-----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, Tf4sf7B8pe7cFJF3aRfhbQj3F8kE7dcavk680IEpZUtHNAuvM0M5VwPwqbAYdx28 9a/qW0ZGhFD60GfX2ss9rg== 0000889812-00-001813.txt : 20000417 0000889812-00-001813.hdr.sgml : 20000417 ACCESSION NUMBER: 0000889812-00-001813 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000229 FILED AS OF DATE: 20000414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ACCLAIM ENTERTAINMENT INC CENTRAL INDEX KEY: 0000804888 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 382698904 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-16986 FILM NUMBER: 601474 BUSINESS ADDRESS: STREET 1: ONE ACCLAIM PLAZA CITY: GLEN COVE STATE: NY ZIP: 11542 BUSINESS PHONE: 5166565000 MAIL ADDRESS: STREET 1: OEN ACCLAIM PALZA CITY: GLEN COVEY STATE: NY ZIP: 11542 FORMER COMPANY: FORMER CONFORMED NAME: GAMMA CAPITAL CORP DATE OF NAME CHANGE: 19880608 10-Q 1 QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended February 29, 2000 ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____to_____ Commission file number 0-16986 ACCLAIM ENTERTAINMENT, INC. --------------------------- (Exact Name of the Registrant as Specified in its Charter) Delaware 38-2698904 -------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) No.) One Acclaim Plaza, Glen Cove, New York 11542 -------------------------------------------- (Address of principal executive offices) (516) 656-5000 (Registrant's telephone number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ As at April 12, 2000, approximately 57 million shares of common stock of the Registrant were issued and outstanding. PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in 000s, except per share data) (Unaudited) February 29 August 31, 2000 1999 ---- ---- ASSETS CURRENT ASSETS Cash and cash equivalents $ 56,511 $ 74,421 Accounts receivable - net 51,879 84,430 Inventories 12,036 15,565 Prepaid expenses 15,135 14,870 ------ ------ TOTAL CURRENT ASSETS 135,561 189,286 ------- ------- OTHER ASSETS Fixed assets - net 37,900 32,694 Excess of cost over fair value of net assets acquired - net of accumulated amortization of $23,346, and $22,058, respectively 19,674 21,199 Other assets 1,506 1,659 ----- ----- TOTAL ASSETS $ 194,641 $ 244,838 ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Trade accounts payable $ 37,881 $ 47,298 Accrued expenses 81,250 103,663 Income taxes payable 6,470 7,692 Current portion of long-term debt 724 724 Obligations under capital leases - current 435 518 --- --- TOTAL CURRENT LIABILITIES 126,760 159,895 ------- ------- LONG-TERM LIABILITIES Long-term debt 50,595 50,957 Obligations under capital leases - noncurrent 694 775 Other long-term liabilities 1,357 1,852 ----- ----- TOTAL LIABILITIES 179,406 213,479 ------- ------- STOCKHOLDERS' EQUITY Preferred stock, $0.01 par value; 1,000 shares authorized; none issued -- -- Common stock, $0.02 par value; 100,000 shares authorized; 56,404 and 56,033 shares issued, respectively 1,128 1,121 Additional paid in capital 209,868 207,273 Accumulated deficit (191,664) (173,122) Treasury stock, 551 and 537 shares, respectively (3,338) (3,262) Accumulated other comprehensive income (759) (651) ---- ----- TOTAL STOCKHOLDERS' EQUITY 15,235 31,359 ------ ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 194,641 $ 244,838 ---------- ---------- See notes to consolidated financial statements. 1 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS (in 000s, except per share data) Three Months Ended Six Months Ended February 29,* February 29,* 2000 1999 2000 1999 ---- ---- ---- ---- NET REVENUES $ 65,943 $135,656 $167,095 $240,487 COST OF REVENUES 34,105 68,230 74,122 118,730 ------ ------ ------ ------- GROSS PROFIT 31,838 67,426 92,973 121,757 ------ ------ ------ ------- OPERATING EXPENSES Marketing and sales 20,164 21,368 46,251 38,887 General and administrative 15,900 18,254 32,789 33,184 Research and development 14,066 11,506 29,144 22,734 ------ ------ ------ ------ TOTAL OPERATING EXPENSES 50,130 51,128 108,184 94,805 ------ ------ ------- ------ EARNINGS(LOSS) FROM OPERATIONS $(18,292) $ 16,298 $(15,211) $ 26,952 -------- ------ -------- ------ OTHER INCOME (EXPENSE) Interest income 1,068 1,005 2,092 1,800 Interest expense (1,296) (1,441) (2,608) (2,849) Other expense (912) (780) (1,493) (21) ----- ----- ------- ---- EARNINGS(LOSS) BEFORE INCOME TAXES $(19,432) $ 15,082 $(17,220) $ 25,882 PROVISION FOR (RECOVERY OF) INCOME TAXES (457) 562 1,322 1,075 ----- --- ----- ----- NET EARNINGS(LOSS) $(18,975) $14,520 $(18,542) $24,807 ========= ======= ========= ======= BASIC EARNINGS(LOSS) PER SHARE $( 0.34) $ 0.27 $( 0.33) $ 0.46 DILUTED EARNINGS(LOSS) PER SHARE $( 0.34) $ 0.21 $( 0.33) $ 0.38 See notes to consolidated financial statements * 28th in 1999. 2 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY (DEFICIENCY) (in 000s, except per share data)
Preferred Stock (1) Common Stock ------------------- ---------------- Issued Issued ------ ------ Additional Paid-In Deferred Shares Amount Shares Amount Capital Compensation ------ ------ ------ ------ ------- ------------ Balance August 31, 1998 ---- ---- 52,634 1,053 193,178 (3,533) ------- ------- ------- ------ -------- -------- Net Earnings ---- ---- ---- ---- ---- ---- Issuances of Common Stock ---- ---- 206 4 1,792 ---- Issuance of Warrants for Litigation Settlements ---- ---- ---- ---- 1,700 ---- Subordinated Notes Conversion ---- ---- 48 1 249 ---- Cancellations of Options ---- ---- ---- ---- (552) 552 Issuance of Common Stock for Deferred Compensation ---- ---- 400 8 3,167 (3,169) Deferred Compensation Expense ---- ---- ---- ---- ---- 3,497 Exercise of Stock Options ---- ---- ---- ---- ---- ---- and Warrants ---- ---- 2,631 52 9,085 ---- Escrowed Shares Received ---- ---- (69) (1) 1 ---- Issuance of Common Stock Under Employee Stock Purchase Plan ---- ---- 183 4 1,306 ---- Foreign Currency Translation Loss ---- ---- ---- ---- ---- ---- ------- ------- ------- ------ -------- -------- Balance August 31, 1999 ---- ---- 56,033 1,121 209,926 (2,653) ------- ------- ------- ------ -------- -------- Net Loss ---- ---- ---- ---- ---- ---- Issuances and Escrowed Shares Received ---- ---- (6) (1) (76) ---- Cancellations of Options ---- ---- ---- ---- (46) 46 Deferred Compensation Expense ---- ---- ---- ---- ---- 1,079 Exercise of Stock Options and Warrants ---- ---- 286 6 1,041 ---- Issuance of Common Stock Under Employee Stock Purchase Plan ---- ---- 91 2 551 ---- Foreign Currency Translation Loss ---- ---- ---- ---- ---- ---- ------- ------- ------- ------ -------- -------- Balance February 29, 2000 ---- ---- 56,404 $1,128 $211,396 $(1,528) ------- ------- ------- ------ -------- -------- Accumulated Other Accumulated Treasury Comprehensive Comprehensive Deficit Stock Income Total Income(Loss) ------- ----- ------ ----- ------------ Balance August 31, 1998 (209,180) (3,103) (188) (21,773) ---- ---------- -------- ------ -------- ------- Net Earnings 36,058 ---- ---- 36,058 $36,058 Issuances of Common Stock ---- ---- ---- 1,796 ---- Issuance of Warrants for Litigation Settlements ---- ---- ---- 1,700 ---- Subordinated Notes Conversion ---- ---- ---- 250 ---- Cancellations of Options ---- ---- ---- ---- ---- Issuance of Common Stock for Deferred Compensation ---- ---- ---- 6 ---- Deferred Compensation Expense ---- ---- ---- 3,497 ---- Exercise of Stock Options ---- ---- ---- ---- ---- and Warrants ---- ---- ---- 9,137 ---- Escrowed Shares Received ---- (159) ---- (159) ---- Issuance of Common Stock Under Employee Stock Purchase Plan ---- ---- ---- 1,310 ---- Foreign Currency Translation Loss ---- ---- (463) (463) (463) ---------- -------- ------ -------- ------- Balance August 31, 1999 (173,122) (3,262) (651) 31,359 $35,595 ---------- -------- ------ -------- ------- Net Loss (18,542) ---- ---- (18,542) (18,542) Issuances and Escrowed Shares Received ---- (76) ---- (153) ---- Cancellations of Options ---- ---- ---- ---- ---- Deferred Compensation Expense ---- ---- ---- 1,079 ---- Exercise of Stock Options and Warrants ---- ---- ---- 1,047 ---- Issuance of Common Stock Under Employee Stock Purchase Plan ---- ---- ---- 553 ---- Foreign Currency Translation Loss ---- ---- (108) (108) (108) ---------- -------- ------ ------- ------- Balance February 29, 2000 $(191,664) $(3,338) $(759) $15,235 $18,650 ---------- -------- ------ ------- -------
(1) The Company is authorized to issue 1,000 shares of preferred stock at a par value of $0.01 per share, none of which shares is presently issued and outstanding. (2) Amounts for the six months ended February 29, 2000 are unaudited. See notes to consolidated financial statements. 3 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (in 000s, except per share data) Six Months Ended February 29,* 2000 1999 ---- ---- CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES Net Earnings(Loss) $ (18,542) $ 24,807 ----------- ---------- Adjustments to reconcile net earnings(loss) to net cash provided by (used in) operating activities: Depreciation and amortization 6,524 5,636 Provision for returns and discounts 42,404 39,022 Deferred compensation expense 1,079 1,331 Non-cash royalty charges 798 529 Non-cash compensation expense 145 285 Other non-cash items (564) (50) Change in assets and liabilities, net of effects of acquisition: Accounts receivable (8,817) (20,426) Inventories 3,295 (9,287) Prepaid expenses (1,027) 5,005 Trade accounts payable (8,847) 802 Accrued expenses (25,316) (6,236) Income taxes payable (719) (220) Other long-term liabilities (494) (1,223) ----- ------- Total adjustments 8,461 15,168 ----- ------ NET CASH(USED IN) PROVIDED BY OPERATING ACTIVITIES (10,081) 39,975 -------- ------ CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES Acquisition of subsidiary, net of cash acquired ----- (421) Acquisition of fixed assets, excluding capital leases (10,355) (3,621) Proceeds from disposals of fixed assets 583 104 Acquisition of other assets (13) --- Disposal of other assets 1 42 ------- -- NET CASH USED IN INVESTING ACTIVITIES (9,784) (3,896) ------- ------- * 28th in 1999. 4 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (Continued) (in 000s, except per share data) Six Months Ended February 29,* 2000 1999 ---- ---- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES Payment of mortgage $ (362) $ (362) Payment of short-term bank loans ---- (16) Exercise of stock options and warrants 1,047 5,951 Proceeds from Employee Stock Purchase Plan 408 310 Payment of obligations under capital leases (272) (512) Other (76) ----- ---- ----- NET CASH PROVIDED BY FINANCING ACTIVITIES 745 5,371 --- ----- EFFECT OF EXCHANGE RATE CHANGES ON CASH 1,210 (441) NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (17,910) 41,009 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 74,421 47,273 CASH AND CASH EQUIVALENTS AT END OF PERIOD 56,511 $ 88,282 Supplemental schedule of noncash investing and financing activities: 2000 1999 ---- ---- Acquisition of equipment under capital leases $ 190 $ 58 Cash paid during the period for: Interest $ 4,638 $ 4,614 Income taxes $ 1,817 $ 1,200 In fiscal 1999, the Company purchased certain assets and liabilities of a distributor in Australia. In connection with the acquisition, liabilities assumed were as follows: Fair value of assets acquired $ 1,186 Excess of cost over fair value of net assets acquired 2,607 Cash paid, net of cash acquired (580) Fair market value of common stock issued (1,796) ------- Liabilities assumed $ 1,417 --------- See notes to consolidated financial statements. * 28th in 1999. 5 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in 000s, except per share data) 1. Interim Period Reporting - The data contained in the February financial statements are unaudited and are subject to year-end adjustments; however, in the opinion of management, all known adjustments (which consist only of normal recurring accruals) have been made to present fairly the consolidated operating results for the unaudited periods. 2. Accounts Receivable Accounts receivable are comprised of the following: February 29, August 31, 2000 1999 ---- ---- Receivables assigned to factor $ 58,953 $ 98,470 Advances from factor 18,102 26,410 ------ ------ Due from factor 40,851 72,060 Unfactored accounts receivable 18,391 10,599 Foreign accounts receivable 28,501 37,461 Other receivables 5,900 3,924 Allowances for returns and discounts (41,764) (39,614) -------- -------- Net accounts receivable $ 51,879 $ 84,430 ========== ========== Pursuant to a factoring agreement, the principal lending institution of Acclaim Entertainment, Inc. (together with its subsidiaries, collectively, the "Company"), acts as its factor for the majority of its North American receivables, which are assigned on a pre-approved basis. At February 29, 2000, the factoring charge amounted to 0.25% of the receivables assigned. The Company's obligations to the lending institution are collateralized by all of the Company's and its North American subsidiaries' accounts receivable, inventories and equipment. The advances for factored receivables are made pursuant to a revolving credit and security agreement, which automatically renewed on January 31, 2000, on substantially the same terms. Pursuant to the terms of the agreement, which can be canceled by either party upon 90-days' notice, the Company is required to maintain specified levels of working capital and tangible net worth, among other covenants. As of February 29, 2000, the Company was in compliance with the covenants under its revolving credit facility except for the covenant prohibiting operating losses and the covenant related to its fixed charge ratio. The Company has received waivers from the lending institution. The Company draws down working capital advances and opens letters of credit (up to an aggregate maximum of $20 million) against the facility in amounts determined on a formula based on factored receivables, inventory and cost of imported goods under outstanding letters of credit. Interest is charged at the lending institution's prime lending rate plus one percent per annum (9.75% at February 29, 2000) on such advances. Pursuant to the terms of certain distribution, warehouse and credit and collection agreements, certain of the Company's accounts receivable are due from distributors. These receivables are not collateralized and as a result management continually monitors the financial condition of these distributors. No additional credit risk beyond amounts provided for collection losses is believed inherent in the Company's accounts receivable. At February 29, 2000 and August 31, 1999, the balance due from distributors was approximately 12% and 17%, respectively, of gross accounts receivable. At February 29, 2000 and August 31, 1999, included in receivables assigned to factor is a balance due from one domestic retail customer of approximately 10% and 15%, respectively, of gross accounts receivable. 6 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in 000s, except per share data) 3. Long Term Debt Long-term debt consists of the following: February 29, August 31, 2000 1999 ---- ---- 10% Convertible Subordinated Notes due 2002 $ 49,750 $ 49,750 Mortgage note 1,569 1,931 ----- ----- 51,319 51,681 Less: current portion 724 724 --- --- $ 50,595 $ 50,957 ========== ========== The 10% Convertible Subordinated Notes due 2002 (the "Notes") are convertible into shares of common stock of the Company ("Common Stock") prior to maturity, unless previously redeemed, at a conversion price of $5.18 per share, subject to adjustment under certain conditions. The Notes are redeemable in whole or in part, at the option of the Company (subject to the rights of holders of senior indebtedness) at 104% of the principal balance at any time through February 28, 2001, at 102% of the principal balance through February 28, 2002, and at 100% of the principal balance at maturity (March 1, 2002) in each case together with accrued interest. 4. Earnings Per Share Basic earnings per share is computed based upon the weighted average number of shares of Common Stock outstanding. Diluted earnings per share is computed based upon the weighted average number of shares of Common Stock outstanding increased by dilutive common stock options and warrants and the effect of assuming the conversion of the outstanding Notes, if dilutive. The table below provides the components of the per share computations.
Three Months Ended Six Months Ended February 29,* February 29,* 1999 2000 1999 2000 ---- ---- ---- ---- Basic EPS Computation - --------------------- Net earnings(loss) $ 14,520 $ (18,975) $ 24,807 $ (18,542) ========== ========== ========== ========== Weighted average common shares outstanding 54,160 56,414 53,527 56,260 Basic earnings(loss) per share $ 0.27 $ (0.34) $ 0.46 $ (0.33) Diluted EPS Computation - ----------------------- Net earnings(loss) $ 14,520 $ (18,975) $ 24,807 $ (18,542) 10% Convertible Subordinated Notes interest expense 1,244 ------ 2,494 ------ ----- ------ ----- ------ Adjusted net earnings $ 15,764 $ (18,975) $ 27,301 $ (18,542) ---------- ---------- --------- ---------- Weighted average common shares outstanding 54,160 56,414 53,527 56,260 Stock options and warrants 10,391 ------ 9,431 ------ 10% convertible subordinated notes 9,605 ------ 9,605 ------ ----- ------ ----- ------ Diluted common shares outstanding 74,156 56,414 72,563 56,260 ------ ------ ------ ------ Diluted earnings(loss) per share $ 0.21 (0.34) $ 0.38 (0.33)
The assumed conversion of the outstanding Notes was excluded from fiscal 2000 diluted earnings per share calculations since they were anti-dilutive. * 28th in 1999 7 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in 000s, except per share data) 5. Acquisition On November 12, 1998 the Company acquired substantially all of the assets and liabilities of a distributor in Australia. The acquisition was accounted for as a purchase. Accordingly, the operating results are included in the Statements of Consolidated Operations from the acquisition date. The acquired assets and liabilities have been recorded at their estimated fair values at the date of acquisition. The consideration was comprised of (i) $638 in cash, of which $479 was paid at closing, and (ii) 206 shares of the Common Stock with a fair value of $1,796. In addition, the Company assumed $1,417 of liabilities. The total cost of the acquisition was $3,851, of which $1,244 was allocated to identified net tangible assets, primarily accounts receivable. The remaining $2,607 represents the excess of the purchase price over the fair value of the net assets acquired, which will be amortized on a straight-line basis over three years. The operating results of the distributor are insignificant to those of the Company. 6. Segment Information In August 1999, the Company adopted SFAS No.131, "Disclosures about Segments of an Enterprise and Related Information", which supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise". The Company's chief operating decision-maker is the Company's Chief Executive Officer. The Company has three reportable segments: North America, Europe, and Pacific Rim, which are organized, managed and analyzed geographically and operate in one industry segment: the development, marketing and distribution of entertainment software. Information about the Company's operations for the quarter and six months ended February 29, 2000 and February 28, 1999 is presented below:
North Pacific America Europe Rim Eliminations Total ------- ------ ------- ------------ ----- Three Months Ended February 29, 2000 Net revenues from external customers 42,010 20,369 3,564 --- 65,943 Intersegment sales 69 815 34 (918) --- -- --- -- ----- --- Total net revenues 42,079 21,184 3,598 (918) 65,943 Interest income 997 60 11 --- 1,068 Interest expense 2,457 16 --- --- 2,473 Depreciation and amortization 2,839 181 256 --- 3,276 Segment operating profit (loss) (9,461) (9,112) 282 --- (18,292) Three Months Ended February 28, 1999 Net revenues from external 98,328 33,239 4,089 --- 135,656 customers 247 1,747 16 (2,010) --- --- ----- -- ------- --- Intersegment sales 98,575 34,986 4,105 (2,010) 135,656 Total net revenues Interest income 967 35 3 --- 1,005 Interest expense 2,147 52 --- --- 2,199 Depreciation and amortization 2,460 162 251 --- 2,873 Segment operating profit (loss) 20,960 (4,454) (208) --- 16,298
8
North Pacific America Europe Rim Eliminations Total ------- ------ ------- ------------ ----- Six Months Ended February 29, 2000 Net revenues from external customers 106,108 52,982 8,005 --- 167,095 Intersegment sales 134 1,487 34 (1,655) --- --- ----- -- ------- --- Total net revenues 106,242 54,469 8,039 (1,655) 167,095 Interest income 2,005 71 16 --- 2,092 Interest expense 4,615 21 2 --- 4,638 Depreciation and amortization 5,653 359 512 --- 6,524 Identifiable assets 173,492 15,335 5,814 --- 194,641 Segment operating profit (loss) (5,250) (10,981) 1,020 --- (15,211) Six Months Ended February 28, 1999 Net revenues from external customers 168,238 67,034 5,215 --- 240,487 Intersegment sales 69 815 34 (918) --- -- --- -- ----- --- Total net revenues 168,307 67,849 5,249 (918) 240,487 Interest income 1,756 41 3 --- 1,800 Interest expense 4,510 103 --- --- 4,613 Depreciation and amortization 4,989 317 330 --- 5,636 Identifiable assets 154,266 27,965 7,888 --- 190,119 Segment operating profit (loss) 34,741 (7,323) (466) --- 26,952
9 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following is intended to update the information contained in the Company's Annual Report on Form 10-K for the year ended August 31, 1999 and presumes that readers have access to, and will have read, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in such Form 10-K. This Quarterly Report on 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 Exchange Act of 1934. When used in this report, the words "believe," "anticipate," "think," "intend," "plan," "will be" and similar expressions identify such forward-looking statements. Such statements regarding future events and/or the future financial performance of the Company are subject to certain risks and uncertainties, including those discussed in "Factors Affecting Future Performance" below at pages 17 to 23, which could cause actual events or the actual future results of the Company to differ materially from any forward-looking statement. In light of the significant risks and uncertainties inherent in the forward-looking statements included herein, the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. Overview The Company develops, publishes, markets and distributes video and computer games for use with game consoles, both dedicated and portable, and PCs on a worldwide basis. The Company owns and operates five software development studios located in the U.S. and the U.K. where it develops its own software, and a motion capture studio in the U.S. From time to time, the Company hires independent developers to create software for it. The Company publishes, or releases to the public under its brand names, software developed by it as well as by third-party developers. The Company distributes its software directly in North America, the U.K., Germany, France, Spain and Australia. The Company also distributes software developed and published by third parties and develops and publishes (1) strategy guides relating to the Company's software and (2) comic book magazines. The video and computer games industry is characterized by rapid technological changes, which have resulted in successive introductions of increasingly advanced game consoles and PCs. As a result of the rapid technological shifts, no single game console or PC system has achieved long-term dominance in the video and computer games market. Therefore, the Company must continually anticipate game console cycles and its research and development group must develop programming tools and engines necessary for the development of software for emerging hardware systems. The Company's revenues have traditionally been derived from sales of software for the then popular game consoles. Accordingly, the Company's performance has been, and is expected in the future to be, materially adversely affected by platform transitions. As a result of the industry transition to 32-bit and 64-bit game consoles which commenced in 1995, the Company's software sales during fiscal 1996, 1997 and 1998 were significantly lower than in fiscal 1994 and 1995. The Company's inability to predict accurately the timing of such transition resulted in material losses in fiscal 1996 and 1997. The video and computer games industry is currently experiencing another platform transition from 32- and 64-bit to 128-bit game consoles and related software and online gaming. The Company believes that sales of new 32-bit and 64-bit hardware systems and related software have peaked and will continue to decrease substantially in future periods. This transition has resulted in industry-wide sales volume and pricing weakness which impacted the Company's first six months of fiscal 2000 and is anticipated to impact the Company for the balance of the fiscal year and possibly into fiscal 2001. The Company will release fewer titles for Nintendo's N64 in fiscal 2000 than it did in fiscal 1999 and does not anticipate releasing new N64 titles in fiscal 2001, as the Company shifts its resources to the development of new technologies and titles for the next generation systems. When the transition is complete the Company anticipates that the eventual installed base of 128-bit systems combined with the potential for online gaming will provide a larger market for its software. However, there can be no assurance that newly-introduced (e.g., Sega's Dreamcast console), or announced (e.g., Sony's PlayStation 2, Nintendo's Dolphin, and Microsoft's 10 X-BOX) 128-bit game consoles and online gaming will achieve commercial success similar to that of the 32-bit PlayStation or 64-bit N64 or the timing of such success, if achieved. See "Factors Affecting Future Performance - Industry Trends, Platform Transitions and Technological Change May Adversely Affect the Company's Revenues and Profitability." The rapid technological advances in game consoles have significantly changed the look and feel of software as well as the software development process. Currently, the process of developing software is extremely complex and the Company expects it to become more complex and expensive in the future with the advent of the more powerful next generation hardware systems. According to the Company's estimates, the average development time for a title is between 12 and 24 months and the average development cost for a title is between $1 and $3 million. Approximately 54% and 62% of the Company's gross revenues in the second quarter and first six months of fiscal 2000 was derived from software developed by its studios. See "Factors Affecting Future Performance - Increased Product Development Costs May Adversely Affect Profitability." The Company's revenues in any period are generally driven by the titles released by the Company in that period. In the past and in fiscal 2000, the Company has experienced delays in the introduction of new titles, which has had a negative impact on its results of operations. It is likely that some of the Company's titles will not be released in accordance with the Company's operating plans for a period, in which event its results of operations and profitability in that period would be negatively affected. See "Factors Affecting Future Performance - Revenues Are Dependent on Timely Introduction of New Titles." Retail sales of the Company's 32- and 64- bit software during the second quarter of fiscal 2000 and six months ended February 29, 2000 generally fell short of the Company's expectations due, in large part, to (1) the slowdown in the rate of growth for the main 32-bit and 64-bit hardware systems and the decline of the market for N64 software, (2) the Company's prior emphasis on the N64 platform, (3) lower-than-expected sales of certain of the Company's products and (4) delays in the introduction of new titles. In addition, the Company increased its sales allowances to address the effects on the Company of industry-wide weakness in cartridge-based hardware and software sales and slower-than-expected sales of certain products. The decline in sales was partially offset by revenues from software for the new Sega Dreamcast 128-bit platform. The Company recorded a loss of approximately $19 million in the second quarter of fiscal 2000, as compared to net earnings of $14.5 million in the second quarter of fiscal 1999 and a loss of $18.5 million for the six months ended February 29, 2000 as compared to net earnings of $24.8 million for the six months ended February 28, 1999. In addition to the factors discussed above, which significantly impacted net revenues (approximately $136 million for the first three months in fiscal 1999 as compared to $66 million for the same period in fiscal 2000, and approximately $167 million for the first six months in fiscal 2000 as compared to approximately $240 million for the same period in fiscal 1999), the Company's operating results for the second quarter and first six months of fiscal 2000 were also negatively impacted by increased research and development expenses. The Company's results of operations in the future will be dependent in large part on (1) the timing and rate of growth of the software market for 128-bit and other emerging game consoles and online gaming and (2) the Company's ability to identify, develop and publish software that performs well in the market place. 11 Results of Operations The following table shows certain statements of consolidated operations data as a percentage of net revenues for the periods indicated:
Three Months Ended Six Months Ended February 29,** February 29,** 2000 1999 2000 1999 ---- ---- ---- ---- Domestic revenues 63.0 72.5 62.7 71.5 Foreign revenues 37.0 27.5 37.3 28.5 ---- ---- ---- ---- Net revenues 100.0 100.0 100.0 100.0 Cost of revenues 51.7 50.3 44.4 49.4 ---- ---- ---- ---- Gross profit 48.3 49.7 55.6 50.6 ---- ---- ---- ---- Marketing and sales 30.5 15.8 27.6 16.2 General and administrative 24.1 13.5 19.6 13.8 Research and development 21.4 8.4 17.5 9.4 ---- --- ---- --- Total operating expenses 76.0 37.7 64.7 39.4 ---- ---- ---- ---- Earnings (loss) from operations (27.7) 12.0 (9.1) 11.2 Other (expense) income, net (1.7) (0.9) (1.2) (0.4) ----- ----- ----- ----- Earnings(loss) before income taxes (29.4) 11.1 (10.3) 10.8 Net earnings(loss) (28.7) 10.7 (11.0) 10.3
Net Revenues The Company's gross revenues were derived from the following product categories: Three Months Ended Six Months Ended February 29,** February 29,** 2000* 1999* 2000* 1999* ----- ----- ----- ----- Portable software 8.0% 5.0% 6.0% 4.0% 32-bit software 28.0% 9.0% 34.0% 19.0% 64-bit software 37.0% 79.0% 32.0% 70.0% 128-bit software 17.0% ----- 21.0% ----- Computer games software 8.0% 6.0% 6.0% 6.0% Other 2.0% 1.0% 1.0% 1.0% * The numbers in this chart do not give effect to sales credits and allowances granted by the Company since the Company does not track such credits and allowances by product category. Accordingly, the numbers presented may vary materially from those that would be disclosed if the Company were able to present such information as a percentage of net revenues. ** 28th in 1999 The decrease in the Company's net revenues from approximately $136 million for the quarter ended February 28, 1999 to approximately $66 million for the quarter ended February 29, 2000 was predominantly due to reduced sales of 64-bit software and increased sales allowances for price protection and concessions relating primarily to 32-bit and 64-bit software. In addition, net revenues were further impacted by the delays in the introduction of new titles. These decreases were partially offset by sales of the Company's Dreamcast-related software which aggregated approximately 21% of gross revenues for the six months ended February 29, 2000. 12 The Company anticipates that titles currently scheduled for introduction in the third and fourth quarters of fiscal 2000 will be shipped as announced; however, no assurance can be given that these titles will be released in accordance with such announcements. Assuming timely shipment of the Company's titles, the Company's fiscal 2000 revenues are anticipated to be lower than its fiscal 1999 revenues and the Company anticipates a net loss for fiscal 2000, as discussed in the March 17, 2000 press release issued by the Company. However, if the Company does not release and sell new titles as planned in fiscal 2000, the Company's net revenues would be further adversely impacted and the Company could incur further losses from operations. The Company anticipates that its mix of domestic and foreign net revenues will continue to be affected by the content of titles released by the Company to the extent such titles are geared towards the domestic market. Foreign net revenues are anticipated to be 30% to 35% of total net revenues for fiscal 2000. A significant portion of the Company's revenues in any quarter is generally derived from software first released in that quarter or in the immediately preceding quarter. See "Factors Affecting Future Performance - Revenues Are Dependent on Timely Introduction of New Titles" and "- The Company's Future Success is Dependent on Its Ability to Release "Hit" Titles." In the quarter ended February 29, 2000, ECW Hardcore (for multiple platforms), Supercross 2000 (for N64) and South Park Rally ( for N64 and Play Station) accounted for approximately 27%, 6%, and 15%, respectively, of the Company's gross revenues. In the quarter ended February 28, 1999, Turok 2: Seeds of Evil (for multiple platforms) and South Park (for N64) accounted for approximately 50% and 22%, respectively , of the Company's gross revenues. For the six months ended February 29, 2000, ECW Hardcore, South Park Rally, South Park Luv Shack, and WWF Attitude (for multiple platforms) accounted for approximately 11%, 7%, 10% and 15%, respectively, of the Company's gross revenues. For the six months ended February 29, 1999, Turok 2: Seeds of Evil (for multiple platforms), WWF War Zone (for multiple platforms), South Park (for N64) and NFL Quarterback Club 99 (for N64) accounted for approximately 28%, 17%, 13% and 11%, respectively, of the Company's gross revenues. The Company is substantially dependent on the hardware platform developers as the sole developers of the platforms marketed by them, as the sole licensors of the proprietary information and technology needed to develop software for those hardware platforms and, in the case of Nintendo and Sony, as the sole manufacturers of software for the hardware platforms marketed by them. For the quarters ended February 29, 2000 and February 28, 1999, the Company derived 37% and 79% of its gross revenues, respectively, from sales of Nintendo compatible software and 28% and 9% of its gross revenues, respectively, from sales of software for PlayStation. For the six months ended February 29, 2000 and 1999, the Company derived 32% and 70% of its gross revenues, respectively, from sales of Nintendo-compatible software and 34% and 19% of its gross revenues, respectively, from sales of software for PlayStation. The Company has also derived 17% and 21% of gross revenues from sales of software for the Sega Dreamcast platform for the quarter and six months ended February 29, 2000. Sales from this platform were not significant in 1999. Gross Profit The Company's gross profit is primarily impacted by the percentage of sales of CD software as compared to the percentage of sales of cartridge software. Gross profit may also be impacted from time to time by the level of returns and price protection and concessions to retailers and distributors, the percentage of foreign sales and the percentage of foreign sales to third-party distributors. The Company's margins on sales of CD software (currently, PlayStation, PCs and Dreamcast) are higher than those on cartridge software (currently, N64 and Game Boy Color) as a result of significantly lower CD software product costs. 13 The Company's margins on foreign software sales to third-party distributors are approximately one-third lower than those on sales that the Company makes directly to foreign retailers. Gross profit decreased from $67.4 million (50% of net revenues) for the quarter ended February 28, 1999 to $31.8 million (48% of net revenues) for the quarter ended February 29, 2000 and from $121.8 million (51% of net revenues) for the six months ended February 28, 1999 to $93.0 million (56% of net revenues) for the six months ended February 29, 2000. The dollar decrease is predominantly due to the decreased sales levels from all platforms. The percentage decrease for the quarter is attributable to a higher percentage of cartridge software, and the percentage increase for the six months ended February 29, 2000 is attributable to higher percentages of sales of CD software during the period. Management anticipates that the Company's future gross profit will be affected principally by (1) the Company's product mix and (2) the levels of product returns, price protection and concessions in respect of its software. Operating Expenses Marketing and sales expenses decreased from $21.4 million (16% of net revenues) for the quarter ended February 28, 1999 to $20.2 million (31% of net revenues) for the quarter ended February 29, 2000 and increased from $38.9 million (16% of net revenues) for the six months ended February 28, 1999 to $46.3 million (28% of net revenues) for the six months ended February 29, 2000. The six month increase is primarily attributable to increased selling and advertising expenses. General and administrative expenses decreased from $18.3 million for the quarter ended February 28, 1999 to $15.9 million for the quarter ended February 29, 2000 and from $33.2 million for the six months ended February 28, 1999 to $32.8 million for the six months ended February 29, 2000. The decrease is primarily attributable to decreased variable expenses. The Company is considering various cost reduction initiatives in an effort to further control its expenses relative to revenue and to reallocate its resources to research and development in preparation for the transition to the next generation systems. Research and development expenses increased from $11.5 million for the quarter ended February 28, 1999 to $14.1 million for the quarter ended February 29, 2000 and from $22.7 million (9% of net revenues) for the six months ended February 28, 1999 to $29.1 million (18% of net revenues) for the six months ended February 29, 2000. The increase is primarily attributed to increased personnel costs at the Company's studios and higher external development costs. Due to the Company's planned release of a higher number of titles, the Company's preparations for releasing titles across all the new platforms and an increase in development expenses related to the next generation of platforms, the Company anticipates that its future research and development expenses will continue to increase, in dollars and as a percentage of revenues. See "Factors Affecting Future Performance-Increased Product Development Costs May Adversely Affect Profitability." Interest income increased slightly in the three and six months ended February 29, 2000 as compared to the three and six months ended February 28, 1999. As of August 31, 1999, the Company had a U.S. tax net operating loss carryforward of approximately $90 million. The provision for income taxes of $1.3 million for the first six months of fiscal 2000 primarily relates to state and foreign taxes. Seasonality The Company's business is seasonal, with higher revenues and operating income typically occurring during its first, second and fourth fiscal quarters (which correspond to the holiday-selling season). However, the timing of the delivery of software titles and the releases of new products cause material fluctuations in the Company's quarterly revenues and earnings, which may cause the Company's results to vary from the seasonal patterns of the industry as a whole. See "Factors Affecting Future Performance - Revenues Vary Due to the Seasonal Nature of Video and Computer Game Software Purchases." 14 Liquidity and Capital Resources The Company derived net cash from operating activities of approximately $40 million and used net cash of approximately $(10) million during the six months ended February 28, 1999 and February 29, 2000, respectively. The decrease in net cash from operating activities in the first half of fiscal 2000 is primarily attributable to losses from operations in fiscal 2000. The Company used net cash in investing activities of approximately $4 million and $10 million during the six months ended February 28, 1999 and February 29, 2000, respectively. The increase in net cash used in investing activities in the first half of fiscal 2000 is primarily attributable to the acquisition of fixed assets. The Company derived cash from financing activities of approximately $5 million and $1 million during the six months ended February 28, 1999 and February 29, 2000. The decrease in net cash provided by financing activities during the six months ended February 29, 2000 is due to lower amounts of proceeds from the exercise of stock options and warrants. The Company generally purchases its inventory of Nintendo software by opening letters of credit when placing the purchase order. At February 29, 2000, the amount outstanding under letters of credit was approximately $14.5 million. Other than such letters of credit, the Company does not currently have any material operating or capital expenditure commitments. The Company has a revolving credit and security agreement with GMAC, its principal domestic lending institution, which agreement was renewed on January 31, 2000, on substantially the same terms. The credit agreement automatically renews for another year by its terms, unless terminated upon 90 days' prior notice by either party. The Company draws down working capital advances and opens letters of credit against the facility in amounts determined on a formula based on factored receivables and inventory, which advances are secured by the Company's assets. GMAC also acts as the Company's factor for the majority of its North American receivables, which are assigned on a pre-approved basis. At February 29, 2000, the factoring charge was 0.25% of the receivables assigned and the interest on advances was at GMAC's prime rate plus one percent. As of February 29, 2000, the Company was in compliance with the covenants under its revolving credit facility except the covenant prohibiting operating losses, and the covenant relating to its fixed charge ratio. The Company has received waivers from the lending institution. See Note 2 of Notes to Consolidated Financial Statements. The Company also has a financing arrangement relating to the mortgage on its corporate headquarters. At February 29, 2000, the outstanding principal balance of the loan was $1.6 million. Management believes that the Company's cash and cash equivalents at February 29, 2000 and projected cash flows or the level of expenses from operations in fiscal 2000 will be sufficient to cover its current or projected reduced operating expenses and such current obligations as are required to be paid in fiscal 2000. However, no assurance can be given as to the sufficiency of such cash flows in fiscal 2000 and beyond. The Company's future liquidity will be materially dependent on its ability to develop, publish and distribute software for game consoles that are popular or which the Company believes will become popular. There can be no assurance that the Company will be able to develop and publish successful software for these new game consoles. See "Factors Affecting Future Performance - If Cash Flows from Operations Are Not Sufficient to Meet the Company's Needs, It May be Forced to Sell Assets, Refinance Debt or Downsize Operations." 15 The Company is party to various litigations arising in the course of its business, the resolution of none of which, the Company believes, will have a material adverse effect on the Company's liquidity, financial condition and results of operations. New Accounting Pronouncement The Company will implement the provisions of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," in fiscal 2001. The Company is presently assessing the impact, if any, of this standard on its consolidated financial statements. Year 2000 Issue To date, the Company has not encountered any significant effects of the year 2000 issue either internally or with third parties. The Company cannot guarantee that problems will not occur in the future or have not yet been detected. 16 FACTORS AFFECTING FUTURE PERFORMANCE The Company's future operating results depend upon many factors and are subject to various risks and uncertainties. The known material risks and uncertainties which may cause the Company's operating results to vary from anticipated results or which may negatively affect its operating results and profitability are as follows: Revenues Are Dependent on Timely Introduction of New Titles The life cycle of a new title generally ranges from less than three months to upwards of 12 months, with the majority of sales occurring in the first 30 to 120 days after release. Therefore, the Company is constantly required to introduce new titles in order to generate revenues and/or to replace declining revenues from older titles. In the past and in fiscal 2000, the Company has experienced delays in the introduction of new titles, which has had a negative impact on its results of operations. If the Company does not introduce titles in accordance with its operating plans for a period, its results of operations and profitability in that period could be negatively affected. The timely shipment of a new title depends on various factors including: o the development process; o bug testing; o approval by hardware licensors; and o approval by third-party licensors. It is likely that some of the Company's titles will not be released in accordance with the Company's operating plans. A significant delay in the introduction of one or more new titles could negatively affect sales and have a negative impact on the Company's financial condition and results of operations, as has been the case in the past. The Company cannot assure stockholders that its new titles will be released in a timely fashion. Factors such as competition for access to retail shelf space, consumer preferences and seasonality could result in the shortening of the life cycle for older titles and increase the importance of the Company's ability to release new titles on a timely basis. Industry Trends, Platform Transitions and Technological Change May Adversely Affect The Company's Revenues and Profitability The life cycle of existing game consoles and the market acceptance and popularity of new game consoles significantly affects the success of the Company's products. The Company cannot guarantee that it will be able to predict accurately the life cycle or popularity of each game console. If the Company: o does not develop software for game consoles that achieve significant market acceptance; o discontinues development of software for a game console that has a longer-than-expected life cycle; o develops software for a game console that does not achieve a significant installed base; or o continues development of software for a game console that has a shorter-than-expected life cycle, it will experience losses from operations, as it did in fiscal 1996 and 1997 and the first six months of fiscal 2000. In addition, the cyclical nature of the video and computer games industry requires the Company continually to adapt its software development efforts to emerging hardware systems as discussed in the March 17, 2000 press announcement. The Company believes that the market for N64 and PlayStation hardware and software has peaked. Sega has introduced a 128-bit game console, Dreamcast, and both Sony and Nintendo have announced plans to introduce 128-bit game consoles and Microsoft has announced plans to introduce its X-Box. No assurance can be given that these new game consoles or 17 online gaming will achieve commercial success similar to and/or installed bases comparable to that of the 32-bit PlayStation or 64-bit N64, or as to the timing of such success. In addition, the Company cannot guarantee that it will be successful in developing and publishing software for these new game consoles. The Company's Future Success Is Dependent on Its Ability to Release "Hit" Titles The market for software is "hits" driven. Therefore, the Company's future success depends on developing, publishing and distributing "hit" titles for game consoles with significant installed bases. If the Company does not publish "hit" titles in the future, its financial condition, results of operations and profitability could be negatively affected, as they were in fiscal 1996 and 1997. However, it is difficult to predict consumer preferences for titles, and few titles achieve sustained market acceptance. The Company cannot assure stockholders that it will be able to publish "hit" titles in the future. If Product Returns, Price Protection and Concessions Exceed Allowances, the Company May Incur Losses The Company is not contractually obligated to accept returns except for defective product. However, the Company may permit customers to return or exchange products and may provide price protection or concessions on products unsold by the customer. If the Company's allowances for returns, exchanges and price protection and concessions are exceeded, its financial condition and results of operations will be negatively impacted, as they were in fiscal 1996. Management makes significant estimates and assumptions regarding allowances for estimated product returns, price protection and concessions in preparing the Company's financial statements. The Company establishes allowances taking into account the potential for product returns, price protection and concessions based primarily on: o market acceptance of products in retail inventories; o level of retail inventories; o seasonality; and o historical return and price concession rates. The Company believes that, at February 29, 2000, its allowances for future returns, exchanges and price protection and concessions are adequate. However, the Company cannot guarantee the adequacy of its current or future allowances. If the Company Is Unable to Obtain or Renew Licenses from Hardware Developers, It Will Not be Able to Release Software for Game Consoles The Company is substantially dependent on each hardware developer: o as the sole licensor of the specifications needed to develop software for its game consoles; o as the sole manufacturer (as to Nintendo and Sony software) of the software developed by the Company for its game consoles; o to protect the intellectual property rights to its game consoles and technology; and o to discourage unauthorized persons from producing software for its game consoles. 18 Substantially all of the Company's revenues have historically been derived from sales of software for game consoles. In the first six months of fiscal 1999 and 2000, the Company derived: o approximately 74% and 38%, respectively, of gross revenues from the sale of Nintendo-compatible software; o approximately 19% and 34%, respectively, of gross revenues from the sale of PlayStation software; and o approximately 2% and 21%, respectively, of gross revenues from the sale of Sega-compatible software. If the Company cannot obtain licenses to develop software from developers of new game consoles or if any of its existing license agreements are terminated, the Company will not be able to release software for those game consoles, which would have a negative impact on its results of operations and profitability. The Company cannot assure stockholders that, at the end of their current terms, it will be able to obtain extensions or that it will be successful in negotiating definitive license agreements with developers of new game consoles. The Company's revenue growth may also be dependent on the hardware developers. In the past, some of the Company's license agreements have limited the number of titles it could release in a given period. This limitation restricted the Company's sales growth, revenues and profitability. If new license agreements contain similar limitations, the Company's revenues and profitability will be negatively impacted. Increased Product Development Costs May Adversely Affect Profitability The Company's research and development expenses increased from $22.7 million (approximately 9% of net revenues) for the six months ended February 28, 1999 to $29.1 million (approximately 17% of net revenues) for the six months ended February 29, 2000. The Company anticipates that its future research and development expenses will continue to increase due to the Company's planned release of a higher number of titles, its preparations to release titles across all the next generation platforms and increased development expenses related to the next generation of platforms. The Company anticipates that its profitability will be negatively impacted by such increased expenses as revenues decline during the transition to the next generation platforms. Inability to Procure Commercially Valuable Intellectual Property Licenses May Prevent Product Releases or Result in Reduced Product Sales The Company's titles often embody trademarks, tradenames, logos or copyrights licensed to it by third parties, such as the NBA, the NFL or their respective players' associations, and Comedy Central. The Company may not be successful in acquiring or renewing licenses to property rights with significant commercial value. The loss of one or more of these licenses could prevent the Company's release of a title or limit its economic success. For example, the Company's license for the WWF properties expired in November 1999 and was not renewed. Sales of titles using WWF properties aggregated 18% of gross revenues in the six months ended February 28, 1999 as compared to 15% for the period ended February 29, 2000. In addition, the Company cannot assure stockholders that these licenses will be available on reasonable terms or at all. License agreements relating to these rights generally extend for a term of two to three years. The agreements are terminable upon the occurrence of a number of factors, including the Company's: o material breach of the agreement; o failure to pay amounts due to the licensor in a timely manner; or o bankruptcy or insolvency. 19 If The Company Does Not Compete Successfully, Demand for Its Products May be Reduced The video, computer and portable games market is highly competitive. Only a small percentage of titles introduced in the market achieve any degree of sustained market acceptance. If the Company's titles are not successful, its operations and profitability will be negatively impacted. The Company cannot guarantee that its titles will compete successfully. Competition in the interactive entertainment software industry is based primarily upon: o the quality of titles; o reviews received for a title from independent reviewers who publish reviews in magazines, websites, newspapers and other industry publications; o publisher's access to retail shelf space; o the success of the game console for which the title is written; o the price of each title; o the number of titles then available for the system for which each title is published; and o the marketing campaign supporting a title at launch and through its life. The Company's chief competitors are the developers of game consoles, to whom the Company pays royalties and/or manufacturing charges, as well as a number of independent software publishers. The hardware developers have a price, marketing and distribution advantage with respect to software marketed by them. The Company's competitors vary in size from very small companies with limited resources to very large corporations with greater financial, marketing and product development resources than the Company, such as Nintendo, Sega and Sony. The Company's competitors also include a number of independent software publishers licensed by the hardware developers. As each hardware cycle matures, significant price competition and reduced profit margins may result and the Company anticipates this in fiscal 2000 and fiscal 2001. In addition, competition from new technologies may reduce demand in markets in which the Company has traditionally competed. If there is prolonged price competition or reduced demand as a result of competing technologies, the Company's operations and liquidity could be negatively impacted. Revenues Vary Due to the Seasonal Nature of Video and Computer Games Software Purchases The video, computer and portable games industry is highly seasonal. Typically, net revenues are highest in the last calendar quarter, decline in the first calendar quarter, are lower in the second calendar quarter and increase in the third calendar quarter. The seasonal pattern is due primarily to the increased demand for software during the year-end holiday-selling season and the reduced demand for software during the summer months. However, the Company's earnings vary significantly and are materially affected by releases of "hit" titles and, accordingly, may not necessarily reflect the seasonal patterns of the industry as a whole. The Company expects that operating results will continue to fluctuate significantly in the future. See "-- Fluctuations in Quarterly Operating Results Lead to Unpredictability of Revenues and Income" below. Fluctuations in Quarterly Operating Results Lead to Unpredictability of Revenues and Income The timing of release of new titles can cause material quarterly revenues and earnings fluctuations. A significant portion of revenues in any quarter is often derived from sales of new titles introduced in that quarter or in the immediately preceding quarter. If the Company is unable to begin volume shipments of a significant new title during the scheduled quarter, its revenues and earnings will be negatively affected in that quarter. In addition, because a majority of the unit sales for a title typically occur in the first 30 to 120 days following its introduction, revenues and earnings may increase significantly in a period in which a major title is introduced and may decline in the following period or in periods in which there are no major title introductions. 20 Quarterly operating results also may be materially impacted by factors including (1) the level of market acceptance or demand for titles and (2) the level of development and/or promotion expenses for a title. Consequently, if net revenues in a period are below expectations, the Company's operating results and financial position in that period are likely to be affected negatively, as occurred in the first six months of fiscal 2000. If Cash Flows from Operations Are Not Sufficient to Meet The Company's Needs, It May be Forced to Sell Assets, Refinance Debt or Downsize Operations The Company generally experienced negative cash flows from operations in fiscal 1996 and 1997. As a result, in those years, the Company sold assets, refinanced debt and downsized operations. Insufficient liquidity in the future may require the Company to take similar actions. The Company is considering various cost reduction initiatives in an effort to further control its expenses relative to revenue and to reallocate its resources to research and development in preparation for the transition to the next generation systems. The Company believes that its cash and cash equivalents at February 29, 2000 and projected cash flows from operations in fiscal 2000 will be sufficient to cover its current and projected reduced operating expenses and the current obligations it must pay in fiscal 2000. See "-- Industry Trends, Platform Transitions and Technological Change May Adversely Affect The Company's Revenues and Profitability" above. However, the Company cannot assure investors that its operating expenses and current obligations will be significantly less than the cash flows available in fiscal 2000 or thereafter. Ability to Service Debt and Prior Rights of Creditors May Adversely Affect Holders of Common Stock The Company believes that its cash, cash equivalents and projected cash flows from operations in fiscal 2000 will be sufficient to make all interest and principal payments on a timely basis. However, if the Company's cash, cash equivalents and projected cash flow from operations in fiscal 2000 or beyond is insufficient to make interest and principal payments when due, the Company may have to restructure its indebtedness. The Company cannot guarantee that it will be able to restructure or refinance its debt on satisfactory terms. In addition, restructuring or refinancing may not be permitted by the terms of the Company's existing indebtedness. The Company cannot assure investors that its future operating cash flows will be sufficient to meet its debt service requirements or to repay its indebtedness at maturity. If Acclaim violates the financial or other covenants contained in its bank agreements or in the indenture governing its outstanding convertible notes, it will be in default under its loan agreements and/or the indenture. If a default occurs and is not waived by the lender, the lender could seek remedies against the Company, including: o penalty rates of interest; o immediate repayment of the debt; and/or o the foreclosure on any assets securing the debt. As of February 29, 2000 the Company was in compliance with the covenants contained in its bank agreements except the covenant prohibiting operating losses and the covenant related to its fixed charge ratio. The Company has received waivers from its lender. The Company expects to comply with the other covenants in its bank agreements and in the indenture but cannot guarantee that it will be able to do so. In addition, factors beyond the Company's control may result in future covenant defaults or a payment default. The Company may not be able to obtain waivers of any future default. If the Company becomes insolvent, is liquidated or reorganized, after payment to the creditors, there may be insufficient assets remaining for a distribution to stockholders. In order to meet its debt service obligations, from time to time the Company also depends on dividends, advances and transfers of funds from its subsidiaries. State and foreign law regulate the payment of dividends by these subsidiaries, which is also subject to the terms of existing bank agreements and the indenture governing its outstanding convertible notes. A significant portion of the Company's assets, operations, trade payables and indebtedness is located at these subsidiaries. The 21 creditors of the subsidiaries would generally recover from these assets on the obligations owed to them by the subsidiaries before any recovery by the Company's creditors and before any assets are distributed to stockholders. Prevalence of Illegal Copying of Software Could Adversely Affect Sales In order to protect its software and proprietary rights, the Company relies mainly on a combination of: o copyrights; o trade secret laws; o patent and trademark laws; and o nondisclosure agreements. However, existing U.S. and international laws afford only limited protection. An unauthorized person may be able to copy the Company's software or otherwise obtain and use its proprietary information. If a significant amount of illegal copying of software published or distributed by the Company occurs, its product sales could be adversely impacted. Policing illegal use of software is extremely difficult, and software piracy is expected to persist. In addition, the laws of some foreign countries in which the Company's software is distributed do not protect the Company and its intellectual property rights to the same extent as the laws of the U.S. The Company cannot guarantee that its attempts to protect its proprietary rights will be adequate. Infringement Could Lead to Costly Litigation and/or the Need to Enter into License Agreements, Which May Result in Increased Operating Expenses Existing or future infringement claims by or against the Company may result in costly litigation or require the Company to license the proprietary rights of third parties, which could have a negative impact on the Company's results of operations, liquidity and profitability. The Company believes that its proprietary rights do not infringe on the proprietary rights of others. However, as the number of titles in the industry increases, the Company believes that claims and lawsuits with respect to software infringement will also increase. From time to time, third parties have asserted that some of the Company's titles infringed upon their intellectual property rights. The Company has also asserted that third parties have likewise infringed its proprietary rights. These infringement claims have sometimes resulted in litigation by and against the Company. To date, none of these claims has negatively impacted the Company's ability to develop, publish or distribute its software. The Company cannot guarantee that future infringement claims will not occur or that they will not negatively impact its ability to develop, publish or distribute its software. Factors Specific to International Sales May Result in Reduced Revenues and/or Increased Costs International sales have historically represented material portions of the Company's revenues and the Company expects that international sales will continue to account for a significant portion of its revenues in future periods. Sales in foreign countries may involve expenses incurred to customize titles to comply with local laws. In addition, titles that are successful in the domestic market may not be successful in foreign markets due to different consumer preferences. International sales are also subject to fluctuating exchange rates and may be affected by the recent adoption of a single currency in much of Europe. These and other factors specific to international sales may result in reduced revenues and/or increased costs. Loss of Key Employees May Negatively Impact The Company's Success The Company's success depends on its ability to identify, hire and retain skilled personnel. The software industry is characterized by a high level of employee mobility and aggressive recruiting among competitors for personnel with technical, marketing, sales, product development and management skills. The Company may not be able to attract and retain skilled personnel or may incur significant costs in order to do so. 22 In particular, the Company is highly dependent upon the management services of Gregory Fischbach, co-chairman of the board and chief executive officer, and James Scoroposki, co-chairman of the board and senior executive vice president. If the Company were to lose either of their services, its business would be negatively impacted. Although the Company has employment agreements with Messrs. Fischbach and Scoroposki through August 2000, they may leave or compete with the Company in the future. If the Company is unable to attract additional qualified employees or retain the services of key personnel, its business could be negatively impacted. Charter and Anti-Takeover Provisions Could Negatively Affect Rights of Holders of Common Stock The board of directors has the authority to issue shares of preferred stock and to determine their characteristics without stockholder approval. This authority is limited by the indenture governing the convertible notes. If the Company issues preferred stock, the rights of common stockholders may be negatively affected by the rights of preferred stockholders. Moreover, if the Company issues preferred stock, it could become more difficult for a third party to acquire a majority of the Company's outstanding voting stock. The Company is also subject to anti-takeover provisions of Delaware corporate law, which may impede a tender offer, change in control or takeover attempt that is opposed by the board. In addition, employment arrangements with some members of management provide for severance payments upon termination of their employment if there is a change in control. Stock Price Is Volatile and Stockholders May Not Be Able to Recoup Their Investment There is a history of significant volatility in the market prices of companies engaged in the software industry, including the Company. Movements in the market price of the Company's common stock from time to time have negatively affected stockholders' ability to recoup their investment in the stock. The price of the Company's common stock is likely to continue to be highly volatile, and stockholders may not be able to recoup their investment. If the Company's future revenues, profitability or product releases do not meet expectations, the price of the Company's common stock may be negatively affected. 23 Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company has not entered into any significant financial instruments for trading or hedging purposes. The Company's earnings are affected by fluctuations in the value of its subsidiaries' functional currency as compared to the currencies of its foreign denominated sales and purchases. The results of operations of the Company's subsidiaries, as reported in U.S. dollars, may be significantly affected by fluctuations in the value of the local currencies in which the Company transacts business. Such amount is recorded upon the translation of the foreign subsidiaries' financial statements into U.S. dollars, and is dependent upon the various foreign exchange rates and the magnitude of the foreign subsidiaries' financial statements. At February 29, 2000, the Company's foreign currency translation adjustment is not material and, for the six months ended February 29, 2000, net foreign currency transaction losses were insignificant. In addition to the direct effects of changes in exchange rates, which are a changed dollar value of the resulting sales and related expenses, changes in exchange rates also affect the volume of sales or the foreign currency sales price as competitors' products become more or less attractive. The Company is not exposed to the material future earnings or cash flow exposures from changes in interest rates on long-term obligations since the majority of the Company's long-term obligations are at fixed rates. 24 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. ACCLAIM ENTERTAINMENT, INC. By: Gregory E. Fischbach April 13, 2000 -------------------- Gregory E. Fischbach Co-Chairman of the Board; Chief Executive Officer; President; Director By: William G. Sorenson April 13, 2000 ------------------- William G. Sorenson Executive Vice President and Chief Financial Officer (principal financial and accounting officer) 25 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company and other participants in the entertainment industry were sued in an action entitled James, et al. v. Meow Media, et al. filed in April 1999 in the U.S. District Court for the Western District of Kentucky, Paducah Division, Civil Action No. 5:99CV96-J. The plaintiffs allege that the defendants caused injury to the plaintiffs as a result of, in the case of the Company, its manufacture and/or supply of "violent" video games to Michael Carneal, then fourteen. The plaintiffs further allege that the defendants were negligent in such manufacture and/or supply thereby breaching a duty to Mr. Carneal and others, including the plaintiffs (the parents of the deceased individuals). Mr. Carneal killed three individuals and wounded five others during a shooting at the Heath High School in McCracken County, Kentucky. The plaintiffs seek damages in the amount of approximately $110,000,000. The Company intends to defend this action vigorously. The Company has entered into a joint defense agreement and is sharing defense costs with certain of the other defendants. The Company, Iguana Entertainment and Gregory E. Fischbach were sued in an action entitled Jeffery Spangenberg vs. Acclaim Entertainment, Inc., Iguana Entertainment, Inc., and Gregory Fischbach filed in August 1998 in the District Court of Travis County, Texas (Cause No. 98-09418). The plaintiff alleges that the defendants (1) breached their employment obligations to the plaintiff, (2) breached a Texas statute covering wage payment obligations based on their alleged failure to pay bonuses to the plaintiff; and (3) made fraudulent misrepresentations to the plaintiff in connection with the plaintiff's employment relationship with the Company, and accordingly, seeks unspecified damages. The Company intends to defend this action vigorously. The SEC issued orders in April 1996 directing a private investigation relating to, among other things, the Company's October 1995 release of its earnings estimate for fiscal 1995. The Company provided documents to the SEC, and the SEC took testimony from Company representatives. The Company was advised in January 2000 that the Staff of the SEC will recommend that the SEC authorize an enforcement action against the Company but not any individuals currently associated with the Company in connection with matters related to the Company's release. The Company has previously settled litigations relating to the Company's October 1995 release, and the related charges were recorded in fiscal 1997. No assurance can be given as to the outcome of the SEC investigation. The Company is also party to various litigations arising in the ordinary course of its business, the resolution of none of which, the Company believes, will have a material adverse effect on the Company's liquidity or results of operations. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On February 2, 2000, at the annual meeting of stockholders of the Company, the stockholders (1) elected the following directors: Gregory E. Fischbach (by a vote of 45,551,444 shares for and 2,721,398 shares withheld); James R. Scoroposki (by a vote of 44,334,293 shares for and 3,938,549 shares withheld); Kenneth L. Coleman (by a vote of 43,299,275 shares for and 4,973,567 shares withheld); Bernard J. Fischbach (by a vote of 43,955,658 shares for and 4,317,184 shares withheld); Robert H. Groman (by a vote of 43,284,589 shares for and 4,988,253 shares withheld); James Scibelli (by a vote of 45,438,362 shares for and 2,834,480 shares withheld); and Michael Tannen (by a vote of 44,745,485 shares for and 3,527,357 shares withheld); and (2) ratified the appointment of KPMG LLP as independent auditors of the 26 Company for the year ending August 31, 2000 by a vote of 46,755,203 shares for, 1,375,189 shares against, and absentions with respect to 144,727 shares. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description 3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1, filed on April 21, 1989, as amended (Registration No. 33-28274) (the "1989 S-1")) 3.2 Amendment to the Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.2 to the 1989 S-1) 3.3 Amendment to the Certificate of Incorporation of the Company (incorporated by reference to Exhibit 4(d) to the Company's Registration Statement on Form S-8, filed on May 19, 1995 (Registration No. 33-59483) (the "1995 S-8")) 3.4 Amended and Restated By-laws of the Company (incorporated by reference to Exhibit 4(e) to the 1995 S-8) 4.1 Specimen form of the Company's common stock certificate (incorporated by reference to Exhibit 4 to the Company's Annual Report on Form 10-K for the year ended August 31, 1989, as amended (File No. 0-16986)) 4.2 Indenture dated as of February 26, 1997 between the Company and IBJ Schroder Bank & Trust Company, as trustee (incorporated by reference to Exhibit 4.3 to the Company's Report on Form 8-K, filed on March 14, 1997 (File No. 0-16986)) +10.1 Employment Agreement dated as of September 1, 1994 between the Company and Gregory E. Fischbach; and Amendment No. 1 dated as of December 8, 1996 between the Company and Gregory E. Fischbach (incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended August 31, 1996 (File No. 0-16986) (the "1996 10-K")) +10.2 Employment Agreement dated as of September 1, 1994 between the Company and James Scoroposki; and Amendment No. 1 dated as of December 8, 1996 between the Company and James Scoroposki (incorporated by reference to Exhibit 10.2 to the 1996 10-K) +10.3 Service Agreement effective January 1, 1998 between Acclaim Entertainment Limited and Rodney Cousens +10.4 Employment Agreement dated as of August 13, 1999 between the Company and William G. Sorenson +10.5 Restricted Stock Agreement dated August 18, 1999 between the Company and William G. Sorenson 27 Exhibit No. Description +10.6 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form S-8 filed on May 4, 1998 (Registration No. 333-51967)) +10.7 1998 Stock Incentive Plan (incorporated by reference to the Company's 1998 Proxy Statement relating to fiscal year ended August 31, 1997) 10.8 Revolving Credit and Security Agreement dated as of January 1, 1993 between the Company, Acclaim Distribution Inc., LJN Toys, Ltd., Acclaim Entertainment Canada, Ltd. and Arena Entertainment Inc., as borrowers, and BNY Financial Corporation ("BNY"), as lender, as amended and restated on February 28, 1995 (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1995 (File No. 0-16986) (the "1995 10-Q")), as further amended and modified by (i) the Amendment and Waiver dated November 8, 1996, (ii) the Amendment dated November 15, 1996, (iii) the Blocked Account Agreement dated November 14, 1996, (iv) Letter Agreement dated December 13, 1996 and (v) Letter Agreement dated February 24, 1997 (incorporated by reference to Exhibit 10.4 to the Company's Report on Form 8-K filed on March 14, 1997 (File No. 0-16986) (the "1997 8-K")) 10.9 Restated and Amended Factoring Agreement dated as of February 28, 1995 between the Company and BNY (incorporated by reference to Exhibit 10.2 to the 1995 10-Q), as further amended and modified by the Amendment to Factoring Agreements dated February 24, 1997 between the Company and BNY (incorporated by reference to Exhibit 10.5 to the 1997 8-K) 10.10* Confidential License Agreement between Nintendo of America and the Company, effective as of February 20, 1997 (incorporated by reference to Exhibit 1 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1998 (File No. 0-16986)) 27 Financial Data Schedule - --------------- * Confidential treatment has been granted with respect to certain portions of this exhibit, which have been omitted therefrom and have been separately filed with the Commission. + Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K None. 28 EX-27 2 FINANCIAL DATA SCHEDULE
5 6-MOS AUG-31-2000 SEP-01-1999 FEB-29-2000 56,511 0 93,643 41,764 12,036 135,561 71,994 34,094 194,641 126,760 49,750 0 0 1,128 14,107 194,641 167,095 92,973 74,122 108,184 1,493 0 2,608 (17,220) 1,322 (18,542) 0 0 0 (18,542) (0.33) (0.33)
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