<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended February 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 0-16986
ACCLAIM ENTERTAINMENT, INC.
(Exact name of the registrant as specified in its charter)
Delaware 38-2698904
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Acclaim Plaza, Glen Cove, New York 11542
(Address of principal executive offices)
(516) 656-5000
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No___
As at April 10, 1997, approximately 49,770,000 shares of Common Stock of the
registrant were outstanding.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000s, except per share data)
<TABLE>
<CAPTION>
February 28, August 31,
1997 1996
------------ ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 44,576 $ 18,814
Marketable equity securities -- 11,278
Accounts receivable - net 48,732 20,478
Inventories 4,190 8,052
Prepaid expenses 19,545 18,513
Other current assets 3,395 --
Income taxes receivable -- 54,334
--------- ---------
TOTAL CURRENT ASSETS 120,438 131,469
--------- ---------
OTHER ASSETS
Fixed assets - net 38,800 42,779
Excess of cost over net assets acquired - net of accumulated
amortization of $15,482 and $13,052, respectively 51,509 54,939
Other assets 12,832 10,464
--------- ---------
TOTAL ASSETS $ 223,579 $ 239,651
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 30,885 $ 29,749
Short-term borrowings 3,900 5,321
Accrued expenses 68,980 78,506
Income taxes payable 1,901 724
Current portion of long-term debt 1,261 25,527
Obligation under capital leases - current 2,362 1,681
--------- ---------
TOTAL CURRENT LIABILITIES 109,289 141,508
--------- ---------
LONG-TERM LIABILITIES
Obligation under capital leases - noncurrent 2,888 3,685
Long-term debt 53,044 --
Other long-term liabilities -- 347
--------- ---------
TOTAL LIABILITIES 165,221 145,540
--------- ---------
MINORITY INTEREST (39) 522
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value; 1,000 shares authorized;
None issued -- --
Common stock, $0.02 par value; 100,000 shares authorized;
50,055 and 50,041 shares issued
respectively 1,001 1,001
Additional paid in capital 168,487 165,782
Accumulated deficit (106,484) (70,642)
Treasury stock, 348 shares (1,813) (1,813)
Foreign currency translation adjustment (2,794) (754)
Unrealized gain on marketable equity securities -- 15
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 58,397 93,589
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 223,579 $ 239,651
--------- ---------
</TABLE>
See notes to consolidated financial statements
1
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(in 000s, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
February 28, February 29, February 28, February 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET REVENUES $ 52,310 $ 17,926 $ 105,648 $ 152,374
COST OF REVENUES 25,746 54,552 49,188 130,416
-------- -------- --------- ---------
GROSS PROFIT (LOSS) 26,564 (36,626) 56,460 21,958
-------- -------- --------- ---------
OPERATING EXPENSES
Selling, advertising, general and
administrative expenses 30,275 39,370 65,620 86,695
Research & development expenses 9,424 6,144 16,968 11,404
Operating interest 248 2,073 1,208 3,105
Depreciation and amortization 4,002 3,699 8,160 7,195
-------- -------- --------- ---------
TOTAL OPERATING EXPENSES 43,949 51,286 91,956 108,399
-------- -------- --------- ---------
(LOSS) FROM OPERATIONS (17,385) (87,912) (35,496) (86,441)
-------- -------- --------- ---------
OTHER INCOME (EXPENSE)
Interest income 500 1,147 791 1,978
Interest expense (715) (525) (1,449) (1,117)
Other (expense) income 42 4,511 (634) 3,677
-------- -------- --------- ---------
(LOSS) BEFORE INCOME TAXES (17,558) (82,779) (36,788) (81,903)
(BENEFIT) FOR INCOME TAXES (380) (26,805) (380) (26,455)
-------- -------- --------- ---------
NET (LOSS) BEFORE
MINORITY INTEREST (17,178) (55,974) (36,408) (55,448)
MINORITY INTEREST (336) (203) (566) (272)
-------- -------- --------- ---------
NET (LOSS) $(16,842) $(55,771) $ (35,842) $ (55,176)
-------- -------- --------- ---------
NET (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARE $ (0.34) $ (1.12) $ (0.72) $ (1.12)
-------- -------- --------- ---------
WEIGHTED AVERAGE NUMBER OF
COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING 49,700 49,915 49,700 49,070
-------- -------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(in 000s, except per share data)
<TABLE>
<CAPTION>
Preferred Stock (1) Common Stock
------------------- ----------------------
Issued Issued Additional
------ ------ Paid-In Deferred
Shares Amount Shares Amount Capital Compensation
------ ------ ------ ------ ------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance August 31, 1995 -- -- 46,281 $926 $168,785 $(10,652)
---- ---- --------- --------- --------- ---------
Net Loss -- -- -- -- -- --
Issuances of Common Stock
and Options -- -- 463 9 7,756 (7,765)
Deferred compensation expense -- -- -- -- -- 3,304
Exercise of Stock Options
and Warrants -- -- 552 11 3,711 --
Pooling of Interests with Sculptured
and Probe -- -- 2,745 55 (55) --
Tax Benefit from Exercise of
Stock Options -- -- -- -- 698 --
Purchase of Treasury Stock -- -- -- -- --
Foreign Currency Translation Loss -- -- -- -- -- --
Unrealized Loss on
Marketable Equity Securities -- -- -- -- -- --
---- ---- --------- --------- --------- ---------
Balance August 31, 1996 -- -- 50,041 1,001 180,895 (15,113)
---- ---- --------- --------- --------- ---------
Net Loss -- -- -- -- -- --
Deferred compensation expense -- -- -- -- -- 2,097
Exercise of Stock Options
and Warrants -- -- 14 -- 40 --
Issuance of Warrants -- -- -- -- 568 --
Foreign Currency Translation Loss -- -- -- -- -- --
Unrealized Loss on
Marketable Equity Securities -- -- -- -- -- --
---- ---- --------- --------- --------- ---------
Balance February 28, 1997 -- -- 50,055 $1,001 $181,503 $(13,016)
---- ---- --------- --------- --------- ---------
<CAPTION>
Unrealized
(Accumulated Foreign Gain (Loss) On
Deficit) Currency Marketable
Retained Treasury Translation Equity
Earnings Stock Adjustment Securities Total
-------- ----- ---------- ---------- -----
<S> <C> <C> <C> <C> <C>
Balance August 31, 1995 $153,141 $(807) $811 $2,503 $314,707
--------- --------- --------- --------- ---------
Net Loss (221,368) -- -- -- (221,368)
Issuances of Common Stock
and Options -- -- -- -- --
Deferred compensation expense -- -- -- -- 3,304
Exercise of Stock Options
and Warrants -- -- -- -- 3,722
Pooling of Interests with Sculptured
and Probe (2,415) -- -- -- (2,415)
Tax Benefit from Exercise of
Stock Options -- -- -- -- 698
Purchase of Treasury Stock -- (1,006) -- -- (1,006)
Foreign Currency Translation Loss -- -- (1,565) -- (1,565)
Unrealized Loss on
Marketable Equity Securities -- -- -- (2,488) (2,488)
--------- --------- --------- --------- ---------
Balance August 31, 1996 (70,642) (1,813) (754) 15 93,589
--------- --------- --------- --------- ---------
Net Loss (35,842) -- -- -- (35,842)
Deferred compensation expense -- -- -- -- 2,097
Exercise of Stock Options
and Warrants -- -- -- -- 40
Issuance of Warrants -- -- -- -- 568
Foreign Currency Translation Loss -- -- (2,040) -- (2,040)
Unrealized Loss on
Marketable Equity Securities -- -- -- (15) (15)
--------- --------- --------- --------- ---------
Balance February 28, 1997 $(106,484) $(1,813) $(2,794) -- $58,397
--------- --------- --------- --------- ---------
</TABLE>
(1) The Company is authorized to issue 1,000 shares of preferred stock at a par
value of $0.01 per share, none of which shares is presently issued and
outstanding.
See notes to consolidated financial statements
3
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(in 000s, except per share data)
<TABLE>
<CAPTION>
Six Months Ended
February 28, February 29,
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Cash received from customers $ 101,231 $ 338,409
Cash paid to suppliers and employees (163,892) (357,189)
Interest received 791 1,978
Interest paid (2,657) (4,222)
Income taxes refunded (paid) 56,154 (262)
--------- ---------
NET CASH (USED IN) OPERATING ACTIVITIES (8,373) (21,286)
--------- ---------
CASH FLOWS PROVIDED BY (USED IN)
INVESTING ACTIVITIES
Sale of marketable equity securities $ 10,153 $ 14,643
Acquisition of subsidiaries, net 1,000 7,161
Acquisition of fixed assets, excluding capital leases (1,329) (8,653)
Acquisition of other assets (2,894) (1,395)
Other investing activities (98) 161
--------- ---------
NET CASH PROVIDED BY INVESTING ACTIVITIES 6,832 11,917
--------- ---------
CASH FLOWS PROVIDED BY (USED IN)
FINANCING ACTIVITIES
Proceeds from Convertible Subordinated Notes 50,000 ---
Proceeds from short-term borrowings 9,416 1,453
Repayment of short-term borrowings (10,267) (3,798)
Payment of mortgage (2,226) ---
Issuance of common stock --- 4
Exercise of stock options 40 3,461
Payment of obligation under capital leases (826) (110)
Payment of long-term debt (19,000) (3,056)
Other financing activities 500 128
Common stock purchased for treasury --- (819)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 27,637 (2,737)
--------- ---------
EFFECT OF EXCHANGE RATE
CHANGES ON CASH (334) (571)
--------- ---------
NET INCREASE (DECREASE) IN CASH 25,762 (12,677)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 18,814 44,749
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 44,576 $ 32,072
--------- ---------
</TABLE>
4
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Continued)
(in 000s, except per share data)
<TABLE>
<CAPTION>
Six Months Ended
February 28, February 29,
1997 1996
------------ ------------
<S> <C> <C>
RECONCILIATION OF NET EARNINGS TO NET CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net (Loss) $(35,842) $ (55,176)
-------- ---------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 8,160 7,195
Loss (Gain) on sale of marketable equity securities 1,016 (3,690)
Provision for returns and discounts 16,557 106,166
Deferred income taxes (418) (13,217)
Minority interest in net earnings of consolidated subsidiary (566) (272)
Deferred compensation expense 2,097 1,132
Non-cash royalty charges 4,906 2,221
Other non-cash charges 599 170
Change in assets and liabilities:
(Increase) in accounts receivable (49,957) (11,332)
Decrease (Increase) in inventories 2,278 (2,441)
(Increase) Decrease in prepaid expenses (5,373) 241
Decrease (Increase) in other current assets 198 (302)
Increase (Decrease) in trade accounts payable 321 (12,793)
(Decrease) in accrued expenses (7,537) (25,690)
Increase (Decrease) in income taxes receivable 55,188 (13,498)
-------- ---------
Total adjustments 27,469 33,890
-------- ---------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES $ (8,373) $ (21,286)
-------- ---------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in 000s, except per share data)
1. Interim Period Reporting - The data contained in these financial statements
are unaudited and are subject to year-end adjustments; however, in the opinion
of management, all known adjustments (which consist only of normal recurring
accruals) have been made to present fairly the consolidated operating results
for the unaudited periods.
Adjustments in the fourth quarter of fiscal 1996, on a pre-tax basis,
aggregated $138,300, a portion of which related to prior quarters. Accordingly,
for comparative quarterly purposes, during fiscal 1997, the 1996 quarterly
operating results may not necessarily be indicative of the results of
operations for such quarterly periods if these year-end adjustments could be
allocated to the respective quarters.
2. Liquidity - The accompanying consolidated financial statements have been
prepared assuming that Acclaim Entertainment, Inc. ("Acclaim"), together with
its subsidiaries (Acclaim and its subsidiaries are collectively hereinafter
referred to as the "Company"), will continue as a going concern. The Company's
significant losses from operations in fiscal 1996 and in the six months ended
February 28, 1997, the uncertainty as to whether the Company's products in
development will achieve commercial success and uncertainty regarding the
resolution of litigation, including various class action lawsuits, raise
substantial doubt about the Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
arise from the outcome of this uncertainty.
3. Acquisitions - On October 9, 1995, the Company acquired Sculptured
Software, Inc. ("Sculptured") and, on October 16, 1995, the Company acquired
Probe Entertainment Limited ("Probe"). Sculptured and Probe are developers of
interactive video games. Both acquisitions were accounted for as poolings of
interests and were effected through the exchange of an aggregate of 2,745
shares of common stock, par value $0.02 per share (the "Common Stock"), of the
Company for all the issued and outstanding shares of Sculptured and Probe. The
Company's consolidated financial statements for fiscal 1996 include the results
of Sculptured and Probe.
4. Accounts Receivable - Accounts receivable are comprised of the following:
February 28, 1997 August 31, 1996
----------------- ---------------
Receivables assigned to factor $47,734 $55,099
Less advances from factor 4,719 23,487
------- -------
Due from factor 43,015 31,612
Unfactored accounts receivable 6,969 12,031
Accounts receivable - foreign 23,875 20,229
Other receivables 2,973 5,472
Allowances for returns and discounts (28,100) (48,866)
------- -------
$48,732 $20,478
------- -------
Pursuant to a factoring agreement, the Company's principal bank acts as its
factor for the majority of its North American receivables, which are assigned
on a pre-approved basis. At February 28, 1997, the factoring charge amounted to
0.25% of the receivables assigned. The Company's obligations to the bank are
collateralized by all of the Company's and its North American subsidiaries'
accounts receivable, inventories and equipment. The advances for factored
receivables are pursuant to a revolving credit and security agreement, which
expires on January 31, 2000.
6
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in 000s, except per share data)
4. Accounts Receivable - (Continued)
The Company draws down working capital advances and opens letters of credit
(up to an aggregate maximum of $20,000) against the facility in amounts
determined on a formula based on factored receivables, inventory and cost of
imported goods under outstanding letters of credit. Effective November 8, 1996,
interest is charged at the bank's prime lending rate (8.25% at February 28,
1997) plus one percent per annum on such advances.
As of August 31, 1996 and November 30, 1996, the Company was in default of
various financial and other covenants under its revolving credit facility
including the prohibition on having a "going concern" explanatory paragraph in
the fiscal 1996 auditors' report on its financial statements. The lender waived
these past defaults, conditioned upon the Company receiving at least $46,000 in
net proceeds from the issuance of the Convertible Subordinated Notes described
more fully in Note 5. On February 26, 1997, the Company received net proceeds of
$47,400 from the issuance of such Notes. The Company is current in its payment
obligations under the revolving credit facility and has negotiated new financial
covenants with the lender. Pursuant to the terms of the agreement, which can be
cancelled by either party upon 90 days notice prior to the end of the term, the
Company is required to maintain specified levels of working capital and tangible
net worth, and may not incur losses in excess of specified amounts, among other
covenants.
Sales credits and allowances for the three months ended February 28, 1997
and February 29, 1996 were $6,800 and $86,451, respectively, and for the six
months ended February 28, 1997 and February 29, 1996 were $16,557 and $106,166,
respectively.
5. Long Term Debt - Long-term debt consists of the following:
February 28, August 31,
1997 1996
---- ----
(A) 10% Convertible Subordinated Notes due 2002 $50,000 --
(B) Term loan -- $19,000
(C) Mortgage note 4,305 6,527
------- -------
54,305 25,527
Less: current portion 1,261 25,527
------- -------
$53,044 $ --
------- -------
(A) In February 1997, the Company issued $50,000 of unsecured 10%
Convertible Subordinated Notes ("Notes") due March 1, 2002 with interest
payable semiannually commencing September 1, 1997. The Notes were sold at par
with proceeds to the Company of $47,400, net of expenses. The indenture
governing the Notes contains covenants that, among other things, substantially
limit the Company's ability to incur additional indebtedness, issue preferred
stock, pay dividends and make certain other payments. The Notes are convertible
into shares of Common Stock at any time after April 26, 1997 and prior to
maturity, unless previously redeemed, at a conversion price of $5.18 per share,
subject to adjustment under certain conditions. The Notes are redeemable, in
whole or in part, at the option of the Company (subject to the rights of holders
of senior indebtedness) at 104% of the principal balance at any time on or after
March 1, 2000 through February 28, 2001 and at 102% of the principal balance
thereafter to maturity.
7
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in 000s, except per share data)
5. Long Term Debt - (Continued)
(B) In conjunction with the acquisition of Acclaim Comics, Inc., in July
1994, Acclaim Comics entered into a term loan guaranteed by the Company which
bore interest at a rate of LIBOR plus 2.5%. The Company used $16,000 of the
proceeds from the issuance of the Notes to pay the remaining outstanding balance
of the term loan.
(C) The mortgage note bore interest at the bank's prime lending rate and is
payable in quarterly installments that commenced March 1, 1996. Effective
January 30, 1997, interest is charged at the bank's prime lending rate (8.25%
at February 28, 1997) plus one percent per annum. The principal amount is
payable in quarterly installments that commenced on May 1, 1996. The mortgage
note is collateralized by a building (Corporate Headquarters) with a carrying
value of approximately $16,910. As of August 31, 1996 and November 30, 1996,
the Company was in default of various financial and other covenants with the
mortgage lender. The mortgage lender waived these past defaults, conditioned
upon the mortgage lender receiving $2,000 from the net proceeds from the
issuance of the Notes and the Company accelerating payment terms on the balance
of the loan. The Company is currently negotiating the acceleration terms. The
Company used $2,000 of the proceeds from the issuance of the Notes to repay a
portion of the mortgage note.
6. Stock Options
On October 28, 1996, the Company granted an aggregate of 5,055 options to
purchase Common Stock at an exercise price of $3.94 per share, the market value
of the common stock on such date, to certain employees, other than directors,
which options were granted in lieu of previously granted options whose exercise
price was higher than $3.94. The vesting schedule for the new options was
identical to that of the old options and commenced on October 28, 1996, the
grant date.
On February 26, 1997, the Company granted approximately 4,100 options to
purchase shares of Common Stock at an exercise price of $4.81 per share, the
market value of the Common Stock on such date, to existing employees, subject
to stockholder approval of an amendment to increase the number of shares
subject to the 1988 Stock Option Plan.
7. Subsequent Events
On March 5, 1997, the Company completed the sale of substantially all of the
assets and certain liabilities of Acclaim Redemption Games, Inc., formerly
Lazer-Tron Corporation, for a purchase price of $6,000 in cash.
8
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following is intended to update the information contained in the
Company's Form 10-K for the year ended August 31, 1996 and Form 10-Q for the
quarter ended November 30, 1996 and presumes that readers have access to, and
will have read, the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained in the Form 10-K and Form 10-Q.
This quarterly report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. When used in this report,
the words "believe," "anticipate," "think," "intend," "plan," "will be" and
similar expressions identify such forward-looking statements. Such statements
regarding future events and/or the future financial performance of the Company
are subject to certain risks and uncertainties, including those discussed in
"Factors Affecting Future Performance" below at pages 16 to 26, which could
cause actual events or the actual future results of the Company to differ
materially from any forward-looking statements. In light of the significant
risks and uncertainties inherent in the forward-looking statements included
herein, the inclusion of such statements should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
Overview
The Company is a developer, publisher and mass marketer of interactive
entertainment software products ("Software") for use with dedicated interactive
entertainment hardware platforms ("Entertainment Platforms") and multimedia
personal computer systems ("PCs"). The Company operates its own Software design
studios, a motion capture studio and markets and distributes its products in the
major territories throughout the world. The Company's operating strategy is to
develop Software for the Entertainment Platforms and PCs that dominate the
interactive entertainment market at a given time or which the Company perceives
as having the potential for achieving mass market acceptance. The Company's
strategy is to emphasize sports simulation and arcade-style titles for
Entertainment Platforms, and fantasy/role-playing, adventure and sports
simulation titles for PCs. The Company intends to continue to support its
existing key brands with the introduction of new titles supporting those brands
and to develop one additional key brand each year based on its original and
licensed properties, which may then be featured on an annual basis in successive
titles.
The Company also engages in: (i) the development and publication of
comic books; (ii) the distribution of Software titles developed by other
Software publishers; (iii) the marketing of its motion capture technology and
studio services; and (iv) the distribution of coin-operated video arcade games.
The Software industry is driven by the size of the installed base of
Entertainment Platforms such as those manufactured by Nintendo, Sony and Sega
and PCs. The industry is characterized by rapid technological change, resulting
in Entertainment Platform and related Software product cycles. No single
Entertainment Platform or system has achieved long-term dominance in the
interactive entertainment market.
Based on information available in 1994 and based on its historical
experience with respect to the transition from 8-bit to 16-bit platforms, the
Company believed that Software sales for 16-bit platforms would, although
continuing to decrease overall, still dominate the interactive entertainment
market in 1995 and that such sales would remain substantial through the 1996
holiday season. Accordingly, although the Company's strategy for the Christmas
1995 season was to develop Software for multiple Entertainment Platforms and
PCs, the Company anticipated that substantially all of its revenues in fiscal
1995 would be derived from its 16-bit Software sales. The Company also
anticipated that its sales of 32-bit and PC Software in fiscal 1996 would grow
as compared to fiscal 1995 but that the majority of its revenues in fiscal 1996
would still be derived from 16-bit Software sales. However, the 16-bit Software
market matured much more rapidly than anticipated by the Company, the Company's
Christmas 1995 16-bit
9
<PAGE>
Software sales were substantially lower than anticipated and, by April 1996, the
Company derived minimal profits from such Software sales and made the decision
to exit the 16-bit and portable cartridge markets.
In connection with the Company's decision to exit the 16-bit and
portable Software markets in April 1996, the Company recorded a special
cartridge video charge of approximately $48.9 million in the second quarter of
fiscal 1996, consisting of provisions of approximately $28.8 million (reflected
in net revenues), and approximately $20.1 million (reflected in cost of
revenues), respectively, to adjust accounts receivable and inventories at
February 29, 1996 to their estimated net realizable values in conjunction with
management's decision to exit the portable and 16-bit cartridge market.
The Company recorded a loss from operations of $274.5 million for
fiscal 1996, which included an additional charge related to 16-bit and portable
Software of $65.0 million in the fourth quarter ended August 31, 1996, and a net
loss (on an after tax basis) of $221.4 million for fiscal 1996. The net loss for
the fourth quarter of fiscal 1996 of $162.2 million reflects additional
write-offs of receivables, the establishment of additional receivables and
inventory reserves, severance charges incurred in the fourth quarter in
connection with the downsizing of the Company and the reduction of certain
deferred costs, as well as an operating loss for the period resulting primarily
from price protection and similar concessions granted to retailers at greater
than anticipated levels in connection with the Company's 16-bit and 32-bit
Software. See "Factors Affecting Future Performance."
As a result of the industry transition to 32-bit and 64-bit
Entertainment Platforms, the Company's Software sales during fiscal 1996 and the
first half of fiscal 1997 were significantly lower than for the comparable
period in fiscal 1995 and the first half of fiscal 1996, respectively.
Management expects that unless and until the installed base of 32-bit and 64-bit
Entertainment Platforms increases substantially, its unit sales and revenues
from the sale of Software for these platforms will be substantially lower than
Software sales levels achieved prior to fiscal 1996, when the current transition
began. Management anticipates that the Company will continue to incur material
losses for the remainder of fiscal 1997. No assurances can be given as to the
future growth of the installed base of 32-bit and 64-bit Entertainment Platforms
or of the Company's results of operations and profitability in future periods.
See "Factors Affecting Future Performance."
The Company is continuing to sell its existing 16-bit and portable
cartridge Software inventory and has released, and may continue to release,
16-bit and/or portable Software selectively to support its key brands and, if
requested by a retailer, may produce additional units of particular title(s) on
a special order basis.
The rapid technological advances in game systems have significantly
changed the look and feel of Software as well as the Software development
process. According to Company estimates, the average development cost for a
title three years ago was approximately $300,000 to $400,000, while the current
average development cost for a title is between $1 million and $2 million. As a
result of the Company's acquisitions of Iguana Entertainment, Inc. ("Iguana"),
Sculptured Software, Inc. ("Sculptured") and Probe Entertainment, Inc. ("Probe")
in 1995 (two of which were completed in fiscal 1996), the Company's fixed costs
relating to the development of Software and its general and administrative
expenses were substantially higher in fiscal 1996 and the first half of fiscal
1997 as compared to prior periods. See "Factors Affecting Future Performance."
Such expenses in the aggregate had a material adverse impact on the Company's
profitability in fiscal 1996 and in the first half of fiscal 1997. Management
plans to reduce the dollar level of product development expenses incurred in the
latter part of fiscal 1997.
In August 1996, the Company down-sized and reorganized some of its
operations. Severance charges and other costs related to the downsizing of
approximately $5 million were incurred in the fourth quarter of fiscal 1996. The
Company has realized operating expense reductions resulting therefrom in the
first half of fiscal 1997.
10
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The Company's ability to generate sales growth and profitability will
be materially dependent on (i) the growth of the Software market for 32-bit and
64-bit Entertainment Platforms and PCs, (ii) the Company's ability to
identify, develop and publish "hit" Software for Entertainment Platforms with
significant installed bases, (iii) the development of, and the generation of
revenues from, its other entertainment operations, and (iv) the success of the
Company's cost reduction efforts.
Results of Operations
The following table sets forth certain statements of consolidated
operations data as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
February 28, February 29, February 28, February 29,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Domestic revenues 56.0% 60.6% 51.2% 67.0%
Foreign revenues 44.0 39.4 48.8 33.0
---- ---- ---- ----
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 49.2 304.3 46.6 85.6
---- ----- ---- ----
Gross profit (loss) 50.8 (204.3) 53.4 14.4
Selling, advertising, general and
administrative expenses 57.9 219.6 62.1 56.9
Research and development expenses 18.0 34.3 16.1 7.5
Operating interest 0.5 11.6 1.1 2.0
Depreciation and amortization 7.7 20.6 7.7 4.7
--- ---- --- ---
Total operating expenses 84.1 286.1 87.0 71.1
(Loss) from operations (33.3) (490.4) (33.6) (56.7)
Other income (expense), net (0.3) 28.6 (1.2) 3.0
----- ---- ----- ---
(Loss) before income taxes (33.6) (461.8) (34.8) (53.7)
Net (loss) (32.2) (311.1) (33.9) (36.2)
</TABLE>
Net Revenues
The Company's gross revenues, which exclude sales credits and
allowances which are material to the Company's results of operations, were
derived from the following product categories:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
February 28, February 29, February 28, February 29,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Portable Software 2.0% 7.0% 2.0% 9.0%
16-Bit Software 9.0% 45.0% 12.0% 56.0%
32-bit Software 26.0% 30.0% 45.0% 20.0%
64-bit Software 45.0% --- 22.0% ---
PC CD Software 14.0% 14.0% 15.0% 11.0%
Other 4.0% 4.0% 4.0% 4.0%
</TABLE>
The increase in the Company's net revenues from $17.9 million for the
three months ended February 29, 1996 to $52.3 million for the three months ended
February 28, 1997 was predominantly due to decreased returns, sales credits and
allowances and sales of the Company's Turok: Dinosaur Hunter Software for
Nintendo's N64 platform. The net revenues for the 1996 period reflect a special
cartridge video charge of $28.8 million. The decrease in the Company's net
revenues from $152.4 for the six months ended February 29, 1996 to $105.6 for
the six months ended February 28, 1997 was predominantly due to reduced unit
sales of 16-bit Software, which were not offset by sales of 32-bit, 64-bit and
PC Software. See "Factors Affecting Future Performance." Management anticipates
that sales of the
11
<PAGE>
Company's 32-bit, 64-bit and PC Software in fiscal 1997 will be materially short
of levels necessary to offset the reduction in revenues from sales of 16-bit
Software and no assurance can be given with respect to the Company's revenues in
future periods. In addition, to date, the Company has not generated material
revenues from any of its operations other than Software publishing and no
assurance can be given that the Company will be able to generate such revenues
in the future.
A significant portion of the Company's revenues in any quarter are
generally derived from Software first shipped in that quarter or in the
immediately preceding quarter. In the quarter ended February 29, 1996, College
Slam and Revolution X accounted for approximately 21% and 13% of the Company's
gross revenues, respectively, and, in the quarter ended February 28, 1997,
Turok: Dinosaur Hunter accounted for approximately 45% of the Company's gross
revenues.
The Company is substantially dependent on Sony, Sega and Nintendo as
the sole manufacturers of the hardware platforms marketed by them and as the
sole licensors of the proprietary information and technology needed to develop
Software for those platforms. For the three months ended February 29, 1996 and
February 28, 1997, the Company derived 25% and 51% of its gross revenues,
respectively, from sales of Nintendo-compatible Software, 41% and 14% of its
gross revenues, respectively, from sales of Sega-compatible Software and 18% and
17% of its gross revenues, respectively, from sales of Software for the Sony
PlayStation.
Gross Profit
Gross profit fluctuates as a result of six factors: (i) the level of
returns, sales credits and allowances; (ii) the number of "hit" products and
average unit selling prices; (iii) the percentage of sales of CD Software; (iv)
the level of manufacture by the Company of its Software; (v) the percentage of
foreign sales; and (vi) the percentage of foreign sales to third party
distributors.
The Company's gross profit is adversely impacted by increases in the
level of returns and allowances to retailers, which reduces the average unit
price obtained for its Software sales. Similarly, lack of "hit" titles or a low
number of "hit" titles, resulting in lower average unit sales prices, adversely
impacts the Company's gross profits.
The Company's margins on sales of CD Software are higher than those on
cartridge Software as a result of significantly lower CD software product costs.
The Company arranges for the manufacture by subcontractors of its Sega
Software under its agreement with Sega. The cost of Software manufactured by the
Company, together with the royalties payable to Sega upon the sale of such
Software, is lower than the cost of the Company's Software products when
manufactured by Sega. The royalty payable to Sega upon the sale of Software
manufactured by the Company is included as an operating expense, rather than as
part of cost of revenues, and increased sales of Software manufactured by the
Company results in higher gross profit as a percentage of net revenues. Software
for the Sony and Nintendo platforms is manufactured by Sony and Nintendo,
respectively. Royalties are payable to Sony and Nintendo as part of the product
cost at the time of manufacture and such costs are included in the Company's
cost of revenues sold which results in lower gross profit as a percentage of net
revenues when compared to gross profit on sales of Sega Software.
The Company's margins on foreign cartridge Software sales are typically
lower than those on domestic sales due to higher prices charged by hardware
licensors for Software distributed by the Company outside North America. The
Company's margins on foreign cartridge Software sales to third party
distributors are approximately one-third lower than those on sales that the
Company makes directly to foreign retailers.
Gross profit increased from a deficit of $(36.6) million ((204)% of net
revenues) for the three months ended February 29, 1996 to $26.6 million (51% of
net revenues) for the three months ended February
12
<PAGE>
28, 1997 primarily due to sales of Turok: Dinosaur Hunter Software. The gross
profit for the three months ended February 29, 1996 reflected a special
cartridge video charge of $48.9 million for which there is no comparable amount
in the current quarter. Gross profit increased from $22.0 million (14% of net
revenues) for the six months ended February 29, 1996 to $56.5 million (53% of
net revenues) for the six months ended February 28, 1997. The increase in gross
profit is primarily attributable to higher levels of sales of CD Software (PC CD
and 32-bit Software) as margins on CD Software are higher than those on
cartridge Software as a result of significantly lower CD product costs, sales of
Turok: Dinosaur Hunter Software and the absence of the special cartridge video
charge.
Management anticipates that the Company's future gross profit will be
affected principally by (i) the percentage of returns, sales credits and
allowances and other similar concessions in respect of the Company's Software
sales and (ii) the Company's product mix (i.e., the percentage of CD Software
and sales related to the Company's new businesses). Although gross margins on
sales of CD Software are, and are anticipated to continue to be, higher than
those on sales of cartridge Software, management believes that stock-balancing
programs for its PC CD Software products will result in higher rates of returns
of such product as compared to the historical rate of return of cartridge
Software. As the percentage of sales of PC CD Software products increases,
management anticipates that its reserves for such returns will increase, thereby
offsetting a portion of the higher gross margins generated from CD Software
sales.
The Company purchases substantially all of its products at prices
payable in United States dollars. Appreciation of the yen could result in
increased prices charged by Sony, Sega or Nintendo to the Company (although, to
date, none of them has effected such a price increase), which the Company may
not be able to pass on to its customers and which could adversely affect its
results of operations.
Operating Expenses
Selling, advertising, general and administrative expenses decreased
from $39.4 million (220% of net revenues) for the three months ended February
29, 1996 to $30 million (58% of net revenues) for the three months ended
February 28, 1997 and decreased from $86.7 million (57% of net revenues) for the
six months ended February 29, 1996 to $65.6 million (62% of net revenues) for
the six months ended February 28, 1997. The dollar decrease is primarily
attributable to reduced selling expenses resulting from decreased sales volume
and decreased advertising expenses.
Research and development expenses increased from $6.1 million (34% of
net revenues) for the three months ended February 29, 1996 to $9.4 million (18%
of net revenues) for the three months ended February 28, 1997 and increased from
$11.4 million (8% of net revenues) for the six months ended February 29, 1996 to
$17.0 million (16% of net revenues) for the six months ended February 28, 1997
due to increased internal Software development resulting from the acquisition of
two Software studios in the first quarter of fiscal 1996.
Operating interest expense was $2.1 million (12% of net revenues) for
the three months ended February 29, 1996 and $0.2 million (0.5% of net revenues)
for the three months ended February 28, 1997 and $3.1 million (2% of net
revenues) for the six months ended February 29, 1996 and $1.2 million (1% of net
revenues) for the six months ended February 28, 1997. The decrease was primarily
attributable to decreased sales volume and to lower outstanding balances under
the Company's principal credit facility.
Depreciation and amortization increased from $3.7 million (21% of net
revenues) for the three months ended February 29, 1996 to $4.0 million (8% of
net revenues) for the three months ended February 28, 1997 and increased from
$7.2 million (5% of net revenues) for the six months ended February 29, 1996 to
$8.2 million (8% of net revenues) for the six months ended February 28, 1997.
The increase is primarily attributable to depreciation relating to fixed assets
held by the Software studios and to the reduction, in the fourth quarter of
fiscal 1996, of the estimated remaining life of goodwill relating to Acclaim
Comics from forty to twenty years.
13
<PAGE>
Seasonality
The Company's business is seasonal, with higher revenues and operating
income typically occurring during its first, second and fourth fiscal quarters
(which correspond to the Christmas and post-Christmas selling season). The
timing of the delivery of Software titles and the releases of new products cause
material fluctuations in the Company's quarterly revenues and earnings.
Liquidity and Capital Resources
The Company used net cash in operating activities of approximately $8.4
million during the six months ended February 28, 1997 and approximately $21.3
million during the six months ended February 29, 1996.
An income tax refund of approximately $53 million related to the
carryback of the Company's loss for fiscal 1996 was included in the net cash
used in operating activities during the six months ended February 28, 1997. The
decrease in cash received from customers is primarily attributable to lower
sales resulting from the maturation of the 16-bit market and the related
transition to 32-bit and 64-bit platforms. See " -- Overview."
The Company derived net cash from investing activities of approximately
$6.8 million and $11.9 million during the six months ended February 29, 1996 and
February 28, 1997, respectively.
The decrease in net cash from investing activities in the six months
ended February 28, 1997 as compared to the six months ended February 29, 1996 is
primarily attributable to cash associated with the acquisition of certain
subsidiaries in the 1996 period, which reflects cash held by subsidiaries at the
respective dates of acquisition, and lower proceeds from the sale of marketable
equity securities. In addition, lower cash amounts were expended on the
acquisition of fixed assets in the six months ended February 28, 1997 as
compared to the six months ended February 29, 1996.
The Company derived net cash from financing activities of approximately
$27.6 million during the six months ended February 28, 1997 and used net cash in
financing activities of approximately $2.7 million during the six months ended
February 29, 1996.
The increase in net cash derived from financing activities in the six
months ended February 28, 1997 as compared to the six months ended February 29,
1996 is primarily attributable to the offering in February 1997 of $50.0 million
of 10% Convertible Subordinated Notes ("Notes") due March 1, 2002 with interest
payable semiannually commencing September 1, 1997. The Notes were sold at par
with proceeds to the Company of $47.4 million, net of expenses. The indenture
governing the Notes contains covenants that, among other things, substantially
limit the Company's ability to incur additional indebtedness, issue preferred
stock, pay dividends and make certain other payments. The Notes are convertible
into shares of Common Stock at any time after April 26, 1997 and prior to
maturity, unless previously redeemed, at a conversion price of $5.18 per share,
subject to adjustment under certain conditions. The Notes are redeemable, in
whole or in part, at the option of the Company (subject to the rights of holders
of senior indebtedness) at 104% of the principal balance at any time on or
after March 1, 2000 through February 28, 2001 and at 102% of the principal
balance thereafter to maturity.
In connection with its acquisition by the Company, Acclaim Comics
entered into a term loan agreement with Midland Bank plc ("Midland") for $40
million. On February 26, 1997, the Company used $16 million of the proceeds from
the issuance of the Notes to repay the remaining outstanding balance of the term
loan.
The Company generally purchases its inventory of Nintendo and Sega (to
the extent not manufactured by the Company) Software by opening letters of
credit when placing the purchase order. At
14
<PAGE>
February 28, 1997, the amount outstanding under letters of credit was
approximately $15.9 million. Other than such letters of credit, the Company does
not currently have any material operating or capital expenditure commitments.
The Company has a revolving credit and security agreement with BNY
Financial Corporation ("BNY"), its principal domestic bank, which agreement
expires on January 31, 2000. The credit agreement will be automatically renewed
for another year by its terms, unless terminated upon 90 days' prior notice by
either party. The Company draws down working capital advances and opens letters
of credit against the facility in amounts determined on a formula based on
factored receivables and inventory, which advances are secured by the Company's
assets. This bank also acts as the Company's factor for the majority of its
North American receivables, which are assigned on a pre-approved basis. At
February 28, 1997, the factoring charge was 0.25% of the receivables assigned
and the interest on advances was at the bank's prime rate plus one percent. As
of August 31, 1996 and November 30, 1996, the Company was in default of various
financial and other covenants under its revolving credit agreement including the
prohibition on having a "going concern" explanatory paragraph in the fiscal 1996
auditors' report on its financial statements. The lender waived these past
defaults, conditioned upon the Company receiving at least $46 million in net
proceeds from the issuance of the Notes. On February 26, 1997, the Company
received net proceeds of $47.4 million from the issuance of the Notes. The
Company is current in its payment obligations under the revolving credit
agreement and has negotiated new financial covenants with the lender. See Note 4
of the Notes to Consolidated Financial Statements and "Factors Affecting
Future Performance -- Liquidity and Bank Relationships."
As of August 31, 1996 and November 30, 1996, the Company was also in
default of its financial covenants and of the cross default provisions of the
financing arrangements with Fleet Bank ("Fleet") relating to the mortgage on its
corporate headquarters. On February 26, 1997, the Company used $2 million of the
proceeds from the issuance of the Notes to pay down a portion of the mortgage
note and the lender has waived the past defaults. The Company is currently
negotiating accelerated payment terms on the balance of the Fleet loan. See Note
5 of the Notes to Consolidated Financial Statements and "Factors Affecting
Future Performance -- Liquidity and Bank Relationships."
Management anticipates that the Company's cash flows from operations
will not be sufficient to cover its operating expenses during the remainder of
fiscal 1997. To provide for its short and long-term liquidity needs, the Company
has reduced the number of its employees, has raised $47.4 million of net
proceeds from the issuance of Notes, sold substantially all of the assets of its
redemption subsidiary and is currently pursuing various alternatives, including
further expense reductions, the raising of additional capital, including a $7.5
million short-term facility to be provided by BNY Financial Corporation and
borrowings from hardware vendors, and the sale of certain other assets. There
can be no assurance that further cost reductions will be effected or that
additional capital infusions will be available or that any capital infusions or
sales of assets could be effected on satisfactory terms. In addition, the
Company's future liquidity will be materially dependent on its ability to
develop and market Software that achieves widespread market acceptance for use
with the Entertainment Platforms and PCs that dominate the market. There can be
no assurance that the Company will be able to publish titles for Entertainment
Platforms with significant installed bases.
The Company is party to various litigations arising in the course of
its business, the resolution of none of which, the Company believes, will have a
material adverse effect on the Company's liquidity, financial condition and
results of operations. The Company is also party to certain class action
litigations. The ultimate outcome of the class action litigations cannot
presently be determined. Accordingly, no provision for any liability that may
result upon adjudication has been recognized in the accompanying financial
statements. See "Legal Proceedings."
15
<PAGE>
Recent Developments
On March 5, 1997, the Company completed the sale of substantially all
of the assets and certain liabilities of Acclaim Redemption Games, Inc.
(formerly Lazer-Tron Corporation) for a purchase price of $6 million in cash.
Factors Affecting Future Performance
Future operating results of the Company depend upon many factors and
are subject to various risks and uncertainties. Some of the risks and
uncertainties which may cause the Company's operating results to vary from
anticipated results or which may materially and adversely affect its operating
results are as follows:
Recent Operating Results
The Company's net revenues declined from $152.4 million for the six
months ended February 29, 1996 to $105.6 million for the six months ended
February 28, 1997. The Company had a net loss of $(35.8) million for the six
months ended February 28, 1997 and a net loss of $(221.4) million in fiscal
1996. Adjustments in the fourth quarter of fiscal 1996, on a pre-tax basis,
aggregated $138.3 million, a portion of which related to prior quarters.
Accordingly, for comparative quarterly purposes, during fiscal 1997, the 1996
quarterly operating results may not necessarily be indicative of the results of
operations for such quarterly periods if these year-end adjustments could be
allocated to the respective quarters. The Company believes that its revenues and
operating results from the sale of its Software for 32- and 64-bit hardware
platforms and for PCs during fiscal 1997 will be materially less than its
revenues and operating profits in fiscal 1994 and 1995. The Company may not be
able to offset the decline in 16-bit Software sales with increased sales of
Software for the new Entertainment Platforms and PCs in fiscal 1998 and beyond.
In such event, the Company's results of operations and profitability will
continue to be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Results of
Operations."
Liquidity and Bank Relationships
The Company's net cash used in operations was approximately $21.3
million and $8.4 million for the six months ended February 29, 1996 and February
28, 1997, respectively. An approximately $53 million income tax refund related
to the carryback of its loss for fiscal 1996 is included in the net cash used in
operating activities for the 1997 period. The Company has experienced negative
cash flow from operations in recent periods primarily due to the industry
transition from 16-bit to 32- and 64-bit Entertainment Platforms and related
Software titles.
The Company anticipates that its cash flows from operations will not be
sufficient to cover its operating expenses during the remainder of fiscal 1997.
There can be no assurance that the Company's operating expenses will not
materially exceed cash flows available from the Company's operations in future
periods. To provide liquidity, the Company has reduced the number of its
employees, has raised approximately $47.4 million of net proceeds from the
issuance of the Notes, sold substantially all the assets of its redemption
subsidiary and is currently pursuing various alternatives, including further
expense reductions, the raising of additional capital, including a $7.5 million
short term facility to be provided by BNY and borrowings from hardware vendors,
and the sale of certain other assets.
As discussed above, the Company (i) on February 26, 1997 consummated
the offering of the Notes, (ii) used approximately $16.0 million of the net
proceeds from the offering of the Notes to retire its term loan to Midland
Bank plc and $2.0 million of such proceeds to pay down a portion of its mortgage
loan from Fleet, (iii) recently effected a series of amendments to its loan
covenants with BNY and Fleet in connection with
16
<PAGE>
obtaining waivers of its defaults under those agreements and (iv) on March 5,
1997, sold substantially all of the assets and certain liabilities of Acclaim
Redemption Games, Inc. (formerly Lazer-Tron Corporation) for $6 million in cash.
There can be no assurance that additional capital infusions will be available or
that any additional capital infusions or sales could be effected on satisfactory
terms. In addition to the foregoing, the Company's liquidity is materially
dependent in the short-term on the Company's ability to achieve its anticipated
sales levels for its titles, including Turok: Dinosaur Hunter and in the future,
on its ability to develop and market "hit" Software for the Entertainment
Platforms that dominate the interactive entertainment market. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity."
At August 31, 1996 and November 30, 1996, the Company was in default of
various financial and other covenants under its loan agreements with BNY and
Fleet. The inclusion of a "going concern" paragraph in respect of the Company's
fiscal 1996 audit report also constituted an event of default under the loan
facility with BNY. BNY and Fleet have waived the defaults at August 31, 1996 and
November 30, 1996, including the "going concern" default. Although the Company
believes it will be able to remain in compliance with the new financial
covenants obtained from its lenders, there can be no assurance that additional
covenant defaults, or a payment default, will not occur in the future. The
Company's ability to meet these covenants and meet such obligations can be
affected by factors beyond its control. There can be no assurance that the
Company will be able to obtain waivers of any future default or that the lenders
will not exercise their remedies including acceleration of the loans, demand for
immediate repayment and/or foreclosure on any collateral securing such loans. In
such event, the Company's operations would be materially adversely effected.
Substantial Leverage and Ability to Service Debt
The Company's ability to satisfy its obligations to its lenders will be
dependent upon its future performance, which is subject to prevailing economic
conditions and financial, business and other factors, including factors beyond
the Company's control. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Recent Developments."
The level of the Company's indebtedness could have important
consequences to investors in the Company, because: (i) a portion of the
Company's cash flow from operations must be dedicated to debt service, including
with respect to the Notes and the Company's existing bank obligations, and will
not be available for other purposes; (ii) the Company's ability to obtain
additional debt financing in the future for working capital, or to pursue
possible expansion of its business or acquisitions, may be limited; and (iii)
the Company's level of indebtedness could limit its flexibility in reacting to
changes in the interactive entertainment industry and economic conditions
generally, making it more vulnerable to adverse economic conditions and limiting
its ability to withstand competitive pressures or take advantage of business
opportunities. Certain of the Company's competitors currently operate on a less
leveraged basis, and are likely to have significantly greater operating and
financing flexibility than the Company.
The Company believes that, based upon current levels of operations, it
should be able to meet its interest obligations on the Notes, and its interest
and principal obligations under its bank agreements when due. However, if the
Company cannot generate sufficient cash flow from operations to meet its debt
obligations when due, the Company might be required to restructure or refinance
its indebtedness. There can be no assurance that any such restructuring or
refinancing will be effected on satisfactory terms or will be permitted by the
terms of the Indenture (the "Indenture") dated as of February 26, 1997 between
the Company and IBJ Schroder Bank & Trust Company (the "Trustee") with respect
to the Notes, or the Company's existing indebtedness. There can be no assurance
that the Company's operating cash flows will be sufficient to meet its debt
service requirements or to repay the Notes at maturity or that the Company will
be able to refinance the Notes or other indebtedness at maturity. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Prior Rights of Creditors."
17
<PAGE>
Prior Rights of Creditors
The Company has outstanding long-term debt (including current portions)
of $54.3 million at February 28, 1997. The Company's failure to make payments of
interest or principal on such indebtedness when due may result in defaults under
its agreements with respect to such indebtedness and under the Indenture.
Certain of such indebtedness is secured by liens on substantially all of the
assets of the Company.
In addition, the Indenture provides that, upon the occurrence of
certain events (each a "Repurchase Event"), the Company may be obligated to
repurchase all or a portion of the outstanding Notes. If a Repurchase Event were
to occur and the Company did not have, or could not obtain, sufficient financial
resources to repurchase the Notes, such failure to repurchase the Notes would
constitute an event of default under the Indenture. The occurrence of certain
Repurchase Events would also constitute a default under certain of the Company's
current debt agreements, including the Company's main credit facility with BNY,
and may constitute an event of default under the terms of future agreements with
respect to the Company's borrowings. The default under the Indenture for the
Company's failure to effect a repurchase of the Notes would also constitute an
event of default under certain of such other existing debt agreements.
Further, the Company's ability to meet its debt service obligations
are, in part, dependent upon its receipt of dividends and other advances and
transfers of funds from its subsidiaries. The ability of the Company's
subsidiaries to pay such dividends and make such advances will be subject to
applicable state and foreign law regulating the payment of dividends and the
terms of the Company's existing bank agreements and the Indenture. A significant
portion of the Company's assets, operations, trade payables and other
indebtedness are located at subsidiaries of the Company and the creditors of
such subsidiaries would generally recover from the assets of such subsidiaries
on the obligations owed to them by such subsidiaries prior to any recovery by
creditors of the Company and prior to any distribution of remaining assets to
equity holders of the Company.
An event of default with respect to the Company's current bank
agreements may result in acceleration of the Company's obligations under such
bank agreements or demand by the lenders for immediate repayment and would
entitle any secured creditor in respect of such debt to proceed against the
collateral securing such defaulted loan. An event of default under the Indenture
may result in action by the Trustee on behalf of the holders of the Notes. In
the event of such acceleration by the Company's creditors or action by the
Trustee, holders of indebtedness would be entitled to payment out of the assets
of the Company. If the Company becomes insolvent, is liquidated or reorganized,
it is possible that there will not be sufficient assets remaining after payment
to such creditors for any distribution to holders of Common Stock.
Going Concern Considerations
The report of KPMG Peat Marwick LLP, independent auditors for the
Company, on the Company's financial statements for the year ended August 31,
1996 includes an explanatory paragraph relating to substantial doubt as to the
ability of the Company to continue as a going concern. The Company incurred
significant losses from operations in fiscal 1996 and in the first half of
fiscal 1997 and anticipates incurring material losses for the second half of
fiscal 1997. The Company was in default of various covenants under the
agreements with certain of its lenders. In addition, the Company has
experienced, and expects to continue to experience during fiscal 1997, negative
cash flow from operations, and is a party to significant litigation, including
various class action lawsuits. A "going concern" explanatory paragraph is
expected to have a material adverse effect on the terms of any bank financing or
capital the Company may seek in the future.
Litigation
18
<PAGE>
The Company and certain of its directors and executive officers are
parties to various litigations, including federal class actions, arising in
connection with the December 1995 revision of the Company's previously announced
earnings, the 1995 acquisition of Lazer-Tron Corporation, statements made with
respect to the Company's agreement with WMS Industries, Inc., a dispute with
Spectrum Holobyte California, Inc. and distribution arrangements with Digital
Pictures, Inc. and Sound Source Interactive, Inc. The Company is also subject to
a private order of investigation from the Securities and Exchange Commission
arising out of the Company's earnings estimate for fiscal 1995 and its decision
in the second quarter of fiscal 1996 to exit the 16-bit portable and cartridge
markets and various other litigations and claims arising in the ordinary course
of business. See "Legal Proceedings." The Company could issue significant
amounts of its securities and/or use a portion of its cash in order to settle
such litigations. The Company could also be the subject of additional material
claims from the prior shareholders of acquired companies alleging that the
Company was to effect registration statements for the resale by such
stockholders and of all or a portion of their shares of Common Stock based on
such stockholders inability to sell all or a portion of their shares of Common
Stock pursuant to such registration statements at times when the Company's
securities were publicly traded for prices significantly higher than the current
market price. No provision for any liability that may result upon adjudication
of these matters has been recognized in the Company's consolidated financial
statements. Accordingly, any payments of settlements or judgments with respect
to these litigations would result in a charge to earnings and could have a
material adverse effect on the financial condition and results of operations of
the Company. Other than ordinary course litigations, the resolution of which the
Company believes would not have a material adverse effect on its business, an
adverse result in the other litigations to which the Company is a party could
have a material adverse effect on the Company. A portion of any settlement or
judgment in one or more of the litigations to which the Company is a party may
be covered by the Company's insurance.
Industry Trends; Platform Transition; Technological Change
The interactive entertainment industry is characterized by, and the
Company anticipates that in both the short- and long-term future it will
continue to undergo, rapid technological change due in large part to (i) the
introduction of Entertainment Platforms incorporating more advanced processors
and operating systems, (ii) the impact of technological changes embodied in PCs
and Software therefor, (iii) the development of electronic and wireless
delivery systems, and (iv) the entry and participation of new companies in the
industry. These factors have resulted in Entertainment Platform and Software
life cycles. As a result, the Company must continually anticipate and adapt its
products to emerging Entertainment Platforms and systems and evolving consumer
preferences. There can be no assurance that the Company will be successful in
developing and marketing Software for new Entertainment Platforms. No single
Entertainment Platform or system has achieved long-term dominance. The process
of developing Software products such as those offered by the Company is
extremely complex and is expected to become more complex and expensive in the
future as consumers demand more sophisticated and elaborate features and as new
platforms and technologies are introduced.
Development of Software for emerging Entertainment Platforms requires
substantial investments in research and development for new and improved
technologies in the areas of graphics, sound, digitized speech, music and video.
Such research and development must occur well in advance of the release of new
Entertainment Platforms in order to allow sufficient lead time to develop and
introduce new Software products on a timely basis. This generally requires the
Company to predict the probable success of future Entertainment Platforms as
much as 12 to 24 months prior to their introduction.
Substantially all of the Company's revenues in fiscal 1997 are
anticipated to be derived from the sale of Software designed to be played on the
Sony PlayStation, the Sega Saturn, the Nintendo N64 and PCs. At any given time,
the Company has expended significant development and marketing resources on
product development for platforms (such as the 16-bit Nintendo SNES and Sega
Genesis platforms) that could have shorter life cycles than the Company
expected, as in fiscal 1996, or on products designed for new platforms (such as
the Sony Playstation and the Nintendo N64) that have not yet achieved large
installed bases. If the Company does not accurately predict the success, size of
the installed base and life
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cycle of existing or future Entertainment Platforms due to, among other things,
the long Software development lead times involved, it could be in the position,
as it was in fiscal 1996 and in the first half of fiscal 1997, of marketing
Software for (i) new Entertainment Platforms that have not yet achieved
significant market penetration and/or (ii) Entertainment Platforms that have
become or are becoming obsolete due to the introduction or success of new
Entertainment Platforms. There can be no assurance that the Company will be able
to accurately predict such matters, and its failure to do so would have a
material adverse effect on the Company.
Failure to develop products for Entertainment Platforms that achieve
significant market acceptance, discontinuance of development for a platform that
has a longer than expected life cycle, development for a platform that does not
achieve a significant installed base or continued development for a platform
that has a shorter than expected life cycle, may have a material adverse effect
on the Company's business, financial condition and operating results.
The Company's results of operations and profitability have been
materially adversely affected during the fiscal year ended August 31, 1996 and
the six months ended February 28, 1997, and are anticipated to be so affected
during the balance of fiscal 1997, by the material decline in sales of the
Company's 16-bit Software and the transition to the new Entertainment Platforms.
The Company is currently developing Software for the Sony PlayStation, the Sega
Saturn, the Nintendo N64 and PCs. There are a significant number of Software
titles for the 32-bit platform market competing for limited shelf space. In
addition, the 32-bit (PlayStation and Saturn) and 64-bit (N64) platforms have
not yet achieved market penetration similar to that of the 16-bit platforms
(Nintendo SNES and Sega Genesis); accordingly, the number of units of each
Software title sold for these newer Entertainment Platforms is significantly
less than the number of units of a title generally sold during 1993, 1994 and
1995 for the 16-bit platforms. There can be no assurance that any of the new
platforms will achieve market penetration similar to that achieved by the
Nintendo SNES and Sega Genesis systems.
Revenue and Earnings Fluctations; Seasonality
The Company has historically derived substantially all of its revenues
from the publication and distribution of Software for then dominant
Entertainment Platforms. The Company's revenues are subject to fluctuation
during transition periods, as occurred in fiscal 1996 and the first half of
fiscal 1997, when new Entertainment Platforms have been introduced but none has
achieved mass market penetration. In addition, the Company's earnings are
materially affected by the timing of release of new Software titles produced by
the Company. Product development schedules are difficult to predict due, in
large part, to the difficulty of scheduling accurately the creative process and,
with respect to the Software for new Entertainment Platforms, the use of new
development tools and the learning process associated with development for new
technologies. Earnings may also be materially impacted by other factors
including, but not limited to (i) the level and timing of market acceptance of
Software titles, (ii) increases or decreases in development, and/or promotion
expenses for new titles and new versions of existing titles, (iii) the timing of
orders from major customers and (iv) changes in shipment volume.
A significant portion of the Company's revenues in any quarter is
generally derived from sales of new Software titles introduced in that quarter
or in the immediately preceding quarter. If the Company were unable to commence
volume shipments of a significant new product during the scheduled quarter, the
Company's revenues and earnings would likely be materially and adversely
affected in that quarter. In addition, because a majority of the unit sales for
a product typically occur in the first 90 to 120 days following the introduction
of the product, the Company's earnings may increase significantly in a period in
which a major product introduction occurs and may decline in the following
period or in periods in which there are no major product introductions. Certain
operating expenses are fixed and do not vary directly in relation to revenue.
Consequently, if net revenue is below expectations, the Company's operating
results are likely to be materially adversely affected.
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The interactive entertainment industry is highly seasonal. Typically,
net revenue is highest during the last calendar quarter (which includes the
holiday buying season), declines in the first calendar quarter, is lowest in the
second calendar quarter and increases in the third calendar quarter. The
seasonal pattern is due primarily to the increased demand for Software during
the year-end holiday buying season. The Company's earnings, however, vary
significantly and are largely dependent on releases of major new products and,
as such, may not necessarily reflect the seasonal patterns of the industry as a
whole. The Company expects that its operating results will continue to fluctuate
significantly in the future.
Dependence On Entertainment Platform Manufacturers; Need For License Renewals
For the fiscal quarter ended February 28, 1997, the Company derived
51%, 14% and 17% of its gross revenues, respectively, from sales of Nintendo-,
Sega- and Sony-compatible products. Accordingly, the Company is substantially
dependent on Nintendo as the sole manufacturer of N64 hardware and Software for
that platform and as the sole licensor of the proprietary information and the
technology needed to develop Software for that platform; on Sega as the sole
manufacturer of Saturn hardware and as the sole licensor of the proprietary
information and the technology needed to develop Software for that platform; and
on Sony as the sole manufacturer of PlayStation hardware and Software for that
platform and as the sole licensor of the proprietary information and the
technology needed to develop Software for that platform. The dedicated hardware
platform manufacturers have in the past and may in the future limit the number
of titles that the Company can release in any year, which may limit any future
growth in sales.
The Company has historically been able to renew and/or negotiate
extensions of its Software license agreements with Entertainment Platform
developers. However, there can be no assurance that, at the end of their current
terms, the Company will continue to be able to do so or that the Company will be
successful in negotiating definitive license agreements with developers of new
hardware systems. The Company has current, executed license agreements with Sony
with respect to the PlayStation platform in the United States, Canada and Japan
and is operating under an oral agreement with respect to the development and
publishing of titles for the PlayStation in Europe. Currently, the Company and
Sega are operating in the ordinary course under the terms of an agreement that
expired in December 1995 and, with respect to the Saturn platform, under an oral
agreement and other arrangements. The Company has executed an agreement with
Nintendo with respect to the N64 platform in Japan, covering the release of
approved titles, and an agreement with respect to the development and production
of one Software title for N64 in the Western Hemisphere. The Company has yet to
execute a formal agreement with Nintendo with respect to further development of
titles for the N64 platform in North America and Europe, although the Company
has been advised of the basic terms of such N64 license and is doing business
with Nintendo under an oral agreement and other arrangements. There can be no
assurance, however, that the Company will be successful in negotiating
agreements with respect to the Sony PlayStation, Sega Saturn and Nintendo N64
platforms. The inability to negotiate agreements with developers of new
Entertainment Platforms or the termination of all of the Company's license
agreements or other arrangements will, and the termination of any one of the
Company's license agreements or other arrangements could, have a material
adverse effect on the Company's financial position and results of operations.
The Company depends on Nintendo, Sega and Sony for the protection of
the intellectual property rights to their respective Entertainment Platforms and
technology and their ability to discourage unauthorized persons from producing
Software for Nintendo, Sega and Sony platforms. The Company also relies upon the
Entertainment Platform manufacturers for the manufacturing of certain software
cartridges and compact-disk based system-read only memories for their platforms.
Reliance On New Products; Product Delays
The Company's ability to maintain favorable relations with retailers
and to receive the maximum advantage from its advertising expenditures is
dependent in part on its ability to provide retailers with a timely and
continuous flow of product. The life cycle of a Software title generally ranges
from less than
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three months to upwards of twelve months, with the majority of sales occurring
in the first 90 - 120 days after release. The Company generally actively markets
its 10 - 15 most recent releases. Accordingly, the Company is constantly
required to develop, introduce and sell new Software in order to generate
revenue and/or to replace declining revenues from previously released products.
In addition, consumer preferences for Software are difficult to predict, and few
Software products achieve sustained market acceptance. There can be no assurance
that new products introduced by the Company will be released in a timely
fashion, will achieve any significant degree of market acceptance, or that such
acceptance will be sustained for any meaningful period. Competition for retail
shelf space, consumer preferences and other factors could result in the
shortening of the life cycle for older products and increase the importance of
the Company's ability to release product on a timely basis.
The Company's current production schedules contemplate that the Company
will commence shipment of a number of new products in fiscal 1997. Shipment
dates will vary depending on the Company's own quality assurance testing, as
well as by the dedicated platform developers and other development factors.
The Company generally submits new games to the dedicated platform manufacturers
and other intellectual property licensors for approval prior to development
and/or manufacturing. Rejection as a result of bugs in Software or a substantial
delay in approval of a product by a manufacturer or licensor could have a
material adverse effect on the Company's financial condition and results of
operations. In the past, the Company has experienced significant delays in the
introduction of certain new products. There can be no assurance that such delays
will not occur and materially adversely affect the Company in the future. It is
likely that in the future certain new products will not be released in
accordance with the Company's internal development schedule or the expectations
of public market analysts and investors. A significant delay in the introduction
of, or the presence of a defect in, one or more new products could have a
material adverse effect on the ultimate success of such product. If the Company
is not able to develop, introduce and sell new competitive titles on a timely
basis, its results of operations and profitability would be materially adversely
affected.
Reliance On "Hit" Titles
The market for Software is "hits" driven and accordingly the Company's
future success is dependent in large part on its ability to develop and market
"hit" titles for Entertainment Platforms with significant installed bases.
During the quarter ended February 28, 1997, sales of the Company's top title
accounted for approximately 45% of the Company's gross sales for that period.
There can be no assurance that the Company will be able to publish "hit" titles
for Entertainment Platforms with significant installed bases and, if it is
unable to do so for any reason, its financial condition, results of operations
and profitability could be materially adversely affected, as they were in fiscal
1996 and in the first half of fiscal 1997.
Inventory Management; Risk of Product Returns
The Company is generally not contractually obligated to accept returns,
except for defective product. However, the Company permits its customers to
return or exchange Software titles and may provide price protection and
discounts on slow moving titles unsold by a customer. Management must make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Among the more significant estimates are
allowances for estimated returns, price concessions and other discounts. At the
time of product shipment, the Company establishes reserves in respect of such
estimates taking into account the potential for product returns and other
discounts based on historical return rates, seasonality, retail inventories and
other factors. In fiscal 1996, price protection, returns, exchanges and other
concessions were materially higher than the Company's reserves therefor, as a
result of which the Company's results of operations and liquidity in fiscal 1996
were materially adversely affected. The Company believes that, as of February
28, 1997, it has established adequate reserves for future price protection,
returns, exchanges and other concessions but there can be no assurance that the
Company's reserves therefor will not be exceeded, which event would have a
material adverse effect on the Company's financial condition and results of
operations.
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In addition, the Company has offered and anticipates that it will
continue to offer stock-balancing programs for its PC Software. The Company has
established reserves for such programs, which have not been material to date. No
assurance can be given that future stock-balancing programs will not become
material and/or will not exceed the Company's reserves for such programs and, if
so exceeded, the Company's results of operations and financial condition could
be materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Increased Product Development Costs
In order to manage its Software development process and to ensure
access to a pool of Software developers, development tools and engines in an
increasingly competitive market, the Company acquired three Software development
studios in calendar 1995. The result of such acquisitions was that the Company's
fixed Software development and operating costs were significantly higher in
fiscal 1996 and in the first half of fiscal 1997 as compared to its historical
rate and were not offset by revenues from Software developed by the studios.
These costs further contributed to the Company's results of operations and
profitability being materially adversely affected in fiscal 1996 and in the
first half of fiscal 1997. No assurance can be given that such costs will not
continue to have a material adverse effect on the Company's operations in future
periods.
Competition
The market for consumer Software products is highly competitive. Only a
small percentage of products introduced in the Software market achieve any
degree of sustained market acceptance. Competition is based primarily upon
price, access to retail shelf space, product enhancements, ability to operate on
popular platforms, availability of titles (including "hits"), new product
introductions, marketing support and distribution systems.
The Company competes with a variety of companies which offer products
that compete directly with one or more of the Company's products. Typically, the
Company's chief competitor on an Entertainment Platform is the hardware
manufacturer of that platform, to whom the Company pays royalties and, in some
cases, manufacturing charges. Accordingly, the hardware manufacturers have a
price, marketing and distribution advantage with respect to Software marketed by
them and such advantage is particularly important in a mature or declining
market which supports fewer full-priced titles and is characterized by customers
who make purchasing decisions on non-"hit" products based primarily on price (as
compared to developing markets with limited Software titles, when price has been
a less important factor in Software sales). The Company's competitors vary in
size from very small companies with limited resources to very large corporations
with greater financial, marketing and product development resources than those
of the Company, such as Nintendo, Sega and Sony. The Company's competitors also
include a number of independent Software publishers licensed by the hardware
manufacturers.
Additionally, the entry and participation of new industries and
companies, including diversified entertainment companies, in markets in which
the Company competes may adversely affect the Company's performance in such
markets. The availability of significant financial resources has become a major
competitive factor in the Software industry, principally as a result of the
technical sophistication of advanced multimedia computer game products requiring
substantial investments in research and development. In particular, many of the
Company's competitors are developing on-line interactive computer games and
interactive networks that will be competitive with the Company's products. As
competition increases, significant price competition and reduced profit margins
may result. In addition, competition from new technologies may reduce demand in
markets in which the Company has traditionally competed. Prolonged price
competition or reduced demand as a result of competing technologies would have a
material adverse effect on the Company's business, financial condition and
operating results. No assurance can be given that the Company will be able to
compete successfully.
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Intellectual Property Licenses and Proprietary Rights
To date, most of the Company's Software incorporates for marketing
purposes properties or trademarks owned by third parties, such as the World
Wrestling Federation, the National Basketball Association, National Football
League or their respective players' associations, which properties are licensed
to the Company. In addition, the Company in the past has obtained agreements
with outside developers for the development of a significant portion of its
Software under such agreements with independent developers, and in such cases
the Company usually acquires copyrights to the underlying Software and obtains
the exclusive right to such Software for a period of time and may have a limited
period in which to market and distribute Software. To the extent future product
releases are not derived from the Company's proprietary properties, the
Company's future success will also be dependent upon its ability to procure
licenses for additional popular intellectual properties. There is intense
competition for such licenses, and there can be no assurance that the Company
will be successful in acquiring additional intellectual property rights with
significant commercial value. There can be no assurance that such licenses will
be available on reasonable terms or at all.
The Company relies primarily on a combination of copyrights, trade
secret laws, patent and trademark laws, nondisclosure agreements and other copy
protection methods to protect its product and proprietary rights. It is the
Company's policy that all employees and third-party developers sign
nondisclosure agreements. There can be no assurance that these measures will be
sufficient to protect the Company's intellectual property rights against
infringement. The Company has "shrinkwrap" license agreements with the end users
of its PC products, but the Company relies on the copyright laws to prevent
unauthorized distribution of its other Software. Existing copyright laws afford
only limited protection. However, notwithstanding the Company's rights to its
Software, it may be possible for unauthorized third parties to illegally copy
the Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. Unauthorized illegal
copying occurs within the Software industry, and if a significant amount of
unauthorized copying of the Company's published products or products distributed
by it were to occur, the Company's business, operating results and financial
condition could be materially adversely affected. Policing illegal unauthorized
use of the Company's products is difficult, and Software piracy can be expected
to be a persistent problem. Further, the laws of certain countries in which the
Company's products are or may be distributed do not protect the Company's
products and intellectual property rights to the same extent as the laws of the
United States.
The Company believes that its products, trademarks and other
proprietary rights do not infringe on the proprietary rights of third parties.
However, as the number of Software products in the industry increases, the
Company believes that claims and lawsuits with respect to Software infringement
will increase. From time to time, third parties have asserted that features or
content of certain of the Company's products may infringe upon intellectual
property rights of such parties, and the Company has asserted that third parties
have likewise infringed the Company's proprietary rights; certain of these
claims have resulted in litigation by and against the Company. To date, no such
claims have had an adverse effect on the Company's ability to develop, market or
sell its products. There can be no assurance that existing or future
infringement claims by or against the Company will not result in costly
litigation or require the Company to license the intellectual property rights of
third parties. See "Legal Proceedings."
The owners of intellectual property licensed by the Company generally
reserve the right to protect such intellectual property against infringement.
International Sales
International sales represented approximately 44% of the Company's net
revenues for the fiscal quarter ended February 28, 1997. The Company expects
that international sales will continue to account for a significant portion of
its net revenues in future periods. International sales are subject to inherent
risks, including unexpected changes in regulatory requirements, tariffs and
other economic barriers, fluctuating exchange rates, difficulties in staffing
and managing foreign operations and the possibility of
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difficulty in accounts receivable collection. Because the Company does not
believe exposure to foreign currency losses is currently material, the Company
currently has no formal financial instruments in place as a hedge against
foreign currency risks. In some markets, localization of the Company's products
is essential to achieve market penetration. The Company may incur incremental
costs and experience delays in localizing its products. These or other factors
could have a material adverse effect on the Company's future international sales
and, consequently, on the Company's business, operating results and financial
condition.
New Business Ventures
During the last three fiscal years, the Company has completed
acquisitions, or has commenced operations, of various new businesses including
(i) the publication of comic books, (ii) the distribution of Affiliated Labels
Software, (iii) the marketing of its motion capture technology and studio
services, and (iv) the distribution of coin-operated video games. The Company
also acquired three Software development studios in calendar 1995. The Company
has made significant investments and has incurred significant expenses in
connection with the acquisition and/or establishment of such businesses in
fiscal 1995 and 1996, and anticipates that it will continue to incur significant
expenses in connection with certain of the operations thereof. To date, none of
such new businesses has generated material revenues and there can be no
assurance that such businesses will generate material revenues or the timing
thereof. To the extent the Company continues to incur material expenses in
connection with such ventures during periods when they do not generate
significant revenues, the Company's results of operations and profitability will
be materially adversely affected.
Dependence on Key Personnel and Employees
The interactive entertainment industry is characterized by a high level
of employee mobility and aggressive recruiting among competitors for personnel
with technical, marketing, sales, product development and management skills. The
ability to identify, hire and retain such personnel is essential to the
Company's success. No assurance can be given that the Company will be able to
attract and retain such personnel or that it will not experience significant
cost increases in order to do so.
In particular, the Company is highly dependent on the management
services of Gregory Fischbach, Co-Chairman of the Board and Chief Executive
Officer, and James Scoroposki, Co-Chairman of the Board and Senior Executive
Vice President of the Company. The loss of the services of any of the Company's
senior management could have a material adverse effect on the Company's
business, operating results, and financial condition. Although, the Company has
employment agreements with Messrs. Fischbach and Scoroposki, there can be no
assurance that such employees will not leave or compete with the Company. The
Company's failure to attract additional qualified employees or to retain the
services of key personnel could materially and adversely affect the Company's
business, operating results and financial condition.
Anti-Takeover Provisions
The Company's Board of Directors has the authority to issue shares of
preferred stock and to determine the designations, preferences and rights and
the qualifications or restrictions of those shares without any further vote or
action by the stockholders. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate actions, could have the effect of making it
more difficult for a third-party to acquire a majority of the outstanding voting
stock of the Company. In addition, the Company is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law (the "DGCL").
In general, this statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is
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approved in a prescribed manner. Employment arrangements with certain members of
the Company's management provide for severance payments upon termination of
their employment after a "change in control" of the Company as defined in such
agreements.
Volatility of Stock Price
There has been a history of significant volatility in the market prices
of companies engaged in the Software industry, including the Company. It is
likely that the market price of the Common Stock will continue to be highly
volatile. Factors such as the timing and market acceptance of product
introductions by the Company, the introduction of products by the Company's
competitors, loss of key personnel of the Company, variations in quarterly
operating results or changes in market conditions in the Software industry
generally may have a significant impact on the market price of the Common
Stock. In the past, the Company has experienced significant fluctuations in its
operating results and, if the Company's future revenue or operating results or
product releases do not meet the expectations of public market analysts and
investors, the price of the Common Stock would likely be materially adversely
affected. In addition, the stock market has experienced and continues to
experience extreme price and volume fluctuations which have affected the market
price of Software companies and companies in the interactive entertainment
industry and which have often been unrelated to the operating performance of
these companies.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company and certain of its directors and/or executive officers were
sued in an action entitled Digital Pictures, Inc. v. Acclaim Entertainment,
Inc.; Gregory E. Fischbach; and Anthony Williams (Case No. 96-3-3301 TC) filed
in December 1996 in the United States Bankruptcy Court for the Northern District
of California. The plaintiff claims damages of approximately $2.2 million
allegedly owed to the plaintiff, an accounting and compensatory, punitive and
exemplary damages based on allegations that the defendants falsified sales,
failed to provide timely statements and to pay amounts the Company owes the
plaintiff pursuant to the July 1994 Sales and Distribution Agreement between the
Company and the plaintiff under which the plaintiff granted the Company the
exclusive worldwide right to sell and distribute the plaintiff's software
products for a term of five years. In addition, the plaintiff alleges, among
other things, fraud and negligent misrepresentation. The Company intends to
defend this action vigorously.
The Company was also sued in an action entitled Sound Source
Interactive, Inc. v. Acclaim Distribution, Inc.; Acclaim Entertainment, Inc.;
and DOES 1 through 100, inclusive (Case No. BC162531) filed in December 1996 in
the Superior Court of the State of California for the County of Los Angeles.
Defendant Acclaim Distribution, Inc. ("ADI") is a wholly owned subsidiary of the
Company. The plaintiff claims compensatory, general, special and consequential
damages in excess of $22 million and punitive damages based on allegations that
the defendants breached (i) the Sales and Distribution Agreement dated as of
June 15, 1995 between ADI and the plaintiff (the "Sales and Distribution
Agreement") under which the plaintiff granted ADI the exclusive right to sell
and distribute the plaintiff's software products by, among other things,
providing the plaintiff with false accounting statements, misrepresenting
product orders, and failing to return or account for software products shipped
by the plaintiff to ADI and wrongfully retaining restock and distribution fees;
and (ii) the Termination Agreement dated as of March 31, 1996 between the
plaintiff and ADI pursuant to which the Sales and Distribution Agreement was
terminated by, among other things, failing to account, failing to pay monies due
and failing to return or account for software products shipped by the plaintiff
to ADI. In addition, the plaintiff alleges, among other things, fraud and
negligent misrepresentation. The Company intends to defend this action
vigorously.
The Company was also sued in an action entitled Spectrum Holobyte
California, Inc.; Microprose Software, Inc. v. Acclaim Entertainment, Inc.,
(Case No. 97-0247 MEJ) filed in January 1997 in the United States District Court
for the Northern District of California. In that complaint, plaintiffs allege
that the Company breached a confidential settlement agreement among the parties
dated November 4, 1996. The purpose of the settlement agreement was to resolve a
suit brought by the Company in 1996, which included counterclaims by Spectrum
and Microprose, regarding each parties' allegations of infringement of their
respective exclusive rights to intellectual property licensed to them by Wizards
of the Coast, Inc. The property involves the character, depictions and game
methodology of Magic: The Gathering, a popular fantasy-adventure story and card
game created by Wizards of the Coast, Inc. Plaintiffs allege that the Company
breached the settlement agreement by failing to release the appropriate number
of games of Magic: The Gathering--BattleMage in the United States and the United
Kingdom by January 10, 1997, the date provided for in the Settlement Agreement.
Plaintiffs seek unspecified monetary damages, attorneys' fees and costs. The
Company intends to defend this action vigorously.
The Company and certain of its directors and/or executive officers were
sued in various complaints filed in December 1995, which were consolidated into
an action entitled In re: Acclaim Ent. Shareholder Litigation, 95 Civ. 4979
(E.D.N.Y.) (TCP) in the United States District Court for the Eastern District of
New York. The plaintiffs, on behalf of a class of the Company's stockholders,
claim unspecified damages arising from the Company's December 4, 1995
announcement that it was revising results for the fiscal year ended August 31,
1995 to reflect a decision to defer $18 million of revenues and $10.5 million of
net income previously reported on October 17, 1995 for the fiscal year ended
August 31, 1995. Defendants
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have answered the complaint and discovery is in progress. The Company intends to
defend this action vigorously.
By summons and complaint dated December 11, 1995, certain of the
Company's directors and/or executive officers were named as defendants, and the
Company was named as a nominal defendant, in a shareholder derivative action
entitled Eugene Block v. Gregory E. Fischbach, James Scoroposki, Robert Holmes,
Bernard J. Fischbach, Michael Tannen, Robert H. Groman and James Scibelli,
defendants, and Acclaim Entertainment, Inc., Nominal Defendant, (CV 95-036316)
(Supreme Court of the State of New York, County of Nassau) (the "Derivative
Action"). The Derivative Action was brought on behalf of the Company (as nominal
defendant), alleging that the individual defendants violated their fiduciary
duties to the Company in connection with the Company's revision of its revenues
for the fiscal year ended August 31, 1995. Plaintiff alleges that the individual
defendants (1) breached their duty of care and candor, (2) caused the Company to
waste corporate assets, and (3) breached their duty of good faith, and,
accordingly, seeks unspecified damages. Plaintiffs withdrew their complaint and
on October 2, 1996 filed an amended complaint. The Court has denied defendants'
motion to dismiss based on plaintiffs' failure to make a proper demand. The
Company intents to defend this action vigorously.
The Company and certain of its directors and/or executive officers also
are defendants in an action entitled Adrienne Campbell and Donna Sizemore,
individually and on behalf of all others similarly situated, v. Acclaim
Entertainment, Inc., Anthony R. Williams, James Scoroposki, and Robert Holmes,
C-95-04395 (EFL), which was commenced in the United States District Court for
the Northern District of California. In that action, plaintiffs, two former
shareholders of Lazer-Tron, filed a class action complaint on December 8, 1995
on behalf of all former Lazer-Tron shareholders who exchanged their Lazer-Tron
stock for Common Stock pursuant to the August 31, 1995 merger transaction.
Plaintiffs allege violations of Sections 10(b), 14(a) and 14(e) of the
Securities Exchange Act of 1934, Sections 11 and 12(2) of the Securities Act of
1933, fraud and breach of fiduciary duty. On October 8, 1996, the Judicial Panel
on Multidistrict Litigation ordered the transfer of the action from the Northern
District of California to the United States District Court for the Eastern
District of New York for coordinated or consolidated pretrial proceeding with
the actions entitled In re Acclaim Ent. Shareholder Litigation discussed above.
The parties are currently negotiating settlement terms with respect to this
action.
The Securities and Exchange Commission (the "Commission") has issued
orders directing a private investigation relating to, among other things, the
Company's earnings estimate for fiscal 1995 and its decision in the second
quarter of fiscal 1996 to exit the 16-bit portable and cartridge markets. The
Company has provided documents to the Commission, and the Commission has taken
testimony from Company representatives. The Company intends to fully cooperate
with the Commission in its investigation. No assurance can be given as to
whether there will be any litigation or, if so, as to the outcome of this
matter.
The Company's subsidiary, Lazer-Tron, was sued in an action entitled
Eric Goldstein, on behalf of himself and all others similarly situated, v.
Lazer-Tron Corporation, Norman B. Petermeier, Matthew F. Kelly, Bryan M. Kelly,
Morton Grosser, Bob K. Pryt and Roger V. Smith (V-009846-7) in the Superior
Court of the State of California, County of Alameda, Eastern Division. The
plaintiffs allege, among other things, breach of fiduciary duty, abuse of
control and negligence. In addition, certain directors and officers of
Lazer-Tron have been named as defendants in an action entitled Adrienne
Campbell, individually and on behalf of all others similarly situated, b. Norman
B. Petermeier, Matthew F. Kelly, Bryan M. Kelly, Morton Grosser, Bob K. Pryt,
Roger V. Smith and Does 1 through 50, inclusive, Civil No. 760717-4, in the
Superior Court of the State of California, County of Alameda. The plaintiffs, on
behalf of a class of Lazer-Tron's shareholders, claim damages based on
allegations that, as a result of lack of due diligence by the named defendants
in fully investigating the proposed acquisition by the Company of Lazer-Tron,
the defendants breached their fiduciary duties to Lazer-Tron's shareholders.
These two actions have been consolidated and are scheduled to be tried in May.
The parties are currently negotiating settlement terms with respect to this
action.
28
<PAGE>
The Company and certain of its directors and/or executive officers were
sued in various complaints filed in April 1994, which were consolidated into an
action entitled In re Acclaim Entertainment, Inc. Securities Litigation (CIV 94
1501) (the "WMS Action"). The plaintiffs, on behalf of a class of the Company's
stockholders consisting of all those who have purchased Acclaim stock for the
period January 4, 1994 to March 30, 1994, claim damages arising from (i) the
Company's alleged failure to comply with the disclosure requirements of the
securities laws in respect of the Company's relationship with WMS Industries
Inc. ("WMS") and the status of negotiations on and the likelihood of renewal of
an agreement with WMS, pursuant to which WMS granted the Company a right of
first refusal to create software for "computer games", "home video games" and
"handheld game machines" based on arcade games released by WMS through March 21,
1995 (ii) statements made by the Company's representative that rumors relating
to the nonrenewal of the agreement were "unsubstantiated" and that talks between
the Company and WMS were continuing, which allegedly were materially false and
misleading and (iii) a claim that the defendants should have disclosed the
likely nonrenewal of the agreement. Discovery is complete, and the parties have
moved for summary judgment. No decision has been rendered on the parties'
summary judgment motions. The Company intends to defend the WMS Action
vigorously.
The Company has also asserted a third-party action against its
insurance company, Mt. Hawley Insurance Company ("Mt. Hawley") based on Mt.
Hawley's disclaimer of coverage for liability which may result from the WMS
Action and for fees and expenses up to the amount of the policy incurred in
connection with the defense of the WMS Action, and has moved for a separate
trial of this action and for an immediate trial of a coverage issue. This motion
was also argued on November 22, 1996, and the Court has not yet issued a
decision on this motion.
The New York State Department of Taxation and Finance, following a
field audit of the Company with respect to franchise tax liability for its
fiscal years ended August 31, 1989, August 31, 1990 and August 31, 1991, has
notified the Company that a stock license fee (plus interest and penalties) of
approximately $1.9 million, relating to the Company's outstanding capital stock
as of 1989, is due to the State of New York. The Company is contesting the fee
and a petition denying liability has been filed. No assurance can be given as to
the outcome of this matter.
A portion of any settlement or award arising from or out of one or more
of the above litigations may be covered by the Company's insurance. The Company
is also party to various litigations arising in the course of its business, the
resolution of none of which, the Company believes, will have a material adverse
effect on the Company's liquidity or results of operations. Other than the
ordinary course litigations, the resolution of which the Company does not
believe would have a material adverse affect on its business, an adverse result
in litigations to which the Company is a party could have a material adverse
effect on the Company. The Company could also be the subject of additional
material claims from the prior shareholders of companies acquired by the Company
and for whom the Company was to effect registration statements for the resale by
such shareholders of all or a portion of their shares of Common Stock and based
on such shareholders' inability to sell all or a portion of their shares of
Common Stock pursuant to such registration statements at times when the
Company's securities were publicly traded at prices significantly higher than
the current market price. No provision for any liability that my result on
adjudication of these matters has been recognized in the Company's consolidated
financial statements. Accordingly, any payments of settlement or judgment in
respect of these litigations would constitute a charge to earnings and could
have a material adverse effect on the financial condition and results of
operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) Reports on Form 8-
None.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ACCLAIM ENTERTAINMENT, INC.
By: /s/ Gregory Fischbach April 10, 1997
----------------------
Gregory Fischbach,
Co-Chairman of the Board and
Chief Executive Officer
By: /s/ J. Mark Hattendorf April 10, 1997
-----------------------
J. Mark Hattendorf,
Executive Vice President and
Chief Financial and Accounting Officer
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