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UNITED STATES
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 September 30, 1999
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 October 31, 1999, the number of outstanding shares of the registrants'
common stock was 35,554,987.
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THE 3DO COMPANY
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at March 31, 1999 and September 30, 1999 3
Condensed Consolidated Statements of Operations for the three and six months ended September 30, 1998 4
and 1999
Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 1998 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
PART II OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
</TABLE>
2
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PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE 3DO COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
March 31, September 30,
1999 1999
---------------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,256 $ 27,987
Short-term investments 11,595 --
Accounts receivable, net of allowances of $4,017 and $5,463, respectively 20,777 20,081
Inventory 874 4,318
Prepaid and other current assets 546 5,277
---------------- -----------------
Total current assets 36,048 57,663
Property and equipment, net 3,320 4,421
Restricted cash -- 8,055
Deposits and other assets 1,120 919
---------------- -----------------
Total assets $ 40,488 $ 71,058
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,859 $ 760
Accrued expenses 6,526 11,454
Deferred revenue 485 586
Short-term debt 9,505 67
Other current liabilities 1,998 1,530
---------------- -----------------
Total current liabilities 20,373 14,397
---------------- -----------------
Total liabilities 20,373 14,397
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; no shares issued -- --
Common stock, $.01 par value; 125,000,000 shares authorized; 29,760
and 39,756 shares issued; 25,540 and 35,536 shares outstanding,
respectively 297 397
Additional paid-in capital 161,975 211,025
Accumulated other comprehensive loss (255) (163)
Accumulated deficit (127,840) (140,536)
Treasury stock, at cost, 4,220 shares (14,062) (14,062)
---------------- -----------------
Total stockholders' equity 20,115 56,661
---------------- -----------------
Total liabilities and stockholders' equity $ 40,488 $ 71,058
================ =================
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
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THE 3DO COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------------------- ----------------------------
1998 1999 1998 1999
--------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 5,024 $ 20,705 $ 14,558 $ 33,777
Cost of revenues 2,043 8,701 4,563 12,586
--------------- -------------- ------------- -------------
Gross profit 2,981 12,004 9,995 21,191
Operating expenses:
Research and development 6,051 9,302 11,574 16,960
Sales and marketing 2,476 5,511 4,352 10,848
General and administrative 2,267 3,052 4,755 5,748
--------------- -------------- ------------- -------------
Total operating expenses 10,794 17,865 20,681 33,556
--------------- -------------- ------------- -------------
Operating loss $ (7,813) $ (5,861) $(10,686) $(12,365)
Net interest and other income (expense) 377 105 813 (9)
--------------- -------------- ------------- -------------
Loss before income and foreign withholding taxes (7,436) (5,756) (9,873) (12,374)
Income and foreign withholding taxes 57 167 187 322
--------------- -------------- ------------- -------------
Net loss $ (7,493) $ (5,923) $(10,060) $(12,696)
=============== ============== ============= =============
Basic net loss per share $ (0.29) $ (0.18) $ (0.39) $ (0.44)
=============== ============== ============= =============
Diluted net loss per share $ (0.29) $ (0.18) $ (0.39) $ (0.44)
=============== ============== ============= =============
Shares used to compute basic net loss per share 25,865 32,349 25,759 28,995
=============== ============== ============= =============
Shares used to compute diluted net loss per share 25,865 32,349 25,759 28,995
=============== ============== ============= =============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
4
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THE 3DO COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended September 30,
---------------------------------------
1998 1999
------------------ ----------------
<S> <C> <C>
Cash flows from operating activities:
Net profit (loss) $ (10,060) $ (12,696)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,494 1,186
Deferred revenue (133) 101
Changes in operating assets and liabilities:
Accounts receivable, net (2,753) 696
Prepaid and other assets 963 (4,754)
Inventory (446) (3,444)
Accounts payable 226 (1,099)
Accrued expenses 1,815 4,928
Other liabilities (1,270) (443)
------------------ ----------------
Net cash used in operating activities (10,164) (15,525)
------------------ ----------------
Cash flows from investing activities:
Short-term investments, net (1,494) 11,621
Capital expenditures (1,274) (2,064)
------------------ ----------------
Net cash provided by (used in) investing activities (2,768) 9,557
------------------ ----------------
Cash flows from financing activities:
Restricted Cash -- (8,055)
Repayment of short-term debt -- (9,438)
Proceeds from secondary offering, net -- 46,403
Proceeds from issuance of common stock, net 1,008 2,747
Payments on capital lease obligations (276) (25)
------------------ ----------------
Net cash provided by financing activities 732 31,632
------------------ ----------------
Effect of exchange rate on cash -- 67
------------------ ----------------
Net increase (decrease) in cash and cash equivalents (12,200) 25,731
Cash and cash equivalents at beginning of period 16,209 2,256
------------------ ----------------
Cash and cash equivalents at end of period $ 4,009 $ 27,987
================== ================
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 8 $ 468
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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THE 3DO COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - GENERAL
The condensed consolidated financial statements of The 3DO Company, a Delaware
corporation (the "Company"), as of September 30, 1999 and for the quarter and
six months ended September 30, 1998 and 1999 are unaudited. In the opinion of
management, these condensed consolidated 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 condensed 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, 1999. The results of
operations for the quarter and six months ended September 30, 1999 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 is recognized at the time of shipment. Subject to certain limitations,
the Company permits its customers to exchange 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 recognized upon persuasive evidence of an
arrangement, 3DO's fulfillment of its obligations (e.g., delivery of the product
golden master) under any such licensing agreement, and determination that
collection of a fixed or determinable license fee is considered probable.
Per-copy royalties on sales that exceed the minimum guarantee are recognized as
earned. Revenue from the Company's on-line service is recognized monthly based
on usage.
In October 1997, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 97-2 SOFTWARE REVENUE RECOGNITION, which supersedes
SOP 91-1. SOP 97-2 is effective for the Company 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 has adopted SOP 97-2 in the prior fiscal
year. However, the effect of adopting SOP 97-2 did not have a material impact on
the Company's consolidated results of operations or financial position.
In December 1998, AcSEC issued SOP 98-9 SOFTWARE REVENUE RECOGNITION, WITH
RESPECT TO CERTAIN ARRANGEMENTS, which requires recognition of revenue using the
"residual method" in a multiple element arrangement when fair value does not
exist for one or more of the delivered elements in the arrangement. Under the
"residual method", the total fair value of the undelivered elements is deferred
and subsequently recognized in accordance with SOP 97-2. SOP 98-9 is effective
for the Company for transactions entered into after March 31, 1999. The effect
of adopting SOP-98-9 did not have a material impact on the Company.
NOTE 3 - NET LOSS PER SHARE
Basic net loss 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 outstanding and, when
dilutive, options to purchase common stock using the treasury stock method.
6
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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 periods presented:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------------- ---------------------------
1998 1999 1998 1999
----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Net loss $ (7,493) $ (5,923) $ (10,060) $ (12,696)
Shares used to compute basic net loss per share - Weighted
average number of common shares outstanding 25,865 32,349 25,759 28,995
Effect of stock options outstanding using the treasury
stock method -- -- -- --
----------- ---------- ------------ ------------
Shares used to compute diluted net loss per share 25,865 32,349 25,759 28,995
Basic net loss per share $ (0.29) $ (0.18) $ (0.39) $ (0.44)
Diluted net loss per share $ (0.29) $ (0.18) $ (0.39) $ (0.44)
</TABLE>
Options to purchase 9,786,808 shares of common stock were excluded from the
Company's dilutive net loss per share calculations for the quarter and six
months ended September 30, 1998 because their effect was anti-dilutive. These
anti-dilutive shares had weighted average exercise prices of $3.12 for quarter
and six months ended September 30, 1998. Options to purchase 13,139,005 shares
of common stock were excluded from the Company's dilutive net loss per share
calculations for the quarter and six months ended September 30, 1999 because
their effect was anti-dilutive. These anti-dilutive shares had weighted average
exercise prices of $4.11 for the quarter and six months ended September 30,
1999.
FOOTNOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS
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 losses were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September30,
---------------------------- ----------------------------
1998 1999 1998 1999
------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss $ (7,493) $ (5,923) $ (10,060) $(12,696)
Change in cumulative translation adjustment -- 67 -- 67
Change in unrealized loss on marketable securities 108 38 103 25
------------- ------------ ------------ ------------
Total comprehensive loss $ (7,385) $ (5,818) $ (9,957) $(12,604)
============= ============ ============ ============
</TABLE>
In June 1998, the FASB issued SFAS No. 133 ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and reporting
standards for derivative financial instruments and hedging activities and
requires the Company to recognize all derivatives as either assets or
liabilities on the balance sheet and measure them at fair value. Gains and
losses resulting from changes in fair value would be accounted for depending on
the use of the derivative and whether it is designated and qualifies for hedge
accounting. SFAS No. 133, as amended by SFAS No.137, will be adopted by the
Company in the first quarter of fiscal 2002 and is not expected to have a
material impact on its financial statements.
In March 1998, the American Institute of Certified Public Accountants issued SOP
No. 98-1 ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR
INTERNAL USE. SOP No. 98-1 requires that certain costs related to the
development or purchase of internal-use software be capitalized and amortized
over the estimated useful life of the software. SOP No. 98-1 is effective for
financial statements issued
7
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for fiscal years beginning after December 15, 1998. The adoption of SOP No.
98-1 did not have a material impact on the results of operations or financial
condition.
FOOTNOTE 5 - GEOGRAPHIC, SEGMENT AND SIGNIFICANT CUSTOMER INFORMATION
The Company adopted the provisions of SFAS No. 131, Disclosure about Segments of
an Enterprise and Related Information, during fiscal 1999. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance. The Company's chief operating decision maker is considered to be
the Company's Chief Executive Officer (CEO). The CEO reviews financial
information presented on a consolidated basis accompanied by disaggregated
information about revenues by products for purposes of making operating
decisions and assessing financial performance. Therefore, the Company operates
in a single operating segment: interactive entertainment software products.
The disaggregated financial information on a product basis reviewed by the CEO
is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -----------------------------
1998 1999 1998 1999
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
PC $ 2,666 $ 4,363 $ 11,921 $ 11,473
Console 1,981 16,242 1,981 22,111
Other 377 100 656 193
-------------- --------------- -------------- --------------
Total revenues $ 5,024 $ 20,705 $ 14,558 $ 33,777
============== =============== ============== ==============
</TABLE>
During the quarter ended September 30, 1998, the Company's three top customers
each accounted for 10% or higher of the Company's total revenues compared to two
customers for the quarter ended September 30, 1999. For the six months ended
September 30, 1998, the Company's five top customers each accounted for 10% or
higher of the Company's total revenues compared to one customer for the six
months ended September 30, 1999.
The Company's export sales, primarily to Japan and the United Kingdom, were
approximately $0.6 million and $2.0 million, or 12% and 10% of total revenues
for the quarter ended September 30, 1998 and 1999, compared to approximately
$1.6 million and $3.8 million, or 11% of total revenues for the six months ended
September 30, 1998 and 1999, respectively. The Company's assets are primarily
located in its corporate office in the United States.
FOOTNOTE 6 - LINES OF CREDIT
In fiscal 1999, the Company entered into two revolving credit agreements with
Coast Business Credit and Merrill Lynch & Co.
The Merrill Lynch credit facility allows the Company to borrow up to $20.0
million or 90% of the cash balances in the pledged collateral bank account at
Merrill Lynch. The amount outstanding under this credit facility bears a
variable per annum rate of interest equal to the sum of the 30-day commercial
paper rate plus 2.10% (7.50% as of September 30, 1999). Interest expense is due
monthly and the loan balance is due at the expiration date of the credit
agreement. This credit agreement will expire on November 30, 2000. As of
September 30, 1999, no borrowings were outstanding under this facility.
The Coast Business Credit revolving credit agreement permits the Company to
obtain a loan amount of up to $20.0 million, or 60% of qualified accounts
receivables, bearing an interest rate equal to Prime Rate plus 2.0% per annum
(10.25% as of September 30, 1999) and will expire on March 31, 2002. Interest
expense is due monthly and the loan balance is due at the expiration date of the
credit agreement. This agreement contains certain financial covenants, including
the requirement that the Company:
- must achieve 80% of the projected quarterly tangible net worth
upon projections acceptable to Coast;
- must maintain $2,000,000 on deposit at all times in restricted
accounts which shall be assigned to and accessible only to Coast;
and
- must not pay dividends.
8
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As of September 30, 1999, the Company's outstanding loan balance with Coast
Business Credit was $0.1 million.
FOOTNOTE 7 - RESTRICTED CASH
As of September 30, 1999, the Company has approximately $8.1 million in
restricted cash. The restricted cash balance consisted of $2.0 million in
government securities, which as part of the Coast revolving credit agreement
provisions, the Company must maintain on deposit at all time in restricted
accounts which shall be assigned to and accessible only by Coast. The remaining
$6.1 million was in short term investments and was collateralized against the
letter of credit for a long term lease for a new office facility that the
Company entered into with Cornerstone Properties, Inc. in September 1999.
FOOTNOTE 8 - SECONDARY PUBLIC OFFERING
In August, 1999, the Company completed a public offering of 9,085,000 shares of
its common stock at $5.44 per share, raising approximately $46.4 million in net
proceeds after deducting underwriting discounts and commissions and estimated
offering expenses. The Company expects to use the proceeds from the offering for
working capital, product development for next-generation video game platforms,
expansion of its operations in Europe and other general corporate purposes.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a leading developer and publisher of branded interactive entertainment
software. Our software products operate on several multimedia platforms
including personal computers, the Sony PlayStation and Nintendo N64 video game
consoles, and the Internet. We are also developing software for the Nintendo
Game Boy Color and are planning to develop software for next-generation video
game consoles. We plan to continue to extend our popular brands across multiple
categories, or "genres," and platforms. These brands include Army Men,
BattleTanx, Family Game Pack, Heroes of Might and Magic, High Heat Baseball and
Might and Magic. Our software products cover a variety of genres, including
action, strategy, adventure/role playing, sports and family entertainment.
We were incorporated in California in September 1991 and commenced operations in
October 1991. In April 1993, we reorganized as a Delaware holding company and
acquired an entity that had developed our hardware technology. We acquired
Cyclone Studios in November 1995, Archetype Interactive Corporation in May 1996
and certain assets of New World Computing, Inc. in June 1996. We currently have
an active subsidiary in the United Kingdom, 3DO Europe, Ltd.
Software publishing revenues consist primarily of revenues from the sale of
software titles published and distributed by us and license fees for software
developed by us and manufactured, marketed and distributed by third party
licensees in Europe, Latin America, Asia and Australia. Software publishing
revenues are net of allowances for returns, price protection and discounts.
Software publishing revenues are recognized at the time of shipment, provided
that we have no related outstanding obligations. Software licensing revenues are
typically recognized when we fulfill our obligations, such as delivery of the
product master under a distribution agreement. Per-copy royalties that exceed
guaranteed minimum royalty levels are recognized as earned. We recognize revenue
from our Meridian 59 online service monthly upon customers' usage.
Cost of software publishing revenues consists primarily of direct costs
associated with software titles, including manufacturing costs and royalties
payable to platform developers such as Sony and Nintendo and, to a lesser
extent, royalties payable to third-party developers. Cost of revenues for
interactive entertainment software varies significantly by platform. Cost of
revenues for video game console titles is typically higher than cost of revenues
for personal computer titles due to relatively higher manufacturing and royalty
costs associated with these products. Cost of revenues for personal computer
titles primarily consists of the cost of the CD-ROM and packaging.
Research and development expenses primarily consist of personnel and support
costs. Internal development costs of software titles are expensed as incurred
and included in research and development expenses.
Sales and marketing expenses primarily consist of advertising and retail
marketing support, sales commissions, sales and marketing personnel costs and
other costs.
General and administration expenses principally consist of administrative
expenses related to finance, accounting, legal, operations, information
technology, customer service and other associated costs.
9
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We expect to continue to incur substantial expenditures to develop our business
in the future. We expect that our operating results will fluctuate as a result
of a wide variety of factors, including the factors described in "Risk Factors".
This Form 10-Q contains forward-looking statements that involve risks and
uncertainties. We use words such as "anticipates," "believes," "plans,"
"expects," "future," "intends," "may," "will," "should," "estimates,"
"predicts," "potential," "continue" and similar expressions to identify such
forward-looking statements. These forward-looking statements include, but are
not limited to, statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Forward-looking statements are
subject to known and unknown risks, uncertainties and other factors that may
cause our actual results, levels of activity, performance, achievements and
prospects to be materially different from those expressed or implied by such
forward-looking statements. These risks, uncertainties and other factors
include, among others, those identified under "Risk Factors" and elsewhere in
this Form -10-Q.
These forward-looking statements apply only as of the date of this Form 10-Q. We
undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties, and assumptions, the forward-looking
events discussed in this Form 10-Q might not occur. Our actual results could
differ materially from those anticipated in these forward-looking statements for
many reasons, including the risks faced by us described above and elsewhere in
this Form 10-Q. Such forward-looking statements include statements as to, among
others:
- our expectations regarding the timing of the introduction of some
new products;
- our expectations regarding the decrease in average selling prices;
- our ability to reduce manufacturing costs;
- our expectations that as more advanced platforms are introduced,
consumer demand for software for older platforms may decline;
- our expectations as to the change in the distribution channels for
interactive software;
- our cash flow from operations and our available credit facilities;
- our expectations regarding the use of the proceeds of the
secondary offering;
- our expectations as to our future cash requirements;
- our expectations as to our international expansion and hiring
personnel for the European expansion;
- our expectations as to the retention of future earnings;
- our expectations regarding the future development of our business;
- our expectations regarding negative cash flows;
- our expectations regarding operating results and expenses;
- our expectations regarding the success and cost of the Year 2000
working group;
- our expectations regarding the development of Year 2000
contingency plans;
- our expectations regarding the effect of recent accounting
pronouncements;
- our expectations regarding product releases;
- our expectations regarding the localization of our products for
European countries; and
- our expectations regarding the planned increase of sales directly
to retailers in North America.
RESULTS OF OPERATIONS
REVENUES. Revenues increased by $15.7 million, or 312% and $19.2 million, or
132% for the three and six months ended September 30, 1999, respectively. This
increase was due primarily to the increase in licensing revenue as we expanded
our international presence, as well as strong demands for our titles for Sony
PlayStation and Nintendo N64 platforms. Sales of interactive entertainment
software for the
10
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personal computer, video game console platforms and other products comprised
21%, 78% and 1% for the quarter ended September 30, 1999 compared to 53%, 39%
and 8% for the quarter ended September 30, 1998, respectively. For the six
months ended September 30, 1999, sales of interactive entertainment software
for personal computer, video game console platforms and other products
comprised 34%, 65% and 1%, compared to 82%, 14% and 4%, respectively, for the
same period last year. The change in product mix was due primarily to the
expansion of our product lines to the console platforms.
COST OF REVENUES. Cost of revenues increased by $6.7 million, or 326%, and $8.0
million, or 176% for the quarter and six months ended September 30, 1999,
respectively. This increase was primarily due to the increased number of
software titles published and distributed in fiscal 2000 compared with fiscal
1999, and higher cost of goods associated with the Nintendo N64 and the Sony
PlayStation products.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by
approximately $3.2 million, or 54%, and $5.3 million, or 47% to $9.3 million and
$17.0 million for the three and six months ended September 30, 1999 from $6.1
million and $11.6 million for same periods in the prior year. This increase was
attributable to higher on-going development expenses as we continued to expand
our product development efforts beyond the personal computer to video game
console systems.
SALES AND MARKETING. Sales and marketing expenses increased by $3.0 million, or
123%, and $6.5 million, or 149% to $5.5 million and $10.8 million for the three
and six months ended September 30, 1999 from $2.5 million and $4.4 million for
the three and six months ended September 30, 1998. The increase was primarily
due to our increased marketing expenses for new product releases. In addition,
we also incurred substantial marketing expenditures for our television ad
campaign for High Heat Baseball and Army Men 3D for the Sony PlayStation in the
current fiscal year. We anticipate that sales and marketing expenses will
increase in the future as additional software titles are released.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased by
$0.8 million, or 35%, and $1.0 million, or 21% to $3.1 million and $5.7 million
for the three and six months ended September 30, 1999 from $2.3 million and $4.8
million for the same prior periods. The increase was attributable to the
increase in administrative and overhead expenses as we continued to build the
infrastructure to support the release of new titles for the personal computer,
Sony PlayStation, Nintendo N64 and Nintendo Game Boy platforms. We expect that
general and administrative expenses will continue to increase in the future.
NET INTEREST AND OTHER INCOME. Net interest and other income decreased by $0.3
million, or 72%, and $0.8 million, or 101% for the three and six month ended
September 30, 1999 compared to the prior comparable periods. The decrease in net
interest and other income was primarily due to the interest expense incurred on
the line of credit with Coast Business Credit, offset by interest income earned
from proceeds from the secondary offering.
INVENTORY. Inventory balance increased by $3.4 million from $0.9 million at
March 31, 1999 to $4.3 million at September 30, 1999. The increase was primarily
due to inventory purchase for products released in September and October 1999,
including Army Men Sarge's (N64), BattleTanx Global Assault (N64) and Army Men
Toy in Space (PC).
ACCRUED EXPENSES. Accrued expense balance increased by $4.9 million from $6.5
million at March 31, 1999 to $11.5 million at September 30, 1999. The increase
was attributable to greater overall expenses including market development fund,
payroll, freight, product fulfillment expense and inventory payable as the
Company continues to expand its operations and increase its product releases.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash and cash equivalent balances and
short-term investment balances, which were $30.0 million at September 30, 1999
and $13.9 million at March 31, 1999. The increase was primarily due to the $46.4
million net cash receipt from the secondary offering, offset by inventory
purchase of $17.6 million, Capital Expenditure of $2.1 million and other cash
used in operations.
In fiscal 1999, we entered into two line of credit agreements. Our agreement
with Coast Business Credit allows us to borrow up to $20.0 million or 60% of
qualified accounts receivable. Borrowings under this line of credit bear
interest at a rate of prime plus 2.0% (10.25% as of September 30, 1999). This
line of credit expires in March 2002. Our agreement with Coast Business Credit
contains financial covenants. See note 6 of the notes to condensed consolidated
financial statements. As of September 30, 1999, our outstanding loan balance
under this facility was $0.1 million. Our agreement with Merrill Lynch & Co.
allows us to borrow up to $20.0 million or 90% of the cash balance in the
pledged collateral account. Borrowings under this line of credit bear interest
at a rate of the 30-day commercial paper rate plus 2.10% (7.50% as of September
30, 1999). This line of credit expires in November 2000. As of September 30,
1999, no borrowings were outstanding under this facility.
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In August 1999, we completed a public offering of our common stock, raising
approximately $46.4 million in net proceeds after deducting underwriting
discounts and commissions and estimated offering expenses. We anticipate that
the net proceeds of the public offering of our common stock, cash receipts from
sales of products, and available borrowings under our credit facilities should
be sufficient to meet our working capital and capital expenditure needs for at
least the next 12 months. We expect to incur negative cash flows for the
remainder of this fiscal 2000, primarily due to our continued investment in the
internal development of entertainment software titles that are scheduled to be
released in the second half of this fiscal year and beyond, which include
additional capital expenditures primarily for computer equipment. In addition,
we anticipate that a substantial portion of our operating expenses in fiscal
2000 will be related to marketing and advertising, as we continue to raise the
brand awareness of our products. We cannot be certain that additional capital
will not be required in fiscal 2000 because cash flows will be affected by the
rate at which we release 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 our products. The level of financing
required beyond fiscal 2000 will depend on these and other factors. If we need
to raise additional funds through public or private financing, we cannot be
certain that additional financing will be available or that, if available, it
will be available on terms acceptable to us. Additional financing may result in
substantial and immediate dilution to existing stockholders. If adequate funds
are not available to satisfy either short- or long-term capital requirements, we
may be required to curtail our operations significantly or to seek funds through
arrangements with strategic partners or other parties that may require us to
relinquish material rights to certain of our products, technologies or potential
markets.
YEAR 2000 COMPLIANCE
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 to properly recognize and process data related to the Year
2000. We rely on such computer systems, applications and devices in operating
and monitoring all major aspects of our business, including, but not limited to,
our financial systems (such as general ledger, billing, accounts payable and
payroll modules), customer service, internal networks and telecommunications
equipment, and end products. We also rely, directly and indirectly, on the
external systems of various independent business enterprises, such as our
customers, licensors, contract manufacturers, suppliers, creditors, and
financial organizations, and of governments, both domestically and
internationally, for the accurate exchange of data and related information.
We have formed a Year 2000 working group to organize, manage, and report on our
Year 2000 remediation efforts. The Year 2000 working group consists of
approximately 20 individuals from all levels of management and covering all
areas of our operations. We have retained an experienced Year 2000 project
manager to lead this working group.
The Year 2000 working group has identified a four-phase approach to determining,
addressing, and reporting on Year 2000 readiness. This approach is expected to
identify areas of operations that could reasonably be expected to have adverse
effects on us should they fail to adequately address their own Year 2000 issues.
Phase 1 (Inventory) involves a comprehensive inventory of systems, software,
and business relationships. We have completed inventorying and
analyzing our remaining centralized computer and embedded systems to
identify any potential Year 2000 issues and will take corrective
action based on the results of analysis. We have inventoried a
representative sample of our desktop hardware and software and
consider this phase complete. In addition, an automated final sweep of
all desktop hardware and software was completed in September 1999.
This final sweep is a new portion of this Phase, added to ensure
completeness.
Phase 2 (Risk Assessment) requires detailed analysis of each item or
relationship identified in Phase 1.
Phase 3 (Remediation Planning) creates project plans to correct or address
individual system, software, or business partner issues identified in
the first two phases. We are replacing or upgrading hardware and
software that are known to be Year 2000 non-compliant.
Phase 4 (Remediation) implements those plans, correcting or replacing
systems, software, or business partners as required. We have upgraded
our financial and accounting systems to the most recent version. We
believe our database and financial applications are Year 2000
compliant. These systems are used to automate order entry, accounts
receivable, accounts payable, purchasing, fixed asset and general
ledger functions. We have upgraded our electronic data interchange
(EDI) systems to be Year 2000 compliant and have participated in
National Retail Federation (NRF) testing. The successful completion of
the NRF testing is reflected on the NRF Web site.
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As of September 30, 1999, our overall progress by phase was as follows:
<TABLE>
<CAPTION>
PERCENTAGE COMPLETED EXPECTED
PHASE AS OF SEPTEMBER 30, 1999 COMPLETION DATE
---------------------------- ----------------------------- ---------------------
<S> <C> <C>
Phase 1 - Inventory 100% August 1999
Phase 2 - Risk Assessment 100% September 1999
Phase 3 - Remediation Planning 90% November 1999
Phase 4 - Remediation 85% November 1999
</TABLE>
We are surveying our critical suppliers, licensees, contract manufacturers,
distributors, and other vendors to determine if their operations and the
products and services that they provide to us are Year 2000 compliant. We intend
to mitigate our risks with respect to the failure of third parties to be Year
2000 ready, including developing contingency plans, where practical. However,
such failures remain a possibility and could harm our business.
In several cases, our business with our customers and suppliers is conducted
through the use of EDI systems. In each case where EDI is used, we are in the
process of conducting electronic testing with these businesses. We expect that
this electronic testing will be completed by November 1999.
Due to the nature of our products, many of them contain no date-related
processing. Therefore, many of them should not be affected by the Year 2000 date
change. However, our Year 2000 working group has developed tests for all of our
significant products to determine the effects of the Year 2000 change. We have
developed tests for these products and completed testing of all of our current
products in September 1999.
COST
We expect to incur costs during the next quarter related to the planning and
remediation described above. Our current estimate (including the Year 2000
issues identified to date) is that the costs associated with the Year 2000 issue
should not have a material adverse effect on our results of operations or
financial position in any quarter. However, we are not certain that we have
fully identified such impact or whether we can resolve it without disruption of
our business or incurring significant expense. We have incurred approximately
$0.6 million in expenditures to date related to the Year 2000 issue.
RISKS AND UNCERTAINTIES
If we fail to find and correct a significant Year 2000 issue, our normal
business operations could be interrupted. We have substantially completed
remediation and validation of our internal systems, as well as developing
contingency plans for certain internal systems. However, if implementation of
replacement upgraded systems or software is delayed, if significant new
non-compliance issues are identified, or if contingency plans fail, our results
of operations or financial condition could be adversely affected. Our risks
include the following:
Software Development Schedules. Our software development teams rely on a variety
of systems and software tools to develop products. If these systems and tools
are not functioning properly, product release schedules, which span the Year
2000 rollover, could be adversely affected. We rely on external contractors to
develop components of some of our products. If a contractor with a significant
contribution to a project should fail to adequately address the Year 2000 issue,
this could have adverse effects on the development schedule for one or more of
our products.
Facilities Operations. We rely on systems and software to run our security and
telecommunications systems. Although both of these components at all of our
locations have been included in the Year 2000 plan, a failure of either of these
systems could prevent normal work at one or more of our locations.
Financial and Accounting Software. We have upgraded our financial and accounting
systems to the most recent available version. We believe our database and
financial applications are Year 2000 compliant. Although all of these business
applications have been (and will continue to be) thoroughly evaluated for year
2000 compliance, a failure in one or more of these software packages could delay
our ability to process customer orders, billing, payroll, accounts payable and
financial statements. Consequently, we may not be able to file our financial
reports with the Securities and Exchange Commission on a timely basis, which
could negatively affect our stock price.
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Production and Fulfillment Facility. We use a third party fulfillment center to
assemble and distribute our products. Even though our third party fulfillment
center is in the process of updating its computer systems to be Year 2000
compliant, we cannot be certain that its computer systems will be operating
properly. In an event that its computer systems are not functioning properly due
to Year 2000 non-compliance and the third party cannot ship products to our
customers, our financial position and earnings will be severely impacted.
CONTINGENCY PLANS
We expect to complete contingency plans for key internal systems and critical
business partners by the end of November 1999. This contingency planning
includes identifying additional vendors who could provide similar goods and
services on short notice. We expect these plans to reduce the risk of
interruption, delay or failure of key processes required for business
operations. However, failure of such plans remains a possibility and could have
a materially adverse impact on our results of operations or financial condition.
The statements regarding year 2000 issues above and in "Risk Factors--The Year
2000 risk may adversely affect us" are "Year 2000 readiness disclosures" within
the meaning of the Year 2000 Information and Readiness Disclosure Act. The
protection of this Act does not apply to federal securities fraud actions.
RISK FACTORS
OUR QUARTERLY OPERATING RESULTS FREQUENTLY VARY SIGNIFICANTLY DUE TO FACTORS
OUTSIDE OUR CONTROL.
We have experienced and expect to continue to experience wide fluctuations in
quarterly operating results as a result of a number of factors. We cannot
control many of these factors, which include the following:
- the timing and number of new title introductions;
- the mix of sales of higher and lower margin products in a quarter;
- market acceptance of our titles;
- development and promotional expenses relating to the introduction
of new titles, sequels or enhancements of existing titles;
- announcements and introductions of new hardware platforms;
- product returns;
- changes in pricing policies by us and our competitors;
- the timing of orders from major customers and distributors; and
- delays in shipment.
For these reasons, you should not rely on period-to-period comparisons of our
financial results as indications of future results. Our future operating results
could fall below the expectations of securities industry analysts or investors.
Any such shortfall could result in a significant decline in the market price of
our common stock. Fluctuations in our operating results will likely increase the
volatility of our stock price.
OUR SALES ARE SEASONAL, AND WE DEPEND ON STRONG SALES DURING THE HOLIDAY SEASON.
Sales of our titles are seasonal. Our peak shipments typically occur in the
third and fourth calendar quarters (our second and third fiscal quarters) as a
result of increased demand during the year-end holiday season. If we do not
achieve strong sales in the second half of each calendar year, our fiscal year
results would be adversely affected.
A SIGNIFICANT PORTION OF OUR REVENUES ARE DERIVED FROM A LIMITED NUMBER OF
BRANDS, SO A DECLINE IN A BRAND'S POPULARITY MAY HARM OUR RESULTS.
Because we depend on a limited number of brands for the development of sequels
and line extensions, if one or more of our brands were to lose their current
popularity, our revenues and profits may be seriously harmed. Furthermore, we
cannot be certain that a sequel or line extension of a popular brand will be as
popular as prior titles in that brand.
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OUR BUSINESS DEPENDS ON "HIT" PRODUCTS, SO IF WE FAIL TO ANTICIPATE CHANGING
CONSUMER PREFERENCES WE COULD SUFFER DECLINING REVENUES.
Few interactive entertainment software products have achieved sustained market
acceptance, with those "hits" accounting for a substantial portion of revenues
in the industry. Our ability to develop a hit title depends on numerous factors
beyond our control, including:
- critical reviews;
- public tastes and preferences that change rapidly and are hard to
predict;
- the price and timing of new interactive entertainment titles
released and distributed by us and our competitors;
- the availability, price and appeal of other forms of
entertainment; and
- rapidly changing consumer preferences and demographics.
If we fail to accurately anticipate and promptly respond to these factors, our
sales could decline. If we do not achieve adequate market acceptance of a title,
we could be forced to accept substantial product returns or grant significant
markdown allowances to maintain our relationship with retailers and our access
to distribution channels.
IF WE DO NOT CREATE TITLES FOR NEW HARDWARE PLATFORMS, OUR REVENUES WILL
DECLINE.
The interactive entertainment software market and the personal computer and
video game console industries in general have been affected by rapidly changing
technology, which leads to software and platform obsolescence. Our titles have
been developed primarily for multimedia personal computers and video game
consoles, including the Nintendo N64 and Sony PlayStation. Our software designed
for personal computers must maintain compatibility with new personal computers,
their operating software and their hardware accessories. If we are unable to
successfully adapt our software and develop new titles to function on various
hardware platforms and operating systems, our business could be seriously
harmed.
TITLES WE DEVELOP FOR NEW PLATFORMS MAY NOT BE SUCCESSFUL.
If we design new titles or develop sequels to operate on a new platform, we will
be required to make substantial development investments well in advance of the
platform introduction. If the new platform does not achieve initial or continued
market acceptance, then our titles may not sell many copies and we may not
recover our investment in product development.
IF OUR NEW PRODUCT INTRODUCTIONS ARE DELAYED, WE COULD LOSE SIGNIFICANT
POTENTIAL REVENUES.
Most of our products have a relatively short life cycle and sell for a limited
period of time after their initial release, usually less than one year. We
depend on the timely introduction of successful new products, including
enhancements of or sequels to existing products and conversions of previously
released products to additional platforms, to replace declining net revenues
from older products.
The complexity of product development, uncertainties associated with new
technologies and the porting of our products to new platforms makes it difficult
to introduce new products on a timely basis. We have experienced delays in the
introduction of some new products. We anticipate that we will experience delays
in the introduction of new products, including some products currently under
development. We may also experience delays in receiving approval of our games
from Sony and Nintendo. Delays in the introduction of products, especially in
the third calendar quarter, could significantly harm our operating results.
IF OUR NEW PRODUCTS HAVE DEFECTS, WE COULD LOSE POTENTIAL REVENUES AND INCREASE
OUR COSTS.
Software products such as those we offer frequently contain errors or defects.
Despite extensive product testing, in the past we have released products with
software errors. This is likely to occur in the future as well. We offer
warranties on our products, and may be required to repair or replace our
defective products. Although we periodically offer software patches for our
personal computer products, such errors may result in a loss of or delay in
market acceptance and cause us to incur additional expenses and delays to fix
these errors.
OUR GROSS MARGINS CAN BE SIGNIFICANTLY AFFECTED BY THE MIX OF PRODUCTS WE SELL.
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We typically earn a higher gross margin on sales of games for the personal
computer platform. Gross margins on sales of products for game console platforms
are generally lower because of:
- license fees payable to Sony and Nintendo; and
- higher manufacturing costs for game cartridges for the Nintendo
N64 console platform.
Therefore, our gross margins in any period can be significantly affected by the
mix of products we sell for the personal computer, Sony PlayStation and Nintendo
N64 platforms.
IF WE DO NOT REDUCE COSTS OR PROPERLY ANTICIPATE FUTURE COSTS, OUR GROSS MARGIN
MAY DECLINE.
We anticipate that the average selling prices of our products may decrease in
the future in response to a number of factors, particularly competitive pricing
pressures and sales discounts. Therefore, to control our gross margin, we must
also seek to reduce our costs of production. The costs of developing new
interactive entertainment software have increased in recent years due to such
factors as:
- the increasing complexity and robust content of interactive
entertainment software;
- increasing sophistication of hardware technology and consumer
tastes; and
- increasing costs of licenses for intellectual properties.
If our average selling prices decline, we must also increase the rate of new
product introductions and our unit sales volume to maintain or increase our
revenue. Furthermore, our budgeted research and development and sales and
marketing expenses are partially based on predictions regarding sales of our
products. To the extent that these predictions are inaccurate, our operating
results may suffer.
IF NEW PLATFORMS ARE ANNOUNCED OR INTRODUCED, SALES OF OUR EXISTING TITLES COULD
DECLINE SUDDENLY.
Historically, the anticipation or introduction of next-generation video game
platforms has resulted in decreased sales of interactive entertainment software
for existing platforms. Sega has recently introduced its Dreamcast system
worldwide, which has received very positive responses from both retailers and
consumers. We recently entered into an agreement with UBI Soft Entertainment
under which UBI Soft will adapt Heroes of Might and Magic III for the Dreamcast
System. We cannot be certain that this product will be released on schedule or
at all. Sony has announced the development of the next generation of the
PlayStation. Nintendo has stated that it is in the process of developing a new
video game platform. If sales of current models of multimedia personal computers
or video game consoles level off or decline as a result of the anticipated
release of new platforms or other technological changes, sales of our software
titles developed for current platforms can be expected to decrease. We expect
that as more advanced platforms are introduced, consumer demand for software for
older platforms may decline. As a result, our titles developed for such
platforms may not generate sufficient sales to make such titles profitable.
Obsolescence of software or platforms could leave us with increased inventories
of unsold titles and limited amounts of new titles to sell to consumers.
OUR MARKETS ARE HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE TO COMPETE
EFFECTIVELY.
The interactive entertainment software industry is intensely competitive and is
characterized by the frequent introduction of new hardware systems and software
products. Our competitors vary in size from small companies to very large
corporations which have significantly greater financial, marketing and product
development resources than us. Due to these greater resources, some of our
competitors are better able to undertake more extensive marketing campaigns,
adopt more aggressive pricing policies, pay higher fees to third party software
developers and licensors of desirable properties.
Our competitors include the following:
- We compete primarily with other publishers of interactive
entertainment software for personal computer and video game
consoles, including Acclaim Entertainment Inc., Activision, Inc.,
Eidos plc, Electronic Arts, GT Interactive Software Corp.,
Interplay Entertainment Corp., LucasArts Entertainment Company and
THQ Inc.
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- Integrated video game console hardware/software companies such as
Sony and Nintendo compete directly with us in the development of
software titles for their respective platforms.
- Large diversified entertainment or software companies, such as The
Walt Disney Company or Microsoft, many of which own substantial
libraries of available content and have substantially greater
financial resources than us, may decide to compete directly with
us or to enter into exclusive relationships with our competitors.
IF WE DO NOT COMPETE SUCCESSFULLY FOR RETAIL SHELF SPACE, OUR SALES WILL
DECLINE.
Retailers of our products typically have a limited amount of shelf space and
promotional resources. Publishers of interactive entertainment software products
compete intensely for high quality retail shelf space and promotional support
from retailers. To the extent that the number of consumer software products
increases, competition for shelf space may intensify and may require us to
increase our marketing expenditures. Due to increased competition for limited
shelf space, retailers and distributors are in an increasingly better position
to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return privileges. Retailers
and distributors also consider marketing support, quality of customer service
and historical performance in selecting products to sell. Our products
constitute a relatively small percentage of any retailer's sales volume, and we
cannot be certain that retailers will continue to purchase our products or to
provide our products with adequate levels of shelf space and promotional
support.
IF MORE MASS MERCHANTS ESTABLISH EXCLUSIVE BUYING ARRANGEMENTS, OUR SALES AND
GROSS MARGIN WOULD BE ADVERSELY IMPACTED.
Mass merchants have become the most important distribution channels for retail
sales of interactive entertainment software. A number of these mass merchants,
including Wal-Mart, have entered into exclusive buying arrangements with other
software developers or distributors, which prevent us from selling some of our
products directly to that mass merchant. If the number of mass merchants
entering into exclusive buying arrangements with software distributors were to
increase, our ability to sell to those merchants would be restricted to selling
through the exclusive distributor. Because we typically earn a lower gross
margin on sales to distributors than on direct sales to retailers, this would
have the effect of lowering our gross margin.
OUR SALES AND ACCOUNTS RECEIVABLE ARE CONCENTRATED IN A LIMITED NUMBER OF
CUSTOMERS.
During the quarter ended September 30, 1998, our three top customers each
accounted for 10% or higher of the Company's total revenues compared to two
customers for the quarter ended September 30, 1999. For the six months ended
September 30, 1998, our five top customers each accounted for 10% or higher of
the Company's total revenues compared to one customer for the six months ended
September 30, 1999. Our sales are made primarily on a purchase order basis,
without long-term agreements. The loss of our relationships with principal
customers or a decline in sales to any principal customer could harm our
business.
Our sales are typically made on credit, with terms that vary depending upon the
customer and the demand for the particular title being sold. We do not hold any
collateral to secure payment by our customers. As a result, we are subject to
credit risks, which are increased when our receivables represent sales to a
limited number of retailers or distributors or are concentrated in foreign
markets. Distributors and retailers in the computer industry have from time to
time experienced significant fluctuations in their businesses, and there have
been a number of business failures among these entities. The insolvency or
business failure of any significant distributor or retailer of our products
could result in reduced revenues and write-offs of accounts receivable. If we
are unable to collect on accounts receivable as they become due and such
accounts are not covered by insurance, it could adversely affect our business,
operating results and financial condition.
RETURNS OR EXCHANGES OF OUR TITLES MAY HARM OUR BUSINESS.
Our arrangements with retailers for published titles require us to accept
returns for unsold titles or defects, or provide adjustments for markdowns. We
establish a reserve for future returns of published titles at the time of sales,
based primarily on these return policies and historical return rates, and we
recognize revenues net of returns. Our provision for sales returns and
allowances was $4.8 million for the six months ended September 30, 1999. If
return rates or markdowns significantly exceed our estimates, our business could
be seriously harmed.
SONY AND NINTENDO CAN INFLUENCE THE NUMBER OF GAMES THAT WE CAN PUBLISH AND
TIMING OF OUR PRODUCT RELEASES.
We depend heavily on non-exclusive licenses with Sony and Nintendo both for the
right to publish titles for their platforms and for the manufacture of our
software designed for use on their platforms. Our licenses with Sony and
Nintendo require that we obtain their approval for title proposals as well as
completed games and all associated artwork and marketing materials. This
approval process could cause a delay
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in our ability to release a new title and cause us to incur additional
expenses to modify the product and obtain approval. As a result, the number
of titles we are able to publish for these platforms may be limited.
The license with Sony covering the United States terminates in September 2001
and the license with Nintendo terminates in May 2001. Our license with Sony
covering many countries in Europe and the Middle East as well as Australia and
New Zealand expires in December 2005. We are currently negotiating with Nintendo
to renew and expand the scope of the Nintendo licenses. If any of these licenses
were terminated or not renewed on acceptable terms, we would be unable to
develop and publish software developed for these platforms and our business
would be seriously harmed.
SONY AND NINTENDO CAN INFLUENCE OUR GROSS MARGIN AND PRODUCT INTRODUCTION
SCHEDULES IN WAYS WE CANNOT CONTROL.
Each of Sony and Nintendo is the sole manufacturer of the titles we publish
under license from them. Each platform license provides that the manufacturer
may raise our costs for the titles at any time and grants the manufacturer
substantial control over whether and when we can release new titles. The
relatively long manufacturing and delivery cycle for cartridge-based titles for
the Nintendo platform (from four to six weeks) requires us to accurately
forecast retailer and consumer demand for our titles far in advance of expected
sales. Nintendo cartridges are also more expensive to manufacture than CD-ROMs,
resulting in greater inventory risks for those titles. Each of Sony and Nintendo
also publishes software for its own platform and also manufactures titles for
all of its other licensees and may choose to give priority to its own titles or
those of other publishers if it has insufficient manufacturing capacity or if
there is increased demand.
IF OUR CONTRACT MANUFACTURERS DO NOT HAVE SUFFICIENT CAPACITY OR DELAY
DELIVERIES, OUR REVENUES WOULD BE HARMED.
Our contract manufacturers, Sony, Nintendo and JVC, may not have sufficient
production capacity to satisfy our scheduling requirements during any period of
sustained demand. If manufacturers do not supply us with finished titles on
favorable terms without delays, our operations could be materially interrupted,
and our business could be seriously harmed.
WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR INTERNATIONAL OPERATIONS AND
REVENUES.
We currently have an office in the United Kingdom with limited staffing. We
intend to expand the scope of our international operations, which will require
us to enhance our management information systems and establish sales, marketing
and distribution infrastructure in markets in which we do not have significant
experience. If we are unable to expand our international operations effectively
and quickly, we may not generate additional revenues from international sales,
while our expenses may have already increased. This could have an adverse impact
on our profitability.
IF OUR INTERNATIONAL OPERATIONS EXPAND, WE WILL ENCOUNTER RISKS WHICH COULD
ADVERSELY AFFECT OUR BUSINESS.
Our products are sold in international markets both directly and through
licensees, primarily in Canada, the United Kingdom and other European countries,
and to a lesser extent in Asia and Latin America. As a result of our current
international sales and our international expansion, we will become increasingly
subject to risks inherent in foreign trade, which can have a significant impact
on our operating results. These risks include the following:
- increased costs to develop foreign language versions of our
products;
- increased credit risks and collection difficulties;
- tariffs and duties;
- increased risk of piracy;
- shipping delays;
- fluctuations in foreign currency exchange rates; and
- international political, regulatory and economic developments.
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IF INTERNET-BASED GAMEPLAY BECOMES POPULAR, WE WOULD NEED TO QUICKLY DEVELOP
PRODUCTS AND ESTABLISH A VIABLE INTERNET BUSINESS MODEL.
We offer a role playing fantasy game called "Meridian 59," which is a
server-based Internet game. This type of game's software resides on a remote
server, and can be played only by accessing that server via the Internet.
Meridian 59 has not achieved significant market penetration. We provide free
play time and other incentives, such as discounts and contests, to interest the
limited number of consumers currently in the Internet game market to try
Meridian 59. We have not yet established that any of these incentives, the
availability of server-based games on the Internet or whether the expenses we
incur in offering these incentives will result in significant growth in the use
of our server-based Internet games or generate revenues for us in the future. A
number of software publishers who compete with us have developed or are
currently developing server-based Internet games for use by consumers over the
Internet. If the Internet becomes a more popular venue for interactive software
games, then we will need to both rapidly develop and release games for the
Internet, and also establish a profitable business model for Internet-based
games.
WE DEPEND ON OUR KEY PERSONNEL AND OUR ABILITY TO HIRE ADDITIONAL QUALIFIED
PERSONNEL.
Our success is largely dependent on the personal efforts of certain personnel,
especially Trip Hawkins. Our success is also dependent upon our ability to hire
and retain additional qualified operating, marketing, technical and financial
personnel. We rely heavily on our own internal development studios to develop
our products. The loss of any key developers or groups of developers may delay
the release of our products. Competition for personnel is intense, especially in
the San Francisco Bay area where we maintain our headquarters, and we cannot be
certain that we will successfully attract and retain additional qualified
personnel.
OUR INTERNAL DESIGN STUDIOS AND OUR MANUFACTURING SOURCES ARE VULNERABLE TO
DAMAGE FROM NATURAL DISASTERS.
All of our internal design studios and most of our manufacturing sources are
vulnerable to damage from fire, floods, earthquakes, power loss,
telecommunications failures and similar events. Our California internal design
studios are located on or near known earthquake fault zones. If a natural
disaster occurs, our ability to develop and distribute our products would be
seriously, if not completely, impaired. The insurance we maintain against fires,
floods, earthquakes and general business interruptions may not be adequate to
cover our losses in any particular case.
ILLEGAL COPYING OF OUR SOFTWARE ADVERSELY AFFECTS OUR SALES.
Although we use copy-protection devices, an unauthorized person may be able to
copy our software or otherwise obtain and use our proprietary information. If a
significant amount of illegal copying of software published or distributed by us
occurs, our 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 our software is
distributed do not protect us and our intellectual property rights to the same
extent as the laws of the U.S.
WE MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
As the number of interactive entertainment software products in the industry
increases and the features and content of these products further overlap,
software developers may increasingly become subject to infringement claims.
Although we make reasonable efforts to ensure that our products do not violate
the intellectual property rights of others, we cannot be certain that claims of
infringement will not be made. Any such claims, with or without merit, can be
time consuming and expensive to defend. From time to time, we have received
communications from third parties asserting that features or content of certain
of our products may infringe upon their intellectual property rights. We cannot
be certain that existing or future infringement claims against us will not
result in costly litigation or require us to seek to license the intellectual
property rights of third parties, which licenses may not be available on
acceptable terms, if at all.
WE DEPEND ON LICENSES FROM THIRD PARTIES FOR THE DEVELOPMENT OF ONE OF OUR
BRANDS.
We license various rights for use in our High Heat Baseball brand. If we were
unable to maintain or renew those licenses, we would be unable to release
additional sequels and line extensions for that brand.
RATING SYSTEMS FOR INTERACTIVE ENTERTAINMENT SOFTWARE, GOVERNMENT CENSORSHIP OR
RETAILER RESISTANCE TO VIOLENT GAMES COULD INHIBIT OUR SALES OR INCREASE OUR
COSTS.
19
<PAGE>
The home video game industry requires interactive entertainment software
publishers to identify products within defined rating categories and
communicating the ratings to consumers through appropriate package labeling and
through advertising and marketing presentations consistent with each product's
rating. If we do not comply with these requirements, it could delay our product
introductions and require us to remove products from the market.
Legislation is currently pending at both the federal and state level in the
United States to establish mandatory video game rating systems. Mandatory
government imposed interactive entertainment software products rating systems
eventually may be adopted in many countries, including the United States. Due to
the uncertainties inherent in the implementation of such rating systems,
confusion in the marketplace may occur and publishers may be required to modify
or remove products from the market. However, we are unable to predict what
effect, if any, such rating systems would have on our business.
Many foreign countries have laws which permit governmental entities to censor
the content of certain works, including interactive entertainment software. As a
result, we may be required to modify some of our products or remove them from
the market which could result in additional expense and loss of revenues.
Certain retailers have in the past declined to stock some software products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. Although such actions have
not yet affected us, we cannot be certain that our distributors or retailers
will not take such actions in the future.
THE YEAR 2000 RISK MAY ADVERSELY AFFECT US.
The inability of many existing computers to recognize and properly process data
as the Year 2000 approaches may cause many computer software applications to
fail or reach erroneous results. Any failure by us, our third-party suppliers or
customers to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain of our business operations. We are in
the process of completing our Year 2000 contingency plan.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
Disclosures of our operating results (particularly if below the estimates of
securities industry analysts), announcements of various events by us or our
competitors and the development and marketing of new titles affecting the
interactive entertainment software industry, as well as other factors, may cause
the market price of our common stock to change significantly over short periods
of time.
OUR FUTURE CAPITAL NEEDS ARE UNCERTAIN AND WE MAY NOT BE ABLE TO SATISFY THEM.
In August 1999, we completed a public offering our common stock, raising
approximately $46.4 million in net proceeds after deducting underwriting
discounts and commissions and estimated offering expenses. We anticipate that
the net proceeds of the public offering of our common stock, cash from
operations, and available borrowings under our credit facilities should be
sufficient to meet our working capital and capital expenditure needs for at
least the next 12 months. After that, we may need to raise additional funds,
which may not be available on acceptable terms, if at all. We may also require
additional capital to acquire or invest in complementary businesses or products
or obtain the right to use complementary technologies. If we issue additional
equity securities to raise funds, the ownership percentage of our existing
stockholders, including the investors in this offering, would be reduced. New
investors may demand rights, preferences or privileges senior to those of
existing holders of our common stock. Debt incurred by us would be senior to
equity in the ability of debtholders to make claims on our assets. The terms of
any debt issued could impose restrictions on our operations. If we cannot raise
needed funds on acceptable terms, we may not be able to develop or enhance our
products, take advantage of future opportunities or respond to competitive
pressures or unanticipated requirements.
FUTURE ACQUISITIONS MAY STRAIN OUR OPERATIONS.
We have acquired various properties and businesses, and we intend to continue to
pursue opportunities by making selective acquisitions consistent with our
business strategy, although we may not make any more acquisitions. The failure
to adequately address the financial and operational risks raised by acquisitions
of technology and businesses could harm our business.
Financial risks related to acquisitions include the following:
- potentially dilutive issuances of equity securities;
20
<PAGE>
- use of cash resources;
- the incurrence of additional debt and contingent liabilities;
- large write-offs; and
- amortization expenses related to goodwill and other intangible
assets.
Acquisitions also involve operational risks, including:
- difficulties in assimilating the operations, products,
technology, information systems and personnel of the acquired
company; diversion of management's attention from other
business concerns;
- impairment of relationships with our retailers, distributors,
licensors and suppliers;
- inability to maintain uniform standards, controls, procedures and
policies;
- entrance into markets in which we have no direct prior experience;
and
- loss of key employees of the acquired company.
WE HAVE NO INTENTION OF PAYING DIVIDENDS.
We have never declared or paid any cash dividends on our capital stock. We
currently intend to retain any future earnings for funding growth and,
therefore, do not expect to pay any dividends for the foreseeable future. In
addition, our line of credit with Coast Business Credit prohibits the payment of
dividends.
ANTI-TAKEOVER PROVISIONS MAY PREVENT AN ACQUISITION.
Provisions of our Amended and Restated Certificate of Incorporation, Bylaws and
Delaware law could make it more difficult for a third party to acquire us, even
if doing so would be beneficial to our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. We place our investments with high quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We are
averse to principal loss and ensure the safety and preservation of our invested
funds by limiting default, market and reinvestment risk. We classify our cash
equivalents, short-term investments and restricted cash as fixed-rate if the
rate of return on such instruments remains fixed over their term. These
fixed-rate investments include fixed-rate U.S. government securities, municipal
bonds, time deposits and certificates of deposit. We classify our cash
equivalents, short-term investments and restricted cash as variable-rate if the
rate of return on such investments varies based on the change in a predetermined
index or set of indices during their term. These variable-rate investments
primarily include money market accounts held at various securities brokers and
banks. The table below presents the amounts and related weighted interest rates
of our investment portfolio at September 30, 1999:
<TABLE>
<CAPTION>
Average
Restricted Cash(1) Interest Rate Cost Fair Value
--------------- ----------------- -----------------
<S> <C> <C> <C>
Fixed rate 5.30% $ 8,055 $ 8,055
</TABLE>
(1) See definition in Note 7 to our Consolidated Financial Statements.
The aggregate fair value of our restricted cash as of September 30, 1999, by
contractual maturity date, consisted of the following:
21
<PAGE>
<TABLE>
<CAPTION>
AGGREGATE FAIR
VALUE
(in thousands)
<S> <C>
Due in one year or less......................................................... $ 6,172
Due in one to three years....................................................... $ 1,983
</TABLE>
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company engages 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 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
Not applicable with respect to the current reporting period.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable with respect to the current reporting period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On September 22, 1999, at the Company's Annual Meeting of Stockholders, the
holders of the Common Stock of the Company elected William A. Hall as a director
of the Company; approved an increase in the authorized number of shares of
Common Stock from 50,000,000 to 125,000,000 in order to accommodate future
general corporate purposes including potential acquisitions and financings,
approved an increase in the number of shares reserved for issuance under the
1993 Incentive Stock Plan by 7,900,000 shares in order to replenish shares
previously approved by stockholders for issuance under the plan that were
reallocated and issued in connection with 3DO's public stock offering in August
1999; and confirmed the appointment of KPMG Peat Marwick LLP as independent
auditors for the fiscal year ending March 31, 2000. The voting on each matter is
set forth below.
1. Votes cast for the election of William A. Hall as a member of the Company's
Board of Directors:
Nominee Votes for Nominee Votes Withheld from Nominee
- -------------------- ------------------------ -------------------------------
William A. Hall 24,515,684 833,866
2. Votes cast for approval of an increase in the authorized number of shares
of Common Stock from 50,000,000 to 125,000,000 in order to accommodate
future general corporate purposes including potential acquisitions and
financings.
FOR Against Abstain Broker Non-Vote
- ---------- --------------- ------------ -----------------------
23,295,645 2,012,072 41,833 N/A
3. Votes cast for approval of an increase in the number of shares reserved for
issuance under the 1993 Incentive Stock Plan by 7,900,000 shares in order to
replenish shares previously approved by stockholders for issuance under the plan
that were reallocated and issued in connection with 3DO's public stock offering
in August 1999:
FOR Against Abstain Broker Non-Vote
- ---------- --------------- ------------ -----------------------
9,557,799 5,161,401 58,703 10,576,647
4. Votes cast to confirm the appointment of KPMG Peat Marwick LLP as
independent auditors for the fiscal year ending March 31, 2000
22
<PAGE>
FOR Against Abstain Broker Non-Vote
- ---------- --------------- ------------ -----------------------
25,257,833 55,953 35,764 N/A
ITEM 5. OTHER INFORMATION.
Not applicable with respect to the current reporting period.
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, 1999.
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: November 12, 1999 /s/ JOHN ADAMS
---------------------------------
John Adams
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
(Duly authorized officer)
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1999, CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE THREE MONTH PERIOD ENDED JUNE 30, 1999 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 27,987
<SECURITIES> 8,055
<RECEIVABLES> 25,545
<ALLOWANCES> 5,463
<INVENTORY> 4,319
<CURRENT-ASSETS> 57,663
<PP&E> 16,278
<DEPRECIATION> 11,858
<TOTAL-ASSETS> 71,058
<CURRENT-LIABILITIES> 14,397
<BONDS> 0
0
0
<COMMON> 397
<OTHER-SE> (163)
<TOTAL-LIABILITY-AND-EQUITY> 71,058
<SALES> 33,777
<TOTAL-REVENUES> 33,777
<CGS> 12,586
<TOTAL-COSTS> 33,556
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 468
<INCOME-PRETAX> (12,374)
<INCOME-TAX> 322
<INCOME-CONTINUING> (12,696)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,696)
<EPS-BASIC> (0.44)
<EPS-DILUTED> (0.44)
</TABLE>
