<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
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 0-21336
THE 3DO COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 94-3177293
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
600 GALVESTON DRIVE
REDWOOD CITY, CALIFORNIA 94063
(Address of principal executive offices, including zip code)
(650) 261-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of July 31, 1998, the number of outstanding shares of the registrants' common
stock was 25,762,999.
<PAGE> 2
THE 3DO COMPANY
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements 3
Consolidated Balance Sheets at
June 30, 1998 and March 31, 1998 3
Consolidated Statements of Operations for
the three months ended June 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for
the three months ended June 30, 1998 and 1997 5
Condensed Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
2
<PAGE> 3
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE 3DO COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
June 30, March 31,
1998 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,653 $ 16,209
Short-term investments 24,561 18,375
Accounts receivable, net 6,391 216
Prepaid and other current assets 1,844 838
--------- ---------
Total current assets 34,449 35,638
Property and equipment, net 3,305 3,336
Deposits and other assets 1,372 1,473
--------- ---------
Total assets $ 39,126 $ 40,447
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 503 $ 495
Accrued expenses 4,837 2,468
Deferred revenue 104 352
Current portion of capital lease obligations 71 335
Other current liabilities 2,004 3,219
--------- ---------
Total current liabilities 7,519 6,869
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares
authorized; no shares issued -- --
Common stock, $.01 par value; 50,000 and 25,000
shares authorized; 25,755 and 25,570
shares issued and outstanding, respectively 258 256
Additional paid-in capital 160,535 159,938
Accumulated other comprehensive loss (293) (290)
Accumulated deficit (117,240) (114,673)
Treasury Stock, at cost, 3,448 shares (11,653) (11,653)
--------- ---------
Total stockholders' equity 31,607 33,578
--------- ---------
Total liabilities and stockholders' equity $ 39,126 $ 40,447
========= =========
</TABLE>
See accompanying Condensed Notes to Consolidated Financial Statements.
3
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THE 3DO COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
For the three months ended
June 30,
--------------------------
1998 1997
--------- --------
<S> <C> <C>
Revenues:
Royalties and license fees $ -- $ 11,962
Software publishing 9,533 2,311
Developer products and other -- 90
-------- --------
Total revenues $ 9,533 $ 14,363
-------- --------
Cost of revenues:
Software publishing 2,519 1,022
Developer products and other -- 42
-------- --------
Total cost of revenues 2,519 1,064
-------- --------
Gross profit 7,014 13,299
-------- --------
Operating expenses:
Research and development 5,523 6,503
Sales and marketing 1,875 1,077
General and administrative 2,488 2,638
-------- --------
Total operating expenses 9,886 10,218
-------- --------
Operating profit (loss) $ (2,872) 3,081
Gain on sale of Systems assets -- 18,032
Net interest and other income (expense) 435 189
-------- --------
Income (loss) before income and foreign withholding taxes (2,437) 21,302
Income and foreign withholding taxes 130 73
-------- --------
Net income (loss) $ (2,567) $ 21,229
======== ========
Basic net income (loss) per share $ (0.10) $ 0.75
======== ========
Diluted net income (loss) per share $ (0.10) $ 0.72
======== ========
Shares used to compute basic net income (loss) per share 25,653 28,460
======== ========
Shares used to compute diluted net income (loss) per share 25,653 29,624
======== ========
</TABLE>
See accompanying Condensed Notes to Consolidated Financial Statements.
4
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THE 3DO COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
For the three months ended
June 30,
--------------------------
1998 1997
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net profit (loss) $ (2,567) $ 21,229
Adjustments to reconcile net profit (loss) to
net cash used in operating activities:
Net loss on disposition of equipment -- 176
Depreciation and amortization 738 1,288
Deferred revenue (248) (11,962)
Gain on sale of Systems assets -- (18,032)
Changes in operating assets and liabilities:
Accounts receivable, net (6,175) 89
Prepaid and other assets (1,018) 389
Accounts payable 8 553
Accrued expenses 2,369 623
Other liabilities (1,215) (1,347)
-------- --------
Net cash used in operating activities (8,108) (6,994)
-------- --------
Cash flows from investing activities:
Proceeds from sale of Systems assets -- 20,000
Proceeds from disposition of equipment -- 74
Short-term investments, net (6,189) (8,104)
Capital expenditures (594) (342)
-------- --------
Net cash provided by (used in) investing activities (6,783) 11,628
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 599 330
Payments on capital lease obligations (264) (626)
-------- --------
Net cash provided by (used in) financing activities 335 (296)
-------- --------
Effect of foreign currency translation -- (18)
-------- --------
Net increase (decrease) in cash and cash equivalents (14,556) 4,320
Cash and cash equivalents at beginning of period 16,209 14,395
-------- --------
Cash and cash equivalents at end of period $ 1,653 $ 18,715
-------- --------
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 6 64
======== ========
</TABLE>
See accompanying Condensed Notes to Consolidated Financial Statements.
5
<PAGE> 6
THE 3DO COMPANY
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - GENERAL
The consolidated financial statements of The 3DO Company, a Delaware corporation
(the "Company"), as of June 30, 1998 and for the quarters ended June 30, 1998
and 1997 are unaudited. In the opinion of management, these financial statements
include all adjustments (consisting of only normal recurring items) necessary
for the fair presentation of the financial position and results of operations
for the interim periods. Certain amounts for prior periods have been
reclassified to conform to the current period presentation.
These consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended March 31, 1998. The results of operations
for the quarter ended June 30, 1998 are not necessarily indicative of the
results expected for the entire year.
NOTE 2 - REVENUE RECOGNITION
Revenue from the sale of software titles published and distributed by the
Company and developer products is recognized at the time of shipment, provided
the Company has no related outstanding obligations. Subject to certain
limitations, the Company permits customers to obtain exchanges of software
titles published and distributed by the Company, within certain specified
periods, and provides price protection on certain unsold merchandise. Software
publishing revenue is reflected net of allowances for returns, price protection
and discounts. Software licensing revenue is typically recognized at the point
of 3DO's fulfillment of its obligations (e.g., delivery of the product golden
master) under any such licensing agreement. Per-copy royalties on sales that
exceed the guarantee are recognized as earned. Revenue from the Company's
on-line service is recognized monthly on usage.
In October 1997, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 97-2 Software Revenue Recognition, which supercedes
SOP 91-1. SOP 97-2 is effective for transactions entered into after March 31,
1998. SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair values of the elements. The fair value of an element must be based
on evidence that is specific to the vendor. If a vendor does not have evidence
of the fair value for all elements in a multiple-element arrangement, all
revenue from the arrangement is deferred until such evidence exists or until all
elements are delivered. The Company adopted SOP 97-2 in the current quarter;
however, the effect of adopting SOP97-2 did not have a material impact on the
Company's consolidated results of operations or financial position.
NOTE 3 - NET INCOME (LOSS) PER SHARE
Basic earnings per share is computed using the weighted average number of shares
of common stock outstanding. Diluted earnings per share is computed using the
weighted average number of shares of common stock and, when dilutive,
outstanding and common equivalent shares from options to purchase common stock
using the treasury stock method.
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The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for the period presented:
<TABLE>
<CAPTION>
For the three months ended
June 30,
--------------------------
1998 1997
--------- --------
<S> <C> <C>
Net income (loss) $ (2,567) $ 21,229
========= ========
Shares used to compute basic net income (loss)
per share - Weighted-average number of
common shares outstanding 25,653 28,460
Effect of common equivalent shares - stock options
outstanding using the treasury stock method -- 1,164
--------- --------
Shares used to compute diluted net income (loss)
per share 25,653 29,624
========= ========
Basic net income (loss) per share $ (0.10) $ 0.75
========= ========
Diluted net income (loss) per share $ (0.10) $ 0.72
========= ========
</TABLE>
Options to purchase 8,616,790 and 208,026 shares of common stock were excluded
from the Company's dilutive net income (loss) per share calculations for the
quarters ended June 30, 1998 and 1997, respectively because their effect was
anti-dilutive. These anti-dilutive shares had weighted average exercise prices
of $3.08 and $8.55 for the quarters ended June 30, 1998 and 1997, respectively.
NOTE 4 - GAIN ON SALE OF SYSTEMS GROUP
On June 23, 1997, the Company sold most of the assets of the Company's former
hardware systems group, including certain technologies and related intellectual
property rights and approximately $1.5 million in equipment, to Samsung
Electronics Company, Ltd. ("Samsung") for $20.0 million, realizing a gain of
approximately $18.0 million. As part of the sales agreement, CagEnt
Technologies, Inc. ("CagEnt"), a subsidiary of Samsung, agreed to assist the
Company, as a subcontractor, with respect to the Company's efforts to complete
the remaining deliverables under the M2 Agreement with MEI. In the event that
CagEnt's subcontracted engineering services are unsatisfactory or are otherwise
terminated prior to completion or are not timely completed, the Company will
incur substantial expenses to complete its obligations under the M2 Agreement.
The Company believes it has adequately provided for such potential obligations
in the consolidated financial statements. However, such an event could have a
material adverse impact on the Company, including, but not limited to, diverting
funds from the Company's software publishing business. CagEnt also acquired from
Samsung the Company's former video encoder business as part of the Company's
transaction with Samsung.
NOTE 5 - INCOME TAXES
Income tax expense totaled $0.1 million for both quarters ended June 30, 1998
and 1997. Income tax expense represents foreign income and withholding taxes,
and minimum state taxes.
7
<PAGE> 8
NOTE 6 - NEW ACCOUNTING STANDARDS
Effective April 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." This Statement requires
that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. This
Statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. For example, other
comprehensive earnings may include foreign currency translation adjustments,
minimum pension liability adjustments and unrealized gains and losses on
marketable securities classified as available-for-sale. Annual financial
statements for prior periods will be reclassified, as required. The company's
total comprehensive earnings were as follows:
<TABLE>
<CAPTION>
Three months ended
(in thousand, unaudited) June 30,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Net income (loss) $ (2,567) $ 21,229
Cumulative translation adjustment -- (2)
-------- --------
Total comprehensive income (loss) $ (2,567) $ 21,227
======== ========
</TABLE>
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The 3DO Company ("3DO" or the "Company") primarily develops, publishes and
distributes interactive entertainment software products for multiple platforms
including IBM-compatible personal computers (the "PC"), the 32-bit PlayStation
platform (the "Sony PlayStation") developed by Sony Computer Entertainment,
Inc., the 64-bit Nintendo 64 platform (the "N64") developed by Nintendo Company,
Ltd., and Internet platforms. During the first quarter of fiscal year 1998, the
Company also designed, developed and licensed hardware technologies for the
64-bit consumer and PC markets.
In December 1995, the Company licensed its next generation 64-bit technology
(the "M2 Technology") to Matsushita Electric Industrial Co. Ltd. ("MEI" or
"Matsushita") for an upfront license fee of $100.0 million plus certain ongoing
royalties (the "M2 Agreement). On April 24, 1996, the Company agreed to make
certain modifications to the M2 system design, pursuant to the terms of an
addendum (the "Addendum") to the M2 Licensing Agreement with MEI. As
consideration for providing engineering and certain support services, the
Company received an additional aggregate fee of approximately $4.5 million
received in installments in fiscal year 1997 and 1998. On July 23, 1997, the
Company and MEI signed a second addendum (the "Second Addendum") to the M2
Agreement. Under the Second Addendum, the Company relinquished its rights to
develop and distribute software and peripherals that are compatible with
hardware products developed by MEI or its sublicensees that incorporate the M2
Technology, and gave up its right to develop and distribute M2-compatible
authoring systems. The Company recognized all remaining revenue in connection
with the M2 Agreement in fiscal year 1998. In addition, the Company relinquished
its right to receive royalties with respect to MEI's potential use of the M2
Technology, as well as certain other rights. In exchange, MEI returned to the
Company all of the approximately 3.2 million shares of the Company's common
stock that it previously owned. The Company recognized approximately $11.0
million of revenue in connection with this transaction.
On June 23, 1997, the Company sold and/or licensed most of the assets of the
Company's former hardware systems group, including certain technologies and
related intellectual property rights and approximately $1.5 million in
equipment, to Samsung Electronics Co. Ltd. ("Samsung") for $20.0 million. As
part of the sales agreement, CagEnt Technologies, Inc. ("CagEnt"), a subsidiary
of Samsung, agreed to assist the Company, as a subcontractor, with respect to
the Company's efforts to complete the remaining deliverables due to MEI under
the M2 Agreement.
No agreement with MEI, including, without limitation, any addendum to the M2
Agreement, relieves the Company of its obligation to complete the deliverables
called for in the M2 Agreement. There can be no assurance that the Company, with
or without CagEnt's subcontracted assistance, will successfully complete the
deliverables required pursuant to the M2 Agreement. In the event that CagEnt's
subcontracted engineering services are unsatisfactory or are not timely
completed, the Company will incur substantial expenses to complete its
obligations under the M2 Agreement. This would have a material adverse impact on
the Company, including, but not limited to, diverting funds from the Company's
software publishing business.
In February 1996, the Company licensed the 3-D graphics portion of the M2
Technology to Cirrus Logic, Inc. ("Cirrus") for the potential development of
high-end 3-D graphics
9
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chips for the PC market. Under the terms of the Joint Development and License
Agreement (the "Cirrus Agreement") the Company agreed to develop certain
modifications to its semiconductor technology familiarly known to the parties as
the "3DEngine." As partial consideration under such agreement, the Company
received the non-refundable sum of $2.5 million. This payment has been
recognized as revenue under the percentage-of-completion method.
On October 3, 1996, Cirrus filed a complaint to rescind the Cirrus Agreement on
the grounds of frustration of purpose, mistake, failure of consideration,
concealment, and non-disclosure, and seeking to obtain a repayment of $2.5
million in nonrefundable payments made to the Company. The Company responded to
Cirrus' complaint and filed a cross-complaint regarding Cirrus' breach of the
Cirrus Agreement and seeking to enforce its rights under said agreement,
including procurement of Cirrus' payment of $4.5 million in nonrefundable
license fees, prepaid royalties and termination fees, plus damages, interest,
and attorneys' fees and costs.
On October 15, 1997, 3DO and Cirrus resolved and settled the parties' respective
claims with respect to the above-referenced litigation, including, inter alia,
the dismissal with prejudice of the subject litigation, the general release of
both parties from any and all claims relating to the Cirrus Agreement, and the
payment by Cirrus to 3DO of a mutually acceptable sum in satisfaction of the
license fees, advance royalties, and payments for engineering services due to
3DO in connection with the Cirrus Agreement. The Company recognized the payment
as revenue in the fiscal year 1998.
On July 19, 1997, the Board of Directors of the Company approved a stock
repurchase plan pursuant to which the Company was authorized to purchase up to
$5.0 million worth of the Company's stock on the open market or in block trades,
from time to time as management deems appropriate, if the market price of the
Company's stock remains below certain levels. As of June 30, 1998, the Company
has reacquired approximately 200,000 shares. The repurchase plan will remain in
effect until rescinded by the Board.
Revenue from the sale of software titles published and distributed by the
Company and developer products is recognized at the time of shipment, provided
the Company has no related outstanding obligations. Subject to certain
limitations, the Company permits customers to obtain exchanges of software
titles published and distributed by the Company, within certain specified
periods, and provides price protection on certain unsold merchandise. Software
publishing revenue is reflected net of allowances for returns, price protection
and discounts. Software licensing revenue is typically recognized at the point
of 3DO's fulfillment of its obligations (e.g., delivery of the product golden
master) under any such agreement. Per-copy royalties on sales that exceed the
guarantee are recognized as earned. Revenue from the Company's on-line service
is recognized monthly on usage.
The Company will continue to incur substantial expenditures to develop its
business throughout the remainder of fiscal year 1999. The Company expects that
its operating results will fluctuate as a result of a wide variety of factors,
including the timing of software product introductions by the Company and its
competitors, the Company's expenditures on research and development, marketing
and promotional programs, and the general state of the national and global
economies. In addition, the Company's revenues will be affected by the seasonal
nature of the market for consumer electronics products and variations as a
result of the demand for a particular software title.
Except for the historical information contained herein, this discussion and
analysis includes certain forward-looking statements within the meaning of
Section 21E of the
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Securities Exchange Act of 1934, which are subject to the "safe harbor" created
by that section. These forward-looking statements include, but are not limited
to, all statements concerning future revenues, expenses, cash flows and capital
resources; all statements regarding CagEnt assisting the Company, as a
subcontractor, in completing the remaining deliverables associated with the M2
Agreement, as amended; the extent to which the Company will receive and/or
recognize revenue from the sale of software titles it publishes and distributes
and/or from its on-line service; the extent to which the Company will receive
and/or recognize revenue with respect to the sale of software titles it licenses
to third-party publishers; the length of time for which the Company's existing
cash resources, working capital financing and other sources of funds will fund
the Company's activities; the Company's ability to develop software products for
new platforms, and the timeliness, cost, and market demand for such products;
the ability of the Company to adequately distribute its software products
through various distribution channels; and the effect of competitive factors in
the marketplace, including the market acceptance of certain formats and the
timing and release of competitors' products. The Company's actual future results
could differ materially from those projected in the forward-looking statements
contained herein. Some factors which could cause future actual results to differ
materially from the Company's recent results or those projected in the
forward-looking statements are described in "Factors Affecting Future
Performance," above. The Company assumes no obligation to update any or all of
the forward-looking statements or such factors.
RESULTS OF OPERATIONS
For the quarter ended June 30, 1998, the Company had a net loss of $2.6 million
compared to a net profit of $21.2 million for the same quarter in fiscal year
1998. Included in the net profit for the three months ended June 30, 1997 was
$12.0 million in revenue recognized from the M2 Agreement and a one-time $18.0
million gain from the sale of certain of the hardware related assets to Samsung.
Revenue for the three months ended June 30, 1998 and 1997 totaled $9.5 million
and $14.4 million, respectively. Royalties and license fees for the quarter
ended June 30, 1997 were $12.0 million. No revenue associated with the royalties
and license fees was recognized for the current quarter due to the sale of the
Company's hardware assets to Samsung in the first quarter of last fiscal year.
Software publishing revenue totaled $9.5 million for the three months ended June
30, 1998, compared to $2.3 million for the same period last fiscal year. The
increase in software publishing revenue was primarily due to the release of Army
Men and Might and Magic VI in the current quarter. Software publishing revenue
was recorded net of allowances for returns, price protection and discounts.
Cost of revenues totaled $2.5 million and $1.1 million for the quarters ended
June 30, 1998 and 1997, respectively. Cost of publishing revenue as a percentage
of publishing revenue was 26% for the current quarter compared to 44% for the
prior comparable period. The improvement was attributable to lower cost to net
revenue ratios for both Army Men and Might and Magic VI and higher software
licensing revenue in fiscal year 1999, which had no associated cost. Cost of
revenues consists of direct costs associated with software titles sold and
royalties paid to third-party software developers. Internal development costs on
software title development for the Company's published titles are recognized as
incurred and included in research and development expenses.
Research and development expenses for the quarter ended June 30, 1998 totaled
$5.5 million, compared to $6.5 million for the same fiscal period in the prior
year. The
11
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decrease was primarily due to the sale of the hardware group to Samsung in June
1997, realizing a saving of approximately $2.7 million in operating expenses.
The decrease was partially offset by higher on-going development expenses
associated with Studio 3DO, Cyclone Studios and New World Computing as the
Company continues to expand its product development efforts.
Sales and marketing expenses for the three months ended June 30, 1998 and 1997
were $1.9 million and $1.1 million, respectively. The increase was attributable
to the sales and marketing expenses related to the release of Army Men, Might
and Magic VI and High Heat Baseball. Moreover, in May 1998 the Company
participated in the Electronic Entertainment Expo ("E3") tradeshow, where the
Company showcased its latest line-up of new video games for the PC, PlayStation
and N64 platforms for the first time since it made the transition from a
hardware company to a software publishing company.
General and administrative expenses decreased from $2.6 million for the quarter
ended June 30, 1997 to $2.5 million for same period in the current fiscal year.
The decrease in the current quarter was attributable to reduced overhead
expenses as the Company transitioned from a hardware systems licensing company
to an entertainment software publishing company. The Company expects that
general and administration expenses will increase in the near future as it
continues to build its infrastructure to support the release of its new video
games for the PC, PlayStation and N64 platforms.
Net interest and other income decreased from $18.2 million for the quarter ended
June 30, 1997 to $0.4 million for the same period this year, due primarily to
the $18.0 million gain on the sale of certain assets of the Company's hardware
systems division to Samsung in June 1997.
Income and foreign withholding taxes were $0.1 for both quarters ended June 30,
1998 and June 30, 1997. Income and foreign withholding taxes primarily consisted
of foreign licensing withholding taxes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity are its cash and cash equivalent
balances and short-term investment balances, which totaled approximately $26.2
million at June 30, 1998. At March 31, 1998, cash and short-term investments
totaled $34.6 million. This decrease was primarily due to cash used in operating
activities and capital expenditures.
The Company will incur negative cash flow for the remainder of fiscal year 1999
from the continued investment in the internal development of entertainment
software titles scheduled to be released in this fiscal year and beyond. The
Company anticipates that its existing cash resources, future lease and working
capital financing and all other sources of funds should be sufficient to fund
the Company's activities through the end of fiscal year 1999. There can be no
assurance that additional capital will not be required in fiscal year 2000 since
cash flows will be affected by the rate at which the Company releases its
products and the resulting sale of these products, the market acceptance of such
products and the levels of advertising and promotions required to promote market
acceptance of the Company's products. The level of financing required beyond
fiscal year 1999 will depend on these and other factors. If the Company needs to
raise additional funds through public or private financing, no assurance can be
given that additional financing will be available or that, if available, it will
be available on terms acceptable to the Company or its stockholders. Additional
financing may result in substantial and
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immediate dilution to existing stockholders. If adequate funds are not available
to satisfy either short or long term capital requirements, the Company may be
required to curtail its operations significantly or to seek funds through
arrangements with strategic partners or others that may require the Company to
relinquish material rights to certain of its technologies, products and/or
potential markets.
FACTORS AFFECTING FUTURE PERFORMANCE
HARDWARE SYSTEMS GROUP SALE
On June 23, 1997, the Company sold certain assets of its former hardware systems
group to Samsung pursuant to an Asset Purchase Agreement (the "Samsung
Agreement"). As part of the Samsung Agreement, CagEnt, a subsidiary of Samsung,
agreed to assist the Company, as a subcontractor, in its efforts to complete the
remaining deliverables associated with the M2 Agreement. No agreement with MEI,
including, without limitation, any addendum to the M2 Agreement, relieves the
Company of its obligation to complete the deliverables called for in the M2
Agreement. There can be no assurance that the Company, with or without CagEnt's
subcontracted assistance, will successfully complete the deliverable items
required pursuant to the M2 Agreement, as amended. In the event that CagEnt's
subcontracted engineering services are unsatisfactory or are otherwise
terminated prior to completion or are not timely completed, the Company will
incur substantial expenses to complete its obligations under the M2 Agreement.
The Company believes that it has adequately provided for such potential
obligations in the consolidated financial statements. However, such an event
could have a material adverse impact on the Company, including, but not limited
to, diverting funds from the Company's software publishing business.
CHANGING PRODUCT PLATFORMS AND FORMATS
The Company has entered new, rapidly changing markets with its software
products, specifically the enhanced graphics card portion of the PC market, the
Sony PlayStation, the Nintendo 64 and Internet markets. The markets for
entertainment software and entertainment software platforms are undergoing rapid
technological change. As a result, the Company must continually anticipate and
adapt its products to emerging platforms and evolving consumer preferences. The
introduction of new platforms and technologies can render existing products
obsolete and unmarketable. Development of entertainment software products for
new hardware platforms requires substantial investments in research and
development for technologies such as motion capture, digitized speech and sound
effects, music and full motion video, and requires the Company to anticipate and
attempt to develop products for those platforms that will ultimately be
successful. Generally, software development efforts must occur well in advance
of the release of new platforms in order to introduce new products on a timely
basis following the release of such platforms. Although the Company intends to
develop and market entertainment software for certain advanced and emerging
platforms, the development and marketing efforts in connection therewith may
require greater technical and financial resources than currently possessed by
the Company. In addition, there can be no assurance that the platforms for which
the Company develops products will achieve market acceptance and, as a result,
there can be no assurance that the Company's development efforts with respect to
such new platforms will lead to marketable products or products that generate
sufficient revenues to offset research and development costs incurred in
connection with the creation of such products. There can be no assurance that
the Company will be successful in developing and marketing products for new
platforms. Failure to develop products for new platforms that achieve
significant market acceptance would have a material adverse effect on the
Company's business, operating results and financial
13
<PAGE> 14
condition. Furthermore, the Company does not have a license to develop products
for certain of the most popular platforms, including the proprietary platform of
Sega. Finally, the Company's products must maintain compatibility with certain
hardware and software accessories. Any changes in any of such third-party
product designs that result in incompatibility of the Company's products could
result in significant product returns and obsolescence.
DEPENDENCE ON THE PC MARKET
The Company's future success is in part dependent on the PC market, which is
extremely dynamic and has historically been characterized by wide fluctuations
in product supply and demand. From time to time, the PC industry has also
experienced significant downturns, often in connection with, or in anticipation
of, declines in general economic conditions. Furthermore, rapid technological
changes in PC hardware may render the current installed base of PCs and the
Company's technology and products obsolete. There can be no assurance that unit
sales of PCs or the number of entertainment software users in the PC market will
continue at their present levels or increase in the future. The Company's
revenues from its entertainment software products will be dependent on marketing
and distribution of titles to an installed base of PC users. Any decrease in
demand for PCs or the number of entertainment software users in the PC market
would have a material adverse effect on the Company's operating results.
DEPENDENCE ON THE PROPRIETARY PLATFORM MARKETS
The market for software products for the various proprietary platforms for which
the Company develops software products, including the Sony PlayStation and
Nintendo 64, are currently experiencing rapid growth. The Company's future
success is partly dependent on its ability to successfully take advantage of
these markets and on the continued growth of these markets. There can be no
assurance that the Company will be able to develop products for these markets in
a timely manner to take advantage of these growing markets, that the Company's
software products for these markets will achieve market acceptance, or that
these markets will continue to grow. In the event that the Company fails to
develop products while these markets are expanding or fails to deliver products
that are commercially successful, or if these markets do not continue to grow,
the Company's operating results would be adversely affected.
DEPENDENCE ON THE INTERNET MARKET
The Company's future success is in part dependent upon continued growth in the
use of the Internet. Rapid growth in the use of and interest in the Internet is
a recent phenomenon. The Internet may not prove to be a viable commercial
marketplace for a number of reasons, including potentially inadequate
development of the necessary infrastructure or timely development of performance
improvements, including high speed modems. In addition, to the extent that the
Internet continues to experience significant growth in the number of users and
level of use, there can be no assurance that the Internet infrastructure will
continue to be able to support the demands placed upon it by any such growth. In
addition, the Internet could lose its viability due to delays in the development
or adoption of new standards and protocols required to handle increased levels
of Internet activity, or due to increased government regulations. Changes in or
insufficient availability of telecommunications services to support the Internet
also could result in slower response times and adversely affect usage of
entertainment software developed for the Internet. If the use of the Internet
does not grow, or if the Internet infrastructure does not effectively support
the growth that may occur, the Company's business, results of operations and
financial conditions would be materially adversely affected.
14
<PAGE> 15
INTERACTIVE MULTIPLE PLAYER GAMES IN THE INTERNET
The availability of multiple player games on the Internet is a relatively recent
phenomenon. The limited history of multiple player games on the Internet has
been characterized by numerous companies entering the market in a short span of
time and competing for a limited number of players of multiple player games by
providing incentives to attract players' interest and by entering into
agreements with the few companies providing Internet game sites that have
developed some player following. However, there has been little evidence of
success in this area and a profitable business model to capitalize on the
Internet multiple player game market has not yet been established. In addition,
multiple player games on the Internet require the implementation of newly
developed software to accept and process payments from players which may contain
errors in the program which have not yet been discovered or corrected. The
Company provides free play time and other incentives such as discounts and
contests to interest the limited number of players in the market into trying the
Company's Internet game, Meridian 59, and has entered into agreements to have
such game distributed through Internet game sites. There can be no assurance
that any of the incentives provided by the Company or the availability of the
Company's games on Internet game sites will result in increased player interest
in the Company's games, that the costs of providing such incentives or entering
into agreements with Internet game site providers will be compensated for by
increased payments from use of the Company's games, that the Company will be
able to continue to offer the incentives it does in accordance with the
applicable laws of the jurisdictions in which the Company's games are
distributed, or that the Company will be able to continue to offer its games
through various Internet game sites. In addition, so far none of the pricing
models implemented by the Company for Internet multiple player games has yielded
profit for the Company, and there can be no assurance that any such model will
do so in the future. Furthermore, the Company has experienced problems with
certain of the Internet hardware and software it has put into operation and
there can be no assurance that such problems or other problems will not reoccur
in the future.
SHORT PRODUCT LIFESPANS
Interactive entertainment software products typically have life spans of only 3
to 12 months. Accordingly, the Company will need to constantly develop and bring
to market new products that achieve market acceptance quickly. The Company's
future success will depend in large part on its ability to develop and introduce
new products on a timely basis. New products must keep pace with competitive
offerings, adapt to new hardware platforms and emerging industry standards, and
provide additional functionality. If the Company is unable, due to resource
constraints or technological or other reasons, to develop and introduce such
products in a timely manner, this inability would have a material adverse effect
on its operating results and financial condition. There can be no assurance that
the Company will be able to complete the timely development and commercial
release of new software products that achieve market acceptance.
COMPETITION
The Company has entered new markets with certain of its software products and in
particular, those products currently in development for the Sony PlayStation,
Nintendo 64 and Internet markets. This has, to some degree, required
distribution through distributors and retailers who had not previously carried
the Company's products. There is intense competition in procuring adequate
distribution of the Company's software products.
15
<PAGE> 16
There can be no assurance that the Company will succeed in obtaining sufficient
distribution to enable its products to achieve market success.
The markets in which 3DO's software products compete are expected to undergo
significant changes, due in part to the introduction, or planned introduction,
of new hardware platforms and electronic delivery systems, and the entry and
participation of new industries and companies. Severe competition exists for
retail shelf space in the consumer software industry. A number of factors,
including the Company's historic performance, discounts to retailers, inventory
and return policies, customer service, product support, brand recognition,
perceived quality and entertainment value of specific titles, and marketing
activities all affect access to distributors and retailers. In addition, sales
of interactive entertainment products are becoming increasingly dependent upon
name recognition of product families. Fewer products in this market are
successful and publishers of these games, including the Company, must incur
substantial marketing and sales expenses to promote retailers' efforts to sell
such products given the product's short lifespan.
A variety of companies offer products that compete directly with one or more of
the Company's software products. These direct competitors vary in size from very
small companies with limited resources to companies with financial, managerial
and technical resources substantially greater than those of the Company. The
Company's competitors include large independent multi-platform software
developers such as Electronic Arts Inc., Eidos plc, Acclaim Entertainment, Inc.,
Lucas Arts Entertainment Co., and GT Interactive Software, as well as publishers
of personal computer software such as Microsoft Corporation and The Learning
Company, Inc.
VARIABILITY OF OPERATING RESULTS
The Company expects that its operating results will experience significant
fluctuations as a result of the timing of new video game hardware and software
product introductions by the Company's competitors, the timeliness with which
the Company is able to release its products to the market, fluctuations in the
PC market, the financial impact of acquisitions of other companies and/or
products by the Company, the Company's investments in research and development,
and expenditures on marketing and promotional programs.
The market for entertainment software is highly seasonal. The Company's revenues
are expected to be affected by the seasonal nature of the market, which is
characterized by increased sales in the fourth calendar quarter coinciding with
the holiday selling season and typically a seasonal low in revenues in the
quarter ending in June. Seasonal trends may also be affected by general economic
or industry factors. The Company's revenues may also reflect substantial
variations as a result of the timing of the introduction of and demand for a
particular software title it has published and/or distributed. Such demand may
increase or decrease as a result of a number of factors, such as consumer
preferences, product announcements by competitors and the popularity of
particular hardware platforms, that cannot be predicted. The software industry
is characterized by frequent product delays, which can materially and adversely
affect the sales of a product if the product is not released in time for the
holiday season.
The Company has stock-balancing programs for its software products that, under
certain circumstances and up to a specified amount, allow for the return and
exchange of software products by resellers. The Company also typically provides
for price protection for its software products that, under certain conditions,
allows the reseller a price reduction from the Company for unsold products. The
Company maintains a policy of exchanging products or giving credits, but does
not typically give cash refunds. The risk
16
<PAGE> 17
of price protection requirements is increasing as a result of the maturing and
the increasingly "hit" based nature of the video game market. Moreover, the risk
of product returns may increase as new hardware platforms become more popular or
market factors force the Company to make changes in its distribution system.
Overstocking in the distribution channel can result in high returns or the
requirement for substantial price protection in subsequent periods. The Company
establishes reserves for returns and price protection based on estimated future
returns of products, taking into account promotional activities, the timing of
new product introductions, distributor and retailer inventories of the Company's
products and other factors. However, there can be no assurance that actual
returns or price protection requirements will not exceed the Company's reserves.
DEPENDENCE ON DISTRIBUTORS
The distribution channels through which consumer software products are sold have
been characterized by change, including consolidations and financial
difficulties of certain distributors and retailers, and the emergence of new
retailers such as general mass merchandisers. The bankruptcy or other business
difficulties of a distributor or retailer could render the Company's accounts
receivable from such entity uncollectible, which could have an adverse effect on
the operating results and financial condition of the Company. In addition, an
increasing number of companies are competing for access to these channels.
Distributors and retailers often carry numerous products that compete with those
of the Company. Retailers of the Company's products typically have a limited
amount of shelf space and promotional resources for which there is intense
competition. There can be no assurance that distributors and retailers will
purchase the Company's products or provide the Company's products with prominent
display or even with adequate levels of shelf space.
DEPENDENCE ON KEY PERSONNEL
The Company's future success depends in large part on the continued service of
its key technical, marketing, sales and management personnel. Given the
Company's early stage of development, the Company is dependent on its ability to
recruit, retain and motivate high-quality personnel, especially highly-skilled
engineers, programmers and artists involved in the ongoing development required
to define future interactive technologies, refine existing interactive
technologies, introduce enhancements for future applications, and develop novel
software titles. The Company is particularly dependent on the skills and
contributions of several key individuals, any one of whom may voluntarily
terminate employment with the Company at any time and whose departure would have
a material adverse effect on the Company's business. The Company is particularly
dependent upon its Chief Executive Officer, Trip Hawkins. The Company does not
have "key person" life insurance policies on any of its employees. The game
software industry is characterized by a high level of employee mobility and
aggressive recruiting of skilled personnel. The Company competes with computer
hardware, software and entertainment companies for the recruitment of skilled
personnel. There can be no assurance that the Company's current employees will
continue to work for the Company or that the Company will be able to obtain the
services of additional personnel necessary for the Company's growth.
PROPRIETARY RIGHTS AND LICENSES
The Company's success will depend in part on its ability to obtain and enforce
intellectual property protection for its products and related technology in both
the United States and other countries. The Company has filed a number of patent
applications with the United States Patent and Trademark Office ("U.S. Patent
Office") and international counterparts of certain of these applications with
the United States Receiving Office pursuant to the
17
<PAGE> 18
Patent Cooperation Treaty. The Company intends to file additional applications
as it deems appropriate for patents covering its technology. The process of
obtaining patent protection is expensive and absorbs significant management and
engineering time. No assurance can be given that any patents will issue from
these applications or that, if any patent does issue, the claims allowed will be
sufficiently broad to protect the key aspects of the Company's technologies, or
that the patent laws will provide effective legal or injunctive remedies to stop
any apparent infringement of the Company's patents. In addition, no assurance
can be given that any patent issued to the Company will not be challenged,
invalidated or circumvented, that the rights granted under patents will provide
competitive advantages to the Company, or that the Company's competitors will
not independently develop or patent technologies that are substantially
equivalent or superior to the Company's technologies.
The Company also relies on trade secrets and proprietary know-how, which it
seeks to protect, in part, by confidentiality agreements with its employees,
consultants, developers, vendors, and current and prospective licensees. The
Company's license agreements typically prohibit unauthorized disclosure and
unauthorized reverse-engineering of the Company's licensed technology. However,
the Company expects that third parties may attempt to reverse-engineer its
technology without authorization and there can be no assurance that the
Company's confidentiality and license agreements will not be breached or that
the Company will have adequate remedies for any breach. As a result, the Company
may not have an adequate remedy if a competitor disassembles or
reverse-engineers products that incorporate the Company's proprietary
technology, even if such technology is protected by trade secret or copyright
law. There can be no assurance that the Company's trade secrets will not
otherwise become known or be independently discovered by competitors.
The Company relies in part on copyright laws to prevent unauthorized duplication
or distribution of its software, written materials and audiovisual works.
Existing copyright laws afford only limited protection, particularly in certain
jurisdictions outside the United States where the Company has licensed and may
seek to license its products and related technology. There can be no assurance
that the copyright laws will adequately protect the Company's technologies.
The Company licenses its trade names, trademarks and logos for use in connection
with authorized products. The Company has experienced difficulty in registering
some of its marks in various jurisdictions, including Japan. There can be no
assurance that the Company will obtain sufficient trademark protection for these
marks, that these marks will not be duplicated without authorization, or that
the Company will have adequate remedies for trademark infringement in any
country.
From time to time, the Company receives communications from third parties
asserting that features or content of certain of the Company's or its licensees'
products infringe upon intellectual property rights held by such third parties.
As the number of patents and products in the Company's industry increases and as
the functionality of such products further overlaps, the Company believes that
its products may increasingly become the subject of infringement claims. The
Company could incur substantial costs in defending itself or its licensees in
litigation brought by others, or in prosecuting infringement claims against
third parties. The Company could also incur substantial costs in interference
proceedings before the U.S. Patent Office in connection with one or more of the
Company's or a third party's patents or patent applications. Those proceedings
could result in an adverse decision as to the priority of the Company's
inventions. A third party claiming infringement may be able to obtain an
injunction or other equitable relief, which could effectively block the ability
of the Company or its licensees to import into various
18
<PAGE> 19
jurisdictions, including the United States, or to distribute and sell products
within particular jurisdictions. Such a result would materially and adversely
affect the Company. Such a third party could also assert claims for substantial
damages against the Company, its licensees or distributors of such products,
which could inhibit the manufacture or sale of licensed products. In the event
of a claim of infringement, the Company or its licensees may be required to
obtain one or more licenses from third parties. There can be no assurance that
the Company or its licensees will be able to obtain from third parties any
required license regarding such technology at a reasonable cost or at all.
Failure by the Company or its licensees to obtain any such license would have a
material adverse impact on the Company's business, results of operations and
financial condition.
VOLATILITY OF STOCK PRICE
Market prices of securities of companies engaged in the entertainment software
industry have been highly volatile. Factors such as announcements of the
introduction of new products by the Company or its competitors, announcements of
joint development efforts or corporate partnerships in the entertainment
software field, market conditions in the technology, entertainment, cable,
telecommunications and other emerging growth company sectors, and rumors
relating to the Company or its competitors, have had and may in the future have
a significant impact on the market price of the Company's common stock. Further,
the stock market has experienced volatility that has particularly affected the
market prices of equity securities of many high technology companies, such as
those in the entertainment software industry, that has often been unrelated to
the operating performance of such companies. These market fluctuations may
adversely affect the price of the Company's common stock.
YEAR 2000 ISSUE
Many existing computer systems and related software applications, and other
control devices, use only two digits to identify a year in the date field,
without considering the impact of the upcoming change in the century. Such
systems, applications and/or devices could fail or create erroneous results
unless corrected so that they can process data related to the Year 2000. The
Company relies on such computer systems, applications and devices in operating
and monitoring all major aspects of its business, including, but not limited to,
its financial systems (such as general ledger, accounts payable and payroll
modules), customer services, internal networks and telecommunications equipment,
and end products. The Company also relies, directly and indirectly, on the
external systems of various independent business enterprises, such as its
customers, suppliers, creditors, financial organizations, and of governments,
both domestically and internationally, for the accurate exchange of data and
related information.
The Company is currently in the process of evaluating the potential impact of
the Year 2000 issue on its business and the related expenses that would
foreseeably be incurred in attempting to remedy such impact (including testing
and implementation of remedial action). Management's current estimate is that
the costs associated with the Year 2000 issue should not have a material adverse
effect on the results of operations or financial position of the Company in any
given year. However, despite the Company's efforts to address the Year 2000
impact on its internal systems, the Company is not certain that it has fully
identified such impact or whether the Company can resolve it without disruption
of its business and without incurring significant expense. In addition, even if
the internal systems of the Company are not materially affected by the Year 2000
issue, the Company could be affected as a result of any disruption in the
operation of the various third-party enterprises with which the Company
interacts.
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<PAGE> 20
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is engaged in certain legal actions arising in the
ordinary course of business. The Company believes it has adequate
legal defenses and believes that the ultimate outcome of these actions
will not have a material effect on the Company's financial position or
results of operations, although there can be no assurance as to the
outcome of such litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits have been filed with this report:
27.01 Financial Data Schedule
(b) No Current Reports on Form 8-K were filed during the quarter ended
June 30, 1998.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE 3DO COMPANY
Dated: August xx, 1998 /s/ JOHN ADAMS
--------------------------------
John Adams
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
(Duly authorized officer)
21
<PAGE> 22
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1998, CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE THREE MONTH PERIOD ENDED JUNE 30, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 1,653
<SECURITIES> 24,560
<RECEIVABLES> 9,267
<ALLOWANCES> 2,876
<INVENTORY> 21
<CURRENT-ASSETS> 34,449
<PP&E> 12,302
<DEPRECIATION> 8,9976
<TOTAL-ASSETS> 39,126
<CURRENT-LIABILITIES> 7,519
<BONDS> 0
0
0
<COMMON> 258
<OTHER-SE> (294)
<TOTAL-LIABILITY-AND-EQUITY> 39,126
<SALES> 9,533
<TOTAL-REVENUES> 9,533
<CGS> 2,519
<TOTAL-COSTS> 9,886
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6
<INCOME-PRETAX> (2,437)
<INCOME-TAX> 130
<INCOME-CONTINUING> (2,437)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,567)
<EPS-PRIMARY> (0.10)
<EPS-DILUTED> (0.10)
</TABLE>
