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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______.
Commission file number 0-21336
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, 2000, the number of outstanding shares of the registrants'
common stock was 46,889,878.
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THE 3DO COMPANY
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2000 and September 30, 2000 3
Condensed Consolidated Statements of Operations for the three and six months ended September 30, 1999 4
and 2000
Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 1999 and 2000 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 2. Change in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 23
</TABLE>
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE 3DO COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
March 31, September 30,
2000 2000
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,772 $ 10,526
Accounts receivable, net of allowances of $10,907 and $6,399, respectively 51,760 31,885
Inventory 7,607 4,970
Prepaid inventory -- 4,637
Prepaid and other current assets 1,986 5,799
--------------- ---------------
Total current assets 83,125 57,817
Property and equipment, net 5,689 10,826
Restricted cash 8,240 6,777
Deposits and other assets 747 527
--------------- ---------------
Total assets $ 97,801 $ 75,947
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,954 $ 1,550
Accrued expenses 12,222 15,225
Deferred revenue 205 364
Short-term debt 8,579 3,467
Other current liabilities 2,025 1,557
--------------- ---------------
Total current liabilities 24,985 22,163
--------------- ---------------
Total liabilities 24,985 22,163
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; no shares issued -- --
Common stock, $.01 par value; 125,000 shares authorized; 40,909 and
44,642 shares issued; 36,689 and 40,421 shares outstanding, respectively 409 446
Additional paid-in capital 214,446 239,202
Accumulated other comprehensive loss (342) (1,172)
Accumulated deficit (127,635) (170,630)
Treasury stock, at cost, 4,220 shares (14,062) (14,062)
--------------- ---------------
Total stockholders' equity 72,816 53,784
--------------- ---------------
Total liabilities and stockholders' equity $ 97,801 $ 75,947
=============== ===============
</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,
------------------------------ ----------------------------
1999 2000 1999 2000
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 20,705 $ 22,935 $ 33,777 $ 30,791
Cost of revenues 8,701 14,744 12,586 19,036
-------------- -------------- ------------- -------------
Gross profit 12,004 8,191 21,191 11,755
Operating expenses:
Research and development 9,302 11,657 16,960 22,872
Sales and marketing 5,511 7,615 10,848 21,510
General and administrative 3,052 3,827 5,748 7,777
-------------- -------------- ------------- -------------
Total operating expenses 17,865 23,099 33,556 52,159
-------------- -------------- ------------- -------------
Operating loss $ (5,861) $(14,908) $(12,365) $(40,404)
Amortization of warrant issuance -- (1,557) -- (1,557)
Net interest and other income (expense) 105 (268) (9) (216)
-------------- -------------- ------------- -------------
Loss before income and foreign withholding taxes (5,756) (16,733) (12,374) (42,177)
Income and foreign withholding taxes 167 -- 322 18
-------------- -------------- ------------- -------------
Loss before extraordinary charges (5,923) (16,733) (12,696) (42,195)
Extraordinary loss from early extinguishment of debt -- -- -- 800
-------------- -------------- ------------- -------------
Net loss $ (5,923) $ (16,733) $ (12,696) $(42,995)
============== ============== ============= =============
Basic and diluted net loss per share:
Loss before extraordinary charges $ (0.18) $ (0.45) $ (0.44) $ (1.14)
-------------- -------------- ------------- -------------
Extraordinary loss from early extinguishment of debt -- -- -- (0.02)
-------------- -------------- ------------- -------------
Net loss per share $ (0.18) $ (0.45) $ (0.44) $ (1.16)
============== ============== ============= =============
Shares used to compute basic net loss per share 32,349 37,483 28,995 37,115
============== ============== ============= =============
Shares used to compute diluted net loss per share 32,349 37,483 28,995 37,115
============== ============== ============= =============
</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,
---------------------------------------
1999 2000
------------------ ----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (12,696) $ (42,995)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,186 1,762
Deferred revenue 101 159
Amortization of warrant issuance -- 1,557
Changes in operating assets and liabilities:
Accounts receivable, net 696 19,875
Prepaid and other assets (4,754) (3,817)
Prepaid inventory -- (4,637)
Inventory (3,444) 2,637
Accounts payable (1,099) (404)
Accrued expenses 4,928 3,003
Other liabilities (443) (411)
------------------ ----------------
Net cash used in operating activities (15,525) (23,271)
------------------ ----------------
Cash flows from investing activities:
Short-term investments, net 11,621 39
Capital expenditures (2,064) (6,675)
------------------ ----------------
Net cash provided by (used in) investing activities 9,557 (6,636)
------------------ ----------------
Cash flows from financing activities:
Restricted cash (8,055) 1,463
Repayment of short-term debt (9,438) (5,112)
Proceeds from issuance of convertible debt -- 20,000
Proceeds from secondary offering, net 46,403 --
Proceeds from issuance of common stock, net 2,747 3,234
Payments on capital lease obligations (25) (55)
------------------ ----------------
Net cash provided by financing activities 31,632 19,530
------------------ ----------------
Effect of exchange rate on cash 67 (869)
------------------ ----------------
Net increase (decrease) in cash and cash equivalents 25,731 (11,246)
Cash and cash equivalents at beginning of period 2,256 21,772
------------------ ----------------
Cash and cash equivalents at end of period $ 27,987 $ 10,526
================== ================
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 468 $ 781
================== ================
</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, 2000 and for the quarters and
six months ended September 30, 1999 and 2000 are unaudited. In the opinion of
management, these condensed consolidated financial statements include all
adjustments (consisting of only normal recurring items, except where indicated)
necessary for the fair presentation of the financial position and results of
operations for the interim periods.
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, 2000. The results of
operations for the quarter and six months ended September 30, 2000 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 adopted SOP 97-2 in the prior fiscal
year. 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, the AICPA 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 - CAPITALIZED SOFTWARE
Capitalization of internal software development costs begins upon establishment
of technological feasibility and ceases when the product is available for
general release to customers. Technological feasibility is established by the
completion of a detailed program design, or in its absence, a working model of
the product. To date, the establishment of technological feasibility for
internal development projects has substantially coincided with general release
and the Company has not capitalized any software development costs on internal
development projects as the eligible costs are immaterial. External development
costs are capitalized once technological feasibility is established or if the
development costs have an alternative future use. The criteria for establishing
technological feasibility for external development projects is consistent with
that used for internal development projects noted above. In the current quarter
the Company began utilizing external developers to translate existing products
to alternate platforms and to localize existing products into various foreign
languages. Technological feasibility of the translated and localized products
was established by the existing products and as a result the Company capitalized
approximately $1.2 million of external development costs during the quarter
ended September 30, 2000. Amortization of capitalized software costs is
recognized on a straight-line basis over the estimated economic lives of the
related products or the amount computed using the ratio of current gross
revenues for a product to the total of current and anticipated future gross
revenues for that product, whichever is greater, and is included in cost of
revenues.
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NOTE 4 - NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number of shares
of common stock outstanding. Diluted net loss 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.
For all periods presented, there were no adjustments to net loss, as reported in
the condensed consolidated statements of operations, for the purpose of
determining net loss used in the calculation of basic and diluted net income
loss per share. 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,
------------------------- ---------------------------
1999 2000 1999 2000
----------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
Net loss $(5,923) $(16,733) $(12,696) $(42,995)
Shares used to compute basic net loss per share - Weighted
average number of common shares outstanding 32,349 37,483 28,995 37,115
Effect of stock options outstanding using the treasury
stock method -- -- -- --
----------- ---------- ------------ ------------
Shares used to compute diluted net loss per share 32,349 37,483 28,995 37,115
Basic net loss per share $ (0.18) $ (0.45) $ (0.44) $ (1.16)
Diluted net loss per share $ (0.18) $ (0.45) $ (0.44) $ (1.16)
</TABLE>
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. Options to purchase 16,133,469
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, 2000
because their effect was anti-dilutive. These anti-dilutive shares had weighted
average exercise prices of $5.41 for the quarter and six months ended September
30, 2000.
NOTE 5 - COMPREHENSIVE INCOME
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.
The Company's total comprehensive losses were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
1999 2000 1999 2000
------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss $ (5,923) $ (16,733) $ (12,696) $(42,995)
Change in cumulative translation adjustment 67 (526) 67 (869)
Change in unrealized loss on marketable securities 38 30 25 39
------------- ------------ ------------ ------------
Total comprehensive loss $ (5,818) $ (17,229) $ (12,604) $(43,825)
============= ============ ============ ============
</TABLE>
NOTE 6 - RECENT ACCOUNTING PRONOUNCEMENTS
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
7
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accounting. SFAS No. 133, as amended by SFAS No.137 and SFAS No. 138, 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 2000, the EITF published their consensus on EITF Issue No. 00-3,
Application of AICPA Statement of Position 97-2, Software Revenue
Recognition, to Arrangements That Include the Right to Use Software Stored on
Another Entity's Hardware. The Issue states that a software element covered
by SOP 97-2 is only present in a hosting arrangement if the customer has the
contractual right to take possession of the software at any time during the
hosting period without significant penalty and it is feasible for the
customer to either run the software on its own hardware or contract with
another party unrelated to the vendor to host the software. The Company
adopted EITF No. 00-03 in the second quarter of fiscal 2001 and it did not
have a material impact on the results of operations or financial condition.
In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation, an interpretation of APB Opinion
No. 25. This Interpretation clarifies the application of Opinion 25 for
certain issues including: (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequence of
various modifications to the terms of a previously fixed stock option or
award, and (d) the accounting for an exchange of stock compensation awards in
a business combination. The Company adopted Interpretation No. 44 in the
second quarter of fiscal 2001 and it did not have a material impact on the
results of operations or financial condition.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements.
In October 2000, the SEC Staff released a frequently asked questions document
to provide additional guidance on implementing SAB 101. The Company will
adopt SAB101 no later than the quarter ended March 31, 2001 and is currently
assessing the impact, if any, that it may have on its financial condition or
results of operations.
NOTE 7 - 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,
-------------- --------------- -----------------------------
1999 2000 1999 2000
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
PC $ 4,363 $ 4,003 $ 11,473 $ 6,418
Console 16,242 18,744 22,111 24,126
Other 100 188 193 247
-------------- --------------- -------------- --------------
Total revenues $ 20,705 $ 22,935 $ 33,777 $ 30,791
============== =============== ============== ==============
</TABLE>
During the quarter ended September 30, 1999, the Company's two top customers
each accounted for 20% and 12% of revenues. For the six months ended September
30, 1999, the Company had one customer that accounted for 17% of revenues.
During the three months ended September 30, 2000, the Company's three top
customers each accounted for 14%, 10% and 10% of revenues. For the six months
ended September 30, 2000, the Company's two top customers each accounted for 14%
and 10% of revenues.
The Company's export sales, primarily to Japan and the United Kingdom, were
approximately $2.0 million and $1.1 million, or 10% and 5% of total revenues for
the quarters ended September 30, 1999 and 2000, and were approximately $3.8
million and $1.6 million, or 11% and 5% of total revenues for the six months
ended September 30, 1999 and 2000, respectively. The Company's assets are
primarily located in its corporate office in the United States.
8
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NOTE 8 - LINES OF CREDIT
In April 2000, the Company terminated the Coast Business Credit revolving line
of credit agreement. The early extinguishment of this line of credit resulted in
an extraordinary charge of $0.8 million for the termination fees paid.
Concurrently, the Company entered into a revolving line of credit with Foothill
Capital.
The Foothill Capital credit facility allows the Company to borrow up to $50.0
million, or 85% of qualified accounts receivables, bearing an interest rate of
Prime Rate plus 0.25% to 1.25% per annum (10.25% as of September 30, 2000)
depending on the company's tangible net worth 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 maintains tangible net
worth of not less than $40 million.
NOTE 9 - RESTRICTED CASH
As of September 30, 2000, the Company has approximately $6.8 million in
restricted cash. The restricted cash balance primarily consisted of $6.1 million
in short-term investments and collateralized against the letter of credit on a
twelve-year lease for a new office facility. The Company entered into the lease
with Cornerstone Properties, Inc. in December 1999. The remaining $0.7 million
was used as collateral against letters of credit for various equipment leases.
NOTE 10 - CONVERTIBLE DEBT
On August 16, 2000 the Company sold a $2 million convertible promissory note to
the Company's Chief Executive Officer and Chairman of the Board, William M.
(Trip) Hawkins III. The note was due and payable upon the earlier of demand by
the holder or August 16, 2003, accrued interest at 10.25% and was convertible
into shares of Common Stock at a price of $6.9375 per share. On September 13,
2000 the note and accrued interest were converted into 290,474 shares of Common
Stock.
On August 23, 2000 the Company sold an $18 million convertible promissory note
to Mr. Hawkins. The note was due and payable upon the earlier of demand by the
holder or August 23, 2003, accrued interest at 10.25% and was convertible into
shares of Common Stock at a price of $6.9375 per share. On September 13, 2000
the note and accrued interest were converted into 2,609,167 shares of Common
Stock.
Associated with the issuance of the promissory notes, the company issued 432,432
warrants to Mr. Hawkins at a exercise price of $20 per share. These warrants
have a five year term. Using the Black Scholes valuation model, the company
estimated the fair value of the warrants at $3.60 per share and expensed $1.6
million associated with the issuance.
NOTE 10 - SUBSEQUENT EVENT
On October 31, 2000 the Company sold 6,464,647 shares of Common Stock at the
stock's closing price that day of $3.09375 per share. As part of the transaction
the Company also issued 1,292,929 warrants with an exercise price of $3.7125 per
share. The Company's Chief Executive Officer and Chairman of the Board, William
M. (Trip) Hawkins III, purchased 4,848,485 of these shares and was issued
969,997 warrants on terms equivalent with third party purchasers.
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 the Sony PlayStation and Nintendo 64 video game consoles, the Nintendo
Game Boy Color hand-held video game system, and on personal computers and the
Internet. We are also developing 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 currently include Army Men,
Heroes, High Heat Baseball, Might and Magic, Vegas Games and World Destruction
League, many of which have won industry awards. Our software products cover a
variety of genres, including action, strategy, adventure/role playing, sports
and family entertainment. We develop the vast majority of our software
internally in our company-owned studios and have created an extensive portfolio
of versatile technologies that we believe allow us to develop new software
titles more quickly and cost-effectively than our
9
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competition. Periodically we utilize external developers and contractors who
possess specific skills to supplement our internal development efforts when
management deems it cost effective.
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 licensing agreement. Per-copy royalties that
exceed guaranteed minimum royalty levels are recognized as earned. We
recognized revenue from our Meridian 59 online service monthly upon
customers' usage.
Cost of software publishing revenues consist 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 and licensors. 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 relate to the development of new products
and consist primarily of direct and indirect salaries and wages of software
research and development personnel, direct research and development expenses,
and amounts paid to outside developers. Software development costs that are
not capitalized are expensed as incurred. Capitalization of internal software
development costs begins upon establishment of technological feasibility and
ceases when the product is available for general release to customers.
Technological feasibility is established by the completion of a detailed
program design, or in its absence, a working model of the product. To date,
the establishment of technological feasibility for internal development
projects has substantially coincided with general release and the Company has
not capitalized any software development costs on internal development
projects, as the eligible costs are immaterial. External development costs
are capitalized once technological feasibility is established or if the
development costs have an alternative future use. The criteria for
establishing technological feasibility for external development projects is
consistent with that used for internal development projects noted above. In
the current quarter the Company began utilizing external developers to
translate existing products to alternate platforms and to localize existing
products into various foreign languages. Technological feasibility of the
translated and localized products was established by existing products and as
a result the Company capitalized external development costs during the
quarter ended September 30, 2000. Amortization of capitalized software costs
is recognized on a straight-line basis over the estimated economic lives of
the related products or the amount computed using the ratio of current gross
revenues for a product to the total of current and anticipated future gross
revenues for that product, whichever is greater, and is included in cost of
revenues.
Sales and marketing expenses consist primarily of advertising and retail
marketing support, sales commissions, sales and marketing personnel costs and
other costs.
General and administration expenses consist primarily 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 Resources and Results of Operations" and "Business." Forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors that may cause our actual results, levels of activity, performance,
10
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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-K.
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 10-Q. Such forward-looking statements
include statements as to, among others:
- the timing of the introduction of some new products;
- the expectations regarding the decrease in average selling
prices;
- our expectations that as more advanced platforms are
introduced, consumer demand for software for older platforms
may decline;
- our cash flow from operations and our available credit
facilities;
- our expectations as to our future cash requirements;
- our expectations regarding the future development of our
business;
- our expectations regarding negative cash flows;
- our expectations regarding operating expenses;
- our expectations regarding the effect of recent accounting
pronouncements;
- our expectations regarding product development and releases;
- our ability to fully apply and utilize our Internet patent
to develop a new Internet business model;
- our expectations regarding profits to be earned from our
core business;
- our ability to release a slate of PlayStation 2 titles;
- our ability to release several new brands, new game genres
and to expand into new market segments; and
- our ability to identify and conclude appropriate agreements
with additional strategic partners.
RESULTS OF OPERATIONS
REVENUES. Revenues were $22.9 million for the three months ended September 30,
2000, an increase of $2.2 million, or 11% from $20.7 million for the three
months ended September 30, 1999. The increase was due primarily to an increase
in the number of titles released during the quarter ended September 30, 2000
compared to the same period last year. Revenues were $30.8 million for the six
months ended September 30, 2000, a decrease of $3.0 million, or 9% from $33.8
million for the six months ended September 30, 1999. The decrease is primarily
due to a general slowdown of software sales in the interactive entertainment
industry as consumers delayed their purchases, particularly in the quarter ended
June 30, 2000, pending the release of the highly anticipated Sony PlayStation 2
in October 2000. Sales of interactive entertainment software for the personal
computer, video game console platforms and other products comprised 17%, 82% and
1% for the quarter ended September 30, 2000 compared to 21%, 78% and 1% for the
quarter ended September 30, 1999, respectively. For the six months ended
September 30, 2000, sales of interactive entertainment software for personal
computer, video game console platforms and other products comprised 21%, 78% and
1%, compared to 34%, 65% and 1%, for the same period last year. The change in
product mix was due primarily to the expansion of our product lines for the
console platforms.
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COST OF REVENUES. Cost of revenues were $14.7 million for the quarter ended
September 30, 2000, an increase of $6.0 million, or 69% from $8.7 million for
the three months ended September 30, 1999. For the six months ended September
30, 2000, cost of revenues were $19.0 million, an increase of $6.5 million, or
51% over the prior year amount of $12.6 million. This increase was primarily due
to an increase in the number of units shipped as well as a shift in the product
mix towards video game console products, which have a higher cost of goods.
Furthermore, software licensing revenue, which has no associated cost of goods,
accounted for 6% of total revenues for the quarter ended September 30, 2000
compared to 10% for the same period last year. For the six months ended
September 30, 2000, software licensing accounted for 7% of total revenue
compared to 13% for the same period last year.
RESEARCH AND DEVELOPMENT. Research and development expenses totaled $11.7
million for the three months ended September 30, 2000, an increase of $2.4
million, or 25%, from $9.3 million for the same period in the prior fiscal year.
For the six months ended September 30, 2000, research and development expenses
were $22.9 million, an increase of $5.9 million, or 35% over the prior year
amount of $17.0 million. This increase was primarily due to higher on-going
expenses as we developed more titles for our currently supported platforms and
began to develop products for the next generation video game console systems.
This increase was offset by capitalized external development related to
localization and platform translation costs after individual titles reached
technical feasibility. These capitalized costs were approximately $1.2 million
for the three and six months ended September 30, 2000. We expect research and
development costs to increase as we continue to expand the development of new
products.
SALES AND MARKETING. Sales and marketing expenses grew to $7.6 million for the
quarter ended September 30, 2000, an increase of $2.1 million, or 38% from $5.5
million for the quarter ended September 30, 1999. For the six months ended
September 30, 2000, sales and marketing expenses were $21.5 million, an increase
of $10.7 million, or 98% over the prior year amount of $10.8 million. This
increase was primarily due to marketing expenses related to our television ad
campaigns during July 2000 for Air Combat and during April 2000 for our major
brands that shipped during the fourth quarter of fiscal 2000, including
BattleTanx, Army Men and High Heat Baseball. 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 were $3.8
million for the three months ended September 30, 2000, an increase of $.8
million, or 25%, from $3.1 million for the same period last year. For the six
months ended September 30, 2000, general and administrative expenses were $7.8
million, an increase of $2.1 million, or 35% over the prior year amount of $5.7
million. The increase was primarily due 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, Sony
PlayStation 2, Nintendo Color Game Boy, Nintendo 64 and the next generation
console platforms. We expect that general and administrative expenses will
continue to increase in the future.
NET INTEREST AND OTHER INCOME (EXPENSE). Net interest and other income
(expense), excluding interest associated with a warrant issuance, was a net
expense of $0.3 million for the three months ended September 30, 2000, a
decrease of $0.4 million compared to income of $0.1 million for the three
months ended September 30, 1999. The change consisted of a decrease in
interest income of $0.1 million, an increase in interest expense of $0.1
million and an increase in currency translation loss of $0.2 million for the
three months ended September 30, 2000. For the six months ended September 30,
2000 net interest and other expense was $0.2 million, an increase in expense
of $0.2 million over the same period of the prior year. The change consisted
of an increase in interest income of $0.3 million, an increase in interest
expense of $0.3 million and an increase in currency translation loss of $0.2
million for the six months ended September 30, 2000. The change in interest
income and interest expense was due to fluctuating cash balances and
increased activity on the line of credit. During the three months ended
September 30, 2000, the company recognized interest expense of $1.6 million
associated with the issuance of warrants (see Note 9).
LIQUIDITY AND CAPITAL RESOURCES
Our working capital was $35.7 million as of September 30, 2000 compared to $58.1
million as of March 31, 2000. Our principal sources of liquidity are cash and
cash equivalent balances, which were $10.5 million at September 30, 2000 and
$21.8 million at March 31, 2000. The decrease was primarily due to the $23.2
million cash used in operating activities and $6.7 million in capital
expenditures offset by cash provided by financing activities of $19.5 million.
In April 2000, we terminated the Coast Business Credit revolving line of credit
agreement. Concurrently, we entered into a revolving line of credit with
Foothill Capital. The Foothill Capital credit facility allows us to borrow up to
$50.0 million, or 85% of qualified accounts receivables, bearing an interest
rate of Prime Rate plus 0.25% to 1.25% per annum (10.25% as of September 30,
2000) depending on the company's tangible net worth 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 maintains
tangible net worth of not less than $40.0 million. As of September 30, 2000, our
outstanding loan balance under this facility was $3.5 million.
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We expect to incur negative cash flows for the remainder of the fiscal year
ended March 31, 2001, 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 2001
will be related to marketing and advertising, as we continue to raise the brand
awareness of our products.
In August 2000, the Company sold two convertible promissory notes totaling
$20 million to the Company's Chief Executive Officer and Chairman of the
Board, William M. (Trip) Hawkins III. Associated with the issuance of the
promissory notes, the company issued 432,432 warrants to Mr. Hawkins at a
strike price of $20 per share. The notes were convertible to shares of Common
Stock at a price of $6.9375 per share. In September 2000, the notes and
accrued interest were converted to 2,899,641 shares of Common Stock.
In October 2000, the Company sold 6,464,647 shares of common stock at the
stock's closing price on October 31, 2000 of $3.09375 per share. As part of the
transaction the Company also issued 1,292,929 warrants with an exercise price of
$3.7125 per share. Mr. Hawkins, purchased 4,848,485 of these shares and was
issued 969,997 of the warrants on terms equivalent with third party purchasers.
We believe that existing sources of liquidity and anticipated funds from
operations will satisfy our projected working capital requirements for the
foreseeable future. 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.
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 production and 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.
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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 fourth and first calendar quarters (our third and fourth fiscal quarters)
as a result of increased demand during the year-end and after holiday season. If
we do not achieve strong sales in the second half of each fiscal 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 relationships 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 systems, including the Nintendo 64, Game Boy Color 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 operating systems and hardware
platforms, such as Sony Playstation 2, 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
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development. We may also experience delays in receiving approval
of our games from Sony and Nintendo. Delays in the introduction of products
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 or
refund the purchase price of 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 64 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, Sony PlayStation 2, Nintendo 64 and Game Boy Color platforms.
OUR FUTURE CAPITAL NEEDS ARE UNCERTAIN AND WE MAY NOT BE ABLE TO SATISFY THEM.
During our third fiscal year quarter, we raised an additional $20 million in
equity financing. We believe that existing sources of liquidity and anticipated
funds from operations will satisfy our projected working capital requirements
for the foreseeable future. However, our ability to maintain sufficient
liquidity through fiscal 2001 is particularly dependent on the Company achieving
its projected sales forecasts in the period. If the Company does not
substantially achieve its anticipated sales forecasts or if expenses exceed
current projections for the period, then the Company may need to raise
additional capital, 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 the secondary 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, or take advantage of future
opportunities, or respond to competitive pressures or unanticipated
requirements.
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.
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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. Sony released the next generation
of the PlayStation in Japan earlier this year, in the United States in October
2000, and has announced plans to release it in Europe in November 2000. Nintendo
has stated that it is in the process of developing a new video game platform
currently referred to as the Nintendo "Game Cube" system. 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:
- 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., Lucas Arts Entertainment Company, Take Two
Interactive, Midway Games, Inc., 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.
During fiscal 2000, the Company's top customer each accounted for
14% of revenues. During the three months ended September 30, 2000, the
Company's three top customers each accounted for 14%, 10% and 10% of
revenues. For the six months ended September 30, 2000, the Company's two top
customers each accounted for 14% and 10% of revenues.
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 frequently
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 $2.4 million for the quarter
ended September 30, 2000. 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.
Our license with Sony covering the United States and Canada for the
PlayStation 2 game console terminates in March 2003, while our license covering
the United States for the PlayStation game console terminates in September 2001.
Our License with Nintendo for the publishing of N64 titles in the Western
hemisphere terminates in May 2001. Our license with Sony covering publishing in
the many countries in Europe and the Middle East as well as Australia and New
Zealand expires in December 2005. Our license with Nintendo regarding publishing
for Game Boy Color in the western hemisphere terminates on October 1, 2002, and
for the European Community and select other countries in the former Soviet Union
and South Africa terminates on January 28, 2003. Our license for the N64 system
for the European Community and select countries in the former Soviet Union and
South Africa terminates on November 25, 2002. If any of these licenses were
terminated or not renewed on acceptable terms, we would be unable to develop and
publish software 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.
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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.
During the first quarter of fiscal 2001, we offered a role playing
fantasy game called "Meridian 59," which was a server-based Internet game. This
type of game's software resided on a remote server, and was played only by
accessing that server via the Internet. Meridian 59 did not achieved significant
market penetration. We have provided 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 did not establish that any of
these incentives, the availability of server-based games on the Internet or
whether the expenses we incurred in offering these incentives resulted in
significant growth in the use of our server-based Internet games or would
generate revenues for us in the future. As a result of these factors, we
announced that we would discontinue the availability of Meridian 59 in June. The
product continued to be offered to users for free until September 2000. A number
of software publishers who competed 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.
In December 1999, we were issued a patent which could allow us to
create a new business model in Internet games and entertainment. However, in
order to fully develop the patent's potential, significant investments will be
required in research and development or to obtain rights to Internet-related
technologies. While we have identified potential strategic partners, we have not
entered into any agreements with any of them and we cannot be certain that we
will be able to do so. Without the required investment in research and
development or without obtaining rights regarding technologies that would allow
us to exploit our Internet-related patent, we cannot be certain that we will be
able to fully utilize the patent in a commercially successful manner. In
addition, even if we are able to use the patent in connection with the
development of new Internet games or other forms of interactive entertainment
that are intended to be experienced through the Internet, the development of
such products will require significant additional investment by us. We cannot be
certain that such products will be commercially successful, nor can we even be
certain that our investment in developing and marketing such products will be
recouped by our sales or licenses of such products.
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 the majority of 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.
18
<PAGE>
OUR INTERNAL DESIGN STUDIOS AND OUR MANUFACTURING SOURCES ARE VULNERABLE TO
DAMAGE FROM 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.
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 and in certain foreign jurisdictions to establish mandatory
video game rating systems. Mandatory government-imposed interactive
entertainment software products rating systems may eventually 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.
19
<PAGE>
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.
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 Foothill Capital 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.
20
<PAGE>
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, 2000:
<TABLE>
<CAPTION>
Average
Interest Rate Cost Fair Value
---------------- ----------------- -----------------
(in thousands) (in thousands)
<S> <C> <C> <C>
Fixed rate 5.508% $ 7,589 $ 7,614
</TABLE>
The aggregate fair value of our restricted cash included in our investment
portfolio as of September 30, 2000, by contractual maturity date, consisted of
the following:
<TABLE>
<CAPTION>
AGGREGATE FAIR
VALUE
---------------
(in thousands)
<S> <C>
Due in one year or less......................................................... $ 6,777
</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
On August 16, 2000 the Company sold a $2 million convertible promissory note
to the Company's Chief Executive Officer and Chairman of the Board, William
M. (Trip) Hawkins III. The note is due and payable upon the earlier of demand
by the holder or August 16, 2003, accrued interest at a 10.25% and is
convertible to shares of Common Stock at a price of $6.9375 per share. On
September 13, 2000 the note and accrued interest were converted to 290,474
shares of Common Stock.
On August 23, 2000 the Company sold an $18 million convertible promissory
note to Mr. Hawkins. The note is due and payable upon the earlier of demand
by the holder or August 23, 2003, accrued interest at 10.25% and is
convertible to shares of Common Stock at a price of $6.9375 per share. On
September 13, 2000 the note and accrued interest were converted to 2,609,167
shares of Common Stock.
Associated with the issuance of the promissory notes, the company issued 432,
432 warrants to Mr. Hawkins at a strike price of $20 per share. These warrants
have a five-year term. Using the Black Scholes valuation model, the company
estimated the fair value of the warrants at $3.60 per share and expensed of $1.6
million associated with the issuance.
21
<PAGE>
On October 31, 2000 the Company issued 6,464,647 shares of common stock at the
stock's closing price of $3.09375 per share. As part of the transaction the
Company also issued 1,292,929 warrants with an exercise price of $3.7125 per
share. The Company's Chief Executive Officer and Chairman of the Board, William
M. (Trip) Hawkins III, purchased 4,848,485 of these shares and was issued
969,997 warrants. Mr. Michael Marks, a private investor, purchased 1,616,162 of
these shares and was issued 323,232 warrants.
The exemption from registration relied upon in connection with each of the above
issuances was Section 4(2) of the Securities Act of 1933.
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 October 18, 2000, at the Company's Annual Meeting of Stockholders,
the holders of the Common Stock of the Company elected H. William Jesse, Jr.
as a director of the Company, approved an increase in the number of shares
reserved for issuance under the 1993 Incentive Stock Plan by 8,789,723 shares
in order to replenish shares previously approved by stockholders for issuance
under the plan, approved an increase in the performance based compensation
limitation to 3,000,000 shares under the 1993 Incentive Stock Plan, approved
an amendment to the 1993 Incentive Stock Plan to remove certain restrictions
to the grant of non-statutory stock options, approved an amendment to the
1994 Employee Stock Purchase Plan to increase the number of shares reserved
for issuance by 2,500,000, approved an amendment to the procedure for grants
for the 1995 Director Option Plan; and confirmed the appointment of KPMG LLP
as independent auditors for the fiscal year ending March 31, 2001. The voting
on each matter is set forth below.
1. Votes cast for the election of H. William Jesse, Jr. as a member of the
Company's Board of Directors:
Nominee Votes for Nominee Votes Withheld from Nominee
--------------------- ----------------------- ---------------------------
H. William Jesse, Jr. 33,822,277 979,431
2. Votes cast for approval of an increase in the number of shares reserved for
issuance under the 1993 Incentive Stock Plan by 8,789,723 shares in order to
replenish shares previously approved by stockholders for issuance under the
plan:
For Against Abstain Broker Non-Vote
---------------- ------------------ ------------ --------------------
11,644,532 11,325,282 102,712 11,729,182
3. Votes cast for approval of an increase in the performance based compensation
limitation to 3,000,000 shares under the 1993 Incentive Stock Plan:
For Against Abstain Broker Non-Vote
-------------- ----------------- ----------- ----------------------
31,404,042 2,877,279 520,387 N/A
4. Votes cast for approval of an amendment to the 1993 Incentive Stock Plan to
remove certain restrictions to the granting of non-statutory stock options:
For Against Abstain Broker Non-Vote
-------------- ----------------- ----------- ----------------------
32,280,809 2,001,124 519,775 N/A
5. Votes cast for approval of an amendment to the 1994 Employee Stock
Purchase Plan to increase the number of shares reserved for issuance by
2,500,000:
For Against Abstain Broker Non-Vote
-------------- ----------------- ----------- ----------------------
22,054,784 927,905 89,837 11,729,182
22
<PAGE>
6. Votes cast for an amendment to the procedure for grants under the 1995
Director Option Plan
For Against Abstain Broker Non-Vote
-------------- ----------------- ----------- ----------------------
26,332,072 7,952,381 517,255 N/A
7. Votes cast to confirm the appointment of KPMG LLP as independent auditors for
the fiscal year ending March 31, 2001:
For Against Abstain Broker Non-Vote
-------------- ----------------- ----------- ----------------------
34,641,563 100,419 59,726 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:
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT NAME
NUMBER ------------
-------
<S> <C>
3.01 Certificate of Amendment of the Restated Certificate of Incorporation of The 3DO Company.
10.1 Convertible Note and Warrant Purchase Agreement dated as of August 16, 2000, between the Company and Mr. William
(Trip) Hawkins, III.
10.2 Convertible Promissory Note dated as of August 16, 2000, between the Company and Mr. Hawkins.
10.3 Warrant to purchase 432,432 shares of Common Stock dated as of August 16, 2000, issued by the Company to Mr. Hawkins.
10.4 Convertible Promissory Note dated as of August 23, 2000, between the Company and Mr. Hawkins.
10.5 Stock Purchase Agreement dated as of October 31, 2000, between the Company and Mr. Hawkins.
10.6 Warrant to purchase 969,697 shares of Common Stock, dated October 31, 2000, issued by the Company to Mr. Hawkins.
10.7 Stock Purchase Agreement dated as of October 31, 2000, between the Company and Mr. Michael Marks.
10.8 Warrant to purchase 323,232 shares of Common Stock, dated October 31, 2000, issued by the Company to Mr. Marks.
10.9 Registration Rights Agreement dated as of October 31, 2000, between the Company and Mr. Marks.
27.01 Financial Data Schedule.
</TABLE>
(b) No Current Reports on Form 8-K were filed during the quarter ended
September 30, 2000.
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 14, 2000 /s/ Kathleen R. McElwee
--------------------------------------
Kathleen R. McElwee
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
(Duly authorized officer)
23
