<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
Interplay Entertainment Corp.
(Exact name of the registrant as specified in its charter)
Delaware 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 Von Karman Avenue, Irvine, California 92606
(Address of principal executive offices)
(949) 553-6655
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Class Issued and Outstanding at May 7, 1999
----- -------------------------------------
Common Stock, $0.001 par value 20,808,861
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 1999
TABLE OF CONTENTS
______________
Page Number
-----------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 1999
and December 31, 1998............................................. 3
Consolidated Statements of Operations for the
Three Months ended March 31, 1999 and 1998........................ 4
Consolidated Statements of Cash Flows for the
Three Months ended March 31, 1999 and 1998........................ 5
Notes to Unaudited Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 29
Part II. Other Information
Item 1. Legal Proceedings................................................. 30
Item 2. Changes in Securities and Use of Proceeds......................... 30
Item 3. Defaults Upon Senior Securities................................... 30
Item 4. Submission of Matters to a Vote of Security Holders............... 30
Item 5. Other Information................................................. 30
Item 6. Exhibits and Reports on Form 8-K.................................. 30
Signatures................................................................. 31
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 1999 1998
------ --------- ------------
<S> <C> <C>
(Unaudited)
Current Assets: (Dollars in thousands)
Cash and cash equivalents $ 363 $ 614
Restricted cash 2,000 -
Trade receivables, net of allowances
of $17,214 and $18,431, respectively 26,266 33,991
Inventories 6,888 6,303
Prepaid licenses and royalties 20,023 18,128
Deferred income taxes 5,358 5,358
Other 2,716 3,101
--------- ------------
Total current assets 63,614 67,495
Property and Equipment, net 4,885 5,679
Other Assets 1,819 1,792
--------- ------------
$ 70,318 $ 74,966
========= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 18,935 $ 23,403
Accrued liabilities 22,030 22,300
Current portion of long-term debt 22,753 24,521
Income taxes payable 254 254
--------- ------------
Total current liabilities 63,972 70,478
Long-Term Debt, net of current portion 73 130
Deferred Income Taxes - 22
Minority Interest 118 143
Commitments and Contingencies
Redeemable Common Stock 1,000 -
Stockholders' Equity:
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 20,808,861 shares as of March 31, 1999
and 18,292,431 shares as of December 31, 1998 20 18
Paid-in capital 61,178 51,918
Retained earnings (accumulated deficit) (56,375) (48,097)
Accumulated comprehensive income adjustments 332 354
--------- ------------
Total stockholders' equity 5,155 4,193
--------- ------------
$ 70,318 $ 74,966
========= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
---------------------------
1999 1998
----------- -----------
(Dollars in thousands, except
per share amounts)
Net revenues $ 21,620 $ 40,996
Cost of goods sold 12,566 19,221
----------- -----------
Gross profit 9,054 21,775
Operating expenses:
Marketing and sales 7,544 8,589
General and administrative 3,518 2,855
Product development 5,382 5,819
----------- -----------
Total operating expenses 16,444 17,263
----------- -----------
Operating income (loss) (7,390) 4,512
Other income (expense):
Interest income 45 6
Interest expense (814) (1,346)
Other (119) (78)
----------- -----------
Total other income (expense) (888) (1,418)
Income (loss) before provision
for income taxes (8,278) 3,094
Provision for income taxes - 245
----------- -----------
Net income (loss) $ (8,278) $ 2,849
=========== ===========
Net income (loss) per share:
Basic $ (0.44) $ 0.26
=========== ===========
Diluted $ (0.44) $ 0.20
=========== ===========
Weighted average number of
common shares outstanding:
Basic 18,689,344 10,952,375
=========== ===========
Diluted 18,689,344 14,144,627
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities: (Dollars in thousands)
Net income (loss) $(8,278) $ 2,849
Adjustments to reconcile net income (loss) to
cash provided by (used in) operating activities:
Depreciation and amortization 779 841
Noncash expense for stock options 10 76
Deferred income taxes (22) 270
Minority interest in earnings (loss) of subsidiary (25) 47
Changes in assets and liabilities:
Trade receivables 7,725 (3,549)
Inventories (585) 273
Income taxes receivable - 1,427
Other current assets 685 853
Other assets 282 -
Prepaid licenses and royalties (1,895) 246
Accounts payable (4,468) (2,928)
Accrued liabilities (270) (318)
Income taxes payable - 243
------- -------
Net cash provided by (used in) operating (6,062) 330
activities
Cash flows from investing activities:
Purchase of property and equipment (294) (466)
------- -------
Net cash used in investing activities (294) (466)
Cash flows from financing activities:
Net (repayments) borrowings on line of credit (1,758) 574
Repayments on notes payable (67) (48)
Net proceeds from issuance of common stock 9,944 -
Proceeds from exercise of stock options 8 10
Additions to restricted cash (2,000) -
Other financing activities - -
------- -------
Net cash provided by financing activities 6,127 536
------- -------
Effect of exchange rate changes on cash and cash equivalents (22) 1
------- -------
Net increase (decrease) in cash and cash equivalents (251) 401
Cash and cash equivalents, beginning of period 614 1,536
------- -------
Cash and cash equivalents, end of period $ 363 $ 1,937
======= =======
Supplemental cash flow information:
Cash paid for:
Interest $ 814 $ 1,372
Income taxes - -
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Note 1. Basis of Presentation
The accompanying interim consolidated financial statements of Interplay
Entertainment Corp. and its subsidiaries (the "Company") are unaudited and
reflect all adjustments (consisting only of normal recurring adjustments) that,
in the opinion of management, are necessary for a fair presentation of the
results for the interim period in accordance with instructions for Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all information
and footnotes required by generally accepted accounting principles for complete
financial statements. The results of operations for the current interim period
are not necessarily indicative of results to be expected for the current year or
any other period.
These consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
annual report on Form 10-K for the year ended December 31, 1998 as filed with
the Securities and Exchange Commission.
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.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to classifications used in the current period.
Restricted Cash
Restricted cash represents cash collateral deposits made in accordance with
the Company's amended Loan and Security Agreement (see Note 4).
Equity Investments
Investments in unconsolidated affiliate companies, in which the Company has a
significant influence but less than a 50% interest, are carried at cost,
adjusted for the Company's proportionate share of their undistributed earnings
or losses.
Revenue Recognition
Revenues are recorded when products are delivered to customers in accordance
with Statement of Position (SOP) 97-2, 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.
6
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Factors Affecting Future Performance
For the three months ended March 31, 1999 the Company incurred a net loss of
$8,278 and used cash in operating activities of $6,467. Partially because of
these losses, the Company's liquidity deteriorated during the period ended March
31, 1999. At March 31, 1999, the Company had negative working capital of $658,
although the Company did have borrowing availability under its line of credit of
$6,032 (See Note 4).
To provide working capital to support the Company's future operations, the
Company took several actions during the period, including extending the
expiration of its line of credit to January 1, 2000, in connection with which
the Company's Chief Executive Officer personally guaranteed $5 million of the
Company's obligations under such line of credit. Further, In March 1999, the
Company entered into a Stock Purchase Agreement with an investor which provides
for the issuance of 2.5 million shares of the Company's Common Stock for $10
million (See Note 8), and in May 1999, the Company entered into a letter of
intent for a $25,000 proposed equity transaction with the same investor (See
Note 10).
The Company believes that funds available under its line of credit, funds
received from the sale of equity securities, amounts to be received under
various product license and distribution agreements and anticipated funds from
operations, if any, will be sufficient to satisfy the Company's projected
working capital and capital expenditure needs and debt obligations in the normal
course of business at least through the expiration of its line on January 1,
2000 (see Note 4). Based upon the Company's estimates, including the Company's
ability to achieve anticipated operating results, the Company believes that it
will be able to renew its line of credit or obtain alternate financing on
reasonable terms.
In addition to the risks related to the Company's liquidity discussed above,
the Company also faces numerous other risks associated with its industry. These
risks include dependence on new product introductions, product completion and
release delays, rapidly changing technology, intense competition, dependence on
distribution channels and risk of customer returns. Certain additional risks
are discussed on pages 19-29 of the Company's Quarterly Report on Form 10-Q for
the period ended March 31, 1999.
The Company's consolidated financial statements have been presented on the
basis that it is a going concern. Accordingly, the consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities or any other adjustments that might result should the Company be
unable to continue as a going concern.
The Company has placed a partial valuation allowance against it's deferred tax
asset. This valuation allowance relates primarily to net operating loss and tax
credit carryforward. The Company will continue to evaluate the uncertainty
surrounding the realization of the net deferred tax asset in future years, and
may increase the valuation allowance placed against its net deferred tax assets.
Note 2. 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 advance payments made for future royalties. These
payments are contingent upon the successful completion of milestones, which
generally represent specific deliverables. Royalty advances are generally
recoupable against future sales based upon the contractual royalty rate. The
Company amortizes the cost of licenses, prepaid royalties and other outside
production costs to cost of goods sold over six months commencing with the
initial shipment of the title at a rate based upon the number 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.
7
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Note 3. Inventories
Inventories consist of the following:
March 31, December 31,
1999 1998
--------- ------------
Packaged software $4,996 $4,070
CD-ROMs, cartridges, manuals, packaging and supplies 1,892 2,233
------ ------
$6,888 $6,303
====== ======
Note 4. Long-Term Debt
Long-term debt consists of the following:
March 31, December 31,
1999 1998
--------- ------------
Loan Agreement $ 22,717 $ 24,475
Other 109 176
-------- --------
22,826 24,651
Less--current portion (22,753) (24,521)
-------- --------
$ 73 $ 130
======== ========
Loan Agreement
Borrowings under the Loan and Security Agreement ("Loan Agreement") bear
interest at LIBOR (4.97 percent at March 31, 1999 and 5.62 percent at December
31, 1998) plus 4.87 percent (9.84 percent at March 31, 1999 and 10.49 percent at
December 31, 1998). On March 18, 1999 the Company amended its line of credit
under the Loan Agreement with a financial institution to extend its current line
of credit through January 1, 2000 and thereafter, based on qualifying
receivables and inventory. Under the terms of the Amendment the $37,500 maximum
credit line will continue through November 29, 1999, $30,000 through December
30, 1999 and $25,000 thereafter. Within the total credit limit, the Company may
borrow up to $14,000 in excess of its borrowing base through July 30, 1999,
$10,000 in excess through September 29, 1999, $7,000 through November 29, 1999
and $5,000 in excess thereafter. Under the amended line of credit the Company
is required to place a cash collateral deposit of $2,000 by March 15, 1999 and
an additional $500 on April 15, 1999. In addition, the Company is required to
maintain certain borrowing limitations beginning July 30, 1999 where actual
borrowings are limited to $35,000 with various month end limitations, generally
decreasing to $25,000 at December 31, 1999 and the $5,000 personal guarantee by
the Company's Chairman and Chief Executive Officer will remain in place
throughout the term. All other terms and conditions remain in full force and
effect. The Company is in compliance with the terms of the Loan Agreement. As
of March 31, 1999, the Company had $6,032 of availability under it's Loan
Agreement.
8
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Note 5. Net Income (Loss) Per Share
Basic net income (loss) per share is calculated by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding and does not include the impact of any potentially dilutive common
stock equivalents. Diluted net income (loss) per share is calculated by
dividing net income (loss) by the weighted average number of shares outstanding,
adjusted for the dilutive effect of outstanding stock options.
The following table sets forth the computation of basic and diluted net income
(loss) per share:
Three Months Ended
March 31,
------------------------
1999 1998
---------- -----------
BASIC
Net income (loss) $ (8,278) $ 2,849
Average common shares outstanding 18,689,344 10,952,375
----------- -----------
Net income (loss) per common share - basic $ (0.44) $ 0.26
=========== ===========
DILUTED
Net income (loss) $ (8,278) $ 2,849
Average common shares outstanding 18,689,344 10,952,375
Stock option adjustment - 3,192,252
----------- -----------
Average common shares outstanding 18,689,344 14,144,627
----------- -----------
Net income (loss) per common share - diluted $ (0.44) $ 0.20
=========== ===========
Options and warrants to purchase 2,468,973 shares of common stock at March 31,
1999 were not included in the computation of diluted earnings per share as the
effect would be antidilutive. The weighted average exercise price of the
outstanding options and warrants at March 31, 1999 and 1998 was $4.40 and $4.79,
respectively.
Note 6. Distribution, Publishing and Investment in Affiliate
Distribution and Publishing Agreements
On February 10, 1999 the Company signed an International Distribution
Agreement with Virgin Interactive Entertainment Limited ("Virgin") which
provides for the exclusive distribution of substantially all of the Company's
products in Europe, CIS, Africa and the Middle East for a seven year period,
cancelable under certain conditions, subject to termination penalties and costs.
Under the Agreement, the Company pays Virgin a monthly overhead fee and a
distribution fee based on net sales, subject to a minimum annual payment, and
Virgin provides certain market preparation, warehousing, sales and fulfillment
services on behalf of the Company. In connection with this arrangement the
Company paid $420 in distribution fees and $455 in overhead fees to Virgin in
the first quarter of 1999. In addition, the Company recorded an asset valuation
and restructuring charge of $584 in the first quarter of 1999 in connection with
the reductions in the Company's European operations.
The Company has also executed a Product Publishing Agreement with Virgin which
provides the Company with an exclusive license to publish and distribute
substantially all of Virgin's products within North America, Latin America and
South America for a royalty based on net sales. During the three months ended
March 31, 1999, the Company did not distribute any of Virgin's products.
9
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Investment in Affiliate
In connection with the International Distribution Agreement and Product
Publishing Agreement, the Company has also executed an Operating Agreement with
Virgin which, among other terms and conditions, provides the Company with a
43.9% equity interest in VIE Acquisition Group LLC ("VIE"), the parent entity of
Virgin under which the Company was obligated to make a cash payment of $9.
However, the Company is not obligated to make any future contributions to the
working capital of Virgin. In addition, two members of Interplay Europe's
management have also acquired a 6.0% interest in VIE.
The Company accounts for its investment in VIE in accordance with the equity
method of accounting. The Company did not recognize any material income or loss
in connection with it's investment in VIE for the quarter ended March 31, 1999.
Note 7. Comprehensive Income (Loss)
Comprehensive income (loss) consists of the following:
Three Months Ended
March 31,
-------------------
1999 1998
------- ------
Net income (loss) $(8,278) $2,849
Other comprehensive income (loss), net of income taxes:
Foreign currency translation adjustments (22) 1
------- ------
Other comprehensive income (loss) (22) 1
------- ------
Total comprehensive income (loss) $(8,300) $2,850
======= ======
For the three months ended March 31, 1999 and 1998, the Company had pre-tax
increase (decrease) in foreign currency translations of $(22) and $1,
respectively.
Note 8. Stockholders' Equity
On March 18, 1999, the Company entered into a Stock Purchase Agreement with an
investor which provides for the issuance of 2.5 million shares of the Company's
Common Stock for $10,000. Under the terms of the Stock Purchase Agreement up to
2.5 million additional shares of the Company's common stock may be issued
without additional consideration based on the average closing share price per
share of the Company's Common Stock as of certain specified future dates;
provided, however, the investor will not be issued a total number of shares
equaling or exceeding 20% of the Company's current outstanding Common Stock
without the approval of the Company's stockholders (See Note 10).
As consideration for the extension of a $5,000 personal guarantee by the
Company's Chairman and Chief Executive Officer (the "Chairman") under the
Company's Loan Agreement (See Note 4), the Company agreed to assume the
obligation of the Chairman under an agreement between the Chairman and the
Company's President, pursuant to which the Chairman granted certain put rights
to the President with respect to the 271,528 common stock options held by the
President. The Company recorded compensation expense of approximately $700
through December 31, 1998 in connection with the grant of the options, and an
additional $300 will be amortized as interest expense over the remaining term of
the Loan Agreement. During the first quarter of 1999, the Company recorded the
Redeemable Common Stock outside of stockholders' equity.
10
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Note 9. Segment and Geographical Information
The Company operates in three principal business segments. Information about
the Company's operations in the United States and foreign areas is as follows:
Three Months Ended
March 31,
-------------------
1999 1998
------- -------
Net revenues:
United States $12,262 $31,245
United Kingdom 9,358 9,751
Other - -
------- -------
Consolidated net revenues $21,620 $40,996
======= =======
Operating income (loss):
United States $(6,867) $ 1,478
United Kingdom (523) 3,034
Other - -
------- -------
Consolidated (loss) income from operations $(7,390) $ 4,512
======= =======
Expenditures made for the acquisition
of long-lived assets:
United States $ 294 $ 348
United Kingdom - 118
Other - -
------- -------
Total expenditures for
long-lived assets $ 294 $ 466
======= =======
Net revenues were made to geographic regions as follows:
Three Months Ended March 31,
----------------------------------------
1999 1998
------------------ ------------------
Amount Percent Amount Percent
------- ------- ------- -------
North America $ 8,751 40.5% $23,516 57.4%
Europe 8,078 37.4 8,265 20.2
Rest of World 1,865 8.6 2,958 7.2
OEM, royalty and
licensing 2,926 13.5 6,257 15.2
------- ----- ------- -----
$21,620 100.0% $40,996 100.0%
======= ===== ======= =====
11
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Amounts and disclosures as of March 31, 1999 and for the three months ended
March 31, 1999 and 1998 are unaudited
(Dollars in thousands, except per share amounts)
Investments in long-lived assets by geographic regions, net are as follows:
March 31, December 31,
1999 1998
------------------ ------------------
Amount Percent Amount Percent
------- ------- ------- -------
North America $ 6,259 96.3% $ 6,621 89.6%
Europe 173 2.7 723 9.8
Rest of World - - - -
OEM, royalty and
licensing 67 1.0 44 0.6
------- ----- ------- -----
$ 6,499 100.0% $ 7,388 100.0%
======= ===== ======= =====
Note 10. Subsequent Events
Distribution Agreement
On April 3, 1999 the Company entered into an exclusive North American
distribution agreement with an investor which provides for the distribution of
eight titles on multiple platforms for a two year period. Under the terms of
the arrangement, the Company will receive a distribution fee for all orders
shipped and will provide certain services including marketing, order processing,
billings and collections.
Product Development Agreement
On April 3, 1999 the Company signed a letter of intent to enter into a multi-
product development agreement with a developer which provides for the delivery
of ten titles to the Company during 1999 in exchange for $500 paid in cash
installments and the issuance of $1,000 in unregistered, restricted Common Stock
of the Company. The shares of Common Stock will be restricted as to
registration rights until such products are delivered and accepted by the
Company. The arrangement also includes certain penalties to the developer in
the event of noncompliance and the terms and conditions are subject to the
approval by the Company's underwriters and lenders, if necessary.
Litigation
In April 1999, the Company was named as one of many defendants in a multi-
party civil action which was filed in the Western District of Kentucky which
alleges that the Company, along with the other defendants, contributed to the
unlawful actions of a convicted felon. The Company believes that this civil
action is without merit and will vigorously defend its position.
Convertible Loan; Potential Change in Control
On May 12, 1999 the Company signed a letter of intent with Titus Interactive
S.A. ("Titus") pursuant to which Titus will loan the Company $5 million, and the
Company and Titus will negotiate certain additional transactions. Should the
definitive agreements contemplated by the letter of intent not be entered into
by the Company and Titus, the loan must be repaid by the Company, or, at the
option of Titus, may be convertible into the Company's Common Stock. In the
event the agreements contemplated by the letter of intent are entered into,
Titus will make a strategic equity investment of $25 million in the Company,
purchasing 6.25 million shares of Common Stock at a purchase price of $4 per
share. As part of the agreements to be negotiated under the letter of intent,
Titus chairman and chief executive officer Herve Caen would become president of
Interplay. The letter of intent also contemplates the swap by Brian Fargo, the
Company's chairman and chief executive officer, of 2 million personal shares of
Interplay Common Stock for an agreed upon number of Titus shares. If the
transactions to be negotiated pursuant to the letter of intent are consummated,
Titus will own approximately 51% of the Company's outstanding Common Stock,
resulting in a change of control of the Company in favor of Titus.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement
The information contained in this Form 10-Q is intended to update the
information contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 and presumes that readers have access to, and will have
read, the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other information contained in such Form 10-K.
This Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934 and such forward-looking statements are
subject to the safe harbors created thereby. For this purpose, any statements
contained in this Form 10-Q except for historical information may be deemed to
be forward-looking statements. Without limiting the generality of the
foregoing, words such as "may," "will," "expect," "believe," "anticipate,"
"intend," "could," "estimate" or "continue" or the negative or other variations
thereof or comparable terminology are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forward-looking
statements.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties, as well as on
certain assumptions. For example, any statements regarding future cash flow,
financing activities, cost reduction measures, compliance with the Company's
line of credit and an extension or replacement of such line are forward-looking
statements and there can be no assurance that the Company will generate positive
cash flow in the future or that the Company will be able to obtain financing on
satisfactory terms, if at all, or that any cost reductions effected by the
Company will be sufficient to offset any negative cash flow from operations or
that the Company will remain in compliance with its line of credit or be able to
renew or replace such line. Additional risks and uncertainties include
possible delays in the completion of products, the possible lack of consumer
appeal and acceptance of products released by the Company, fluctuations in
demand, lost sales because of the rescheduling of products launched or orders
delivered, failure of the Company's markets to continue to grow, that the
Company's products will remain accepted within their respective markets, that
competitive conditions within the Company's markets will not change materially
or adversely, that the Company will retain key development and management
personnel, that the Company's forecasts will accurately anticipate market
demand, that there will be no material adverse change in the Company's
operations or business. Additional factors that may affect future operating
results are discussed in more detail in "Factors Affecting Future Performance,"
below as well as the Company's Annual Report on Form 10-K on file with the
Securities and Exchange Commission. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions, and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that the assumptions
underlying the forward-looking statements are reasonable, the business and
operations of the Company are subject to substantial risks that increase the
uncertainty inherent in the forward-looking statements, and the inclusion of
such information should not be regarded as a representation by the Company or
any other person that the objectives or plans of the Company will be achieved.
In addition, risks, uncertainties and assumptions change as events or
circumstances change. The Company disclaims any obligation to publicly release
the results of any revisions to these forward-looking statements which may be
made to reflect events or circumstances occurring subsequent to the filing of
this Form 10-Q with the SEC or otherwise to revise or update any oral or written
forward-looking statement that may be made from time to time by or on behalf of
the Company.
13
<PAGE>
Results of Operations
The following table sets forth certain selected consolidated statements of
operations data, segment data and platform data for the periods indicated in
dollars and as a percentage of total net revenues:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------------------------------------
1999 1998
------------------------ ------------------------
% of Net % of Net
Amount Revenues Amount Revenues
----------- -------- ----------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Net revenues $ 21,620 100.0% $ 40,996 100.0%
Cost of goods sold 12,566 58.1% 19,221 46.9%
----------- ----- ----------- -----
Gross profit 9,054 41.9% 21,775 53.1%
Operating expenses:
Marketing and sales 7,544 34.9% 8,589 21.0%
General and administrative 3,518 16.3% 2,855 7.0%
Product development 5,382 34.9% 5,819 14.2%
----------- ----- ----------- -----
Total operating expenses 16,444 76.1% 17,263 42.2%
----------- ----- ----------- -----
Operating income (loss) (7,390) -34.2% 4,512 10.9%
Other income (expense) (888) -4.1% (1,418) -3.5%
----------- ----- ----------- -----
Income (loss) before income taxes (8,278) -38.3% 3,094 7.4%
Provision for income taxes - 0.0% 245 0.6%
----------- ----- ----------- -----
Net income (loss) $ (8,278) -38.3% $ 2,849 6.8%
=========== ===== =========== =====
Net revenues by geographic region:
North America $ 8,751 40.5% $ 23,516 57.3%
International 9,943 46.0% 11,223 27.4%
OEM, royalty and licensing 2,926 13.5% 6,257 15.3%
Net revenues by platform:
Personal computer $ 14,020 64.9% $ 21,191 51.7%
Video game console 4,674 21.6% 13,548 33.0%
</TABLE>
Net Revenues
Net revenues for the three months ended March 31, 1999 decreased 47.3% to
$21.6 million from $41 million in the comparable 1998 quarter. North America
net revenues decreased to $8.8 million, or 40.5% of net revenues, from $23.5
million, or 57.3% of net revenues, in the 1998 quarter. International net
revenues decreased to $9.9 million, or 46% of net revenues, from $11.2 million,
or 27.4% of net revenues in the 1998 quarter. OEM, royalty and licensing net
revenues decreased to $2.9 million, or 13.5% of net revenues, in the 1999
quarter from $6.3 million, or 15.3% of net revenues, in the 1998 quarter.
The decrease in North America and International net revenues for the three
months ended March 31, 1999 was primarily due to decreased title releases and a
high level of product returns and markdowns. The Company expects that OEM,
royalty and licensing net revenues may continue to decline, both in dollars and
as a percentage of net revenues during the remainder of 1999 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.
Cost of Goods Sold; Gross Margin
Cost of goods sold decreased 34.6% in the three months ended March 31, 1999 to
$12.6 million, or 58.1% of net revenues, from $19.2 million, or 46.9% of net
revenues in the comparable 1998 quarter. Gross margin decreased to 41.9% in the
1999 quarter from 53.1% in the 1998 quarter.
The decrease in gross margin during the three months ended March 31, 1999 was
primarily a result of a lower net revenues base than in the 1998 period. The
1999 period also included the effects of additional write-off's of prepaid
royalties relating to titles or platform versions of titles which had been
canceled or were expected to achieve lower unit sales than were originally
anticipated.
14
<PAGE>
Operating Expenses
Total operating expenses decreased 4.7% to $16.4 million, or 76.1% of net
revenues, in the three months ended March 31, 1999 from $17.3 million, or 42.2%
of net revenues, for the comparable 1998 quarter.
Marketing and Sales. Marketing and sales expenses primarily include
advertising and retail marketing support, sales commissions, marketing and sales
personnel, customer support services and other costs. Marketing and sales
expenses decreased 12.2% to $7.5 million, or 34.9% of net revenues, for the
three months ended March 31, 1999 from $8.6 million, or 21.0% of net revenues
for the comparable 1998 quarter. The decreases in absolute dollars were
primarily attributable to decreased advertising and other marketing costs
associated with the decrease in major titles launched and products sold during
the 1999 period, as well as a reduction of personnel as a result of
International Distribution Agreement entered into in February 1999 between the
Company and Virgin Interactive Entertainment Limited ("Virgin"), offset in part
by increased marketing development funds in the U.S. market. The increase as a
percentage of net revenues for the three months ended March 31, 1999 was
primarily attributable to a lower net revenues base than the 1998 period. The
Company expects that in future periods marketing and sales expenses will
increase in absolute dollars, but may vary as a percentage of net revenues.
General and Administrative. General and administrative expenses primarily
include administrative personnel expenses, facilities costs, professional
expenses and other overhead charges. General and administrative expenses
increased 23.2% to $3.5 million, or 16.3% of net revenues, in the three months
ended March 31, 1999 from $2.9 million, or 7.0% of net revenues in the
comparable 1998 quarter. The increase in absolute dollars in the three months
ended March 31, 1999 was primarily due to a $0.6 million anticipated asset
valuation and restructuring charge in connection with the Company's transaction
with Virgin. The increase as a percentage of net revenues was primarily due to
a lower net revenues base than in the 1998 period. The Company may in the
future be required to make additional payments of approximately $0.2 million in
the aggregate under a lease of equipment originally utilized by Engage. The
Company is attempting to mitigate this potential expense by using or subleasing
a portion of the equipment. 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 decreased 7.5% to $5.4 million, or 24.9% of net
revenues, in the three month period ended March 31, 1999 from $5.8 million, or
14.2% of net revenues, in the comparable 1998 quarter. The decreases in
absolute dollars in the three months ended March 31, 1999 was primarily due to
decreased labor and overhead costs as a result of personnel reductions. The
increases as a percentage of net revenues was due to a lower net revenues base
than in the 1998 period. 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 Expense
Other expense for the three month period ended March 31, 1999 primarily
included interest expense on the Company's line of credit. Other expense
decreased to $0.9 million in the three months ended March 31, 1999 from $1.4
million in the comparable 1998 quarter. The decrease in the three months ended
March 31, 1999 was primarily due to decreased interest expense resulting from
the repayment of the Subordinated Secured Promissory Notes and the reduction of
the outstanding balance of the line of credit from the proceeds of the IPO in
June 1998, $9.8 million related to distribution and other advances on future
products and $10 million related to a Stock Purchase Agreement with an investor
for 2.5 million shares of the Company's Common Stock.
Provision (Benefit) for Income Taxes
The Company recorded no tax benefit in the three months ended March 31, 1999
compared to a tax provision of $0.2 million in the three months ended March 31,
1998. No tax benefit was recorded in the 1999 quarter due to the uncertainty of
realization in future periods.
15
<PAGE>
Liquidity and Capital Resources
The Company has funded its operations to date primarily through the use of
lines of credit and equipment leases, through cash generated by the private sale
of securities and from the proceeds from the initial public offering and from
operations. As of March 31, 1999 the Company's principal sources of liquidity
included cash and short term investments of approximately $0.4 million and the
Company's line of credit bearing interest at the London Interbank Offered Rate
plus 4.87% (9.84% as of March 31, 1999), expiring January 1, 2000. Under the
terms of the line of credit as in effect on March 31, 1999, the Company had
available borrowings and letters of credit up to $37.5 million through November
29, 1999, $30.0 million through December 30, 1999 and $25 million thereafter,
based in part upon qualifying receivables and inventory. Within the overall
credit limit, the line of credit as of March 31, 1999 also provided that the
Company could borrow up to $14 million in excess of its borrowing base through
July 30, 1999, $10 million in excess through September 29, 1999, and up to
$5 million in excess of its borrowing base thereafter. Under the line of
credit the Company is required to place a cash collateral deposit of $2 million
by March 15, 1999 and an additional $0.5 million for a total of $2.5 million on
April 15, 1999. In addition, the Company is required to maintain certain
borrowing limitations beginning July 30, 1999 where actual borrowings are
limited to $35 million with various month end limitations, generally decreasing
to $25 million at December 31, 1999 and the $5 million personal guarantee by the
Company's Chairman and Chief Executive Officer will remain in place throughout
the term. All other terms and conditions remain in full force and effect. The
Company is in compliance with the terms of the Loan Agreement. As of March 31,
1999, the Company's balance on the line of credit was $22.7 million with stand
by letters of credit outstanding totaling $2.6 million. Based upon certain
assumptions, including without limitation, the Company's ability to achieve
anticipated operating results, the Company believes that it will be able to
renew its line of credit or obtain alternate financing on reasonable terms.
However, there can be no assurance that the assumptions relied on by the Company
will prove correct or that the Company will be able to renew or replace its line
of credit or obtain alternate financing on reasonable terms, if at all.
In March 1999, the Company obtained equity financing by selling 2.5 million
shares of its Common Stock to Titus for $10 million. The purchase price of such
transaction will be recalculated based upon the per share price of the Company's
common stock at certain future dates. As a consequence of such recalculation,
Titus may be issued additional shares by the Company pursuant to such
transaction. In the event such additional number of shares results in aggregate
ownership by Titus of 20% or greater of the outstanding Common Stock of the
Company, the Company must have obtained the approval of its stockholders for
such issuance. In the event such approval is not obtained, the Company would be
required to issue Titus a promissory note in a principal amount equal to the
value of the shares in excess of 20% of the Company's outstanding Common Stock
to which Titus would otherwise be entitled, with interest at a rate of 10%.
There can be no assurance that the Company will obtain the approval of its
stockholders for any additional issuance, and that the Company will not issue a
promissory note to Titus as set forth above.
In May 1999, the Company and Titus signed a letter of intent under the terms
of which Titus loaned the Company $5 million, which obligation must be repaid by
the Company in the event the transactions contemplated by the letter of intent
are not consummated, or, in lieu of such repayment and at the option of Titus,
such obligation may be converted into shares of the Company's Common stock at an
agreed upon price. The letter of intent contemplates a strategic equity
investment by Titus of $25 million, subject to the entering into of definitive
agreements concerning such transaction by the Company and Titus. There can be
no assurance that the transactions contemplated by the letter of intent,
including the additional equity investment by Titus, will be consummated.
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 $6.1 million during the three months
ended March 31, 1999 and provided $0.3 million during the three months ended
March 31, 1998. The cash used by operating activities in the three months ended
March 31, 1999 was primarily attributable to the net loss incurred and decreases
in accounts payable, offset in part by a decrease in accounts receivable.
Cash provided by financing activities of $6.1 million in the three months
ended March 31, 1999 resulted primarily from the issuance of Common Stock to an
investor, offset in part by repayments on the line of credit. Cash provided by
financing activities of $0.5 million in the three months ended March 31, 1998
resulted primarily from borrowings under the Company's line of credit.
16
<PAGE>
Cash used in investing activities of $0.3 million and $0.5 million in the
three months ended March 31, 1999 and 1998, respectively, consisted of capital
expenditures, primarily for office and computer equipment used in Company
operations. The Company does not currently have any material commitments with
respect to any capital expenditures.
To provide liquidity, the Company has implemented certain measures during the
forth quarter of 1998 and the first quarter of 1999, including a reduction of
personnel, a decrease in management compensation and the delay, cancellation or
scale back of certain product development and marketing programs, among other
actions. There can be no assurance that the Company's operating expenses or
current obligations will not materially exceed cash flows available from the
Company's operations in fiscal 1999 and beyond or that the increased line of
credit will be sufficient to finance any negative cash flow from operations or
that such line of credit will be renewed or replaced on reasonable terms, if at
all. In addition, no assurance can be given that the measures heretofore
effected will not materially adversely affect the Company's ability to develop
and publish commercially viable titles, or that such measures, whether alone or
in conjunction with increased net revenues, if any, will be sufficient to
generate operating profits in fiscal 1999 and beyond. The Company may be
required to seek additional funds through debt or equity financings, product
licensing or distribution transactions or some other source of financing in
order to provide sufficient working capital for the Company. Certain of such
measures may require third party consents or approvals, including the Company's
financial institution, and there can be no such assurance that such consents or
approvals can be obtained.
The Company believes that funds available under its line of credit, amounts to
be received under various product license and distribution agreements,
anticipated funds from operations, and the proceeds from potential debt or
equity financings will be sufficient to satisfy the Company's projected working
capital and capital expenditure needs and debt obligations in the normal course
of business at least through the expiration of its line on January 1, 2000.
Based upon certain assumptions, including without limitation, the Company's
ability to achieve anticipated operating results and the completion of the
proposed transaction with Titus under the May 1999 letter of intent or other
potential debt or equity financings, the Company believes that it will be able
to renew its line of credit or obtain alternate financing on reasonable terms.
However, there can be no assurance that the assumptions relied on by the Company
will prove correct or that the Company will be able to renew or replace its line
of credit on satisfactory terms, if at all. Further, there can be no assurance
that the Company will complete the proposed transaction with Titus or other
potential debt or equity financings during such period. If the Company is
required to raise additional working capital, there can be no assurance that the
Company will be able to raise such additional working capital on acceptable
terms, if at all. In the event the Company is unable to raise additional working
capital, further measures would be necessary including, without limitation, the
sale or consolidation of certain operations, the delay, cancellation or scale
back of product development and marketing programs and other actions. No
assurance can be given that such measures would not materially adversely affect
the Company's ability to develop and publish commercially viable titles, or
that such measures would be sufficient to generate operating profits in fiscal
1999 and beyond. Certain of such measures may require third party consents or
approvals, including the Company's financial institution, and there can be no
such assurance that such consents or approvals can be obtained.
Year 2000 Issue
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. Therefore, they do not
properly recognize a year that begins with "20" rather than "19". Others do not
correctly process "leap year" dates. As a result, such systems and applications
could fail or create erroneous results unless corrected so that they can
correctly process data related to the year 2000 and beyond. The Company relies
on its systems and applications in operating and monitoring all major aspects of
its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
systems equipment and end products. The Company also relies, directly and
indirectly, on external systems of suppliers for the management and control of
product development and of business enterprises such as developers, customers,
suppliers, creditors, financial organizations, and governmental entities, both
domestic and international, for accurate exchange of data. The Company could be
affected through disruptions in the operation of the enterprises with which the
Company interacts or from general widespread problems or an economic crisis
resulting from non-compliant Year 2000 systems. Despite the Company's efforts
to address the Year 2000 impact on its internal systems and business operations,
there can be no assurance that such impact will not result in a material
disruption
17
<PAGE>
of its business or have a material adverse effect on the Company's business,
operating results and financial condition.
The Company is currently in the process of assessing the potential impact of
the Year 2000 issue on its business and the related foreseeable expenses that
may be incurred in attempting to remedy such impact. The Company is employing a
combination of internal resources and outside consultants to evaluate and
address Year 2000 issues. The Company's Year 2000 plan includes (i) Assessment:
Conducting an evaluation of the Company's computer based systems, facilities and
products (and those of significant dealers, vendors and other third parties with
which the Company does business) to determine their Year 2000 compliance, (ii)
Remediation: Coordinating the replacement and/or upgrade of non-compliant
systems, as necessary, and (iii) Test and Implement: Developing and overseeing
the implementation of all of the initiatives in the Company's Year 2000
compliance plan. For example, the Company is in the process of upgrading its
internal accounting software and expects such upgrade to be completed prior to
the commencement of the 3rd quarter in 1999. Although the Company has
identified certain systems and applications that are not Year 2000 compliant and
the Company is in the process of upgrading its software to address the Year 2000
issue, there can be no assurance that such upgrades will be completed on a
timely basis at reasonable costs, or that such upgrades will be able to
anticipate all of the problems triggered by the actual impact of the year 2000.
In addition, the inability of any internal system to achieve Year 2000
compliance could result in material disruption to the Company's operations.
With respect to customers, developers, suppliers and other enterprises upon
which the Company relies, even where assurances are received from such third
parties, there remains a risk that failure of systems and applications of such
third parties could have a material adverse effect on the Company.
The Company is currently assessing its products for Year 2000 compliance and
anticipates such assessment to be complete prior to the end of the 3rd quarter
in 1999. However, there can be no assurance that any of the Company's products
are or will be Year 2000 compliant. The failure of any of the Company's products
to achieve Year 2000 compliance would result in increased warranty costs,
customer satisfaction issues, potential lawsuits and other material costs and
liabilities. In addition, if the computer systems on which the consumers use
the Company's products are not Year 2000 compliant, such non compliance could
adversely affect the consumers ability to use such products.
The Company believes that it will substantially complete the implementation of
its Year 2000 plan prior to the commencement of the 3rd quarter in 1999.
However, if the Company does not complete its Year 2000 plan prior to the
commencement of the year 2000, or if the Company fails to identify and remediate
all critical Year 2000 problems or if major suppliers, developers or customers
experience material Year 2000 problems, the Company's results of operations or
financial condition could be materially adversely effected.
The Company has estimated that the total cost of Year 2000 compliance will be
less than $500,000, $46,000 of which had been spent. The costs of compliance
have been included in the Company's 1999 budget. The Company currently does
not have a formal contingency plan in the event that an area of its operations
does not become Year 2000 compliant. The Company will consider adopting a
formal plan upon completion of the Year 2000 assessment or if, pending such
completion, it becomes more evident that there will be an area of non-compliance
in its systems or at a critical third party.
The foregoing statements are based upon management's best estimates at the
present time, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources, third party
modification plans and other factors. There can be no assurance that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, the
nature and amount of programming required to upgrade or replace each of the
affected programs, the rate and magnitude of related labor and consulting costs
and the success of the Company's external customers, developers and suppliers in
addressing the Year 2000 issue. The Company's evaluation is ongoing and it
expects that new and different information will become available to it as the
evaluation continues. Consequently, there can be no assurance that all material
elements will be Year 2000 compliant in time.
18
<PAGE>
FACTORS AFFECTING FUTURE PERFORMANCE
Future operating results of the Company depend upon many factors and are
subject to various risks and uncertainties. Some of the risks and uncertainties
which may cause the Company's operating results to vary from anticipated results
or which may materially and adversely affect its operating results are as
follows:
Liquidity; Future Capital Requirements
The Company used net cash in operations of $6.1 million and provided net cash
from operations of $0.3 million, respectively, in the three months ended March
31, 1999 and 1998. There can be no assurance that the Company will ever
generate positive cash flow from operations. The Company's ability to fund its
capital requirements out of available cash, its 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 may be required to seek additional funds through debt or equity
financings, product licensing or distribution transactions or some other source
of financing in order to provide sufficient working capital for the Company.
The issuance of additional equity securities by the Company could result in
substantial dilution to stockholders. If the Company is required to raise
additional working capital, there can be no assurance that the Company will be
able to raise such additional working capital on acceptable terms, if at all.
In the event the Company is unable to raise additional working capital, further
cost reduction measures would be necessary including, without limitation, the
sale or consolidation of certain operations, the delay, cancellation or scale
back of product development and marketing programs and other actions. No
assurance can be given that such measures would not materially adversely affect
the Company's ability to publish commercially viable titles, or that such
measures would be sufficient to generate operating profits. Certain of such
measures may require third party approvals, including the Company's financial
institution, and there can be no assurance that such consents or approvals can
be obtained.
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, delays in shipment, 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 and may not be
recaptured in subsequent quarters. 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. 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 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
19
<PAGE>
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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors Affecting Future Performance," 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.
Significant Recent Losses
The Company has experienced significant losses in recent periods, including a
loss of $8.3 million and $16.6 million for each of the three months ended March
31, 1999 and December 31, 1998, respectively. These losses resulted primarily
from delays in the completion of certain products, a higher than expected level
of product returns and markdowns on products released during the year and lower
than expected worldwide sales of certain releases, as well as from operating
expense levels that were high relative to the Company's revenue level. 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 or adequate working capital, or bring its costs into
line with revenues, so as to attain or sustain profitability in the future.
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. 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 frequently experienced significant
delays in the introduction of new products, including certain products currently
under development. 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.
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 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 consumer 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
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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. For example, the Company had
higher than expected product returns and markdowns in the three months ended
March 31, 1999 and there can be no assurance that higher than expected product
returns and markdowns will not continue in the future. 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.
Continued Listing on the NASDAQ National Market
The Company's Common Stock is currently quoted on the NASDAQ National Market
under the symbol "IPLY." For continued inclusion on the NASDAQ National Market,
a company must meet certain tests, such as a minimum bid price of $1.00 and net
tangible assets of at least $4.0 million. In the event that the Company fails to
satisfy the listing standards on a continuous basis, the Company's Common Stock
may be removed from listing on the NASDAQ National Market. If the Company's
Common Stock is delisted from the NASDAQ National Market, trading of the
Company's Common Stock, if any, would be conducted in the over-the-counter
market in the so-called "pink sheets" or, if available, the NASD's "Electronic
Bulletin Board." In such event, investors could find it more difficult to
dispose of, or to obtain accurate quotations as to the value of, the Company's
Common Stock and the trading price per share would most likely be reduced as a
result. Upon consummation of the proposed transaction contemplated by the May
12, 1999 letter of intent between the Company and Titus, or the conversion of
the $5 million loan, See note 10 of the notes to unaudited Consolidated
Financial Statements, the Company should continue to meet the listing standards
of the NASDAQ National Market.
Distribution Agreement
In February 1999 in connection with the Company's acquisition of a 43.9%
membership interest in Virgin's parent entity, the Company signed an
International Distribution Agreement with Virgin. Under this Agreement, the
Company appointed Virgin as the exclusive distribution for substantially all of
the Company's products in Europe, CIS, Africa and the Middle East, subject to
certain reserved rights, for a seven year period. Because of the exclusive
nature of the Agreement, if Virgin were to experience problems with its
business, or were to fail to perform as expected, the Company's business,
operating results and financial condition could be materially and adversely
affected. In connection with this Agreement, Virgin will hire the Company's
European sales and marketing personnel, and the Company will pay Virgin a
distribution fee for its marketing and distribution of the Company's products,
subject to a minimum amount, as well as a fixed overhead fee, subject to
reduction in certain events. Because of the minimum distribution fee, in the
event the Company's European sales are lower than expected, the Company may
effectively pay a higher distribution fee on the units sold, which could have a
material adverse effect on the Company's business, operating results and
financial condition. In addition, due to the fixed nature of the overhead fee,
the Company will not be able to reduce its European sales and marketing expenses
in response to downturns in the Company's sales in Europe, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
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 involved 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
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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 arrangements with the Company.
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 98, 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.
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. 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 98, PlayStation and
Nintendo 64 platforms, as well as for the Sega Dreamcast platform scheduled for
release in Fall 1999. 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 platforms. 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., Mattel, Activision, Inc.,
Microsoft Corporation, LucasArts Entertainment Company, Midway Games Inc.,
Acclaim Entertainment Inc., Havas Interactive 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
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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 sale 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.
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 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, including Wal-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 profit than sales to retailers, this would have the effect of lowering the
Company's gross profit. In addition, this trend could increase the 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 more 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 uncollectible 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.
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
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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
return 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
three months ended March 31, 1999 were adversely affected by a higher than
expected level of product returns and markdown allowances and consequently
reduced net revenues. There can be no assurance that the Company will not
continue to experience such high levels of product returns and markdown
allowances in future periods, which could have a material adverse effect on the
Company's business, operating results and financial condition.
Dilution; Shares Eligible for Future Sale
In March 1999, the Company entered into a Stock Purchase Agreement with Titus
Interactive S.A. ("Titus"), pursuant to which Titus purchased from the Company
2.5 million shares of the Company's Common Stock for an aggregate purchase price
of $10 million. Pursuant to such Agreement, the Company may become obligated to
issue additional shares of Common Stock to Titus without additional
consideration in certain events (see Note 8 to the Company's Consolidated
Financial Statements.) Such issuance could result in material dilution to the
Company's stockholders.
In addition, the Company has agreed to register all of the shares held by
Titus (up to 9,658,216 shares if Titus exercises its option to acquire the
shares owned by Universal and the maximum number of additional shares are
issued) for resale under the Securities Act of 1933, as amended. Such
registration could temporarily 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 Company's
Common Stock.
On May 12, 1999 the Company signed a letter of intent with Titus pursuant to
which Titus will loan the Company $5 million, and the Company and Titus will
negotiate certain additional transactions. Should the definitive agreements
contemplated by the letter of intent not be entered into by the Company and
Titus, the loan must be repaid by the Company, or, at the option of Titus, may
be convertible into the Company's Common Stock. In the event the agreements
contemplated by the letter of intent are entered into, Titus will make a
strategic equity investment of $25 million in the Company, purchasing 6.25
million shares of Common Stock at a purchase price of $4 per share. As part of
the agreements to be negotiated under the letter of intent, Titus chairman and
chief executive officer Herve Caen would become president of Interplay. The
letter of intent also contemplates the swap by Brian Fargo, the Company's
chairman and chief executive officer, of 2 million personal shares of Interplay
Common Stock for an agreed upon number of Titus shares. If the transactions to
be negotiated pursuant to the letter of intent are consummated, Titus will own
approximately 51% of the Company's outstanding Common Stock, resulting in a
change of control of the Company in favor of Titus.
Dependence Upon Third Party Licenses
Many of the Company's products, such as its Star Trek, Major League Baseball
and Caesar's 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. For example, Paramount has granted
the Star Trek license to a third party upon the expiration of the Company's
rights. 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.
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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 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, Europe and Australia 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.
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 46.0% and 27.4% of the Company's
total net revenues in the three months ended March 31, 1999 and 1998,
respectively. Additionally, in February 1999, the Company entered into an
International Distribution Agreement with Virgin for the exclusive distribution
of its products in selected international territories. 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
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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.
Risks Associated with New European Currency
On January 1, 1999, eleven of the fifteen member countries of the European
Union ("Participating Countries") established fixed conversion rates between
their existing sovereign currencies and a new European currency, the "euro".
The euro was adopted by the Participating Countries as the common legal currency
on that date. A significant portion of the Company's sales are made to
Participating Countries and consequently, the Company anticipates that the euro
conversion will, among other things, create technical challenges to adapt
information technology and other systems to accommodate euro-denominated
transactions and limit the Company's ability to charge different prices for its
producers in different markets. While the Company anticipates that the
conversion will not cause material disruption of its business, there can be no
assurance that the conversion will not have a material effect on the Company's
business or financial condition.
Protection of Proprietary Rights
The Company regards its software as proprietary and relies on a combination of
patent, 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, and holds the
rights to one patent application related to the software engine for its Messiah
title. 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 generally 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 counties, 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. 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 communications from third parties 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.
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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 products' 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 submits its products to industry-created review boards and
publishes their ratings on its game packaging, the Company believes that
mandatory government-run integrative 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 and
financial condition.
Control by Directors and Officers
The Company's directors and executive officers and Universal Studios, Inc.
("Universal"), which currently has two representatives on the Company's Board of
Directors, beneficially own, in the aggregate, approximately 52.5% of the
Company's outstanding Common Stock. These stockholders, if acting together with
Titus, see "Potential for Control by Titus", 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.
Potential for Control by Titus
Titus beneficially owns approximately 12.0% of the Company's outstanding
Common Stock, and may be issued additional shares based upon the Company's stock
price at certain future dates, further increasing its ownership in the Company
in addition to any other potential increases in ownership. Titus also holds an
option to purchase the 4,658,216 shares of the Common Stock currently held by
Universal, which would increase its ownership percentage to approximately 34.4%.
Further, the $5 million loan made by Titus to the Company is convertible into
Common Stock of the Company at the option of Titus in the event the transactions
contemplated by the letter of intent are not consummated, resulting in a further
ownership increase. If the transactions contemplated by the letter of intent
are entered into by the Company and Titus, Titus would own approximately 51.0%
of the Common Stock of the Company, resulting in a change in control of the
Company in favor of Titus. The effect of such a change in control on the
Company is uncertain, and there can be no assurance that such a change in
control would not have a material adverse effect on the Company's business,
operating results or financial condition.
Year 2000 Compliance
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. Therefore, they do not
properly recognize a year that begins with "20" rather than "19". Others do not
correctly process "leap year" dates. As a result, such systems and applications
could fail or create erroneous results unless corrected so that they can
correctly process data related to the Year 2000 and beyond. The Company relies
on its systems and applications in operating and monitoring all major aspects of
its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
systems equipment
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and end products. The Company also relies, directly and indirectly, on external
systems of suppliers for the management and control of product development and
of business enterprises such as developers, customers, suppliers, creditors,
financial organizations, and governmental entities, both domestic and
international, for accurate exchange of data. The Company could be affected
through disruptions in the operation of the enterprises with which the Company
interacts or from general widespread problems or an economic crisis resulting
from noncompliant Year 2000 systems. Despite the Company's efforts to address
the Year 2000 impact on its internal systems and business operations, there can
be no assurance that such impact will not result in a material disruption of its
business or have a material adverse effect on the Company's business, operating
results and financial condition.
The Company is currently in the process of assessing the potential impact of
the Year 2000 issue on its business and the related foreseeable expenses that
may be incurred in attempting to remedy such impact. Although the Company has
identified certain systems and applications that are not Year 2000 compliant and
the Company is in the process of upgrading its software to address the Year 2000
issue, there can be no assurance that such upgrades will be completed on a
timely basis at reasonable costs, or that such upgrades will be able to
anticipate all of the problems triggered by the actual impact of the Year 2000.
In addition, the inability of any internal system to achieve Year 2000
compliance could result in material disruption to the Company's operations.
With respect to customers, developers, suppliers and other enterprises upon
which the Company relies, even where assurances are received from such third
parties, there remains a risk that failure of systems and applications of such
third parties could have a material adverse effect on the Company.
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, it 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 where the
Company plans to have established an on-line service, the Company's business,
operating results and financial condition could be materially adversely
affected.
Risks Associated with Acquisitions
As part of its strategy to enhance distribution and product development
capabilities, the Company intends to review potential acquisitions of
complementary businesses, products and technologies. Some of these acquisitions
could be 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.
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.
28
<PAGE>
Anti-Takeover Effects; Delaware Law and Certain Charter and Bylaw Provisions
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.
Stock Price Volatility
The trading price of the Company's Common Stock has been and could continue to
be subject to wide fluctuations in response to quarter to quarter variations in
results of operations, announcements of new products by the Company or its
competitors, product development or release schedule, general conditions in the
computer, software, entertainment, media or electronics industries, changes in
earnings estimates or buy/sell recommendations by analysts, investor perceptions
and expectations regarding the products, plans and strategic position of the
Company, its competitors and its customers, or other events or factors. In
addition, the public stock markets have experienced extreme price and trading
volume volatility, particularly in high technology sectors of the market. This
volatility has significantly affected the market prices of securities of many
technology companies for reasons frequently unrelated to the operating
performance of the specific companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any derivative financial instruments as of March 31,
1999. Further, the Company is not exposed to interest rate risk as the
Company's revolving line of credit agreement has a variable interest rate.
Therefore, the fair value of these instruments are not affected by changes in
market interest rates. The Company believes that the market risk arising from
holdings of its financial instruments is not material.
29
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in various legal proceedings, claims and
litigation arising in the ordinary course of business, including
disputes arising over the ownership of intellectual property rights and
collection matters. In the opinion of management, the outcome of such
routine claims will not have a material adverse effect on the Company's
business, financial condition or results of operations.
Item 2. Changes in Securities and Use of Proceeds
On March 18, 1999, the Company issued and sold 2.5 million shares of
the Company's Common Stock for $10 million to Titus Interactive S.A., a
French corporation. Such shares were issued in reliance upon the
exemption provided by Section 4(2) of the Securities Act.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The following exhibits are filed as part of this report:
Exhibit
Number Exhibit Title
------- -------------
27.1 Financial data schedule for the three month
period ended March 31, 1999.
(b) Reports on Form 8-K
-------------------
None
30
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERPLAY ENTERTAINMENT CORP.
Date: May 14, 1999 By: /s/ BRIAN FARGO
------------------------------
Brian Fargo,
Chairman of the Board
and Chief Executive Officer
(Principal Executive Officer)
Date: May 14, 1999 By: /s/ MANUEL MARRERO
-----------------------------
Manuel Marrero,
Chief Financial Officer
(Principal Financial and Accounting Officer)
31
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