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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 June 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 July 31, 1999, the number of outstanding shares of the registrants'
common stock was 33,633,181.
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THE 3DO COMPANY
INDEX
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<CAPTION>
PART I FINANCIAL INFORMATION PAGE
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Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheets at March 31, 1999 and June 30, 1999 3
Condensed Consolidated Statements of Operations for the three months ended June 30, 1998 and 1999 4
Condensed Consolidated Statements of Cash Flows for the three months ended June 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 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
</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, June 30,
1999 1999
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,256 $ 10,415
Short-term investments 11,595 2,031
Accounts receivable, net 20,777 11,835
Prepaid and other current assets 1,420 1,482
------------------ -----------------
Total current assets 36,048 25,763
Property and equipment, net 3,320 4,020
Restricted cash -- 2,000
Deposits and other assets 1,120 1,009
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Total assets $ 40,488 $ 32,792
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,859 $ 1,223
Accrued expenses 6,526 7,943
Deferred revenue 485 369
Short-term debt 9,505 --
Other current liabilities 1,998 1,561
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Total current liabilities 20,373 11,096
Long-term debt -- 7,888
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Total liabilities 20,373 18,984
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; no shares
issued -- --
Common stock, $.01 par value; 50,000 shares authorized; 29,760
and 29,915 shares issued; 25,540 and 25,695 shares
outstanding, respectively 297 299
Additional paid-in capital 161,975 162,453
Accumulated other comprehensive loss (255) (269)
Accumulated deficit (127,840) (134,613)
Treasury stock, at cost, 4,220 shares (14,062) (14,062)
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Total stockholders' equity 20,115 13,808
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Total liabilities and stockholders' equity $ 40,488 $ 32,792
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</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 June 30,
----------------------------------------
1998 1999
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<S> <C> <C>
Revenues $ 9,533 $ 13,072
Cost of revenues 2,519 3,885
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Gross profit 7,014 9,187
Operating expenses:
Research and development 5,523 7,659
Sales and marketing 1,875 5,336
General and administrative 2,488 2,696
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Total operating expenses 9,886 15,691
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Operating loss $ (2,872) $ (6,504)
Net interest and other income (expense) 435 (114)
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Loss before income and foreign withholding taxes (2,437) (6,618)
Income and foreign withholding taxes 130 155
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Net loss $ (2,567) $ (6,773)
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Basic net loss per share $ (0.10) $ (0.26)
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Diluted net loss per share $ (0.10) $ (0.26)
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Shares used to compute basic net loss per share 25,653 25,641
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Shares used to compute diluted net loss per share 25,653 25,641
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</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>
Three Months Ended June 30,
---------------------------------------
1998 1999
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<S> <C> <C>
Cash flows from operating activities:
Net profit (loss) $(2,567) $(6,773)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 738 573
Deferred revenue (248) (116)
Changes in operating assets and liabilities:
Accounts receivable, net (6,175) 8,942
Prepaid and other assets (1,018) (62)
Accounts payable 8 (636)
Accrued expenses 2,369 1,417
Other liabilities (1,215) (423)
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Net cash provided by (used in) operating activities (8,108) 2,922
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Cash flows from investing activities:
Short-term investments, net (6,189) 9,552
Capital expenditures (594) (1,164)
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Net cash provided by (used in) investing activities (6,783) 8,388
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Cash flows from financing activities:
Repayment of short-term debt -- (9,505)
Proceeds from long-term debt -- 7,888
Proceeds from issuance of common stock, net 599 480
Payments on capital lease obligations (264) (14)
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Net cash provided by (used in) financing activities 335 (1,151)
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Net increase (decrease) in cash and cash equivalents (14,556) 10,159
Cash and cash equivalents at beginning of period 16,209 2,256
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Cash and cash equivalents at end of period $ 1,653 $12,415
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Supplemental cash flow information:
Cash paid during the period for:
Interest $ 6 $ 236
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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THE 3DO COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - GENERAL
The condensed consolidated financial statements of The 3DO Company, a
Delaware corporation (the "Company"), as of June 30, 1999 and for the quarter
ended June 30, 1998 and 1999 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, 1999. The results of
operations for the quarter ended June 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 February 1998, the Accounting Standards Executive Committee (AcSEC) of the
AICPA issued SOP 98-4, DEFERRAL OF THE EFFECTIVE DATE OF SOP 97-2. The SOP
defers the effective date for applying the provisions regarding
vendor-specific objective evidence (VSOE) of fair value until fiscal years
beginning after December 15, 1998.
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 is not expected to have a material impact on
the Company.
NOTE 3 - NET 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 outstanding and,
when dilutive, 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>
THREE MONTHS ENDED
JUNE 30,
-----------------------------------
1998 1999
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<S> <C> <C>
Net loss $ (2,567) $ (6,773)
Shares used to compute basic net loss per share - Weighted-average
number of common shares outstanding 25,653 25,641
Effect of stock options outstanding using the treasury stock method -- --
--------------- --------------
Shares used to compute diluted net loss per share 25,653 25,641
Basic net loss per share $ (0.10) $ (0.26)
Diluted net loss per share $ (0.10) $ (0.26)
</TABLE>
Options to purchase 8,616,790 shares of common stock were excluded from the
Company's dilutive net loss per share calculations for the quarter ended June
30, 1998 because their effect was anti-dilutive. These anti-dilutive shares
had weighted average exercise prices of $3.08 for quarter ended June 30,
1998. Options to purchase 11,542,151 shares of common stock were excluded
from the Company's dilutive net loss per share calculations for the quarter
ended June 30, 1999 because their effect was anti-dilutive. These
anti-dilutive shares had weighted average exercise prices of $3.45 for the
quarter ended June 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
(in thousand) JUNE 30,
-------------------------------
1998 1999
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<S> <C> <C>
Net loss $ (2,567) $ (6,773)
Unrealized loss on marketable securities (3) (14)
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Total comprehensive loss $ (2,570) $ (6,787)
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</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 for fiscal years beginning after
December 15, 1998. The Company does not expect the adoption of SOP No. 98-1
to have a material impact on its results of operations or financial condition.
7
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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
JUNE 30,
---------------------------------
1998 1999
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<S> <C> <C>
Revenues:
PC $ 9,255 $ 7,111
Console -- 5,869
Other 278 92
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Total revenues $ 9,533 $ 13,072
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</TABLE>
During the first quarter of fiscal 1999, the Company's five top customers
each accounted for approximately 24%, 14%, 13%, 13% and 10%, respectively, of
the Company's total revenues. For the three months ended June 30, 1999, the
Company's two top customers each accounted for approximately 12% and 11%,
respectively.
The Company's export sales, primarily to Japan and the United Kingdom, were
approximately $0.9 million and $1.8 million, or 10% and 13% of total revenues
for the quarter ended June 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% (7.23% as of June 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 June
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
(9.75% as of June 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.
As of June 30, 1999, the Company's outstanding loan balance with Coast
Business Credit was $7.9 million.
FOOTNOTE 7 - SUBSEQUENT EVENT
8
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In July and August 1999, the Company completed a public offering of 9,085,000
shares of its common stock at $5.44 per share, raising approximately $46.2
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.
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
9
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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 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 $3.5 million, or 37%, to $13.1 million for
the quarter ended June 30, 1999 from $9.5 million for the same quarter fiscal
1999. 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 personal computer comprised 54% of revenues in
the quarter ended June 30, 1999. Sales of titles for video game console
platforms comprised 45% of revenue and sales of other products comprised 1%
of revenue. Sales of interactive entertainment software for personal
computer comprised 97% of revenues and sales of other products comprised of
3% of revenues for the quarter ended June 30, 1998. We had no revenue from
sales of titles for video game console platforms for the quarter ended June
30, 1998.
COST OF REVENUES. Cost of revenues increased by $1.4 million, or 54%, to $3.9
million for the three months ended June 30, 1999 from $2.5 million for the
three months ended June 30, 1998. 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 $2.2 million, or 39%, to $7.7 million for the current quarter
from $5.5 million for same quarter prior year. This increase was principally
due to higher on-going development expenses as we continued to expand our
product development efforts and began to develop products for video game
console systems in addition to the personal computer.
SALES AND MARKETING. Sales and marketing expenses increased from $1.9 million
for the three months ended June 30, 1998 to $5.3 million for the three months
ended June 30, 1999. The increase of $3.5 million, or 185%, was primarily due to
our increased marketing expenses for new
10
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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 quarter. 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
$0.2 million, or 8%, to $2.7 million for the three months ended June 30, 1999,
from $2.5 million for the same prior period. 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 and Nintendo N64 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
$0.5 million from an income of $0.4 million for the quarter ended June 30,
1998 to an expense of $0.1 for the quarter ended June 30, 1999. 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 in the current
quarter.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash and cash equivalent balances and
short-term investment balances, which were $14.4 million at June 30, 1999 and
$13.9 million at March 31, 1999. This decrease was due primarily due to cash
used in operations of $14.2 million, capital expenditures of $1.1 million and
inventory purchased of $3.8 million, offset by net cash received from
operations of $19.7 million.
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% (9.75% as of June 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 June 30, 1999, our outstanding loan
balance under this facility was $7.9 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%
(7.23% as of June 30, 1999). This line of credit expires in November 2000. As
of June 30, 1999, no borrowings were outstanding under this facility.
In July and August 1999, we completed a public offering of our common stock,
raising approximately $46.2 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. 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
anticipate that the net proceeds of the secondary offering of our common
stock, cash from operations, and available borrowings under our credit
facilities should be sufficient to fund our activities for at least the next
12 months. 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.
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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 substantially 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 essentially complete. An automated
final sweep of all desktop hardware and software is scheduled during
August 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.
As of June 30, 1999, our overall progress by phase was as follows:
<TABLE>
<CAPTION>
PERCENTAGE COMPLETED EXPECTED
PHASE AS OF JUNE 30, 1999 COMPLETION DATE
---------------------------- ----------------------------- -------------------
<S> <C> <C>
Phase 1 - Inventory 98% August 1999
Phase 2 - Risk Assessment 85% September 1999
Phase 3 - Remediation Planning 40% September 1999
Phase 4 - Remediation 15% October 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. To
date, we have received responses from more than half of our critical
suppliers, manufacturers, distributors and other vendors. These responses
have been analyzed as they arrive. We are in the process of contacting
significant parties who have not responded.
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 September 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 is in the process of
developing tests for all of our significant products to determine the effects
of the Year 2000 change. We have developed tests for these products and
expect to complete testing of all of our current products by September 1999.
While we expect to find few date-related issues with our products, we have
not fully identified such impact and may or may not incur expenses related to
the remediation of Year 2000 problems in our existing products.
COST
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We expect to incur costs during the next two quarters 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 $0.5 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 currently expect to
substantially complete remediation and validation of our internal systems, as
well as to develop contingency plans for certain internal systems, by the end
of the second quarter of fiscal 2000. 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.
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 develop contingency plans for key internal systems and critical
business partners by the end of the second quarter of fiscal 2000. 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;
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- 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.
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
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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.
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.
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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 introduced its Dreamcast system in
Japan and expects to introduce it in the United States and Europe in late
1999. 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 recently 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.
- 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.
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OUR SALES AND ACCOUNTS RECEIVABLE ARE CONCENTRATED IN A LIMITED NUMBER OF
CUSTOMERS.
Sales to our five largest customers accounted for approximately 74% of our
revenues for the quarter ended June 30, 1998 and 45% of our revenues for the
quarter ended June 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 $1.7 million for the quarter ended June 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 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
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may not generate additional revenues from international sales, while our
expenses may have already increased. This could have an adverse impact on our
profitability.
We are in the process of negotiating for licenses from Sony and Nintendo to
sell our products in Europe. We cannot be certain that we will be able to
obtain these licenses on acceptable terms.
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.
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.
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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.
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 have not yet adopted a Year 2000 contingency plan.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
19
<PAGE>
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 July and August 1999, we completed a public offering our common stock,
raising approximately $46.2 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;
- 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.
20
<PAGE>
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 and short-term
investments 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 and short-term investments 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 June 30,
1999:
<TABLE>
<CAPTION>
Average
Short-term investments(1) Interest Rate Cost Fair Value
---------------- ----------------- -----------------
<S> <C> <C> <C>
Fixed rate 5.62% $ 1,993 $ 2,031
</TABLE>
(1) See definition in Note A to our Consolidated Financial
Statements.
The aggregate fair value of the our investment in short-term investments as
of June 30, 1999, by contractual maturity date, consisted of the following:
<TABLE>
<CAPTION>
AGGREGATE FAIR
VALUE
-----
(in thousands)
<S> <C>
Due in one to three years....................................................... $ 2,031
</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 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.
21
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE 3DO COMPANY
Dated: August 13, 1999 /S/ JOHN ADAMS
------------------------------------------
John Adams
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
(Duly authorized officer)
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE 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 STATMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 12,415
<SECURITIES> 2,031
<RECEIVABLES> 16,381
<ALLOWANCES> 4,546
<INVENTORY> 657
<CURRENT-ASSETS> 27,648
<PP&E> 15,377
<DEPRECIATION> 11,357
<TOTAL-ASSETS> 32,792
<CURRENT-LIABILITIES> 11,096
<BONDS> 0
0
0
<COMMON> 299
<OTHER-SE> (269)
<TOTAL-LIABILITY-AND-EQUITY> 40,488
<SALES> 13,072
<TOTAL-REVENUES> 13,072
<CGS> 3,885
<TOTAL-COSTS> 15,691
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 236
<INCOME-PRETAX> (6,618)
<INCOME-TAX> 155
<INCOME-CONTINUING> (6,773)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,773)
<EPS-BASIC> (0.26)
<EPS-DILUTED> (0.26)
</TABLE>
