Company has received communication
from third parties asserting that features or content of certain of its
products may infringe upon the intellectual property rights of such parties.
There can be no assurance that existing or future infringement claims against
the Company will not result in costly litigation or require the Company to
license the intellectual property rights of third parties, either of which
could have a material adverse effect on the Company's business, operating
results and financial condition. See "Risk Factors--Protection of Proprietary
Rights."
EMPLOYEES
As of March 31, 1998, the Company had 501 full time employees, including 296
in product development, 120 in sales and marketing and 85 in finance, general
and administrative. This includes 33 full time employees
44
<PAGE>
of Shiny, 20 full time employees of Interplay OEM and 47 full time employees
of Interplay Europe. The Company also retains independent contractors to
provide certain services, primarily in connection with its product development
activities. The Company and its full time employees are not subject to any
collective bargaining agreements and the Company believes that its relations
with its employees are good.
From time to time the Company has retained actors and/or "voice over" talent
to perform in certain of the Company's products, and the Company expects to
continue this practice in the future. These performers are typically members
of the Screen Actors Guild ("SAG") or other performers' guilds, which guilds
have established collective bargaining agreements governing their members'
participation in interactive media projects. The Company or an affiliated
entity may be required to become subject to the jurisdiction of SAG's
collective bargaining agreement, or some other applicable performers guild,
with respect to the Company's development projects in the future in order to
engage the services of performers in the development of the Company's
products.
FACILITIES
The Company's headquarters are located in Irvine, California, where the
Company leases approximately 101,325 square feet of office space. This lease
expires in June 2006 and provides the Company with one five year option to
extend the term of the lease and expansion rights, on an "as available basis,"
to approximately double the size of the office space. Interplay Europe leases
approximately 10,000 square feet of space in Buckinghamshire, England. This
lease expires, at Interplay Europe's option, either in November 2000 or in
November 2005. Shiny leases approximately 4,100 square feet of space in Laguna
Beach, California, which lease expires in October 1998 and which provides
Shiny with an option to extend the term for an additional five years. The
Company believes that its facilities are adequate for its current needs and
that suitable additional or substitute space will be available in the future
to accommodate expansion of the Company's operations.
LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. As of the date
of this Prospectus, the Company is not a party to any legal proceedings, the
final outcome of which, in management's opinion, individually or in aggregate,
would have a material adverse effect on the Company's business, operating
results or financial condition.
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<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND CERTAIN SIGNIFICANT EMPLOYEES
The following table sets forth certain information regarding the Company's
directors and executive officers and certain significant employees, and their
ages as of March 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
Brian Fargo............. 35 Chairman of the Board of Directors and Chief Executive Officer
Christopher J. Kilpa-
trick.................. 41 President and Director
Richard S.F. Lehrberg... 50 Executive Vice President and Director
James C. Wilson......... 48 Chief Financial Officer
Steven "Chuck" Camps.... 38 Chief Operating Officer and Assistant Secretary
Phillip G. Adam......... 44 Vice President of Business Development
Kim Motika.............. 37 Vice President of Sales
Patricia J. Wright...... 37 Vice President of Development
Keven F. Baxter......... 38 Vice President of Corporate Affairs and General Counsel
Peter A. Bilotta........ 43 President of Interplay Productions Limited
Jill S. Goldworn........ 34 President of Interplay OEM, Inc.
David Perry............. 30 President of Shiny Entertainment, Inc.
David R. Dukes(1)(2).... 54 Director
Charles S. Paul(2)...... 48 Director
Mark Pinkerton(1)....... 37 Director
Paul A. Rioux(1)(2)..... 52 Director
</TABLE>
- --------
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
Brian Fargo, Chairman of the Company's Board of Directors, founded the
Company in 1983 and has served as the Company's chief executive officer since
that time. Prior to June 1995, Mr. Fargo also served as the Company's
President. Mr. Fargo also currently serves as a member of the Board of
Directors of the Interactive Digital Software Association.
Christopher J. Kilpatrick has served as President of the Company since June
1995, and served as Vice President and General Counsel of the Company from May
1994 to May 1995. From June 1990 to May 1994 Mr. Kilpatrick was a shareholder
and member of Stradling Yocca Carlson & Rauth, counsel to the Company, and was
a shareholder of such firm until September 1997. Mr. Kilpatrick currently
serves as a director of several privately-held companies, including Masimo
Corporation, a manufacturer of medical devices.
Richard S.F. Lehrberg joined the Company as Vice President in November 1991
and has served as Executive Vice President of the Company since October 1994.
Mr. Lehrberg served as a director of the Company since April 1989. Prior to
joining the Company, from December 1988 to November 1991, Mr. Lehrberg served
as President of Lehrberg Associates, an international licensing company. From
August 1982 to November 1988, Mr. Lehrberg was employed by Activision, Inc.,
an interactive entertainment software publisher, in various positions,
including Vice President and General Manager of the Entertainment Division.
James C. Wilson joined the Company in August 1997 and has served as Chief
Financial Officer of the Company since October 1997. Prior to joining the
Company, from January 1996 to August 1997, Mr. Wilson served as Chief
Financial Officer, Treasurer and Vice President of Administration of Cloud 9
Interactive Inc., a publisher and developer of educational and entertainment
multi-media products. Between October 1993 and December 1995, Mr. Wilson
served as Vice President--Finance and Chief Financial Officer of Applause
Enterprises Inc., a worldwide distributor of gifts and toys. Between February
1992 and October 1993, Mr. Wilson served as a Finance Executive for Sega of
America, a video game system manufacturer.
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Steven "Chuck" Camps joined the Company in February 1993 and has served as
Chief Operating Officer of the Company since June 1995 and as Assistant
Secretary since October 1994. Mr. Camps served as Chief Financial Officer of
the Company from February 1993 through October 1997. Mr. Camps served as a
consultant to the Company from October 1992 to February 1993. Prior to
consulting for the Company, Mr. Camps served as Chief Financial Officer of
Pratt Industries (USA), Inc., a manufacturing and finance company. Prior to
July 1987, Mr. Camps served as a Manager at Arthur Andersen & Co., a worldwide
accounting firm.
Phillip G. Adam joined the Company as Vice President of Sales and Marketing
in December 1990 and has served as Vice President of Business Development of
the Company since October 1994. Prior to joining the Company, from January
1984 to December 1990, Mr. Adam served as President of Spectrum Holobyte, an
interactive entertainment software publisher, where he was a co-founder. From
May 1990 to May 1996, Mr. Adam served as the Chairman or a member of the Board
of Directors of the Software Publishers Association and, during part of such
period, as President of the Software Publishers Association. From March 1997
to March 1998 Mr. Adam served as the Chairman of the Public Policy Committee
of the Interactive Digital Software Association.
Kim Motika joined the Company as National Sales Manager in November 1991,
and was promoted to Vice President of Sales of the Company in October 1994.
Prior to joining the Company, from May 1989 to October 1991, Ms. Motika served
as a Sales Manager for Ashton-Tate, a software publisher, and served as
Western Regional Vice President of Ingram Micro, a worldwide distributor of
information technology products, from 1983 to 1988.
Patricia J. Wright joined the Company as Vice President of Marketing of the
Company in October 1995 and has served as Vice President of Development since
June 1997. Prior to joining the Company, from April 1993 to October 1995, Ms.
Wright served as Vice President of Marketing for Activision, Inc. and as
Director of Marketing for the Barbie Products division of Mattel, Inc., a toy
manufacturer, from January 1990 to April 1993.
Keven F. Baxter joined the Company as Corporate Counsel in June 1995, was
promoted to General Counsel in June 1996 and has served as Vice President of
Corporate Affairs of the Company since October 1997. Prior to joining the
Company, from 1988 to 1994, Mr. Baxter practiced corporate law in the Business
and Technology Group of the law firm Brobeck, Phleger & Harrison.
Peter A. Bilotta has served as President of Interplay Europe since August
1994. Prior to joining the Company, from January 1992 to July 1994, Mr.
Bilotta served as Managing Director--Distributed Territories of Acclaim
Entertainment Ltd., an entertainment software publisher. Mr. Bilotta also
served as Managing Director and Chief Executive Officer of Arena Entertainment
Inc., an interactive entertainment software publisher, from March 1991 to
December 1991. Mr. Bilotta serves as a director of Interactive Media, Ltd., a
privately-held interactive entertainment software developer, and Bizarre Love
Triangle, a privately-held interactive entertainment software distributor.
Jill S. Goldworn has served as President of Interplay OEM, Inc., the
Company's OEM subsidiary, since December 1996. Prior to that, Ms. Goldworn
served as Vice President, OEM and Merchandising of the Company since June
1995. Prior to that, Ms. Goldworn served as Director of the OEM division of
the Company from September 1992 to June 1995. Prior to joining the Company,
from November 1991 to August 1992, Ms. Goldworn served as Director of Contract
Sales of PC Globe, Inc., a publisher of desktop geography software.
David Perry has served as President of Shiny Entertainment, Inc. since
October 1993. Mr. Perry founded Shiny, developer of Earthworm Jim, in October
1993. Prior to founding Shiny, from January 1991 to September 1993, Mr. Perry
served as a consulting engineer for Virgin Interactive Entertainment Inc., an
interactive entertainment software publisher.
David R. Dukes was elected to serve as a director of the Company in March
1998. From September 1989 until his retirement in May 1998, Mr. Dukes was
employed by Ingram Micro in various executive capacities,
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including Acting President of Ingram Micro Asia-Pacific from May 1997 to May
1998, Chief Executive Officer of Ingram Alliance from January 1994 to May
1998, President of Ingram Micro from September 1989 to December 1991 and Chief
Operating Officer of Ingram Micro from September 1989 to December 1993.
Mr. Dukes currently serves as Vice Chairman of the Board of Directors of
Ingram Micro.
Charles S. Paul has served as a director of the Company since October 1994.
Mr. Paul served as a member of the Compensation Committee from October 1994 to
December 1995. Since March 1995, Mr. Paul has been employed by Sega GameWorks,
a location-based entertainment company, and has served as the Chairman and
Chief Executive Officer of Sega GameWorks L.L.C., a location-based
entertainment software company, since March 1996. Mr. Paul previously served
as Executive Vice President of Universal from December 1986 to March 1995.
Mr. Paul is a director of National Golf Properties, Inc. and Entertainment
Properties Trust, both real estate investment trusts.
Mark Pinkerton has served as a director of the Company since March 1998. Mr.
Pinkerton has served as a Senior Manager of Corporate Development and
Strategic Planning for Universal since July 1996. From February 1995 to June
1996, Mr. Pinkerton was an independent consultant. Mr. Pinkerton was a Vice
President in the Mergers and Acquisitions Department of the Investment Banking
Division of Lehman Brothers Inc., an investment banking and stock brokerage
firm, from August 1991 to January 1995.
Paul A. Rioux has served as a director of the Company since July 1996. Mr.
Rioux has served as President of Universal Studios New Media, Inc., a
subsidiary of Universal, since April 1996. Previously, from November 1989 to
April 1996, Mr. Rioux served as Executive Vice President of Sega of America.
All members of the Board of Directors hold office until the next annual
meeting of stockholders or until their successors are elected and qualified.
The Bylaws do not permit removal of directors except for cause, unless
approved by a two-thirds vote of the Company's stockholders. Officers serve at
the discretion of the Board of Directors. Messrs. Pinkerton and Rioux were
appointed as directors by Universal pursuant to its rights under the
Shareholders' Agreement. See "Certain Transactions--Transactions With Fargo
and Universal."
BOARD COMMITTEES
The Company has two standing committees of the Board of Directors: an Audit
Committee and a Compensation Committee. The Audit Committee reviews the
functions of the Company's management and independent auditors pertaining to
the Company's financial statements and performs such other related duties and
functions as are deemed appropriate by the Audit Committee and the Board of
Directors. The Compensation Committee determines officer and director
compensation and administers the Company's benefit plans.
DIRECTOR COMPENSATION
The Company's directors currently do not receive cash or equity compensation
for attendance at Board of Directors or committee meetings. However, in the
future, non-employee directors may receive compensation for attendance and may
be reimbursed for certain expenses in connection with attendance at board and
committee meetings.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.
The Compensation Committee currently consists of Messrs. Dukes, Paul and
Rioux. No member of the Compensation Committee or executive officer of the
Company has a relationship that would constitute an interlocking relationship
with executive officers and directors of another entity. During 1997,
decisions regarding executive compensation were made by the Compensation
Committee of the Board of Directors, which then consisted of Messrs. Fargo,
Kilpatrick and Rioux. Messrs. Fargo and Kilpatrick are directors, officers and
employees of the Company. Mr. Rioux is an officer of Universal Studios New
Media, Inc., a subsidiary of Universal, which has entered into various
transactions with the Company. See "Certain Transactions--Transactions with
Fargo and Universal."
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<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
earned during the twelve months ended December 31, 1997 by the Company's Chief
Executive Officer, each of the two other most highly compensated executive
officers of the Company whose total salary and bonus during such year exceeded
$100,000 (collectively, the "Named Executive Officers") and a selected
executive officer.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
----------------------- ---------------------
SECURITIES
NAME AND PRINCIPAL POSITION SALARY BONUS OTHER(1) UNDERLYING OPTIONS(#)
- --------------------------- -------- ----- -------- ---------------------
<S> <C> <C> <C> <C>
Brian Fargo....................... $237,500 $ -- $ -- --
Chief Executive Officer
Christopher J. Kilpatrick......... 200,000 -- 4,750 20,000
President
Richard S.F. Lehrberg............. 200,000 -- 4,792 --
Executive Vice President
James C. Wilson................... (2) (2) (2) 50,000
Chief Financial Officer
</TABLE>
- --------
(1) Consists of matching payments made under the Company's 401(k) plan. See
"Employee Benefit Plans--401(k) Plan."
(2) Mr. Wilson joined the Company in August 1997 at an annual base salary of
$135,000. Although not a Named Executive Officer for the year ended
December 31, 1997, the Company anticipates that he will so qualify in
future years.
OPTION MATTERS
Option Grants. The following table sets forth certain information concerning
stock options granted to the Named Executive Officers and a selected executive
officer during the twelve months ended December 31, 1997.
STOCK OPTION GRANTS DURING TWELVE MONTHS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
NUMBER OF PERCENT OF TOTAL STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM ($)(4)
OPTIONS EMPLOYEES IN PRICE EXPIRATION ---------------------
NAME GRANTED(1) FISCAL YEAR ($/SH)(2) DATE(3) 5% 10%
- ---- ---------- ---------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Christopher J.
Kilpatrick(5).......... 20,000 5.7% $8.00 07/17/07 $100,623 $254,999
James C. Wilson......... 50,000 14.3 8.00 07/17/07 251,558 637,497
</TABLE>
- --------
(1) Represents options granted pursuant to the Company's 1997 Plan. All such
options were granted at an exercise price equal to the fair market value
of the Common Stock on the date of grant. All such options vest at the
rate of 20% per year.
(2) Subsequent to December 31, 1997, the Compensation Committee repriced all
options granted at an exercise price of greater than $8.00 which were held
by current employees of the Company or its wholly owned subsidiaries,
including the options listed above, to an exercise price of $8.00.
(3) Options granted to such individuals pursuant to the 1997 Plan expire 10
years from the date of grant.
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<PAGE>
(4) Represents amounts that may be realized upon exercise of the options
immediately prior to expiration of their terms assuming appreciation of 5%
and 10% over the option term. The 5% and 10% numbers are calculated based
on rules required by the Securities and Exchange Commission (the "
Commission") and do not reflect the Company's estimate of future stock
price growth. The actual value realized may be greater or less than the
potential realizable value set forth.
(5) Pursuant to the terms of his employment contract, Mr. Kilpatrick's options
granted prior to December 31, 1997 will be fully vested as of the closing
of the Offering. See "Management--Employment Agreements."
Recent Option Grants. In February 1998, the Company granted options to
purchase an aggregate of 240,100 shares of Common Stock to certain officers
and other employees of the Company, including Brian Fargo (150,000 shares) and
Christopher J. Kilpatrick (20,000 shares). The options granted to Messrs.
Fargo and Kilpatrick have an exercise price of $8.00 per share and vest over a
period of five years from the date of grant.
Option Exercises and Year-End Option Values. Shown below is information
relating to the exercise of stock options during the twelve months ended
December 31, 1997 for each of the Named Executive Officers and a selected
executive officer, and the year-end value of unexercised options.
AGGREGATE OPTION EXERCISES AND 1997 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN-THE-
UNEXERCISED OPTIONS MONEY OPTIONS AT
AT YEAR-END YEAR-END(1)
SHARES ACQUIRED (EXERCISABLE/ (EXERCISABLE/
NAME ON EXERCISE VALUE REALIZED UNEXERCISABLE) UNEXERCISABLE)
- ---- --------------- -------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Brian Fargo............. -- -- 0/ 0 --
Richard S.F. Lehrberg... -- -- 572,874/ 0 $3,063,157/ $ 0
Christopher J.
Kilpatrick............. -- -- 251,528/ 0 496,299/ 0
James C. Wilson......... -- -- 0/ 50,000 0/ 0
</TABLE>
- --------
(1) Represents an amount equal to the difference between the assumed initial
public offering price of $5.50 per share and the option exercise price,
multiplied by the number of unexercised in-the-money options.
EMPLOYEE BENEFIT PLANS
Stock Incentive Plans. The Company has granted options under three stock
option plans. The Interplay Productions Incentive Stock Option, Nonqualified
Stock Option and Restricted Stock Purchase Plan--1991 (the "1991 Plan") was
adopted by the Board of Directors and stockholders of the Company in March
1992, the Interplay Productions 1994 Incentive Stock Option and Nonqualified
Stock Option Plan (the "1994 Plan") was adopted by the Board of Directors and
stockholders of the Company in March 1994 and the Interplay Productions 1997
Stock Incentive Plan (the "1997 Plan" and, together with the 1991 Plan and the
1994 Plan, the "Plans") was adopted by the Board of Directors and stockholders
of the Company in January 1997. The Plans have been amended from time to time.
The 1991 Plan and the 1994 Plan were terminated by the Board of Directors for
purposes of future grants in March 1998.
The Company believes that its equity compensation program is an important
element of the overall compensation package which it can offer to attract and
retain employees and that it represents a competitive advantage over certain
competitors. The Company anticipates that it will be necessary in the future
to grant options to attract key personnel, to retain its existing employees
and, where appropriate, as part of strategic acquisition opportunities. See
"Risk Factors--Dilution."
The Plans are administered by the Board of Directors, unless the Board of
Directors delegates such authority to a committee composed of members of the
Board of Directors (hereinafter referred to collectively as the "Board").
Subject to certain limitations set forth in the Plans, the Board has the
authority (i) to select the persons to whom rights under the Plans (the
"Awards") will be granted, (ii) to determine whether an Award will be an
50
<PAGE>
incentive stock option within the meaning of Section 422 of the Internal
Revenue Code (an "ISO"), an option that does not qualify as an ISO (a
"Nonqualified Stock Option," and together with ISOs, the "Options"), a right
to purchase restricted stock (a "Right to Purchase") under either the 1991
Plan or the 1997 Plan, or a combination of the foregoing, and (iii) to specify
the type of consideration to be paid to the Company upon the exercise of an
Award. All employees, directors, consultants, advisors or other independent
contractors of the Company or of any present or future parent or subsidiary
corporation of the Company are eligible to participate in the Plans. Any
eligible person may be granted a Nonqualified Stock Option or a Right to
Purchase under either the 1991 Plan or the 1997 Plan, but only employees may
be granted ISOs under the Plans.
As of March 31, 1998, an aggregate of 898,425, 639,984 and 2,219,891 shares
of the Company's Common Stock were authorized pursuant to the 1991 Plan, 1994
Plan and the 1997 Plan, respectively, of which, 302,198, 638,784, and 539,350
shares, respectively, were subject to currently outstanding Options. The 1991
Plan and 1994 Plan were terminated for purposes of future grants in March
1998. As of March 31, 1998, an aggregate of 1,680,541 shares of Common Stock
were available for grant under the 1997 Plan. No shares of the Company's
Common Stock have been issued pursuant to Rights to Purchase under any of the
Plans. In addition, 572,874 shares are subject to non-statutory options
granted outside the Company's stock option plans. To the extent any
outstanding Award expires or terminates prior to exercise in full or if shares
issued upon exercise of an Award are repurchased by the Company, the
unexercised portion of such Award or the repurchased shares are returned to
the pool of shares reserved under the 1997 Plan and will thereafter be
available for grant or offer under the 1997 Plan.
The exercise price per share of an ISO under the 1997 Plan must equal at
least the fair market value of a share of the Company's Common Stock on the
date of grant. However, the exercise price per share of any ISO granted to a
person who at the time of grant owns stock possessing more than ten percent of
the total combined voting power of all classes of stock of the Company or any
parent or subsidiary corporation of the Company must be at least 110% of the
fair market value of a share of the Company's Common Stock on the date of
grant. The exercise price per share of Nonqualified Stock Options granted
under the 1997 Plan must be at least 85% of the fair market value of a share
of the Company's Common Stock on the date of grant. In no event shall any
person receive options or Rights to Purchase under the 1997 Plan in any one
calendar year pursuant to which the aggregate number of shares of Common Stock
that may be acquired thereunder exceeds 500,000 shares.
Employee Stock Purchase Plan. The Company's Employee Stock Purchase Plan
(the "Purchase Plan"), covering an aggregate of 200,000 shares of Common
Stock, was adopted by the Board of Directors and approved by the Company's
stockholders in March 1998. The Purchase Plan, which is intended to qualify as
an "employee stock purchase plan" under Section 423 of the Internal Revenue
Code of 1986, as amended (the "Code"), will be implemented by twelve-month
offerings with purchases occurring at six-month intervals commencing on the
date of this Prospectus. The Purchase Plan will be administered by the Board
of Directors. The Purchase Plan permits eligible employees to purchase Common
Stock through payroll deductions, which may not exceed 15% of an employee's
compensation. The price of stock purchased under the Purchase Plan will be 85%
of the lower of the fair market value of the Common Stock at the beginning of
the offering period or on the applicable purchase date.
401(k) Plan. The Company maintains a defined contribution retirement plan
with a cash or deferred arrangement as described in Section 401(k) of the Code
(the "401(k) Plan"). The 401(k) Plan is intended to be qualified under Section
401(a) of the Code. All employees of the Company are eligible to participate
in the 401(k) Plan on the first day of the plan year or the first day of the
seventh month of the plan year, whichever first occurs, following completion
of one year of service with the Company. The 401(k) Plan provides that each
participant may make elective contributions up to 15% of his or her
compensation, subject to statutory limits. The Company also provides a 50%
matching contribution, up to six percent of an employee's compensation,
subject to statutory limits. Under the terms of the 401(k) Plan, allocation of
the matching contribution is integrated with Social Security, in accordance
with applicable non-discrimination rules under the Code.
51
<PAGE>
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Brian Fargo for a
term of five years commencing March 1994, pursuant to which he currently
serves as Chairman of the Board of Directors and Chief Executive Officer of
the Company. The employment agreement provides for a base salary of $250,000
per year, with such annual raises as may be approved by the Board of
Directors, plus annual bonuses at the discretion of the Board of Directors. In
the event that Mr. Fargo is terminated without cause or resigns for good
reason as set forth in the agreement, the Company is required to pay Mr. Fargo
150% of his base salary and 75% of his imputed annual bonuses for the
remainder of the term of the agreement, which payments are contingent upon Mr.
Fargo's non-competition with the Company, as defined in the agreement. Mr.
Fargo is also entitled to participate in the incentive compensation and other
employee benefit plans established by the Company from time to time.
The Company has entered into an employment agreement with Christopher J.
Kilpatrick for a term of five years commencing May 1994, pursuant to which he
currently serves as President of the Company. The employment agreement
provides for a base salary of $157,200 per year, with annual raises determined
by the Board of Directors of not less than ten percent per year, plus annual
bonuses at the discretion of the Board of Directors. In the event Mr.
Kilpatrick is terminated by the Company at any time for any reason, or in the
event Mr. Kilpatrick terminates his employment on or before November 14, 1998
for good reason as defined in the agreement, or after November 14, 1998 for
any reason, the Company is required to pay Mr. Kilpatrick 150% of his base
salary and 75% of his imputed annual bonuses for 12 months following such
termination, which payments are contingent upon Mr. Kilpatrick's non-
competition with the Company, as set forth in the agreement. In addition, in
the event Mr. Kilpatrick is terminated without cause or resigns for good
reason as defined in the agreement, all stock options held by Mr. Kilpatrick
will vest to the extent they would have vested through the end of the term of
the agreement. In June 1995, following a change in control of the Company as
defined in the agreement, all of the stock options then held by Mr. Kilpatrick
automatically vested. Upon the closing of the Offering, the options granted
Mr. Kilpatrick in 1997 will automatically vest. Mr. Kilpatrick is also
entitled to participate in the incentive compensation and other employee
benefit plans established by the Company from time to time.
The Company has entered into an employment agreement with Richard S.F.
Lehrberg for a term of five years commencing March 1994, pursuant to which he
currently serves as Executive Vice President of the Company. The employment
agreement provides for a base salary of $200,000 per year, with annual raises
as approved by the Board of Directors. Mr. Lehrberg is also entitled to an
annual bonus based on the achievement of goals and objectives agreed upon by
the Board of Directors and Mr. Lehrberg, up to a maximum of $134,000 per year.
In 1994 and 1995, Mr. Lehrberg agreed to defer the receipt of bonuses in the
amounts of $120,000 and $34,000, respectively, payable under the agreement,
and such accrued bonuses will be paid following the closing of the Offering.
In the event Mr. Lehrberg is terminated without cause or resigns for good
reason as set forth in the agreement, the Company is required to pay Mr.
Lehrberg 150% of his base salary and 75% of his imputed annual bonuses for the
remainder of the term of the agreement, which payments are contingent upon
Mr. Lehrberg's non-competition with the Company, as defined in the agreement.
Mr. Lehrberg is also entitled to participate in the incentive compensation and
other employee plans established by the Company from time to time.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Bylaws provide that the Company will indemnify its directors
and officers and may indemnify its employees and other agents to the fullest
extent permitted by the General Corporation Law of the State of Delaware (the
"DGCL"). The Company believes that indemnification under its Bylaws covers at
least negligence and gross negligence by indemnified parties, and permits the
Company to advance litigation expenses in the case of stockholder derivative
actions or other actions, against an undertaking by the indemnified party to
repay such advances if it is ultimately determined that the indemnified party
is not entitled to indemnification. Prior to the closing of the Offering, the
Company expects to have in place liability insurance for its officers and
directors.
52
<PAGE>
In addition, the Company's Certificate of Incorporation provides that,
pursuant to the DGCL, its directors shall not be liable for monetary damages
for breach of the directors' fiduciary duty to the Company and its
stockholders. This provision in the Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief
will remain available under the DGCL. In addition, each director will continue
to be subject to liability for breach of the director's duty of loyalty to the
Company, for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director and for payment of dividends or approval of
stock repurchases or redemptions that are unlawful under the DGCL. The
provision also does not affect a director's responsibilities under any other
law, such as the federal securities laws or state or federal environmental
laws.
The Company has entered into separate indemnification agreements with its
directors and officers. These agreements require the Company, among other
things, to indemnify them against liabilities that may arise by reason of
their status or service as directors or officers (other than liabilities
arising from actions not taken in good faith or in a manner the indemnitee
believed to be opposed to the best interests of the Company), and to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified. Insofar as indemnification for liabilities arising
under the Securities Act may be permitted to directors, officers or persons
controlling the Company pursuant to the foregoing provisions, the Company has
been informed that in the opinion of the Commission, such indemnification is
against public policy as expressed in the Securities Act and is therefore
unenforceable. The Company believes that its Certificate of Incorporation and
Bylaw provisions and indemnification agreements are necessary to attract and
retain qualified persons as directors and officers.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following sets forth certain information concerning the beneficial
ownership of the Company's outstanding Common Stock as of June 1, 1998 for (i)
each person (or group of affiliated persons) who is known by the Company to
own beneficially five percent or more of the Company's Common Stock, (ii) each
director of the Company, (iii) each of the Named Executive Officers, and (iv)
all directors and executive officers of the Company as a group.
<TABLE>
<CAPTION>
PERCENTAGE OF OUTSTANDING
SHARES OWNED
------------------------------
SHARES
BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1)(2) OFFERING OFFERING(3)
- ------------------------------------ ------------ ------------ --------------
<S> <C> <C> <C>
Universal Studios, Inc.(4)....... 5,408,216 49.4% 29.7%
Mark Pinkerton(5)
Paul A. Rioux(5)
100 Universal City Plaza
Universal City, CA 91608
Brian Fargo(6)................... 4,922,897 44.9 30.4
16815 Von Karman Avenue
Irvine, CA 92606
Christopher J. Kilpatrick(7)..... 251,628 2.2 1.5
Richard S. F. Lehrberg(8)........ 512,057 4.5 3.1
James C. Wilson.................. -- -- --
Charles S. Paul.................. -- -- --
David R. Dukes................... -- -- --
All Directors and Executive Offi-
cers as a Group
(7 persons)(9).................. 11,094,798 94.7% 62.2%
</TABLE>
- --------
(1) Beneficial ownership is determined in accordance with the rules of the
Commission 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 June 1, 1998, 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.
(2) Excludes shares which will be issued to such persons upon the closing of
the Offering pursuant to the conversion of Subordinated Secured Promissory
Notes and Common Stock Warrants held by such persons at an exercise price
of $3.85 per share (based on the initial public offering price of $5.50
per share), as follows: Brian Fargo (519,481 shares), Christopher J.
Kilpatrick (25,974 shares) and Richard S.F. Lehrberg (77,922 shares). See
"Description of Capital Stock--Common Stock Warrants." Also excludes
100,000 shares which Mr. Fargo has agreed to purchase in the Offering at
the initial public offering price.
(3) The percentages indicated reflect the issuance of 2,272,418 shares upon
the closing of the Offering pursuant to the exercise of Common Stock
Warrants by the cancellation of Subordinated Secured Promissory Notes at
an exercise price based on the initial public offering price of $5.50 per
share. See "Description of Capital Stock--Common Stock Warrants." The
percentage with respect to Mr. Fargo also reflects his purchase of 100,000
shares in the Offering.
(4) Universal has granted the Underwriters' 30-day option to purchase up to
750,000 shares to cover over-allotments, if any. If such option is
exercised in full, following the completion of the offering Universal will
beneficially own 4,658,216 shares, or 25.6%, of the Company's Common
Stock.
(5) Messrs. Pinkerton and Rioux, who are employees of Universal or its
subsidiaries and have been appointed as directors by Universal, disclaim
beneficial ownership of the shares held by Universal.
(6) Does not include 5,408,216 shares held by Universal, as to which Mr. Fargo
may be deemed to have beneficial ownership due to certain contractual
rights held by Mr. Fargo, as such rights terminate upon the closing of the
Offering. See "Certain Transactions--Transactions with Fargo and
Universal."
(7) Includes 251,528 shares subject to options exercisable within 60 days of
June 1, 1998.
(8) Includes 510,374 shares subject to options exercisable within 60 days of
June 1, 1998.
(9) Includes 761,902 shares subject to options exercisable within 60 days of
June 1, 1998.
54
<PAGE>
CERTAIN TRANSACTIONS
TRANSACTIONS WITH FARGO
In April 1991, Brian Fargo, the Chief Executive Officer and Chairman of the
Board of Directors of the Company, loaned $536,375 to the Company, evidenced
by a promissory note due April 30, 1996, which note was subsequently converted
into a demand note. The note provides that interest accrues at a rate of nine
percent per year with accrued interest paid on a semi-annual basis. As of
December 31, 1997, the loan balance was $16,107.
Prior to moving to its current business location in August 1996, the Company
occupied premises owned by Mr. Fargo consisting of approximately 22,792 square
feet located at 17922 Fitch Avenue, Irvine, California, pursuant to a Lease
Agreement, dated March 1, 1994, between the Company and Mr. Fargo, which had a
term extending through December 31, 2002 and provided for monthly rent of
$19,125, subject to increase in accordance with the Consumer Price Index. The
Company entered into a restated Lease Agreement with Mr. Fargo in October
1996. When the Company relocated to its present location in August 1996,
Interplay subleased such premises to Engage pursuant to a Sublease Agreement
dated October 1, 1996, and the Company concurrently executed an agreement with
Engage pursuant to which the Company subleased 5,000 square feet of
specialized audio facilities from Engage, on the same terms, until December
1997. In December 1997, Engage entered into a direct lease with the owner of
such property and all leases and subleases involving the Company were
terminated.
TRANSACTIONS WITH FARGO AND UNIVERSAL
The Company, Mr. Fargo and Universal entered into a Stock Purchase
Agreement, dated January 25, 1994, for the purchase of Common Stock. On March
30, 1994, pursuant to the Stock Purchase Agreement, Universal purchased
1,824,897 shares of Common Stock from the Company for a purchase price of $15
million and 1,216,598 shares of Common Stock from Mr. Fargo for a purchase
price of $10 million. Pursuant to the Stock Purchase Agreement, the Company,
Mr. Fargo and Universal entered into an Option Agreement, dated March 30,
1994, pursuant to which Mr. Fargo granted Universal an option to purchase
additional shares of Common Stock held by Mr. Fargo. Pursuant to such
Agreement, Universal purchased 1,216,598 additional shares of Common Stock
from Mr. Fargo at a price of $9.10 per share on April 25, 1995 and 1,150,123
additional shares of Common Stock at a price of $14.62 per share on April 26,
1996, such that Universal became a 35% owner of the Company as of April 25,
1995 and a 45% owner of the Company as of April 26, 1996. In order to acquire
sufficient shares of Common Stock for sale to Universal on each of the three
sale dates, Mr. Fargo acquired such number of shares as was required for sale
to Universal from existing shareholders of the Company in simultaneous
transactions. Pursuant to the Stock Purchase Agreement, the Company, Mr. Fargo
and Universal entered into a Shareholders' Agreement dated March 30, 1994, as
amended October 8, 1996 and in March 1998, which contains certain restrictions
on transfer of shares, rights of first refusal, voting provisions,
registration rights and certain restrictions on corporate actions. Only the
mutual rights of first refusal as between Universal and Mr. Fargo and the
registration rights of Universal and Mr. Fargo will survive the closing of the
Offering. See "Description of Capital Stock--Registration Rights." For his
services in connection with such transaction, Mr. Fargo was awarded a bonus of
$1.0 million by the Board of Directors on March 28, 1994. Mr. Fargo has agreed
to defer the payment of such bonus to a future date.
The Company has entered into three Merchandising License Agreements with
MCA/Universal Merchandising Inc., a subsidiary of Universal. Pursuant to an
agreement dated May 23, 1994, the Company has the exclusive right to use the
theme and characters of the Waterworld motion picture in software products for
specified platforms until July 31, 1998. Pursuant to an agreement dated May
23, 1994, the Company has the non-exclusive right to use the theme and
characters of the Casper motion picture in software products for specified
platforms for a period of three years following the release of such motion
picture. Pursuant to an agreement dated April 16, 1996, the Company has the
exclusive right to the theme and characters of the Flipper motion picture for
an interactive story book product on specified platforms until June 1, 2001.
Each of the agreements provide for the Company to pay specified advances
against royalties and for specified royalty
55
<PAGE>
guarantees. To date, the Company has paid a total of $0.5 million, $0.3
million and $30,000, respectively, in advances and royalty payments under such
agreements. In addition, pursuant to a letter agreement dated September 27,
1996, with Universal Interactive Studios, a subsidiary of Universal ("UIS"),
the Company has the exclusive distribution rights in North America for
PlayStation versions of Disruptor (the "Disruptor Agreement"), plus the
exclusive rights to manufacture, publish and distribute Disruptor on any video
game platform outside of North America. Currently, approximately $1.9 million
is due UIS pursuant to the Disruptor Agreement, of which $1.5 million will be
paid to UIS upon the closing of the Offering. On August 16, 1995, the Company
and UIS entered into an exclusive distribution agreement pursuant to which UIS
agreed to distribute the Company's interactive software products in Europe
through UIS's affiliate, MCA Home Video, Inc., which in turn distributes
through Cinema International Corporation ("CIC"). The distribution agreement
was subsequently terminated, and the Company and UIS/CIC are currently
negotiating a final accounting reconciliation to determine the amounts owed to
the Company. In December 1996 UIS, on behalf of CIC, paid $300,000 to the
Company as an interim payment pending the resolution of the final accounting
reconciliation. The Company issued a promissory note to UIS dated December 20,
1996 in the principal amount of $300,000 (the "Advance Note") evidencing the
interim payment made to the Company. The Advance Note is guaranteed by
Interplay Europe, does not bear interest and was payable on March 31, 1997. In
March 1998, the Company entered into an agreement with UIS whereby the Company
agreed to pay to UIS all net amounts owed to UIS under the Disruptor Agreement
and the Company and UIS agreed to work together to determine the final amount,
if any, due to Interplay to resolve such accounting dispute and to pay any
amounts found to be owing to the other party in connection therewith.
Mark Pinkerton and Paul A. Rioux, directors of the Company, are employees of
Universal or its subsidiaries.
ENGAGE TRANSACTIONS
In June 1995, the Company formed a subsidiary to divest Engage, which
formerly operated as a division of the Company. Pursuant to a Stock Purchase
Agreement dated June 30, 1995, the Company sold 10,000,000 shares of common
stock of Engage to Mr. Fargo for $237,000. In connection with such sale, the
Company and Mr. Fargo entered into an Option Agreement dated June 30, 1995,
granting the Company an option to repurchase all of such shares at an
aggregate exercise price of $337,000 at any time prior to June 30, 2005 (the
"Termination Date"). In conjunction with a financing agreement between Engage
and Mr. Fargo, the Option Agreement was amended in March 1998 to reduce the
shares subject to such option to 19% of the shares held by Mr. Fargo and to
reduce the exercise price to $250,000. In the event the Company elects not to
exercise its option to repurchase the shares, upon certain events Universal
has an option to purchase the shares at the same exercise price. If Universal
exercises its option to purchase the shares, the Company has an option to
purchase such shares from Universal at the $250,000 exercise price until the
Termination Date.
Prior to March 1996, the Company loaned Engage approximately $1.8 million to
fund the operations of Engage, which debt was evidenced by a convertible
demand promissory note dated March 29, 1996, bearing interest at the prime
rate plus two percent per annum. Approximately, $0.8 million of the principal
amount was repaid to the Company in a number of installments during 1996 and
1997. In connection with a secured debt financing in August 1997, the
remaining outstanding principal of approximately $1.0 million was converted
into a secured convertible promissory note due in August 1998, bearing
interest at a rate of eight percent per annum. As part of the August 1997
transaction, the Company loaned an additional $100,000 to Engage on the same
terms.
In March 1996, the Company entered into an agreement with Engage which,
among other things, provides that the Company will provide certain
administrative services to Engage, and grants Engage the exclusive right to
use certain of the Company's products in Internet-based on-line services.
Engage currently owes the Company approximately $300,000 in connection with
such agreement.
FINANCING TRANSACTIONS
In October 1996, the Company sold an aggregate of $2,400,000 in Subordinated
Secured Promissory Notes and Common Stock Warrants to Brian Fargo
($2,000,000), Richard S.F. Lehrberg ($300,000) and
56
<PAGE>
Christopher J. Kilpatrick ($100,000). The Secured Subordinated Promissory
Notes bear interest at a rate of 12% per annum. Messrs. Fargo, Lehrberg and
Kilpatrick elected to receive 11,688, 1,683 and 100 shares of Common Stock,
respectively, in lieu of the May 1997 interest payment due under the Secured
Subordinated Promissory Notes, at a price of $11.25 per share. In February
1998, the Company offered to amend the terms of such Notes and Warrants to
permit the exercise of the Warrants or the repayment of the Notes upon the
closing of this Offering whether or not this Offering constitutes a Qualified
Event (as defined in the Notes and Warrants). Messrs. Fargo, Lehrberg and
Kilpatrick have elected to exercise such Warrants for 519,481, 77,922 and
25,974 shares of Common Stock, respectively, by canceling such Notes effective
upon the closing of the Offering at an exercise price of $3.85 per share
(based upon the initial public offering price of $5.50 per share). See
"Description of Capital Stock--Common Stock Warrants."
OTHER TRANSACTIONS
In March 1998, the Company entered into Indemnification Agreements with all
of its directors and executive officers providing for indemnification of such
persons by the Company in certain circumstances. See "Management--Limitation
of Liability and Indemnification Matters."
David R. Dukes, a director of the Company, is an officer and director of
Ingram Micro, a customer of the Company. During the eight months ended
December 31, 1997 and the three months ended March 31, 1998, the Company
derived net revenues of $2.4 million and $1.3 million, respectively, from
sales to Ingram Micro. See "Business--Sales and Distribution."
Until September 1997, Christopher J. Kilpatrick, an officer and director of
the Company, was a shareholder of Stradling Yocca Carlson & Rauth, counsel to
the Company.
The Company has entered into Employment Agreements with certain executive
officers. See "Management--Employment Agreements."
57
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the completion of the Offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, $.001 par value,
and 5,000,000 shares of Preferred Stock, $.001 par value.
COMMON STOCK
As of March 31, 1998, there were 10,953,028 shares of Common Stock issued
and outstanding and held by 17 stockholders of record and 2,053,206 shares of
Common Stock reserved for issuance upon the exercise of stock options
outstanding under the Company's 1991 Plan, 1994 Plan, 1997 Plan and non-
statutory stock options granted outside the Company's plans. The outstanding
shares of Common Stock are fully paid and nonassessable. The Company's
Certificate of Incorporation provides that holders of Common Stock are
entitled to one vote for each share on all matters submitted to a vote of
stockholders, provided that, with respect to the election of directors,
stockholders shall be entitled to cumulate their votes whereby each
stockholder will have a number of votes equal to the number of shares held
multiplied by the number of directors to be elected. In addition, with respect
to the election of directors, certain preferential voting rights will exist
until the closing of the Offering. See "Certain Transactions--Transactions
with Fargo and Universal." The Certificate of Incorporation of the Company
provides that the authorized number of directors shall be between seven and
nine, with the exact number fixed at seven until changed by unanimous vote of
the Board of Directors.
Subject to the preference in dividend rights of any series of Preferred
Stock which the Company may issue in the future, the holders of Common Stock
are entitled to receive such cash dividends, if any, as may be declared by the
Board of Directors out of legally available funds. Upon liquidation,
dissolution or winding up of the Company, after payment of all debts and
liabilities and after payment of the liquidation preferences of any shares of
Preferred Stock then outstanding, the holders of the Common Stock will be
entitled to all assets that are legally available for distribution.
Other than the rights described above, the holders of Common Stock have no
preemptive subscription, redemption, sinking fund or conversion rights and
have equal rights and preferences. The rights and preferences of holders of
Common Stock will be subject to the rights of any series of Preferred Stock
which the Company may issue in the future.
PREFERRED STOCK
The Board of Directors has the authority, without further action by the
stockholders, to issue up to 5,000,000 shares of Preferred Stock, $.001 par
value, in one or more series and to fix the rights, preferences and privileges
thereof, including voting rights, terms of redemption, redemption prices,
liquidation preference and number of shares constituting any series or the
designation of such series. The rights of the holders of the Common Stock will
be subject to, and may be adversely affected by, the rights of the holders of
any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company,
thereby delaying, deferring or preventing a change in control of the Company.
Furthermore, such Preferred Stock may have other rights, including economic
rights senior to the Common Stock, and, as a result, the issuance thereof
could have a material adverse effect on the market value of the Common Stock.
The Company has no present plans to issue shares of Preferred Stock.
COMMON STOCK WARRANTS
In connection with its subordinated debt financing in October 1996 through
February 1997, the Company issued and sold certain Common Stock Warrants (the
"Warrants") to purchasers of its Subordinated Secured Promissory Notes (the
"Notes"), at a price equal to one percent of the purchaser's total investment
in the Notes and Warrants. The Company sold an aggregate of $14,803,000 of
such Notes and Warrants. The Warrants entitle the Warrant holder to purchase,
by surrender of such holder's Note, up to that number of shares of Common
Stock equal to the quotient determined by dividing the purchaser's aggregate
investment in the Notes and Warrants by the Exercise Price (as defined below),
rounded to the nearest whole number of shares. The
58
<PAGE>
"Exercise Price" per share of Common Stock under the Warrants is the product
of 0.70 multiplied by either of the following amounts, as applicable: (i) in
the event of a Qualified IPO (as defined in the Warrants), the initial public
offering price of Common Stock; or (ii) in the event of a Sales Transaction
(as defined in the Warrants), the fair market value per share of the Company's
Common Stock as established in such Sales Transaction or, if no such price is
established, as determined in good faith by the Board of Directors. In
February 1998, the Company offered to amend the terms of each holder's Note
and Warrant to permit such holder to exercise its Warrant upon the closing of
the Offering whether or not the Offering constitutes a Qualified IPO, and
offered each holder the option to either exercise its Warrant effective upon
the closing of the Offering or to have its Note repaid following the closing
of the Offering. Holders of an aggregate amount of $8,748,808 of the Notes and
Warrants elected to exercise their Warrants, and 2,272,418 shares of Common
Stock will be issued to such holders upon the closing of the Offering at an
exercise price of $3.85 per share (based on the initial public offering price
of $5.50). Holders of $5,993,650 in principal amount of the Notes elected to
have their Notes repaid out of the proceeds of the Offering. See "Use of
Proceeds."
REGISTRATION RIGHTS
The Shareholders' Agreement provides each of Universal and Brian Fargo with
certain registration rights with respect to their respective shares of the
Common Stock of the Company. Pursuant to the terms of the Shareholders'
Agreement, each of Universal and Mr. Fargo have four demand registrations,
whereby such party may require the Company to register not less than 1,000,000
shares of the Common Stock owned by such party, subject to certain conditions
and restrictions contained therein. Each of Universal and Mr. Fargo also have
unlimited piggyback registrations whereby they are entitled to be notified of
and participate in registrations of the Company's Common Stock initiated by
the Company or a third party, subject to certain conditions and restrictions.
The Company has also agreed to indemnify and hold harmless the stockholders
who are a party to the Shareholders' Agreement and the officers and directors
of Universal from any loss, claim or damage arising from such registrations
unless, and to the extent that, such loss, claim or damage arises out of or is
based upon an untrue statement, alleged untrue statement or omission or
alleged omission made in reliance upon and in conformity with written
information furnished by or on behalf of such party for use in the preparation
of the documents related to the registration.
The Company and the holders of the Warrants have entered into an Investors
Rights Agreement, as amended ("Investors Rights Agreement") which provides
such holders with certain registration rights with respect to the shares of
Common Stock issuable upon exercise of the Warrants. Pursuant to the terms of
the Investors Rights Agreement, the Warrant holders have one demand
registration, whereby the holders of a majority of the shares of Common Stock
issuable upon exercise of the Warrants may require the Company to register the
shares of Common Stock owned by such parties, subject to certain conditions
and restrictions. In addition, the Investors Rights Agreement provides the
Warrant holders certain piggyback registration and S-3 registration rights,
subject to certain conditions and restrictions. The Company has also agreed to
indemnify and hold harmless the stockholders who are a party to the Investors
Rights Agreement from any loss, claim or damage arising from such
registrations unless, and to the extent that, such loss, claim or damage
arises out of or is based upon an untrue statement, alleged untrue statement
or omission or alleged omission made in reliance upon and in conformity with
written information furnished by or on behalf of such party for use in the
preparation of the documents related to the registration.
DELAWARE ANTI-TAKEOVER LAW
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law (the "DGCL"). Section 203 provides, with certain
exceptions, that a Delaware corporation may not engage in certain business
combinations with a person or affiliate or associate of such person who is an
"interested stockholder" for a period of three years from the date such person
became an interested stockholder, unless: (i) the transaction resulting in the
acquiring person's becoming an interested stockholder, or the business
combination, is approved by the board of directors of the corporation before
the person becomes an interested stockholder, (ii) the interested stockholder
acquires 85% or more of the outstanding voting stock of the corporation in the
same
59
<PAGE>
transaction that makes it an interested stockholder, excluding (a) shares held
by directors who are also officers, or (b) shares held in certain employee
stock plans in which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered in a
tender or exchange offer, or (iii) on or after the date the person becomes an
interested stockholder, the business combination is approved by the
corporation's board of directors and by the holders of at least two-thirds of
the corporation's outstanding voting stock, at an annual or special meeting
(excluding shares held by the interested stockholder). Except as otherwise
specified in Section 203, an "interested stockholder" is defined as: (a) any
person that is the owner of 15% or more of the outstanding voting stock of the
corporation, (b) any person that is an affiliate or associate of the
corporation and was the owner of 15% or more of the outstanding voting stock
of the corporation at any time within the three-year period immediately prior
to the date on which it is sought to be determined whether such person is the
interested stockholder, or (c) the affiliates and associates of any such
person. By restricting the ability of the Company to engage in business
combinations with an interested person, the application of Section 203 to the
Company may provide a barrier to hostile or unwanted takeovers.
A "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to such interested stockholder. For purposes
of Section 203, an "interested" stockholder is a person who, together with
affiliates and associates, owns (or within three years prior, did own) 15% or
more of the corporation's voting stock.
CERTAIN PROVISIONS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
The Company's Certificate of Incorporation also provides that stockholder
action can be taken only at an annual or special meeting of stockholders and
may not be taken by written consent. The Bylaws provide that special meetings
of stockholders can be called only by the Chairman of the Board, the President
or the Board of Directors. Stockholders are not permitted to call a special
meeting or to require that the Board of Directors call a special meeting of
stockholders. Moreover, the business permitted to be conducted at any special
meeting of stockholders is limited to the business set forth in the notice for
the meeting. The Bylaws set forth an advance notice procedure with regard to
the nomination, other than by or at the direction of the Board of Directors,
of candidates for election as directors at any special meeting of stockholders
and with regard to business to be brought before an annual meeting of
stockholders of the Company, other than the election of directors. The Bylaws
do not permit removal of directors except for cause, unless approved by a two-
thirds vote of the Company's stockholders. See "Management--Directors,
Executive Officers and Certain Significant Employees."
The Company's Certificate of Incorporation limits the liability of directors
to the Company and its stockholders to the fullest extent permitted by the
DGCL. Specifically, under the DGCL, a director will not be personally liable
for monetary damages for breach of the director's fiduciary duty as a
director, except liability (i) for a breach of the director's duty of loyalty
to the Company or its stockholders, (ii) for acts or omissions by a director
not in good faith or which involve intentional misconduct or a knowing
violation of the law, (iii) for liability arising under Section 174 of the
DGCL (relating to the declaration of dividends and purchase or redemption of
shares in violation of the DGCL), or (iv) for any transaction from which the
director derived an improper personal benefit. The inclusion of this provision
in the Company's Certificate of Incorporation may have the effect of reducing
the likelihood of derivative litigation against Directors and may discourage
or deter stockholders or management from bringing a lawsuit against directors
for breach of their duty of care. This limitation on monetary liability does
not alter the duties of Directors, affect the availability of equitable
relief, or affect the availability of monetary relief predicated on claims
based on federal law, including the federal securities laws.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is U.S. Stock Transfer
Corporation, Glendale, California.
60
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the Offering, there has been no public market for the Common Stock.
Future sales of substantial amounts of Common Stock in the public market could
adversely affect prevailing market prices and adversely affect the Company's
ability to raise additional capital in the capital markets at a time and price
favorable to the Company.
Upon completion of the Offering, the Company will have 18,225,446 shares of
Common Stock outstanding, assuming no exercise of outstanding options. Of
these shares, the 5,000,000 shares sold in the Offering (5,750,000 shares
assuming the Underwriters' over-allotment option is exercised in full) will be
freely transferable without restriction or further registration under the
Securities Act, unless they are purchased by "affiliates" of the Company as
that term is used under the Securities Act. The remaining 13,225,446 shares
held by existing stockholders (12,475,446 shares assuming the Underwriters'
over-allotment option is exercised in full) will be "restricted securities" as
defined in Rule 144 ("Restricted Shares"). Restricted Shares may be sold in
the public market only if registered or if they qualify for an exemption from
registration under Rule 144, which is summarized below. Sales of Restricted
Shares in the public market, or the availability of such shares for sale,
could adversely affect the market price of the Common Stock.
All officers, directors, certain stockholders and certain option holders
have agreed with the Underwriters that they will not sell any Common Stock
owned by them for a period of 180 days after the effective date of the
Offering without the prior written consent of Piper Jaffray Inc. (the "180-Day
Lock-Up"). An aggregate of 7,781,868 shares of Common Stock (7,031,868 shares
assuming the Underwriters' over-allotment option is exercised in full) are
subject to the 180-Day Lock-Up. In addition, Brian Fargo, the Company's
Chairman and Chief Executive Officer, has agreed with the Underwriters that he
will not sell any of the 5,542,378 shares of Common Stock owned by him for a
period of one year after the effective date of the Offering without the prior
written consent of Piper Jaffray Inc. (the "Fargo Lock-Up"). Upon the
expiration of the 180-Day Lock-Up (or earlier upon the consent of Piper
Jaffray Inc.), 5,925,357 Restricted Shares (5,175,357 Restricted Shares
assuming the Underwriters' over-allotment option is exercised in full) will
become eligible for sale subject to the volume and other restrictions of Rule
144, and 1,856,511 Restricted Shares will be eligible for sale without
restriction under Rule 144(k). Upon the expiration of the Fargo Lock-Up, the
5,542,378 shares subject thereto will become eligible for sale subject to the
volume and other restrictions of Rule 144.
In general, under Rule 144, beginning 90 days after the effective date of
the Offering, any person (or persons whose shares are aggregated) who has
beneficially owned Restricted Shares for at least one year is entitled to
sell, within any three-month period, a number of shares that does not exceed
the greater of one percent of the then outstanding shares of the Company's
Common Stock (approximately 182,254 shares immediately after the Offering) or
the average weekly trading volume during the four calendar weeks preceding
such sale. Sales under Rule 144 are also subject to certain requirements as to
the manner of sale, notice and availability of current public information
about the Company. In addition, Restricted Shares which have been beneficially
owned for at least two years and which are held by non-affiliates may, under
Rule 144(k) be sold free of any restrictions under Rule 144.
The Company intends to file a registration statement on Form S-8 under the
Act to register shares of Common Stock reserved for issuance under its Plans,
thus permitting the resale by non-affiliates of shares issued under the plan
in the public market without restriction under the Securities Act. Such
registration statement will become effective immediately upon filing, which is
expected on or shortly after the closing of the Offering. As of March 31,
1998, options or rights to purchase 2,053,206 shares of Common Stock were
outstanding under the Company's Plans, of which 1,580,188 shares are subject
to the 180-Day Lock-Up and 150,000 shares are subject to the Fargo Lock-Up.
61
<PAGE>
UNDERWRITING
The Company and the Selling Stockholder have entered into a Purchase
Agreement (the "Purchase Agreement") with the underwriters listed in the table
below (the "Underwriters"), for whom Piper Jaffray Inc., Bear, Stearns & Co.
Inc., and UBS Securities LLC are acting as representatives (the
"Representatives"). Subject to the terms and conditions contained in the
Purchase Agreement, the Company has agreed to sell to the Underwriters, and
each of the Underwriters has severally agreed to purchase from the Company,
the aggregate number of shares of Common Stock set forth opposite their
respective names below:
<TABLE>
<CAPTION>
NAME OF UNDERWRITER NUMBER OF SHARES
------------------- ----------------
<S> <C>
Piper Jaffray Inc. ......................................... 1,280,000
Bear, Stearns & Co. Inc. ................................... 960,000
UBS Securities LLC.......................................... 960,000
BancAmerica Robertson Stephens.............................. 250,000
BT Alex. Brown Incorporated................................. 250,000
Cowen & Company............................................. 250,000
Deutsche Bank Securities Inc. .............................. 250,000
Hambrecht & Quist LLC....................................... 250,000
NationsBanc Montgomery Securities LLC....................... 250,000
J.C. Bradford & Co. ........................................ 100,000
Crowell, Weedon & Co. ...................................... 100,000
Wedbush Morgan Securities Inc. ............................. 100,000
---------
Total..................................................... 5,000,000
=========
</TABLE>
Subject to the terms and conditions of the Purchase Agreement, the
Underwriters have agreed to purchase all of the Common Stock being sold
pursuant to the Purchase Agreement, if any is purchased (excluding Common
Stock covered by the over-allotment option granted by the Selling Stockholder
to the Underwriters). In the event of a default by any Underwriter, the
Purchase Agreement provides that, in certain circumstances, purchase
commitments of nondefaulting Underwriters may be increased or the Purchase
Agreement may be terminated.
The Underwriters propose initially to offer the shares to the public at the
public offering price set forth on the cover page of this Prospectus. Brian
Fargo, the Company's Chairman and Chief Executive Officer, has agreed to
purchase 100,000 of the shares from the Underwriters at such price. The
Underwriters will not receive any underwriting discount with respect to the
purchase of such shares by Mr. Fargo. The Underwriters may allow a selling
concession not in excess of $0.20 per share to certain dealers. The
Underwriters may allow, and such dealers may reallow, a concession not in
excess of $0.10 per share to other dealers. After the Offering, the public
offering price and other selling terms may be changed by the Underwriters.
The Selling Stockholder has granted the Underwriters an option, exercisable
by the Representatives within 30 days after the date of the Purchase
Agreement, to purchase up to an additional 750,000 shares of Common Stock at
the same price per share to be paid by the Underwriters for the shares offered
hereby. The Underwriters may exercise such option solely for the purpose of
covering over-allotments incurred in the sale of shares of Common Stock
offered hereby. To the extent such option to purchase is exercised, each
Underwriter will become committed to purchase such additional shares of Common
Stock in the same proportion as set forth in the above table.
The Company and its directors, officers and certain stockholders (holding in
the aggregate 13,224,246 shares of Common Stock upon completion of the
Offering, or 12,474,246 shares if the Underwriters' over-allotment option is
exercised in full) have agreed to deliver to the Representatives prior to the
date of this Prospectus lock-up agreements under which they agree not to,
directly or indirectly, offer, pledge, sell, contract to sell, sell any option
or contract to purchase, purchase any option or contract to sell, grant any
option, right or warrant for the sale of, or otherwise dispose of or transfer
any shares of Common Stock or any securities exchangeable or exercisable for
or convertible into its Common Stock, whether now owned or hereafter acquired
or with respect
62
<PAGE>
to which the Company and any such director, officer or stockholder has or
hereafter acquires the power of disposition, or participate in any
registration statement under the Securities Act with respect to any of the
foregoing or enter into any swap or any other agreement or any transaction
that transfers, in whole or in part, directly or indirectly, the economic
consequence of ownership of the Common Stock for a period of 180 days after
the date of this Prospectus (one year in the case of Brian Fargo, the
Company's Chairman and Chief Executive Officer), without the prior written
consent of Piper Jaffray Inc. on behalf of the Underwriters. Piper Jaffray
Inc. may, at its sole discretion and at any time without notice, release all
or any portion of the shares subject to such lock-up agreements. See "Shares
Eligible for Future Sale."
In the Purchase Agreement, the Company, the Selling Stockholder and the
Underwriters have agreed to indemnify each other against certain liabilities,
including liabilities under the Securities Act, and to contribute to payments
the Underwriters may be required to make in respect thereof. The Company has
agreed to reimburse the Underwriters for their reasonable out of pocket
expenses incurred in connection with the Offering. The Company and Piper
Jaffray Inc. are parties to an agreement pursuant to which Piper Jaffray Inc.
has in the past performed and may in the future perform certain financial
advisory services to the Company, including advice with respect to mergers and
acquisitions.
The Representatives have informed the Company and the Selling Stockholder
that they do not intend to confirm sales to accounts over which they exercise
discretionary authority without the prior written approval of the customer.
Prior to the Offering there has been no public market for the Common Stock.
The initial public offering price was determined by negotiation between the
Company, the Selling Stockholder and the Representatives. Among the factors
considered in determining such public offering price were the nature of the
Company's business, its history and present state of development, recent
financial operating information, prospects and management abilities, the
general conditions of the securities markets at the time of the Offering and
other factors deemed relevant.
During and after the Offering, the Underwriters may purchase and sell Common
Stock in the open market. These transactions may include overallotment,
stabilizing transactions and purchases to cover syndicate short positions
created in connection with the Offering. The Underwriters also may impose a
penalty bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of the Common Stock sold in the Offering for their
account may be reclaimed by the syndicate if such securities are repurchased
by the syndicate in stabilizing or covering transactions. These activities may
stabilize, maintain or otherwise affect the market price of the Common Stock,
which may be higher than the price that might otherwise prevail in the open
market. These transactions may be effected on the Nasdaq National Market, in
the over-the-counter market or otherwise, and these activities, if commenced,
may be discontinued at any time.
63
<PAGE>
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Stradling Yocca Carlson & Rauth, a Professional Corporation,
Newport Beach, California. An investment partnership in which certain
shareholders of Stradling Yocca Carlson & Rauth are partners holds an
aggregate of $100,000 of the Company's Subordinated Secured Promissory Notes
and Common Stock Warrants, which will be converted into 25,974 shares of
Common Stock upon the closing of the Offering at an exercise price of $3.85
per share (based on an assumed initial public offering price of $5.50 per
share), and holds 523 shares of the Company's Common Stock. Certain legal
matters in connection with the Offering will be passed upon for the
Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California.
EXPERTS
The Consolidated Financial Statements and schedule of the Company as of
April 30, 1996 and 1997, and as of December 31, 1997, and for each of the
three years in the period ended April 30, 1997 and the eight months ended
December 31, 1997 included in this Prospectus and elsewhere in the
Registration Statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their reports with respect thereto, and
are included herein in reliance upon the authority of said firm as experts in
giving said reports.
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus, which constitutes a part of the Registration
Statement, does not contain all the information set forth in the Registration
Statement and the exhibits and schedules thereto. For further information with
respect to the Company and the Common Stock offered hereby, reference is made
to the Registration Statement and to the exhibits and schedules filed
therewith. A copy of the Registration Statement may be inspected without
charge at the public reference facilities of the Commission located at 450
Fifth Street, N.W., Washington, D.C. 20549, and at the regional offices of the
Commission located at 7 World Trade Center, Suite 1300, New York, New York
10048, and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of all or any part of the Registration Statement may be obtained at the
prescribed rates from the Public Reference Section of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549 and its public reference facilities
in New York, New York and Chicago, Illinois, upon the payment of the fees
prescribed by the Commission. The Registration Statement is also available
through the Commission's website on the world wide web at http://www.sec.gov.
Statements made in this Prospectus as to the contents of any contract,
agreement or other document referred to are not necessarily complete. With
respect to each such contract, agreement or other document filed as an exhibit
to the Registration Statement, reference is made to the exhibit for a more
complete description of the matter involved, and each such statement shall be
deemed qualified by such reference.
64
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants................................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statements of Operations...................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit).................. F-5
Consolidated Statements of Cash Flows...................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Interplay Entertainment Corp.:
We have audited the accompanying consolidated balance sheets of INTERPLAY
ENTERTAINMENT CORP. (a Delaware corporation) and subsidiaries as of April 30,
1996 and 1997 and December 31, 1997, and the related consolidated statements
of operations, stockholders' equity (deficit) and cash flows for each of the
three years in the period ended April 30, 1997 and the eight months ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
The Subordinated Secured Promissory Notes mature on November 30, 1998 and
give the holders the option, 30 days thereafter, to notify the Company in
writing that the Notes are due and payable. In addition, the Company's line of
credit matures in May 1999. For further discussion about the terms of these
borrowings and management's plan in connection with their repayment, see Notes
6 and 13.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interplay Entertainment
Corp. and subsidiaries as of April 30, 1996 and 1997 and December 31, 1997,
and the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the three years in the period ended April
30, 1997 and the eight months ended December 31, 1997 in conformity with
generally accepted accounting principles.
Arthur Andersen LLP
Orange County, California
March 20, 1998 (except for the first
paragraph of Note 8--Litigation and Note 13--
Reincorporation, for which the date is May 29,
1998)
F-2
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
APRIL 30,
---------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
------- -------- ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
------
Current Assets:
Cash and cash equivalents................... $ 4,923 $ 5,410 $ 1,536 $ 1,937
Trade receivables, net of allowances of
$9,100, $14,894, $14,461 and $11,394, re-
spectively................................. 22,983 22,346 34,684 38,233
Inventories................................. 5,896 7,404 6,338 6,065
Prepaid licenses and royalties.............. 14,483 10,914 12,628 12,382
Income taxes receivable..................... 1,425 1,601 1,427 --
Deferred income taxes....................... 323 7,889 7,792 7,522
Other....................................... 6,053 2,354 4,218 3,365
------- -------- -------- --------
Total current assets........................ 56,086 57,918 68,623 69,504
------- -------- -------- --------
Property and Equipment, net................... 7,838 8,117 7,026 6,746
------- -------- -------- --------
Other Assets.................................. 4,587 2,970 2,172 2,077
------- -------- -------- --------
$68,511 $ 69,005 $ 77,821 $ 78,327
======= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
- ----------------------------------------------
Current Liabilities:
Accounts payable............................ $16,945 $ 16,975 $ 17,121 $ 14,193
Accrued expenses............................ 15,549 21,100 22,549 22,231
Short term borrowings....................... 5,050 10,950 -- --
Current portion of long-term debt........... 57 123 14,767 14,825
Income taxes payable........................ -- 880 570 813
------- -------- -------- --------
Total current liabilities................. 37,601 50,028 55,007 52,062
------- -------- -------- --------
Long-Term Debt, net of current portion........ 51 14,847 23,387 23,855
------- -------- -------- --------
Deferred Income Taxes......................... 366 403 434 434
------- -------- -------- --------
Minority Interest............................. 298 326 260 307
------- -------- -------- --------
Commitments and Contingencies
Stockholders' Equity (Deficit):
Preferred stock, no par value--
Authorized--5,000,000 shares
Issued and outstanding--none............... -- -- -- --
Common stock, $.001 par value--
Authorized 50,000,000 shares
Issued and outstanding--10,829,781,
11,114,060, 10,951,828 and 10,953,028
shares, respectively....................... 11 11 11 11
Paid-in capital............................. 17,783 18,020 18,408 18,494
Retained earnings (accumulated deficit)..... 12,401 (14,818) (19,877) (17,028)
Cumulative translation adjustment........... -- 188 191 192
------- -------- -------- --------
Total stockholders' equity (deficit)...... 30,195 3,401 (1,267) 1,669
------- -------- -------- --------
$68,511 $ 69,005 $ 77,821 $ 78,327
======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
EIGHT MONTHS ENDED THREE MONTHS ENDED
YEARS ENDED APRIL 30, DECEMBER 31, MARCH 31,
---------------------------------- ----------------------- ------------------------
1995 1996 1997 1996 1997 1997 1998
---------- ---------- ---------- ----------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenues............ $ 79,546 $ 96,952 $ 83,262 $ 50,364 $ 85,961 $ 22,410 $ 40,996
Cost of goods sold...... 45,491 49,939 62,480 35,725 44,864 13,508 19,221
---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ 34,055 47,013 20,782 14,639 41,097 8,902 21,775
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating expenses:
Marketing and sales..... 14,280 23,285 24,627 15,747 20,603 7,280 8,589
General and
administrative......... 5,528 9,025 9,408 8,730 8,989 3,088 2,855
Product development..... 8,200 15,120 21,431 12,464 14,291 5,384 5,819
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total operating ex-
penses................. 28,008 47,430 55,466 36,941 43,883 15,752 17,263
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating income
(loss)................. 6,047 (417) (34,684) (22,302) (2,786) (6,850) 4,512
---------- ---------- ---------- ---------- ---------- ---------- ----------
Other income (expense):
Interest income......... 244 102 190 48 92 324 6
Interest expense........ (38) (531) (1,907) (1,088) (3,009) (663) (1,346)
Other................... 840 (378) 117 (45) 644 (36) (78)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total other income (ex-
pense)................. 1,046 (807) (1,600) (1,085) (2,273) (375) (1,418)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) before
provision (benefit) for
income taxes........... 7,093 (1,224) (36,284) (23,387) (5,059) (7,225) 3,094
Provision (benefit) for
income taxes........... 2,844 (480) (9,065) (5,918) -- (1,782) 245
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)....... $ 4,249 $ (744) $ (27,219) $ (17,469) $ (5,059) $ (5,443) $ 2,849
========== ========== ========== ========== ========== ========== ==========
Net income (loss) per
share:
Basic................... $ 0.40 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.26
========== ========== ========== ========== ========== ========== ==========
Diluted................. $ 0.35 $ (0.07) $ (2.46) $ (1.58) $ (0.45) $ (0.49) $ 0.23
========== ========== ========== ========== ========== ========== ==========
Weighted average number
of common shares
outstanding:
Basic................... 10,568,042 10,661,944 11,085,632 11,066,487 11,123,327 11,114,060 10,952,375
========== ========== ========== ========== ========== ========== ==========
Diluted................. 12,045,687 10,661,944 11,085,632 11,066,487 11,123,327 11,114,060 14,144,627
========== ========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK RETAINED CUMULATIVE
------------------ PAID-IN EARNINGS TRANSLATION
SHARES AMOUNT CAPITAL (DEFICIT) ADJUSTMENT TOTAL
---------- ------ ------- --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, April 30,
1994................... 10,565,136 $11 $16,146 $ 8,896 $-- $ 25,053
Exercise of stock op-
tions................ 176,763 -- 54 -- -- 54
Tax benefit from exer-
cise of stock op-
tions................ -- -- 620 -- -- 620
Compensation of stock
options granted...... -- -- 93 -- -- 93
Net income............ -- -- -- 4,249 -- 4,249
---------- --- ------- -------- ---- --------
Balance, April 30,
1995................... 10,741,899 11 16,913 13,145 -- 30,069
Exercise of stock op-
tions................ 177,104 -- 140 -- -- 140
Repurchase of common
stock................ (89,222) -- -- -- -- --
Tax benefit from exer-
cise of stock op-
tions................ -- -- 424 -- -- 424
Compensation for stock
options granted...... -- -- 306 -- -- 306
Net loss.............. -- -- -- (744) -- (744)
---------- --- ------- -------- ---- --------
Balance, April 30,
1996................... 10,829,781 11 17,783 12,401 -- 30,195
Exercise of stock op-
tions................ 313,403 -- 58 -- -- 58
Repurchase of common
stock................ (29,124) -- (275) -- -- (275)
Proceeds from war-
rants................ -- -- 148 -- -- 148
Compensation for stock
options granted...... -- -- 306 -- -- 306
Net loss.............. -- -- -- (27,219) -- (27,219)
Translation adjust-
ment................. -- -- -- -- 188 188
---------- --- ------- -------- ---- --------
Balance, April 30,
1997................... 11,114,060 11 18,020 (14,818) 188 3,401
Issuance of common
stock................ 16,362 -- 184 -- -- 184
Repurchase of common
stock................ (178,594) -- -- -- -- --
Compensation for stock
options granted...... -- -- 204 -- -- 204
Net loss.............. -- -- -- (5,059) -- (5,059)
Translation adjust-
ment................. -- -- -- -- 3 3
---------- --- ------- -------- ---- --------
Balance, December 31,
1997................... 10,951,828 11 18,408 (19,877) 191 (1,267)
Issuance of common
stock................ 1,200 -- 10 -- -- 10
Compensation for stock
options granted...... -- -- 76 -- -- 76
Net income............ -- -- -- 2,849 -- 2,849
Translation adjust-
ment................. -- -- -- -- 1 1
---------- --- ------- -------- ---- --------
Balance, March 31, 1998
(unaudited)............ 10,953,028 $11 $18,494 $(17,028) $192 $ 1,669
========== === ======= ======== ==== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
EIGHT MONTHS ENDED THREE MONTHS ENDED
YEARS ENDED APRIL 30, DECEMBER 31, MARCH 31,
-------------------------- -------------------- -----------------------
1995 1996 1997 1996 1997 1997 1998
------- ------- -------- ----------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net income (loss)..... $ 4,249 $ (744) $(27,219) $(17,469) $ (5,059) $(5,443) $ 2,849
Adjustments to
reconcile net income
(loss) to the cash
provided by (used in)
operating
activities--
Depreciation and
amortization......... 756 1,985 3,172 1,817 2,138 741 840
Gain on sale of
property and
equipment............ -- (21) -- -- -- -- --
Noncash expense for
stock options........ 93 306 306 204 204 76 76
Noncash interest
expense.............. -- -- -- -- 184 -- --
Write-off of non-
current assets....... -- 388 250 -- -- -- --
Deferred income
taxes................ 1,360 (335) (6,649) -- 128 -- 653
Minority interest in
earnings (loss) of
subsidiary........... -- 25 28 (4) (66) 23 44
Changes in assets and
liabilities:
Trade receivables.... (7,824) (3,229) 3,926 (1,823) (12,338) 3,641 (9,708)
Inventories.......... (1,343) (2,193) (1,508) (824) 1,066 (805) 273
Income taxes
receivable.......... -- (1,403) (176) -- 174 -- 1,427
Other current
assets.............. (1,364) (2,232) 5,732 2,713 (1,864) (258) (2,837)
Other assets......... (1,098) (467) 5,610 -- 543 -- --
Prepaid licenses and
royalties........... (6,897) (5,966) (4,102) (3,922) (1,714) 90 245
Accounts payable..... (328) 7,589 (1,999) (272) 146 (3,059) (2,927)
Accrued expenses..... 4,027 9,223 5,618 7,047 1,449 5,061 8,968
Income taxes
payable............. (347) (467) -- (5,919) (310) (1,807) (140)
------- ------- -------- -------- -------- ------- -------
Net cash provided by
(used in) operating
activities......... (8,716) 2,459 (17,011) (18,452) (15,319) (1,740) (237)
------- ------- -------- -------- -------- ------- -------
Cash flows from
investing activities:
Purchase of property
and equipment........ (3,323) (4,585) (3,451) (1,981) (792) (617) (296)
Proceeds from sales of
property and
equipment............ -- 14 -- -- -- -- --
Acquisition of
subsidiary, net of
cash acquired of
$119................. -- (3,196) -- -- -- -- --
Proceeds from sale of
investment in
affiliate............ -- 200 -- -- -- -- --
Proceeds from sale of
marketable
securities........... 15,012 69 -- -- -- -- --
------- ------- -------- -------- -------- ------- -------
Net cash provided by
(used in) investing
activities......... 11,689 (7,498) (3,451) (1,981) (792) (617) (296)
------- ------- -------- -------- -------- ------- -------
Cash flows from
financing activities:
Net borrowings on line
of credit............ -- 5,050 5,900 5,392 12,296 466 971
Issuances of
Subordinated Secured
Promissory Notes and
Warrants............. -- -- 14,803 13,230 -- 1,961 --
Borrowings (repay-
ments) on notes pay-
able................. (122) (117) (75) (34) (62) 31 (48)
Proceeds from exercise
of stock options..... 54 140 58 57 -- -- 10
Tax benefit from stock
option exercise...... 620 424 -- -- -- -- --
Other financing activ-
ities................ -- (11) -- -- -- -- --
------- ------- -------- -------- -------- ------- -------
Net cash provided by
financing
activities......... 552 5,486 20,686 18,645 12,234 2,458 933
------- ------- -------- -------- -------- ------- -------
Effect of exchange rate
changes on cash and
cash equivalents...... -- (58) 263 -- 3 -- 1
------- ------- -------- -------- -------- ------- -------
Net increase (decrease)
in cash and cash
equivalents........... 3,525 389 487 (1,788) (3,874) 101 401
Cash and cash
equivalents, beginning
of year............... 1,009 4,534 4,923 4,923 5,410 3,135 1,536
------- ------- -------- -------- -------- ------- -------
Cash and cash
equivalents, end of
year.................. $ 4,534 $ 4,923 $ 5,410 $ 3,135 $ 1,536 $ 3,236 $ 1,937
======= ======= ======== ======== ======== ======= =======
Supplemental cash flow
information:
Cash paid during the
year for:
Interest.............. $ 22 $ 480 $ 1,638 $ 822 $ 2,936 $ 563 $ 1,372
======= ======= ======== ======== ======== ======= =======
Income taxes.......... $ 1,318 $ 526 $ -- $ -- $ -- $ -- $ --
======= ======= ======== ======== ======== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS
ENDED MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. LINE OF BUSINESS
Interplay Entertainment Corp., a Delaware corporation, and its subsidiaries
(collectively with Interplay Productions, a California corporation, the
"Company"), develop, publish, and distribute interactive entertainment
software. In addition, the Company distributes certain titles to hardware or
peripheral device manufacturers for use in bundling arrangements. The
Company's software is developed for use on various interactive entertainment
software platforms, including personal computers and current generation video
game consoles, such as the PlayStation and Nintendo 64.
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 its 91 percent-owned subsidiary
Shiny Entertainment, Inc. All significant intercompany accounts and
transactions have been eliminated.
Change of Fiscal Year End
Effective May 1, 1997, the Company changed its fiscal year end from April 30
to December 31.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents and Noncash Activities
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents.
During the fiscal year ended April 30, 1997, in a noncash financing
transaction, the Company acquired 29,124 shares of common stock in exchange
for a $275 note payable.
Inventories
Inventories consist of CD-ROMs, video game console cartridges (cartridges),
manuals, packaging materials, supplies and packaged software ready for
shipment and are valued at the lower of cost (first-in, first-out) or market.
Prepaid Licenses and Royalties
Prepaid licenses and royalties consist of payments for intellectual property
rights, payments to celebrities and sports leagues and advanced royalty
payments to outside developers. In addition such costs include certain other
outside production costs generally consisting of film cost and amounts paid
for digitized motion data with alternative future uses. Payments to developers
represent contractual advanced payments made for future royalties. 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 sales over six months commencing with the initial shipment of
the title at a rate based upon the number
F-7
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
of units shipped. Management evaluates the 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 net product sales.
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 five year period. Leasehold improvements are amortized on a
straight line basis over the lesser of the estimated useful life or the
remaining lease term.
Other Non-current Assets
Other non-current assets consist primarily of goodwill which the Company is
amortizing on a straight-line basis over seven years (see Note 3). Accumulated
amortization as of April 30, 1995, 1996 and 1997 and December 31, 1997 was $0,
$327, $710 and $965, respectively.
Long-lived Assets
As prescribed by Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets
to be Disposed of," the Company assesses the recoverability of its long-lived
assets (including goodwill) by determining whether the asset balance can be
recovered over the remaining depreciation or amortization period through
projected undiscounted future cash flows. Cash flow projections, although
subject to a degree of uncertainty, are based on trends of historical
performance and management's estimate of future performance, giving
consideration to existing and anticipated competitive and economic conditions.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, accounts receivable,
accounts payable and notes payable approximates the fair value. In addition,
the carrying value of all borrowings approximate fair value based on interest
rates currently available to the Company.
Revenue Recognition
Revenues are recorded when products are delivered to customers in accordance
with Statement of Position (SOP) 91-1, Software Revenue Recognition. For those
agreements that provide the customers the right to multiple copies in exchange
for guaranteed amounts, revenue is recognized at the delivery of the product
master or the first copy. Per copy royalties on sales that exceed the
guarantee are recognized as earned. The Company is generally not contractually
obligated to accept returns, except for defective product. However, the
Company permits customers to return or exchange product and may provide price
protection on products unsold by a customer. In accordance with SFAS No. 48,
revenue is recorded net of an allowance for estimated returns, exchanges,
markdowns, price concessions, and warranty costs. Such reserves are based upon
management's evaluation of historical experience, current industry trends and
estimated costs. The amount of reserves ultimately required could differ
materially in the near term from the amounts included in the accompanying
consolidated financial statements. Postcontract customer support provided by
the Company is limited to telephone support. These costs are not material and
are charged to expenses as incurred.
Product Development
Product development expenses are charged to operations in the period
incurred and consist primarily of payroll and payroll related costs.
F-8
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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.
Foreign Currency Translation
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 balance sheets as a
separate component of stockholders' equity (deficit). Gains (losses) resulting
from foreign currency transactions amounted to $(7), $325, $364 and $246
during the years ended April 30, 1995, 1996 and 1997 and the eight months
ended December 31, 1997, respectively, and are included in other income
(expense) in the consolidated statements of operations.
Net Income (Loss) Per Share
The Company accounts for net income per share in accordance with SFAS No.
128 "Earnings Per Share" and SFAS No. 129, "Disclosure of Information about
Capital Structure." Basic net income (loss) per share is computed by dividing
income (loss) available to common stockholders by the weighted average number
of common shares outstanding. Diluted net income (loss) per share is computed
by dividing income (loss) available to common stockholders by the weighted
average number of common shares outstanding plus the effect of any dilutive
stock options and common stock warrants issued in connection with Subordinated
Secured Promissory Notes.
For the year ended April 30, 1995 and the three months ended March 31, 1998,
1,477,645 and 3,192,252 dilutive stock options and warrants, respectively,
were included in the diluted net income per share calculation. For years ended
April 30, 1996 and 1997 and the eight months ended December 31, 1997, all
options and warrants to purchase common stock were excluded from the diluted
loss per share calculation as the effect of such inclusion would be
antidilutive (see Note 10).
F-9
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Pro Forma Data (unaudited)
Pro forma net income (loss) represents the reduction of interest expense
assuming (i) the conversion or repayment of the Subordinated Secured
Promissory Notes (Notes) as of the beginning of the period, and (ii) the
application of proceeds of the Offering to repay outstanding borrowings on the
line of credit. Pro forma net income (loss) per share was computed by dividing
pro forma net income (loss) by the pro forma weighted average shares
outstanding. Pro forma weighted average shares includes the shares of common
stock from the exercise of common stock warrants, and the number of shares of
common stock issued in the Offering sufficient to repay approximately $16.8
million of the outstanding borrowings on the line of credit and the Notes that
are not expected to convert to common stock.
<TABLE>
<CAPTION>
EIGHT MONTHS THREE MONTHS
YEAR ENDED ENDED ENDED
APRIL 30, DECEMBER 31, MARCH 31,
1997 1997 1998
---------- ------------ ------------
<S> <C> <C> <C>
Pro forma net income (loss):
Historical income (loss) before pro-
vision (benefit) for income taxes.. $ (36,284) $ (5,059) $ 3,094
Adjust interest expense............. 1,616 2,379 1,062
Less provision (benefit) for income
taxes.............................. (9,065) -- 245
---------- ---------- ----------
Pro forma net income (loss)......... $ (25,603) $ (2,680) $ 3,911
========== ========== ==========
Pro forma net income (loss) per
share: $ (1.55) $ (0.15) $ 0.22
========== ========== ==========
Pro forma weighted average number of
common shares outstanding: 16,494,414 17,591,200 17,420,248
========== ========== ==========
</TABLE>
Stock-Based Compensation
As permitted under generally accepted accounting principles, the Company
accounts for employee stock options in accordance with the Accounting
Principles Board Opinion No. 25 and makes the necessary pro forma disclosures
mandated by SFAS No. 123 (see Note 10).
Pending Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." In addition, the American
Institute of Certified Public Accountants issued SOP 97-2, "Software Revenue
Recognition" and SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." SFAS No. 130, SFAS No. 131 and SOP
97-2 are effective for fiscal years beginning after December 15, 1997 and SOP
98-1 is effective for fiscal years beginning after December 15, 1998. The
Company does not believe that adoption of these standards will have a material
impact on the Company's results of operations.
Unaudited Quarterly Information
The accompanying financial information as of March 31, 1998 and for the
three months ended March 31, 1997 and 1998 is unaudited and has been prepared
on substantially the same basis as the annual financial
F-10
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
statements. In the opinion of management, the unaudited information contains
all adjustments (consisting of normal recurring accruals) necessary to present
fairly the financial position and results of operations as of such date and
for such periods.
3. ACQUISITION
Effective June 24, 1995, the Company acquired a 91 percent interest in Shiny
Entertainment, Inc. (Shiny) for $3,624 in cash and stock. The acquisition was
accounted for using the purchase method. The allocation of purchase price is
summarized as follows:
<TABLE>
<S> <C>
Cash and cash equivalents............................................ $ 119
Receivables.......................................................... 107
Other current assets................................................. 6
Property and equipment............................................... 417
Goodwill............................................................. 3,057
Accounts payable and accrued expenses................................ (82)
------
Total purchase price............................................... $3,624
======
</TABLE>
The purchase agreement requires the Company to pay the former owner of Shiny
additional cash payments of up to $5,325 upon the delivery and acceptance of
five future Shiny interactive entertainment software titles, as defined.
Future payments, if any, will be expensed in the six-month period following
the initial shipment of such products. As of December 31, 1997, the Company
had not been required to make any additional payments.
4. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS
Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
APRIL 30,
------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
------ ------ ------------ ---------
<S> <C> <C> <C> <C>
Packaged software..................... $4,211 $5,309 $4,171 $3,852
CD-ROMs, cartridges, manuals, packag-
ing and supplies..................... 1,685 2,095 2,167 2,213
------ ------ ------ ------
$5,896 $7,404 $6,338 $6,065
====== ====== ====== ======
</TABLE>
Other Current Assets
Other current assets consist of the following:
<TABLE>
<CAPTION>
APRIL 30,
------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
------ ------ ------------ ---------
<S> <C> <C> <C> <C>
Prepaid expenses....................... $2,960 $ 977 $1,640 $1,301
Royalties receivables.................. 1,331 581 1,644 --
Deposits............................... 553 560 162 214
Other receivables...................... 236 236 772 1,850
Stockholder receivable................. 973 -- -- --
------ ------ ------ ------
$6,053 $2,354 $4,218 $3,365
====== ====== ====== ======
</TABLE>
F-11
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
APRIL 30,
---------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
------- ------- ------------ ---------
<S> <C> <C> <C> <C>
Computers and equipment........... $ 9,179 $11,325 $12,383 $12,793
Furniture and fixtures............ 336 702 474 511
Leasehold improvements............ 1,249 1,514 1,125 1,144
------- ------- ------- -------
10,764 13,541 13,982 14,448
Less--accumulated depreciation and
amortization..................... (2,926) (5,424) (6,956) (7,702)
------- ------- ------- -------
$ 7,838 $ 8,117 $ 7,026 $ 6,746
======= ======= ======= =======
</TABLE>
Accrued Expenses
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
APRIL 30,
--------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
------- ------- ------------ ---------
<S> <C> <C> <C> <C>
Royalties payable..................... $ 5,463 $ 8,178 $ 6,901 $ 5,051
Accrued payroll....................... 2,621 2,261 2,707 3,027
Payable to distributor................ 2,806 1,715 4,240 554
Accrued bundle and affiliate.......... 2,115 4,149 2,923 2,981
Deferred income....................... -- 2,464 3,442 4,845
Other................................. 2,544 2,333 2,336 5,773
------- ------- ------- -------
$15,549 $21,100 $22,549 $22,231
======= ======= ======= =======
</TABLE>
5. SHORT-TERM BORROWINGS
In May 1993, the Company entered into a trade finance agreement with a bank,
bearing interest at prime (8.25 percent at April 30, 1996) plus one-half
percent. Amounts outstanding under this agreement were $5,050 at April 30,
1996. This agreement expired in October 1996. In April 1996, the Company
entered into a line of credit agreement with the same bank, bearing interest
at prime plus one-half percent. No amounts were outstanding under this line of
credit at April 30, 1996, and the line of credit expired in June 1996. In
October 1996, the Company entered into a trade finance agreement with two
banks, bearing interest at prime (8.5 percent at April 30, 1997) plus one-half
percent. Amounts outstanding under this agreement were $10,950 at April 30,
1997. In June 1997, the Company retired this trade finance agreement and
entered into a Loan and Security Agreement with a financial institution (see
Note 6).
F-12
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
6. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
APRIL 30,
------------- DECEMBER 31, MARCH 31,
1996 1997 1997 1998
---- ------- ------------ ---------
<S> <C> <C> <C> <C>
Subordinated Secured Promissory
Notes............................. $-- $14,655 $ 14,655 $ 14,655
Loan Agreement..................... -- -- 23,246 23,820
Other.............................. 108 315 253 205
---- ------- -------- --------
108 14,970 38,154 38,680
Less--current portion.............. (57) (123) (14,767) (14,825)
---- ------- -------- --------
$ 51 $14,847 $ 23,387 $ 23,855
==== ======= ======== ========
</TABLE>
Subordinated Secured Promissory Notes
From October 1996 through February 1997, the Company issued $14,803 in
Subordinated Secured Promissory Notes (Notes) and nondetachable Warrants to
purchase common stock (Warrants). Employees, officers, and directors of the
Company hold $2,600 of the total Notes outstanding. Of the total proceeds
received, $14,655 represents the principal amount of the Notes and $148
represents the purchase price of the Warrants. The amount paid for the
Warrants approximates management's estimate of the fair market value of the
Warrants at the date of issuance and is included in paid-in capital in the
accompanying consolidated balance sheets.
The Notes bear interest at a rate of 12.0 percent per year. Interest is
payable quarterly, with the first payment due May 1, 1997. The principal
amount and all accrued but unpaid interest will be payable upon the
consummation of a qualified initial public offering (IPO), as defined or the
sale of substantially all of the Company's assets or a merger where the
Company is not the surviving entity (Sales Transaction). If neither of these
events occur prior to November 30, 1998, the Note holders may elect to extend
the Notes one additional year or may notify the Company in writing of their
desire to full payment in cash. Interest expense related to the notes was $856
for the year ended April 30, 1997 and $1,172 for the eight months ended
December 31, 1997.
Each Warrant holder has the right to purchase from the Company the number of
shares of common stock equal to the investor's aggregate investment (including
Notes and Warrants) divided by the product of .70 multiplied by (a) the IPO
price per share or (b) in the event of a Sales Transaction, the fair market
value per share as determined in the Sales Transaction. The term of the
Warrants commenced on the date of issuance and expire upon the redemption of
the Notes, as described above (see Note 13).
Total interest due on the Notes at May 1, 1997 was $856. The Company offered
to pay the interest in cash or offered to issue one share of common stock for
each $11.25 of interest due (management's estimate of fair value of the
Company's common stock at the time). Interest of $672 was paid in cash and
$184 of interest was paid with 16,362 shares of common stock.
Loan Agreement
In June 1997, the Company entered into a Loan and Security Agreement (Loan
Agreement) with a financial institution which was amended in February 1998.
Borrowings under the Loan Agreement bear interest at LIBOR (5.72 percent at
December 31, 1997) plus 4.87 percent (10.59 percent at December 31, 1997). The
agreement
F-13
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
provides for a line of credit and letters of credit to be issued, based in
part on qualified receivables and inventory. Combined borrowings under this
Loan Agreement may be up to a maximum of $35,000 through August 30, 1998;
$30,000 from August 31 to December 30, 1998; and $25,000 thereafter. Within
the total credit limits, the Company may borrow up to $10,000 in excess of its
borrowing base through August 1998 and up to $5,000 in excess of its borrowing
base thereafter through December 30, 1998. The line of credit is secured by
cash, accounts receivable and inventory and expires in May 1999.
7. INCOME TAXES
The Company files a consolidated U.S. Federal income tax return which
includes substantially all of its domestic operations. The Company files
separate tax returns for each of its foreign subsidiaries in the countries in
which they reside.
Income (loss) before provision (benefit) for income taxes consists of the
following:
<TABLE>
<CAPTION>
EIGHT MONTHS
YEARS ENDED APRIL 30, ENDED
------------------------ DECEMBER 31,
1995 1996 1997 1997
------ ------- -------- ------------
<S> <C> <C> <C> <C>
Domestic.............................. $5,689 $(1,890) $(32,888) $(2,784)
Foreign............................... 1,404 666 (3,396) (2,275)
------ ------- -------- -------
Total............................... $7,093 $(1,224) $(36,284) $(5,059)
====== ======= ======== =======
The provision (benefit) for income taxes is comprised of the following:
<CAPTION>
EIGHT MONTHS
YEARS ENDED APRIL 30, ENDED
------------------------ DECEMBER 31,
1995 1996 1997 1997
------ ------- -------- ------------
<S> <C> <C> <C> <C>
Current:
Federal............................. $ 915 $ (275) $ (1,689) $ (179)
State............................... 125 10 -- --
Foreign............................. -- 456 153 51
------ ------- -------- -------
1,040 191 (1,536) (128)
Deferred:
Federal............................. 1,591 (653) (7,303) 128
State............................... 213 (18) (226) --
------ ------- -------- -------
1,804 (671) (7,529) 128
------ ------- -------- -------
$2,844 $ (480) $ (9,065) $ --
====== ======= ======== =======
</TABLE>
The Company's available net operating loss (NOL) carryforward for federal
tax reporting purposes approximates $17,300 and may be subject to certain
limitations as defined under Section 382 of the Internal Revenue Code. The
federal NOL carryforwards expire through the year 2012. The Company's NOL's
for state tax reporting purposes approximate $13,000 and expire through the
year 2002.
F-14
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
A reconciliation of the statutory federal income tax rate and the effective
tax rate as a percentage of pretax income is as follows:
<TABLE>
<CAPTION>
YEARS ENDED EIGHT MONTHS
APRIL 30, ENDED
-------------------- DECEMBER 31,
1995 1996 1997 1997
---- ----- ----- -------------
<S> <C> <C> <C> <C>
Statutory income tax rate.............. 34.0 % (34.0)% (34.0)% (34.0)%
State and local income taxes, net of
federal income tax benefit............ 6.6 (3.0) (3.0) (3.0)
Valuation allowance.................... -- -- 8.0 39.7
Other.................................. (0.5) (2.2) 4.0 (2.7)
---- ----- ----- -----
Effective income tax rate.............. 40.1 % (39.2)% (25.0)% -- %
==== ===== ===== =====
</TABLE>
The components of the Company's net deferred income tax asset (liability)
are as follows:
<TABLE>
<CAPTION>
APRIL 30,
---------------- DECEMBER 31,
1996 1997 1997
------- ------- ------------
<S> <C> <C> <C>
Current deferred tax asset (liability):
Prepaid royalties......................... $(4,681) $(3,060) $(2,760)
Nondeductible reserves.................... 3,655 5,532 5,603
Accrued expenses.......................... 675 769 1,015
Foreign loss and credit carryforward...... 568 207 1,008
Federal and state net operating losses.... -- 6,264 6,668
Research and development credit
carryforward............................. -- 831 831
Other..................................... 106 241 330
------- ------- -------
323 10,784 12,695
Valuation allowance....................... -- (2,895) (4,903)
------- ------- -------
$ 323 $ 7,889 $ 7,792
======= ======= =======
Non-current deferred tax asset (liability):
Depreciation expense...................... $ (591) $ (585) $ (625)
Nondeductible reserves.................... 155 127 191
Other..................................... 70 55 --
------- ------- -------
$ (366) $ (403) $ (434)
======= ======= =======
</TABLE>
F-15
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office space in Irvine, California for its corporate
offices. The lease expires in June 2006 with one five-year option to extend
the term of the lease. The Company has also entered into various computer
equipment operating leases. Future minimum lease payments under noncancelable
operating leases are as follows:
<TABLE>
<S> <C>
Year ending December 31:
1998............................................................... $ 2,036
1999............................................................... 1,710
2000............................................................... 1,414
2001............................................................... 1,522
2002............................................................... 1,669
Thereafter......................................................... 6,133
-------
$14,484
=======
</TABLE>
Total rent expense was $362, $697 and $2,089 for the years ended April 30,
1995, 1996 and 1997, respectively, and $1,292 for the eight months ended
December 31, 1997.
Pending Internal Revenue Service Examination
The Internal Revenue Service (the IRS) is currently examining the Company's
consolidated federal income tax returns for the years ended April 30, 1994,
1995 and 1996. The consolidated federal income tax return for the year ended
April 30, 1997 remains open. The IRS has preliminarily challenged the timing
of certain tax deductions taken by the Company. The Company is currently
contesting such challenges. However, if the IRS is successful in its position,
the effect on the consolidated financial statements would be to reduce amounts
currently shown as deferred income taxes and net operating loss carryforwards
and the recording of interest expense of approximately $700. In conjunction
with this matter, the Company has recorded certain reserves and, in the
opinion of management, settlement of this matter will not have a material
adverse effect on the consolidated financial position or operating results of
the Company.
Litigation
In July 1997, S3 Incorporated (S3), an original equipment manufacturer (OEM)
customer, filed a complaint against the Company claiming, among other things,
that the Company breached its obligations to S3 under a license agreement. In
September 1997, the Company filed a cross-complaint against S3 claiming, among
other things, that S3 breached the license agreement by failing to make
guaranteed payments. Both parties are seeking in excess of $1,000 in the
lawsuit. On April 28, 1998, the Company entered into a Settlement and Release
Agreement pursuant to which S3 has agreed to pay the Company certain amounts
in full settlement of all claims.
The Company is also involved in other litigation arising from the normal
course of business. Management believes that the final outcome of all legal
matters will not have a material adverse effect on the Company's financial
position or results of operations.
Employment Agreements
The Company has entered into employment agreements with three of its
officers 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
F-16
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
good reason, as defined, the employees are entitled to 150 percent of their
annual salary and 75 percent of the imputed bonus, as defined. These
agreements expire in 1999.
9. COMMON STOCK
During 1994, the Company issued 1,824,897 shares of common stock for cash to
a corporate stockholder. In addition, the corporate stockholder purchased
1,216,598 shares of common stock for cash from the founder of the Company (the
Founder). In connection with this transaction, the corporate stockholder was
granted options to purchase additional shares from the Founder, which were
exercisable in 1995 and 1996. The corporate stockholder exercised these
options and purchased 1,150,123 and 1,216,598 shares from the Founder during
1996 and 1995, respectively.
On May 26, 1995, the Company entered into an Agreement of Settlement and
Mutual Release with a former employee whereby 89,222 shares of common stock
were cancelled and the former employee's remaining shares of 45,000 shares
were retained by the former employee.
On February 1, 1997, the Company repurchased 29,124 shares of common stock
from an employee in exchange for a $275 note payable. The note bears interest
at 7 percent and is payable over 36 months.
On September 12, 1997, the Company entered into a Separation and Release
Agreement with a former employee whereby 178,594 shares of common stock were
cancelled and the former employee's remaining shares of 149,500 shares were
retained by the former employee.
10. EMPLOYEE BENEFIT PLANS
Stock Option Plans
The Company has three stock option plans. Under the Incentive Stock Option,
Nonqualified Stock Option and Restricted Stock Purchase Plan--1991 (1991
Plan), the Company may grant options to its employees to purchase up to
2,250,000 shares of common stock. Under the Incentive Stock Option and
Nonqualified Stock Option Plan--1994 (1994 Plan), the Company may grant
options to its employees to purchase up to 808,300 shares of common stock.
Under the 1997 Stock Incentive Plan, adopted in 1997, the Company may grant
options to its employees, consultants and directors to purchase up to 700,000
shares of common stock (See Note 13).
Options under all three plans generally vest over five years. Holders of
options under the 1991 Plan and the 1994 Plan shall be deemed 100 percent
vested in the event of a merger in which the Company is not the surviving
entity, a sale of substantially all of the assets of the Company, or a sale of
all shares of common stock of the Company. The Company has treated the
difference, if any, between the exercise price and the estimated fair market
value, as determined by the board of directors on the date of grant, as
compensation expense for financial reporting purposes. Compensation expense
for the vested portion aggregated $306 for each of the years ended April 30,
1996 and 1997 and $204 for the eight months ended December 31, 1997.
F-17
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following is a summary of option activity pursuant to the Company's stock
option plans:
<TABLE>
<CAPTION>
APRIL 30, 1996 APRIL 30, 1997 DECEMBER 31, 1997
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of year...... 1,665,479 $1.69 1,824,025 $ 3.16 1,630,022 $ 4.59
Granted................. 418,050 8.79 136,800 14.08 263,750 11.25
Exercised............... (177,104) 0.79 (313,403) 0.18 -- --
Cancelled............... (82,400) 7.16 (17,400) 8.50 (54,800) 12.50
--------- ----- --------- ------ --------- ------
Options outstanding at
end of year............ 1,824,025 $3.16 1,630,022 $ 4.59 1,838,972 $ 5.31
========= ===== ========= ====== ========= ======
Options exercisable..... 1,434,775 1,218,102 1,324,132
========= ========= =========
</TABLE>
The following outlines the significant assumptions used to calculate the fair
value information presented utilizing the Black Scholes Single Option approach
with ratable amortization:
<TABLE>
<CAPTION>
APRIL 30,
--------------------- DECEMBER 31,
1996 1997 1997
---------- ---------- ------------
<S> <C> <C> <C>
Risk free rate.......................... 6.1% 6.1% 6.1%
Expected life........................... 7.12 years 7.13 years 8.02 years
Expected volatility..................... -- -- --
Expected dividends...................... -- -- --
Weighted-average grant-date fair value
of options granted..................... $2.34 $3.68 $3.61
</TABLE>
A detail of the options outstanding and exercisable as of December 31, 1997
is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
--------------- ----------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.15-$ 0.47 676,659 4.31 years $ 0.21 676,659 $ 0.21
2.00- 4.44 274,913 6.15 years 3.48 274,913 3.48
4.50- 8.50 446,350 7.26 years 7.91 278,360 7.84
10.00- 14.62 441,050 8.49 years 11.65 94,200 11.62
------------- --------- ---------- ------ --------- ------
$ 0.15-$14.62 1,838,972 6.30 years $ 5.31 1,324,132 $ 3.30
============= ========= ========== ====== ========= ======
</TABLE>
F-18
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following table shows pro forma net loss as if the fair value based
accounting method prescribed by SFAS No. 123 had been used to account for
stock based compensation cost:
<TABLE>
<CAPTION>
EIGHT MONTHS
YEARS ENDED APRIL 30, ENDED
---------------------- DECEMBER 31,
1996 1997 1997
---------- ----------- ------------
<S> <C> <C> <C>
Net loss as reported.................. $ (744) $ (27,219) $(5,059)
Pro forma compensation expense........ (121) (348) (276)
--------- ----------- -------
Pro forma net loss.................... $ (865) $ (27,567) $(5,335)
========= =========== =======
Basic and diluted net loss as report-
ed................................... $ (0.07) $ (2.46) $ (0.45)
Basic and diluted pro forma net loss.. $ (0.08) $ (2.49) $ (0.48)
</TABLE>
Profit Sharing 401(k) Plan
The Company sponsors a 401(k) plan (the Plan) for full-time employees over
18 years of age. Eligible employees may participate in the Plan in each year
in which the employee has greater than 1,000 hours of service with the
Company. The Company matches 50 percent of the participant's contributions up
to the first six percent of the participant's salary deferral. The profit
sharing contribution amount is at the sole discretion of the Company's board
of directors. Participants vest at a rate of 20 percent per year after the
first year of service for profit sharing contributions and 20 percent per year
after the first three years of service for matching contributions.
Participants become 100 percent vested upon death, permanent disability or
termination of the Plan. Benefit expense for the years ended April 30, 1995,
1996 and 1997 was $53, $160, and $229, respectively, and $178 for the eight
months ended December 31, 1997.
11. RELATED PARTIES
The Company has amounts due from a business controlled by the Chairman and
CEO of the Company. Net amounts due, prior to reserves, at April 30, 1996, and
1997 and December 31, 1997 were $1,607, $783 and $1,515, respectively. Such
amounts at April 30 and December 31, 1997 are fully reserved. Through December
1997, the Company rented office space from the Chairman and CEO of the
Company. Rent expense paid to the Chairman and CEO was $236, $248 and $191 for
the years ended April 30, 1995, 1996 and 1997, respectively and $160 for the
eight months ended December 31, 1997.
12. SIGNIFICANT CUSTOMERS
For the year ended April 30, 1997 one customer accounted for approximately
15 percent of net revenues. No single customer accounted for ten percent or
more of net revenues in the years ended April 30, 1995 and 1996 and the eight
months ended December 31, 1997.
13. SUBSEQUENT EVENTS
Reincorporation
On March 2, 1998, the Board of Directors of Interplay Productions approved a
reincorporation plan. Under the reincorporation plan Interplay Productions
formed a new subsidiary in Delaware into which Interplay
F-19
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Productions has been merged. The new Delaware Corporation has 50,000,000
shares of Common Stock and 5,000,000 shares of Preferred Stock authorized for
issuance. The reincorporation plan became effective on May 29, 1998.
Initial Public Offering
On March 2, 1998, the Company's Board of Directors authorized management to
pursue an initial public offering of the Company's common stock (IPO). The
Company plans to file an S-1 Registration Statement with the Securities and
Exchange Commission to sell common stock to the public. The proceeds of the
offering will be used, in part, to repay debt.
Subordinated Secured Promissory Notes
As discussed in Note 6, the Note holders may elect to convert their Notes to
common stock upon the closing of a qualified IPO, as defined. In accordance
with the terms of the Notes, the Company has requested that each holder elect
to either convert the outstanding principal amount to common stock upon the
closing of the IPO or receive full payment in cash from the proceeds of the
IPO. In the event this IPO is completed, the holders of approximately $8,700
of Notes and Warrants have elected to exercise their Warrants by cancellation
of their Notes to common stock and the balance of approximately $6,100 have
requested payment in cash.
If the Company does not complete the IPO prior to November 30, 1998, the
holders have the option, 30 days thereafter, to notify the Company in writing,
that they declare the Notes due and payable or may unilaterally elect to
extend the Notes one year. Management's current projections indicate that
there will be sufficient cash flow from operations to fund that obligation
should the Note holders elect cash payment. However, if the Company is not
able to achieve the operating plan and therefore cash flows from operations
are insufficient to repay the Notes, management would be prepared to implement
certain cost-cutting measures. Such measures would include deferrals of
advertising expenditures, capital additions and product development projects.
Stock Options (unaudited)
Effective February 9, 1998, the Company repriced substantially all
outstanding options with exercise prices greater than $8 per share and
subsequently reissued these options with exercise prices equal to $8 per
share, management's estimate of the fair value of the Company's common stock
as of the date of reissuance. The effect of this has not been reflected in the
information in Note 10. These options were accounted for as new grants.
Effective March 2, 1998, the number of shares authorized under the 1991 Plan
and the 1994 Plan were reduced to 898,425 and 639,984, respectively, and such
plans were terminated for purposes of future grants. The aggregate reduction
of 1,519,891 shares were contributed to the 1997 Plan resulting in 2,219,891
authorized shares under the 1997 Plan, of which 1,680,541 remain available for
grant. Also, on February 23, 1998, the Company granted 240,100 stock options
with an exercise price equal to the estimated fair market value of $8 per
share.
F-20
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
A schedule of the options outstanding as of February 28, 1998 giving effect
for the repricing discussed above is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
--------------- ----------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.15-$ 0.47 676,659 4.15 years $0.20 676,659 $0.20
2.00- 4.44 274,913 5.99 years 3.48 274,913 3.48
4.50- 6.66 81,500 6.37 years 5.33 61,500 5.61
7.00- 10.00 1,021,634 8.36 years 8.15 320,260 8.19
------------ --------- ---------- ----- --------- -----
$0.15-$10.00 2,054,706 6.58 years $4.80 1,333,332 $3.05
============ ========= ========== ===== ========= =====
</TABLE>
14. OPERATIONS BY GEOGRAPHICAL AREA
The Company operates in one industry segment. Information about the
Company's operations in the United States and foreign areas for the fiscal
years ended April 30, 1995, 1996 and 1997 and for the eight months ended
December 31, 1997 and the three months ended March 31, 1998 is presented
below:
<TABLE>
<CAPTION>
APRIL 30, APRIL 30, APRIL 30, DECEMBER 31, MARCH 31,
1995 1996 1997 1997 1998
--------- --------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Net revenues:
United States......... $68,021 $78,823 $ 54,469 $65,199 $31,245
United Kingdom........ 11,525 18,127 27,867 20,689 9,751
Other................. -- 2 926 73 --
------- ------- -------- ------- -------
Consolidated net
revenues........... $79,546 $96,952 $ 83,262 $85,961 $40,996
======= ======= ======== ======= =======
Income (loss) from
operations:
United States......... $ 5,090 $(1,410) $(30,764) $ 298 $ 1,478
United Kingdom........ 957 1,853 (3,871) (2,666) 3,034
Other................. -- (860) (49) (418) --
------- ------- -------- ------- -------
Consolidated income
(loss) from
operations......... $ 6,047 $ (417) $(34,684) $(2,786) $ 4,512
======= ======= ======== ======= =======
Identifiable assets:
United States......... $39,211 $57,550 $ 53,722 $65,535 $69,650
United Kingdom........ 5,015 10,234 13,836 12,033 9,070
Other................. -- 727 1,447 253 (393)
------- ------- -------- ------- -------
Consolidated
identifiable
assets............. $44,226 $68,511 $ 69,005 $77,821 $78,327
======= ======= ======== ======= =======
</TABLE>
F-21
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
AMOUNTS AND DISCLOSURES AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 ARE UNAUDITED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Net revenues for the years ended April 30, 1995, 1996 and 1997 and the eight
months ended December 31, 1997 and the three months ended March 31, 1998 were
made to geographic regions as follows:
<TABLE>
<CAPTION>
APRIL 30, 1995 APRIL 30, 1996 APRIL 30, 1997 DECEMBER 31, 1997 MARCH 31, 1998
--------------- --------------- --------------- ------------------- ---------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------- ------- ------- ------- --------- --------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
North America........... $51,892 65.2% $54,702 56.4% $38,606 46.4% $ 51,833 60.3% $23,516 57.4%
Europe.................. 12,911 16.2 17,683 18.3 26,752 32.1 19,941 23.2 8,265 20.2
Rest of world........... 918 1.2 6,896 7.1 5,254 6.3 4,701 5.5 2,958 7.2
OEM, royalty and
licensing.............. 13,825 17.4 17,671 18.2 12,650 15.2 9,486 11.0 6,257 15.2
------- ----- ------- ----- ------- ----- --------- ------- ------- -----
$79,546 100.0% $96,952 100.0% $83,262 100.0% $ 85,961 100.0% $40,996 100.0%
======= ===== ======= ===== ======= ===== ========= ======= ======= =====
</TABLE>
F-22
<PAGE>
FUTURE
RELEASES
BALDUR'S GATE
CAESARS PALACE VIP SERIES
CRIME KILLER
DESCENT:
[ANIMATED DEPICTIONS OF CHARACTERS FREESPACE THE GREAT WAR
AND ARTWORK FROM CERTAIN OF THE
LISTED FUTURE RELEASES ARE ARRANGED
VERTICALLY TO THE LEFT OF THE EARTHWORM JIM 3D
RIGHT COLUMN]
FALLOUT 2
M.A.X. 2
MESSIAH
REDNECK RAMPAGE RIDES AGAIN
STAR TREK:
SECRET OF VULCAN FURY
VR BASEBALL '99
VR FOOTBALL '99
WILD 9
THERE CAN BE NO ASSURANCE
THAT THE ANTICIPATED FUTURE
TITLES WILL BE RELEASED IN
A TIMELY MANNER, IF AT ALL.
SEE "RISK FACTORS"
COMMENCING ON PAGE FIVE.
STAR TREK AND RELATED
ELEMENTS(TM) & (C) 1998
PARAMOUNT PICTURES. ALL
RIGHTS RESERVED.
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN CON-
NECTION WITH THE OFFER MADE IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH IN-
FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE ANY OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY TO ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SO-
LICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUB-
SEQUENT TO THE DATE OF THE PROSPECTUS.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Summary Consolidated Financial Data...................................... 4
Risk Factors............................................................. 5
Use of Proceeds.......................................................... 16
Dividend Policy.......................................................... 16
Dilution................................................................. 17
Capitalization........................................................... 18
Selected Consolidated Financial Data..................................... 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 20
Business................................................................. 32
Management............................................................... 46
Principal Stockholders................................................... 54
Certain Transactions..................................................... 55
Description of Capital Stock............................................. 58
Shares Eligible for Future Sale.......................................... 61
Underwriting............................................................. 62
Legal Matters............................................................ 64
Experts.................................................................. 64
Available Information.................................................... 64
Index to Consolidated Financial Statements............................... F-1
</TABLE>
----------------
UNTIL JULY 14, 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
5,000,000 Shares
[LOGO OF INTERPLAY APPEARS HERE]
Common Stock
----------------
PROSPECTUS
----------------
Piper Jaffray inc.
Bear, Stearns & Co. Inc.
UBS Securities
June 19, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
