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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, 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 July 31, 2000, the number of outstanding shares of the registrants'
common stock was 36,866,871.
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THE 3DO COMPANY
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2000 and June 30, 2000 3
Condensed Consolidated Statements of Operations for the three months ended June 30, 1999 and 2000 4
Condensed Consolidated Statements of Cash Flows for the three months ended June 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 20
PART II OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 21
</TABLE>
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PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THE 3DO COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
March 31, June 30,
2000 2000
---------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,772 $ 15,121
Short-term investments -- 2,024
Accounts receivable, net of allowances of $10,907 and $7,371, respectively 51,760 25,378
Inventory 7,607 8,177
Prepaid and other current assets 1,986 4,301
---------------- ---------------
Total current assets 83,125 55,001
Property and equipment, net 5,689 6,777
Restricted cash 8,240 6,248
Deposits and other assets 747 685
---------------- ---------------
Total assets $ 97,801 $ 68,711
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,954 $ 998
Accrued expenses 12,222 10,142
Deferred revenue 205 194
Short-term debt 8,579 8,657
Other current liabilities 1,911 1,911
---------------- ---------------
Total current liabilities 24,871 21,902
Long-term liabilities:
Obligations under capital leases 114 $ 89
---------------- ---------------
Total long-term liabilities 114 89
---------------- ---------------
Total liabilities 24,985 21,991
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 41,047
shares issued; 36,689 and 36,827 shares outstanding, respectively 409 410
Additional paid-in capital 214,446 214,944
Accumulated other comprehensive loss (342) (675)
Accumulated deficit (127,635) (153,897)
Treasury stock, at cost, 4,220 shares (14,062) (14,062)
---------------- ---------------
Total stockholders' equity 72,816 46,720
---------------- ---------------
Total liabilities and stockholders' equity $ 97,801 $ 68,711
================ ===============
</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,
---------------------------------
1999 2000
--------------- ----------------
<S> <C> <C>
Revenues $ 13,072 $ 7,856
Cost of revenues 3,885 4,292
--------------- ----------------
Gross profit 9,187 3,564
Operating expenses:
Research and development 7,659 11,214
Sales and marketing 5,336 13,896
General and administrative 2,696 3,950
--------------- ----------------
Total operating expenses 15,691 29,060
--------------- ----------------
Operating loss (6,504) (25,496)
Net interest and other income (114) 52
--------------- ----------------
Loss before income and foreign withholding taxes (6,618) (25,444)
Income and foreign withholding taxes 155 18
--------------- ----------------
Loss before extraordinary charges (6,773) (25,462)
Extraordinary loss from early extinguishment of debt -- 800
--------------- ----------------
Net loss $ (6,773) $ (26,262)
=============== ================
Basic and diluted net loss per share:
Loss before extraordinary charges $ (0.26) $ (0.69)
--------------- ----------------
Extraordinary loss from early extinguishment of debt $ -- $ (0.02)
--------------- ----------------
Net loss $ (0.26) $ (0.71)
=============== ================
Shares used to compute basic net loss per share 25,641 36,747
=============== ================
Shares used to compute diluted net loss per share 25,641 36,747
=============== ================
</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,
---------------------------------------
1999 2000
------------------ ----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (6,773) $ (26,262)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 573 846
Deferred revenue (116) (11)
Changes in operating assets and liabilities:
Accounts receivable, net 8,942 26,382
Prepaid and other assets (279) (2,365)
Inventory 217 (570)
Accounts payable (636) (956)
Accrued expenses 1,417 (2,080)
Other liabilities (423) --
------------------ ----------------
Net cash provided by (used in) operating activities 2,922 (5,016)
------------------ ----------------
Cash flows from investing activities:
Short-term investments, net 9,552 (2,015)
Capital expenditures (1,164) (1,824)
------------------ ----------------
Net cash provided by (used in) investing activities 8,388 (3,839)
------------------ ----------------
Cash flows from financing activities:
Restricted Cash -- 1,992
Repayment of short-term debt (9,505) (8,579)
Proceeds from short-term debt 7,888 8,657
Proceeds from issuance of common stock, net 480 499
Payments on capital lease obligations (14) (25)
------------------ ----------------
Net cash provided by (used in) financing activities (1,151) 2,544
------------------ ----------------
Effect of exchange rate changes on cash and cash equivalents -- (340)
------------------ ----------------
Net increase (decrease) in cash and cash equivalents 10,159 (6,651)
Cash and cash equivalents at beginning of period 2,256 21,772
------------------ ----------------
Cash and cash equivalents at end of period $ 12,415 $ 15,121
================== ================
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 236 $ 505
</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 June 30, 2000 and for the quarters
ended June 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) necessary for the fair presentation of the
financial position and results of operations for the interim periods. Certain
amounts for prior periods have been reclassified to conform to the current
period presentation.
These condensed consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2000.
The results of operations for the quarter ended June 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
(AICPA) issued Statement of Position (SOP) 97-2 SOFTWARE REVENUE RECOGNITION,
which supersedes SOP 91-1. SOP 97-2 is effective for the Company for
transactions entered into after March 31, 1998. SOP 97-2 generally requires
revenue earned on software arrangements involving multiple elements to be
allocated to each element based on the relative fair values of the elements. The
fair value of an element must be based on evidence that is specific to the
vendor. If a vendor does not have evidence of the fair value for all elements in
a multiple-element arrangement, all revenue from the arrangement is deferred
until such evidence exists or until all elements are delivered. The Company has
adopted SOP 97-2 in the prior fiscal year. However, the effect of adopting SOP
97-2 did not have a material impact on the Company's consolidated results of
operations or financial position.
In December 1998, the AICPA issued SOP 98-9, modification of SOP 97-2
SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which
requires recognition of revenue using the "residual method" in a multiple
element arrangement when fair value does not exist for one or more of the
delivered elements in the arrangement. Under the "residual method," the total
fair value of the undelivered elements is deferred and subsequently recognized
in accordance with SOP 97-2. SOP 98-9 is effective for the Company for
transactions entered into after March 31, 1999. The effect of adopting SOP 98-9
did not have a material impact on the Company.
NOTE 3 - NET INCOME (LOSS) PER SHARE
Basic earnings per share is computed using the weighted average number of shares
of common stock outstanding. Diluted earnings per share is computed using the
weighted average number of shares of common stock outstanding and, when
dilutive, options to purchase common stock using the treasury stock method.
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For all periods presented, there were no adjustments to net income (loss), as
reported in the condensed consolidated statements of operations, for the purpose
of determining net income (loss) used in the calculation of basic and diluted
net income (loss) per share. The following is a reconciliation of the
denominators of the basic and diluted earnings per share computations for the
periods presented:
<TABLE>
<CAPTION>
Three Months Ended
(in thousands, except per share amounts) June 30,
---------------------------------
1999 2000
--------------- --------------
<S> <C> <C>
Net loss $ (6,773) $ (26,262)
Shares used to compute basic net loss per share - Weighted-average
number of common shares outstanding 25,641 36,747
Effect of stock options outstanding using the treasury stock method -- --
--------------- --------------
Shares used to compute diluted net loss per share 25,641 36,747
Basic net loss per share $ (0.26) $ (0.71)
Diluted net loss per share $ (0.26) $ (0.71)
</TABLE>
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. Options to purchase 16,308,199 shares
of common stock were excluded from the Company's dilutive net loss per share
calculations for the quarter ended June 30, 2000 because their effect was
anti-dilutive. These anti-dilutive shares had weighted average exercise prices
of $5.94.
NOTE 4 - 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. 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
were reclassified, as required. The Company's total comprehensive losses were as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
-----------------------------
1999 2000
-----------------------------
<S> <C> <C>
Net loss........................................................................ $(6,773) $(26,262)
Change in cumulative translation adjustment..................................... - (342)
Change in unrealized loss on marketable securities.............................. (14) 9
-----------------------------
Total comprehensive loss........................................................ $(6,787) $(26,595)
</TABLE>
NOTE 5 - 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
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 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
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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 adoption of SOP No. 98-1 did not have a material impact on the
results of operations or financial condition.
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 will adopt EITF No.
00-03 in the second quarter of fiscal 2000 and does not expect its adoption to
have a significant impact on the Company.
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. In general, this Interpretation is effective July 1, 2000. The
Company does not expect the adoption of Interpretation No. 44 to have a material
effect on its consolidated financial position or results of operations.
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. The SEC has
recently indicated that it intends to issue further guidance with respect to the
adoption of specific issues addressed by SAB 101. Until such time as this
guidance is issued, the Company is unable to assess the impact, if any, that it
may have on its financial condition or results of operations.
NOTE 6 - 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,
----------------- ------------------
1999 2000
----------------- ------------------
<S> <C> <C>
Revenues:
PC $ 7,111 $ 2,414
Console 5,869 5,382
Other 92 60
================= ==================
Total revenues $ 13,072 $ 7,856
================= ==================
</TABLE>
During the quarter ended June 30, 1999, the Company's two top customers each
accounted for 12% and 11% of revenues, respectively. For the three months ended
June 30, 2000, the Company's three top customers each accounted for 20%, 14% and
11% of revenues, respectively.
The Company's export sales, primarily to Japan and the United Kingdom, were
approximately $1.8 million and $0.7, or 13% and 9% of total revenues for the
quarter ended June 30, 1999 and 2000, respectively. The Company's assets are
primarily located in its corporate office in the United States.
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NOTE 7 - SHORT-TERM DEBT
In April 2000, the Company terminated the Coast Business Credit revolving line
of credit agreement. The early extinguishments 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 June 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 8 - RESTRICTED CASH
As of June 30, 2000, the Company has approximately $6.2 million in restricted
cash. The restricted cash balance primarily consisted of $6.1 million in
short-term investments 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 $0.1 million
was used as collateral against letters of credit for various equipment leases.
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 PlayStation and Nintendo-Registered Trademark- 64 video game
consoles, the Nintendo GameBoy 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-Registered Trademark-, BattleTanx-TM-,
Family Game Pack-Registered Trademark-, Heroes of Might and Magic-Registered
Trademark-, High Heat Baseball-Registered Trademark-, and Might and Magic,
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 competition.
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 consists primarily of direct
costs associated with software titles, including manufacturing costs and
royalties payable to platform developers such as Sony-Registered Trademark-
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 consist primarily 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.
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We expect to continue to incur substantial expenditures to develop our
business in the future. We expect that our operating results will fluctuate as a
result of a wide variety of factors, including the factors described in "Risk
Factors."
This Form-10Q 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 contained in 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, achievements and prospects to be materially
different from those expressed or implied by such forward-looking statements.
These risks, uncertainties and other factors include, among others, those
identified under "Risk Factors" and elsewhere in this Form 10-Q.
These forward-looking statements apply only as of the date of this Form
10-Q. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties, and assumptions,
the forward-looking events discussed in this Form 10-Q might not occur. Our
actual results could differ materially from those anticipated in these
forward-looking statements for many reasons, including the risks faced by us
described above and elsewhere in this prospectus. 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 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 expenses;
- our expectations regarding the effect of recent accounting
pronouncements;
- our expectations regarding product development and releases;
- our expectations regarding the localization of our products for
European countries;
- our expectations regarding the planned increase of sales directly
to retailers in North America:
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- our expectations regarding our expected receipt of increased
revenues in fiscal year 2001;
- our expectations regarding expected increases in gross margin
dollars in fiscal year 2001;
- our expectations regarding our ability to release a large number
of new SKUs or products for existing and new platforms; and
- our ability to fully apply and utilize our Internet patent to
develop a new Internet business model and earn significant profits
in fiscal 2002 and beyond.
- our expectations regarding our maintaining a position of leadership
in revenue growth in the video game industry.
- our ability to increase research and development and marketing
efficiencies related to our core business.
- our expectations regarding profits to be earned from our core
business.
- our ability to release a slate of PlayStation 2 titles concurrently
with the debut of the platform in the U.S.
- our ability to release several new brands, new game genres and to
expand into new market segments.
- our expectations regarding Sony's plan to supply 10 million
PlayStation 2 computer entertainment systems by March 2001, and its
plan to release 5 million PlayStation game consoles by March 2001.
- our expectations regarding the volatility of our revenues in the
first two quarters in fiscal year 2001.
- our ability to identify and conclude appropriate agreements with
several acquisition targets as well as additional strategic
partners.
- our expectations regarding the private placement investment to be
conducted with Trip Hawkins.
RESULTS OF OPERATIONS
REVENUES. Revenues were $7.9 million for the three months ended June 30,
2000, a decrease of $5.2 million, or 40% from $13.1 million for the three
months ended June 30, 1999. The decrease was principally due to the decreased
number of software titles published and distributed during the quarter ended
June 30, 2000 compared to the same quarter in the prior fiscal year.
Moreover, the interactive entertainment software industry has experienced a
slowdown in entertainment software sales as consumers delayed their purchases
pending the release of the highly anticipated PlayStation 2 system expected
in the United Stated in late October 2000. Sales of interactive entertainment
software for the personal computer, video game console platforms and other
products comprised 30%, 69% and 1% for the quarter ended June 30, 2000
compared to 54%, 45% and 1% for the quarter ended June 30, 1999,
respectively. The change in product mix was due primarily to the expansion of
our product lines for the console platforms. For the current fiscal quarter,
the Company revised its price protection reserve to more closely reflect the
Company's historical experience. As a result, the price protection reserve
was $1.7 million lower than if the Company applied the former method of
estimating the price protection reserve.
COST OF REVENUES. Cost of revenues were $4.3 million for the quarter ended
June 30, 2000, an increase of $0.4 million, or 10% from $3.9 million for the
three months ended June 30, 1999. The increase was primarily due to the
change in product mix to 69% of sales derived from the video game console
platforms in the quarter ended March 31, 2000 compared to 45% in the same
quarter last year. The video game console platforms, including the Nintendo
N64, the Sony PlayStation and the Nintendo Game Boy Color, have higher cost
of goods compared to the personal computer platform. Furthermore, software
licensing revenue, which has no associated cost of goods, accounted for 9% of
total revenues for the quarter ended June 30, 2000 compared to 16% for the
same period last year.
RESEARCH AND DEVELOPMENT. Research and development expenses totaled $11.2
million for the three months ended June 30, 2000, an increase of $3.5 million,
or 45%, from $7.7 million for the same period in the prior fiscal year. 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.
SALES AND MARKETING. Sales and marketing expenses grew to $13.9 million for the
quarter ended June 30, 2000, an increase of $8.6 million, or 162% from $5.3
million for the quarter ended June 30, 1999. This increase was primarily due to
marketing expenses related
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to our April 2000 television ad campaigns for all of our major brands
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 $4.0
million for the three months ended June 30, 2000, an increase of $1.3
million, or 48%, from $2.7 million for the same period last year. 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, PlayStation, Nintendo Color GameBoy,
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. Net interest and other income was $0.1 million
for the three months ended June 30, 2000, an increase of $0.2 million compared
to a net loss of $0.1 million for the same period in the prior fiscal year. The
increase in net interest and other income was primarily due to the increase in
cash and short-term investment balances.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital was $33.1 million as of June 30, 2000 compared to $58.1
million as of March 31, 2000. Our principal sources of liquidity are cash and
cash equivalent balances and short-term investment balances, which were $17.1
million at June 30, 2000 and $21.8 million at March 31, 2000. The decrease was
primarily due to the $5.0 million cash used in operating activities and $1.8
million in capital expenditures.
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 June 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 June 30, 2000, our outstanding loan
balance under this facility was $8.7 million.
We expect to incur negative cash flows for the remainder of fiscal 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. We expect that additional capital will be required before the end of
the second quarter of this fiscal year. The level of financing required will
depend on 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. 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;
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- 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.
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 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, GameBoy
Color and PlayStation. Our software designed for personal computers must
maintain compatibility with new personal computers, their operating software
and their
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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
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,
PlayStation, Nintendo 64 and GameBoy Color platforms.
IF WE DO NOT REDUCE COSTS OR PROPERLY ANTICIPATE FUTURE COSTS, OUR GROSS MARGIN
MAY DECLINE.
We anticipate that the average selling prices of our products may
decrease in the future in response to a number of factors, particularly
competitive pricing pressures and sales discounts. Therefore, to control our
gross margin, we must also seek to reduce our costs of production. The costs of
developing new interactive entertainment software have increased in recent years
due to such factors as:
- the increasing complexity and robust content of interactive
entertainment software;
- increasing sophistication of hardware technology and consumer
tastes; and
- increasing costs of licenses for intellectual properties.
If our average selling prices decline, we must also increase the rate
of new product introductions and our unit sales volume to maintain or increase
our revenue. Furthermore, our budgeted research and development and sales and
marketing expenses are partially based on predictions regarding sales of our
products. To the extent that these predictions are inaccurate, our operating
results may suffer.
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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. Sega has recently introduced its Dreamcast
system worldwide, which has received very positive responses from both retailers
and consumers. We recently entered into agreements with UBI Soft Entertainment
and Midway under which UBI Soft and Midway, respectively, will adapt Heroes of
Might and Magic III and Army Men Sarge's Heroes for the Dreamcast System. Sony
recently released the next generation of the PlayStation in Japan, and has
announced plans to release it in the United States in October 2000 and 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 "Dolphin" 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, Midway Games, Inc.,
Take Two Interactive, 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.
For the fiscal year ended March 31, 2000, one customer accounted for
10% or higher of the Company's total revenues compared to two customers for the
fiscal year ended March 31, 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 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 $3.2 million for
the quarter ended June 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 for the PlayStation
game console terminates in September 2001, while 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.
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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.
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 achieve 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 continues to be offered to users for free until August. 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
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may delay the release of our products. Competition for personnel is intense,
especially in the San Francisco Bay area where we maintain our headquarters,
and we cannot be certain that we will successfully attract and retain
additional qualified personnel.
OUR INTERNAL DESIGN STUDIOS AND OUR MANUFACTURING SOURCES ARE VULNERABLE TO
DAMAGE FROM NATURAL DISASTERS.
All of our internal design studios and most of our manufacturing
sources are vulnerable to damage from fire, floods, earthquakes, power loss,
telecommunications failures and similar events. Our California internal design
studios are located on or near known earthquake fault zones. If a natural
disaster occurs, our ability to develop and distribute our products would be
seriously, if not completely, impaired. The insurance we maintain against fires,
floods, earthquakes and general business interruptions may not be adequate to
cover our losses in any particular case.
ILLEGAL COPYING OF OUR SOFTWARE ADVERSELY AFFECTS OUR SALES.
Although we use copy-protection devices, an unauthorized person may be
able to copy our software or otherwise obtain and use our proprietary
information. If a significant amount of illegal copying of software published or
distributed by us occurs, our product sales could be adversely impacted.
Policing illegal use of software is extremely difficult, and software piracy is
expected to persist. In addition, the laws of some foreign countries in which
our software is distributed do not protect us and our intellectual property
rights to the same extent as the laws of the U.S.
WE MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
As the number of interactive entertainment software products in the
industry increases and the features and content of these products further
overlap, software developers may increasingly become subject to infringement
claims. Although we make reasonable efforts to ensure that our products do not
violate the intellectual property rights of others, we cannot be certain that
claims of infringement will not be made. Any such claims, with or without merit,
can be time consuming and expensive to defend. From time to time, we have
received communications from third parties asserting that features or content of
certain of our products may infringe upon their intellectual property rights. We
cannot be certain that existing or future infringement claims against us will
not result in costly litigation or require us to seek to license the
intellectual property rights of third parties, which licenses may not be
available on acceptable terms, if at all.
WE DEPEND ON LICENSES FROM THIRD PARTIES FOR THE DEVELOPMENT OF ONE OF OUR
BRANDS.
We license various rights for use in our High Heat Baseball brand. If
we were unable to maintain or renew those licenses, we would be unable to
release additional sequels and line extensions for that brand.
RATING SYSTEMS FOR INTERACTIVE ENTERTAINMENT SOFTWARE, GOVERNMENT CENSORSHIP OR
RETAILER RESISTANCE TO VIOLENT GAMES COULD INHIBIT OUR SALES OR INCREASE OUR
COSTS.
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.
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THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
Disclosures of our operating results (particularly if below the
estimates of securities industry analysts), announcements of various events by
us or our competitors, and the development and marketing of new titles affecting
the interactive entertainment software industry, as well as other factors, may
cause the market price of our common stock to change significantly over short
periods of time.
OUR FUTURE CAPITAL NEEDS ARE UNCERTAIN AND WE MAY NOT BE ABLE TO SATISFY THEM.
During our second fiscal year quarter, we anticipate that we will 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
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.
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.
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ANTI-TAKEOVER PROVISIONS MAY PREVENT AN ACQUISITION.
Provisions of our Amended and Restated Certificate of Incorporation,
Bylaws and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. We place our investments with high quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We are
averse to principal loss and ensure the safety and preservation of our invested
funds by limiting default, market and reinvestment risk. We classify our cash
equivalents, short-term investments and restricted cash as fixed-rate if the
rate of return on such instruments remains fixed over their term. These
fixed-rate investments include fixed-rate U.S. government securities, municipal
bonds, time deposits and certificates of deposit. We classify our cash
equivalents, short-term investments and restricted cash as variable-rate if the
rate of return on such investments varies based on the change in a predetermined
index or set of indices during their term. These variable-rate investments
primarily include money market accounts held at various securities brokers and
banks. The table below presents the amounts and related weighted interest rates
of our investment portfolio at June 30, 2000:
<TABLE>
<CAPTION>
Average
Interest Rate Cost Fair Value
---------------- ----------------- -----------------
(in thousands) (in thousands)
<S> <C> <C> <C>
Fixed rate 6.38% $ 8,241 $ 8,272
</TABLE>
The aggregate fair value of our restricted cash as of June 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..................................... $ 6,271
Due in one to three years................................... $ 2,001
</TABLE>
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company engages in certain legal actions arising in the ordinary course
of business. The Company believes it has adequate legal defenses and believes
that the ultimate outcome of these actions will not have a material effect on
the Company's financial position or results of operations, although there can be
no assurance as to the outcome of such litigation.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS
Not applicable with respect to the current reporting period.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable with respect to the current reporting period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable with respect to the current reporting period.
ITEM 5. OTHER INFORMATION.
Not applicable with respect to the current reporting period.
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 27.01 Financial Data Schedule
(b) No Current Reports on Form 8-K were filed during the quarter ended
June 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: August 11, 2000 /S/ KATHLEEN R. MCELWEE
---------------------------------
Kathleen R. McElwee
Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
(Duly authorized officer)
21
