<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 DECEMBER 2, 2000
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 (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
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 of January 9, 2001, approximately 56,990,931 shares of Common Stock
of the Registrant were issued and outstanding.
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
December 2, August 31,
2000 2000
--------- ---------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 5,531 $ 6,738
Accounts receivable, net 29,706 3,958
Inventories 5,258 4,708
Prepaid expenses 1,887 2,476
--------- ---------
Total Current Assets 42,382 17,880
--------- ---------
Fixed assets, net 39,185 41,615
Goodwill, net 586 540
Other assets 189 198
--------- ---------
Total Assets $ 82,342 $ 60,233
========= =========
Liabilities and Stockholders' Deficiency
Current Liabilities
Current portion of long-term debt $ 1,521 $ 1,521
Obligations under capital leases - current 437 514
Trade accounts payable 24,025 21,844
Accrued expenses 47,622 39,677
Accrued selling expenses 30,319 31,093
--------- ---------
Total Current Liabilities 103,924 94,649
--------- ---------
Long-Term Liabilities
Long-term debt 54,494 54,964
Obligations under capital leases - non-current 804 883
Other long-term liabilities 4,377 3,717
--------- ---------
Total Liabilities 163,599 154,213
--------- ---------
Stockholders' Deficiency
Preferred stock, $0.01 par value; 1,000 shares
authorized; none issued -- --
Common stock, $0.02 par value; 100,000 shares authorized;
57,273 and 56,625 shares issued, respectively 1,146 1,133
Additional paid in capital 215,324 213,940
Accumulated deficit (294,061) (304,866)
Treasury stock, 551 and 551 shares, respectively (3,338) (3,338)
Accumulated other comprehensive income (328) (849)
--------- ---------
Total Stockholders' Deficiency (81,257) (93,980)
--------- ---------
Total Liabilities and Stockholders' Deficiency $ 82,342 $ 60,233
========= =========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
(UNAUDITED)
THREE MONTHS ENDED
DECEMBER 2, 2000 NOVEMBER 30, 1999
--------- ---------
<S> <C> <C>
Net revenues $ 72,039 $ 101,153
Cost of revenues 24,058 40,016
--------- ---------
Gross profit 47,981 61,137
Operating expenses:
Marketing and selling 11,962 26,087
General and administrative 10,598 15,484
Research and development 11,456 15,079
--------- ---------
Total operating expenses 34,016 56,650
--------- ---------
EARNINGS FROM OPERATIONS 13,965 4,487
Other income (expense):
Interest income 304 1,024
Interest expense (3,121) (2,716)
Other expense (92) (581)
--------- ---------
Total other income (expense) (2,909) (2,273)
--------- ---------
EARNINGS BEFORE INCOME TAXES 11,056 2,214
Provision for income taxes 251 1,780
--------- ---------
NET EARNINGS $ 10,805 $ 434
========= =========
Basic earnings per share $ 0.19 $ 0.01
========= =========
Diluted earnings per share $ 0.18 $ 0.01
========= =========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(In thousands of dollars)
<TABLE>
<CAPTION>
Preferred Stock Common Stock
Issued Issued Additional
------ ------ Paid-In Deferred Accumulated
Shares Amount Shares Amount Capital Compensation Deficit
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at August 31, 1999 -- -- 56,033 1,121 209,926 (2,653) (173,122)
--------- --------- --------- --------- --------- --------- ---------
Net loss -- -- -- -- -- -- (131,744)
Issuances of common stock -- -- 14 -- 100 -- --
Escrowed shares received -- -- (72) (1) (628) -- --
Cancellations of options -- -- -- -- (66) 66 --
Deferred compensation expense -- -- -- -- -- 2,274 --
Issuance of warrants for litigation
settlements -- -- -- -- 2,550 -- --
Exercise of stock options and warrants -- -- 427 9 1,553 -- --
Issuance of common stock under
employee stock purchase plan -- -- 223 4 818 -- --
Foreign currency translation loss -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT AUGUST 31, 2000 -- -- 56,625 $ 1,133 $ 214,253 ($ 313) ($304,866)
--------- --------- --------- --------- --------- --------- ---------
Net earnings (unaudited) -- -- -- -- -- -- 10,805
Issuances of common stock (unaudited) -- -- 720 14 886 -- --
Escrowed shares received (unaudited) -- -- (72) (1) -- -- --
Deferred compensation expense (unaudited) -- -- -- -- -- 235 --
Issuance of common stock from
escrow for litigation
settlements (unaudited) -- -- -- -- 263 -- --
Foreign currency translation
gain (unaudited) -- -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 2, 2000 (unaudited) -- -- 57,273 $ 1,146 $ 215,402 ($ 78) ($294,061)
--------- --------- --------- --------- --------- --------- ---------
<CAPTION>
Accumulated
Other Comprehensive
Treasury Comprehensive Income
Stock Income Total (loss)
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Balance at August 31, 1999 (3,262) (651) 31,359 --
--------- --------- --------- ---------
Net loss -- -- (131,744) (131,744)
Issuances of common stock -- -- 100 --
Escrowed shares received (76) -- (705) --
Cancellations of options -- -- -- --
Deferred compensation expense -- -- 2,274 --
Issuance of warrants for litigation
settlements -- -- 2,550 --
Exercise of stock options and warrants -- -- 1,562 --
Issuance of common stock under
employee stock purchase plan -- -- 822 --
Foreign currency translation loss -- (198) (198) (198)
--------- --------- --------- ---------
BALANCE AT AUGUST 31, 2000 ($ 3,338) ($ 849) ($ 93,980) ($131,942)
--------- --------- --------- ---------
Net earnings -- -- 10,805 10,805
Issuances of common stock -- -- 900 --
Escrowed shares received -- -- (1) --
Deferred compensation expense -- -- 235 --
Issuance of common stock from
escrow for litigation
settlements -- -- 263 --
Foreign currency translation
gain -- 521 521 521
--------- --------- --------- ---------
BALANCE AT DECEMBER 2, 2000* ($ 3,338) ($ 328) ($ 81,257) $ 11,326
--------- --------- --------- ---------
</TABLE>
* Amounts for the three-months ended December 2, 2000 are unaudited.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except per share data)
<TABLE>
<CAPTION>
(Unaudited)
THREE MONTHS ENDED
DECEMBER 2, NOVEMBER 30,
2000 1999
-------- --------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
NET EARNINGS $ 10,805 $ 434
ADJUSTMENTS TO RECONCILE NET EARNINGS TO NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Depreciation and amortization 2,269 3,248
Provision for returns and discounts 4,247 25,300
Deferred compensation expense 235 608
Non-cash royalty charges (754) 388
Other non-cash items 131 10
CHANGE IN ASSETS AND LIABILITIES:
Accounts receivable (net of advances) (27,840) (21,955)
Inventories (577) 4,205
Prepaid expenses 4,886 1,283
Accounts payable (6,881) (2,512)
Accrued expenses 11,022 (4,469)
Income taxes 15 1,684
Other long-term liabilities 661 (494)
-------- --------
TOTAL ADJUSTMENTS (12,586) 7,296
-------- --------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (1,781) 7,730
-------- --------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Acquisition of fixed assets, excluding capital leases (72) (4,605)
Disposal of fixed assets -- 33
Acquisition of other assets -- (5)
Disposal of other assets 1 --
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (71) (4,577)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Payment of mortgages (386) (181)
Exercise of stock options and warrants -- 950
Payment of obligations under capital leases (143) (135)
Proceeds from issuances of common stock 900 --
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 371 634
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 274 226
-------- --------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,207) 4,013
-------- --------
CASH AND CASH EQUIVALENTS: BEGINNING OF PERIOD 6,738 74,421
-------- --------
CASH AND CASH EQUIVALENTS: END OF PERIOD $ 5,531 $ 78,434
======== ========
Supplemental schedule of noncash investing and financing activities:
Acquisition of equipment under capital leases -- $ 193
Cash paid during the period for:
Interest $ 3,121 $ 2,164
Income Taxes $ 2 $ 651
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, 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.
CHANGE IN INTERIM REPORTING PERIOD
The Company's fiscal year ends on August 31. The Company will report for
fiscal year 2001 and prospectively its quarterly results of operations on
the Saturday closest to the calendar quarter end. For November and first
quarter of fiscal year 2001 this date was December 2, 2000. The change is
not expected to have a material effect on the financial condition, results
of operations or cash flows of the Company for any of the fiscal 2001
quarters ending as follows:
FY 2001 FY 2000
------- -------
First Quarter December 2, 2000 November 30, 1999
Second Quarter March 3, 2001 February 29, 2000
Third Quarter June 2, 2001 May 31, 2000
Fourth Quarter August 31, 2001 August 31, 2000
RECLASSIFICATION
Certain prior year balances have been reclassified to conform with the
current quarter's presentation.
2. ACCOUNTS RECEIVABLE
Accounts receivable are comprised of the following:
DECEMBER 2, 2000 AUGUST 31,2000
---------------- --------------
Receivables assigned to factor............... $ 52,160 $ 25,461
Less: advances from factor.................. (21,545) (13,073)
--------- --------
Due from factor.............................. 30,615 12,388
Unfactored accounts receivable............... 15,049 15,084
Foreign accounts receivable.................. 16,146 12,429
Other receivables............................ 5,209 3,140
Less: Allowances for returns and discounts.. (37,313) (39,083)
--------- --------
Accounts receivable, net..................... $ 29,706 $ 3,958
========== ========
Pursuant to a factoring agreement, the principal lending institution for the
Company acts as its factor for the majority of its North American receivables,
which are assigned on a pre-approved basis. As of December 2, 2000, the
factoring charge amounted to 0.25% of the receivables assigned. The Company's
obligations to the lending institution, the factor, are collateralized by all of
the Company's and its North American subsidiaries' accounts receivable,
inventories and equipment. The advances for factored receivables are made
pursuant to a revolving credit and security agreement, which expires on August
31, 2003 but automatically renews for additional one-year periods, unless
terminated upon 90 days' notice by either party. During August 2000, the factor
advanced $15,000 of additional interim funding above the standard loan agreement
formula. The excess borrowing is at the factor's discretion, and the Company was
obligated to repay the entire amount of such excess borrowing, and thereafter
remain within the current borrowing formula, by November 30,
6
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
2000. The Company repaid the excess borrowing and remained within the current
formula at the end of the first quarter of fiscal 2001.
Pursuant to the terms of the agreement, the Company is required to maintain
specified levels of working capital and tangible net worth, among other
covenants. As of December 2, 2000, the Company was not in compliance with
certain of the financial covenants under its revolving credit facility. The
Company received waivers regarding this non-compliance from the factor. While
the Company anticipates that it will not be in compliance with the financial
covenants in its bank agreements in the near term, and anticipates being able to
obtain necessary waivers as it has in the past, the Company may not be able to
obtain waivers of any future covenant violations.
The Company draws down working capital advances and opens letters of credit
(up to an aggregate maximum of $20 million) against the facility in amounts
determined on a formula based on factored receivables, inventory and cost of
imported goods under outstanding letters of credit. Interest is charged at the
lending institution's prime lending rate plus one percent per annum (10.5% at
December 2, 2000) on such advances.
In November 2000, the Company amended the revolving credit and security
agreement with the third-party domestic financing institution to provide the
Company with an increased borrowing base against eligible receivables.
Effective September 2000, the Company and certain of the Company's European
subsidiaries reached an agreement to amend their current receivable facility
under which the domestic financing institution provided account receivables
financing of up to the lesser of approximately $18.0 million or 60% of eligible
receivables related to the Company's international operations. The interest rate
is 2% above LIBOR. This credit facility has a term of three years automatically
renewing for additional one-year periods thereafter, unless terminated upon 90
days' prior notice by either party. It is secured by the factored receivables
and assets of such subsidiaries.
Pursuant to the terms of certain distribution, warehouse and credit and
collection agreements, certain of the Company's accounts receivable are due from
distributors. These receivables are not collateralized and as a result
management continually monitors the financial condition of these distributors.
No additional credit risk beyond amounts provided for collection losses is
believed inherent in the Company's accounts receivable. At December 2, 2000 and
August 31, 2000, the balance due from distributors was approximately 18% and
17%, respectively, of gross accounts receivable.
7
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
3. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 2, 2000 AUGUST 31,2000
---------------- --------------
<S> <C> <C>
(A) 10% Convertible Subordinated Notes due 2002........ $ 49,750 $ 49,750
(B) Mortgage notes..................................... 6,265 6,735
-------- --------
56,015 56,485
Less: current portion................................. 1,521 1,521
-------- --------
$ 54,494 $ 54,964
======== ========
</TABLE>
(A) In February 1997, the Company issued $50,000 of unsecured 10% Convertible
Subordinated Notes ("Notes") due March 1, 2002 with interest payable
semiannually. 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 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 through
February 28, 2001 and at 102% of the principal balance thereafter to maturity.
At December 2, 2000 and August 31, 2000, the fair value of the Notes was
approximately $8,400 and $19,900, respectively, based on quoted market values.
(B) The Company has two mortgage notes. One mortgage note is collateralized by
the Company's corporate headquarters building in the U.S. and requires quarterly
principal payments of $181 through February 1, 2002, plus interest at the bank's
prime lending rate plus one percent per annum (10.5% at December 2, 2000). The
principal balance outstanding under the mortgage note at December 2, 2000 and
August 31, 2000 was $1,026 and $1,207, respectively. Pursuant to a seven-year
term secured credit facility entered into in March 2000, the Company's
third-party lending institution provided the Company with mortgage financing
related to its purchase of a building in the U.K. The Company is making
quarterly principal payments of (pound)137.5 (approximately $200 at December 2,
2000). Interest is charged on this facility at 2% above LIBOR (8% at December 2,
2000). The principal balance outstanding under this mortgage note at December 2,
2000 and August 31, 2000 was $5,103 and $5,528, respectively. The U.K. building
is being held for sale by the Company.
Maturities of long-term debt are as follows:
Years ending November 30,
2001............................................... $ 1,521
2002............................................... 50,837
2003............................................... 797
2004............................................... 797
2005............................................... 797
Thereafter......................................... 1,266
-----------
$ 56,015
===========
8
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
4. EARNINGS PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS ENDED
DECEMBER 2, 2000 NOVEMBER 30, 1999
---------------- -----------------
<S> <C> <C>
BASIC EPS COMPUTATION:
Net earnings...................................... $ 10,805 $ 434
Weighted average common shares outstanding........ 56,166 56,105
Basic earnings per share.......................... $ 0.19 $ 0.01
=========== ===========
DILUTED EPS COMPUTATION:
Net earnings $ 10,805 $ 434
10% Convertible Subordinated Notes interest expense 1,244 --
Adjusted net earnings............................. $ 12,049 $ 434
Weighted average common shares outstanding........ 56,166 56,105
Stock options and warrants........................ 2 6,666
10% convertible subordinated notes................ 9,604 --
Diluted common shares outstanding................. 65,772 62,771
Diluted earnings per share........................ $ 0.18 $ 0.01
=========== ===========
</TABLE>
The assumed conversion of the outstanding Notes was excluded from the
November 30, 1999 diluted earnings per share calculation since they were
anti-dilutive.
9
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
5. SEGMENT INFORMATION
The Company has three reportable segments: North America, Europe, and
Pacific Rim, which are organized, managed and analyzed geographically and
operate in one industry segment: the development, marketing and distribution of
entertainment software. The Company's chief operating decision-maker is the
Company's Chief Executive Officer. Information about the Company's operations
for the fiscal quarters ended December 2, 2000 and November 30, 1999 is
presented below:
<TABLE>
<CAPTION>
NORTH AMERICA EUROPE PACIFIC RIM ELIMINATIONS TOTAL
------------- ------ ----------- ------------ -----
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED DECEMBER 2, 2000
Net revenues from external customers....... $55,958 $14,142 $1,939 - $72,039
Intersegment sales......................... 251 2,544 - (2,795) -
------- ------- ------ ------- -------
Total net revenues......................... 56,209 16,686 1,939 (2,795) 72,039
Interest income............................ 278 24 2 - 304
Interest expense........................... 3,041 78 2 - 3,121
Depreciation and amortization.............. 1,886 282 101 - 2,269
Identifiable assets........................ 56,212 23,916 2,214 - 82,342
Segment operating profit (loss)............ 14,414 (74) (375) - 13,965
THREE MONTHS ENDED NOVEMBER 30, 1999
Net revenues from external customers....... 64,099 32,613 4,441 - 101,153
Intersegment sales......................... 56 359 - (415) -
------- ------- ------ ------- -------
Total net revenues......................... 64,155 32,972 4,441 (415) 101,153
Interest income............................ 1,007 11 6 - 1,024
Interest expense........................... 2,705 11 - - 2,716
Depreciation and amortization.............. 2,571 422 255 - 3,248
Identifiable assets........................ 202,223 33,763 6,603 - 242,589
Segment operating profit (loss)............ 5,616 (1,867) 738 - 4,487
</TABLE>
The Company's gross revenues were derived from the following product
categories:
DECEMBER 2, 2000 NOVEMBER 30, 1999
---------------- -----------------
Portable software.................. 14.0% 4.0%
32-bit software.................... 59.0% 38.0%
64-bit software.................... 2.0% 28.0%
128- bit software.................. 17.0% 23.0%
Computer games software............ 1.0% 5.0%
Other.............................. 7.0% 2.0%
----- -----
Total.............................. 100.0% 100.0%
===== =====
10
<PAGE>
ACCLAIM ENTERTAINMENT, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
6. EQUITY
In connection with a litigation settlement accrued in a prior period, in
October 2000 the Company released from escrow 150 shares of common stock.
The fair value of the common shares was $263, which was included in accrued
litigation settlements until the common stock was issued.
In November, 2000, the Company received $900 from the sale of 720 shares of
common stock to two of its executive officers at $1.25 per share, the fair
value of the common stock on the date of the sale.
11
<PAGE>
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 Annual Report on Form 10-K for the fiscal year ended August 31, 2000
and presumes that readers have access to, and will have read, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in such Form 10-K.
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," "expect,"
"project," "will be" and similar expressions identify such forward-looking
statements. The forward-looking statements included herein are based on current
expectations and assumptions that involve a number of risks and uncertainties.
Such statements regarding future events and/or the future financial performance
of Acclaim Entertainment, Inc., together with its subsidiaries (the "Company")
are subject to certain risks and uncertainties, such as delays in the completion
or release of products, the possible lack of consumer appeal and acceptance of
products released by the Company, fluctuations in demand, that competitive
conditions within the Company's markets will change materially or adversely,
that the Company's forecasts will accurately anticipate market demand, and the
risks discussed in "Factors Affecting Future Performance", which could cause
actual events or the actual future results of the Company to differ materially
from any forward-looking statement. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions, and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that the assumptions
underlying the forward-looking statements are reasonable, the business and
operations of the Company are subject to substantial risks that increase the
uncertainty inherent in the forward-looking statements. 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 develops, publishes, markets and distributes video and computer
games for use with game consoles, both dedicated and portable, and PCs on a
worldwide basis. The Company owns and operates four software development studios
located in the U.S. and U.K. where it develops its own software, and also a
motion capture studio and a recording studio in the U.S. The Company also
contracts with independent software developers to create software for it. The
Company publishes, or releases to the public under its brand names, software
developed by it as well as by third-party developers. The Company distributes
its software directly to retailers in North America, U.K., Germany, France,
Spain and Australia. The Company also distributes software developed and
published by third parties, develops and publishes strategy guides in support of
the Company's software and issues "special edition" comic book magazines from
time to time to support its time-valued brands, Turok and Shadowman.
The video and computer games industry is characterized by rapid
technological changes, which have resulted in successive introductions of
increasingly advanced game consoles and PCs. As a result of the rapid
technological shifts, no single game console or PC system has achieved long-term
dominance in the video and computer games market. Therefore, the Company must
continually anticipate game console cycles and its research and development
group must develop programming tools and engines necessary for the development
of software for emerging hardware systems.
The Company's revenues have traditionally been derived from sales of
software for the then-popular game consoles. Accordingly, the Company's
performance has been, and is expected in the future to be, materially adversely
affected by platform transitions. As a result of the industry transition to
32-bit and 64-bit game consoles which commenced in 1995, the Company's software
sales during fiscal 1996, 1997 and 1998 were significantly lower than in fiscal
1994 and 1995. The Company's inability to predict accurately the timing of such
transition resulted in material losses in fiscal 1996 and 1997. The video and
computer games industry is currently experiencing another platform transition
from 32-bit and 64-bit to 128-bit game consoles and related software. The
Company believes that sales of new 32-bit and 64-bit game consoles have peaked
and will continue to decrease substantially in future periods. This transition
during fiscal 2000 resulted in increased competition, fewer hit titles capable
of achieving significant sales levels and increased price weakness for non-hit
titles. The software transition has also resulted in industry-wide software
pricing weakness which impacted the Company's operating results during fiscal
2000 and is anticipated to adversely impact the Company in fiscal 2001, as the
market shifts from the current game consoles to the next-generation systems that
were launched by Sega in fiscal 2000 and Sony in fiscal 2001, and which are
anticipated to be launched in North America by Nintendo and Microsoft in the
fall of 2001. The Company will continue to support PlayStation, Dreamcast and
Game Boy Color and also has begun to publish
12
<PAGE>
for PlayStation 2. The Company will not release any new N64 titles in fiscal
2001 and will release fewer titles for Sega's Dreamcast. The Company anticipates
publishing its first titles for Game Boy Advance in the fourth quarter of fiscal
2001. The Company expects its portfolio of titles for fiscal 2002 to be
dominated by PlayStation 2, Game Cube, X-Box and Game Boy Advance. Although the
Company does not believe that the installed base of next-generation platforms in
2001 will support software sales at the levels achieved in 1999 (before the
current platform transition), when the transition is complete the Company
anticipates that the eventual installed base of 128-bit systems will provide a
larger market for its software, with improved gross margins (based on the
predominance of CD-based product rather than cartridge-based product) as
compared to 1999. There can be no assurance that newly-introduced (e.g., Sony's
PlayStation 2 and Sega's Dreamcast), or the announced (e.g., Nintendo's Game
Cube and Microsoft's X-Box) 128-bit game consoles will achieve commercial
success similar to that of the 32-bit PlayStation or 64-bit N64 or the timing
of such success, if achieved. See "Liquidity and Capital Resources" below, and
"Factors Affecting Future Performance: Industry Trends, Platform Transitions and
Technological Change May Adversely Affect the Company's Revenues and
Profitability."
The rapid technological advances in game consoles have significantly changed
the look and feel of software as well as the software development process.
Currently, the process of developing software is extremely complex and the
Company expects it to become more complex and expensive in the future with the
advent of the more powerful next-generation game consoles. According to the
Company's estimates, the average development time for a title is between 12 and
36 months and the average development cost for a title is between $1 million and
$6 million. The average development time for the Company's software for portable
systems is currently between six and nine months and the average development
cost for a title is between $100,000 and $300,000. For the first quarter of
fiscal 2001 and 2000, approximately 9% and 68%, respectively, of the Company's
gross revenue was derived from software developed by its studios, as the
Company's revenues generated from its most significant releases in the quarter
were externally developed. See "Factors Affecting Future Performance: Increased
Product Development Costs May Adversely Affect Profitability."
The Company's revenues in any period are generally driven by the titles
released by the Company in that period. In the first quarter of fiscal 2001 as
in the past, the Company has experienced delays in the introduction of new
titles, which has had a negative impact on its results of operations. It is
likely that some of the Company's future titles will not be released in
accordance with the Company's operating plans, in which event its results of
operations and profitability in that period would be negatively affected. See
"Liquidity and Capital Resources" below, and "Factors Affecting Future
Performance: Revenues and Liquidity Are Dependent on Timely Introduction of New
Titles."
Net revenues for the quarter ended December 2, 2000 were $72.0 million, a
decrease of $29.2 million, compared to $101.2 million in the first quarter of
the prior year. This decrease was anticipated by the Company's fiscal 2001
operating plan, and reflects achievement of its first quarter goal. The
anticipated lower sales reflected the Company's revised release schedule and the
hardware transition from 32-bit and 64-bit consoles to the next-generation
128-bit consoles. Revenues from the Company's 64-bit software in fiscal 2000
were significantly below the Company's expectations due, in large part, to (1)
the decline of the market for N64 software and the Company's prior emphasis on
the N64 platform, and (2) the slowdown in the rate of growth of the installed
base of 64-bit game consoles. In response to the foregoing trends, the Company
does not plan to release any additional titles for the N64. In addition, the
Company during fiscal 2000 substantially increased its sales allowances to
address the effects on the Company of increased competition and industry-wide
weakness in cartridge-based software sales and slower-than-expected sales of
certain products. The decline in fiscal 2000 sales was partially offset by
revenues from software for the Sega Dreamcast 128-bit game console which is a
CD-based delivery system, but sales for this console were lower in the first
quarter of fiscal 2001 than the comparable period of the prior year. See
"Results of Operations" below.
For fiscal 2001, the Company has changed its quarterly closing dates from
the last calendar day of the quarter to the Saturday closest to the quarter end.
The change applies to quarterly dates while the year end date remains unchanged.
For the first quarter of fiscal 2001, the quarter end date is December 2, 2000,
which compares to the prior years' closing date of November 30, 1999. The change
is not expected to have a material effect on the financial condition, results of
operations or cash flows of the Company for any quarter of fiscal 2001.
The Company recorded net earnings of $10.8 million for the quarter ended
December 2, 2000 compared to net earnings of $0.4 million in the quarter ended
November 30, 1999. The increased earnings are attributed to a significant
reduction in operating expenses in fiscal 2001 when compared to fiscal 2000. In
the third and fourth quarters of fiscal 2000, the Company implemented expense
reduction initiatives, which reduced operating expenses commencing with the
fourth quarter of fiscal 2000. The plan reduced fixed and variable expenses
company wide, eliminated certain marginal titles under development, reduced
staff and lowered marketing expenses.
The Company has implemented a focused effort to reduce its marketing and
selling and other operating expenses by approximately 30% in fiscal 2001 as
compared to fiscal 2000 through:
13
<PAGE>
o Reduction of Marketing and Selling Expenses - the Company has
implemented a plan to substantially reduce its selling and marketing
expenses. In particular, the Company projects that fiscal 2001 selling
and marketing expenses will decline approximately 38% from fiscal 2000
levels.
o Reduction of Overhead and Other Operating Expenses - Through a series
of targeted headcount and other operating expense reductions, the
Company has implemented a cost reduction plan that is anticipated to
reduce other operating expenses by approximately 25% in fiscal 2001
compared to fiscal 2000 (excluding the one time goodwill writedown).
In addition, in fiscal 2001, the Company shifted its product development
strategy in response to the ongoing platform transition to emphasize the
licensing of software developed by third parties, rather than software developed
by the Company's internal studios, in an effort to reduce fixed expenses and
continue its development of certain key titles scheduled for release in the
first and second quarters of fiscal 2002.
While significant expense reductions of $23.0 million or 40% were realized
in the first quarter of fiscal 2001 as compared to the same period in fiscal
2000, there is no guarantee that the Company can accomplish all the above
expense reductions for the entire year.
As the Company continues to manage through the current game console
transition and prepares to compete in the software market for next-generation
game consoles, it is necessary that the Company meet its product release
schedule, sales projections and manage its operational expenditures at the
planned levels in order to generate sufficient liquidity to fund its operations.
See "Liquidity and Capital Resources" below.
The Company's results of operations in the future will be dependent in large
part on (1) the timing and rate of growth of the software market for 128-bit and
other emerging game consoles and (2) the Company's ability to identify, develop
and timely publish, in accordance with its product release schedule, software
that performs well in the marketplace.
14
<PAGE>
RESULTS OF OPERATIONS
The following table shows certain statements of consolidated operations data
as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
DECEMBER 2, 2000 NOVEMBER 30, 1999
---------------- -----------------
<S> <C> <C>
Domestic revenues........................................................ 77.7% 63.4%
Foreign revenues......................................................... 22.3% 36.6%
----- -----
Net revenues............................................................. 100.0% 100.0%
Cost of revenues......................................................... 33.4% 39.6%
----- -----
Gross profit............................................................. 66.6% 60.4%
----- -----
Operating expenses:
Marketing and selling............................................... 16.6% 25.8%
General and administrative.......................................... 14.7% 15.3%
Research and development............................................ 15.9% 14.9%
----- -----
47.2% 56.0%
----- -----
Total operating expenses.................................................
Earnings from operations................................................. 19.4% 4.4%
Interest income.......................................................... 0.4% 1.0%
Interest expense......................................................... (4.3%) (2.7%)
Other income (expense)................................................... (0.1%) (0.6%)
----- -----
Total other income (expense) (4.0%) (2.3%)
Earnings before income taxes............................................. 15.3% 2.2%
Provision for income taxes............................................... 0.3% 1.8%
----- -----
Net earnings............................................................. 15.0% 0.4%
===== =====
</TABLE>
NET REVENUES
The Company's gross revenues were derived from the following product
categories:
<TABLE>
<CAPTION>
DECEMBER 2, 2000* NOVEMBER 30, 1999*
----------------- ------------------
<S> <C> <C>
Portable software........................................................ 14.0% 4.0%
32-bit software.......................................................... 59.0% 38.0%
64-bit software.......................................................... 2.0% 28.0%
128- bit software........................................................ 17.0% 23.0%
Computer games software.................................................. 1.0% 5.0%
Other 7.0% 2.0%
----- ----
Total.................................................................... 100.0% 100%
===== ====
</TABLE>
--------------------
* The numbers in this chart do not give effect to sales credits and allowances
granted by the Company since the Company does not track such credits and
allowances by product category. Accordingly, the numbers presented may vary
materially from those that would be disclosed if the Company were able to
present such information as a percentage of net revenues.
15
<PAGE>
The Company's net revenues decreased $29.2 million or 29% to approximately
$72.0 million for the first quarter ended December 2, 2000 from approximately
$101.2 million for the quarter ended November 30, 1999. This decrease was
anticipated by the Company's fiscal 2001 operating plan, and reflects
achievement of its first quarter goal. The anticipated lower sales reflected the
Company's revised release schedule and the hardware transition from 32-bit and
64-bit consoles to the next-generation 128-bit consoles.
The Company anticipates that its titles currently scheduled for introduction
throughout fiscal 2001 will be released as planned; however, no assurance can be
given that these titles will be released in accordance with the Company's
current expectations. The Company has a license to develop, and release, titles
for Sony's PlayStation 2 and Sega's Dreamcast platforms which were introduced in
the U.S. in the first quarter of fiscal 2001 and 2000, respectively. The Company
has released 16 titles for Dreamcast in fiscal 2000 and plans to release five
additional titles in the second quarter of fiscal 2001. As for Sony's
PlayStation 2, released in the fall of 2000, the Company expects to release 12
titles in fiscal 2001. The first title was launched in November 2000 and the
second was released in the second quarter of fiscal 2001. If the Company does
not release new titles as planned in fiscal 2001, the Company's net revenues
could be materially and negatively impacted and the Company could incur losses
from operations.
The Company anticipates that its mix of domestic and foreign net revenues
will continue to be affected by the content of titles released by the Company to
the extent such titles are positioned for the domestic market.
A significant portion of the Company's revenues in any quarter are generally
derived from software first released in that quarter or in the immediately
preceding quarter. See "Factors Affecting Future Performance: Revenues and
Liquidity Are Dependent on Timely Introduction of New Titles" and "The Company's
Future Success is Dependent on Its Ability to Release "Hit" Titles."
In the quarter ended December 2, 2000, BMX (for multiple platforms) and
Mary-Kate and Ashley (for multiple platforms) accounted for approximately 40%
and 18%, respectively, of the Company's gross revenues. In the quarter ended
November 30, 1999, WWF Attitude (for multiple platforms), Turok Rage Wars (for
multiple platforms) and South Park (for multiple platforms) accounted for
approximately 25%, 14% and 13%, respectively, of the Company's gross revenues.
The Company no longer distributes WWF or South Park software.
The Company also licenses intellectual properties from third parties, such
as the NFL, MLB and NBA. These licenses generally permit the Company to market
titles utilizing the licensors' properties in exchange for royalty payments. The
Company's license for the WWF properties expired in November 1999 and was not
renewed. Sales of titles using WWF properties aggregated 0% and 25% of gross
revenues in the first quarter of fiscal 2001 and 2000, respectively. In the
first quarter of fiscal 2001, as a result of Comedy Partners' (South Park)
repeated refusal to approve the Company's proposed projects and designs, the
Company did not make royalty payments under the license agreement, resulting
in the purported termination of the license by Comedy Partners based on the
Company's refusal. This matter is the subject of litigation. See "Legal
Proceedings." Sales of titles using South Park properties aggregated 0% and 13%
of gross revenues in the first quarter of fiscal 2001 and 2000, respectively.
The Company is substantially dependent on the game console developers as the
sole developers of the game consoles marketed by them, as the sole licensors of
the proprietary information and technology needed to develop software for those
hardware platforms and, in the case of Nintendo and Sony, as the sole
manufacturers of software for the hardware platforms marketed by them. For the
quarter ended December 2, 2000 and November 30, 1999, the Company derived 16%
and 32% of its gross revenues, respectively, from sales of Nintendo-compatible
software; 61% and 38% of its gross revenues, respectively, from sales of
PlayStation software and 14% and 23% of its gross revenues, respectively, from
sales of Sega-compatible software.
GROSS PROFIT
Gross profit is primarily impacted by the percentage of sales of CD-based
software as compared to the percentage of sales of cartridge-based software.
Gross profit may also be significantly impacted from time to time by the level
of returns and price protection and concessions to retailers and distributors to
which the Company provides discounts and allowances. The percentage of foreign
sales and the percentage of foreign sales to third-party distributors may impact
gross margins as well.
The Company's margins on sales of CD-based software (currently, PlayStation,
Dreamcast and PCs) are higher than those on cartridge-based software (currently,
N64 and Game Boy Color) primarily because CD-based software
16
<PAGE>
manufacturing costs are significantly lower. The Company's margins on foreign
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 decreased to $48.0 million (67% of net revenues) for the
quarter ended December 2, 2000 from $61.1 million (60% of net revenues) for the
quarter ended November 30, 1999. The dollar decrease is predominantly due to the
decreased sales levels, partially offset by a reduction in sales allowances. The
increase in margin percent for the first quarter of fiscal 2001 over the same
period last year is due to the reduced dependency on N64 titles. In the first
quarter ended December 2, 2000, N64 titles accounted for only 2.3% of revenues,
while N64 titles accounted for approximately 28% of total volume in the same
period of the prior year. In addition, sales allowances decreased due to
significant increases in the retail sell-through rate of products released in
the first quarter of fiscal 2001 and the continued sell-through of previously
released inventory in the retail channel during the holiday-selling season.
The Company's gross profit in fiscal 2001 will continue to be dependent in
large part on the timing and rate of growth of the software market for 128-bit
and other emerging game consoles (primarily PlayStation 2) and the Company's
ability to identify, develop and timely publish, in accordance with its product
release schedule, software that sells through at projected levels at retail. See
"Factors Affecting Future Performance: Liquidity and Cash Requirements and
Dependence on Achieving Timely Product Release and Sales Objectives."
OPERATING EXPENSES
Operating expenses for the first quarter of fiscal 2001 of $34.0 million
were $22.7 million or 40% lower than the $56.7 million of operating expenses for
the comparable period a year ago.
Marketing and selling expenses of $12.0 million (17% of net revenues)
decreased by $14.1 million or 54% for the quarter ended December 2, 2000 from
$26.1 million (26% of net revenues) for the quarter ended November 30, 1999. The
decrease in marketing expense is primarily due to lower net revenues and reduced
marketing expenditures when compared to the same period of the prior year.
General and administrative expenses of $10.6 million (15% of net revenues)
decreased by $4.9 million or 32% for the quarter ended December 2, 2000 from
$15.5 million (15% of net revenues) for the quarter ended November 30, 1999. The
decrease in the first quarter ended December 2, 2000 over the same period of the
prior year is primarily due to the cost reduction efforts initiated by the
company in the second half of fiscal 2000, primarily salary savings realized
from staff reductions.
Research and development expenses of $11.5 million (16% of net revenues)
decreased by $3.6 million or 24% for the quarter ended December 2, 2000 from
$15.1 million (15% of net revenues) for the quarter ended November 30, 1999. The
decrease in research and development is primarily related to the reduction in
the number of overall titles being developed and staff reductions. In addition,
the Company is no longer simultaneously developing software for both the older
32- bit and 64-bit systems as well as for the next-generation 128-bit systems.
The Company is developing software predominately for the next-generation systems
which has contributed to the decrease in research and development expenses in
the first quarter of 2001 compared to the comparable period of the prior year.
The Company accounts for capitalized software development costs in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed". Software development costs are capitalized once technological
feasibility is established. Technological feasibility is evaluated on a
product-by-product basis. For products where a proven game engine technology
exists, the Company capitalizes these costs and expenses them upon release of
the product or when they are deemed unrecoverable. The Company capitalized
approximately $0.5 million and $0 of software development costs for the first
quarters ended December 2, 2000 and November 30, 1999, respectively.
Interest income decreased to $0.3 million in the first quarter ended
December 2, 2000 from $1.0 million in the first quarter ended November 30, 1999
due to lower cash balances available for investment. Interest expense increased
by $0.4 million to $3.1 million in the first quarter of fiscal 2001 from $2.7
million in first quarter of fiscal 2000 due to higher interest rates and
increased borrowing levels from the company's primary lending institution.
As of August 31, 2000, the Company had a U.S. tax net operating loss
carryforward of approximately $126.0 million. The provision for income taxes for
the periods presented relate to Federal alternative minimum, state and foreign
income taxes.
17
<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 corresponds to the holiday-selling season). The timing of the delivery of
software titles and the release of new products cause material fluctuations in
the Company's quarterly revenues and earnings, which may cause the Company's
results to vary from the seasonal patterns of the industry as a whole. See
"Factors Affecting Future Performance: Revenues Vary Due to the Seasonal Nature
of Video and PC Game Software Purchases."
LIQUIDITY AND CAPITAL RESOURCES
At December 2, 2000, the Company had a negative working capital position of
approximately ($61.5) million as compared to ($76.8) million at August 31, 2000.
Cash and cash equivalents totaled approximately $5.5 million at December 2, 2000
versus $6.7 million at August 31, 2000. The decrease in net cash from the
quarter ended November 30, 1999 to the quarter ended December 2, 2000 is
primarily attributable to the loss from operations for the fiscal year ended
August 31, 2000. See "Factors Affecting Future Performance: Liquidity and Cash
Requirements and Dependence on Achieving Timely Product Release and Sales
Objectives".
Short-term liquidity in 2000 was addressed by the Company receiving
additional borrowings under its revolving credit and security agreement with its
principal lending institution on a short-term basis and in the first quarter of
fiscal 2001 with proceeds from the issuance of common stock. Based on its
current available cash resources, including the new additional collateral
funding provided by the Company's third-party lender, and assuming the Company
meets its sales forecast by successfully achieving its planned product release
schedule, and giving effect to the continuation of savings from implemented
expense reductions, the Company expects to have sufficient resources to meet its
projected cash and operating requirements through fiscal 2001. In addition, the
Company is actively working with its investment bankers and third-party lending
institution in the development of a supplemental financing plan that would
provide additional long-term financing, although there can be no assurance the
Company will be able to consummate any such financing.
If the Company does not substantially achieve the overall projected revenue
levels for fiscal 2001 as reflected in its business operating plans, the Company
either will require additional financing to fund operations or the Company will
need to make further significant expense reductions, including, without
limitation, the sale of certain assets or the consolidation of certain
operations and staff reductions and/or the delay, cancellation or reduction of
certain product development and marketing programs. Certain of such measures may
require third-party consents or approvals including from the Company's primary
lender, and there can be no such assurance that consents or approvals can be
obtained.
In the event the Company does not achieve the product release schedule,
sales assumptions or any additional expense reductions described above, there
can be no assurance that the Company will be able to arrange additional
financing on satisfactory terms, if at all. Additionally, the Company cannot
assure its investors that its future operating cash flows will be sufficient to
meet its debt service requirement or to repay its indebtedness at maturity. In
any such event, the Company's operations and liquidity will be materially
adversely affected.
The Company used net cash in operating activities of approximately ($1.8)
million during the quarter ended December 2, 2000, and provided net cash from
operating activities of approximately $7.7 million during the quarter ended
November 30, 1999. The decrease in net cash from operating activities in the
first quarter of fiscal 2001 is primarily attributable to the increase in
accounts receivable.
The Company used net cash in investing activities of approximately ($0.1)
million and ($4.6) million during the quarter ended December 2, 2000 and
November 30, 1999, respectively. Cash used in investing activities in the first
quarter of fiscal 1999, is primarily attributable to the acquisition of fixed
assets, primarily an enterprise-wide computer system.
The Company derived net cash from financing activities of approximately $0.4
million and $0.6 million during the quarter ended December 2, 2000 and November
30, 1999, respectively. The decrease in net cash derived from financing
activities in the first quarter of fiscal 2001 as compared to the first quarter
of fiscal 2000 is primarily attributable to the decrease in proceeds from the
exercise of stock options and warrants, partially offset by an increase in
proceeds from the issuance of common stock.
The Company generally purchases its inventory of Nintendo software by
opening letters of credit when placing the purchase order. At December 2, 2000,
the amount outstanding under letters of credit was approximately $2.9 million.
Other than such letters of credit and ordinary course of business minimum
royalty and payable obligations, the Company does not currently have any
material operating or capital expenditure commitments.
18
<PAGE>
The Company has a revolving credit and security agreement with a third-party
domestic financing institution since 1989. The credit agreement expires August
31, 2003 but automatically renews for additional one-year periods, 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 based on a formula including factored receivables and
inventory, which advances are secured by substantially all of the Company's
assets. The domestic financing institution also acts as the Company's factor for
the majority of its North American receivables, which are assigned on a
pre-approved basis. At December 2, 2000, the factoring charge was 0.25% of the
receivables assigned and the interest on advances was at the prime rate plus one
and one half percent. Pursuant to the terms of the agreement with its
third-party lender, the Company is required to maintain specified levels of
working capital and tangible net worth, among other covenants. As of December 2,
2000, the Company was not in compliance with certain of the financial covenants
under its revolving credit facility. The Company received waivers regarding this
non-compliance from the third-party lender. While the Company anticipates that
it will not be in compliance with the financial covenants in its bank agreements
in the near term, and anticipates being able to obtain necessary waivers as it
has in the past, the Company may not be able to obtain waivers of any future
covenant violations. If the Company becomes insolvent, is liquidated or
reorganized, after payment to the creditors, there are likely to be insufficient
assets remaining for any distribution to stockholders.
During August 2000, the domestic financing institution advanced the Company
$15.0 million additional interim funding above the standard borrowing base under
the loan agreement. Such additional interim funding was repaid by November 30,
2000.
In November 2000, the Company amended the revolving credit and security
agreement with its third-party domestic financing institution to provide the
Company with an increased borrowing base against eligible receivables.
Effective September 2000, the Company and certain of the Company's European
subsidiaries reached an agreement to amend their current receivable facility
under which the domestic financing institution provided account receivables
financing of up to the lesser of approximately $18.0 million or 60% of eligible
receivables related to the Company's international operations. The interest rate
is 2% above LIBOR. This credit facility has a term of three years automatically
renewing for additional one-year periods thereafter, unless terminated upon
90-days' prior notice by either party. It is secured by the factored receivables
and assets of such subsidiaries.
In March 2000, pursuant to a seven-year term secured credit facility, the
domestic financing institution provided the Company with mortgage financing in
the amount of $6.2 million relating to its purchase of a building in the U.K.
The Company has decided not to utilize the facility and it is now held for sale.
Interest is charged on this facility at a rate of 2% above LIBOR. The Company
also has a financing arrangement relating to the mortgage on its corporate
headquarters. At August 31, 2000, the outstanding principal balance on the
Company's corporate headquarters was $1.0 million.
NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the SEC issued SAB No. 101, Revenue Recognition in
Financial Statements, which summarizes certain of the SEC staff's views in
applying accounting principles generally accepted in the United States of
America to revenue recognition in financial statements. On June 26, 2000, the
SEC issued SAB No. 101B which postponed the implementation of SAB No. 101 until
the fourth quarter of fiscal 2001 for the Company. The Company believes that its
revenue recognition policies and practices are in conformity with SAB No. 101.
19
<PAGE>
FACTORS AFFECTING FUTURE PERFORMANCE
The Company's future operating results depend upon many factors and are
subject to various risks and uncertainties. The known material risks and
uncertainties which may cause the Company's operating results to vary from
anticipated results or which may negatively affect its operating results and
profitability are as follows:
LIQUIDITY AND CASH REQUIREMENTS ARE DEPENDENT ON ACHIEVING TIMELY PRODUCT
RELEASES AND SALES OBJECTIVES
The Company's significant loss from operations for the fiscal year ended
August 31, 2000 and working capital and stockholders' deficiencies at August 31,
2000 raised substantial doubt about the Company's ability to continue as a going
concern. Short-term liquidity in 2000 was addressed by the Company receiving
additional borrowings under its revolving credit and security agreement with its
principal lending institution on a short-term basis and in the first quarter of
fiscal 2001 with proceeds from the issuance of common stock. Based on its
current available cash resources, including the new additional collateral
funding provided by the Company's third-party lender, and assuming the Company
continues to meet its sales forecast by successfully achieving its planned
product release schedule, and giving effect to the continuation of savings from
implemented expense reductions, the Company expects to have sufficient resources
to meet its projected cash and operating requirements through fiscal 2001. In
addition, the Company is actively working with its investment bankers and
third-party lending institution in the development of a supplemental financing
plan that would provide additional long-term financing, although there can be no
assurance the Company will be able to consummate any such financing.
If the Company does not substantially achieve the overall projected revenue
levels for fiscal 2001 as reflected in its business operating plans, the Company
either will require additional financing to fund operations or the Company will
need to make further significant expense reductions, including, without
limitation, the sale of certain assets or the consolidation of certain
operations and staff reductions and/or the delay, cancellation or reduction of
certain product development and marketing programs. Certain of such measures may
require third-party consents or approvals, including from the Company's primary
lender, and there can be no such assurance that consents or approvals can be
obtained.
In the event the Company does not achieve its product release schedule,
sales assumptions or any additional expense reductions described above, there
can be no assurance that the Company will be able to arrange additional
financing on satisfactory terms, if at all. Additionally, the Company cannot
assure its investors that its future operating cash flows will be sufficient to
meet its debt service requirement or to repay its indebtedness at maturity. In
any such event, the Company's operations and liquidity will be materially
adversely affected.
While the Company anticipates that it will not be in compliance with the
financial covenants in its bank agreements in the near term, and anticipates
being able to obtain necessary waivers as it has in the past, the Company may
not be able to obtain waivers of any future covenant violations.
GOING CONCERN CONSIDERATION
At August 31, 2000, the Company's independent auditors' report, as prepared
by KPMG LLP and dated November 29, 2000, which appears in the Company's Form
10-K, includes an explanatory paragraph relating to substantial doubt as to the
ability of the Company to continue as a going concern due to the Company's
significant loss from operations in fiscal 2000 and its working capital and
stockholders' deficiencies. While the accompanying unaudited financial
statements for the quarter ended December 2, 2000 have been prepared under the
assumption that the Company will continue as a going concern and report that the
Company has earned net income of $10.8 million or $0.18 per diluted share, the
Company cannot assure its stockholders and investors that it will continue to
achieve profitability.
IF CASH FLOWS FROM OPERATIONS ARE NOT SUFFICIENT TO MEET THE COMPANY'S NEEDS, IT
MAY BE FORCED TO SELL ASSETS, REFINANCE DEBT, OR FURTHER DOWNSIZE OPERATIONS
In the second half of fiscal 2000, the Company implemented an expense
reduction initiative, which reduced operating expenses commencing with the
fourth quarter of that fiscal year. Additionally, during the first quarter of
fiscal 2001, the Company implemented incremental expense reduction initiatives
to reduce operating expenses throughout fiscal 2001 in line with its sales
forecasts; however, if the Company does not achieve its product release
schedule, sales assumptions or any additional expense reductions described
above, the Company may experience insufficient liquidity in fiscal 2001, which
may require the Company to sell assets or consolidate operations, reduce staff,
refinance debt and/or otherwise restructure its operations. The Company's
operating plan for fiscal 2001 lowered fixed and variable expenses worldwide,
eliminated certain software development projects that were not expected to
achieve the Company's financial return parameters within the next 12 to 18
months and eliminated non-essential marketing expenses and implemented
20
<PAGE>
certain staff reductions. Although the Company believes the actions it has taken
should return the Company's annual operations to profitability it cannot assure
its shareholders and investors that it will achieve profitability or the sales
necessary to avoid further reductions. See "Industry Trends, Platform
Transitions and Technological Change May Adversely Affect The Company's Revenues
and Profitability" below and "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources".
ABILITY TO SERVICE DEBT AND PRIOR RIGHTS OF CREDITORS MAY ADVERSELY AFFECT
HOLDERS OF COMMON STOCK
The Company believes that its current available cash resources, including
the new additional collateral funding being provided by the Company's
third-party lender, and assuming the Company meets its sales forecasts by
successfully achieving its planned product release schedule, and giving effect
to the continuation of savings from implemented expense reductions, will be
sufficient to meet its projected cash and operating requirements, which include
the timely payment of all interest and principal payments through fiscal 2001.
If however, the Company's cash and projected cash flow from operations in fiscal
2001 or beyond is insufficient to make interest and principal payments when due,
the Company may have to restructure its indebtedness. The Company cannot
guarantee that it will be able to restructure or refinance its debt on
satisfactory terms. In addition, restructuring or refinancing may not be
permitted by the terms of the Company's existing indebtedness. The Company
cannot assure investors that its future operating cash flows will be sufficient
to meet its debt service requirements or to repay its indebtedness at maturity.
If the Company violates the financial or other covenants contained in its
bank agreements or in the indenture governing its outstanding convertible notes,
it will be in default under its loan agreements and/or the indenture. If a
default occurs and is not waived by the lender, the lender could seek remedies
against the Company, including: (1) penalty rates of interest; (2) immediate
repayment of the debt; and/or (3) the foreclosure on any assets securing the
debt. Pursuant to the terms of the agreement with its third-party lender, the
Company is required to maintain specified levels of working capital and tangible
net worth, among other covenants. As of December 2, 2000, the Company was not in
compliance with certain of the financial covenants under its revolving credit
facility. The Company received waivers regarding this non-compliance from the
third-party lender.
While the Company anticipates that it will not be in compliance with the
financial covenants in its bank agreements in the near term, and anticipates
being able to obtain necessary waivers as it has in the past, the Company may
not be able to obtain waivers of any future covenant violations. If the Company
becomes insolvent, is liquidated or reorganized, after payment to the creditors,
there are likely to be insufficient assets remaining for any distribution to
stockholders.
In order to meet its debt service obligations, from time to time the Company
also depends on dividends, advances and transfers of funds from its
subsidiaries. State and foreign law regulate the payment of dividends by these
subsidiaries, which is also subject to the terms of existing bank agreements and
the indenture governing its outstanding convertible notes. A significant portion
of the Company's assets, operations, trade payables and indebtedness is located
among these foreign subsidiaries. The creditors of the subsidiaries would
generally recover from these assets on the obligations owed to them by the
subsidiaries before any recovery by the Company's creditors and before any
assets are distributed to stockholders.
REVENUES AND LIQUIDITY ARE DEPENDENT ON TIMELY INTRODUCTION OF NEW TITLES
The life cycle of a new title generally ranges from less than three months
to upwards of 12 months, with the majority of sales occurring in the first 30 to
120 days after release. Therefore, the Company is constantly required to
introduce new titles in order to generate revenues and/or to replace declining
revenues from older titles. In the past and in the first quarter of fiscal 2001,
the Company experienced delays in the introduction of new titles, which has had
a negative impact on its results of operations. The complexity of
next-generation systems has resulted in higher development expenses, longer
development cycles, and the need to carefully monitor and plan the product
development process. If the Company does not introduce titles in accordance with
its operating plans for a period, its results of operations, liquidity and
profitability in that period could be negatively affected.
The timely shipment of a new title depends on various factors, including (1)
the development process; (2) bug testing; (3) approval by hardware licensors;
and (4) approval by third- party licensors.
It is likely that some of the Company's titles will not be released in
accordance with the Company's operating plans. A significant delay in the
introduction of one or more new titles could negatively affect sales and have a
negative impact on the Company's financial condition, liquidity and results of
operations, as was the case in fiscal 2000 and the first quarter of fiscal 2001.
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The Company cannot assure stockholders that its new titles will be released
in a timely fashion. Factors such as competition for access to retail shelf
space, consumer preferences and seasonality could result in the shortening of
the life cycle for older titles and increase the importance of the Company's
ability to release new titles on a timely basis.
INDUSTRY TRENDS, PLATFORM TRANSITIONS AND TECHNOLOGICAL CHANGE MAY ADVERSELY
AFFECT THE COMPANY'S REVENUES AND PROFITABILITY
The life cycle of existing game consoles and the market acceptance and
popularity of new game consoles significantly affects the success of the
Company's products. The Company cannot guarantee that it will be able to predict
accurately the life cycle or popularity of each game console. If the Company (1)
does not develop software for games consoles that achieve significant market
acceptance; (2) discontinues development of software for a game console that has
a longer-than-expected life cycle; (3) develops software for a game console that
does not achieve a significant installed base; or (4) continues development of
software for a game console that has a shorter-than-expected life cycle, it will
experience losses from operations.
In addition, the cyclical nature of the video and computer games industry
requires the Company to continually adapt software development efforts to
emerging hardware systems. The industry is migrating to a 128-bit game console.
Sega has introduced Dreamcast while Sony released PlayStation 2 on a limited
basis in the Fall of 2000. Both Nintendo and Microsoft have announced plans to
release their own 128-bit game consoles. No assurance can be given that these
new game consoles will achieve commercial success similar to and/or installed
bases comparable to that of the 32- bit PlayStation or 64-bit N64, or as to the
timing of such success. In addition, the Company cannot guarantee that it will
be successful in developing and publishing software for these new game consoles
nor can it guarantee that Microsoft or Nintendo will release its new platforms
in accordance with their announced release dates in the near future.
THE COMPANY'S FUTURE SUCCESS IS DEPENDENT ON ITS ABILITY TO RELEASE "HIT" TITLES
The market for software is "hits" driven. Therefore, the Company's future
success depends on developing, publishing and distributing "hit" titles for game
consoles with significant installed bases. If the Company does not publish "hit"
titles in the future, its financial condition, results of operations and
profitability could be negatively affected as has occurred in the past. It is
difficult to predict consumer preferences for titles, and few titles achieve
sustained market acceptance. The Company cannot assure stockholders that it will
be able to publish "hit" titles in the future.
IF PRODUCT RETURNS, PRICE PROTECTION AND CONCESSIONS EXCEED ALLOWANCES, THE
COMPANY MAY INCUR LOSSES
The Company is not contractually obligated to accept returns except for
defective product. The Company may permit customers to return or exchange
products and may provide price protection or concessions on products unsold by
the customer. The Company is having to more frequently provide price protection
and concessions. Coupled with more competitive pricing, if the Company's
allowances for returns, exchanges and price concessions are exceeded, the
Company's financial condition and results of operations will be negatively
impacted, as has occurred in the past.
Management makes significant estimates and assumptions regarding
allowances for estimated product returns, price protection and concessions in
preparing the Company's financial statements. The Company establishes allowances
taking into account the potential for product returns, price protection and
concessions based primarily on: (1) market acceptance of products in retail and
distributor inventories; (2) level of retail inventories; (3) seasonality; and
(4) historical return and price concession rates.
The Company believes that at December 2, 2000, its allowances for
future returns, exchanges and price protection and concessions are adequate. The
Company cannot guarantee the adequacy of its current or future allowances. See
Note 2 of the Notes to the Consolidated Financial Statements.
IF THE COMPANY IS UNABLE TO OBTAIN OR RENEW LICENSES FROM HARDWARE DEVELOPERS,
IT WILL NOT BE ABLE TO RELEASE SOFTWARE FOR GAME CONSOLES
The Company is substantially dependent on each hardware developer (1)
as the sole licensor of the specifications needed to develop software for its
game consoles; (2) as the sole manufacturer (Nintendo and Sony software) of the
software developed by the Company for its game consoles; (3) to protect the
intellectual property rights to its game consoles and technology and (4) to
discourage unauthorized persons from producing software for its game consoles.
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Substantially all of the Company's revenues have historically been derived
from sales of software for game consoles. In the quarters ended December 2, 2000
and November 30, 1999, the Company derived:
o approximately 16% and 32%, respectively, of gross revenues from the
sale of Nintendo-compatible software;
o approximately 61% and 38%, respectively, of gross revenues from the
sale of Sony PlayStation software;
o approximately 14% and 23%, respectively, of gross revenues from the
sale of Sega compatible software; and
o approximately 1% and 5%, respectively, of gross revenue from the sale
of PC software.
If the Company cannot obtain licenses to develop software from developers of
new game consoles or if any of its existing license agreements are terminated,
the Company will not be able to release software for those game consoles, which
would have a negative impact on its results of operations and profitability.
Although, the Company cannot assure its stockholders that, at the end of their
current terms, it will be able to obtain extensions or that it will be
successful in negotiating definitive license agreements with developers of new
game consoles, to date the Company has always obtained extensions or new
agreements with the hardware companies.
The Company's revenue growth may also be dependent on the hardware
companies. If new license agreements contain similar limitations, the Company's
revenue and profitability may be negatively impacted.
INCREASED PRODUCT DEVELOPMENT COST MAY ADVERSELY AFFECT PROFITABILITY
The Company's research and development expenses decreased $3.6 million to
$11.5 million (approximately 16% of net revenues) for the quarter ended December
2, 2000 from $15.1 million (approximately 15% of net revenues) for the quarter
ended November 30, 1999. The Company anticipates that its future research and
development expenses will decrease due to the Company's focus on fewer hardware
systems. During the fiscal 2000 transition year, the Company focused its
development efforts and costs on N64, PlayStation, PlayStation 2, X-Box and
Dreamcast, while incurring incremental costs in the development of tools and
engines necessary for the new platforms. The Company's current release schedule
commencing in the second quarter of 2001 is developed around PlayStation 2,
X-Box, Game Boy Advance and Game Cube. In addition, the Company will continue to
support PlayStation, Dreamcast and Game Boy Color through a select group of
independent software developers, thus permitting the Company to reduce in part
its internal development costs. Although the Company anticipates that its future
product development expenses will decrease in fiscal 2001, the Company cannot
assure its investors that its product development expenses will not increase
thereafter as a result of the complexity of developing games for the new 128-bit
game consoles. The Company anticipates that its profitability will continue to
be impacted by the levels of research and development expenses relative to
revenues, and by fluctuations relating to the timing of development in
anticipation of the next-generation platforms.
INABILITY TO PROCURE COMMERCIALLY VALUABLE INTELLECTUAL PROPERTY LICENSES MAY
PREVENT PRODUCT RELEASES OR RESULT IN REDUCED PRODUCT SALES
The Company's titles often embody trademarks, trade names, logos, or
copyrights licensed to it by third parties, such as the NBA, the NFL and MLB or
their respective players' associations. The Company may not be successful in
acquiring or renewing licenses to property rights with significant commercial
value. The loss of one or more of these licenses could prevent the Company's
release of a title or limit its economic success. For example, the Company's
license for the WWF properties expired in November 1999 and was not renewed.
Sales of titles using WWF properties aggregated 0% of gross revenues in the
quarter ended December 2, 2000 as compared to 25% for the quarter ended November
30, 1999. In the first quarter of fiscal 2001, as a result of Comedy Partners'
(South Park) repeated refusal to approve the Company's proposed projects and
designs, the Company did not make royalty payments under the license
agreement, resulting in the purported termination of the license by Comedy
Partners based on the Company's refusal. This matter is the subject of
litigation. See "Legal Proceedings." Sales of titles using South Park properties
aggregated 0% and 13% of gross revenues in the first quarter of fiscal 2001 and
2000, respectively. In addition, the Company cannot assure stockholders that its
licenses will be extended on reasonable terms or at all.
License agreements relating to these rights generally extend for a term of
two to three years. The agreements are terminable upon the occurrence of a
number of factors, including the Company's (1) material breach of the agreement;
(2) failure to pay amounts due to the licensor in a timely manner; or (3)
bankruptcy or insolvency.
IF THE COMPANY DOES NOT COMPETE SUCCESSFULLY, DEMAND FOR ITS PRODUCTS MAY BE
REDUCED
The video and computer games market is highly competitive. Only a small
percentage of titles introduced in the market achieve any degree of sustained
market acceptance. If the Company's titles are not successful, its operations
and profitability will be negatively impacted. The Company cannot guarantee that
its titles will compete successfully.
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Competition in the video and computer games industry is based primarily
upon:
o the quality of titles;
o reviews received for a title from independent reviewers who publish
reviews in magazines, websites, newspapers and other industry
publications;
o publisher's access to retail shelf space;
o the success of the game console for which the title is written;
o the price of each title;
o the number of titles then available for the system for which each title
is published; and
o the marketing campaign supporting a title at launch and through its
life.
The Company's chief competitors are the developers of games consoles, to
whom the Company pays royalties and/or manufacturing charges, as well as a
number of independent software publishers. The hardware developers have a price,
marketing and distribution advantage with respect to software marketed by them.
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 the Company, such as Nintendo, Sega and Sony.
The Company's competitors also include a number of independent software
publishers licensed by the hardware developers.
As each hardware cycle matures, significant price competition and reduced
profit margins result and the Company anticipates this to continue throughout
the transition period of fiscal 2001. In addition, competition from new
technologies may reduce demand in markets in which the Company has traditionally
competed. As a result of prolonged price competition and reduced demand as a
result of competing technologies, the Company's operations and liquidity have
been, and in the future could continue to be, negatively impacted.
REVENUES VARY DUE TO THE SEASONAL NATURE OF VIDEO AND COMPUTER GAMES SOFTWARE
PURCHASES
The video and computer games industry is highly seasonal. Typically, net
revenues are highest in the last calendar quarter, decline in the first calendar
quarter, are lower in the second calendar quarter and increase in the third
calendar quarter. The seasonal pattern is due primarily to the increased demand
for software during the year-end holiday selling season and the reduced demand
for software during the summer months. The Company's earnings vary significantly
and are materially affected by releases of "hit" titles and, accordingly, may
not necessarily reflect the seasonal patterns of the industry as a whole. The
Company expects that operating results will continue to fluctuate significantly
in the future. See "Fluctuations in Quarterly Operating Results Lead to
Unpredictability of Revenues and Income" below.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS LEAD TO UNPREDICTABILITY OF REVENUES
AND INCOME
The timing of release of new titles can cause material quarterly revenues
and earnings fluctuations. A significant portion of revenues in any quarter is
often derived from sales of new titles introduced in that quarter or in the
immediately preceding quarter. If the Company is unable to begin volume
shipments of a significant new title during the scheduled quarter, as was the
case in the second half of fiscal 2000, its revenues and earnings will be
negatively affected in that period. In addition, because a majority of the unit
sales for a title typically occur in the first 30 to 120 days following its
introduction, revenues and earnings may increase significantly in a period in
which a major title is introduced and may decline in the following period or in
which there are no major title introductions.
Quarterly operating results also may be materially impacted by factors
including (1) the level of market acceptance or demand for titles and (2) the
level of development and/or promotion expenses for a title. Consequently, if net
revenues in a period are below expectations, the Company's operating results and
financial position in that period are likely to be negatively affected, as
occurred in the fourth quarter of fiscal 2000.
STOCK PRICE IS VOLATILE AND STOCKHOLDERS MAY NOT BE ABLE TO RECOUP THEIR
INVESTMENT
There is a history of significant volatility in the market prices of
companies engaged in the software industry, including the Company. Movements in
the market price of the Company's common stock from time to time have negatively
affected stockholders' ability to recoup their investment in the stock. The
price of the Company's common stock is likely to continue to be highly volatile,
and stockholders may not be able to recoup their investment. If the Company's
future revenues, profitability or product releases do not meet expectations, the
price of the Company's common stock may be negatively affected.
NASDAQ DELISTING AND LIQUIDITY OF COMMON STOCK
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In order to maintain the listing of the Company's common stock on The Nasdaq
National Market, the Company was required, among other things, to maintain net
tangible assets of at least $4 million for continued listing on The Nasdaq
National Market.
In the fourth quarter of fiscal 2000, the Company's securities were delisted
from quotation on The Nasdaq National Market. The Company's common stock is
currently trading on The NASDAQ Small Cap Market. Although the Company meets the
current listing criteria for The NASDAQ Small Cap Market, no assurance can be
given as to the Company's ongoing ability to meet The NASDAQ Small Cap Market
maintenance requirements. One of such maintenance requirements is that the
Company's common stock continue to trade above $1.00 per share.
In order to obtain relisting of its common stock on The NASDAQ National
Market, the Company must satisfy certain quantitative designation criteria,
which it does not currently meet. No assurance can be give that the Company will
be able to meet such relisting criteria for The NASDAQ National Market in the
near future.
If the Company's common stock was to be delisted from trading on the NASDAQ
Small Cap Market, trading, if any in the common stock may continue to be
conducted on the OTC Bulletin Board or in the non-NASDAQ over-the-counter
market. Delisting of the common stock would result in limited release of the
market price of the common stock and limited news coverage of the Company and
could restrict investors' interest in the common stock and materially adversely
affect the trading market and prices for the common stock and the Company's
ability to issue additional securities or to secure additional financing.
If the Company's common stock is delisted from The NASDAQ Small Cap Market,
it could become subject to the "penny stock" rules. "Penny stocks" generally are
equity securities with a price of less than $5.00 per share, which are not
registered on certain national securities exchanges or quoted on the NASDAQ
system. If the Company's common stock was delisted from NASDAQ, it could become
subject to the SEC's penny stock rules. These rules, among other things, require
broker-dealers to satisfy special sales practice requirements, including making
individualized written suitability determinations and receiving a purchaser's
written consent prior to any transaction. In addition, under the penny stock
rules, additional disclosure in connection with trades in the common stock would
be required, including the delivery of a disclosure schedule explaining the
nature and risks of the penny stock market. Such requirements could severely
limit the liquidity of the common stock.
PREVALENCE OF ILLEGAL COPYING OF SOFTWARE COULD ADVERSELY AFFECT SALES
In order to protect its software and proprietary rights, the Company relies
mainly on a combination of (1) copyrights; (2) trade secret laws; (3) patent and
trademark laws; and (4) nondisclosure agreements.
Existing U.S. and international laws afford only limited protection. An
unauthorized person may be able to copy the Company's software or otherwise
obtain and use its proprietary information. If a significant amount of illegal
copying of software published or distributed by the Company occurs, its product
sales could be adversely impacted. Policing illegal use of software is extremely
difficult and software piracy is expected to persist. In addition, the laws of
some foreign countries in which the Company's software is distributed do not
protect the Company and its intellectual property rights to the same extent as
the laws of the U.S. The Company cannot guarantee that its attempts to protect
its proprietary rights will be adequate.
INFRINGEMENT COULD LEAD TO COSTLY LITIGATION AND/ OR THE NEED TO ENTER INTO
LICENSE AGREEMENTS, WHICH MAY RESULT IN INCREASED OPERATING EXPENSES
Existing or future infringement claims by or against the Company may result
in costly litigation or require the Company to license the proprietary rights of
third parties, which could have a negative impact on the Company's results of
operations, liquidity and profitability.
The Company believes that its proprietary rights do not infringe on the
proprietary rights of others. As the number of titles in the industry increases,
the Company believes that claims and lawsuits with respect to software
infringement will also increase. From time to time, third parties have asserted
that some of the Company's titles infringed its proprietary rights. The Company
has also asserted that third parties have likewise infringed its proprietary
rights. These infringement claims have sometimes resulted in litigation by and
against the Company. To date, none of these claims has negatively impacted the
Company's ability to develop, publish or distribute its software. The Company
cannot guarantee that future infringement claims will not occur or that they
will not negatively impact its ability to develop, publish or distribute its
software.
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FACTORS SPECIFIC TO INTERNATIONAL SALES MAY RESULT IN REDUCED REVENUES AND/OR
INCREASED COSTS
International sales have historically represented material portions of the
Company's revenues and the Company expects that international sales will
continue to account for a significant portion of its revenues in future periods.
Sales in foreign countries may involve expenses incurred to customize titles to
comply with local laws. In addition, titles that are successful in the domestic
market may not be successful in foreign markets due to different consumer
preferences. International sales are also subject to fluctuating exchange rates
and may be affected by the recent adoption of a single currency in much of
Europe. These and other factors specific to international sales may result in
reduced revenues and/or increased costs.
LOSS OF KEY EMPLOYEES MAY NEGATIVELY IMPACT THE COMPANY'S SUCCESS
The Company's success depends on its ability to identify, hire and retain
skilled personnel. The software 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
Company may not be able to attract and retain skilled personnel or may incur
significant costs in order to do so.
In particular, the Company is highly dependent upon 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.
If the Company were to lose either of their services, its business would be
negatively impacted. Although the Company has employment agreements with Messrs.
Fischbach and Scoroposki through August 31, 2003, they may leave or compete with
the Company in the future. If the Company is unable to attract additional
qualified employees or retain the services of key personnel, its business could
be negatively impacted.
CHARTER AND ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY AFFECT RIGHTS OF HOLDERS
OF COMMON STOCK
The board of directors has the authority to issue shares of preferred stock
and to determine their characteristics without stockholder approval. In this
regard, the board of directors recently approved a stockholder rights plan. If
the Series B junior participating preferred stock is issued it would be more
difficult for a third party to acquire a majority of the Company's voting stock.
In addition to the Series B preferred stock, the board of directors may
issue additional preferred stock and, if this is done, the rights of common
stockholders may be additionally negatively affected by the rights of those
preferred stockholders.
The Company is also subject to anti-takeover provisions of Delaware
corporate law, which may impede a tender offer, change in control or takeover
attempt that is opposed by the board. In addition, employment arrangements with
some members of management provide for severance payments upon termination of
their employment if there is a change in control.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has not entered into any significant financial instruments for
trading or hedging purposes.
The Company's results of operations are affected by fluctuations in the
value of its subsidiaries' functional currency as compared to the currencies of
its foreign denominated sales and purchases. The results of operations of the
Company's subsidiaries, as reported in U.S. dollars, may be significantly
affected by fluctuations in the value of the local currencies in which the
Company transacts business. Such amount is recorded upon the translation of the
foreign subsidiaries' financial statements into U.S. dollars, and is dependent
upon the various foreign exchange rates and the magnitude of the foreign
subsidiaries' financial statements. At December 2, 2000 and November 30, 1999,
the Company's foreign currency translation adjustments were not material. In
addition to the direct effects of changes in exchange rates, which are a changed
dollar value of the resulting sales and related expenses, changes in exchange
rates also affect the volume of sales or the foreign currency sales price as
competitors' products become more or less attractive.
The Company is not exposed to material future earnings or cash flow
exposures from changes in interest rates on long-term obligations since the
majority of the Company's long-term obligations are at fixed rates, however, the
Company is exposed to fluctuations in future earnings and cash flow from changes
in interest rates on its short term borrowings which are set at minimal
thresholds of prime or LIBOR plus a fixed rate.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company and other participants in the entertainment industry were sued
in an action entitled James, et al. v. Meow Media, et al. filed in April 1999 in
the U.S. District Court for the Western District of Kentucky, Paducah Division,
Civil Action No. 5:99 CV96-J. The plaintiffs allege that the defendants caused
injury to the plaintiffs as a result of, in the case of the Company, its
manufacture and/or supply of "violent" video games to Michael Carneal, then
fourteen. The plaintiffs further allege that the defendants were negligent in
such manufacture and/or supply thereby breaching a duty to Mr. Carneal and
others, including the plaintiffs (the parents of the deceased individuals). Mr.
Carneal killed three individuals and wounded five others during a shooting at
the Heath High School in McCracken County, Kentucky. The plaintiffs seek damages
in the amount of approximately $110,000,000. The Company intends to defend this
action vigorously. The Company has entered into a joint defense agreement and is
sharing defense costs with certain of the other defendants. The U.S. District
Court for the Western District of Kentucky dismissed this action; however, it is
currently on appeal to the U.S. Court of Appeals for the Sixth Circuit.
The Company, Iguana Entertainment and Gregory E. Fischbach were sued in an
action entitled Jeffery Spangenberg vs. Acclaim Entertainment, Inc., Iguana
Entertainment, Inc., and Gregory Fischbach filed in August 1998 in the District
Court of Travis County, Texas (Cause No. 98-09418). The plaintiff alleged that
the defendants (1) breached their employment obligations to the plaintiff, (2)
breached a Texas statute covering wage payment obligations based on their
alleged failure to pay bonuses to the plaintiff; and (3) made fraudulent
misrepresentations to the plaintiff in connection with the plaintiff's
employment relationship with the Company, and accordingly, sought unspecified
damages. The Company has negotiated and implemented a settlement with regard to
this action, and in that connection released from escrow 150,000 shares of
common stock. See Statements of Consolidated Stockholders' Deficiency and Note 6
of the Notes to the Consolidated Financial Statements.
The Company received a demand for indemnification from the defendant
Lazer-Tron Corporation ("Lazer-Tron") in a matter entitled J. Richard Oltmann v.
Steve Simon, No. 98 C1759 and Steve Simon v. J. Richard Oltmann, J Richard
Oltmann Enterprises, Inc., d/b/a Haunted Trails Amusement Parks, and RLT
Acquisitions, Inc., d/b/a Lazer-Tron, No. A 98CA 426, consolidated as U.S.
District Court Northern District of Illinois Case No. 99 C 1055 (the "Lazer-Tron
Action"). The Lazer-Tron Action involves the assertion by plaintiff Simon that
defendants Oltmann, Haunted Trails and Lazer-Tron misappropriated plaintiff's
trade secrets. Plaintiff alleges claims for Lanham Act violations, unfair
competition, misappropriation of trade secrets, conspiracy, and fraud against
all defendants, and seeks damages in unspecified amounts, including treble
damages for Lanham Act claims, and an accounting. Pursuant to an Asset Purchase
Agreement (the "Agreement") made as of March 5, 1997, the Company sold
Lazer-Tron to RLT Acquisitions, Inc. ("RLT"). Under the Agreement, the Company
assumed and excluded specific liabilities, and agreed to indemnify RLT for
certain losses, as specified in the Agreement. In an August 1, 2000 letter,
counsel for Lazer-Tron in the Lazer-Tron Action asserted that the Company's
indemnification obligations in the Agreement applied to the Lazer-Tron Action,
and demanded that the Company indemnify Lazer-Tron for any losses which may be
incurred in the Lazer-Tron Action. In an August 22, 2000 response, the Company
asserted that any losses which may result from the Lazer-Tron Action are not
assumed liabilities
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under the Agreement for which the Company must indemnify Lazer-Tron. In a
November 20, 2000 letter, Lazer-Tron responded to Acclaim's August 22 letter and
reiterated its position that the Company must indemnify Lazer-Tron with respect
to the Lazer-Tron Action. No other action with respect to this matter has been
taken to date.
On November 27, 2000, the Company was sued in the U.S. District Court for
the Southern District of New York, in an action entitled Comedy Partners vs.
Acclaim Entertainment, Inc. (00 Civ 9051 (S.D.N.Y.) (AKH.) In the complaint in
this matter, plaintiff, with whom the Company had a license agreement, asserts
claims for copyright infringement, trademark and trade dress infringement and
breach of contract predicated on its allegation that the Company failed to pay
certain royalties due under the license agreement and that, as a result, the
license was terminated. Plaintiff further alleges that the Company continued to
sell licensed products following termination, in violation of the license
agreement. Plaintiff seeks $1.6 million in damages, plus injunctive relief. The
Company answered the complaint and asserted a counterclaim on January 15, 2001.
The Company does not believe the outcome of this matter will have a material
adverse effect on the Company's financial position or results of operations.
On or about December 15, 2000, an action was commenced against the Company
entitled Comedy Partners v. Acclaim Entertainment, Inc., Index No. 605476/00
(Supreme Court, New York County). In this action, plaintiff asserts that the
Company placed certain commercial advertisements on the plaintiff's programming
service pursuant to an Advertising Sales Contract which is alleged to exist
between the parties, that plaintiff invoiced the Company for such commercials,
and that the Company has failed to pay the invoices. Plaintiff seeks a total of
$196,098 in damages, plus interest. The Company's answer to the complaint is due
January 19, 2001.
The Company is also party to various litigations arising in the ordinary
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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company issued to Gregory Fischbach, as of November 14, 2000, 360,000
shares of Common Stock in consideration of payment by Mr. G. Fischbach to the
Company of $450,000 (based on the closing sale price of the Common Stock on such
date).
The Company issued to James Scoroposki, as of November 14, 2000, 360,000
shares of Common Stock in consideration of payment by Mr. Scoroposki to the
Company of $450,000 (based on the closing sale price of the Common Stock on such
date).
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ Gregory E. Fischbach Co-Chairman of the Board; Chief January 16, 2001
------------------------- Executive Officer; President;
Gregory E. Fischbach and Director
/s/ Gerard F. Agoglia Executive Vice President and Chief January 16, 2001
------------------------- Financial Officer (principal
Gerard F. Agoglia financial and accounting officer)
30
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description
----------- -----------
3.1 Certificate of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 to the Company's Registration Statement
on Form S-1, filed on April 21, 1989, as amended (Registration No.
33-28274) (the "1989 S-1"))
3.2 Amendment to the Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.2 to the 1989 S-1)
3.3 Amendment to the Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 4(d) to the Company's
Registration Statement on Form S-8, filed on May 19, 1995
(Registration No. 33-59483)
3.4 Amended and Restated By-laws of the Company (incorporated by
reference to Exhibit 3 to the Company's Current Report on Form
8-K, filed on June 12, 2000 (File No. 0-16 986) (the "2000 8-K"))
4.1 Specimen form of the Company's common stock certificate
(incorporated by reference to Exhibit 4 to the Company's Annual
Report on Form 10-K for the year ended August 31, 1989, as amended
(File No. 0-16986))
4.2 Indenture dated as of February 26, 1997 between the Company and
IBJ Schroder Bank & Trust Company, as trustee (incorporated by
reference to Exhibit 4.3 to the Company's Current Report on Form
8-K, filed on March 14, 1997 (File No. 0-16986))
4.3 Rights Agreement dated as of June 5, 2000, between the Company and
American Securities Transfer & Trust, Inc. (incorporated by
reference to Exhibit 4 of the 2000 8-K)
+10.1 Employment Agreement dated as of September 1, 1994 between the
Company and Gregory E. Fischbach; and Amendment No. 1 dated as of
December 8, 1996 between the Company and Gregory E. Fischbach
(incorporated by reference to Exhibit 10.1 to the Company's Annual
Report on Form 10-K for the year ended August 31, 1996 (File No.
0-16986) (the "1996 10-K"))
+10.2 Employment Agreement dated as of September 1, 1994 between the
Company and James Scoroposki; and Amendment No. 1 dated as of
December 8, 1996 between the Company and James Scoroposki
(incorporated by reference to Exhibit 10.2 to the 1996 10-K)
+10.3 Service Agreement effective January 1, 1998 between Acclaim
Entertainment Limited and Rodney Cousens (incorporated by
reference to Exhibit 10.3 to the Company's Annual Report on From
10-K for the year ended August 31, 1999 (File No. 0-16986) (the
"1999 10-K")
+10.4 Employment Agreement dated as of August 13, 1999 between the
Company and William G. Sorenson (incorporated by reference to
Exhibit 10.4 to the 1999 10-K)
+10.5 Restricted Stock Agreement dated August 18, 1999 between the
Company and William G. Sorenson (incorporated by reference to
Exhibit 10.5 to the 1999 10-K)
+10.6 Employee Stock Purchase Plan (incorporated by reference to Exhibit
4(a) to the Company's Registration Statement on Form S-8 filed on
May 4, 1998 (Registration No. 333-51967))
+10.7 1998 Stock Incentive Plan (incorporated by reference to the
Company's 1998 Proxy Statement relating to fiscal year ended
August 31, 1997)
31
<PAGE>
Exhibit No. Description
----------- -----------
10.8 Revolving Credit and Security Agreement dated as of January 1,
1993 between the Company, Acclaim Distribution Inc., LJN Toys,
Ltd., Acclaim Entertainment Canada, Ltd. and Arena Entertainment
Inc., as borrowers, and BNY Financial Corporation ("BNY"), as
lender, as amended and restated on February 28, 1995 (incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended February 28, 1995 (File No.
0-16986) (the "1995 10-Q")), as further amended and modified by
(i) the Amendment and Waiver dated November 8, 1996, (ii) the
Amendment dated November 15, 1996, (iii) the Blocked Account
Agreement dated November 14, 1996, (iv) Letter Agreement dated
December 13, 1996 and (v) Letter Agreement dated February 24, 1997
(incorporated by reference to Exhibit 10.4 to the Company's Report
on Form 8-K filed on March 14, 1997 (File No. 0-16986) (the "1997
8-K"))
10.9 Restated and Amended Factoring Agreement dated as of February 28,
1995 between the Company and BNY (incorporated by reference to
Exhibit 10.2 to the 1995 10-Q), as further amended and modified by
the Amendment to Factoring Agreements dated February 24, 1997
between the Company and BNY (incorporated by reference to Exhibit
10.5 to the 1997 8-K)
10.10* Confidential License Agreement between Nintendo of America and the
Company, effective as of February 20, 1997 (incorporated by
reference to Exhibit 1 to the Company's Quarterly Report on Form
10-Q for the quarter ended February 28, 1998 (File No. 0-16986))
+10.11 Employment Agreement dated as of August 11, 2000 between the
Company and Gerard F. Agoglia (incorporated by reference to
Exhibit 10.11 to the Company's Annual Report on Form 10-K for the
year ended August 31, 2000 (File No. 0-16986))
+10.12 Amendment No. 3, dated August 1, 2000, to the Employment Agreement
between the Company and Gregory E. Fischbach, dated as of
September 1, 1994
+10.13 Amendment No. 3, dated August 1, 2000, to the Employment Agreement
between the Company and James Scoroposki, dated as of September 1,
1994
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
--------------
* Confidential treatment has been granted with respect to certain portions of
this exhibit, which have been omitted therefrom and have been separately
filed with the Commission
+ Management contract or compensatory plan or arrangement
32
