U.S. Securities and Exchange Commission
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
Commission file number 0-29750
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 August 12, 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 |
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Interactive Magic, Inc.
Consolidated Balance Sheets
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1999 1998
(UNAUDITED) (AUDITED)
------------------------------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 3,680 $ 2,943
Trade receivables, net of allowances of $525 and $2,871, respectively 332 2,109
Inventories 226 892
Advance royalties, net 347 1,586
Software development costs, net - 912
Prepaid expenses and other 49 252
------------------------------------
Total current assets 4,634 8,694
Property and equipment, net 1,017 1,082
Noncurrent assets:
Royalties receivable 115 726
Goodwill 3,817 0
Other 11 18
------------------------------------
Total noncurrent assets 4,971 744
====================================
Total assets $ 9,594 $10,520
====================================
<PAGE>
SEE ACCOMPANYING NOTES.
JUNE 30 DECEMBER 31
1999 1998
(UNAUDITED) (AUDITED)
------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities:
Accounts payable and accrued expenses $ 2,095 $ 1,698
Royalties and commissions payable 357 768
Lines of credit 1,323 1,348
Current portion of capital lease obligations 52 23
------------------------------------
Total current liabilities 3,827 3,837
Noncurrent liabilities:
Accrued interest payable to related parties 164 117
Long-term debt 2,455 -
Capital lease obligations, less current portion 24 15
------------------------------------
Total noncurrent liabilities 2,643 132
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; 10,690,183
and 9,850,867 shares issued and outstanding at June 30, 1999 and
December 31, 1998, respectively 1,069 985
Additional paid-in capital 39,183 31,522
Accumulated deficit (37,077) (25,862)
Accumulated other comprehensive loss (51) (94)
-------------------------------------
Total stockholders' equity (deficit) 3,124 (6,551)
====================================
Total liabilities and stockholders' equity (deficit) $ 9,594 $ 10,520
====================================
</TABLE>
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
1999 1998 1999 1998
-----------------------------------------------------------------
Net revenues:
<S> <C> <C> <C> <C>
CD-ROM product sales $ - $ 2,495 $ 561 $ 6,552
Online sales 498 426 965 784
Royalties and licenses - 901 7 1,399
Advertising and other 479 0 606 0
------------------------------------------------------------------
Total net revenues 977 3,822 2,139 8,735
Cost of revenues:
Cost of products and services 1,934 604 2,350 1,572
Royalties and amortized software costs 222 461 311 1,370
-----------------------------------------------------------------
Total cost of revenues 2,156 1,065 2,661 2,942
-----------------------------------------------------------------
Gross (loss) profit (1,179) 2,757 (522) 5,793
Operating expenses:
Sales and marketing 1,569 2,048 3,091 3,715
Product development 1,348 858 3,193 1,961
General and administrative 1,270 570 2,122 1,019
Goodwill 365 0 556 0
-----------------------------------------------------------------
Total operating expenses 4,552 3,476 8,962 6,695
-----------------------------------------------------------------
Operating loss (5,731) (719) (9,484) (902)
Other (income) expense:
Interest expense - third parties 228 230 2,573 430
Interest expense - related parties 20 71 38 178
Other (869) 18 (922) 18
-----------------------------------------------------------------
Total other (income) expense (621) 319 1,689 626
-----------------------------------------------------------------
Loss before income taxes (5,110) (1,038) (11,173) (1,528)
Income tax expense 7 - 42 128
-----------------------------------------------------------------
Net loss $ (5,117) $ (1,038) $ (11,215) $ (1,656)
=================================================================
Basic loss per share:
Net loss per share $ (0.48) $ (0.27) $ (1.07) $ (0.46)
=================================================================
Weighted average shares used in computing basic
loss per share 10,684,509 3,778,979 10,501,317 3,605,233
=================================================================
</TABLE>
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
1999 1998
-----------------------------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss $ (11,215) $ (1,656)
Adjustments to reconcile net loss to net cash used in operating
activities:
Issuance of warrants 76 -
Depreciation and amortization 839 205
Gain on the sale of advance royalties (NOTE 3) (855) -
Amortization of capitalized software development costs 329 275
Noncash interest expense 2,386 51
Write-off of capitalized software development costs 620 -
Changes in operating assets and liabilities net of effects of purchase of
MPG-Net (NOTE 4)
Trade and royalties receivables 2,430 (2,074)
Inventories 666 (164)
Advance royalties (121) 313
Prepaid expenses and other 74 (10)
Accounts payable and accrued expenses (35) 139
Royalties and commissions payable (411) 292
Accrued interest 47 178
-----------------------------------------
Net cash used in operating activities (5,170) (2,451)
INVESTING ACTIVITIES
Acquisition of MPG-Net (NOTE 4) (15) -
Proceeds from the sale of advance royalties (NOTE 3) 2,315 -
Purchase of property and equipment (37) (101)
Increase in notes receivable (200) -
Software development costs (37) (1,115)
------------------------------------------
Net cash provided by (used in) investing activities 2,026 (1,216)
FINANCING ACTIVITIES
Proceeds from issuance of common and preferred stock 220 3,268
Payments on long-term debt - (500)
Proceeds from issuance of convertible debentures 3,660 -
</TABLE>
<PAGE>
Interactive Magic, Inc.
Consolidated Statements of Cash Flows (continued)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
1999 1998
-----------------------------------------
<S> <C> <C>
Net borrowings from lines-of-credit (25) 900
Payments on capital lease obligations (17) (20)
-----------------------------------------
Net cash provided by financing activities 3,838 3,648
Effect of currency exchange rate changes on cash and cash equivalents
43 (21)
-----------------------------------------
Net increase (decrease) in cash and cash equivalents 737 (40)
Cash and cash equivalents at beginning of period 2,943 384
=========================================
Cash and cash equivalents at end of period $ 3,680 $ 344
=========================================
NONCASH INVESTING AND FINANCING ACTIVITIES
Conversion of notes payable into common and preferred stock $ - $ 2,600
=========================================
Issuance of common stock in settlement of accrued interest payable to
related parties $ - $ 319
=========================================
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 6) $ $ 1,067 $ -
=========================================
Issuance of warrants to broker in connection with convertible debenture
(NOTE 6) $ 390 $ -
=========================================
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE THREE AND SIX MONTHS ENDED JUNE
30, 1999 AND 1998 IS UNAUDITED)
1. DESCRIPTION OF BUSINESS
Interactive Magic, Inc. (or the "Company") is a developer and publisher of
Internet and online games and an operator of online game services. The Company
develops and publishes proprietary online multi-player games and is building the
Company Entertainment Network ("iEN"), an Internet distribution infrastructure
which will offer online gamers a variety of free, subscription and pay-per-play
games and services, including simulation, parlor, strategy, role playing and
action games.
The Company is the exclusive game site operator for AT&T WorldNet, an
Internet service provider ("ISP"), and has been contracted to provide online
games for America Online, the world's leading online Internet services company.
The Company seeks to establish itself as a major provider of online gaming
services for ISPs, Internet portals and online services in order to broaden its
audience of users. GameHub, AT&T WorldNet's co-branded online gaming service,
was launched in January 1999 and is currently being marketed by AT&T to new
WorldNet subscribers as a premium service included with their subscription. The
GameHub site offers consumers a mix of free and pay-per-play games in all
categories, including strategy, role playing, simulation, action and parlor
games. In addition to games, GameHub will offer chat rooms, forums and shopping
areas. GameHub is expected to generate revenue from subscriber premiums,
e-commerce and advertising. GameHub complements the Company's online gaming
strategy by expanding the Company's network of player communities.
2. 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 six months ended June 30, 1999 and 1998, the
Company incurred losses of $11,215,000 and $1,656,000, 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.
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)
3. 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 the Company a license to use these products on the Internet. The
transaction was consummated on June 30, 1999. Cash proceeds to the Company, net
of related expenses, were $2.3 million. The carrying value of net assets sold
(primarily CD-ROM advance royalties) was $ 1.5 million. The Company recognized a
gain of $855,000 related to the sale, which is included in other (income)
expense in the consolidated statements of operations.
4. BUSINESS COMBINATION
On February 12, 1999 the Company completed the acquisition of MPG-Net, Inc.
("MPG-Net") 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>
SIX MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE
1999 30, 1998
--------------------------- --------------------------
<S> <C> <C>
Net revenues $2,233 $ 8,843
Net loss before extraordinary items (11,870) (3,677)
Net loss (11,675) (3,122)
Loss per share $(1.09) $(0.72)
</TABLE>
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
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):
JUNE 30 DECEMBER 31
1999 1998
---------------------------------
Finished goods $ 770 $ 1,065
Components 100 117
---------------------------------
870 1,182
Inventory valuation reserve (644) (290)
=================================
$ 226 $ 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 June 30, 1999 and December 31, 1998, the reserve for
advance royalties was $226,000 and $1,654,000, respectively.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
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):
JUNE 30, 1999 DECEMBER 31, 1998
----------------------------------------
Balance at beginning of period $ 912 $ 425
Capitalized 37 1,450
Written off (620) -
Amortized (329) (963)
----------------------------------------
Balance at end of period $ - $ 912
========================================
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, trade receivables, accounts
payable and other liabilities approximates fair value at June 30, 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)
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)
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.
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)
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. 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 broker of the debenture, 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 and six months ended June 30, 1999,
amortization of the debt issuance costs was approximately $52,000 and $100,000,
respectively.
The debenture accrues interest at an annual interest rate of 6% and is due with
principal 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").
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
6. LONG-TERM DEBT (CONTINUED)
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. However, the debenture was convertible at the date of issuance and the
value of the conversion feature was 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 and six months
ended June 30, 1999, the Company recorded approximately $93,000 and $152,000 in
interest expense related to such accretion, respectively. For the three and six
months ended June 30, 1999, interest expense related to this debenture totaled
$.3 million and $2.5 million, respectively.
7. STOCK OPTIONS, STOCK PLANS AND WARRANTS
The following table summarizes the activity under the Company's Stock Option
Plans for the six months ended June 30, 1999:
OPTIONS WEIGHTED-AVERAGE EXERCISE
OUTSTANDING PRICE PER SHARE
-------------------------------------------
Balances at December 31, 1998 1,981,968 2.72
Options granted 923,330 3.71
Options exercised (89,316) 2.60
Options canceled (447,481) 4.07
-------------------------------------------
Balances at June 30, 1999 2,368,501 $2.85
===========================================
At June 30, 1999 the Company had 1,194,139 options exercisable at exercise
prices ranging from $1.00 - $6.00 per share.
<PAGE>
Interactive Magic, Inc.
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS, STOCK PLANS AND WARRANTS (CONTINUED)
STOCK WARRANTS
The following summarizes the activity of warrants for the six months ended June
30, 1999:
WARRANTS
OUTSTANDING
----------------------
Balance at December 31, 1998 729,172
Issued 520,000
Exercised -
----------------------
Balance at June 30, 1999 1,249,172
======================
All of the Company's outstanding warrants at June 30, 1999 were exercisable at
prices ranging from $1.00 to $9.60 per share.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW
On May 25, 1999 the Company signed a definitive agreement with Ubi Soft
Entertainment S.A. to sell to Ubi Soft the rights the Company had for the
development of CD-ROM games with various game developers. The Company retained
the Online rights for the games under development. The transaction was closed on
June 30, 1999 with the Company receiving $2,500,000 cash for the CD-ROM
development agreements. The sale of the development rights marked the Company's
exit from the CD-ROM business. Accordingly the second quarter, 1999 results
reflect the final period we were engaged in this portion of our business. The
three month and six month financial statement comparisons are therefore heavily
impacted by the disposition of the CD-ROM business.
NET REVENUES
Net revenues decreased by 74% to $ 1.0 million for the three months ended June
30, 1999 from $3.8 million for the three months ended June 30, 1998. Net revenue
decreased from $8.7 in the first six months of 1998 to $2.1 million in the first
six months of 1999.
The following table summarizes the changes in revenue from 1998 to 1999:
<TABLE>
<CAPTION>
- -------------------------------------- -------------------------------------- ----------------------------------
- -------------------------------------- -------------------------------------- ----------------------------------
Three Months ended June 30 ($000) Six months ended June 30 ($000)
- -------------------------------------- -------------------------------------- ----------------------------------
<S> <C> <C>
Revenue for the period in 1998 $3,822 $8,735
- -------------------------------------- -------------------------------------- ----------------------------------
Decrease in CD-ROM revenue (2,495) (5,991)
- -------------------------------------- -------------------------------------- ----------------------------------
Increase in On-Line Revenue 72 181
- -------------------------------------- -------------------------------------- ----------------------------------
Decrease in Royalty & Licensing (901) (1,392)
- -------------------------------------- -------------------------------------- ----------------------------------
Increase in Advertising & Other 479 606
--- ---
- -------------------------------------- -------------------------------------- ----------------------------------
Revenue for the period in 1999 $977 $2,139
==== ======
- -------------------------------------- -------------------------------------- ----------------------------------
</TABLE>
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 second quarter of 1999 increased to $ 2.2 million from $1.1
million in the same period of 1998, despite negligible CD-ROM revenue. The
increase was due to the establishment of reserves and inventory write-downs
associated with the exited CD-ROM business. For the six month period, cost of
revenue in 1999 is $281,000 below the comparable period for 1998. The decrease
reflects the considerably lower level of CD-ROM shipments offset partially by
the expenses in the second quarter for the establishment of reserves and
inventory write-downs associated with the exit of the CD-ROM business.
<PAGE>
OPERATING EXPENSES
Operating expenses increased $1.1 million or 31% from the first quarter of 1998
to the same period in 1999. On a year-to-date basis, operating expenses were
$2.3 million higher in 1999 compared to 1998. For both the three and six month
periods, the increased level of spending reflects the Company's continued
support of CD-ROM in the first four months of 1999, prior to implementation of
cost reduction programs. In addition, there is an additional expense of $
365,000 and $ 556,000 for the three and six month periods, respectively, due to
amortization expense of goodwill associated with the MPG-Net acquisition. The
following is a summary of major variances:
<TABLE>
<CAPTION>
- ---------------------------------------------- ---------------------------------------- --------------------------------------
- ---------------------------------------------- ---------------------------------------- --------------------------------------
Three Months ended June 30 ($000) Six months ended June 30 ($000)
- ---------------------------------------------- ---------------------------------------- --------------------------------------
<S> <C> <C>
Operating Expenses for the period in 1998 $3,476 $6,695
- ---------------------------------------------- ---------------------------------------- --------------------------------------
Sales and Marketing (479) (624)
- ---------------------------------------------- ---------------------------------------- --------------------------------------
Product Development 490 1,232
- ---------------------------------------------- ---------------------------------------- --------------------------------------
General and Administrative 700 1,103
- ---------------------------------------------- ---------------------------------------- --------------------------------------
Goodwill Amortization 365 556
--- ---
- ---------------------------------------------- ---------------------------------------- --------------------------------------
Operating Expenses for the period in 1999 $4,552 $8,962
====== ======
- ---------------------------------------------- ---------------------------------------- --------------------------------------
</TABLE>
SALES AND MARKETING. Decreased for the three months and six months of 1999
versus 1998 due to the lower level of titles being released on CD-ROM; and a
significant decrease in market development funds spending in 1999 compared to
1998.
PRODUCT DEVELOPMENT. Increases in both the quarter and year-to-date despite exit
from CD-ROM business due to lower actual spending on CD-ROM games being offset
by a combination of increased development for on-line games and the write-off of
unamortized development costs associated with the exit of the CD-ROM business.
GENERAL AND ADMINISTRATIVE. Higher for both the three and six month periods due
to: the additional expense of being a publicly-held company; relocation expenses
relating to the consolidation of our Florida and Texas operations to North
Carolina; severance and up-front spending associated with implementation of cost
reduction programs.
Goodwill Amortization, Goodwill from the MPG-Net acquisition is being amortized
to income over 36 months.
OTHER (INCOME) EXPENSE
Other (income) / expense yielded $940,000 additional income for the three months
ended June 30,1999 versus 1998 due to the gain recognized on the sale of the
CD-ROM business. For the first six months of 1999 compared to 1998 there is
additional expense of $1,063,000. The higher expense level is due to higher
interest expense relating to the recognition of the beneficial conversion
feature of the $ 4,000,000 convertible debenture, and related warrants, which
were issued in the first quarter of 1999; which is partially offset by the gain
on the sale of the CD-ROM business in the second quarter.
INCOME TAX EXPENSE
The Company recorded $42,000 income tax expense for the first half 1999 compared
to $128,000 for the same period in 1998. The entire tax expense in each period
is attributable to earnings in Europe.
<PAGE>
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.
The following is a condensed table of cash on hand and major cash flow items
from December 31, 1998 to June 30, 1999:
-----------------------------------------------------------------------------
$ Million
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Cash on hand, December 31, 1998 $2.9
----------------------------------------------------------------
----------------------------------------------------------------
Net loss for the first six months (11.2)
----------------------------------------------------------------
Add: non-cash charges and expenses 4.2
----------------------------------------------------------------
Less: non-cash gain on sale of CD-ROM (.9)
----------------------------------------------------------------
Changes in working capital 2.7
-----------------------------------------------------------------------------
Net Cash Used in Operations (5.2)
----------------------------------------------------------------
Net proceeds from sale of CD-ROM 2.3
----------------------------------------------------------------
Net proceeds from issuing convertible debentures 3.7
-----------------------------------------------------------------------------
Net change in cash for the six months ended June 30, 1999 .8
-----------------------------------------------------------------------------
----------------------------------------------------------------
Cash on hand, June 30, 1999 $3.7
----------------------------------------------------------------=============
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 June 30, 1999). The balance outstanding under this line as of June
30, 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. Management expects the disposition of its CD-ROM
operations will reduce its operating losses and expects to be able to attract
additional capital, if needed, for its online operations. However, there can be
no assurance that management's plans will be executed as anticipated.
We do not have any current arrangements or commitments for any future financing.
We may not be able to obtain sufficient additional financing to satisfy cash
requirements. We may be required to obtain financing on terms that are not
favorable to us and our shareholders. If we are unable to obtain additional
financing when needed, we may be required to delay or scale back product
development and marketing programs in order to meet our short-term cash
requirements, which could have a material adverse effect on our business,
financial condition and results of operations.
<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 has been and plans to
continue contacting critical vendors and suppliers to obtain assurances of their
ability to ensure smooth delivery of products and services after December 1999.
Additionally, the Company plans to 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 April 1, 1999 through June 30, 1999 the Company issued 260,000
warrants, to the underwriters in conjunction with the Company's Initial
Public Offering, and granted 300,000 options to 26 employees.
(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 was paid to an affiliate of one of the Company's directors).
From the effective date through June 30,1999 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.
<PAGE>
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 on
August 27, 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.
The Company announced, on July 20,1999, it was changing its name to
iEntertainment Network. The name change will be submitted for shareholder
approval at the next Annual Shareholder's Meeting. The Company is also in the
process of changing its "ticker symbol" on the Nasdaq exchange to "IENT" from
"IMGK".
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
27.01 Financial Data Schedule
(B) REPORTS ON FORM 8-K
Since the filing of the Company's 1999 First Quarter, Form 10-QSB, the Company
filed current reports on Form 8-K in conjunction with the following events:
o Sale of the Company's CD-ROM business to Ubi Soft Entertainment S.A. for
$2,500,000 in cash, filed July 15,1999 (as amended).
o Notification of Nasdaq hearing for continued listing, filed July 30, 1999.
o Resignation of Avi Suriel, a member of the Board of Directors, filed August 3,
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 13, 1999 By: /s/ J.W. Stealey
--------------------
J.W. Stealey
Chairman of the Board of Directors
and Chief Executive Officer
August 13, 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 June 30, 1999 and
the related Statement of Operations for the six month period ended June 30, 1999
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,680
<SECURITIES> 0
<RECEIVABLES> 857
<ALLOWANCES> 525
<INVENTORY> 226
<CURRENT-ASSETS> 4,634
<PP&E> 2,437
<DEPRECIATION> 1,420
<TOTAL-ASSETS> 9,594
<CURRENT-LIABILITIES> 0
<BONDS> 2,455
0
0
<COMMON> 1,069
<OTHER-SE> 2,055
<TOTAL-LIABILITY-AND-EQUITY> 9,594
<SALES> 0
<TOTAL-REVENUES> 2,139
<CGS> 2,661
<TOTAL-COSTS> 11,623
<OTHER-EXPENSES> (922)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,611
<INCOME-PRETAX> (11,173)
<INCOME-TAX> 42
<INCOME-CONTINUING> (11,215)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,215)
<EPS-BASIC> (1.07)
<EPS-DILUTED> (1.07)
</TABLE>
