-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Q/xfsIl21deABRH68KKSNw3FIYzMez14st70D7Ju6D3H+cxvxj+LH4+LXV5dfEq6 i1YHif6bh5D/xqp5tQ5FQA== 0001017062-00-001226.txt : 20000516 0001017062-00-001226.hdr.sgml : 20000516 ACCESSION NUMBER: 0001017062-00-001226 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERPLAY ENTERTAINMENT CORP CENTRAL INDEX KEY: 0001057232 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330102707 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24363 FILM NUMBER: 636077 BUSINESS ADDRESS: STREET 1: 16815 VON KARMAN AVE CITY: IRVINE STATE: CA ZIP: 92606 BUSINESS PHONE: 9495536655 MAIL ADDRESS: STREET 1: 16815 VON KARMAN AVE CITY: IRVINE STATE: CA ZIP: 92606 10-Q 1 FORM 10-Q FOR PERIOD END 3/31/00 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2000 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number 0-24363 Interplay Entertainment Corp. (Exact name of the registrant as specified in its charter) Delaware 33-0102707 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 16815 Von Karman Avenue, Irvine, California 92606 (Address of principal executive offices) (949) 553-6655 (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 [_] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Class Issued and Outstanding at May 10, 2000 ----- -------------------------------------- Common Stock, $0.001 par value 30,032,048 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES FORM 10-Q MARCH 31, 2000 TABLE OF CONTENTS ______________
Page Number ----------- Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 2000 (unaudited) and December 31, 1999 3 Consolidated Statements of Operations for the Three Months ended March 31, 2000 and 1999 (unaudited) 4 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2000 and 1999 (unaudited) 5 Notes to Unaudited Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 27 Part II. Other Information Item 1. Legal Proceedings 27 Item 2. Changes in Securities and Use of Proceeds 27 Item 6. Exhibits and Reports on Form 8-K 27 Signatures 28
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, December 31, ASSETS 2000 1999 ------ ------------ -------------- (Unaudited) (Dollars in thousands) Current Assets: Cash and cash equivalents $ 2,455 $ 399 Restricted cash 2,634 2,597 Trade receivables, net of allowances of $7,301 and $9,161, respectively 17,232 22,209 Inventories 4,281 6,057 Prepaid licenses and royalties 19,684 19,249 Other 1,176 874 ----------- ----------- Total current assets 47,462 51,385 Property and Equipment, net 4,266 4,225 Other Assets 1,231 1,326 ----------- ----------- $ 52,959 $ 56,936 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIT - ------------------------------------- Current Liabilities: Current debt $ 20,796 $ 19,630 Accounts payable 16,645 21,462 Accrued liabilities 13,062 17,915 ----------- ----------- Total current liabilities 50,503 59,007 Long-Term Debt, net of current portion 10,000 - Commitments and Contingencies Stockholders' Deficit: Preferred stock, $.001 par value, authorized 5,000,000 shares; issued and outstanding, none - - Common stock, $.001 par value, authorized 50,000,000 shares; issued and outstanding 30,022,538 shares as of March 31, 2000 and 29,989,125 shares as of December 31, 1999 30 30 Paid-in capital 87,411 87,390 Accumulated deficit (95,280) (89,782) Accumulated comprehensive income adjustments 295 291 ----------- ----------- Total stockholders' deficit (7,544) (2,071) ----------- ----------- $ 52,959 $ 56,936 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended March 31, ----------------------------------- 2000 1999 --------------- --------------- (Dollars in thousands, except per share amounts) Net revenues $ 18,143 $ 21,620 Cost of goods sold 9,572 12,566 --------------- --------------- Gross profit 8,571 9,054 Operating expenses: Marketing and sales 4,863 7,544 General and administrative 2,561 3,518 Product development 5,635 5,382 --------------- --------------- Total operating expenses 13,059 16,444 --------------- --------------- Operating loss (4,488) (7,390) Other expense: Interest expense, net (987) (769) Other expense, net (23) (119) --------------- --------------- Total other expense (1,010) (888) --------------- --------------- Net loss $ (5,498) $ (8,278) =============== =============== Net loss per share: Basic and diluted $ (0.18) $ (0.44) =============== =============== Weighted average number of common shares outstanding: Basic and diluted 29,996,585 18,689,344 =============== ===============
The accompanying notes are an integral part of these consolidated financial statements. 4 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended March 31, ------------------------------------- 2000 1999 --------------- ---------------- (Dollars in thousands) Cash flows from operating activities: Net loss $(5,498) $(8,278) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization 765 779 Noncash expense for stock options - 10 Deferred income taxes - (22) Minority interest in loss of subsidiary - (25) Changes in assets and liabilities: Trade receivables 4,977 7,725 Inventories 1,776 (585) Other current assets (302) 685 Other assets - 282 Prepaid licenses and royalties (435) (1,895) Accounts payable (4,817) (4,468) Accrued liabilities (4,853) (270) --------------- ---------------- Net cash used in operating activities (8,387) (6,062) Cash flows from investing activities: Purchase of property and equipment (711) (294) --------------- ---------------- Net cash used in investing activities (711) (294) Cash flows from financing activities: Net borrowings (payments) on line of credit 1,203 (1,758) Net proceeds from issuance of common stock - 9,944 Net proceeds from issuance of notes payable 10,000 - Proceeds from exercise of stock options 21 8 Additions to restricted cash (37) (2,000) Other debt (37) (67) --------------- ---------------- Net cash provided by financing activities 11,150 6,127 --------------- ---------------- Effect of exchange rate changes on cash and cash equivalents 4 (22) --------------- ---------------- Net increase (decrease) in cash and cash equivalents 2,056 (251) Cash and cash equivalents, beginning of period 399 614 --------------- ---------------- Cash and cash equivalents, end of period $ 2,455 $ 363 =============== ================ Supplemental cash flow information: Cash paid for: Interest $ 916 $ 814 Income taxes - - =============== ================
The accompanying notes are an integral part of these consolidated financial statements. 5 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The accompanying interim consolidated financial statements of Interplay Entertainment Corp. and its subsidiaries (the "Company") are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the results for the interim period in accordance with instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1999 as filed with the Securities and Exchange Commission. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made to the prior period's financial statements to conform to classifications used in the current period. Restricted Cash Restricted cash represents cash collateral deposits made in accordance with the Company's Loan and Security Agreement (see Note 3). Restricted cash earns interest at the bank's prime rate (9 percent at March 31, 2000) less three percent (6 percent at March 31, 2000). Revenue Recognition Revenues are recorded when products are delivered to customers in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition". For those agreements that provide the customers the right to multiple copies in exchange for guaranteed amounts, revenue is recognized at the delivery of the product master or the first copy. Per copy royalties on sales that exceed the guarantee are recognized as earned. The Company is generally not contractually obligated to accept returns, except for defective, shelf-worn and damaged products in accordance with negotiated terms. However, the Company permits customers to return or exchange product and may provide price protection on products unsold by a customer. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue Recognition when Right of Return Exists", revenue is recorded net of an allowance for estimated returns, exchanges, markdowns, price concessions, and warranty costs. Such reserves are based upon management's evaluation of historical experience, current industry trends and estimated costs. The amount of reserves ultimately required could differ materially in the near term from the amounts included in the accompanying consolidated financial statements. Customer support provided by the Company is limited to telephone and Internet support. These costs are not material and are charged to expenses as incurred. Recent Accounting Pronouncements In December 1999, the Securities Exchange Commission ("SEC") staff released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition," as amended by SAB No. 101A, to provide guidance on the recognition, presentation and disclosure of revenue in financial statements. SAB No. 101 explains the SEC staff's general framework for revenue recognition, stating that certain criteria be met in order to recognize revenue. SAB No. 101 also addresses the question of gross vs. net revenue presentation and financial statement and Management's Discussion and Analysis disclosures related to revenue recognition. The Company adopted SAB No. 101 effective January 1, 2000 and the adoption of this standard reduced net sales and cost of sales by approximately $800,000 but did not have an impact on the Company's gross profit or net loss for the three months ended March 31, 2000. The Company did not apply this standard to the 1999 period as the impact would have been immaterial to the financial statements taken as a whole. 6 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Factors Affecting Future Performance For the three months ended March 31, 2000, the Company incurred a net loss of $5.5 million and used cash in operating activities of $8.4 million. Partially because of these losses, the Company's liquidity has not improved substantially during the three months ended March 31, 2000. At March 31, 2000, the Company had negative working capital of $3 million, although the Company did have unrestricted cash and cash equivalents on hand of $2.5 million and borrowing availability under its line of credit of $2.2 million (see Note 3). To provide working capital to support the Company's operations, subsequent to March 31, 2000, the Company extended its line of credit through April 2001, in connection with which Titus Interactive SA ("Titus") provided a $20 million corporate guarantee, and the Company also completed a transaction with Titus, which provided for the issuance of convertible, redeemable Preferred Stock for $20 million. In addition, Titus may be entitled to receive additional shares of Common Stock upon conversion of their Preferred Stock if the Company defaults on its line of credit and Titus is obligated to pay on the $20 million corporate guarantee that Titus provided on the extension of the Company's line of credit through April 2001. In addition, the Company secured a $5 million supplemental line of credit with Titus expiring in May 2001 (see Note 9). The Company believes that funds available under its line of credit, funds to be received from the sale of equity securities and anticipated funds from operations, if any, should be sufficient to satisfy the Company's projected working capital and capital expenditure needs in the normal course of business at least through the expiration of its line of credit in April 2001 (see Notes 3 and 9). However, there can be no assurance that the Company will be able to raise sufficient funds to satisfy its projected working capital and capital expenditure needs beyond April 2001. In addition to the risks related to the Company's liquidity discussed above, the Company also faces numerous other risks associated with its industry. These risks include dependence on new product introductions, product completion and release delays, rapidly changing technology, intense competition, dependence on distribution channels and risk of customer returns. Certain additional risks are discussed on pages 17-27 of this Quarterly Report on Form 10-Q. The Company's consolidated financial statements have been presented on the basis that it is a going concern. Accordingly, the consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities or any other adjustments that might result should the Company be unable to continue as a going concern. Note 2. Inventories Inventories consist of the following:
March 31, December 31, 2000 1999 ---------------- ---------------- (Dollars in thousands) Packaged software $2,769 $4,394 CD-ROMs, cartridges, manuals, packaging and supplies 1,512 1,663 ---------------- ---------------- $4,281 $6,057 ================ ================
7 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 3. Debt Debt consists of the following:
March 31, December 31, 2000 1999 ------------ ------------ (Dollars in thousands) Loan Agreement $ 20,421 $ 19,218 Promissory Notes 10,000 - Other 375 412 ------------ ------------ 30,796 19,630 Less--current portion (20,796) (19,630) ------------ ------------ Long-term debt, net of current portion $ 10,000 $ - ============ ============
Loan Agreement Borrowings under the Loan and Security Agreement ("Loan Agreement") bear interest at LIBOR (6.13 percent at March 31, 2000 and 6.48 percent at December 31, 1999) plus 4.87 percent (11 percent at March 31, 2000 and 11.35 percent at December 31, 1999). At March 31, 2000, the Company had availability of $2.2 million on its line of credit. Subsequent to March 31, 2000, the Company further amended its line of credit, which, among other things, extended the expiration through April 2001 (see Note 9). The Company is currently in compliance with the terms of the Loan Agreement. Promissory Notes In February 2000 and in March 2000, the Company borrowed a cumulative total of $10 million from Titus. These notes mature in May 2000 and have an interest rate of 10 percent per annum. In April 2000, these notes were exchanged for shares of the Company's Series A Preferred stock (see Note 9). Note 4. Commitments and Contingencies The Company and the former owner of Shiny Entertainment ("Shiny") have a dispute over additional cash payments upon the delivery and acceptance of interactive entertainment software titles that Shiny was committed to deliver over time. The Company believes that no amounts are due as of March 31, 2000 under the applicable agreements. Note 5. Net Loss Per Share Basic net loss per share is calculated by dividing net loss available to common stockholders by the weighted average number of common shares outstanding and does not include the impact of any potentially dilutive common stock equivalents. Diluted net loss per share is the same as basic because the effect of outstanding stock options and warrants is anti-dilutive. There were options and warrants outstanding to purchase 3,561,780 shares of common stock and there were 484,848 shares of restricted common stock at March 31, 2000, which were excluded from the loss per share computation. At March 31, 1999 there were options to purchase 2,468,973 shares of common stock, which were not included in the loss per share computation. The weighted average exercise price of the outstanding options and warrants at March 31, 2000 and 1999 was $3.23 and $4.40, respectively. 8 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 6. Comprehensive Loss Comprehensive loss consists of the following:
Three Months Ended March 31, ------------------------ 2000 1999 ---------- ---------- (Dollars in thousands) Net loss $(5,498) $(8,278) Other comprehensive income (loss), net of income taxes: Foreign currency translation adjustments 4 (22) --------- --------- Other comprehensive income (loss) 4 (22) --------- --------- Total comprehensive loss $(5,494) $(8,300) ========= =========
During the three months ended March 31, 2000 and 1999, the net effect of income taxes on comprehensive income (loss) was immaterial. Note 7. Related Parties Distribution and Publishing Agreements The Company amended its International Distribution Agreement with Virgin Interactive Entertainment Limited ("Virgin") effective January 1, 2000. Under the amended Agreement, the Company no longer pays Virgin an overhead fee or minimum commissions. In addition, the Company extended the term of the agreement through February 2007 and implemented an incentive plan that will allow Virgin to earn a higher commission rate as defined. In connection with this agreement the Company incurred distribution commission expense of $772,000 and $420,000 for the three months ended March 31, 2000 and 1999, respectively. In addition, the Company recognized overhead fees of $455,000 and recorded an asset valuation and restructuring charge of $584,000 for the three months ended March 31, 1999. In connection with the Product Publishing Agreement with Virgin, the Company did not recognize any material revenues or gross profits for performing distribution services on behalf of Virgin during the three months ended March 31, 2000 and 1999. During the three months ended March 31, 2000, the Company recognized $400,000 in commission revenue for performing distribution services on behalf of Titus. Investment in Affiliate The Company accounts for its investment in VIE Acquisition Group LLC ("VIE") in accordance with the equity method of accounting. The Company did not recognize any material income or loss in connection with its investment in VIE for the three months ended March 31, 2000 and 1999. 9 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 8. Segment and Geographical Information The Company operates in one principal business segment. Information about the Company's operations in the United States and foreign markets is presented below:
Three Months Ended March 31, ---------------------- 2000 1999 -------- ------- Net revenues: (Dollars in thousands) United States $18,100 $12,262 United Kingdom 43 9,358 -------- ------- Consolidated net revenues $18,143 $21,620 ======== ======== Operating income (loss): United States $(4,205) $(6,867) United Kingdom (283) (523) -------- ------- Consolidated loss from operations $(4,488) $(7,390) ======== ======== Expenditures made for the acquisition of long-lived assets: United States $ 711 $ 294 -------- ------- Total expenditures for long-lived assets $ 711 $ 294 ======== ========
Net revenues by geographic regions were as follows:
Three Months Ended March 31, ---------------------------------------------------- 2000 1999 ---------------------- ---------------------- Amount Percent Amount Percent --------- -------- --------- -------- (Dollars in thousands) North America $10,019 55.2 % $ 8,751 40.5 % Europe 4,919 27.1 8,078 37.4 Rest of World 1,064 5.9 1,865 8.6 OEM, royalty and licensing 2,141 11.8 2,926 13.5 --------- -------- --------- -------- $18,143 100.0 % $21,620 100.0 % ========= ======== ========= ========
10 INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Net investments in long-lived assets by geographic regions were as follows:
March 31, December 31, 2000 1999 --------------------- --------------------- Amount Percent Amount Percent -------- -------- -------- -------- (Dollars in thousands) North America $5,389 98.0 % $5,435 97.9 % Europe 42 0.8 47 0.9 Rest of World - - - - OEM, royalty and licensing 66 1.2 69 1.2 -------- -------- -------- -------- $5,497 100.0 % $5,551 100.0 % ======== ======== ======== ========
Note 9. Subsequent Events Amendment to Credit Facility Subsequent to March 31, 2000, the Company extended its line of credit through April 2001 generally under the same terms, except that Titus provided a $20 million corporate guarantee and the financial institution agreed to release to the Company the $2.6 million of cash held as collateral upon receipt of certain Titus financial statements. Sale of Preferred Stock Subsequent to March 31, 2000, the Company completed a transaction with Titus under a Stock Purchase Agreement dated April 14, 2000 and issued 719,424 shares of newly designated Series A Preferred Stock ("Preferred Stock") which has preferences under certain events, as defined. The Preferred Stock is convertible by Titus, redeemable by the Company, and accrues a 6 percent dividend per annum. The Company may redeem the Preferred Stock shares at the original issue price at any time after termination of Titus's guarantee of the Company's principal line of credit. Titus may convert the Preferred Stock shares into shares of Common Stock at any time after May 2001 or earlier under certain events as defined. The conversion rate is the lesser of $2.78 or 85 percent of the market price per share at the time of conversion, as defined. The Preferred Stock is entitled to the same voting rights as if it had been converted to Common Stock shares. Conversion rights are limited to 5,504,507 shares of Common Stock unless the Company's stockholders have approved the issuance of the Preferred Stock at which time the Preferred Stock shares would be convertible to 7,194,240 shares of Common Stock at closing. In connection with this transaction, Titus received a warrant for 350,000 shares of the Company's Common Stock at $3.79 per share exercisable at anytime, and a warrant for 50,000 shares of the Company's Common Stock at $3.79 per share which would only be exercisable by Titus if the Company does not meet certain financial operating performance targets for the year ending December 31, 2000, as defined. Both warrants expire in April 2010. In connection with the $20 million corporate guarantee provided by Titus on the extension of the Company's line of credit, if the Company defaults in accordance with the line of credit agreement, and Titus is forced to pay on its corporate guarantee of such line, the Series A Preferred Stock conversion rights will be adjusted so as to make such shares convertible into up to approximately 42.8 million shares of Common Stock. In the event that the Company is able to repay to Titus the amounts paid under the guarantee within six months, the conversion rate shall be returned to the level at which it existed prior to such adjustment. In the event that the Company is unable to repay such amounts within six months, the conversion rate shall be readjusted at the end of such six month period based on the average closing price of the Company's Common Stock for the last 20 trading days during such period. If such average price is $10.00 per share, the shares would be convertible into 7,194,240 shares of Common Stock, and if less than $10.00, the shares would be convertible into approximately an additional 5,000,000 shares for each dollar the average price is below $10.00, up to a maximum of approximately 42.8 million shares. The Common Stock shares issuable upon conversion of the Preferred Stock or the exercise of the warrants are subject to certain registration rights. The Company also secured a $5 million supplemental line of credit with Titus expiring in May 2001. Amounts drawn on this line will be subject to interest of up to 12 percent per annum payable quarterly. In connection with this line of credit, Titus received a warrant for up to 100,000 shares of the Company's Common Stock at $3.79 per share that will expire in April 2010. The warrant will vest if and to the extent that the Company draws on the line of credit, as defined. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Statement The information contained in this Form 10-Q is intended to update the information contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1999 and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information contained in such Form 10-K. This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 and such forward-looking statements are subject to the safe harbors created thereby. For this purpose, any statements contained in this Form 10-Q, except for historical information, may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate" or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties, as well as on certain assumptions. For example, any statements regarding future cash flow, financing activities, cost reduction measures, compliance with the Company's line of credit and an extension or replacement of such line are forward-looking statements and there can be no assurance that the Company will generate positive cash flow in the future or that the Company will be able to obtain financing on satisfactory terms, if at all, or that any cost reductions effected by the Company will be sufficient to offset any negative cash flow from operations or that the Company will remain in compliance with its line of credit or be able to renew or replace such line. Additional risks and uncertainties include possible delays in the completion of products, the possible lack of consumer appeal and acceptance of products released by the Company, fluctuations in demand, lost sales because of the rescheduling of products launched or orders delivered, failure of the Company's markets to continue to grow, that the Company's products will remain accepted within their respective markets, that competitive conditions within the Company's markets will not change materially or adversely, that the Company will retain key development and management personnel, that the Company's forecasts will accurately anticipate market demand, that there will be no material adverse change in the Company's operations or business. Additional factors that may affect future operating results are discussed in more detail in "Factors Affecting Future Performance," below as well as the Company's Annual Report on Form 10-K on file with the Securities and Exchange Commission. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking statements are reasonable, the business and operations of the Company are subject to substantial risks that increase the uncertainty inherent in the forward-looking statements, and the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. In addition, risks, uncertainties and assumptions change as events or circumstances change. The Company disclaims any obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with the SEC or otherwise to revise or update any oral or written forward- looking statement that may be made from time to time by or on behalf of the Company. 12 Results of Operations The following table sets forth certain selected consolidated statements of operations data, segment data and platform data for the periods indicated in dollars and as a percentage of total net revenues:
Three Months Ended March 31, ------------------------------------------ 2000 1999 ------------------- ------------------- % of Net % of Net Amount Revenues Amount Revenues -------- -------- -------- -------- (Dollars in thousands) Net revenues $18,143 100.0% $21,620 100.0% Cost of goods sold 9,572 52.8% 12,566 58.1% ------- ----- ------- ----- Gross profit 8,571 47.2% 9,054 41.9% ------- ----- ------- ----- Operating expenses: Marketing and sales 4,863 26.8% 7,544 34.9% General and administrative 2,561 14.1% 3,518 16.3% Product development 5,635 31.1% 5,382 24.9% ------- ----- ------- ----- Total operating expenses 13,059 72.0% 16,444 76.1% ------- ----- ------- ----- Operating loss (4,488) -24.7% (7,390) -34.2% Other expense (1,010) -5.6% (888) -4.1% ------- ----- ------- ----- Net loss $(5,498) -30.3% $(8,278) -38.3% ======= ===== ======= ===== Net revenues by geographic region: North America $10,019 55.2% $ 8,751 40.5% International 5,983 33.0% 9,943 46.0% OEM, royalty and licensing 2,141 11.8% 2,926 13.5% Net revenues by platform: Personal computer $12,962 71.4% $14,020 64.9% Video game console 3,040 16.8% 4,674 21.6% OEM, royalty and licensing 2,141 11.8% 2,926 13.5%
North American, International and OEM, Royalty and Licensing Net Revenues Overall, net revenues for the three months ended March 31, 2000 decreased compared to the same period in 1999. The increase in North American net revenues for the three months ended March 31, 2000 was primarily due to more title releases across multiple platforms and a lower level of product returns and markdowns compared to the same period in 1999. The decrease in international net revenues was due primarily to decreased net revenues in Europe due to strong sales of the major hit title Baldur's Gate in the 1999 period that did not repeat in 2000. OEM, royalty and licensing net revenues decreased in the three months ended March 31, 2000 compared to the same period in 1999 due to decreased net revenues from licensing transactions offset in part by an increase in the OEM business. The Company expects that OEM, royalty and licensing net revenues in 2000 will be generally consistent with 1999. Platform Net Revenues PC net revenues decreased in the three months ended March 31, 2000 compared to the same period in 1999 primarily due to Baldur's Gate sales of $2 million in 2000 compared to $13 million in 1999. Excluding sales of Baldur's Gate, the Company's all-time best-selling title, the Company's net revenues increased by $7.5 million in 2000 over 1999 and are less dependent on major hit titles. In addition, the provision for returns and allowances decreased from 29% of gross revenues for the three months ended March 31, 1999 to 12% of gross revenues in the 2000 period, due to the Company's significantly improved inventory in channel position and continued concentration on a sell-through product distribution strategy. The Company released 8 PC titles during the three months ended March 31, 2000 compared to 7 PC titles in the 1999 period and continues to expect its PC net revenues to increase in total for 2000. Video game console net revenues decreased in the three months ended March 31, 2000 compared to the same period in 1999 due to only distributing its first major next generation console title MDK2 (Dreamcast) in North America. The Company anticipates commencing worldwide distribution of MDK2 in the second quarter of 2000. Even though video game console sales are not expected to grow in 2000 for this segment of the industry, the Company continues to expect its video game console net revenues to increase in total in 2000 as a result of the added penetration into this segment and the expected release of more titles. 13 Cost of Goods Sold; Gross Profit Margin Cost of goods sold decreased in the three months ended March 31, 2000 compared to the same period in 1999 due to lower net revenues and a higher percentage of PC titles as compared to video game console titles. The 1999 period reflects write-offs of prepaid royalties in 1999 relating to titles which had been canceled due to the Company discontinuing its licensed sports product line last year. The Company expects its cost of goods sold to increase in 2000 as compared to 1999 due to its expected higher net revenues base. The increase in gross profit margin was primarily due to a higher percentage of PC titles sold and a lower level of product returns and markdowns compared to the 1999 period. The Company expects its gross profit margin to increase in total for 2000 as compared to 1999 due to a significantly improved inventory in channel position and continued concentration on a sell-through product distribution strategy to improve inventory management and reduce returns and allowances offset in part by the anticipated increase in video game console releases. Marketing and Sales Marketing and sales expenses primarily consist of advertising and retail marketing support, sales commissions, marketing and sales personnel, customer support services and other related operating expenses. The decrease in marketing and sales expenses for the three months ended March 31, 2000 is primarily attributable to decreased advertising and retail marketing support expenditures as well as lower personnel costs compared to the 1999 period. In addition, the Company amended its International Distribution Agreement with Virgin Interactive Entertainment Limited ("Virgin") effective January 1, 2000, which eliminated the fixed monthly overhead fees the Company incurred in the 1999 period. The Company expects its marketing and sales expenses to continue to decrease in total for 2000 as compared to 1999. General and Administrative General and administrative expenses primarily consist of administrative personnel expenses, facilities costs, professional fees, bad debt expenses and other related operating expenses. The decrease in general and administrative expenses for the three months ended March 31, 2000 is primarily attributable to completing the reorganization of the Company's European operations, for which the Company recognized a charge of $0.6 million in the 1999 period. The Company is continuing its efforts to reduce North American operating expenses and expects its general and administrative expenses to continue to decrease in total for 2000 as compared to 1999. Product Development Product development expenses, which primarily consist of personnel and support costs, are charged to operations in the period incurred. The increase in product development expenses for the three months ended March 31, 2000 is primarily due to increased expenditures devoted to the Company's focus on next generation video game console platforms. The Company expects its product development expenses to continue to increase in total for 2000 as compared to 1999. Other Expense, Net Other income (expense) primarily consists of interest expense on the Company's line of credit and newly issued promissory notes to Titus Interactive, S.A. ("Titus"). Other expense increased in the three months ended March 31, 2000 compared to the same period in 1999 due to increased interest expense on increased borrowings under the Company's line of credit and promissory notes. The promissory note borrowings were cancelled in the second quarter of 2000 upon issuance of the Series A Preferred Stock to Titus. Liquidity and Capital Resources The Company has funded its operations to date primarily through the use of lines of credit and equipment leases, through cash generated by the private sale of securities, from the proceeds from the initial public offering and from operations. As of March 31, 2000 the Company's principal sources of liquidity included unrestricted cash of $2.5 million and $2.2 million available under the Company's line of credit bearing interest at the London Interbank Offered Rate plus 4.87 percent (11 percent as of March 31, 2000). Under the terms of the line of credit, the Company has maximum availability for borrowings and letters of credit up to $25 million based in part upon qualifying receivables and inventory. Within the overall credit limit, the line of credit also provides that the Company may 14 borrow up to $7 million in excess of its borrowing base. Under the line of credit the Company is required to maintain a cash collateral deposit of $2.6 million and a $5 million personal guarantee by the Company's Chairman and Chief Executive Officer ("Chairman"). As of March 31, 2000, the Company's balance on the line of credit was $20.4 million with no stand by letters of credit outstanding. Subsequent to March 31, 2000, The Company extended its line of credit through April 2001 generally under the same terms, except that Titus provided a $20 million corporate guarantee and the financial institution agreed to release to the Company the $2.6 million of cash held as collateral upon receipt of certain Titus financial statements. In connection with the $20 million corporate guarantee provided by Titus on the extension of the Company's line of credit, if the Company defaults under the terms of the line of credit agreement, and the financial institution demands Titus to pay on its corporate guarantee, Titus may have the right to receive additional shares of the Company's Common Stock upon conversion of their Preferred Stock. In addition, the Company secured a $5 million supplemental line of credit with Titus expiring in May 2001. Based upon certain assumptions, including without limitation, the Company's ability to achieve anticipated operating results, the Company believes that it will be able to renew its line of credit or obtain alternative financing on reasonable terms. However, there can be no assurance that the assumptions relied on by the Company will prove correct or that the Company will be able to renew or replace its line of credit or obtain alternative financing on reasonable terms, if at all. The Company's primary capital needs have historically been to fund working capital requirements necessitated by its net losses, its sales growth, the development and introduction of products and related technologies and the acquisition or lease of equipment and other assets used in the product development process. The Company's operating activities used cash of $8.4 million during the three months ended March 31, 2000, primarily attributable to a decrease in accounts payable and accrued liabilities and the net loss for the year, offset in part by a decrease in trade receivables, inventories and depreciation and amortization. Cash provided by financing activities of $11.2 million for the three months ended March 31, 2000 consisted primarily of the proceeds from debt instruments issued to Titus and borrowings on the Company's line of credit. Cash used in investing activities of $0.7 million for the three months ended March 31, 2000 consisted of capital expenditures, primarily for office and computer equipment used in Company operations. The Company does not currently have any material commitments with respect to any capital expenditures. To reduce the Company's working capital needs, the Company has implemented various measures including a reduction of personnel, a reduction of fixed overhead commitments and has scaled back certain marketing programs. In addition, the Company believes that its amended International Distribution Agreement with Virgin will further reduce its international costs and expenses in future periods. The Company is pursuing various alternatives, including further expense reductions, in an effort to continue to reduce operating expenses as much as possible without an adverse impact on its ability to generate successful future business activities. There can be no assurance that the Company will be able to undertake such measures, or that such measures would not materially and adversely affect the Company's ability to publish commercially viable titles, or that such measures would be sufficient to generate operating profits. In addition, the Company's long term liquidity will be materially dependent on its ability to develop and market successful titles for the hardware platforms that dominate the interactive entertainment market. To provide working capital to support the Company's future operations, the Company took several actions including extending its line of credit to April 2001, as discussed above. In addition, the Company completed a transaction with Titus under a Stock Purchase Agreement dated April 14, 2000 and issued 719,424 shares of newly designated Series A Preferred Stock ("Preferred Stock") which has preferences under certain events, as defined. The Preferred Stock is convertible by Titus, redeemable by the Company, and accrues a 6 percent dividend per annum. The Company may redeem the Preferred Stock at the original issue price at any time after termination of Titus's guarantee of the Company's principal line of credit. Titus may convert the Preferred Stock shares into shares of Common Stock at any time after May 2001 or earlier under certain events as defined. The conversion rate is the lesser of $2.78 or 85 percent of the market price per share at the time of conversion, as defined. The Preferred Stock is entitled to the same voting rights as if it had been converted to Common Stock. Conversion rights are limited to 5,504,507 shares of Common Stock unless the Company's stockholders have approved the issuance of the Preferred Stock at which time the Preferred Stock shares would be convertible to 7,194,240 shares of Common Stock at closing. In the event that the Company defaults on its line of credit and Titus is forced to pay on its corporate guarantee of such line, the Series A Preferred Stock conversion rights will be adjusted so as to make such shares convertible into up to approximately 42.8 million shares of Common Stock. In the event that the Company is able to repay to Titus the amounts paid under the guarantee within six months, the conversion rate shall be returned 15 to the level at which it existed prior to such adjustment. In the event that the Company is unable to repay such amounts within six months, the conversion rate shall be readjusted at the end of such six month period based on the average closing price of the Company's Common Stock for the last 20 trading days during such period. If such average price is $10.00 per share, the shares would be convertible into 7,194,240 shares of Common Stock, and if less than $10.00, the shares would be convertible into approximately an additional 5,000,000 shares for each dollar the average price is below $10.00, up to a maximum of approximately 42.8 million shares. In connection with this transaction, Titus received a warrant for 350,000 shares of Common Stock at $3.79 per share exercisable at any time, and a warrant for 50,000 shares of the Company's Common Stock at $3.79 per share which would only be exercisable by Titus if the Company's audited pre-tax income for the year ending December 31, 2000, is less than $2.1 million. Both warrants expire in April 2010. The Common Stock shares issuable upon conversion of the Preferred Stock or the exercise of the warrants are subject to certain registration rights. The Company also obtained a $5 million supplemental secured line of credit with Titus expiring in May 2001. Amounts drawn on this line will be subject to interest of up to 12 percent per annum payable quarterly. In connection with this line of credit, Titus received a warrant for up to 100,000 shares of the Company's Common Stock at $3.79 per share that will expire in April 2010. The warrant will become exercisable if and to the extent that the Company draws on the line of credit. The Company believes that funds available under its line of credit, amounts to be received from equity financing, amounts to be received under various product license and distribution agreements and anticipated funds from operations will be sufficient to satisfy the Company's projected working capital and capital expenditure needs in the normal course of business at least through the expiration of its line of credit in April 2001. Based upon certain assumptions, including without limitation, the Company's ability to achieve anticipated operating results, the Company believes that it will be able to renew its line of credit or obtain alternative financing on reasonable terms. However, there can be no assurance that the assumptions relied on by the Company will prove correct or that the Company will be able to renew or replace its line of credit on satisfactory terms, if at all. Further, there can be no assurance that the Company will not be required to raise additional working capital through debt or equity financing during such period. If the Company is required to raise additional working capital, there can be no assurance that the Company will be able to raise such additional working capital on acceptable terms, if at all. In the event the Company is unable to raise additional working capital, further measures would be necessary including, without limitation, the sale or consolidation of certain operations, the delay, cancellation or scale back of product development and marketing programs and other actions. No assurance can be given that such measures would not materially adversely affect the Company's ability to develop and publish commercially viable titles, or that such measures would be sufficient to generate operating profits in 2000 and beyond. Certain of such measures may require third party consents or approvals, including the Company's financial institution, and there can be no such assurance that such consents or approvals can be obtained. FACTORS AFFECTING FUTURE PERFORMANCE Our future operating results depend upon many factors and are subject to various risks and uncertainties. Some of the risks and uncertainties which may cause our operating results to vary from anticipated results or which may materially and adversely affect its operating results are as follows: Liquidity; Future Capital Requirements We used net cash in operations of $8.4 and $26.4 million during the three months ended March 31, 2000 and the year ended December 31, 1999, respectively. We cannot assure you that we will ever generate positive cash flow from operations. Our ability to fund our capital requirements out of our available cash, line of credit and cash generated from our operations depends on a number of factors. Some of these factors include the progress of our product development programs, the rate of growth of our business, and our products' commercial success. We may have to seek additional funds through debt or equity financings, product licensing or distribution transactions or other sources of financing in order to provide ourselves with enough working capital. If we issue additional equity securities, our existing stockholders could suffer a large amount of dilution in their ownership. In the event we have to raise additional working capital from other sources, we cannot assure you that we will be able to raise additional working capital on acceptable terms, if at all. In the event we cannot raise additional working capital, we would have to take additional actions to continue to reduce our costs, including selling or consolidating certain operations, delaying, canceling or scaling back product development and marketing programs and other actions. These measures could materially and adversely affect our ability to publish successful titles, and these measures may not 16 be enough to generate operating profits. We might have to get the approval of other parties, including our financial lender, for some of these measures, and we cannot assure you that we would be able to obtain those approvals. Fluctuations in Operating Results; Uncertainty of Future Results; Seasonality Our operating results have fluctuated a great deal in the past and will probably continue to fluctuate significantly in the future, both on a quarterly and an annual basis. Many factors may cause or contribute to these fluctuations, and many of these factors are beyond our control. Some of these factors include the following: . delays in shipping our products . demand for our products . demand for our competitors' products . the size and rate of growth of the market for interactive entertainment software . changes in computing platforms . the number of new products and product enhancements released by us and our competitors . changes in our product mix . the number of our products that are returned . the timing of orders placed by our distributors and dealers . the timing of our development and marketing expenditures . price competition . the level of our international and OEM, royalty and licensing net revenues. Many factors make it difficult to accurately predict the quarter in which we will ship our products. Some of these factors include: . the uncertainties associated with the interactive entertainment software development process . long manufacturing lead times for Nintendo-compatible products . possible production delays . the approval process for products compatible with the Sony Computer Entertainment, Nintendo and Sega video game consoles . approvals required from other licensors. Because of the limited number of products we introduce in any particular quarter, a delay in the introduction of a product may materially and adversely affect our operating results for that quarter, and may not be recaptured in later quarters. A significant portion of our operating expenses is relatively fixed, and planned expenditures are based largely on sales forecasts. If net revenues do not meet our expectations in any given quarter, operating results may be materially adversely affected. The interactive entertainment software industry is highly seasonal, with the highest levels of consumer demand occurring during the year-end holiday buying season, followed by demand during the first calendar quarter. As a result, our net revenues, gross profits and operating income have historically been highest during the fourth and the following first calendar quarters, and have declined from those levels in the following second and third calendar quarters. Our failure or inability to introduce products on a timely basis to meet these seasonal increases in demand may have a material adverse effect on our business, operating results and financial condition. We may over time become increasingly affected by the industry's seasonal patterns. Although we seek to reduce the effect of such seasonal patterns on our business by distributing our product release dates more evenly throughout the year, we cannot assure you that these efforts will be successful. We cannot assure you that we will be profitable in any particular period given the uncertainties associated with software development, manufacturing, distribution and the impact of the industry's seasonal patterns on our net revenues. As a result of the foregoing factors it is likely that our operating results in one or more future periods will fail to meet or exceed the expectations of securities analysts or investors. In that event, the trading price of our Common Stock would likely be materially adversely affected. 17 Significant Recent Losses We have experienced significant net losses in recent periods, including losses of $5.5 million and $41.7 million for the three months ended March 31, 2000 and the year ended December 31, 1999, respectively. These losses resulted largely from delays in the completion of certain products, a higher than expected level of product returns and markdowns on products released during the year, and the cost of restructuring our operations, including international distribution arrangements. These losses also resulted from lower than expected worldwide sales of certain releases, as well as from operating expense levels that were high relative to our revenue level. We may experience similar problems in current or future periods and we may not be able to generate sufficient net revenues or adequate working capital, or bring our costs into line with revenues, so as to attain or sustain profitability in the future. Dependence on New Product Introductions; Risk of Product Delays and Product Defects Our products typically have short life cycles, and we depend on the timely introduction of successful new products to generate net revenues, to fund operations and to replace declining net revenues from older products. These new products include enhancements of or sequels to our existing products and conversions of previously released products to additional platforms. If in the future, for any reason, net revenues from new products fail to replace declining net revenues from existing products, our business, operating results and financial condition could be materially adversely affected. The timing and success of new interactive entertainment software product releases remains unpredictable due to the complexity of product development, including the uncertainty associated with new technology. The development cycle of new products is difficult to predict but typically ranges from 12 to 24 months with six to 12 months for adapting a product to a different technology platform. In the past, we have frequently experienced significant delays in the introduction of new products, including certain products currently under development. Because net revenues associated with the initial shipments of a new product generally constitute a high percentage of the total net revenues associated with a product, any delay in the introduction of, or the presence of a defect in, one or more new products expected in a period could have a material adverse effect on the ultimate success of these products and on our business, operating results and financial condition. The cost of developing and marketing new interactive entertainment software has increased in recent years due to such factors as the increasing complexity and content of interactive entertainment software, the increasing sophistication of hardware technology and consumer tastes and the increasing costs of obtaining licenses for intellectual properties. We expect this trend to continue. We cannot assure you that our new products will be introduced on schedule, if at all, or that, if introduced, these products will achieve significant market acceptance or generate significant net revenues for us. In addition, software products as complex as the ones we offer may contain undetected errors when first introduced or when new versions are released. We cannot assure you that, despite testing prior to release, errors will not be found in new products or releases after shipment, resulting in loss of or delay in market acceptance. This loss or delay could have a material adverse effect on our business, operating results and financial condition. Uncertainty of Market Acceptance; Dependence on Hit Titles Consumer preferences for interactive entertainment software are always changing and are extremely difficult to predict. Historically, few interactive entertainment software products have achieved continued market acceptance. Instead, a limited number of releases have become "hits" and have accounted for a substantial portion of revenues in our industry. Further, publishers with a history of producing hit titles have enjoyed a significant marketing advantage because of their heightened brand recognition and consumer loyalty. We expect the importance of introducing hit titles to increase in the future. We cannot assure you that our new products will achieve significant market acceptance, or that we will be able to sustain this acceptance for a significant length of time if we achieve it. We also cannot assure you that product life cycles will be sufficient to permit us to recover product development and other associated costs. 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 believe that these trends will continue in our industry and that our future revenue will continue to be dependent on the successful production of hit titles on a continuous basis. Because we introduce a relatively limited number of new products in a given period, the failure of one or more of these products to achieve market acceptance could have a material adverse effect on our business, operating results and financial condition. Further, if we do not achieve market acceptance, we could be forced to accept substantial product returns or grant significant markdown allowances to maintain our relationship with retailers and our access to distribution channels. For example, we had significantly higher than expected product returns and markdowns during the year ended December 31, 1999 and we cannot assure you that higher than expected product returns and markdowns will not continue in the future. In the event that we are forced to accept significant product 18 returns or grant significant markdown allowances, our business, operating results and financial condition could be materially adversely affected. Control by Titus Titus currently owns 12,817,255 shares, or approximately 43 percent, of our outstanding Common Stock, 719,424 shares of our Series A Preferred Stock that have certain voting rights and are convertible into at least 7,194,240 shares of Common Stock at any time after May 2001 if not previously redeemed by the Company, and warrants for up to 500,000 shares of our Common Stock. In addition, if we default on our line of credit and Titus is obligated to pay on the $20 million corporate guarantee that they provided on the extension of our line of credit through April 2001, the Series A Preferred Stock may become convertible into up to 42.8 million shares of our Common Stock, which would constitute approximately 75 percent of our Common Stock as of the date hereof. In connection with Titus' investment, Herve Caen, Titus' chairman and chief executive officer, serves as our president and as a member of our Board of Directors, and Herve's brother Eric Caen, who is president and a director of Titus, also serves on our Board of Directors. As a consequence, Titus holds significant voting power with respect to the election of our Board of Directors and the right of approval of certain significant corporate actions, and Herve and Eric Caen have substantial authority over our operations. As the Company's capital structure currently stands, in the event that the Stockholder Agreement pursuant to which our Board of Directors is currently nominated terminates, Titus would be able to elect 4 of 7 members of the Board of Directors. In such event, Titus would be able to set our dividend policy and otherwise exercise substantial control over our management. This control could prevent or hinder a sale of the Company on terms that are not acceptable to Titus. Continued Listing on the NASDAQ National Market Our Common Stock is currently quoted on the NASDAQ National Market under the symbol "IPLY." For continued inclusion on the NASDAQ National Market, a company must meet certain tests, including a minimum bid price of $1.00 and net tangible assets of at least $4 million. In the event that we fail to satisfy the listing standards on a continuous basis, our Common Stock may be removed from listing on the NASDAQ National Market. If our Common Stock were delisted from the NASDAQ National Market, trading of our Common Stock, if any, would be conducted on the NASDAQ Small Cap Market, in the over-the-counter market on the so-called "pink sheets" or, if available, the NASD's "Electronic Bulletin Board." In any of those cases, investors could find it more difficult to dispose of, or to obtain accurate quotations as to the value of, our Common Stock. The trading price per share of our Common Stock would most likely be reduced as a result. Distribution Agreement In connection with our acquisition of a 43.9 percent membership interest in Virgin's parent entity in February 1999, we signed an International Distribution Agreement with Virgin. Under this Agreement, as amended, we appointed Virgin as our exclusive distributor for substantially all of our products in Europe, the CIS, Africa and the Middle East, subject to certain reserved rights, for an eight-year period. Because of the exclusive nature of the Agreement, if Virgin were to experience problems with its business, or were to fail to perform as expected, our business, operating results and financial condition could be materially and adversely affected. In connection with this Agreement, Virgin hired our European sales and marketing personnel, and we pay Virgin a distribution fee for marketing and distributing our products and certain direct costs and expenses. Dependence on Third Party Software Developers We rely on third party interactive entertainment software developers for the development of a significant number of our interactive entertainment software products. As there continues to be high demand for reputable and competent third party developers, we cannot assure you that third party software developers that have developed products for us in the past will continue to be available to develop products for us in the future. Many third party software developers have limited financial resources, which could expose us to the risk that such developers may go out of business prior to completing a project. In addition, due to our limited control over third party software developers, we cannot assure you that such developers will complete products for us on a timely basis or within acceptable quality standards, if at all. Due to increased competition for skilled third party software developers, we have had to agree to make advance payments on royalties and guaranteed minimum royalty payments to intellectual property licensors and game developers, and we expect to continue to enter into these kinds of arrangements. If the products subject to these arrangements do not have sufficient sales volumes to recover these royalty advances and 19 guaranteed payments, we would have to write-off unrecovered portions of these payments, which could have a material adverse effect on our business, operating results and financial condition. Further, we cannot assure you that third party developers will not demand renegotiation of their arrangements with the Company. Rapidly Changing Technology; Platform Risks The interactive entertainment software industry is subject to rapid technological change. New technologies, including operating systems such as Microsoft Windows 98 and 2000, technologies that support multi-player games, new media formats such as on-line delivery and digital video disks ("DVDs") and as yet unreleased video game platforms could render our current products or products in development obsolete or unmarketable. We must continually anticipate and assess the emergence of, and market acceptance of, new interactive entertainment software platforms well in advance of the time the platform is introduced to consumers. Because product development cycles are difficult to predict, we must make substantial product development and other investments in a particular platform well in advance of introduction of the platform. If the platforms for which we develop software are not released on a timely basis or do not attain significant market penetration, our business, operating results and financial condition could be materially adversely affected. Alternatively, if we fail to develop products for a platform that does achieve significant market penetration, then our business, operating results and financial condition could also be materially adversely affected. The emergence of new interactive entertainment software platforms and technologies and the increased popularity of new products and technologies may materially and adversely affect the demand for products based on older technologies. The broad range of competing and incompatible emerging technologies may lead consumers to postpone buying decisions with respect to products until one or more emerging technologies gain widespread acceptance. This postponement could have a material adverse effect on our business, operating results and financial condition. We are currently actively developing products for Microsoft Windows 98 and 2000, Sony PlayStation and PlayStation 2, and Sega Dreamcast platforms. We are also planning to develop product for new platforms expected to be introduced in 2001 by Microsoft and Nintendo. Our success will depend in part on our ability to anticipate technological changes and to adapt our products to emerging game platforms. We cannot assure you that we will be able to anticipate future technological changes, to obtain licenses to develop products for those platforms on favorable terms or to create software for those new platforms. Any failure to do so could have a material adverse effect on our business, operating results and financial condition. Industry Competition; Competition for Shelf Space The interactive entertainment software industry is intensely competitive and new interactive entertainment software programs and software platforms are regularly introduced. Our competitors vary in size from small companies to very large corporations with significantly greater financial, marketing and product development resources than ours do. Due to these greater resources, certain of our competitors can undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors of desirable motion picture, television, sports and character properties and pay more to third party software developers than we can. We believe that the main competitive factors in the interactive entertainment software industry include: . product features . brand name recognition . access to distribution channels . quality . ease of use, price, marketing support and quality of customer service. We compete primarily with other publishers of PC and video game console interactive entertainment software. Significant competitors include: . Electronic Arts Inc. . GT Interactive Software Corp. . Mattel, Inc. . Activision, Inc. . Infogrames Entertainment . Microsoft Corporation 20 . LucasArts Entertainment Company . Midway Games Inc. . Acclaim Entertainment, Inc. . Havas Interactive . Hasbro, Inc. . The 3DO Company . Take Two Interactive Software, Inc. . Eidos PLC . THQ Inc. In addition, integrated video game console hardware/software companies such as Sony Computer Entertainment, Nintendo and Sega compete directly with us in the development of software titles for their respective platforms. Large diversified entertainment companies, such as The Walt Disney Company, many of which own substantial libraries of available content and have substantially greater financial resources, may decide to compete directly with us or to enter into exclusive relationships with our competitors. We also believe that the overall growth in the use of the Internet and on-line services by consumers may pose a competitive threat if customers and potential customers spend less of their available home PC time using interactive entertainment software and more using the Internet and on-line services. Retailers of our products typically have a limited amount of shelf space and promotional resources, and there is intense competition among consumer software producers, and in particular interactive entertainment software products, for high quality retail shelf space and promotional support from retailers. To the extent that the number of consumer software products and computer platforms 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 policies. Our products constitute a relatively small percentage of any retailer's sale volume, and we cannot assure you that retailers will continue to purchase our products or to provide our products with adequate levels of shelf space and promotional support. A prolonged failure in this regard may have a material adverse effect on our business, operating results and financial condition. Dependence on Distribution Channels; Risk of Customer Business Failures; Product Returns We currently sell our products directly through our own sales force to mass merchants, warehouse club stores, large computer and software specialty chains through catalogs in the U.S. and Canada, as well as to certain distributors. Outside North America, we generally sell products to third party distributors. Our sales are made primarily on a purchase order basis, without long-term agreements. The loss of, or significant reduction in sales to, any of our principal retail customers or distributors could materially adversely affect our business, operating results and financial condition. The distribution channels through which publishers sell consumer software products evolve continuously through a variety of means, including consolidation, financial difficulties of certain distributors and retailers, and the emergence of new distributors and new retailers such as warehouse chains, mass merchants and computer superstores. As more consumers own PCs, the distribution channels for interactive entertainment software will likely continue to change. 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 arrangements prevent us from selling certain of our products directly to that mass merchant. If the number of mass merchants entering into exclusive buying arrangements with our competitors were to increase, our ability to sell to such merchants would be restricted to selling through the exclusive distributor. Because sales to distributors typically have a lower gross profit than sales to retailers, this would have the effect of lowering our gross profit. This trend could have a material adverse impact on our business, operating results and financial condition. In addition, emerging methods of distribution, such as the Internet and on-line services, may become more important in the future, and it will be important for us to maintain access to these channels of distribution. We cannot assure you that we will maintain access or that our access will allow us to maintain our historical sales volume levels. Distributors and retailers in the computer industry have from time to time experienced significant fluctuations in their businesses, and a number have failed. The insolvency or business failure of any significant distributor or 21 retailer of our products could have a material adverse effect on our business, operating results and financial condition. We typically make sales to distributors and retailers on unsecured credit, with terms that vary depending upon the customer and the nature of the product. Although we have insolvency risk insurance to protect against our customers' bankruptcy, insolvency or liquidation, this insurance contains a significant deductible and a co-payment obligation, and the policy does not cover all instances of non-payment. In addition, while we maintain a reserve for uncollectible receivables, the actual reserve may not be sufficient in every circumstance. As a result, a payment default by a significant customer could have a material adverse effect on our business, operating results and financial condition. We are exposed to the risk of product returns and markdown allowances with respect to our distributors and retailers. We allow distributors and retailers to return defective, shelf-worn and damaged products in accordance with negotiated terms, and also offer a 90-day limited warranty to our end users that our products will be free from manufacturing defects. In addition, we provide markdown allowances to our customers to manage our customers' inventory levels in the distribution channel. Although we maintain a reserve for returns and markdown allowances, and although our agreements with certain of our customers place certain limits on product returns and markdown allowances, we could be forced to accept substantial product returns and provide markdown allowances to maintain our relationships with retailers and our access to distribution channels. Product return and markdown allowances that exceed our reserves could have a material adverse effect on our business, operating results and financial condition. In this regard, our results of operations for the year ended December 31, 1999 were adversely affected by a higher than expected level of product returns and markdown allowances, which reduced our net revenues. We may continue to experience such high levels of product returns and markdown allowances in future periods, which could have a material adverse effect on our business, operating results and financial condition. Shares Eligible for Future Sale In 1999, we entered into two Stock Purchase Agreements with Titus, pursuant to which Titus purchased 10,795,455 shares of our Common Stock from us for an aggregate purchase price of $35 million. As part of the agreements, Titus' chairman and chief executive officer became our president, and our chairman and chief executive officer exchanged 2 million personal shares of our Common Stock for an agreed upon number of Titus shares. As a result of these transactions, Titus currently owns approximately 43 percent of our outstanding common stock. In addition, Titus purchased 719,424 shares of Preferred Stock from us in April 2000. The Preferred Stock is convertible by Titus, redeemable by us, and accrues a six percent dividend per year. Titus may convert the Preferred Stock at any time after May 2001 and has conversion rights limited to 5,504,507 shares of Common Stock unless our stockholders approve the issuance of the Preferred Stock at which time the Preferred Stock shares would become convertible into at least 7,194,240 shares of our Common Stock. Titus also received warrants to purchase up to 500,000 shares of our Common Stock. If we default in accordance with the line of credit agreement, and Titus is forced to pay on their corporate guarantee, the Series A Preferred Stock may become convertible into up to 42.8 million shares of our Common Stock. We have agreed to register all of the unregistered shares held by Titus for resale under the Securities Act of 1933, as amended. This registration could temporarily impair our ability to raise capital through the sale of our equity securities, and, if such registered shares are sold, could have a material adverse effect on the market price of our Common Stock. Dependence upon Third Party Licenses Many of our products, such as our Star Trek, Advanced Dungeons and Dragons and the Caesar's Palace titles, are based on original ideas or intellectual properties licensed from other parties. We cannot assure you that we will be able to obtain new licenses, or renew existing licenses, on commercially reasonable terms, if at all. For example, Viacom Consumer Products, Inc. has granted the Star Trek license to another party upon the expiration of our rights. If we are unable to obtain licenses for the underlying content that we believe offers the greatest consumer appeal, we would either have to seek alternative, potentially less appealing licenses, or release the products without the desired underlying content, either of which could have a material adverse effect on our business, operating results and financial condition. We cannot assure you that acquired properties will enhance the market acceptance of our products based on those properties. We also cannot assure you that our new product offerings will generate net revenues in excess of their costs of development and marketing or minimum royalty obligations, or that net revenues from new product sales will meet or exceed net revenues from existing product sales. 22 Dependence on Licenses from and Manufacturing by Hardware Companies We are required to obtain a license to develop and distribute software for each of the video game console platforms for which we develop products, including a separate license for each of North America, Japan and Europe. We have obtained licenses to develop software for the PlayStation and are working towards obtaining similar rights for the upcoming PlayStation 2. We have also obtained agreements to develop software for the Sega Dreamcast platform, which was introduced in the United States and Europe in Fall 1999. We cannot assure you that we will be able to obtain licenses from hardware companies on acceptable terms or that any existing or future licenses will be renewed by the licensors. In addition, Sony Computer Entertainment, Nintendo and Sega each have the right to approve the technical functionality and content of the Company's products for such platform prior to distribution. Due to the nature of the approval process, we must make significant product development expenditures on a particular product prior to the time we seek these approvals. Our inability to obtain these approvals could have a material adverse effect on our business, operating results and financial condition. Hardware companies such as Sony Computer Entertainment, Nintendo and Sega may impose upon their licensees a restrictive selection and product approval process, such that those licensees are restricted in the number of titles that will be approved for distribution on the particular platform. While we have prepared our future product release plans taking this competitive approval process into consideration, if we incorrectly predict its impact and fail to obtain approvals for all products in our development plans, this failure could have a material adverse effect on our business, operating results and financial condition. We depend upon Sony Computer Entertainment, Nintendo and Sega for the manufacture of our products that are compatible with their respective video game consoles. As a result, Sony Computer Entertainment, Nintendo and Sega have the ability to raise prices for supplying these products at any time and effectively control the timing of our release of new titles for those platforms. PlayStation and Dreamcast products consist of CD-ROMs and are typically delivered by Sony Computer Entertainment and Sega, respectively, within a relatively short lead time. Manufacturers of Nintendo and other video game cartridges typically deliver software to us within 45 to 60 days after receipt of a purchase order. If we experience unanticipated delays in the delivery of video game console products from Sony Computer Entertainment, Sega or Nintendo, or if actual retailer and consumer demand for our interactive entertainment software differs from our forecast, our business, operating results and financial condition could be materially adversely affected. Dependence on Key Personnel Our success depends to a significant extent on the continued service of our key product design, development, sales, marketing and management personnel, and in particular on the leadership, strategic vision and industry reputation of our founder and Chief Executive Officer, Brian Fargo. Our future success will also depend upon our ability to continue to attract, motivate and retain highly qualified employees and contractors, particularly key software design and development personnel. Competition for highly skilled employees is intense, and we cannot assure you that we will be successful in attracting and retaining such personnel. Specifically, we may experience increased costs in order to attract and retain skilled employees. Our failure to retain the services of Brian Fargo or other key personnel or to attract and retain additional qualified employees could have a material adverse effect on our business, operating results and financial condition. Risks Associated with International Operations; Currency Fluctuations Our international net revenues accounted for 33 and 46 percent of our total net revenues for the three months ended March 31, 2000 and 1999, respectively. In February 1999, we entered into an International Distribution Agreement with Virgin for the exclusive distribution of our products in selected international territories. We intend to continue to expand our direct and indirect sales, marketing and product localization activities worldwide. This expansion will require a great deal of management time and attention and financial resources in order to develop improved international sales and support channels. We cannot assure you, however, that we will be able to maintain or increase international market demand for our products. Our international sales and operations are subject to a number of inherent risks, including the following: . the impact of recessions in foreign economies . the time and financial costs associated with translating and localizing products for international markets . longer accounts receivable collection periods . greater difficulty in accounts receivable collection 23 . unexpected changes in regulatory requirements . difficulties and costs of staffing and managing foreign operations . political and economic instability. These factors may have a material adverse effect on our future international net revenues and, consequently, on our business, operating results and financial condition. We currently do not engage in currency hedging activities. Although exposure to currency fluctuations to date has been insignificant, we cannot assure you that fluctuations in currency exchange rates in the future will not have a material adverse effect on net revenues from international sales and licensing, and thus on our business, operating results and financial condition. Risks Associated with New European Currency On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing sovereign currencies and a new European currency, the euro. These eleven countries adopted the euro as the common legal currency on that date. We make a significant portion of our sales to these countries. Consequently, we anticipate that the euro conversion will, among other things, create technical challenges to adapt information technology and other systems to accommodate euro-denominated transactions. The euro conversion may also limit our ability to charge different prices for our products in different markets. While we anticipate that the conversion will not cause major disruption of our business, the conversion may have a material effect on our business or financial condition. Protection of Proprietary Rights We regard our software as proprietary and rely on a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and other methods to protect our proprietary rights. We own or license various copyrights and trademarks, and hold the rights to one patent application related to the software engine for one of our titles. While we provide "shrinkwrap" license agreements or limitations on use with our software, it is uncertain to what extent these agreements and limitations are enforceable. We are aware that some unauthorized copying occurs within the computer software industry, and if a significantly greater amount of unauthorized copying of our interactive entertainment software products were to occur, our operating results could be materially adversely affected. While we use copy protection on some of our products, we do not provide source code to third parties unless they have signed nondisclosure agreements with respect to that source code. We rely on existing copyright laws to prevent unauthorized distribution of our software. Existing copyright laws afford only limited protection. Policing unauthorized use of our products is difficult, and software piracy can be a persistent problem, especially in certain international markets. Further, the laws of certain countries where our products are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of the U.S. or are weakly enforced. Legal protection of our rights may be ineffective in such countries, and as we leverage our software products using emerging technologies, such as the Internet and on-line services, our ability to protect our intellectual property rights and to avoid infringing others' intellectual property rights may be diminished. We cannot assure you that existing intellectual property laws will provide adequate protection for our products in connection with these emerging technologies. As the number of interactive entertainment software products in the industry increases and the features and content of these products continues to 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 assure you 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 receive communications from third parties regarding such claims. We cannot assure you that existing or future infringement claims against us will not result in costly litigation or require us to license the intellectual property rights of third parties, either of which could have a material adverse effect on our business, operating results and financial condition. Entertainment Software Rating System; Governmental Restrictions Legislation is periodically introduced at the state and federal levels in the U.S. and in foreign countries to establish a system for providing consumers with information about graphic violence and sexually explicit material contained in interactive entertainment software products. Such a system would include procedures for interactive entertainment software publishers to identify particular products within defined rating categories and communicate 24 these ratings to consumers through appropriate package labeling and through advertising and marketing presentations. In addition, many foreign countries have laws that permit governmental entities to censor the content of certain works, including interactive entertainment software. In certain instances, we may be required to modify our products to comply with the requirements of these governmental entities, which could delay the release of those products in those countries. Those delays could have a material adverse effect on our business, operating results and financial condition. While we currently voluntarily submit our products to industry-created review boards and publish their ratings on our game packaging, we believe that mandatory government-run interactive entertainment software products rating systems eventually will be adopted in many countries that represent significant markets or potential markets for our products. Due to the uncertainties inherent in the implementation of such rating systems, confusion in the marketplace may occur, and we are unable to predict what effect, if any, such rating systems would have on our business. In addition to such regulations, certain retailers have in the past declined to stock certain of our products because they believed that the content of the packaging artwork or the products would be offensive to the retailer's customer base. While to date these actions have not had a material adverse effect on our business, operating results or financial condition, we cannot assure you that similar actions by our distributors or retailers in the future would not have a material adverse effect on our business, operating results and financial condition. Control by Directors and Officers Including Titus, our directors and executive officers beneficially own voting stock with total of about 64 percent of the aggregate voting power in the Company, and could, under certain circumstances, gain substantial additional voting power. See "Factors Affecting Future Performance - Control by Titus". These stockholders can control substantially all matters requiring our stockholders' approval, including the election of directors (subject to our stockholders' cumulative voting rights) and the approval of mergers or other business combination transactions. This concentration of voting power could discourage or prevent a change in control. Development of Internet/On-Line Services or Products We seek to establish an on-line presence by creating and supporting sites on the Internet. Our future plans envision conducting and supporting on-line product offerings through these sites or others. Our ability to successfully establish an on-line presence and to offer online products will depend on several factors outside our control. These factors include the emergence of a robust online industry and infrastructure and the development and implementation of technological advancements to the Internet to increase bandwidth to the point that will allow us to conduct and support on-line product offerings. Because global commerce and the exchange of information on the Internet and other similar open, wide area networks are relatively new and evolving, we cannot assure you that a viable commercial marketplace on the Internet will emerge from the developing industry infrastructure or that the appropriate complementary products for providing and carrying Internet traffic and commerce will be developed. We also cannot assure you that we will be able to create or develop a sustainable or profitable on-line presence or that we will be able to generate any significant revenue from on-line product offerings in the near future, if at all. If the Internet does not become a viable commercial marketplace, or if this development occurs but is insufficient to meet our needs or if such development is delayed beyond the point where we plan to have established an on-line service, our business, operating results and financial condition could be materially adversely affected. Risks Associated with Acquisitions As part of our strategy to enhance distribution and product development capabilities, we intend to review potential acquisitions of complementary businesses, products and technologies. Some of these acquisitions could be material in size and scope. While we will continue to search for appropriate acquisition opportunities, we cannot assure you that the Company will be successful in identifying suitable acquisition opportunities. If we do identify any potential acquisition opportunity, we cannot assure you that we will consummate the acquisition, and if the acquisition does occur, we cannot assure you that it will be successful in enhancing our business or will increase our earnings. As the interactive entertainment software industry continues to consolidate, we may face increased competition for acquisition opportunities, which may inhibit our ability to complete suitable transactions or increase their cost. Future acquisitions could also divert substantial management time, result in short term reductions in earnings or special transactions or other charges and may be difficult to integrate with existing operations or assets. We may, in the future, issue additional shares of Common Stock in connection with one or more acquisitions, which may dilute our stockholders. Additionally, with respect to future acquisitions, our stockholders may not have an opportunity to review the financial statements of the entity being acquired or to vote on these acquisitions. 25 Anti-Takeover Effects; Delaware Law and Certain Charter and Bylaw Provisions Our Certificate of Incorporation and Bylaws, as well as Delaware corporate law, contain certain provisions that could delay, defer or prevent a change in control and could materially adversely affect the prevailing market price of our common stock. Certain of these provisions impose various procedural and other requirements that could make it more difficult for stockholders to take certain corporate actions. Stock Price Volatility The trading price of our Common Stock has been and could continue to be subject to wide fluctuations in response certain factors, including: . quarter to quarter variations in results of operations . our announcements of new products . our competitors' announcements of new products . our product development or release schedule . general conditions in the computer, software, entertainment, media or electronics industries . changes in earnings estimates or buy/sell recommendations by analysts . investor perceptions and expectations regarding our products, plans and strategic position and those of our competitors and customers . other events or factors In addition, the public stock markets experience extreme price and trading volume volatility, particularly in high technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons often unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our Common Stock. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not have any derivative financial instruments as of March 31, 2000. However, we are exposed to certain market risks arising from transactions in the normal course of business, principally the risk associated with interest rate fluctuations on our revolving line of credit agreement, and the risk associated with foreign currency fluctuations. We do not hedge our interest rate risk, or our risk associated with foreign currency fluctuations. Interest Rate Risk Our interest rate risk is immaterial due to the short maturity of the line of credit agreement. We have no fixed rate debt. Foreign Currency Risk Our earnings are affected by fluctuations in the value of our foreign subsidiary's functional currency, and by fluctuations in the value of the functional currency of our investment in a foreign company that is accounted for under the equity method. Our risk associated with foreign exchange fluctuations has been immaterial to date. 26 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is involved in various legal proceedings, claims and litigation arising in the ordinary course of business, including disputes arising over the ownership of intellectual property rights and collection matters. In the opinion of management, the outcome of known routine claims will not have a material adverse effect on the Company's business, financial condition or results of operations. The Company and the former owner of Shiny have a dispute over additional cash payments upon the delivery and acceptance of interactive entertainment software titles that Shiny was committed to deliver over time. The Company believes that no amounts are due as of March 31, 2000 under the applicable agreements. Item 2. Changes in Securities and Use of Proceeds On April 14, 2000, the Company closed a strategic equity investment by Titus Interactive SA ("Titus") resulting in the issuance of 719,424 shares of the Company's Series A Preferred Stock for $20 million in a transaction that included warrants to Titus for up to 500,000 shares of Common Stock at $3.79 per share. See Part I, Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations -Liquidity and Capital Resources" for a detailed discussion of the terms of these securities, including the conversion rights of the Series A Preferred Stock. The Company will use the cash proceeds to fund its operations. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - The following exhibits are filed as part of this report: Exhibit Number Exhibit Title - ------- -------------- 10.1 Amendment Number 2 of International Distribution Agreement between the Company and Virgin Interactive Entertainment Limited, effective as of January 1, 2000. 27.1 Financial data schedule for the three-month period ended March 31, 2000. 27 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. INTERPLAY ENTERTAINMENT CORP. Date: May 12, 2000 By: /s/ BRIAN FARGO ----------------------- Brian Fargo, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: May 12, 2000 By: /s/ MANUEL MARRERO --------------------- Manuel Marrero, Chief Financial Officer (Principal Financial and Accounting Officer) 28 EX-10.1 2 AMENDMENT #2 TO INT'L DISTRIBUTION AGREEMENT AMENDMENT NUMBER 2 OF INTERNATIONAL DISTRIBUTION AGREEMENT This Amendment Number 2 of International Distribution Agreement (this "Amendment") is entered into as of January 1, 2000, by Interplay Entertainment Corp., a Delaware corporation ("Interplay") and Virgin Interactive Entertainment Limited, a corporation formed under the laws of England and Wales ("Virgin"), with reference to the following facts: A. The parties have entered into that certain International Distribution Agreement dated February 10, 1999, subsequently amended under that certain Amendment Number 1 of International Distribution Agreement dated July 1, 1999 (collectively, the "Agreement"), under which Virgin obtained from Interplay the right to distribute Interplay products in certain territories. B. The parties desire to amend the Agreement. Therefore, the parties agree as follows: I. Section 5(e) of the Agreement is deleted in its entirety and replaced with the following: "(e) No Reserves. Virgin shall not deduct or retain reserves from ----------- payments due to Interplay under this Agreement. Within ten business days after the date of this Amendment, Virgin shall pay to Interplay any reserves that Virgin currently retains, to the extent that such currently- retained reserves exceed the amount of markdown allowances, returns, or credits as of December 31, 1999, that have not already been accounted for through a deduction from the amount of Virgin's payments owed or paid to Interplay." II. Section 5(f) of the Agreement is deleted in its entirety and replaced with the following: "(f) Returns. Virgin may not grant any markdown allowance, price ------- protection or other credit for Products without the prior written consent of Interplay, not to be unreasonably withheld or delayed. For any calendar month during the term of this Agreement, the amount of any Interplay- approved markdown allowances and returns resulting from Virgin's distribution of Products may be deducted by Virgin from its payments to Interplay under Exhibit `B' for that month; provided, however, that (i) ----------- ------------------ any allowances and returns so deducted shall have been processed by Virgin during that month, and (ii) Virgin shall provide Interplay with a statement of any such markdown allowances and returns, itemized by Product and customer." III. Section 13(a) of the Agreement is deleted in its entirety and replaced with the following: "(a) Term. This Agreement shall become effective on the date hereof, ---- and unless sooner terminated pursuant to the terms of this Agreement, shall continue in full force and effect until February 10, 2007, on which date this Agreement shall expire." IV. Section 1 of Exhibit "B" of the Agreement is deleted in its entirety and replaced with the following: "1. Virgin Sales Targets and Payments to Interplay. ---------------------------------------------- (a) For each calendar year, Virgin and Interplay shall agree upon a target amount of Net Sales (as defined below) for the year. Such target amount of Net Sales shall be referred to herein as the `Base Plan Net Sales' and shall be set forth on Schedule `B-1' attached hereto. (b) Virgin shall pay to Interplay, in the time and manner set forth in subsection (c) below, a percentage of Net Sales (such payment to Interplay shall be referred to herein as the `Pass-Through Amount') based upon whether, and to what extend, Virgin has exceeded the Base Plan Net Sales for the year. The Pass-Through Amount shall be calculated as follows:
The Pass-Through For Net Sales in a Calendar Year That Are: Amount Shall Be: - -------------------------------------------------------------------------------- 100% of BPNS* or less 85% of such Net Sales In excess of 100% of BPNS but not more than 105% of BPNS 84% of such Net Sales In excess of 105% of BPNS but not more than 110% of BPNS 83% of such Net Sales In excess of 110% of BPNS but not more than 115% of BPNS 82% of such Net Sales In excess of 115% of BPNS but not more than 120% of BPNS 81% of such Net Sales In excess of 120% of BPNS 80% of such Net Sales
*"BPNS" means the Base Plan Net Sales for the applicable year. (c) Within 50 days after the end of each calendar month during the term of this Agreement, Virgin shall pay Interplay the Pass-Through Amount for Net Sales during the month. (d) "Net Sales" shall mean the gross wholesale price of the Products invoiced or shipped by Virgin in the distribution of the Products less: (i) Any applicable taxes on the sale or license of the Products, other than taxes based solely on Virgin's income and tax withholdings to the extent creditable by Virgin. (ii) Any Interplay-authorized markdown allowances and/or retroactive discounts and rebates, on the terms set forth in Section 5(f) of this Agreement. -2- (iii) Amounts for returns, such as credits or defectives, on the terms set forth in Section 5(f) of this Agreement. (iv) Agency commissions on Products sold in Austria and Spain." V. Section 2 of Exhibit "B" of the Agreement is deleted in its entirety and replaced with the following: "2. COGS and Marketing Reimbursement. Within 10 days after the end of -------------------------------- each calendar month during the term of this Agreement, Virgin shall deliver to Interplay an itemized statement of Virgin's cost of goods sold (including shipping, handling and insurance) with respect to Products sold during that month and marketing expenses paid during that month. Within 60 days of Interplay's receipt of such statement, Interplay shall either pay to Virgin the amount stated, or state specific reasons for deduction or denial. If Interplay states deductions or a denial Virgin may request an audited verification under Section 6 of this Agreement. With the sole --------- exception of credits for returns and markdowns in accordance with Section 5(f) of this Agreement, Virgin shall not deduct from its payments ------------ to Interplay any of its costs, including, without limitation, the cost of goods sold and marketing costs." VI. Section 3 of Exhibit "B" of the Agreement is deleted in its entirety and replaced with the following: "Intentionally deleted." VII. Section 4 of Exhibit "B" of the Agreement, is deleted in its entirety and replaced with the following: "Intentionally deleted." VIII. Section 5 of Exhibit "B" of the Agreement is deleted in its entirety, and replaced with the following: "5. As of the date of this Amendment, the previously-applicable provision for Interplay's payment of Minimum Distribution Fee is eliminated. For purposes of clarification only, the provision applicable during 1999 for a 4.5 million British Pound Minimum Distribution Fee is prorated for the 46 weeks out of the 52 week year during which Virgin performed distribution services for Interplay under this Agreement, resulting in a Minimum Distribution Fee for 1999 of 3.98 million British Pounds." IX. Section 6 of Exhibit "B" of the Agreement is added, as follows: "6. Credit for Compensation Contribution. Virgin shall credit ------------------------------------ Interplay for any compensation contribution due after December 31, 1999 under Section 16.4 of that certain February 10, 1999 Amended and Restated Operating Agreement between VIE Acquisition Holdings LLC and Interplay, as amended." X. Miscellaneous. The Agreement and this Amendment constitute the entire ------------- agreement between the parties on the subject matter hereof and thereof, and no amendment of the terms -3- herein or therein shall be valid unless made in a writing signed by the parties. California law shall govern the interpretation and enforcement of this Amendment without regard to conflicts of laws principles. Unless otherwise defined herein, terms used herein shall bear the same respective meanings ascribed to such terms in the Agreement. Except as amended hereby, the Agreement remains in full force and effect. This Amendment may be executed in counterparts. Wherefore, the parties hereto have executed this Amendment as of the date first written above. "VIRGIN" Virgin Interactive Entertainment Limited By: /s/ Herve Caen ------------------------------------ Its: Authorized Officer ------------------------------------ "INTERPLAY" Interplay Entertainment Corp. By: /s/ Brian Fargo ------------------------------------ Its: Chief Executive Officer ------------------------------------ -4- EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 2,455 0 17,232 7,301 4,281 47,462 17,540 13,274 52,959 50,503 0 0 0 30 (7,869) 52,959 17,730 18,143 9,572 9,572 14,069 2,471 987 (5,498) 0 (5,498) 0 0 0 (5,498) 0.18 0.18
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