<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 June 30, 2000
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 August 7, 2000
----- ----------------------------------------
Common Stock, $0.001 par value 30,047,405
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2000
TABLE OF CONTENTS
_____________
<TABLE>
<CAPTION>
Page Number
------------
<S> <C> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2000 (unaudited)
and December 31, 1999 3
Consolidated Statements of Operations for the Three and Six
Months ended June 30, 2000 and 1999 (unaudited) 4
Consolidated Statements of Cash Flows for the Six Months
ended June 30, 2000 and 1999 (unaudited) 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 28
Part II. Other Information
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 2000 1999
------ ----------- -------------
<S> <C> <C>
(Unaudited)
Current Assets: (Dollars in thousands)
Cash and cash equivalents $ 210 $ 399
Restricted cash 2,528 2,597
Trade receivables, net of allowances
of $5,258 and $9,161, respectively 32,519 22,209
Inventories 3,845 6,057
Prepaid licenses and royalties 20,178 19,249
Other 1,177 874
----------- ------------
Total current assets 60,457 51,385
Property and Equipment, net 4,619 4,225
Other Assets 1,135 1,326
----------- ------------
$ 66,211 $ 56,936
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current Liabilities:
Current debt $ 20,420 $ 19,630
Accounts payable 13,320 21,462
Accrued liabilities 21,681 17,915
----------- ------------
Total current liabilities 55,421 59,007
Commitments and Contingencies
Stockholders' Equity (Deficit):
Series A Preferred stock, $.001 par value,
authorized 5,000,000 shares; issued and outstanding,
719,424 shares as of June 30, 2000 and none as of
December 31, 1999 19,335 -
Common stock, $.001 par value, authorized 50,000,000
shares; issued and outstanding 30,047,405 shares
as of June 30, 2000 and 29,989,125 shares as of
December 31, 1999 30 30
Paid-in-capital 88,445 87,390
Accumulated deficit (97,314) (89,782)
Accumulated other comprehensive income 294 291
----------- ------------
Total stockholders' equity (deficit) 10,790 (2,071)
----------- ------------
$ 66,211 $ 56,936
=========== ============
</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)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net revenues $ 24,921 $ 29,430 $ 43,064 $ 50,982
Cost of goods sold 11,456 17,616 21,028 30,135
----------- ----------- ------------ -----------
Gross profit 13,465 11,814 22,036 20,847
Operating expenses:
Marketing and
sales 6,541 6,895 11,404 14,409
General and
administrative 2,428 3,158 4,987 6,177
Product
development 5,678 5,010 11,313 10,400
Other - 1,123 - 1,633
----------- ----------- ------------ ----------
Total operating
expenses 14,647 16,186 27,704 32,619
----------- ----------- ------------ ----------
Operating loss (1,182) (4,372) (5,668) (11,772)
Other expense:
Interest expense,
net 637 909 1,555 1,722
Other expense,
net 84 268 176 346
----------- ---------- ------------ -----------
Total other
expense 721 1,177 1,731 2,068
Loss before provision
for income taxes (1,903) (5,549) (7,399) (13,840)
Provision for income
taxes - 1,372 1,372
------------ ---------- ----------- -----------
Net loss $ (1,903) $ (6,921) $ (7,399) $ (15,212)
=========== ========== =========== ===========
Cumulative dividend
on participating
preferred stock $ 133 $ - $ 133 $ -
----------- ---------- ---------- -----------
Net loss available
to Common
Stockholders $ (2,036) $ (6,921) $ (7,532) $ (15,212)
=========== ========== ========== ===========
Net loss per common
share:
Basic and
diluted $ (0.07) $ (0.33) $ (0.25) $ (0.77)
=========== ========== ========= ===========
Weighted average
number of common
shares outstanding:
Basic and
diluted 30,022,811 20,932,509 30,009,698 19,817,123
=========== =========== =========== ===========
</TABLE>
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>
Six Months Ended
June 30,
----------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities: (Dollars in thousands)
Net loss $ (7,399) $(15,212)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 1,401 1,517
Noncash expense for stock options - 20
Deferred income taxes - 1,336
Minority interest in loss of subsidiary - (19)
Changes in assets and liabilities:
Trade receivables (10,310) 3,291
Inventories 2,212 (2,309)
Prepaid licenses and royalties (929) (1,794)
Other current assets (303) (383)
Other assets - 409
Accounts payable (8,142) (1,958)
Accrued liabilities 3,766 (2,687)
-------- --------
Net cash used in operating activities (19,704) (17,789)
Cash flows from investing activities:
Purchase of property and equipment (1,604) (908)
-------- --------
Net cash used in investing activities (1,604) (908)
Cash flows from financing activities:
Net borrowings on line of credit 1,202 5,480
Net proceeds from issuance of preferred stock 19,202 -
Net proceeds from issuance of common stock 236 9,257
Net proceeds from issuance of warrants 798 -
Net proceeds from issuance of notes payable - 6,676
Payments on notes payable (375) -
Proceeds from exercise of stock options 21 8
Additions to restricted cash - (2,536)
Interest proceeds from restricted cash 69 -
Payments on other debt (37) -
-------- --------
Net cash provided by financing activities 21,116 18,885
-------- --------
Effect of exchange rate changes on cash and cash equivalents 3 (64)
-------- --------
Net increase (decrease) in cash and cash equivalents (189) 124
Cash and cash equivalents, beginning of period 399 614
-------- --------
Cash and cash equivalents, end of period $ 210 $ 738
======== ========
Supplemental cash flow information:
Cash paid for:
Interest $ 1,555 $ 1,756
Income taxes - -
======== ========
Supplemental disclosures of Noncash transactions:
Accretion of preferred stock to redemption value $ (133) $ -
Issuance of common stock in exchange for rights to
intellectual properties - 1,000
Issuance of note payable in exchange for put rights - 1,000
Issuance of note payable in lieu of common stock - 1,052
======== ========
</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
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 in the United
States for complete financial statements. The results of operations for the
current interim period are not necessarily indicative of results to be expected
for the current year or any other period.
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, 1999 as filed with
the Securities and Exchange Commission.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States 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 period'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 Loan and Security Agreement (see Note 3). Restricted cash earns
interest at the bank's prime rate (9.5 percent at June 30, 2000) less three
percent (6.5 percent at June 30, 2000). Subsequent to June 30, 2000, the
Company's financial institution released the $2.5 million of restricted cash
making it available for use by the Company as working capital for operations.
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, shelf-worn and damaged
products in accordance with negotiated terms. However, the Company permits
customers to return or exchange product and may provide price protection on
products unsold by a customer. In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 48, "Revenue Recognition when Right of Return
Exists", revenue is recorded net of an allowance for estimated returns,
exchanges, markdowns, price concessions, and warranty costs. Such reserves are
based upon management's evaluation of historical experience, current industry
trends and estimated costs. The amount of reserves ultimately required could
differ materially in the near term from the amounts included in the accompanying
consolidated financial statements. Customer support provided by the Company is
limited to telephone and Internet support. These costs are not material and are
charged to expense as incurred.
6
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
In December 1999, the Securities Exchange Commission ("SEC") staff released
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition," as amended by
SAB No. 101A and SAB No. 101B, to provide guidance on the recognition,
presentation and disclosure of revenue in financial statements. SAB No. 101
explains the SEC staff's general framework for revenue recognition, stating that
certain criteria be met in order to recognize revenue. SAB No. 101 also
addresses the question of gross vs. net revenue presentation and financial
statement and Management's Discussion and Analysis disclosures related to
revenue recognition. The Company adopted SAB No. 101 effective January 1, 2000
and the adoption of this standard reduced net sales and cost of sales by
approximately $0.6 and $1.5 million but did not have an impact on the Company's
gross profit or net loss for the three and six months ended June 30, 2000. The
Company did not apply this standard to the 1999 period as the impact would have
been immaterial to the financial statements taken as a whole.
Factors Affecting Future Performance
For the six months ended June 30, 2000, the Company incurred a net loss of
$7.4 million and used cash in operating activities of $19.7 million. However,
the Company's liquidity has improved substantially during the six months ended
June 30, 2000. At June 30, 2000, the Company had positive working capital of $5
million compared to a negative $7.6 million at December 31, 1999.
To provide working capital to support the Company's operations, the Company
extended its line of credit through April 2001, in connection with which Titus
Interactive SA ("Titus") provided a $20 million corporate guarantee. The
Company also completed a transaction with Titus, which provided for the issuance
of convertible, redeemable Preferred Stock for $20 million. In addition, Titus
may be entitled to receive additional shares of Common Stock upon conversion of
their Preferred Stock if the Company defaults on its line of credit and Titus is
obligated to pay on the $20 million corporate guarantee that Titus provided on
the extension of the Company's line of credit through April 2001. In addition,
the Company secured a $5 million supplemental line of credit with Titus expiring
in May 2001 (see Note 3).
The Company believes that funds available under its lines of credit, funds
received from the sale of equity securities and anticipated funds from
operations, if any, should be sufficient to satisfy the Company's projected
working capital and capital expenditure needs in the normal course of business
at least through the expiration of its line of credit in April 2001 (see Note
3). The Company believes that it will be able to renew its line of credit or
obtain alternative financing on reasonable terms. However, there can be no
assurance that the Company will be able to raise sufficient funds to satisfy its
projected working capital and capital expenditure needs beyond April 2001.
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 fluctuations in operating results, dependence on new product
introductions, product completion and release delays, rapidly changing
technology, intense competition, dependence on distribution channels and the
risk of customer returns. Certain additional risks are discussed on pages 18-28
of this Quarterly Report on Form 10-Q.
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.
7
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 2. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- --------------
(Dollars in thousands)
<S> <C> <C>
Packaged software $2,321 $4,394
CD-ROMs, cartridges, manuals,
packaging and supplies 1,524 1,663
------------- --------------
$3,845 $6,057
============= ==============
</TABLE>
Note 3. Current Debt
Current debt consists of the following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------- --------------
(Dollars in thousands)
<S> <C> <C>
Loan agreement $20,420 $19,218
Other - 412
------------- --------------
$20,420 $19,630
============= ==============
</TABLE>
Borrowings under the Loan and Security Agreement ("Loan Agreement") bear
interest at LIBOR (6.68 percent at June 30, 2000 and 6.48 percent at December
31, 1999) plus 4.87 percent (11.55 percent at June 30, 2000 and 11.35 percent at
December 31, 1999). At June 30, 2000, the Company did not have any availability
on its line of credit with the financial institution, and had $5 million
available under its line of credit with Titus (see Notes 1 and 5). During the
three months ended June 30, 2000, the Company extended its line of credit
through April 2001 generally under the same terms, except that Titus provided a
$20 million corporate guarantee and the financial institution agreed to release
to the Company the $2.5 million of restricted cash held as collateral upon
receipt of certain Titus financial statements. Subsequent to June 30, 2000, the
financial institution released the restricted cash making it available for use
by the Company as working capital for operations. The Company is currently in
compliance with the terms of the Loan Agreement.
In April 2000, the Company secured a $5 million supplemental line of credit
with Titus expiring in May 2001. Amounts borrowed under this line will be
subject to interest at the maximum legal rate for parties other than financial
institutions, currently 10 percent per annum, payable quarterly (See Note 5).
In connection with this line of credit, Titus received a warrant for up to
100,000 shares of the Company's Common Stock at $3.79 per share that will expire
in April 2010 and is exercisable if and to the extent that the Company borrows
under the line of credit, as defined. No amounts have been borrowed under this
line of credit.
Note 4. Commitments and Contingencies
The Company and the former owner of Shiny Entertainment ("Shiny") have a
dispute over additional cash payments upon the delivery and acceptance of
interactive entertainment software titles that Shiny was committed to deliver
over time. The Company believes that no amounts are due as of June 30, 2000
under the applicable agreements.
8
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 5. Stockholders' Equity
In April 2000, the Company completed a $20 million transaction with Titus
under a Stock Purchase Agreement and issued 719,424 shares of newly designated
Series A Preferred Stock ("Preferred Stock") and a warrant for 350,000 shares of
the Company's Common Stock, which has preferences under certain events, as
defined. The Preferred Stock is convertible by Titus, redeemable by the
Company, and accrues a 6 percent cumulative dividend per annum as declared by
the Company's Board of Directors. The Company may redeem the Preferred Stock
shares at the original issue price at any time after termination of Titus's
guarantee of the Company's principal line of credit. Titus may convert the
Preferred Stock shares into shares of Common Stock at any time after May 2001 or
earlier under certain events as defined. The conversion rate is the lesser of
$2.78 or 85 percent of the market price per share at the time of conversion, as
defined. The Preferred Stock is entitled to the same voting rights as if it had
been converted to Common Stock shares subject to a maximum of 7,619,047 votes.
Conversion rights are limited to 5,504,507 shares of Common Stock unless the
Company's stockholders have approved the issuance of the Preferred Stock at
which time the Preferred Stock shares would be convertible to 7,194,240 shares
of Common Stock at closing. In connection with this transaction, Titus received
a warrant for 350,000 shares of the Company's Common Stock at $3.79 per share
exercisable at anytime. The fair value of the warrant was estimated on the date
of the grant using the Black-Scholes pricing model with the following weighted
average assumptions: dividend yield of zero percent; expected volatility of 92
percent; risk-free interest rate of 5.85 percent; and an expected life of one-
year. This resulted in the Company allocating $19,202,000 to the Preferred
Stock and $798,000 to the warrant. The value of the warrant is being accreted
over a one-year period as a dividend to the Preferred Stock. As of June 30,
2000, the Company had accreted $133,000. In addition, Titus received a warrant
for 50,000 shares of the Company's Common Stock at $3.79 per share which would
only be exercisable by Titus if the Company does not meet certain financial
operating performance targets for the year ending December 31, 2000, as defined.
Both warrants expire in April 2010.
In connection with the $20 million corporate guarantee provided by Titus on
the extension of the Company's line of credit, if the Company defaults in
accordance with the line of credit agreement, and Titus is forced to pay on its
corporate guarantee of such line, the Series A Preferred Stock conversion rights
will be adjusted so as to make such shares convertible into up to approximately
42.8 million shares of Common Stock. In the event that the Company is able to
repay to Titus the amounts paid under the guarantee within six months, the
conversion rate shall be returned to the level at which it existed prior to such
adjustment. In the event that the Company is unable to repay such amounts
within six months, the conversion rate shall be readjusted at the end of such
six month period based on the average closing price of the Company's Common
Stock for the last 20 trading days during such period. If such average price is
$10.00 per share, the shares would be convertible into 7,194,240 shares of
Common Stock, and if less than $10.00, the shares would be convertible into
approximately an additional 5,000,000 shares for each dollar the average price
is below $10.00, up to a maximum of approximately 42.8 million shares. The
Common Stock shares issuable upon conversion of the Preferred Stock or the
exercise of the warrants are subject to certain registration rights.
The Company also secured a $5 million supplemental line of credit with Titus
expiring in May 2001. Amounts drawn on this line will be subject to interest at
the maximum legal rate for parties other than financial institutions, currently
10 percent per annum, payable quarterly. In connection with this line of
credit, Titus received a warrant for up to 100,000 shares of the Company's
Common Stock at $3.79 per share that will expire in April 2010 and is
exercisable if and to the extent that the Company borrows under the line of
credit, as defined. No amounts have been borrowed under this line of credit.
9
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Other Operating Expenses
The Company recorded an asset valuation, restructuring charge and severance
expense of $0.6 and $1.1 million during the three and six months ended June 30,
1999, respectively, in connection with the reductions in the Company's European
operations. In addition, the Company recorded severance expense of $0.5 million
for the departure of the Company's former president during the three months
ended June 30, 1999.
Note 7. Net Loss Per Share
Basic net loss per share is calculated by dividing net 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 loss per share is the same as basic net loss per share
because the effect of outstanding stock options and warrants is anti-dilutive.
The impact of the Preferred Stock conversion rights into Common Stock shares
(see Note 5) were excluded from the loss per share computation at June 30, 2000.
There were options and warrants outstanding to purchase 3,886,680 shares of
Common Stock and there were 484,848 shares of restricted Common Stock at June
30, 2000, which were excluded from the loss per share computation. At June 30,
1999 there were options to purchase 2,323,580 shares of Common Stock, which were
not included in the loss per share computation. The weighted average exercise
price of the outstanding options and warrants at June 30, 2000 and 1999 was
$3.56 and $3.84, respectively.
Note 8. Comprehensive Loss
Comprehensive loss consists of the following:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Net loss $(1,903) $(6,921) $(7,399) $(15,212)
Other comprehensive income (loss),
net of income taxes:
Foreign currency translation
adjustments (1) (42) 3 (64)
------------ ------------ ------------ ------------
Total comprehensive loss $(1,904) $(6,963) $(7,396) $(15,276)
============ ============ ============ ============
</TABLE>
During the three and six months ended June 30, 2000 and 1999, the net effect
of income taxes on comprehensive income (loss) was immaterial.
Note 9. Related Parties
Distribution and Publishing Agreements
The Company amended its International Distribution Agreement with Virgin
Interactive Entertainment Limited ("Virgin") effective January 1, 2000. Under
the amended Agreement, the Company no longer pays Virgin an overhead fee or
minimum commissions. In addition, the Company extended the term of the
agreement through February 2007 and implemented an incentive plan that will
allow Virgin to earn a higher commission rate as defined. In connection with
this agreement the Company incurred distribution commission expense of $758,000
and $604,000 for the three months ended June 30, 2000 and 1999, respectively,
and $1,530,000 and $1,024,000 for
10
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
the six months ended June 30, 2000 and 1999, respectively. In addition, the
Company recognized overhead fees of $1,315,000 and $1,770,000 for the three and
six months ended June 30, 1999, respectively.
In connection with the Product Publishing Agreement with Virgin, the Company
earned $185,000 and zero for performing publishing and distribution services on
behalf of Virgin during the three months ended June 30, 2000 and 1999,
respectively, and earned $176,000 and zero for the six months ended June 30,
2000 and 1999, respectively.
As of June 30, 2000 and December 31, 1999, Virgin owed the Company $13.4
million and $9.1 million and the Company owed Virgin $12.6 million and $7.8
million, respectively.
The Company performs distribution services on behalf of Titus and receives a
commission for performance. During the three months ended June 30, 2000 and
1999, the Company recognized $45,000 and $128,000, respectively, and during the
six months ended June 30, 2000 and 1999, the Company recognized $445,000 and
$128,000, respectively.
During the three and six months ended June 30, 2000, the Company recognized $3
million in licensing revenue under a multi-product license agreement with Titus
for the technology underlying one title and the content of three titles for
multiple game platforms, for a maximum of twelve years, with variable royalties
payable to the Company from five to ten percent, as defined. The Company earned
a $3 million non-refundable fully-recoupable advance against royalties upon
signing and completing all of its obligations under the agreement. In June
1999, the Company executed Publishing agreements with Titus Interactive S.A.
("Titus") for two titles. As a result of these agreements, the Company
recognized revenue of $2.2 million for delivery of these titles to Titus.
As of June 30, 2000 and December 31, 1999, Titus owed the Company $3.7 million
and zero and the Company owed Titus $0.4 million and $0.3 million, respectively.
Investment in Affiliate
The Company accounts for its investment in VIE Acquisition Group LLC ("VIE")
in accordance with the equity method of accounting. The Company did not
recognize any material income or loss in connection with its investment in VIE
for the three and six months ended June 30, 2000 and 1999.
11
<PAGE>
INTERPLAY ENTERTAINMENT CORP. AND SUSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 10. Segment and Geographical Information
The Company operates in one principal business segment. Information about the
Company's operations in the United States and foreign markets is presented
below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
Net revenues: (Dollars in thousands)
<S> <C> <C> <C> <C>
United States $24,921 $28,813 $43,022 $ 41,075
United Kingdom - 617 42 9,907
---------- ---------- ---------- ----------
Consolidated net revenues $24,921 $29,430 $43,064 $ 50,982
========== ========== ========== ==========
Operating income (loss):
United States $ (925) $(2,340) $(5,129) $ (9,206)
United Kingdom (257) (2,032) (539) (2,566)
---------- ---------- ---------- ----------
Consolidated loss from operations $(1,182) $(4,372) $(5,668) $(11,772)
========== ========== ========== ==========
Expenditures made for the acquisition
of long-lived assets:
United States $ 856 $ 615 $ 1,558 $ 908
United Kingdom 41 - 44 -
---------- ---------- ---------- ----------
Total expenditures for
long-lived assets $ 897 $ 615 $ 1,602 $ 908
========== ========== ========== ==========
</TABLE>
Net revenues by geographic regions were as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------------------------- ----------------------------------------------------
2000 1999 2000 1999
---------------------------------------------------- -----------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent
------------ ------------- ---------- ----------- ---------- ------------- ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
North America $12,752 51.2 % $15,599 53.0 % $23,482 54.5 % $24,343 47.7 %
Europe 5,375 21.5 5,047 17.1 9,607 22.3 13,066 25.6
Rest of World 1,389 5.6 1,466 5.0 2,436 5.7 3,330 6.5
OEM, royalty and
licensing 5,405 21.7 7,318 24.9 7,539 17.5 10,243 20.2
------------ ------------- ---------- ----------- ---------- ------------- ------------ -----------
$24,921 100.0 % $29,430 100.0 % $43,064 100.0 % $50,982 100.0 %
============ ============= ========== =========== ========== ============= ============ ===========
</TABLE>
Net investments in long-lived assets by geographic regions were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--------------------------- ---------------------------
Amount Percent Amount Percent
------------ ------------- ------------ -------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
North America $5,624 97.8 % $5,435 97.9 %
Europe 71 1.2 47 0.9
Rest of World - - - -
OEM, royalty and
licensing 59 1.0 69 1.2
------------ ------------- ------------ -------------
$5,754 100.0 % $5,551 100.0 %
============ ============= ============ =============
</TABLE>
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, 1999 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 Six Months Ended
June 30, June 30,
------------------------------------------------------------------------------------------------
2000 1999 2000 1999
----------------------- ---------------------- --------------------- ----------------------
% of Net % of Net % of Net % of Net
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
----------- ---------- -------- ----------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Net revenues $24,921 100.0% $29,430 100.0% $43,064 100.0% $ 50,982 100.0%
Cost of goods sold 11,456 46.0% 17,616 59.9% 21,028 48.8% 30,135 59.1%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Gross profit 13,465 54.0% 11,814 40.1% 22,036 51.2% 20,847 40.9%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Operating expenses:
Marketing and sales 6,541 26.2% 6,895 23.4% 11,404 26.5% 14,409 28.3%
General and administrative 2,428 9.7% 3,158 10.7% 4,987 11.6% 6,177 12.1%
Product development 5,678 22.8% 5,010 17.0% 11,313 26.3% 10,400 20.4%
Other - 0.0% 1,123 3.8% - 0.0% 1,633 3.2%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Total operating expenses 14,647 58.7% 16,186 54.9% 27,704 64.4% 32,619 64.0%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Operating loss (1,182) -4.7% (4,372) -14.8% (5,668) -13.2% (11,772) -23.1%
Other expense 721 2.9% 1,177 4.0% 1,731 4.0% 2,068 4.1%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Loss before income taxes (1,903) -7.6% (5,549) -18.8% (7,399) -17.2% (13,840) -27.2%
Provision for income taxes - 0.0% 1,372 4.7% - 0.0% 1,372 2.7%
----------- ---------- -------- ----------- --------- ---------- --------- ----------
Net loss $(1,903) -7.6% $(6,921) -23.5% $(7,399) -17.2% $(15,212) -29.9%
=========== ========== ======== =========== ========= ========== ========= ==========
Net revenues by geographic
region:
North America $12,752 51.2% $15,599 53.0% $23,482 54.5% $ 24,343 47.7%
International 6,764 27.1% 6,513 22.1% 12,043 28.0% 16,396 32.1%
OEM, royalty and licensing 5,405 21.7% 7,318 24.9% 7,539 17.5% 10,243 20.2%
Net revenues by platform:
Personal computer $15,222 61.1% $19,237 65.3% $28,420 66.0% $ 32,999 64.7%
Video game console 4,294 17.2% 2,875 9.8% 7,105 16.5% 7,740 15.2%
OEM, royalty and licensing 5,405 21.7% 7,318 24.9% 7,539 17.5% 10,243 20.2%
</TABLE>
North American, International and OEM, Royalty and Licensing Net Revenues
Overall, net revenues for the three months ended June 30, 2000 decreased
compared to the same period in 1999. The decrease in North American net
revenues for the three months ended June 30, 2000 was primarily due to fewer
title releases across multiple platforms offset in part by a lower level of
product returns and allowances compared to the same period in 1999. The
increase in international net revenues was due primarily to increased net
revenues in Europe, due to a lower level of product returns and allowances
compared to the same period in 1999. OEM, royalty and licensing net revenues
decreased in the three months ended June 30, 2000 compared to the same period in
1999 due to decreased net revenues in the OEM business offset in part by an
increase in licensing transactions, which was primarily due to a $3 million
multi-product licensing transaction with Titus Interactive SA ("Titus").
Total net revenues for the six months ended June 30, 2000 decreased compared
to the same period in 1999. The decrease in North American net revenues for the
six months ended June 30, 2000 was primarily due to fewer title releases across
multiple platforms offset in part by a lower level of product returns and
allowances compared to the same period in 1999. The Company expects that North
American net revenues in 2000 will increase slightly compared to 1999. The
decrease in international net revenues was due primarily to decreased net
revenues in Europe, due to strong sales of the major hit title Baldur's Gate in
the 1999 period that did not repeat in 2000, offset in part by a lower level of
product returns and allowances compared to the same period in 1999. The Company
expects that international net revenues in 2000 will increase slightly compared
to 1999. OEM, royalty and licensing net revenues decreased in the six months
ended June 30, 2000 compared to the same period in 1999 due to decreased net
revenues from the OEM business. The Company expects that OEM, royalty and
licensing net revenues in 2000 will be generally consistent with 1999.
14
<PAGE>
Platform Net Revenues
PC net revenues decreased in the three months ended June 30, 2000 compared to
the same period in 1999 primarily due to Baldur's Gate sales of $1 million in
2000 compared to $5 million in 1999. Excluding sales of Baldur's Gate, the
Company's all-time best-selling title, the Company's net revenues remained
consistent in 2000 compared to 1999. In addition, the provision for returns and
allowances decreased from 19 percent of gross revenues for the three months
ended June 30, 1999 to 13 percent of gross revenues in the 2000 period due to
the Company's significantly improved inventory in channel position and continued
concentration on a sell-through product distribution strategy. The Company
released 6 PC titles during the three months ended June 30, 2000 compared to 11
PC titles in the 1999 period. Video game console net revenues increased in the
three months ended June 30, 2000 compared to the same period in 1999 due to
releasing 4 console titles compared to 2 titles in the 1999 period. The Company
released its first major next generation console title MDK2 (Dreamcast) in
Europe and continued to have strong sales of this title in North America.
Net revenues of PC titles decreased in the six months ended June 30, 2000
compared to the same period in 1999 primarily due to Baldur's Gate sales of $3
million in 2000 compared to $18 million in 1999. Excluding sales of Baldur's
Gate, the Company's all-time best-selling title, the Company's net revenues
increased by $10 million in 2000 over 1999. In addition, the provision for
returns and allowances decreased from 24 percent of gross revenues for the six
months ended June 30, 1999 to 13 percent of gross revenues in the 2000 period
due to the Company's significantly improved inventory-in-channel position and
continued concentration on a sell-through product distribution strategy. The
Company expects its PC net revenues to increase in total for 2000. Video game
console net revenues decreased in the six months ended June 30, 2000 compared to
the same period in 1999 due to lower price points for current generation console
titles. The Company expects its video game console net revenues to increase in
total in 2000 as a result of the added penetration into this segment and the
expected release of more titles.
Cost of Goods Sold; Gross Profit Margin
Cost of goods sold decreased in the three months ended June 30, 2000 compared
to the same period in 1999 due to lower net revenues and a higher percentage of
internally developed titles. The 1999 period reflects write-offs of prepaid
royalties in 1999 relating to titles which had been canceled by the Company.
The increase in gross profit margin was primarily due to a higher percentage of
internally developed titles sold, a lower level of product returns and markdowns
and increased licensing revenues compared to the 1999 period.
Cost of goods sold decreased in the six months ended June 30, 2000 compared to
the same period in 1999 due to lower net revenues and a higher percentage of
internally developed titles. The 1999 period reflects write-offs of prepaid
royalties in 1999 relating to titles which had been canceled mainly due to the
Company discontinuing its licensed sports product line last year. The Company
expects its cost of goods sold to increase in 2000 as compared to 1999 due to
its expected higher net revenues base. The increase in gross profit margin was
primarily due to a higher percentage of internally developed titles sold, a
lower level of product returns and markdowns and increased gross profit margins
in the OEM business compared to the 1999 period. The Company expects its gross
profit margin to increase in total for 2000 as compared to 1999 due to a
significantly improved inventory in channel position and continued concentration
on a sell-through product distribution strategy to improve inventory management
and reduce returns and allowances offset in part by the anticipated increase in
video game console releases.
Marketing and Sales
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. The decrease in
marketing and sales expenses for the three and six months ended June 30, 2000
compared to the 1999 period is primarily attributable to decreased advertising
and retail marketing support expenditures as well as lower personnel costs. In
addition, the Company amended its International Distribution Agreement with
Virgin Interactive Entertainment Limited ("Virgin") effective January 1, 2000,
which eliminated the fixed monthly overhead fees the Company incurred in the
1999 period. The Company expects its marketing and sales expenses to continue
to decrease in total for 2000 as compared to 1999.
15
<PAGE>
General and Administrative
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. The decrease in general and administrative
expenses for the three and six months ended June 30, 2000 is primarily
attributable to a decrease in bad debt expense offset in part by executive
severance charges. The Company is continuing its efforts to reduce North
American operating expenses and expects its general and administrative expenses
to continue to decrease in total for 2000 as compared to 1999.
Product Development
Product development expenses, which primarily consist of personnel and support
costs, are charged to operations in the period incurred. The increase in
product development expenses for the three and six months ended June 30, 2000 is
primarily due to increased expenditures devoted to the Company's focus on next
generation video game console platforms. The Company expects its product
development expenses to continue to increase in total for 2000 as compared to
1999.
Other Operating Expense
Other operating expenses are primarily one-time expenses associated with the
operations of the Company. During the three and six months ended June 30, 2000
the Company did not incur any other operating expenses. Other operating
expenses of $1.1 million and $1.6 million for the three and six months ended
June 30, 1999, respectively, were primarily due to the anticipated asset
valuation and restructuring charge in connection with the Company's reductions
in its European operations. In addition, the Company recorded severance expense
for the departure of the Company's former president during the six months ended
June 30, 1999.
Other Expense, net
Other expense primarily consists of interest expense on the Company's line of
credit. Other expense decreased in the three and six months ended June 30, 2000
compared to the same periods in 1999 due to decreased interest expense on
decreased average borrowings under the Company's line of credit.
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, from the proceeds from the initial public offering and from
operations.
As of June 30, 2000 the Company's principal sources of capital included
unrestricted cash of $0.2 million, $2.5 million of restricted cash released by
the bank in July 2000, and $5 million available under the Company's supplemental
line of credit with Titus expiring in May 2001. The Company's balance on the
financial institution line of credit was $20.4 million with no stand by letters
of credit outstanding at June 30, 2000. As of July 31, 2000, the Company's
availability under its financial institution line of credit was $1.3 million.
The line of credit bears interest at the London Interbank Offered Rate plus 4.87
percent (11.55 percent as of June 30, 2000). Under the terms of the line of
credit, the Company has maximum availability for borrowings and letters of
credit up to $25 million based in part upon qualifying receivables and
inventory. Within the overall credit limit, the line of credit also provides
that the Company may borrow up to $7 million in excess of its borrowing base.
Under the line of credit the Company is required to maintain a $5 million
personal guarantee by the Company's Chairman and Chief Executive Officer
("Chairman") and a $20 million corporate guarantee provided by Titus. In
connection with the $20 million corporate guarantee provided by Titus, if the
Company defaults under the terms of the line of credit agreement, and the
financial institution demands Titus to pay on its corporate guarantee, Titus may
have the right to receive additional shares of the Company's Common Stock upon
conversion of their Preferred Stock, as discussed in more detail below.
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 alternative financing on
reasonable terms. However, there can be no assurance that the assumptions
relied on by the Company will prove
16
<PAGE>
correct or that the Company will be able to renew or replace its line of credit
or obtain alternative financing on reasonable terms, if at all.
The Company's primary capital needs have historically been to fund working
capital requirements necessitated by its net losses, its sales growth and
fluctuation, 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 $19.7 million during the six months ended June 30, 2000, primarily
attributable to a decrease in accounts payable, an increase in accounts
receivable and the net loss for the six month period then ended, offset in part
by an increase in accrued expenses, inventories and depreciation and
amortization. Cash provided by financing activities of $21.1 million for the
six months ended June 30, 2000 consisted primarily of the proceeds from the
issuance of the Company's Series A Preferred Stock ("Preferred Stock") to Titus
and borrowings on the Company's line of credit. Cash used in investing
activities of $1.6 million for the six months ended June 30, 2000 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 reduce the Company's working capital needs, the Company has implemented
various measures including a reduction of personnel, a reduction of fixed
overhead commitments and has scaled back certain marketing programs. In
addition, the Company believes that its amended International Distribution
Agreement with Virgin will further reduce its international costs and expenses
in future periods. The Company is pursuing various alternatives, including
further expense reductions, in an effort to continue to reduce operating
expenses as much as possible without an adverse impact on its ability to
generate successful future business activities. There can be no assurance that
the Company will be able to undertake such measures, or that such measures would
not materially and adversely affect the Company's ability to publish
commercially viable titles, or that such measures would be sufficient to
generate operating profits. In addition, the Company's long term liquidity will
be materially dependent on its ability to develop and market successful titles
for the hardware platforms that dominate the interactive entertainment market.
To provide working capital to support the Company's future operations, the
Company took several actions including extending its line of credit to April
2001, as discussed above. In addition, the Company completed a transaction with
Titus under a Stock Purchase Agreement dated April 14, 2000 and issued 719,424
shares of newly designated Preferred Stock which has preferences under certain
events, as defined. The Preferred Stock is convertible by Titus, redeemable by
the Company, and accrues a 6 percent dividend per annum. The Company may redeem
the Preferred Stock at the original issue price at any time after termination of
Titus's guarantee of the Company's principal line of credit. Titus may convert
the Preferred Stock shares into shares of Common Stock at any time after May
2001 or earlier under certain events as defined. The conversion rate is the
lesser of $2.78 or 85 percent of the market price per share at the time of
conversion, as defined. The Preferred Stock is entitled to the same voting
rights as if it had been converted to Common Stock subject to a maximum of
7,619,047 votes. Conversion rights are limited to 5,504,507 shares of Common
Stock unless the Company's stockholders have approved the issuance of the
Preferred Stock at which time the Preferred Stock shares would be convertible to
7,194,240 shares of Common Stock at closing. In the event that the Company
defaults on its line of credit and Titus is forced to pay on its corporate
guarantee of such line, the Series A Preferred Stock conversion rights will be
adjusted so as to make such shares convertible into up to approximately 42.8
million shares of Common Stock. In the event that the Company is able to repay
to Titus the amounts paid under the guarantee within six months, the conversion
rate shall be returned to the level at which it existed prior to such
adjustment. In the event that the Company is unable to repay such amounts
within six months, the conversion rate shall be readjusted at the end of such
six month period based on the average closing price of the Company's Common
Stock for the last 20 trading days during such period. If such average price is
$10.00 per share, the shares would be convertible into 7,194,240 shares of
Common Stock, and if less than $10.00, the shares would be convertible into
approximately an additional 5,000,000 shares for each dollar the average price
is below $10.00, up to a maximum of approximately 42.8 million shares.
In connection with this transaction, Titus received a warrant for 350,000
shares of Common Stock at $3.79 per share exercisable at any time, and a warrant
for 50,000 shares of the Company's Common Stock at $3.79 per share which would
only be exercisable by Titus if the Company's audited pre-tax income for the
year ending December 31, 2000, is less than $2.1 million. Both warrants expire
in April 2010. The Common Stock shares issuable upon conversion of the
Preferred Stock or the exercise of the warrants are subject to certain
registration rights. The Company also obtained a $5 million supplemental
secured line of credit with Titus expiring in May 2001. Amounts
17
<PAGE>
drawn on this line will be subject to interest at the maximum legal rate for
parties other than financial institutions, currently 10 percent per annum,
payable quarterly. In connection with this line of credit, Titus received a
warrant for up to 100,000 shares of the Company's Common Stock at $3.79 per
share that will expire in April 2010. The warrant will become exercisable if and
to the extent that the Company borrows under the line of credit. No amounts have
been borrowed under this line of credit.
The Company believes that funds available under its lines of credit, amounts
to be received from equity financing, amounts to be received under various
product license and distribution agreements and anticipated funds from
operations will be sufficient to satisfy the Company's projected working capital
and capital expenditure needs in the normal course of business at least through
the expiration of its line of credit in April 2001. 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 alternative 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 not be required to raise additional working capital
through debt or equity financing 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 2000 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.
FACTORS AFFECTING FUTURE PERFORMANCE
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. Some of the risks and uncertainties which may
cause our operating results to vary from anticipated results or which may
materially and adversely affect its operating results are as follows:
Liquidity; Future Capital Requirements
We used net cash in operations of $19.7 million and $26.4 million during the
six months ended June 30, 2000 and the year ended December 31, 1999,
respectively. We cannot assure you that we will ever generate positive cash
flow from operations. Our ability to fund our capital requirements out of our
available cash, lines of credit and cash generated from our operations depends
on a number of factors. Some of these factors include the progress of our
product development programs, the rate of growth of our business, and our
products' commercial success. We may have to seek additional funds through debt
or equity financings, product licensing or distribution transactions or other
sources of financing in order to provide ourselves with enough working capital.
If we issue additional equity securities, our existing stockholders could suffer
a large amount of dilution in their ownership. In the event we have to raise
additional working capital from other sources, we cannot assure you that we will
be able to raise additional working capital on acceptable terms, if at all. In
the event we cannot raise additional working capital, we would have to take
additional actions to continue to reduce our costs, including selling or
consolidating certain operations, delaying, canceling or scaling back product
development and marketing programs and other actions. These measures could
materially and adversely affect our ability to publish successful titles, and
these measures may not be enough to generate operating profits. We might have
to get the approval of other parties, including our financial lender and Titus,
for some of these measures, and we cannot assure you that we would be able to
obtain those approvals.
Fluctuations in Operating Results; Uncertainty of Future Results; Seasonality
Our operating results have fluctuated a great deal in the past and will
probably continue to fluctuate significantly in the future, both on a quarterly
and an annual basis. Many factors may cause or contribute to these
fluctuations, and many of these factors are beyond our control. Some of these
factors include the following:
. delays in shipping our products
. demand for our products
18
<PAGE>
. demand for our 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 us and our
competitors
. changes in our product mix
. the number of our products that are returned
. the timing of orders placed by our distributors and dealers
. the timing of our development and marketing expenditures
. price competition
. the level of our international and OEM, royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which we
will ship our products. Some of these factors include:
. the uncertainties associated with the interactive entertainment software
development process
. long manufacturing lead times for Nintendo-compatible products
. possible production delays
. the approval process for products compatible with the Sony Computer
Entertainment, Nintendo and Sega video game consoles
. approvals required from other licensors
. the release of new game hardware platforms.
Because of the limited number of products we introduce in any particular
quarter, a delay in the introduction of a product may materially and adversely
affect our operating results for that quarter, and may not be recaptured in
later quarters. A significant portion of our operating expenses is relatively
fixed, and planned expenditures are based largely on sales forecasts. If net
revenues do not meet our 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, our net revenues, gross profits and
operating income have historically been highest during the fourth and the
following first calendar quarters, and have declined from those levels in the
following second and third calendar quarters.
Our failure or inability to introduce products on a timely basis to meet these
seasonal increases in demand may have a material adverse effect on our business,
operating results and financial condition.
We may over time become increasingly affected by the industry's seasonal
patterns. Although we seek to reduce the effect of such seasonal patterns on
our business by distributing our product release dates more evenly throughout
the year, we cannot assure you that these efforts will be successful. We cannot
assure you that we will be profitable in any particular period given the
uncertainties associated with software development, manufacturing, distribution
and the impact of the industry's seasonal patterns on our net revenues.
As a result of the foregoing factors it is likely that our operating results
in one or more future periods will fail to meet or exceed the expectations of
securities analysts or investors. In that event, the trading price of our
Common Stock would likely be materially adversely affected.
Significant Recent Losses
We have experienced significant net losses in recent periods, including losses
of $7.4 million and $41.7 million for the six months ended June 30, 2000 and the
year ended December 31, 1999, respectively. The 1999 losses resulted primarily
from delays in the completion of certain products, a higher than expected level
of product returns and allowances on products previously released, and the cost
of restructuring our operations, including international distribution
arrangements. The year to date 2000 losses resulted primarily from lower than
expected worldwide sales of certain product releases, as well as from operating
expense levels that were high relative to our achieved revenue level. We may
experience similar problems in future periods and we may not be able to generate
sufficient net revenues or adequate working capital, or bring our costs into
line with revenues, so as to attain or sustain profitability in the future.
19
<PAGE>
Dependence on New Product Introductions; Risk of Product Delays and Product
Defects
Our products typically have short life cycles, and we depend on the timely
introduction of successful new products to generate net revenues, to fund
operations and to replace declining net revenues from older products. These new
products include enhancements of or sequels to our existing products and
conversions of previously released products to additional platforms. If in the
future, for any reason, net revenues from new products fail to replace declining
net revenues from existing products, our 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 with
six to 12 months for adapting a product to a different technology platform. In
the past, we have 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 these products and on our business, operating results
and financial condition. The cost of developing and marketing new interactive
entertainment software has increased in recent years due to such factors as the
increasing complexity and content of interactive entertainment software, the
increasing sophistication of hardware technology and consumer tastes and the
increasing costs of obtaining licenses for intellectual properties. We expect
this trend to continue. We cannot assure you that our new products will be
introduced on schedule, if at all, or that, if introduced, these products will
achieve significant market acceptance or generate significant net revenues for
us. In addition, software products as complex as the ones we offer may contain
undetected errors when first introduced or when new versions are released. We
cannot assure you that, despite testing prior to release, errors will not be
found in new products or releases after shipment, resulting in loss of or delay
in market acceptance. This loss or delay could have a material adverse effect
on our business, operating results and financial condition.
Uncertainty of Market Acceptance; Dependence on Hit Titles
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our new products will achieve significant market acceptance, or
that we will be able to sustain this acceptance for a significant length of time
if we achieve it. We also cannot assure you that product life cycles will be
sufficient to permit us to recover product development and other associated
costs. Most of our products have a relatively short life cycle and sell for a
limited period of time after their initial release, usually less than one year.
We believe that these trends will continue in our industry and that our future
revenue will continue to be dependent on the successful production of hit titles
on a continuous basis. Because we introduce a relatively limited number of new
products in a given period, the failure of one or more of these products to
achieve market acceptance could have a material adverse effect on our business,
operating results and financial condition. Further, if we do not achieve market
acceptance, we could be forced to accept substantial product returns or grant
significant markdown allowances to maintain our relationship with retailers and
our access to distribution channels. For example, we had significantly higher
than expected product returns and markdowns during the year ended December 31,
1999 and we cannot assure you that higher than expected product returns and
markdowns will not continue in the future. In the event that we are forced to
accept significant product returns or grant significant markdown allowances, our
business, operating results and financial condition could be materially
adversely affected.
Control by Titus
Titus currently owns 12,817,255 shares, or approximately 43 percent, of our
outstanding Common Stock, 719,424 shares of our Series A Preferred Stock that
have certain voting rights and are convertible into at least 7,194,240 shares of
Common Stock at any time after May 2001 if not previously redeemed by the
Company, and warrants for up to 500,000 shares of our Common Stock. In addition,
if we default on our line of credit and Titus is obligated to pay on the $20
million corporate guarantee that they provided on the extension of our line of
credit through April 2001, the Series A Preferred Stock may become convertible
into up to 42.8 million shares of our Common Stock, which would constitute
approximately 75 percent of our Common Stock as of the date hereof. In
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connection with Titus' investment, Herve Caen, Titus' chairman and chief
executive officer, serves as our president and as a member of our Board of
Directors, and Herve's brother Eric Caen, who is president and a director of
Titus, also serves on our Board of Directors. As a consequence, Titus holds
significant voting power with respect to the election of our Board of Directors
and the right of approval of certain significant corporate actions, and Herve
and Eric Caen have substantial authority over our operations. As the Company's
capital structure currently stands, in the event that the Stockholder Agreement
pursuant to which our Board of Directors is currently nominated terminates,
Titus would be able to elect 4 of 7 members of the Board of Directors. In such
event, Titus would be able to set our dividend policy and otherwise exercise
substantial control over our management. This control could prevent or hinder a
sale of the Company on terms that are not acceptable to Titus.
Continued Listing on the NASDAQ National Market
Our 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, including a minimum bid price of $1.00 and net tangible
assets of at least $4 million. In the event that we fail to satisfy the listing
standards on a continuous basis, our Common Stock may be removed from listing on
the NASDAQ National Market. The continued listing of our Common Stock on the
NASDAQ National Market was recently reviewed by a NASDAQ listing qualifications
panel, which determined to allow the continued listing of our Common Stock on
the NASDAQ National Market, subject to certain conditions. There can be no
assurance that we will satisfy such conditions, or that we will be able to
maintain our listing in the future. If our Common Stock were delisted from the
NASDAQ National Market, trading of our Common Stock, if any, would be conducted
on the NASDAQ Small Cap Market, in the over-the-counter market on the so-called
"pink sheets" or, if available, the NASD's "Electronic Bulletin Board." In any
of those cases, investors could find it more difficult to dispose of, or to
obtain accurate quotations as to the value of, our Common Stock. The trading
price per share of our Common Stock would most likely be reduced as a result.
Distribution Agreement
In connection with our acquisition of a 43.9 percent membership interest in
Virgin's parent entity in February 1999, we signed an International Distribution
Agreement with Virgin. Under this Agreement, as amended, we appointed Virgin as
our exclusive distributor for substantially all of our products in Europe, the
CIS, Africa and the Middle East, subject to certain reserved rights, for an
eight-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, our business, operating results and financial condition could be
materially and adversely affected. In connection with this Agreement, Virgin
hired our European sales and marketing personnel, and we pay Virgin a
distribution fee for marketing and distributing our products and certain direct
costs and expenses.
Dependence on Third Party Software Developers
We rely on third party interactive entertainment software developers for the
development of a significant number of our interactive entertainment software
products. As there continues to be high demand for reputable and competent
third party developers, we cannot assure you that third party software
developers that have developed products for us in the past will continue to be
available to develop products for us in the future. Many third party software
developers have limited financial resources, which could expose us to the risk
that such developers may go out of business prior to completing a project. In
addition, due to our limited control over third party software developers, we
cannot assure you that such developers will complete products for us on a timely
basis or within acceptable quality standards, if at all. Due to increased
competition for skilled third party software developers, we have had to agree to
make advance payments on royalties and guaranteed minimum royalty payments to
intellectual property licensors and game developers, and we expect to continue
to enter into these kinds of arrangements. If the products subject to these
arrangements do not have sufficient sales volumes to recover these royalty
advances and guaranteed payments, we would have to write-off unrecovered
portions of these payments, which could have a material adverse effect on our
business, operating results and financial condition. Further, we cannot assure
you that third party developers will not demand renegotiation of their
arrangements with the Company.
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Rapidly Changing Technology; Platform Risks
The interactive entertainment software industry is subject to rapid
technological change. New technologies, including operating systems such as
Microsoft Windows 98 and 2000, 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 our current products or
products in development obsolete or unmarketable. We must continually anticipate
and assess the emergence of, and market acceptance of, new interactive
entertainment software platforms well in advance of the time the platform is
introduced to consumers. Because product development cycles are difficult to
predict, we must make substantial product development and other investments in a
particular platform well in advance of introduction of the platform. If the
platforms for which we develop software are not released on a timely basis or do
not attain significant market penetration, our business, operating results and
financial condition could be materially adversely affected. Alternatively, if we
fail to develop products for a platform that does achieve significant market
penetration, then our 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 emerging technologies gain widespread acceptance.
This postponement could have a material adverse effect on our business,
operating results and financial condition. We are currently developing products
for Microsoft Windows 98 and 2000, Sony PlayStation and PlayStation 2, and Sega
Dreamcast platforms. We are also planning to develop product for new platforms
expected to be introduced in 2001 by Microsoft and Nintendo. Our success will
depend in part on our ability to anticipate technological changes and to adapt
our products to emerging game platforms. We cannot assure you that we will be
able to anticipate future technological changes, to obtain licenses to develop
products for those platforms on favorable terms or to create software for those
new platforms. Any failure to do so could have a material adverse effect on our
business, operating results and financial condition.
Industry Competition; Competition for Shelf Space
The interactive entertainment software industry is intensely competitive and
new interactive entertainment software programs and software platforms are
regularly introduced. Our competitors vary in size from small companies to very
large corporations with significantly greater financial, marketing and product
development resources than ours do. Due to these greater resources, certain of
our competitors can 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 we can. We believe that the main competitive factors
in the interactive entertainment software industry include:
. product features
. brand name recognition
. access to distribution channels
. quality
. ease of use, price, marketing support and quality of customer service.
We compete primarily with other publishers of PC and video game console
interactive entertainment software. Significant competitors include:
. Electronic Arts Inc.
. Mattel, Inc.
. Activision, Inc.
. Infogrames Entertainment
. Microsoft Corporation
. LucasArts Entertainment Company
. Midway Games Inc.
. Acclaim Entertainment, Inc.
. Havas Interactive
. Hasbro, Inc.
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. The 3DO Company
. Take Two Interactive Software, Inc.
. Eidos PLC
. THQ Inc.
In addition, integrated video game console hardware/software companies such as
Sony Computer Entertainment, Nintendo and Sega compete directly with us 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, may decide to compete directly with us or to enter
into exclusive relationships with our competitors. We also believe that the
overall growth in the use of the Internet and on-line services by consumers may
pose a competitive threat if customers and potential customers spend less of
their available home PC time using interactive entertainment software and more
using the Internet and on-line services.
Retailers of our 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 us to
increase our 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. Our
products constitute a relatively small percentage of any retailer's sale volume,
and we cannot assure you that retailers will continue to purchase our products
or to provide our products with adequate levels of shelf space and promotional
support. A prolonged failure in this regard may have a material adverse effect
on our business, operating results and financial condition.
Dependence on Distribution Channels; Risk of Customer Business Failures; Product
Returns
We currently sell our products directly through our own sales force to mass
merchants, warehouse club stores, large computer and software specialty chains
through catalogs in the U.S. and Canada, as well as to certain distributors.
Outside North America, we generally sell products to third party distributors.
Our sales are made primarily on a purchase order basis, without long-term
agreements. The loss of, or significant reduction in sales to, any of our
principal retail customers or distributors could materially adversely affect our
business, operating results and financial condition.
The distribution channels through which publishers sell consumer software
products evolve continuously through a variety of means, 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 will likely
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 us from selling certain of our products directly to that mass merchant.
If the number of mass merchants entering into exclusive buying arrangements with
our competitors were to increase, our 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 our gross profit. This trend could have a
material adverse impact on our 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 us to maintain access to these channels of distribution. We
cannot assure you that we will maintain access or that our access will allow us
to maintain our historical sales volume levels.
Distributors and retailers in the computer industry have from time to time
experienced significant fluctuations in their businesses, and a number have
failed. The insolvency or business failure of any significant distributor or
retailer of our products could have a material adverse effect on our business,
operating results and financial condition. We typically make sales to
distributors and retailers on unsecured credit, with terms that vary depending
upon the customer and the nature of the product. Although we have insolvency
risk insurance to protect against our customers' bankruptcy, insolvency or
liquidation, this insurance contains a significant deductible and a co-payment
obligation, and the policy does not cover all instances of non-payment. In
addition, while we maintain a reserve for uncollectible receivables, the actual
reserve may not be sufficient in every circumstance. As a result, a payment
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default by a significant customer could have a material adverse effect on our
business, operating results and financial condition.
We are exposed to the risk of product returns and markdown allowances with
respect to our distributors and retailers. We allow distributors and retailers
to return defective, shelf-worn and damaged products in accordance with
negotiated terms, and also offer a 90-day limited warranty to our end users that
our products will be free from manufacturing defects. In addition, we provide
markdown allowances to our customers to manage our customers' inventory levels
in the distribution channel. Although we maintain a reserve for returns and
markdown allowances, and although our agreements with certain of our customers
place certain limits on product returns and markdown allowances, we could be
forced to accept substantial product returns and provide markdown allowances to
maintain our relationships with retailers and our access to distribution
channels. Product return and markdown allowances that exceed our reserves could
have a material adverse effect on our business, operating results and financial
condition. In this regard, our results of operations for the year ended
December 31, 1999 were adversely affected by a higher than expected level of
product returns and markdown allowances, which reduced our net revenues. We may
continue to experience such high levels of product returns and markdown
allowances in future periods, which could have a material adverse effect on our
business, operating results and financial condition.
Shares Eligible for Future Sale
In 1999, we entered into two Stock Purchase Agreements with Titus, pursuant to
which Titus purchased 10,795,455 shares of our Common Stock from us for an
aggregate purchase price of $35 million. As part of the agreements, Titus'
chairman and chief executive officer became our president, and our chairman and
chief executive officer exchanged 2 million personal shares of our Common Stock
for an agreed upon number of Titus shares. As a result of these transactions,
Titus currently owns approximately 43 percent of our outstanding common stock.
In addition, Titus purchased 719,424 shares of Preferred Stock for $20 million
from us in April 2000. The Preferred Stock is convertible by Titus, redeemable
by us, and accrues a six percent dividend per year. Titus may convert the
Preferred Stock at any time after May 2001 and has conversion rights limited to
5,504,507 shares of Common Stock unless our stockholders approve the issuance of
the Preferred Stock at which time the Preferred Stock shares would become
convertible into at least 7,194,240 shares of our Common Stock. Titus also
received warrants to purchase up to 500,000 shares of our Common Stock. If we
default in accordance with the line of credit agreement, and Titus is forced to
pay on their corporate guarantee, the Series A Preferred Stock may become
convertible into up to 42.8 million shares of our Common Stock.
We have agreed to register all of the unregistered shares held by Titus as
well as shares issuable upon Titus' exercise of warrants or conversion of
preferred stock for resale under the Securities Act of 1933, as amended. This
registration could temporarily impair our ability to raise capital through the
sale of our equity securities, and, if such registered shares are sold, could
have a material adverse effect on the market price of our Common Stock.
Dependence upon Third Party Licenses
Many of our products, such as our Star Trek, Advanced Dungeons and Dragons and
the Caesar's Palace titles, are based on original ideas or intellectual
properties licensed from other parties. We cannot assure you that we will be
able to obtain new licenses, or renew existing licenses, on commercially
reasonable terms, if at all. For example, Viacom Consumer Products, Inc. has
granted the Star Trek license to another party upon the expiration of our
rights. If we are unable to obtain licenses for the underlying content that we
believe offers the greatest consumer appeal, we would either have to seek
alternative, potentially less appealing licenses, or release the products
without the desired underlying content, either of which could have a material
adverse effect on our business, operating results and financial condition. We
cannot assure you that acquired properties will enhance the market acceptance of
our products based on those properties. We also cannot assure you that our 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
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the PlayStation and PlayStation
2. We have also obtained agreements to develop software for the Sega Dreamcast
platform, which was introduced in the United States and Europe in Fall 1999. We
cannot assure you that we 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, Sony Computer Entertainment, Nintendo
and Sega each 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, we must make significant product development
expenditures on a particular product prior to the time we seek these approvals.
Our inability to obtain these approvals could have a material adverse effect on
our 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 those licensees are restricted in the number of titles that
will be approved for distribution on the particular platform. While we have
prepared our future product release plans taking this competitive approval
process into consideration, if we incorrectly predict its impact and fail to
obtain approvals for all products in our development plans, this failure could
have a material adverse effect on our business, operating results and financial
condition. We depend upon Sony Computer Entertainment, Nintendo and Sega for
the manufacture of our products that are compatible with their respective video
game consoles. As a result, Sony Computer Entertainment, Nintendo and Sega have
the ability to raise prices for supplying these products at any time and
effectively control the timing of our release of new titles for those platforms.
PlayStation and Dreamcast products consist of CD-ROMs and are typically
delivered by Sony Computer Entertainment and Sega, respectively, within a
relatively short lead time. Manufacturers of Nintendo and other video game
cartridges typically deliver software to us within 45 to 60 days after receipt
of a purchase order. If we experience unanticipated delays in the delivery of
video game console products from Sony Computer Entertainment, Sega or Nintendo,
or if actual retailer and consumer demand for our interactive entertainment
software differs from our forecast, our business, operating results and
financial condition could be materially adversely affected.
Dependence on Key Personnel
Our success depends to a significant extent on the continued service of our
key product design, development, sales, marketing and management personnel, and
in particular on the leadership, strategic vision and industry reputation of our
founder and Chief Executive Officer, Brian Fargo. Our future success will also
depend upon our 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
we cannot assure you that we will be successful in attracting and retaining such
personnel. Specifically, we may experience increased costs in order to attract
and retain skilled employees. Our failure to retain the services of Brian Fargo
or other key personnel or to attract and retain additional qualified employees
could have a material adverse effect on our business, operating results and
financial condition.
Risks Associated with International Operations; Currency Fluctuations
Our international net revenues accounted for 28 and 32 percent of our total
net revenues for the six months ended June 30, 2000 and 1999, respectively. In
February 1999, we entered into an International Distribution Agreement with
Virgin for the exclusive distribution of our products in selected international
territories. We intend to continue to expand our direct and indirect sales,
marketing and product localization activities worldwide. This expansion will
require a great deal of management time and attention and financial resources in
order to develop improved international sales and support channels. We cannot
assure you, however, that we will be able to maintain or increase international
market demand for our products. Our international sales and operations are
subject to a number of inherent risks, including the following:
. the impact of recessions in foreign economies
. the time and financial costs associated with translating and localizing
products for international markets
. longer accounts receivable collection periods
. greater difficulty in accounts receivable collection
. unexpected changes in regulatory requirements
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. difficulties and costs of staffing and managing foreign operations
. political and economic instability.
These factors may have a material adverse effect on our future international
net revenues and, consequently, on our business, operating results and financial
condition. We currently do not engage in currency hedging activities. Although
exposure to currency fluctuations to date has been insignificant, we cannot
assure you 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 our 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 established fixed conversion rates between their existing sovereign
currencies and a new European currency, the euro. These eleven countries
adopted the euro as the common legal currency on that date. We make a
significant portion of our sales to these countries. Consequently, we
anticipate that the euro conversion will, among other things, create technical
challenges to adapt information technology and other systems to accommodate
euro-denominated transactions. The euro conversion may also limit our ability
to charge different prices for our products in different markets. While we
anticipate that the conversion will not cause major disruption of our business,
the conversion may have a material effect on our business or financial
condition.
Protection of Proprietary Rights
We regard our software as proprietary and rely on a combination of patent,
copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights.
We own or license various copyrights and trademarks, and hold the rights to one
patent application related to the software engine for one of our titles. While
we provide "shrinkwrap" license agreements or limitations on use with our
software, it is uncertain to what extent these agreements and limitations are
enforceable. We are aware that some unauthorized copying occurs within the
computer software industry, and if a significantly greater amount of
unauthorized copying of our interactive entertainment software products were to
occur, our operating results could be materially adversely affected. While we
use copy protection on some of our products, we do not provide source code to
third parties unless they have signed nondisclosure agreements with respect to
that source code.
We rely on existing copyright laws to prevent unauthorized distribution of our
software. Existing copyright laws afford only limited protection. Policing
unauthorized use of our products is difficult, and software piracy can be a
persistent problem, especially in certain international markets. Further, the
laws of certain countries where our products are or may be distributed either do
not protect our products and intellectual property rights to the same extent as
the laws of the U.S. or are weakly enforced. Legal protection of our rights may
be ineffective in such countries, and as we leverage our software products using
emerging technologies, such as the Internet and on-line services, our ability to
protect our intellectual property rights and to avoid infringing others'
intellectual property rights may be diminished. We cannot assure you that
existing intellectual property laws will provide adequate protection for our
products in connection with these emerging technologies.
As the number of interactive entertainment software products in the industry
increases and the features and content of these products continues to overlap,
software developers may increasingly become subject to infringement claims.
Although we make reasonable efforts to ensure that our products do not violate
the intellectual property rights of others, we cannot assure you that claims of
infringement will not be made. Any such claims, with or without merit, can be
time consuming and expensive to defend. From time to time, we receive
communications from third parties regarding such claims. We cannot assure you
that existing or future infringement claims against us will not result in costly
litigation or require us to license the intellectual property rights of third
parties, either of which could have a material adverse effect on our business,
operating results and financial condition.
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 for interactive entertainment software publishers to identify
particular products within defined rating categories and communicate these
ratings to consumers through appropriate package labeling and through
advertising and marketing
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presentations. In addition, many foreign countries have laws that permit
governmental entities to censor the content of certain works, including
interactive entertainment software. In certain instances, we may be required to
modify our products to comply with the requirements of these governmental
entities, which could delay the release of those products in those countries.
Those delays could have a material adverse effect on our business, operating
results and financial condition. While we currently voluntarily submit our
products to industry-created review boards and publish their ratings on our game
packaging, we believe that mandatory government-run interactive entertainment
software products rating systems eventually will be adopted in many countries
that represent significant markets or potential markets for our products. Due to
the uncertainties inherent in the implementation of such rating systems,
confusion in the marketplace may occur, and we are unable to predict what
effect, if any, such rating systems would have on our business. In addition to
such regulations, certain retailers have in the past declined to stock certain
of our products because they believed that the content of the packaging artwork
or the products would be offensive to the retailer's customer base. While to
date these actions have not had a material adverse effect on our business,
operating results or financial condition, we cannot assure you that similar
actions by our distributors or retailers in the future would not have a material
adverse effect on our business, operating results and financial condition.
Control by Directors and Officers
Including Titus, our directors and executive officers beneficially own voting
stock with total of about 59 percent of the aggregate voting power in the
Company, and could, under certain circumstances, gain substantial additional
voting power. See "Factors Affecting Future Performance - Control by Titus".
These stockholders can control substantially all matters requiring our
stockholders' approval, including the election of directors (subject to our
stockholders' cumulative voting rights) and the approval of mergers or other
business combination transactions. This concentration of voting power could
discourage or prevent a change in control.
Development of Internet/On-Line Services or Products
We seek to establish an on-line presence by creating and supporting sites on
the Internet. Our future plans envision conducting and supporting on-line
product offerings through these sites or others. Our ability to successfully
establish an on-line presence and to offer online products will depend on
several factors outside our control. These factors include the emergence of a
robust online industry and infrastructure and the development and implementation
of technological advancements to the Internet to increase bandwidth to the point
that will allow us 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, we cannot
assure you that a viable commercial marketplace on the Internet will emerge from
the developing industry infrastructure or that the appropriate complementary
products for providing and carrying Internet traffic and commerce will be
developed. We also cannot assure you that we will be able to create or develop
a sustainable or profitable on-line presence or that we will be able to generate
any significant revenue from on-line product offerings in the near future, if at
all. If the Internet does not become a viable commercial marketplace, or if this
development occurs but is insufficient to meet our needs or if such development
is delayed beyond the point where we plan to have established an on-line
service, our business, operating results and financial condition could be
materially adversely affected.
Risks Associated with Acquisitions
As part of our strategy to enhance distribution and product development
capabilities, we intend to review potential acquisitions of complementary
businesses, products and technologies. Some of these acquisitions could be
material in size and scope. While we will continue to search for appropriate
acquisition opportunities, we cannot assure you that the Company will be
successful in identifying suitable acquisition opportunities. If we do identify
any potential acquisition opportunity, we cannot assure you that we will
consummate the acquisition, and if the acquisition does occur, we cannot assure
you that it will be successful in enhancing our business or will increase our
earnings. As the interactive entertainment software industry continues to
consolidate, we may face increased competition for acquisition opportunities,
which may inhibit our ability to complete suitable transactions or increase
their cost. Future acquisitions could also divert substantial management time,
result in short term reductions in earnings or special transactions or other
charges and may be difficult to integrate with existing operations or assets.
We may, in the future, issue additional shares of Common Stock in connection
with one or more acquisitions, which may dilute our stockholders. Additionally,
with respect to future acquisitions, our stockholders may not have an
opportunity to review the financial statements of the entity being acquired or
to vote on these acquisitions.
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Anti-Takeover Effects; Delaware Law and Certain Charter and Bylaw Provisions
Our Certificate of Incorporation and Bylaws, as well as Delaware corporate
law, contain certain provisions that could delay, defer or prevent a change in
control and could materially adversely affect the prevailing market price of our
common stock. Certain of these provisions impose various procedural and other
requirements that could make it more difficult for stockholders to take certain
corporate actions.
Stock Price Volatility
The trading price of our Common Stock has been and could continue to be
subject to wide fluctuations in response certain factors, including:
. quarter to quarter variations in results of operations
. our announcements of new products
. our competitors' announcements of new products
. our 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 our products, plans and
. strategic position and those of our competitors and customers
. other events or factors
In addition, the public stock markets experience 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 often unrelated to the operating performance of
the specific companies. These broad market fluctuations may adversely affect
the market price of our Common Stock.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of June 30, 2000.
However, we are exposed to certain market risks arising from transactions in the
normal course of business, principally the risk associated with interest rate
fluctuations on our revolving line of credit agreement, and the risk associated
with foreign currency fluctuations. We do not hedge our interest rate risk, or
our risk associated with foreign currency fluctuations.
Interest Rate Risk
Our interest rate risk is immaterial due to the short maturity of the line of
credit agreement. We have no fixed rate debt.
Foreign Currency Risk
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our investment in a foreign company that is accounted for
under the equity method. Our risk associated with foreign exchange fluctuations
has been immaterial to date.
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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 known
routine claims will not have a material adverse effect on the Company's
business, financial condition or results of operations.
The Company and the former owner of Shiny have a dispute over
additional cash payments upon the delivery and acceptance of
interactive entertainment software titles that Shiny was committed to
deliver over time. The Company believes that no amounts are due as of
June 30, 2000 under the applicable agreements.
Item 2. Changes in Securities and Use of Proceeds
On April 14, 2000, the Company closed a strategic equity investment by
Titus Interactive SA ("Titus") resulting in the issuance of 719,424
shares of the Company's Series A Preferred Stock for $20 million in a
transaction that included warrants to Titus for up to 500,000 shares of
Common Stock at $3.79 per share. See Part I, Item 2 - "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a detailed discussion
of the terms of these securities, including the conversion rights of
the Series A Preferred Stock. The Company will use the cash proceeds to
fund its operations.
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 six-month period ended June 30,
2000.
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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: August 11, 2000 By: /s/ BRIAN FARGO
------------------------------
Brian Fargo,
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: August 11, 2000 By: /s/ MANUEL MARRERO
------------------------------
Manuel Marrero,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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