U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
Commission file number 000-29750
INTERACTIVE MAGIC, INC.
(Exact name of small business issuer as specified in its charter)
North Carolina 56-2092059
(State of incorporation) (I.R.S. Employer Identification Number)
215 Southport Drive, Suite 1000
Morrisville, North Carolina 27560
(Address of principal executive office)
(919) 461-0722
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No | |
As of June 30, 1999 (the most recent practicable date), there were 10,690,183
shares of the issuer's Common Stock, $.10 par value per share, outstanding.
Transitional Small Business Disclosure Format (check one)
Yes |_| No |X|
The consolidated financial statements included herein have been restated for the
accounting of the convertible debentures issued by the Company on January 25,
1999 (Note 7) and for the change in accounting from the pooling of interests to
the purchase method of accounting for the acquisition of MPG-Net (Note 4). See
Note 2 of the consolidated financial statements for a detailed explanation of
the changes.
<PAGE>
INTERACTIVE MAGIC, INC.
Form 10-QSB Quarterly Report
INDEX
PART I FINANCIAL INFORMATION PAGE
Item 1 Financial Statements 3
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II OTHER INFORMATION 20
Item 1 Legal Proceedings 20
Item 2 Changes in Securities and Use of Proceeds 20
Item 3 Defaults Upon Senior Securities 21
Item 4 Other Information 21
Item 5 Exhibits and Reports on Form 8-K 21
SIGNATURES 22
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Interactive Magic, Inc.
Consolidated Balance Sheets
(In thousands, except share data)
(Restated)
<TABLE>
<CAPTION>
March 31 December 31
1999 1998
(Unaudited) (Audited)
------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,255 $ 2,943
Trade receivables, net of allowances of $1,521 and $2,871, respectively 1,404 2,109
Inventories 834 892
Advance royalties, net 1,812 1,586
Software development costs, net 344 912
Prepaid expenses and other 123 252
------------------------------------
Total current assets 7,772 8,694
Property and equipment, net 1,173 1,082
Noncurrent assets:
Royalties receivable 706 726
Goodwill 4,182 0
Other 57 18
------------------------------------
Total noncurrent assets 4,945 744
====================================
Total assets $13,890 $10,520
====================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
March 31 December 31
1999 1998
(Unaudited) (Audited)
------------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 1,380 $ 1,698
Royalties and commissions payable 488 768
Lines of credit 1,323 1,348
Current portion of capital lease obligations 52 23
------------------------------------
Total current liabilities 3,243 3,837
Noncurrent liabilities:
Accrued interest payable to related parties 145 117
Long-term debt 2,296 -
Capital lease obligations, less current portion 35 15
------------------------------------
Total noncurrent liabilities 2,476 132
Stockholders' equity (deficit):
Preferred Stock, $.10 par value; 25,000,000 shares authorized; none
issued and outstanding - -
Common stock, $.10 par value; 50,000,000 shares authorized; 10,675,183
and 9,850,867 shares issued and outstanding at March 31, 1999 and
December 31, 1998, respectively 1,068 985
Additional paid-in capital 39,171 31,522
Accumulated deficit (31,960) (25,862)
Accumulated other comprehensive loss (108) (94)
-------------------------------------
Total stockholders' equity (deficit) 8,171 (6,551)
====================================
Total liabilities and stockholders' equity (deficit) $ 13,890 $ 10,520
====================================
</TABLE>
See accompanying notes.
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)
(Restated)
<TABLE>
<CAPTION>
Three months ended March 31
1999 1998
----------------------------------
<S> <C> <C>
Net revenues:
CD-ROM product sales $ 561 $ 4,057
Online sales 467 358
Royalties and licenses 7 498
Advertising and other 127 0
----------------------------------
Total net revenues 1,162 4,913
Cost of revenues:
Cost of products and services 416 968
Royalties and amortized software costs 89 909
----------------------------------
Total cost of revenues 505 1,877
----------------------------------
Gross profit 657 3,036
Operating expenses:
Sales and marketing 1,522 1,667
Product development 1,845 1,103
General and administrative 852 449
Goodwill amortization 191 0
----------------------------------
Total operating expenses 4,410 3,219
----------------------------------
Operating loss (3,753) (183)
Other (income) expense:
Interest expense - third parties 2,345 200
Interest expense - related parties 18 107
Other (53) -
----------------------------------
Total other expense 2,310 307
----------------------------------
Loss before income taxes (6,063) (490)
Income tax expense 35 128
----------------------------------
Net loss $ (6,098) $ (618)
==================================
Basic loss per share:
Net loss per share $ (0.59) $ (0.18)
==================================
Weighted average shares used in computing basic loss per share 10,316,300 3,429,558
==================================
</TABLE>
See accompanying notes.
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
(In thousands, except share data)
(Restated)
<TABLE>
<CAPTION>
Series A Convertible Series B Convertible
Preferred Stock Preferred Stock Common Stock
--------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997 82,634 $ 8 - $ - - -
Exercise of stock options - - - - - -
Issuance of common stock - - - - - -
Exercise of warrants - - - - - -
Issuance of preferred stock - - 778,746 78 - -
Conversion of notes payable into common stock - - - - - -
Recapitalization contemporaneous with the
initial public offering (Note 9) (82,634) (8) (778,746) (78) 6,793,699 679
Issuance of common stock - - - - 2,990,000 299
Exercise of warrants - - - - 18,330 2
Exercise of stock options - - - - 48,838 5
Issuance of warrants - - - - - -
Comprehensive loss
Net loss - - - - - -
Other comprehensive loss - - - - - -
Total comprehensive loss
--------------------------------------------------------------------------
Balance at December 31, 1998 - - - - 9,850,867 985
Exercise of stock options - - - - 74,316 8
Issuance of warrants - - - - - -
Issuance of convertible debenture (Note 7) - - - - - -
Issuance of common stock (Note 4) - - - - 750,000 75
Comprehensive loss
Net loss - - - - - -
Other comprehensive loss - - - - - -
Total comprehensive loss
==========================================================================
Balance at March 31, 1999 (Unaudited) - $ - - $ - 10,675,183 $ 1,068
==========================================================================
<PAGE>
Accumulated
Additional Other
Class A Class B Paid-In Comprehensive Accumulated
Common Stock Common Stock Capital Loss Deficit Total
----------------------------------------------------
Shares Amount Shares Amount
-------------------------------------------------------------------------------------------------------------
3,145,696 $ 314 7,875 $ 1 $5,047 $(59) $(14,210) $(8,899)
268,750 27 102,500 10 381 - - 418
- - 48,604 5 (5) - - -
516,769 52 - - (52) - - -
- - - - 3,091 - - 3,169
- - 442,478 44 1,956 - - 2,000
(3,931,215) (393) (601,457) (60) 460 - - 600
- - - - 20,176 - - 20,475
- - - - (2) - - -
- - - - 76 - - 81
- - - - 394 - - 394
- - - - - - (11,652) (11,652)
- - - - - (35) - (35)
-------------
(14,687)
-------------------------------------------------------------------------------------------------------------
- - - - 31,522 (94) (25,862) 6,551
- - - - 199 - - 207
- - - - 466 - - 466
- - - - 3,201 - - 3,201
- - - - 3,783 - - 3,858
- - - - - - (6,098) (6,098)
- - - - - (14) - (14)
-------------
(6,112)
=============================================================================================================
- $ - - $ - $39,171 $(108) $(31,960) $8,171
=============================================================================================================
</TABLE>
See accompanying notes.
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
(Restated)
<TABLE>
<CAPTION>
Three months ended March 31
1999 1998
-----------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (6,098) $ (618)
Adjustments to reconcile net loss to net cash used in operating
activities:
Issuance of warrants 76 -
Depreciation and amortization 317 89
Amortization of capitalized software development costs 212 250
Noncash interest expense 2,194 33
Write-off of capitalized software development costs 393 -
Changes in operating assets and liabilities net of effects of purchase of
MPG-Net (Note 4):
Trade and royalties receivables 767 (1,698)
Inventories 58 (128)
Advance royalties (226) 367
Prepaid expenses and other (46) 22
Accounts payable and accrued expenses (650) 254
Royalties and commissions payable (280) 77
Accrued interest 28 18
-----------------------------------------
Net cash used in operating activities (3,255) (1,334)
INVESTING ACTIVITIES
Proceeds from acquisition of MPG-Net (Note 4) 18 -
Purchase of property and equipment (36) (51)
Increase in notes receivable (200) -
Software development costs (37) (583)
------------------------------------------
Net cash used in investing activities (255) (634)
FINANCING ACTIVITIES
Proceeds from issuance of common stock 207 9
Proceeds from issuance of preferred stock - 3,169
Payments on long-term debt - (20)
Proceeds from issuance of convertible debentures 3,660 -
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows (continued)
(In Thousands)
(Unaudited)
(Restated)
Three months ended March 31
1999 1998
-----------------------------------------
Net borrowings from lines-of-credit (25) (1,426)
Payments on capital lease obligations (6) (12)
-----------------------------------------
Net cash provided by financing activities 3,836 1,720
Effect of currency exchange rate changes on cash and cash equivalents (14) (20)
-----------------------------------------
Net increase (decrease) in cash and cash equivalents 312 (268)
Cash and cash equivalents at beginning of period 2,943 384
=========================================
Cash and cash equivalents at end of period $ 3,255 $ 116
=========================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 26 $ 276
=========================================
NONCASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock in connection with acquisition of MPG-Net (Note 4) $ 3,891 $ -
=========================================
Contingently issuable warrants provided to holder of convertible debenture
(Note 7) $ 1,067 $ -
=========================================
Issuance of warrants to broker in connection with convertible debenture
(Note 7) $ 390 $ -
=========================================
</TABLE>
See accompanying notes.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements
(Restated)
(Information as of March 31, 1999 and for the three months ended March 31,
1999 and 1998 is unaudited)
1. DESCRIPTION OF BUSINESS
Interactive Magic, Inc. (the "Company") develops, publishes, and distributes 3-D
interactive, simulation and strategy entertainment software to customers around
the world via (1) retail distribution through international and domestic
software outlets and (2) proprietary, pay-for-play online service on the
Internet. The Company also provides real-time 3-D entertainment for multi-user
online/Internet play, as well as creating interactive entertainment platforms on
the internet, such as online game channels, game hub and websites. The Company
has agreements with various software licensors to manufacture, market, sell and
distribute software in the United States. Through its wholly owned subsidiaries
located in the United Kingdom and Germany, and through its online services, the
Company also distributes its products internationally.
2. RESTATEMENT
The consolidated financial statements included herein have been restated for the
accounting for the convertible debentures issued by the Company on January 25,
1999 (Note 7) and for the change in accounting from the pooling of interests to
the purchase method of accounting for the acquisition of MPG-Net (Note 4). See
Note 2 of the consolidated financial statements for a detailed explanation of
the changes.
The restatement reflects adjustments to the March 31, 1999 financial statements
for an increase of approximately $2.6 million to additional paid-in capital
related to the beneficial conversion feature of the debenture and the value
assigned to the contingently issuable warrants. Interest expense for the three
months ended March 31, 1999 increased by approximately $1.6 million due to the
expensing of the beneficial conversion feature and the accretion related to the
contingently issuable warrants. The carrying value of the debenture at March 31,
1999 decreased by approximately $1 million (Note 7), and the net loss for the
three months ended March 31, 1999 increased by $1.6 million.
The restatement also reflects the change in accounting from the pooling of
interests to the purchase method of accounting for the acquisition of MPG-Net.
The Company consummated its business combination with MPG-Net on February 12,
1999. In late February 1999, subsequent to the merger, the management of the
Company began to explore and evaluate various business strategies, including the
potential sale of its CD-ROM business. Effective May 25, 1999, the Company
executed an agreement to sell a significant portion of its CD-ROM business. The
transaction was consummated on June 30, 1999. Although the CD-ROM asset
disposition was not contemplated at the time of the MPG-Net merger, the
proximity of the transaction to the closing of the merger made it impracticable
for the Company to overcome the presumption that the asset disposition was done
in contemplation of the merger. Therefore, the pooling treatment was rescinded
and the Company restated its financial statements to reflect the MPG-Net merger
as a purchase business combination. The adjustments to change the method of
accounting for the merger increased net assets by approximately $4.2 million and
$17.7 million at March 31, 1999 and December 31, 1998, respectively. For the
three months ended March 31, 1999, these adjustments decreased revenues by
approximately $2,000 and increased net loss by approximately $10,000. For the
three months ended March 31, 1998, these adjustments decreased revenues by
approximately $52,000 and decreased net loss by approximately $631,000.
The effects of the restatement on the consolidated balance sheets at March 31,
1999 and December 31, 1998 and the consolidated statements of operations for the
three months ended March 31, 1999 and 1998 are as follows:
<PAGE>
Consolidated Balance Sheets (In thousands):
<TABLE>
<CAPTION>
As of March 31, 1999 As of December 31,
(Unaudited) 1998
-----------------------------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
-----------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 3,255 $ 3,255 $ 3,025 $ 2,943
Trade receivables, net 1,404 1,404 2,168 2,109
Inventories 834 834 892 892
Advance royalties, net 1,812 1,812 1,586 1,586
Software development costs, net 344 344 912 912
Prepaid expenses and other 123 123 112 252
-----------------------------------------------
Total current assets 7,772 7,772 8,695 8,694
Property and equipment, net 1,173 1,173 1,273 1,082
Noncurrent assets:
Royalties receivable 706 706 726 726
Goodwill -- 4,182 -- --
Other 66 57 30 18
-----------------------------------------------
Total noncurrent assets 772 4,945 756 744
-----------------------------------------------
Total assets $ 9,717 $ 13,890 $ 10,724 $ 10,520
===============================================
Liabilities and stockholders' equity (deficit):
Current liabilities:
Accounts payable and accrued expenses $ 1,380 $ 1,380 $ 2,248 $ 1,698
Royalties and commissions payable 488 488 768 768
Lines of credit 1,323 1,323 1,348 1,348
Current portion of capital lease obligations 52 52 56 23
Rent payable to related parties -- -- 481 --
Accrued interest payable to related parties -- -- 4,320 --
Notes payable to related parties -- -- 12,490 --
-----------------------------------------------
Total current liabilities 3,243 3,243 21,777 3,837
Noncurrent liabilities:
Accrued interest payable to related parties 145 145 117 117
Long-term debt 3,304 2,296 -- --
Capital lease obligations, less current portion 35 35 43 15
-----------------------------------------------
Total noncurrent liabilities 3,484 2,476 160 132
Stockholders' equity (deficit):
Preferred stock, $.10 par value; 25,000,000 shares authorized;
none issued and outstanding -- -- -- --
Common stock, $.10 par value; 50,000,000 shares authorized;
10,675,183 and 10,375,867 shares issued and outstanding at
March 31, 1999 and December 31, 1998, respectively 1,068 1,068 1,038 985
Deferred compensation -- -- (29) --
Additional paid-in capital 50,101 39,171 31,523 31,522
Accumulated deficit (48,071) (31,960) (43,585) (26,862)
Accumulated other comprehensive loss (108) (108) (94) (94)
-----------------------------------------------
Total stockholders' equity (deficit) 2,990 8,171 (11,147) 6,551
-----------------------------------------------
Total liabilities and stockholders' equity (deficit) $ 9,717 $ 13,890 $ 10,724 $ 10,520
===============================================
</TABLE>
<PAGE>
Consolidated Statement of Operations
<TABLE>
<CAPTION>
Three months ended March 31, 1999 Three months ended March 31, 1998
(Unaudited) (Unaudited)
----------------------------------------------------------------
As As
Previously As Previously As
(In thousands, except share and per share data) Reported Restated Reported Restated
(Unaudited): ----------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues:
CD-ROM product sales $ 561 $ 561 $ 4,057 $ 4,057
Online sales 484 467 386 358
Royalties and licenses 7 7 516 498
Advertising and other 112 127 6 --
----------------------------------------------------------------
Total net revenues 1,164 1,162 4,965 4,913
Cost of revenues:
Cost of products and services 429 416 988 968
Royalties and amortized software costs 91 89 910 909
----------------------------------------------------------------
Total cost of revenues 520 505 1,898 1,877
----------------------------------------------------------------
Gross profit 644 657 3,067 3,036
Operating expenses:
Sales and marketing 1,475 1,522 1,704 1,667
Product development 2,020 1,845 1,327 1,103
General and administrative 1,244 852 590 449
Goodwill amortization -- 191 -- --
----------------------------------------------------------------
Total operating expenses 4,739 4,410 3,621 3,219
----------------------------------------------------------------
Operating loss (4,095) (3,753) (554) (183)
Other (income) expense:
Interest expense - third parties 743 2,345 200 200
Interest expense - related parties 144 18 367 107
Other (38) (53) -- --
----------------------------------------------------------------
Total other (income) expense 849 2,310 567 307
----------------------------------------------------------------
Loss before income taxes and extraordinary item (4,944) (6,063) (1,121) (490)
Income tax expense 35 35 128 128
----------------------------------------------------------------
Loss before extraordinary item (4,979) (6,098) (1,249) (618)
Extraordinary gain on early extinguishment of debt 493 -- -- --
----------------------------------------------------------------
Net loss $ (4,486) $ (6,098) $ (1,249) $ (618)
================================================================
Basic loss per share:
Loss before extraordinary item $ (0.47) $ (0.59) $ (0.32) $ (0.18)
Extraordinary item 0.05 -- -- --
----------------------------------------------------------------
Net loss per share $ (0.42) $ (0.59) $ (0.32) $ (0.18)
=================================================================
Weighted average shares used in computing basic loss
per share 10,555,467 10,316,300 3,954,558 3,429,558
=================================================================
</TABLE>
3. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
Interactive Magic, Inc. (the "Company"), a North Carolina corporation, and its
wholly owned subsidiaries, iMagicOnline Corporation, Interactive Magic Ltd. And
Interactive Magic GmbH. All significant intercompany accounts and transactions
have been eliminated.
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As shown in the consolidated
financial statements during the three months ended March 31, 1999 and 1998, the
Company incurred losses of $6,098,000 and $618,000, respectively, and has
experienced negative cash flows from operations. These factors, among others,
indicate that the Company may be unable to continue as a going concern for a
reasonable period of time. The consolidated financial statements do not include
any adjustments relating to the recoverability and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern.
The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and ultimately to
attain profitability. On May 25, 1999, the Company executed an Agreement
Regarding Assignment of Contracts (the "Agreement") to sell its rights under
certain development contracts for CD-ROM products between the Company and third
party developers (and assume certain liabilities thereto) for $2.5 million. The
Agreement provides for the Company to retain the right to use these products on
the Internet. The transaction was consummated during the second quarter of 1999.
While the financial information furnished is unaudited, the condensed
consolidated financial statements included in this report reflect all
adjustments (consisting only of normal recurring adjustments) which the Company
considers necessary for the fair presentation of the results of operations for
the interim periods covered and of the financial condition of the Company at the
date of the interim balance sheet. The results for interim periods are not
necessarily indicative of the results for the entire year. The condensed
consolidated financial statements should be read in conjunction with the
Interactive Magic, Inc. consolidated financial statements and the notes thereto,
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 1998.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
4. BUSINESS COMBINATION
On February 12, 1999 the Company completed the acquisition of MPG-Net, Inc.
("MPG-Net") Company by exchanging 600,000 shares of its common stock valued at
approximately $3.1 million for all of the outstanding common stock of MPG-Net
and issuing 150,000 shares of its common stock valued at approximately $.8
million in full settlement of certain debt obligations of MPG-Net. MPG-Net is
primarily in the business of developing, publishing and distributing
interactive, real time 3-D entertainment for multi-user online/Internet play, as
well as creating entertainment platforms on the Internet such as online game
channels, game hubs and websites. The merger was accounted for as a purchase in
accordance with Accounting Principles Board Opinion No. 16 and, accordingly, the
operating results of MPG-Net have been included in the Company's consolidated
financial statements since the date of acquisition. The excess of the aggregate
purchase price over the fair market value of the net assets acquired of
approximately $4.3 million is being amortized over 3 years.
The following unaudited consolidated pro forma data summarizes the combined
operating results of the Company and MPG-Net as if the acquisition had occurred
at January 1, 1998:
<TABLE>
<CAPTION>
Three months ended Three Months ended
March 31, 1999 March 31, 1998
--------------------------- --------------------------
<S> <C> <C>
Net revenues $1,256 $ 4,965
Net loss before extraordinary items (6,581) (1,249)
Net loss (6,088) (1,249)
Loss per share $(0.58) $(0.32)
</TABLE>
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include amounts in demand deposit accounts and
investments with an original maturity date of three months or less when
purchased.
INVENTORIES
Inventories consist of pre-packaged CD-ROM software packages and related
materials and are stated at the lower of cost or market. Costs are determined
using the first-in, first-out ("FIFO") cost flow assumption.
Inventories consist of the following (in thousands):
March 31 December 31
1999 1998
---------------------------------
Finished goods $ 856 $ 1,065
Components 329 117
---------------------------------
1,185 1,182
Inventory valuation reserve (351) (290)
=================================
$ 834 $ 892
=================================
ADVANCE ROYALTIES
Advance royalties represent prepayments made to independent software developers
under development agreements. Advance royalties are expensed as part of
royalties and amortized software costs at the contractual royalty rate based on
actual net product sales. Management continuously evaluates the future
realization of advance royalties, and charges to cost of revenues any amount
that management deems unlikely to be amortized at the contractual royalty rate
through product sales. At March 31, 1999 and December 31, 1998, the reserve for
advance royalties was $1,724,000 and $1,654,000, respectively.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation for equipment, furniture
and fixtures and purchased software is computed using the straight-line method
over the estimated useful lives of the assets, ranging from five to seven years.
Leasehold improvements are amortized on a straight-line basis over the term of
the estimated useful life of the asset or the remaining lease term, whichever is
less. Depreciation expense, including amortization of equipment leased under
capital leases, was $126,000 and $89,000 for the three months ended March 31,
1999 and 1998, respectively.
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
March 31 December 31
1999 1998
------------------------------------
<S> <C> <C>
Equipment $ 2,413 $ 1,547
Furniture and fixtures 411 188
Software 537 488
Leasehold improvements 77 59
------------------------------------
3,438 2,282
Less accumulated depreciation and amortization (2,265) (1,200)
------------------------------------
$ 1,173 $ 1,082
====================================
</TABLE>
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
SOFTWARE DEVELOPMENT COSTS
Costs incurred in the development of software for sale to customers are
capitalized after a product's technological feasibility has been established.
Capitalization of such costs is discontinued when a product is available for
general release to customers. Capitalized software development costs are
capitalized at the lower of cost or net realizable value and amortized using the
greater of the revenue curve method or the straight-line method over the
estimated economic life of the related product. Amortization begins when a
product is ready for general release to customers.
Information related to net capitalized software development costs is as follows
(in thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
------------------------------------------
<S> <C> <C>
Balance at beginning of period $ 912 $ 425
Capitalized 37 1,450
Written off (393) -
Amortized (212) (963)
------------------------------------------
Balance at end of period $ 344 $ 912
==========================================
</TABLE>
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, trade receivables, accounts
payable and other liabilities approximates fair value at March 31, 1999 and
December 31, 1998.
REVENUE RECOGNITION
In October 1997, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position (SOP) 97-2 Software Revenue Recognition as amended in
March 1998 by SOP 98-4 and October 1998 by SOP 98-9. These SOPs provide guidance
on applying generally accepted accounting principles in recognizing revenue on
software transactions. The Company adopted SOP 97-2 for software transactions
entered into beginning January 1, 1998. Based on the current requirements of the
SOPs, application of these statements did not have a material impact on the
Company's revenue recognition policies.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
However, AcSEC is currently reviewing further modifications to the SOP with the
objective of providing more definitive, detailed implementation guidelines. This
guidance could lead to unanticipated changes in the Company's operations and
revenue recognition practices.
Revenue from CD-ROM product sales is recognized at the time of product shipment.
Revenue from online sales is recognized at the time the game is played and is
based upon actual usage by the customer on an hourly basis. Revenue from
royalties and licenses is recognized when earned under the terms of the relevant
agreements with original equipment manufacturers ("OEMs"), international
distributors and other third parties. With respect to license agreements that
provide customers the right to multiple copies in exchange for guaranteed
amounts, net revenue is recognized upon delivery of the product master or the
first copy; provided collectibility is probable. Per copy royalties on sales
that exceed the guarantee are recognized as earned. The Company accepts product
returns and provides price protection on certain unsold merchandise. Revenue is
recorded net of an allowance for estimated future returns, markdowns, price
protection and warranty costs. Such reserves are based upon management's
evaluation of historical experience, current industry trends and estimated
costs.
Revenue from certain software development contracts with fixed price components
is recognized on the percentage of completion basis in accordance with the
American Institute of Certified Public Accountants' SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts." In
accordance with SOP 81-1, the Company recognizes percentage of completion
revenue based upon the ratio of accumulated incurred costs to the total
estimated costs to complete each contract.
The accounts receivable allowance consists primarily of reserves for product
returns, markdowns, price protection and warranty costs. The allowance also
includes a reserve for doubtful accounts, which management records based on
historical experience and current evaluation of potential collectibility issues.
The Company does not require collateral for unpaid balances. Credit losses have
historically been within management's expectations.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
PRODUCT DEVELOPMENT
Product development expenses (excluding capitalized software development costs)
are charged to operations in the period incurred and consist primarily of
payroll and payroll related costs.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising expense was
approximately $521,000 and $638,000 for the three months ended March 31, 1999
and 1998, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Significant estimates include provisions for doubtful accounts, sales returns
and allowances, warranty provisions, and estimates regarding the recoverability
of prepaid royalty advances and inventory. Actual results could differ from
those estimates.
FOREIGN CURRENCY TRANSLATION
The Company follows the principles of the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign
Currency Translation," using the local currency of its operating subsidiaries as
the functional currency. Accordingly, all assets and liabilities outside the
United States are translated into U.S. dollars at the rate of exchange in effect
at the balance sheet date. Income and expense items are translated at the
weighted average exchange rate prevailing during the period. Adjustments
resulting from translation of financial statements are reflected as a component
of accumulated other comprehensive loss.
INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". Under SFAS No. 109, the liability method is used
in accounting for income taxes and deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
5. SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS (CONTINUED)
BASIC NET LOSS PER SHARE
Basic net loss per share has been calculated in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires companies to compute earnings per
share under two different methods (basic and diluted). Basic net loss per share
is calculated by dividing net loss by the weighted average shares of common
stock outstanding during the period. All shares used in computing basic net loss
per share reflect the retroactive effect of the Company's July 1998 one-for-two
reverse stock split.
Had the Company been in a net income position, diluted earnings per share would
have been presented and would have included potential common shares related to
outstanding options and warrants. The diluted earnings per share computation is
not included, as all potential common shares are antidilutive. The Company
evaluated the requirements of the Securities and Exchange Commission Staff
Accounting Bulletin No. 98 ("SAB 98"), and concluded that there are no nominal
issuances of common stock or potential common stock which would be required to
be shown as outstanding for all periods as outlined in SAB 98.
6. LINES OF CREDIT
The Company maintains a revolving line of credit arrangement with a bank for up
to $2,750,000. The principal balance outstanding at any point in time is payable
on demand with interest payable monthly at the current prime rate (7.75% at
March 31, 1999). The weighted-average interest rate on the line of credit was
7.75% and 8.50% for the three months ended March 31, 1999 and 1998,
respectively. The balance outstanding as of March 31, 1999 and December 31, 1998
was $1,316,000. Advances on the line of credit are collateralized by a personal
guarantee of the Company's majority stockholder. In consideration for this
guarantee, the Company will pay the stockholder an amount equal to 6% of the
outstanding balance on the line of credit (which has been recorded as interest
expense). At March 31, 1999 and December 31, 1998, the Company owed the
stockholder $145,000 and $117,000 relating to this guarantee, respectively.
These amounts are due no earlier than January 1, 2000.
The Company also entered into a line of credit agreement with its bank to borrow
up to $150,000. The Company's net property and equipment collateralize the line
of credit. The principal balance outstanding at any point in time is payable on
demand with interest payable monthly at the current prime rate. The
weighted-average interest rate on the line of credit was 7.75% and 8.50% for the
three months ended March 31, 1999 and 1998, respectively. The balance
outstanding at March 31, 1999 and December 31, 1998 was $7,000 and $32,000,
respectively.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
7. LONG-TERM DEBT
On January 25, 1999, the Company issued a $4 million convertible debenture ("the
debenture") for net cash proceeds to the Company of approximately $3.7 million.
The Company also issued 200,000 warrants to the debenture broker, which
represented additional debt issuance costs, valued at $390,000. These warrants
were recorded as additional paid-in capital and the resulting debt issuance
costs will be amortized to interest expense over the term of the debenture.
These warrants have a weighted average exercise price of $4.85 and were
exercisable upon issuance. For the three months ended March 31, 1999,
amortization of the debt issuance costs was approximately $42,000.
The debenture accrues interest at an annual interest rate of 6% and the accrued
interest and principal are due on January 25, 2002. The holder of the
convertible debenture may convert all or any portion of the debenture into the
Company's common stock where the number of shares to be issued will be
determined by dividing the principal plus interest due by the conversion price.
The conversion price will be equal to the lesser of a conversion price ranging
from 77% to 93% of the market price of the Company's common stock (as defined in
the securities purchase agreement) or a conversion price ranging from 104% to
120% of a fixed conversion price (as defined in the securities purchase
agreement). On the date of conversion, if the Company's common stock trades at a
price higher than the fixed conversion price, the Company is obligated to issue
to the holder of the debenture warrants to purchase the Company's stock at a
one-for-two ratio of common stock issued as a result of the debenture conversion
at an exercise price equal to the debenture conversion price (the "contingently
issuable warrants").
The contingently issuable warrants were valued at approximately $1.1 million at
the date of issuance and were recorded as additional paid-in capital. The
beneficial conversion feature of the debenture also resulted in a portion of the
proceeds of the debenture being allocated to the conversion feature based on its
intrinsic value of $2.1 million, which was recorded as additional paid-in
capital. The debenture was convertible at the date of issuance and the value of
the conversion feature was therefore immediately recorded as additional interest
expense and accreted into the carrying value of the debenture. Based on the
recorded fair value of the contingently issuable warrants, the carrying value
assigned to the debenture at the date of issuance was $2.9 million. The
difference between the initial carrying value of the debenture and the $4
million face value will be accreted into the carrying value as additional
interest expense over the term of the debenture. For the three months ended
March 31, 1999, the Company recorded approximately $59,000 in interest expense
related to such accretion. For the three months ended March 31, 1999, interest
expense related to this debenture totaled $2.2 million.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
8. LEASES
The Company rents its facilities and certain office equipment under
noncancelable operating and capital leases which expire at various times through
2001.The monthly rent under certain facility leases is periodically adjusted
based on changes in the Consumer Price Index.
Property and equipment includes the following amounts for capital leases (in
thousands):
<TABLE>
<CAPTION>
March 31 1999 December 31 1998
-------------------------------------------
<S> <C> <C>
Leased equipment $ 247 $ 157
Leased furniture and fixtures 53 53
-------------------------------------------
300 210
Less: accumulated amortization (174) (125)
===========================================
$ 126 $ 85
===========================================
</TABLE>
Total rent expense incurred was approximately $103,000 and $99,000 for the three
months ended March 31, 1999 and 1998, respectively.
9. STOCKHOLDERS' EQUITY (DEFICIT)
RECAPITALIZATION
The Company was recapitalized through the exchange of securities, which was
effective as of the closing date of the Company's initial public offering in
July 1998, as follows:
Class A Common Stock: Exchanged for an aggregate of 3,931,215 shares of
common stock.
Class B Common Stock: Exchanged for an aggregate of 601,457 shares of
common stock.
Series A Convertible Preferred Stock: Converted into an aggregate of 82,634
shares of common stock.
Series B Convertible Preferred Stock: Converted into an aggregate of
2,045,649 shares of common stock.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
9. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Series C Redeemable Convertible Preferred Stock: Converted into an
aggregate of 132,744 shares of common stock.
Upon consummation of the initial public offering, the Company has authorized
capital of 50,000,000 shares of $.10 par value common stock and 25,000,000
shares of $.10 par value preferred stock.
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS
EMPLOYEE STOCK OPTIONS AND STOCK PLANS
Effective January 2, 1995, the Company adopted two employee incentive stock
option plans (the "1995 Plans"). One plan provided for the granting of options
to purchase Class A Common Stock which was voting stock, and one plan provided
for the granting of options to purchase Class B Common Stock which was
non-voting. The 1995 Plans are intended as incentives to induce key employees of
the Company to remain in the employ of the Company or of any subsidiary of the
Company, and to encourage such employees to own stock in the Company. This
purpose is carried out by granting options to purchase shares of Common Stock.
The Company may grant incentive stock options ("ISOs") within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended to eligible
participants under the 1995 Plans. The exercise price of an ISO may not be less
than 100% of the fair market value of the underlying shares at the time the ISO
is granted.
The 1995 Plans are administered by the Board of Directors. The Board has the
authority to administer the 1995 Plans and determine, among other things, the
interpretation of any provisions of the 1995 Plans, the eligible employees who
are to be granted stock options, the number of shares which may be issued and
the option exercise price.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
The Company's incentive stock options vest over time with 20% vesting during the
second year after the date of grant with an additional 5% vesting each calendar
quarter thereafter. Incentive stock options generally may only be exercised if
the participant has been employed by the Company continuously for at least one
year as of the last day of the first twelve-month period following the. date of
option grant. The option is only exercisable if the participant is employed by
the Company and for limited periods of time after the participant's termination
of employment. If the participant ceases to be employed on account of
termination by the Company for cause or resignation (other than retirement as
defined in the option agreement), the right to exercise any unexercised portion
of the option terminates. If the participant is terminated by the company
without cause, the participant shall be entitled to purchase, within three
months, option shares equal to an additional 25% of the participant's option
shares that were not exercisable as of the termination date. The option becomes
immediately and fully exercisable in the event of a change in control as defined
in the option agreement.
Performance options vest upon the earlier of the Company's achievement of
certain performance standards or seven years from the date of grant. The number
and exercise price of the options are fixed at the date of grant. Options are
exercisable only in the event the participant is employed by the Company and for
limited periods of time after the participant's termination of employment. If
the participant ceases to be an employee on account of resignation) (other than
retirement as defined in the option agreement) or termination for cause, the
right to exercise any unexercised portion of the option shall terminate. The
option becomes immediately and fully exercisable as of a change in control as
defined in the agreement.
During May 1998, the Company's 1998 Stock Plan (the "Plan") was adopted by the
Board of Directors and approved by the shareholders of the Company. The Company
anticipates that no future grants will be made under the Company's 1995
incentive stock plans after the effective date of the 1998 Plan. A total of
800,000 shares of Common Stock have been reserved for issuance under the Plan.
The Plan provides for grants to employees of incentive stock options. In
addition, the Plan provides for grants of nonqualified stock options and stock
purchase rights to employees, directors and consultants of the Company. The Plan
is administered by the Board of Directors or by a Committee appointed by the
Board. The administrator determines the terms of options and stock purchase
rights granted, including the exercise price and the number of shares subject to
option or stock purchase right. The exercise price of incentive stock options
granted under the Plan must be at least equal to the fair market value of the
Company's Common Stock on the date of the grant. The maximum term of options
granted under the plan is 10 years.
During May 1998, the Company's 1998 Employee Stock Purchase Plan (the "Purchase
Plan") was adopted by the Company's Board of Directors and approved by the
Company's shareholders. The Purchase Plan is intended to qualify under Section
423 of the Internal Revenue Code of 1986, as amended. The Company has reserved
500,000 shares of Common Stock for issuance under the Purchase Plan. Under the
Purchase Plan, an eligible employee may purchase shares of Common Stock from the
Company through payroll deductions of up to 10% of his or her base compensation,
not to exceed $25,000 per year, at a price per share equal to 85% of the fair
market vale of a share of the Company's Common Stock on the last day of the
offering period. The maximum number of shares that an employee may purchase in
any offering period is 2,500 shares. Any employee who is customarily employed
for at least 20 hours per week, and more than five months per calendar year and
who is employed on or before the commencement date of an offering period is
eligible to participate in the Purchase Plan.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
The following table summarizes the activity under the Company's Stock Option
Plans:
<TABLE>
<CAPTION>
Options Weighted-Average Exercise Options
Outstanding Price Per Share Exercisable
-------------------------------------------------------------------------
<S> <C> <C> <C>
Balances at December 31, 1997 1,993,048 $2.14 1,007,328
Options granted 739,434 4.80 -
Options exercised (420,088) 1.19 -
Options canceled (330,426) 4.70 -
-------------------------------------------------------------------------
Balances at December 31, 1998 1,981,968 2.72 813,072
Options granted 623,330 4.25 -
Options exercised (74,316) 2.92 -
Options canceled (110,770) 5.71 -
-------------------------------------------------------------------------
Balances at March 31, 1999 (Unaudited) 2,420,212 $3.11 932,815
=========================================================================
</TABLE>
The following summarizes information about the Company's stock options
outstanding at March 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$1.000 902,500 3.78 $1.00 586,171 $1.00
$2.000 - $4.125 562,986 6.42 $3.56 114,906 $2.73
$4.250 - $4.500 652,150 6.03 $4.29 25,000 $4.25
$6.000 302,576 5.34 $6.00 206,738 $6.00
----------------------------------------------------------------------------------
2,420,212 5.20 $3.11 932,815 $2.41
==================================================================================
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS No. 123. The fair
value for each option was estimated at the date of grant using a Black-Scholes
option-pricing model with the following weighted average assumptions:
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
<TABLE>
<CAPTION>
Three months ended Three months ended
March 31, 1999 March 31, 1998
---------------------------- -----------------------------
<S> <C> <C>
Expected dividend yield 0% 0%
Risk-free interest rate 5% 6%
Expected volatility 66% 59%
Expected life (in years from vesting) 2.5 4.9
</TABLE>
For purpose of pro forma disclosures, the estimated fair values of the stock
options are amortized to expense over the vesting period. The grant date
Black-Scholes weighted-average value of options was $2.11 for 1998.
The following table shows pro forma net loss and net loss per share as if the
fair value accounting method prescribed by SFAS No. 123 had been used to account
for stock based compensation (in thousands, except per share data):
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
Three months ended Three months ended
March 31 March 31
1999 1998
(Unaudited) (Unaudited)
<S> <C> <C>
Net loss as reported $(6,098) $ (618)
Pro forma compensation expense (227) (62)
-------- --------
Pro forma net loss $(6,325) $ (680)
-------- --------
Net loss per share:
Historical $(0.59) $ (.18)
Pro forma (for SFAS 123 disclosure purposes) $(0.61) $ (.20)
=======================================================================================================================
</TABLE>
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
10. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
STOCK WARRANTS
Warrants issued in connection with notes payable and convertible debt were
recorded at their estimated fair value and credited to additional paid in
capital. The resulting debt discount is amortized to interest expense over the
term of the related debt. Warrants issued to members of the Board of Directors,
consultants and financial advisors are recorded at their estimated fair value
and the related general and administrative expense is charged when the warrants
are issued. The estimated fair value of warrants issued to the placement agent
in connection with the issuance of preferred stock in February 1998 was recorded
as a stock issuance cost.
The following summarizes the activity of warrants:
Warrants
Outstanding
--------------------
Balance at December 31, 1997 750,054
Issued 514,993
Exercised (535,875)
--------------------
Balance at December 31, 1998 729,172
Issued 260,000
Exercised -
--------------------
Balance at March 31, 1999 989,172
====================
All of the Company's outstanding warrants at March 31, 1999 were exercisable at
prices ranging from $1.00 to $8.00 per share.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
The Company has reserved authorized shares of Common Stock for future issuance
as follows:
March 31, 1999
--------------------
Outstanding stock options 2,420,212
Possible future issuance under stock option plan 1,464,325
Stock purchase warrants 989,172
--------------------
4,873,709
====================
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
(Restated)
11. DISPOSITION OF ASSETS
On May 25, 1999, the Company executed an Agreement Regarding Assignment of
Contracts (the "Agreement") to sell its rights under certain development
contracts for CD-ROM products between the Company and third party developers
(and assume certain liabilities thereto) for $2.5 million. The Agreement
provides for the Company to retain the right to use these products on the
Internet. The transaction was consummated during the second quarter of 1999.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
NET REVENUES
Net revenues decreased by 76% to $ 1.2 million for the three months ended March
31, 1999 from $4.9 million for the three months ended March 31, 1998.
The following is a reconciliation of net revenue for the first quarter of 1998
to the same period for 1999:
$ Thousand
----------
Net revenue, first three months 1998 $ 4,913
Lower CD-ROM revenue (4,534)
Increased Online revenue 109
Increased advertising revenue Online 127
Lower royalty & licensing revenue (491)
Lower returns, allowances & discounts 1,038
-------
Net revenue, first three months 1999 $ 1,162
-------
The decrease in CD-ROM revenue reflects our intention to exit this line of
business. As a comparison, the following table lists the CD-ROM titles released
during the first quarter of 1999 and 1998:
--------------------------------------------------------------
1999 1998
--------------------------------------------------------------
North v. South Battles of Caesar
--------------------------------------------------------------
IF-22
--------------------------------------------------------------
IPanzer
--------------------------------------------------------------
Liberation Day
--------------------------------------------------------------
Semper Fi
--------------------------------------------------------------
Online revenues and related advertising continued to increase as our usage hours
and ad impressions both grew. The number of registered users at our Internet
Entertainment Network (iEN) web sites is now over 500,000. The number of monthly
ad impressions exceeded 12 million in March 1999.
COST OF REVENUES.
Cost of revenues consist of costs of products sold (including cost of Internet
access) and royalties and amortization of software development costs. Cost of
revenues in the first quarter of 1999 decreased by 73% to $ .5 million from $1.9
million in the same period of 1998. This decrease was due almost entirely to the
lower level of CD-ROM revenue. Gross margins for the first three months of 1999
and 1998 were 57% and 62% respectively.
<PAGE>
OPERATING EXPENSES
Operating expenses increased $1.2 million or 37% from the first quarter of 1998
to the same period in 1999. The following is a summary of major variances:
$ Thousand
----------
Operating expenses, first three months 1998 $ 3,219
Decrease in sales & marketing expense (145)
Increase in product development expense 742
Increase in Goodwill Amortization 191
Increase in general & administrative expense 403
---------
Operating expenses, first three months 1999 $ 4,410
---------
SALES AND MARKETING. Sales and marketing expenses for the first three months of
1999 decreased 9% from the same period in 1998. The decrease was attributable to
the lower number of titles released in 1999.
PRODUCT DEVELOPMENT. Product development expense increased $ 742 thousand in the
first quarter of 1999 versus 1998, or 67%. Nearly all of this increase was due
to our write-offs of capitalized development costs associated with a revaluation
of estimated revenues to be derived from products to be released in 1999.
GENERAL AND ADMINISTRATIVE. General and administrative expense was $ 403
thousand higher in the first quarter of 1999 than the same period last year. The
increase was due to the higher costs associated with being a public-traded
corporation and the effect of the MPG-Net acquisition on professional fees in
the quarter.
Goodwill Amortization. Goodwill from the MPG-Net acquisition in the first
quarter of 1999 is being amortized on a straight-line basis over a 36 month
period.
OTHER EXPENSE
Other (income) / expense increased $ 2.0 million in the first three months of
1999 compared to 1998. The increase was due to higher interest expense relating
to the $ 4,000,000 convertible debenture financing.
As explained in Footnote 6 of the Financial Statements, we recorded, as
additional interest expense, the beneficial conversion feature and contingently
issuable warrants related to the $ 4.0 million convertible debenture issued in
the first quarter of 1999. This item is a non-cash charge to earnings with a
corresponding increase in additional paid in capital. Therefore there is no net
effect on total equity for the item.
INCOME TAX EXPENSE
The Company recorded $35,000 income tax expense for the first quarter 1999
compared to $128,000 for the same period in 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have been and will continue to be
significant, and, to date, its cash requirements have exceeded its cash flow
from operations. The Company historically has satisfied cash requirements
through borrowings, the private sale of equity securities, and its initial
public offering.
Net cash used in operations of $3.3 million during the three months ended March
31, 1999 is due primarily to the Company's operating loss. Offsetting the cash
used from operations in the quarter was the $3.7 million proceeds from the
issuance of the convertible debentures.
The Company maintains a revolving line of credit arrangement with a bank for up
to $2.8 million. The principal balance outstanding at any point in time is
payable on demand with interest payable monthly at the bank's current prime rate
(7.75% as of March 31, 1999). The balance outstanding under this line as of
March 31, 1999 was $1.3 million. Advances on the line of credit are
collateralized by a personal guarantee of the Company's majority shareholder.
The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and ultimately to
attain profitability.
<PAGE>
YEAR 2000 ISSUE
The Company's products are of a nature that they are not date dependent or
subject to failure because of Year 2000 issues. The Company however, has
assigned full-time information technology professionals to the task of
identifying and resolving Year 2000 problems that may affect the Company's
business, and has adopted a Year 2000 compliance plan. Under the Company's Year
2000 compliance plan, the Company has and will continue to inventory and collect
documentation on all of its computers, computer related equipment, and equipment
with embedded processors. In addition, the Company will contact critical vendors
and suppliers to obtain assurances of their ability to ensure smooth delivery of
products and services after December 1999. Additionally, the Company will
prioritize and implement any necessary repairs or replacements to equipment in
order to achieve Year 2000 compliance, which it expects to complete by the end
of 1999. The Company will also implement a testing program, scheduled for
completion by the end of 1999. The Company has not prepared estimates of costs
for correction of Year 2000 problems. Based on information available at this
time, including the Year 2000 compliance status of equipment that has been
examined as well as the anticipated replacement schedule for equipment, the
Company does not believe that the cost of remedial actions will have a material
adverse effect on the Company's results of operations or financial condition.
There can be no assurance, however, that there will not be a delay in, or
increased costs associated with, the implementation of corrections as the Year
2000 compliance plan is performed. Failure to implement such changes could have
an adverse effect on future results of operations. In addition, unexpected costs
of correcting equipment that has not yet been fully evaluated could have an
adverse effect on future results of operations.
EURO CONVERSION
On January 1, 1999, the European Community began denominating significant
financial transactions in a new monetary unit, the Euro. The Euro is intended to
replace the traditional currencies of the individual EU member countries. The
Company's operations in Europe are continuing to operate in the traditional
currencies and are not converting internal financial systems to the Euro as a
functional currency. The Company is evaluating when to convert its local
currency in Europe to the Euro with as little disruption to customer and vendors
as possible. The Company does not intend to make such a conversion in 1999.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) Not applicable.
(c) From January 1, 1999 through March 31, 1999 the Company issued 260,000
warrants and granted 623,330 options.
(d) The Company's Registration Statement of Form SB-2 (Registration No.
333-53755) covering certain shares of its common stock was declared
effective on July 21, 1998. A total of 2,990,000 shares of the
Company's common stock, par value $0.10 per share, were registered
(including an over-allotment option for the sale of 390,000 shares).
The Company consummated an initial public offering of 2,600,000 shares
of common stock at a price to the public of $8.00 per share on July 27,
1998. The lead underwriters in the offering were BlueStone Capital
Partners, L.P. and Royce Investment Group, Inc.. During August 1998,
the underwriters exercised their right to purchase an additional
390,000 shares at the initial public offering price. The aggregate
offering price of the amount registered and sold was $23,920,000. The
total proceeds received by the Company, net of underwriting discounts
and estimated expenses of the offering, were approximately $21,885,000.
The total underwriting discount was $1,674,000. Expenses paid to or for
the underwriters were approximately $361,000. Other expenses in
connection with the offering were approximately $1,409,000 (of which
$400,000
<PAGE>
was paid to an affiliate of one of the Company's directors). From the
effective date through March 31,1999 the net offering proceeds were
used as follows: $8,870,000 for repayment of indebtedness (of which
$483,000 was paid to officers of the Company), and the remaining
proceeds received by the Company were used to fund operations.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. OTHER INFORMATION
We have been notified by the Nasdaq Stock Market that we are no longer in
compliance with the net tangible asset listing requirement of $ 4,000.000 for
continued listing under Maintenance Standard 1 as set forth in Marketplace Rule
4450(a)(3). We corresponded with Nasdaq regarding our plans to resume compliance
at a later date, but our request for continued listing was denied. We have
appealed the Nasdaq Staff decision to a Nasdaq Listing Qualifications Panel
pursuant to Nasdaq Marketplace rules. An oral hearing date has been granted for
late August 1999.
Delisting by Nasdaq would have a serious impact on our near-term ability to
raise capital. For a further explanation of such risks, please refer to our
"Risk Factor" section of our 1998 Annual Report Form 10KSB.
Effective March 15, 1999 Douglas Kubel resigned as Vice President to pursue
other interests.
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
27.01 Financial Data Schedule
(B) REPORTS ON FORM 8-K
During the three months ended March 31, 1999 the Company filed Form 8-K's in
conjunction with the following transactions:
o Issuance of a $ 4,000,000 convertible note debenture, filed January 25, 1999
o Acquisition of MPG-Net, Inc., filed February 12, 1999
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTERACTIVE MAGIC, INC.
August 5, 1999 By: /s/ J.W. Stealey
--------------------
J.W. Stealey
Chairman of the Board of Directors
and Chief Executive Officer
August 5, 1999 By: /s/ Michael W. Oliver
-------------------------
Michael W. Oliver
Chief Financial Officer
(Principal Financial and Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated Balance Sheet of Interactive Magic, Inc. as of March 31, 1999 and
the related Statement of Operations for the three month period ended March 31,
1999 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
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<TOTAL-ASSETS> 13,890
<CURRENT-LIABILITIES> 3,243
<BONDS> 2,296
0
0
<COMMON> 1,068
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<SALES> 561
<TOTAL-REVENUES> 1,162
<CGS> 416
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<OTHER-EXPENSES> (53)
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<INCOME-PRETAX> (6,063)
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