-----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, ADtuGp06Fyj1KnXk+zKWY/t2EGTE20w6i1wStc9y02QhOWJCC/XB+pzxq/TpYZpN rDsdPr03mkQAPikpuwTUXw== 0000889812-99-000115.txt : 19990115 0000889812-99-000115.hdr.sgml : 19990115 ACCESSION NUMBER: 0000889812-99-000115 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981130 FILED AS OF DATE: 19990114 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: 99505979 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 November 30, 1998 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 incorporation (I.R.S. Employer or organization) Identification 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 January 12, 1999, approximately 53,725,000 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) November 30, August 31, 1998 1998 ASSETS CURRENT ASSETS Cash and cash equivalents $58,023 $47,273 Accounts receivable - net 55,624 39,177 Inventories 7,554 3,430 Prepaid expenses 11,304 16,571 ------ ------ TOTAL CURRENT ASSETS 132,505 106,451 ------- ------- OTHER ASSETS Fixed assets - net 29,653 29,294 Excess of cost over fair value of net assets acquired - net of accumulated amortization of $19,856 and $19,218, respectively 23,402 21,433 Other assets 2,715 3,229 ----- ----- TOTAL ASSETS $188,275 $160,407 -------- -------- LIABILITIES AND STOCKHOLDERS' DEFICIENCY CURRENT LIABILITIES Trade accounts payable $33,832 $24,218 Short-term borrowings --- 16 Accrued expenses 95,939 92,207 Income taxes payable 6,395 6,918 Current portion of long-term debt 724 724 Obligation under capital leases - current 1,345 1,468 ----- ----- TOTAL CURRENT LIABILITIES 138,235 125,551 ------- ------- LONG-TERM LIABILITIES Long-term debt 51,500 51,931 Obligation under capital leases - noncurrent 1,085 1,110 Other long-term liabilities 2,907 3,588 ----- ----- TOTAL LIABILITIES 193,727 182,180 ------- ------- STOCKHOLDERS' DEFICIENCY Preferred stock, $0.01 par value; 1,000 shares authorized; none issued -- -- Common stock, $0.02 par value; 100,000 shares authorized; 53,609 and 52,634 shares issued, respectively 1,072 1,053 Additional paid in capital 195,911 189,645 Accumulated deficit (198,893) (209,180) Treasury stock, 523 shares (3,103) (3,103) Foreign currency translation adjustment (439) (188) ----- ----- TOTAL STOCKHOLDERS' DEFICIENCY (5,452) (21,773) ------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $188,275 $160,407 -------- --------
See notes to consolidated financial statements. 1 ACCLAIM ENTERTAINMENT, INC AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS (in 000s, except per share data) (Unaudited) Three Months Ended November 30, 1998 1997 ---- ---- NET REVENUES $104,831 $92,277 COST OF REVENUES 50,500 44,002 ------ ------ GROSS PROFIT 54,331 48,275 ------ ------ OPERATING EXPENSES Marketing and sales 17,519 17,098 General and administrative 14,930 14,081 Research and development 11,228 8,344 ------ ----- TOTAL OPERATING EXPENSES 43,677 39,523 ------ ------ EARNINGS FROM OPERATIONS 10,654 8,752 ------ ----- OTHER INCOME (EXPENSE) Interest income 795 460 Interest expense (1,407) (1,440) Other income 758 344 --- --- EARNINGS BEFORE INCOME TAXES 10,800 8,116 ------ ----- PROVISION FOR INCOME TAXES 513 106 --- --- NET EARNINGS BEFORE MINORITY INTEREST 10,287 8,010 ------ ----- MINORITY INTEREST --- (5) ----- --- NET EARNINGS $10,287 $8,015 ------- ------ BASIC EARNINGS PER SHARE $0.19 $0.16 ----- ----- DILUTED EARNINGS PER SHARE $0.16 $0.15 ----- ----- See notes to consolidated financial statements. ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED STOCKHOLDERS' (DEFICIENCY) EQUITY (in 000s, except per share data)
Preferred Stock (1) Common Stock ------------------- ----------------- Issued Issued ------ ------ (Accumulated Additional Deficit) Paid-In Deferred Retained Shares Amount Shares Amount Capital Compensation Earnings ------ ------ ------ ------ ------- ------------ -------- Balance August 31, 1996 ---- ---- 50,041 $1,001 $180,895 $(15,113) $(70,642) -------- -------- ------ ------ -------- --------- --------- Net Loss ---- ---- ---- ---- ---- ---- (159,228) Issuances and Cancellations of Warrants and Options ---- ---- ---- ---- 722 566 ---- Deferred Compensation Expense ---- ---- ---- ---- ---- 6,134 ---- Exercise of Stock Options ---- ---- 81 1 169 ---- ---- Escrowed Shares Received ---- ---- ---- ---- ---- ---- ---- Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ---- Unrealized Loss on Marketable Equity Securities ---- ---- ---- ---- ---- ---- ---- -------- -------- -------- -------- -------- ----- ------------- ------------- Balance August 31, 1997 ---- ---- 50,122 1,002 181,786 (8,413) (229,870) -------- -------- ------ ----- ------- ------- --------- Net Earnings ---- ---- ---- ---- ---- ---- 20,690 Issuance of Common Stock for Litigation Settlements ---- ---- 1,274 26 6,868 ---- ---- Issuances and Cancellations of Common Stock and Options ---- ---- 15 1 239 690 ---- Deferred Compensation Expense ---- ---- ---- ---- ---- 4,190 ---- Exercise of Stock Options ---- ---- 1,223 24 4,285 ---- ---- Escrowed Shares Received ---- ---- ---- ---- ---- ---- ---- Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ---- -------- -------- -------- -------- -------- --------- ------------- Balance August 31, 1998 ---- ---- 52,634 1,053 193,178 (3,533) (209,180) -------- -------- ------ ----- ------- ------- --------- Net Earnings ---- ---- ---- ---- ---- ---- 10,287 Issuances of Common Stock ---- ---- 206 4 1,792 ---- ---- Issuance of Warrants for Litigation Settlement ---- ---- ---- ---- 950 ---- ---- Subordinated Notes Conversion ---- ---- 48 1 249 ---- ---- Issuances and Cancellations of Common Stock and Options ---- ---- ---- ---- (362) 362 ---- Deferred Compensation Expense ---- ---- ---- ---- ---- 630 ---- Exercise of Stock Options and Warrants ---- ---- 721 14 2,645 ---- ---- Foreign Currency Translation Gain ---- ---- ---- ---- ---- ---- ---- -------- -------- -------- -------- --------- -------- --------- Balance November 30, 1998 ---- ---- 53,609 $1,072 $198,452 $(2,541) $(198,893) ---------- -------- ------ ------ -------- -------- --------- Unrealized Foreign Gain (Loss) On Currency Marketable Treasury Translation Equity Stock Adjustment Securities Total ----- ---------- ---------- ----- Balance August 31, 1996 $(1,813) $(754) $15 $93,589 -------- ------ --- ------- Net Loss ---- ---- ---- (159,228) Issuances and Cancellations of Warrants and Options ---- ---- ---- 1,288 Deferred Compensation Expense ---- ---- ---- 6,134 Exercise of Stock Options ---- ---- ---- 170 Escrowed Shares Received (1,091) ---- ---- (1,091) Foreign Currency Translation Gain ---- 107 ---- 107 Unrealized Loss on Marketable Equity Securities ---- ---- (15) (15) -------- -------- ---- ---- Balance August 31, 1997 (2,904) (647) 0 (59,046) ------- ----- - ------- Net Earnings ---- ---- ---- 20,690 Issuance of Common Stock for Litigation Settlements ---- ---- ---- 6,894 Issuances and Cancellations of Common Stock and Options ---- ---- ---- 930 Deferred Compensation Expense ---- ---- ---- 4,190 Exercise of Stock Options ---- ---- ---- 4,309 Escrowed Shares Received (199) ---- ---- (199) Foreign Currency Translation Gain ---- 459 ---- 459 -------- --- ------ --- Balance August 31, 1998 (3,103) (188) 0 (21,773) ------- ---- - ------- Net Earnings ---- ---- ---- 10,287 Issuances of Common Stock ---- ---- ---- 1,796 Issuance of Warrants for Litigation Settlement ---- ---- ---- 950 Subordinated Notes Conversion ---- ---- ---- 250 Issuances and Cancellations of Common Stock and Options ---- ---- ---- ---- Deferred Compensation Expense ---- ---- ---- 630 Exercise of Stock Options and Warrants ---- ---- ---- 2,659 Foreign Currency Translation Gain ---- (251) ---- (251) ------- ----- ------- ------- Balance November 30, 1998 $(3,103) $(439) $0 $(5,452) ------- ----- -- -------
(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. See notes to consolidated financial statements. 3 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (in 000s, except per share data)
(Unaudited) Three Months Ended November 30, 1998 1997 ---- ---- CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES Net Earnings $10,287 $8,015 ------- ------ Adjustments to reconcile net earnings to net cash (used in) provided by operating activities: Depreciation and amortization 2,763 3,449 Provision for returns and discounts 16,730 13,640 Minority interest in net earnings of consolidated subsidiary --- (5) Deferred compensation expense 630 1,106 Non-cash royalty charges 136 221 Other non-cash items (22) 446 Change in assets and liabilities, net of effects of acquisition: Accounts receivable (29,356) (32,366) Inventories (4,048) 1,996 Prepaid expenses 5,205 7,421 Trade accounts payable 9,637 4,083 Accrued expenses 335 (3,608) Income taxes payable (188) 99 Other long-term liabilities (681) 2,591 ----- ----- Total adjustments 1,141 (927) ----- ----- NET CASH PROVIDED BY OPERATING ACTIVITIES 11,428 7,088 ------ ----- CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES Acquisition of subsidiary, net of cash acquired (421) --- Acquisition of fixed assets, excluding capital leases (1,868) (746) Disposal of fixed assets 56 9 Disposal of other assets 43 --- -- ----- NET CASH (USED IN) INVESTING ACTIVITIES (2,190) (737) ------- -----
4 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (Continued) (in 000s, except per share data)
(Unaudited) Three Months Ended November 30, 1998 1997 ---- ---- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES Payment of mortgage $(181) $(348) Payment of short-term bank loans (16) (618) Exercise of stock options and warrants 2,659 62 Payment of obligation under capital leases (343) (283) Miscellaneous financing activities -- 46 ---- -- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,119 (1,141) ----- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (607) (185) ----- ----- NET INCREASE IN CASH AND CASH EQUIVALENTS 10,750 5,025 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 47,273 26,254 ------ ------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $58,023 $31,279 ------- ------- Supplemental schedule of noncash investing and financing activities: 1998 1997 ---- ---- Acquisition of equipment under capital leases $58 $--- Cash paid during the year for: Interest $2,414 $1,849 Income taxes $624 $--- 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. 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 these 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: November 30, August 31, 1998 1998 ---- ---- Receivables assigned to factor $78,400 $79,338 Advances from factor 28,872 34,914 ------ ------ Due from factor 49,528 44,424 Unfactored accounts receivable 4,956 6,398 Foreign accounts receivable 36,648 22,201 Other receivables 1,852 3,414 Allowances for returns and discounts (37,360) (37,260) -------- -------- $55,624 $39,177 ------- ------- Pursuant to a factoring agreement, the Company's principal bank acts as its factor for the majority of its North American receivables, which are assigned on a pre-approved basis. At November 30, 1998, the factoring charge amounted to 0.25% of the receivables assigned. The Company's obligations to the bank 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 expires on January 31, 2000. Pursuant to the terms of the agreement, as amended, which can be canceled by either party upon 90-days notice prior to the end of the term, the Company is required to maintain specified levels of working capital and tangible net worth, among other covenants. As of November 30, 1998, the Company was in compliance with the covenants under its revolving credit facility. 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 bank's prime lending rate plus one percent per annum (8.75% at November 30, 1998) on such advances. Pursuant to the terms of certain distribution, warehouse and credit and collection agreements, certain of the Company's foreign 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 November 30, 1998 and August 31, 1998, the balance due from a distributor was approximately 25% and 24%, respectively, of foreign 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: November 30, August 31, 1998 1998 10% Convertible Subordinated Notes due 2002 $49,750 $50,000 Mortgage note 2,474 2,655 ----- ----- 52,224 52,655 Less: current portion 724 724 --- --- $51,500 $51,931 ------- ------- The 10% Convertible Subordinated Notes due 2002 (the "Notes") are convertible into shares of 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 on or after March 1, 2000 through February 28, 2001 and at 102% of the principal balance thereafter to maturity. 4. Earnings Per Share Basic earnings per share is computed based upon the weighted average number of common shares outstanding. Diluted earnings per share is computed based upon the weighted average number of common shares outstanding increased by dilutive common stock options and warrants and the effect of assuming the conversion of the outstanding Notes, if dilutive. Prior year earnings per share data has been restated to apply the provisions of SFAS 128. The table below provides the components of the per share computations. Three Months Ended November 30, 1998 1997 ---- ---- BASIC EPS COMPUTATION Net earnings $10,287 $8,015 ------- ------ Weighted average common shares outstanding 52,900 50,385 Basic earnings per share $0.19 $0.16 DILUTED EPS COMPUTATION Net earnings $10,287 $8,015 10% Convertible Subordinated Notes Interest Expense 1,244 --- ----- ------ Adjusted Net Income $11,531 $8,015 ------- ------ Weighted average common shares outstanding 52,900 50,385 Stock options and warrants 8,470 3,370 10% Convertible Subordinated Notes 9,605 --- ----- ------ Diluted common shares outstanding 70,975 53,755 ------ ------ Diluted earnings per share $0.16 $0.15 5. Comprehensive Income Effective September 1, 1998 the Company has adopted Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" which requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in the financial statements. The Company's total comprehensive earnings were as follows: 7 ACCLAIM ENTERTAINMENT, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in 000s, except per share data) 5. Comprehensive Income - (Continued) Three Months Ended November 30, 1998 1997 ---- ---- Net earnings 10,287 8,015 Other comprehensive earnings (losses): Foreign currency translation adjustments (251) 93 ----- -- Comprehensive earnings $10,036 $8,108 ------- ------ 6. 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 Earnings 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 of the Company 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. 7. Revenue Recognition The Company adopted Statement of Position ("SOP") 97-2, "Software Revenue Recognition", effective for transactions entered into commencing September 1, 1998. SOP 97-2 indicates that revenue for noncustomized software should be recognized when persuasive evidence of an arrangement exists, the software has been delivered, the Company's selling price is fixed or determinable and collectibility of the resulting receivable is probable. The implementation of SOP 97-2 did not have a significant impact on the Company's results of operations. 8 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, 1998 and presumes that readers have access to, and will have read, the "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 16 to 24, 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 Acclaim Entertainment, Inc. ("Acclaim"), together with its subsidiaries (Acclaim and its subsidiaries are collectively referred to as the "Company"), is a worldwide developer, publisher and mass marketer of interactive entertainment software ("Software") for use with dedicated interactive entertainment hardware platforms ("Entertainment Platforms") and multimedia personal computer systems ("PC"s). The Company owns and operates four Software development studios (the "Studios"), located in the United States and the United Kingdom, and publishes and distributes its Software directly in North America, the United Kingdom, Germany, France and Australia. The Company's operating strategy is to develop and maintain a core of key brands and franchises (e.g., Turok, NFL Quarterback Club and All Star Baseball) to support the various Entertainment Platforms and PCs that dominate the interactive entertainment market at a given time or which the Company perceives as having the potential for achieving mass market acceptance. The Company emphasizes sports simulation and arcade-style Software for Entertainment Platforms, and fantasy/role-playing, real-time simulation, adventure and sports simulation Software for PCs. The Company also engages, to a lesser extent, in the distribution of Software developed by third-party Software publishers ("Affiliated Labels") and the development and publication of comic book magazines and strategy guides relating to the Company's Software. The Company believes the Software industry is driven by the size of the installed base of Entertainment Platforms (such as those manufactured by Nintendo Co., Ltd. (Japan) (Nintendo Co., Ltd. and its subsidiary, Nintendo of America, Inc., are collectively referred to as "Nintendo"), Sony Corporation (Sony Corporation and its affiliate, Sony Computer Entertainment America, are collectively referred to as "Sony") and Sega Enterprises Ltd. ("Sega")) and PCs dedicated for home use. The industry is characterized by rapid technological change, resulting in Entertainment Platform and related Software product cycles. No single Entertainment Platform or system has achieved long-term dominance in the interactive entertainment market. Accordingly, the Company must continually anticipate and adapt its Software to emerging Entertainment Platforms. The rapid technological advances in game systems have significantly changed the look and feel of Software as well as the Software development process. According to Company estimates, the average development cost for a title for Entertainment Platforms approximately three years ago was approximately $300,000 to $400,000, while the average development cost for a title for Entertainment Platforms and PCs is currently between $1 million and 9 $2 million. Approximately 75% of the Company's gross revenues in the first quarter of fiscal 1999 was derived from Software developed by the Studios. The process of developing Software is extremely complex and is expected to become more complex and expensive in the future as new platforms and technologies are introduced. See "Factors Affecting Future Performance - Increased Product Development Costs." The Company's performance has historically been materially affected by platform transitions and product cycles. As a result of the industry transition to 32- and 64-bit Entertainment Platforms 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. See "Factors Affecting Future Performance - Industry Trends; Platform Transition; Technological Change." The Company recorded net earnings of $8.0 million and $10.3 million in the first quarter of fiscal 1998 and 1999, respectively. The fiscal 1999 period results primarily reflect increased sales in the United States of the Company's 32- and 64-bit Software. Although revenues from the sale of N64 and PlayStation Software are anticipated to continue to grow in the second quarter of fiscal 1999 and for fiscal 1999 as a whole, the Company does not anticipate that, for fiscal 1999 as a whole, it will achieve its fiscal 1998 growth rate. No assurance can be given as to the future growth of the installed base of 32- and 64-bit Entertainment Platforms, the future growth of the Software market therefor or of the Company's results of operations and profitability in future periods. The results for the first quarter of fiscal 1998 and 1999 also reflect the Company's significantly reduced operating expenses as compared to prior periods. The Company's ability to generate sales growth and profitability will be materially dependent on (i) the growth of the Software market for 32- and 64-bit Entertainment Platforms and PCs and (ii) the Company's ability to identify, develop and publish "hit" Software for Entertainment Platforms with significant installed bases. Results of Operations The following table sets forth certain statements of consolidated operations data as a percentage of net revenues for the periods indicated: Three Months Ended November 30, ------------------------------- 1998 1997 ---- ---- Domestic revenues 70.3% 59.0% Foreign revenues 29.7 41.0 ---- ---- Net revenues 100.0 100.0 Cost of revenues 48.2 47.7 ---- ---- Gross profit 51.8 52.3 Marketing and sales 16.7 18.5 General and administrative 14.3 15.3 Research and development 10.7 9.0 ---- --- Total operating expenses 41.7 42.8 Earnings from operations 10.1 9.5 Other income (expense), net 0.2 (0.7) Earnings before income taxes 10.3 8.8 Net earnings 9.8 8.7 10 Net Revenues The Company's gross revenues were derived from the following product categories: Three Months Ended November 30, ------------------------------- 1998* 1997* ----- ----- Portable Software 2.0% 1.0% 16-bit Software --- 1.0% 32-bit Software 31.0% 15.0% 64-bit Software 60.0% 73.0% PC Software 5.0% 9.0% Other 2.0% 1.0% *The numbers in this chart do not give effect to sales credits and allowances granted by the Company in the periods covered 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. The increase in the Company's net revenues from $92.3 million for the quarter ended November 30, 1997 to $104.8 million for the quarter ended November 30, 1998 was predominantly due to increased sales in the United States of the Company's 32- and 64-bit Software. The increase in sales in the fiscal 1999 quarter was primarily due to the continued increase in the installed base of Nintendo's 64-bit N64 ("N64") and Sony's 32-bit PlayStation ("PlayStation") consoles worldwide and the quality and market acceptance of the Company's titles for those Entertainment Platforms. Although revenues from the sale of N64 and PlayStation Software are anticipated to continue to grow in the second quarter of fiscal 1999 and for fiscal 1999 as a whole, the Company does not anticipate that, for fiscal 1999 as a whole, it will achieve its fiscal 1998 growth rate. The Company's domestic sales in the first quarter of fiscal 1999 comprised a higher percentage of total net revenues as compared to the first quarter of fiscal 1998 primarily because the titles published by the Company in the 1999 period were aimed at, and achieved greater popularity in, the domestic market (e.g., WWF War Zone and NFL Quarterback Club '99). 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 date, the Company has not generated material revenues from any of its operations other than Software publishing and no assurance can be given that the Company will be able to generate such revenues in the future. A significant portion of the Company's revenues in any quarter are generally derived from Software first released in that quarter or in the immediately preceding quarter. See "Factors Affecting Future Performance- Revenue and Earnings Fluctuations; Seasonality" and "- Reliance on New Titles; Product Delays." In the quarter ended November 30, 1998, WWF War Zone (for multiple platforms), NFL Quarterback Club '99 (for the N64), and Extreme G2 (for the N64) accounted for approximately 31%, 23% and 15%, respectively, of the Company's gross revenues. In the quarter ended November 30, 1997, Extreme G, NFL Quarterback Club '98 and Turok: Dinosaur Hunter (all for the N64) accounted for approximately 32%, 31% and 8%, respectively, of the Company's gross revenues. See "Factors Affecting Future Performance - Reliance on "Hit" Titles." 11 The Company is substantially dependent on the Entertainment Platform manufacturers as the sole manufacturers of the Entertainment Platforms marketed by them, as the sole licensors of the proprietary information and technology needed to develop Software for those Entertainment Platforms and, in the case of Nintendo and Sony, as the sole manufacturers of Software for the Entertainment Platforms marketed by them. For the quarters ended November 30, 1997 and 1998, the Company derived 75% and 62% of its gross revenues, respectively, from sales of Nintendo-compatible Software and 15% and 31% of its gross revenues, respectively, from sales of Software for PlayStation. In prior periods, the Company has also derived substantial portions of its gross revenues from sales of Software for platforms marketed by Sega. Such revenues have not been material in recent periods. Although the Company does not plan to release any titles for Sega's 32-bit platform in fiscal 1999, it may release titles for other Entertainment Platforms introduced by Sega in future periods. See "Factors Affecting Future Performance - Dependence on Entertainment Platform Manufacturers; Need for License Renewals." Gross Profit Gross profit fluctuates primarily as a result of five factors: (i) the level of returns, sales credits and allowances; (ii) the number of "hit" products and average unit selling prices; (iii) the percentage of sales of CD Software; (iv) the percentage of foreign sales; and (v) the percentage of foreign sales to third-party distributors. All royalties payable to Nintendo, Sony and Sega are included in cost of revenues. The Company's gross profit is adversely impacted by increases in the level of returns and allowances to retailers, which reduces the average unit price obtained for its Software sales. Similarly, lack of "hit" titles or a low number of "hit" titles, resulting in lower average unit sales prices, adversely impacts the Company's gross profits. The Company's margins on sales of CD Software (currently, PlayStation and PCs) are higher than those on cartridge Software (currently, N64) as a result of significantly lower CD Software product costs. The Company's margins on foreign Software sales are typically lower than those on domestic sales due to higher prices charged by hardware licensors for Software distributed by the Company outside North America. 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 increased from $48.3 million (52% of net revenues) for the quarter ended November 30, 1997 to $54.3 million (52% of net revenues) for the quarter ended November 30, 1998 predominantly due to increased sales volume. Management anticipates that the Company's future gross profit will be affected principally by (i) the percentage of returns, sales credits and allowances and other similar concessions in respect of the Company's Software sales and (ii) the Company's product mix (i.e., the percentage of CD Software). Although gross margins on sales of CD Software are higher than on cartridge Software, management believes that if the Company is required to institute stock-balancing programs for its PC Software, the Company will experience higher rates of returns of such product as compared to the historical rate of return of cartridge Software. In such event, management anticipates that its reserves for such returns will increase, thereby offsetting a portion of the higher gross margins generated from PC Software sales. The Company purchases substantially all of its products at prices payable in United States dollars. Appreciation of the yen could result in increased prices charged by Nintendo, Sony or Sega to the Company (although, to date, none of them has effected such a price increase), which the Company may not be able to pass on to its customers and which could adversely affect its results of operations. Operating Expenses In fiscal 1997, the Company effected a variety of cost reduction measures to reduce its operating expenses. The Company realized the benefits of such measures in the fourth quarter of fiscal 1997 and 12 thereafter in the form of reduced operating expenses as compared to prior periods. In addition, in fiscal 1998, the Company consolidated or eliminated certain operations. Marketing and sales expenses were $17.1 million (19% of net revenues) for the quarter ended November 30, 1997 and $17.5 million (17% of net revenues) for the quarter ended November 30, 1998. The percentage decrease is primarily attributable to increased sales volume. General and administrative expenses were $14.1 million (15% of net revenues) for the quarter ended November 30, 1997 and $14.9 million (14% of net revenues) for the quarter ended November 30, 1998. The percentage decrease is primarily attributable to increased sales volume. Research and development expenses increased from $8.3 million (9% of net revenues) for the quarter ended November 30, 1997 to $11.2 million (11% of net revenues) for the quarter ended November 30, 1998. The increase was primarily attributable to increased personnel costs at the Studios. Due to the Company's planned release of a higher number of titles and increasing Software development costs, the Company anticipates that its future research and development expenses will continue to increase as a percentage of net revenues as compared to fiscal 1998. See "Factors Affecting Future Performance - Increased Product Development Costs." Although the Company anticipates that its aggregate operating expenses will increase in dollars in fiscal 1999, it does not anticipate that such expenses will increase materially as a percentage of net revenues. However, no assurance can be given that the Company's operating expenses will not increase as a percentage of net revenues or that the cost reduction measures heretofore effected will not materially adversely affect the Company's ability to develop and publish commercially viable titles, or that such measures, whether alone or in conjunction with increased revenues, if any, will be sufficient to generate operating profits in fiscal 1999 and beyond. See "Factors Affecting Future Performance - Recent Operating Results." As of August 31, 1998, the Company had a U.S. tax net operating loss carryforward of approximately $110 million. In the first quarter of fiscal 1998 and 1999, the Company utilized a portion of its net operating loss carryforwards. The provision for income taxes of $0.5 million in fiscal 1999 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-Revenue and Earnings Fluctuations." Liquidity and Capital Resources The Company derived net cash from operating activities of approximately $7.1 million and $11.4 million during the quarter ended November 30, 1997 and 1998, respectively. The increase in net cash from operating activities in the first quarter of fiscal 1999 is primarily attributable to profitable operations. The Company used net cash in investing activities of approximately $0.7 million and $2.2 million during the quarter ended November 30, 1997 and 1998, respectively. The increase in net cash used in investing activities in the first quarter of fiscal 1999 is primarily attributable to the acquisition of fixed assets and of certain assets of a distributor located in Australia. The Company used net cash in financing activities of approximately $1.1 million during the quarter ended November 30, 1997 and derived net cash from financing activities of approximately $2.1 million during the quarter ended November 30,1998. The increase in net cash provided by financing activities 13 in the first quarter of fiscal 1999 as compared to the first quarter of fiscal 1998 is primarily attributable to the proceeds of $2.7 million from the exercise of outstanding stock options and warrants, and lower required payments in respect of outstanding debt obligations during the 1999 period. The Company generally purchases its inventory of Nintendo Software by opening letters of credit when placing the purchase order. At November 30, 1998, the amount outstanding under letters of credit was approximately $39.1 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 BNY, its principal domestic bank, which agreement expires on January 31, 2000. The credit agreement may be automatically renewed 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. BNY also acts as the Company's factor for the majority of its North American receivables, which are assigned on a pre-approved basis. At November 30, 1998, the factoring charge was 0.25% of the receivables assigned and the interest on advances was at BNY's prime rate plus one percent. See Note 2 of Notes to Consolidated Financial Statements and "Factors Affecting Future Performance -- Liquidity and Bank Relationships." The Company also has a financing arrangement relating to the mortgage on its corporate headquarters. At November 30, 1998, the outstanding principal balance of the loan was $2.5 million. See "Factors Affecting Future Performance -- Liquidity and Bank Relationships." Management believes, based on the currently anticipated growth of the installed base of 32- and 64-bit Entertainment Platforms and the cost reduction measures effected by the Company, that the Company's cash and cash equivalents at November 30, 1998 and cash flows from operations in fiscal 1999 will be sufficient to cover its operating expenses and such current obligations as are required to be paid in fiscal 1999. However, no assurance can be given as to the sufficiency of such cash flows in fiscal 1999 and beyond. To provide for its short- and long-term liquidity needs, in fiscal 1997 and 1998, the Company significantly reduced the number of its employees, consolidated or eliminated certain operations, raised $47.4 million of net proceeds from the issuance of 10% Convertible Subordinated Notes due 2002 (the "Notes"), and sold substantially all of the assets of Acclaim Redemption Games, Inc., formerly Lazer-Tron Corporation ("Lazer-Tron"). The Company's future liquidity will be materially dependent on its ability to develop and market Software that achieves widespread market acceptance for use with the Entertainment Platforms that dominate the market. There can be no assurance that the Company will be able to publish Software for Entertainment Platforms with significant installed bases or that such Software will achieve widespread market acceptance. In conjunction with then pending class action and other litigations and claims for which the settlement obligation was then probable and estimable, the Company recorded a charge of $23.6 million during the year ended August 31, 1997. During fiscal 1998, the Company settled substantially all such litigations and claims for amounts approximating the accrued liabilities. The Company is also 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. Year 2000 Issue Until recently, computer programs were generally written using two digits rather than four to define the applicable year. Accordingly, such programs may be unable to distinguish properly between the year 1900 and the year 2000. In fiscal 1997, the Company commenced a Year 2000 date conversion project to address necessary code changes, testing and implementation in respect of its internal computer systems. Project completion is planned for the middle of calendar 1999. To date, the cost of this project has not been material to the Company's results of operations or liquidity and the Company 14 does not anticipate that the cost of completing the project will be material to its results of operations or liquidity in fiscal 1999. Management anticipates that the Company's Year 2000 date conversion project as it relates to the Company's internal systems will be completed on a timely basis. The Company's Software for N64, PlayStation and PCs are Year 2000 compliant. The Company is currently seeking information regarding Year 2000 compliance from vendors, customers, manufacturers, outside developers, and financial institutions associated with the Company. Project completion for this phase is planned for the middle of calendar 1999. However, given the reliance on third-party information as it relates to their compliance programs and the difficulty of determining potential errors on the part of external service suppliers, no assurance can be given that the Company's information systems or operations will not be affected by mistakes, if any, of third parties or third-party failures to complete the Year 2000 project on a timely basis. There can be no assurance that the systems of other companies on which the Company's systems rely will be timely converted or that any such failure to convert by another company would not have a material adverse effect on the Company's systems. The cost of the Company's Year 2000 project and the date on which the Company believes it will complete the necessary modifications are based on the Company's estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of resources, third-party modification plans and other factors. The Company presently believes that the Year 2000 issue will not pose significant operational problems for its internal information systems and products. However, if the anticipated modifications and conversions are not completed on a timely basis, or if the systems of other companies on which the Company's systems and operations rely are not converted on a timely basis, the Year 2000 issue could have a material adverse effect on the Company's results of operations. The Company does not currently have any contingency plans in place to address the failure of timely conversion of its and/or third-party systems in respect of the Year 2000 issue. Any failure of the Company to address any unforeseen Year 2000 issues could materially adversely affect the Company's results of operations. Euro Conversion The January 1, 1999 adoption of the Euro has created a single-currency market in much of Europe. For a transition period from January 1, 1999 to June 30, 2002, the existing local currencies will remain legal tender as denominations of the Euro. The Company does not anticipate that its systems will be materially adversely affected by the conversion to the Euro. The Company has analyzed the impact of conversion to the Euro on its existing systems and is implementing modifications to its current systems to handle Euro invoicing for transactions. The Company anticipates that the cost of such modifications will not have a material adverse effect on its results of operations or liquidity in fiscal 1999. Due to numerous uncertainties, the Company cannot reasonably estimate the effect that the conversion to the Euro will have on its pricing or market strategies, and the impact, if any, that such conversion will have on its financial condition or 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 2000. The Company is presently assessing the impact, if any, of this standard on its consolidated financial statements. 15 FACTORS AFFECTING FUTURE PERFORMANCE Future operating results of the Company depend upon many factors and are subject to various risks and uncertainties. Some of the risks and uncertainties which may cause the Company's operating results to vary from anticipated results or which may materially and adversely affect its operating results are as follows: Recent Operating Results The Company's net revenues increased from $92.3 million for the quarter ended November 30, 1997 to $104.8 million for the quarter ended November 30, 1998. The Company had net earnings of $8.0 million and $10.3 million in the quarter ended November 30, 1997 and 1998, respectively. For the most part, the increase in revenues and earnings in the fiscal 1999 period reflects increased sales in the United States of the Company's Software for the N64 and PlayStation platforms. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company's revenues and operating results in fiscal 1996 and 1997 were affected principally by the industry transition from 16-bit to 32- and 64-bit Entertainment Platforms. The Company had anticipated that sales of Software for the older platforms would dominate Christmas 1995 sales and would be material in Christmas 1996. Therefore, the Company focused its development efforts on 16-bit Software for fiscal 1996 and 1997. However, sales of 16-bit Software decreased much more rapidly than anticipated by the Company in calendar 1996, which resulted in the Company's reduced revenues and net losses in fiscal 1996 and 1997. In 1998, the interactive entertainment hardware market was characterized by the growth of the installed base of N64 and PlayStation units worldwide. This growth had a positive impact on the Company's operating results for fiscal 1998 and in the first quarter of fiscal 1999. Although N64 and PlayStation have achieved significant market acceptance worldwide and the Company anticipates that the installed base of N64 and PlayStation units will continue to grow in the short term, the Company cannot assure investors that the installed base of either or both will grow at the present rate, if at all. Also, there is no assurance that the Company's revenues from sales of Software for these platforms will increase as the installed base increases. In fiscal 1997 and 1998, the Company took various actions to reduce its operating expenses. See "--Liquidity and Bank Relationships" below for a description of these actions. As a result, the Company's operating expenses in the first quarter of fiscal 1998 and 1999 were substantially lower than in prior comparable periods. Although the Company anticipates that its operating expenses will increase in dollar terms in the remainder of fiscal 1999, the Company intends to monitor its operating expenses closely and does not anticipate that they will increase materially as a percentage of net revenues. However, the Company cannot assure stockholders that its operating expenses will not increase as a percentage of net revenues in the remainder of fiscal 1999 and beyond. Any such increase could negatively impact the Company's profits in fiscal 1999 and beyond. Liquidity and Bank Relationships The Company generally experienced negative cash flow from operations in fiscal 1996 and 1997 which, for the most part, was a result of the Company's net losses in these periods. The Company derived net cash from operations of approximately $7.1 million and $11.4 million in the first quarter of fiscal 1998 and 1999, respectively. The Company believes that its cash flows from operations in fiscal 1999 will be sufficient to cover its operating expenses and those current obligations that it must pay in the remainder of fiscal 1999. The Company's belief is based on the anticipated continued growth of the installed base of 32- and 64- bit Entertainment Platforms, the anticipated success of the Company's Software for those platforms and the resulting continued growth of the Company's net revenues. However, the Company cannot assure investors that its operating expenses and current obligations will be significantly less than cash flows available from its operations in fiscal 1999 or in the 16 future. The Company's long-term liquidity depends mainly on the Company publishing "hit" Software for the dominant Entertainment Platforms. In order to provide liquidity, in fiscal 1997 and 1998, the Company took a number of actions including: (1) significantly reducing the number of its employees, (2) consolidating its Studio operations and (3) eliminating certain operations, such as its coin-operated video game subsidiary. In addition, in February 1997, the Company completed an offering of $50 million of Notes. Of the net proceeds of the offering, the Company used approximately $16 million to retire a term loan from Midland Bank plc ("Midland") and $2 million to pay down a portion of a mortgage loan from Fleet Bank ("Fleet"). In March 1997, the Company sold substantially all of the assets and certain liabilities of Lazer-Tron for $6 million in cash. Under its revolving credit facility with BNY Financial Corporation ("BNY"), its lead institutional lender, the Company is required to comply with certain financial covenants which are generally measured on a quarterly basis. The Company was in compliance with such covenants as of November 30, 1998. Although the Company expects to continue to comply with such covenants, it cannot make any guarantee of compliance. 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(s). If such defaults occur and are not waived by the lender, the lender could accelerate the loan or exercise other remedies. Such actions would have a negative impact on the Company's liquidity and operations. Substantial Leverage and Ability to Service Debt The Company's debt level could have important consequences to its stockholders because a portion of cash flow from operations must be set aside to pay down debt, including the outstanding Notes, and its existing bank obligations. Therefore, these funds are not available for other purposes. Additionally, a high debt level limits the Company's ability to obtain additional debt financing in the future, or to pursue possible expansion of its business or acquisitions. Also, high debt levels could limit the Company's flexibility in reacting to changes in the interactive entertainment industry and economic conditions generally. These limitations make the Company more vulnerable to adverse economic conditions and restrict its ability to withstand competitive pressures or take advantage of business opportunities. Some of the Company's competitors currently have a lower debt level, and are likely to have significantly greater operating and financing flexibility, than the Company. Based upon current levels of operations, the Company believes it can meet its interest obligations on the Notes, and interest and principal obligations under its bank agreements, when due. However, if the Company's cash flow from operations is not enough to meet its debt obligations 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 indenture governing the Notes (the "Indenture"), or existing indebtedness. The Company cannot assure stockholders that its operating cash flows will be sufficient to meet debt service requirements. Also, the Company cannot guarantee stockholders that its future operating cash flows will be sufficient to repay the Notes, or that the Company will be able to refinance the Notes or other indebtedness at maturity. See "--Prior Rights of Creditors". Prior Rights of Creditors The Company has outstanding long-term debt (including current portions) of $52.2 million at November 30, 1998. Certain of the indebtedness is secured by liens on substantially all of the Company's assets. If the Company does not timely pay interest or principal on its indebtedness when due, the Company will be in default under its loan agreements and the Indenture. In addition, the Indenture provides that, upon the occurrence of certain events, the Company may be obligated to repurchase all or a portion of the outstanding Notes. If such a repurchase event occurs and the Company does not have, or is unable to obtain, sufficient financial resources to repurchase the Notes, the Company would be in default under the Indenture. In addition, the occurrence of certain repurchase events would constitute a default under some of the Company's current loan agreements. 17 Further, the Company depends on dividends and other advances and transfers of funds from its subsidiaries to meet some debt service obligations. State and foreign law regulate the payment of dividends by the Company's subsidiaries, which is also subject to the terms of the Company's existing bank agreements and the Indenture. A significant portion of the Company's assets, operations, trade payables and other indebtedness is located at its subsidiaries. The 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 the Company's stockholders. If the Company is unable to meet its current bank obligations, a default would occur under the Company's existing bank agreements. Such default, if not waived, could result in acceleration of the Company's obligations under the bank agreements. Moreover, default could result in a demand by the lenders for immediate repayment and would entitle any secured creditor in respect of such debt to proceed against the collateral securing the defaulted loan. Additionally, an event of default under the Indenture may result in actions by IBJ Schroder Bank & Trust Company, as trustee, on behalf of the holders of the Notes. In the event of such acceleration by the Company's creditors or action by the trustee, holders of indebtedness would be entitled to payment out of the Company's assets. If the Company becomes insolvent, is liquidated or reorganized, it is possible that there would be insufficient assets remaining after payment to the creditors for any distribution to the Company's stockholders. Industry Trends; Platform Transition; Technological Change The interactive entertainment industry is characterized by rapid technological change due in large part to: o the introduction of Entertainment Platforms incorporating more advanced processors and operating systems; o the impact of technological changes embodied in PCs; o the development of electronic and wireless delivery systems; and o the entry and participation of new companies in the industry. These factors, among others, have resulted in Entertainment Platform and Software life cycles. No single Entertainment Platform has achieved long-term dominance. Accordingly, the Company must continually anticipate and adapt its Software to emerging Entertainment Platforms and systems. The process of developing Software is extremely complex and is expected to become more complex and expensive in the future as new platforms and technologies are introduced. Development of Software currently requires substantial investment in research and development in the areas of graphics, sound, digitized speech, music and video. The Company cannot guarantee that it will be successful in developing and marketing Software for new Entertainment Platforms. Substantially all of the Company's revenues in the first quarter of fiscal 1998 and 1999 were derived from the sale of Software designed for N64, PlayStation and PCs. In the past, the Company has expended significant development and marketing resources on product development for Entertainment Platforms that have not achieved the results it anticipated. If the Company (1) does not develop Software for Entertainment Platforms that achieve significant market acceptance, (2) discontinues development of Software for a platform that has a longer than expected life cycle, (3) develops Software for a platform that does not achieve a significant installed base or (4) continues development of Software for a platform that has a shorter than expected life cycle, the Company may experience losses from operations. The Company cannot guarantee that it will be able to predict accurately such matters, and failure to do so would negatively affect the Company. The Company's results of operations and cash flows were negatively affected during fiscal 1996 and 1997 by the significant decline in sales of the Company's 16-bit Software and the transition to the new 18 Entertainment Platforms. Because (1) there were a significant number of titles competing for limited shelf space and (2) the new Entertainment Platforms had not achieved market penetration similar to that of the 16-bit platforms in prior years, the number of units of each title sold for the newer Entertainment Platforms was significantly less than the number of units of a title generally sold in prior years for 16-bit platforms. In 1998, the interactive entertainment hardware market was characterized by the worldwide growth of the installed base of N64 and PlayStation units and related Software. Although the Company anticipates that the installed base of these platforms will continue to grow in the short term and that the market for Software for these platforms will also continue to grow, the Company cannot guarantee that the hardware or Software market will continue to grow at the current rate. Revenue and Earnings Fluctuations; Seasonality Historically, the Company has derived substantially all of its revenues from the publication and distribution of Software for the then dominant Entertainment Platforms. The Company's revenues are subject to fluctuation during transition periods, as in fiscal 1996 and 1997, when new Entertainment Platforms have been introduced but none has achieved mass-market penetration. In addition, the timing of release of the Company's new titles impacts the Company's earnings in any given period. Earnings also may be materially impacted by other factors including: (1) the level and timing of market acceptance of titles, (2) increases or decreases in development and/or promotion expenses for new titles and (3) the timing of orders from major customers. A significant portion of the Company's revenues in any quarter is generally 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 90 to 120 days following the introduction of the title, the Company's 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. Also, certain operating expenses are fixed and do not vary directly in relation to revenue. Consequently, if net revenue is below expectations, the Company's operating results are likely to be negatively affected. The interactive entertainment industry is highly seasonal. Typically, net revenues are highest during the last calendar quarter (which includes the holiday selling season), 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. However, the Company's earnings vary significantly and are largely dependent on releases of major new titles and, accordingly, may not necessarily reflect the seasonal patterns of the industry as a whole. The Company expects that its operating results will continue to fluctuate significantly in the future. Dependence on Entertainment Platform Manufacturers; Need for License Renewals The following table shows the percent of the Company's gross revenues for the first quarter of fiscal 1998 and 1999 derived from sales of Software for the indicated platforms: Quarter Ended November 30, Title 1997 1998 ----- ---- ---- Nintendo- compatible 75% 62% Sony-compatible 15% 31% The Company is substantially dependent on the Entertainment Platform manufacturers as the sole manufacturers of the Entertainment Platforms marketed by them, as the sole licensors of the proprietary information and technology needed to develop Software for those Entertainment Platforms and, in the case of Nintendo and Sony, as the sole manufacturers of the Software developed by the Company for the compatible Entertainment Platform. The Entertainment Platform manufacturers have in the past and may in the future limit the number of titles the Company can release in any year, which may limit any future growth in sales. 19 In the past, the Company has been able to renew and/or negotiate extensions of its Software license agreements with the Entertainment Platform developers. However, the Company cannot assure stockholders that, at the end of their current terms, the Company will be able to obtain extensions or that it will be successful in negotiating definitive license agreements with developers of new Entertainment Platforms. If the Company cannot obtain licenses from developers of new Entertainment Platforms or if its existing license agreements are terminated, the Company's financial position and results of operations will be materially adversely affected. In addition, the termination of any one of the Company's license agreements or other arrangements could negatively affect its financial position and results of operations. In addition to licensing arrangements, the Company depends on the Entertainment Platform manufacturers for the protection of the intellectual property rights to their respective Entertainment Platforms and technology and their ability to discourage unauthorized persons from producing software for the Entertainment Platforms developed by each of them. The Company also relies upon the Entertainment Platform manufacturers for the manufacture of certain cartridge and CD-based read-only memory (ROM) software. Reliance on New Titles; Product Delays The Company's ability to maintain favorable relations with retailers and to receive the maximum advantage from its advertising expenditures depends on its ability to provide retailers with a timely and continuous flow of product. The life cycle of a title generally ranges from less than three months to upwards of 12 months, with the majority of sales occurring in the first 90 to 120 days after release. The Company actively markets its current releases while simultaneously supporting its back catalogue with pricing and sales incentives. The Company is constantly required to develop, introduce and sell new titles in order to generate revenue and/or to replace declining revenues from previously released titles. In addition, it is difficult to predict consumer preferences for titles, and few titles achieve sustained market acceptance. The Company cannot assure stockholders that its new titles will be released in a timely fashion, will achieve any significant degree of market acceptance, or that such acceptance will be sustained for any meaningful period. Competition for retail shelf space, consumer preferences and other factors could result in the shortening of the life cycle for older titles and increase the importance of the Company's ability to release titles on a timely basis. The timely shipment of a title depends on various factors, including quality assurance testing by the Company and the manufacturers. The Company generally submits new titles to the Entertainment Platform manufacturers and other intellectual property licensors for approval prior to development and/or manufacture. Since the Company is required to engage Nintendo or Sony, as the case may be, to manufacture titles developed by the Company for the platforms marketed by them, the Company's ability to control its supply of Nintendo or Sony titles and the timing of their delivery is limited. If the title is rejected by the manufacturer as a result of bugs in Software or if there is a substantial delay in the approval of a product by an Entertainment Platform manufacturer or licensor, the Company's financial condition and results of operations could be negatively impacted. In the past, the Company has experienced significant delays in the introduction of certain new titles and such delays may occur in the future. Moreover, it is likely that in the future certain new titles will not be released in accordance with the Company's internal development schedule or the expectations of public market analysts and investors. A significant delay in the introduction of, or the presence of a defect in, one or more new titles could negatively affect the ultimate success of the Company's titles. If the Company does not develop, introduce and sell new competitive titles on a timely basis, its results of operations and profitability will be negatively affected. Reliance on "Hit" Titles The market for Software is "hits" driven. Therefore, the Company's future success depends on developing and marketing "hit" titles for Entertainment Platforms with significant installed bases. Sales of 20 the Company's top three titles accounted for approximately 69% of gross revenues for the first quarter of fiscal 1999 and sales of the Company's top three titles accounted for approximately 71% of gross revenues for the first quarter of fiscal 1998. The Company cannot assure stockholders that it will be able to publish "hit" titles in the future. 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. Inventory Management; Risk of Product Returns Generally, the Company is not contractually obligated to accept returns, except for defective product. However, the Company may permit customers to return or exchange product and may provide price protection or other concessions on products unsold by the customer. Accordingly, management must 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. Also, management must make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting periods. Among the more significant of such estimates are allowances for estimated returns, price concessions and other discounts. At the time of shipment, the Company establishes reserves in respect of such estimates taking into account the potential for product returns and other discounts based on historical return rates, seasonality, level of retail inventories, market acceptance of products in retail inventories and other factors. In fiscal 1996, price allowances, returns and exchanges were significantly higher than reserves. This shortfall had a negative impact on the Company's results of operations and liquidity in fiscal 1996. The Company believes that, at November 30, 1998, it has established adequate reserves for future price protection, returns, exchanges and other concessions. However, the Company cannot guarantee the adequacy of its reserves. If the reserves are exceeded, the Company's financial condition and results of operations will be negatively impacted. In addition, the Company offers stock-balancing programs for its PC Software. The Company has established reserves for such programs, which have not been material to date. Future stock-balancing programs may become material and/or exceed reserves for such programs. If so exceeded, the Company's results of operations and financial condition could be negatively impacted. Litigation In conjunction with then pending class action and other litigations and claims for which the settlement obligation was then probable and estimable, the Company recorded a charge of $23.6 million during the year ended August 31, 1997. During fiscal 1998, the Company settled substantially all such litigations and claims for amounts approximating the accrued liabilities. The Company is also party to various litigations arising in the course of its business and certain other litigations. For a discussion of certain claims and litigations to which the Company is currently a party, see "Legal Proceedings." The Company may be required to record additional material charges in future periods in conjunction with litigations to which the Company is or becomes a party. If the Company has to record additional charges to earnings from an adverse result in such litigations or from settlements which exceed the related accrued liabilities, the Company may experience a negative effect on its financial condition and results of operations. Increased Product Development Costs As a result of the calendar 1995 acquisitions of its Studios, beginning in fiscal 1996, the Company's fixed software development and overhead costs were significantly higher as compared to historical levels. These costs negatively impacted the Company's results of operations and profitability in fiscal 1996 and 1997. In fiscal 1998, the Company consolidated its Studio operations to reduce their overhead expenses. Due to the Company's planned release of a higher number of titles and increasing Software development costs, the Company anticipates that its future research and development expenses will continue to 21 increase as a percentage of net revenues as compared to fiscal 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations." Competition The market for Software is highly competitive. Only a small percentage of titles introduced in the Software market achieve any degree of sustained market acceptance. Competition is based primarily upon: o quality of titles; o the publisher's access to retail shelf space; o product features; o the success of the Entertainment Platform for which the Software is written; o price of titles; o the number of titles available for the Entertainment Platform for which the Software is written; and o marketing support. The Company competes with a variety of companies that offer products that compete directly with one or more of its titles. Typically, the chief competitor on an Entertainment Platform is the developer of that platform, to whom the Company pays royalties and, in some cases, manufacturing charges. Accordingly, the developers have a price, marketing and distribution advantage with respect to Software marketed by them. This advantage is particularly important in a mature or declining market which supports fewer full-priced titles and is characterized by customers who make purchasing decisions on titles based primarily on price, unlike developing markets with limited titles, when price has been a less important factor in Software sales. 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. Additionally, the entry and participation of new companies, including diversified entertainment companies, in markets in which the Company competes may adversely impact the Company's performance in these markets. The availability of significant financial resources has become a major competitive factor in the Software industry, primarily as a result of the costs associated with developing and marketing Software. As competition increases, significant price competition and reduced profit margins may result. In addition, competition from new technologies may reduce demand in markets in which we have traditionally competed. Prolonged price competition or reduced demand as a result of competing technologies would negatively impact the Company's business. The Company may not be able to compete successfully. Intellectual Property Licenses and Proprietary Rights Some of the Company's Software embodies trademarks, tradenames, logos or copyrights licensed to the Company by third parties (such as the NBA, the NFL or their respective players' associations), the loss of which could prevent the release of a title or limit its economic success. License agreements generally extend for a term of two to three years and are terminable in the event of material breach (including failure to pay amounts due by the Company to the licensor in a timely manner) by, or bankruptcy or insolvency of, the Company and certain other events. Since competition is intense, the Company may not be successful in the future in acquiring intellectual property rights with significant commercial value. In addition, the Company cannot assure its stockholders that these licenses will be available on reasonable terms or at all. In order to protect its titles and proprietary rights, the Company relies mainly on a combination of: 22 o copyrights; o trade secret laws; o patent and trademark laws; o nondisclosure agreements; and o other copy protection methods. It is Company policy that all employees and third-party developers sign nondisclosure agreements. These measures may not be sufficient to protect the Company's intellectual property rights against infringement. Additionally, the Company has "shrinkwrap" license agreements with the end users of its PC titles, but relies on the copyright laws to prevent unauthorized distribution of its other Software. Existing copyright laws afford only limited protection. Notwithstanding the Company's rights to its Software, it may be possible for third parties to copy illegally its titles or to reverse engineer or otherwise obtain and use the Company's proprietary information. Illegal copying occurs within the Software industry, and if a significant amount of illegal copying of the Company's published titles or titles distributed by the Company occurs, the Company's business could be adversely impacted. Policing illegal use of the Company's titles is difficult, and Software piracy is expected to persist. Further, the laws of certain countries in which the Company's titles are distributed do not protect the Company and its intellectual property rights to the same extent as the laws of the United States. The Company believes that its titles, trademarks and other 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 features or content of certain of the Company's titles may infringe upon intellectual property rights of such parties. The Company has asserted that third parties have likewise infringed its proprietary rights. Some of these claims have resulted in litigation by and against the Company. To date, no such claims have had a negative effect on the Company's ability to develop, market or sell its titles. Existing or future infringement claims by or against the Company may result in costly litigation or require the Company to license the intellectual property rights of third parties. The owners of intellectual property licensed by the Company generally reserve the right to protect such intellectual property against infringement. International Sales International sales represented approximately 41% and 30% of net revenues in the first quarter of 1998 and 1999, respectively. The Company expects that international sales will continue to account for a significant portion of its net revenues in future periods. International sales are subject to the following inherent risks: o unexpected changes in regulatory requirements; o tariffs and other economic barriers; o fluctuating exchange rates; o difficulties in staffing and managing foreign operations; and o the possibility of difficulty in accounts receivable collection. Because the Company believes that exposure to foreign currency losses is not currently material, the Company does not hedge against foreign currency risks. In some markets, localization of the Company's titles is essential to achieve market penetration. As a result of the inherent risks, the Company may incur incremental costs and experience delays in localizing the Company's titles. These risk factors or other factors could have a negative effect on the Company's future international sales and, consequently, on its business. 23 Dependence on Key Personnel and Employees 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's successful operations depend on the Company's ability to identify, hire and retain such personnel. The Company may not be able to attract and retain such personnel or may incur significant costs in order to do so. 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. The loss of the services of either of these two could have a negative impact on the Company's business. Although the Company has employment agreements with Messrs. Fischbach and Scoroposki, 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, the Company's business could be negatively impacted. Anti-Takeover Provisions The Board of Directors has the authority (subject to certain limitations imposed by the Indenture) to issue shares of preferred stock and to determine their characteristics without stockholders approval. If preferred stock is issued, the rights of holders of common stock, par value $0.02 per share (the "Common Stock"), of the Company are subject to, and may be negatively affected by, the rights of preferred stockholders. If preferred stock is issued, it will provide flexibility in connection with possible acquisitions and other corporate actions; however, it could make it more difficult for a third-party to acquire a majority of the Company's outstanding voting stock. In addition, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which may make it more difficult or more expensive or discourage a tender offer, change in control or takeover attempt that is opposed by the Board. In addition, employment arrangements with certain members of the Company's management provide for severance payments upon termination of their employment if there is a change in control. Volatility of Stock Price There is a history of significant volatility in the market prices of companies engaged in the software industry, including the Company. The market price of the Common Stock is likely to continue to be highly volatile. The following factors may have a significant impact on the market price of the Common Stock: o timing and market acceptance of product introductions by the Company; o the introduction of products by the Company's competitors; o loss of any of the Company's key personnel; o variations in quarterly operating results; or o changes in market conditions in the software industry generally. In the past, the Company has experienced significant fluctuations in its operating results and, if its future revenues or operating results or product releases do not meet expectations, the price of the Common Stock may be negatively affected. Stockholders should not use historical trends as well as other factors affecting the Company's operating results and financial condition to anticipate results or trends in future periods because of the risk factors disclosed above. Also, stockholders should not consider historic financial performance as a reliable indicator of future performance. 24 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company, Iguana 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 (i) breached their employment obligations to the plaintiff, (ii) breached a Texas statute covering wage payment obligations based on their alleged failure to pay bonuses to the plaintiff; and (iii) 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 Securities and Exchange Commission (the "Commission") has issued orders directing a private investigation relating to, among other things, the Company's earnings estimate for fiscal 1995 and its decision in the second quarter of fiscal 1996 to exit the 16-bit portable and cartridge markets. The Company has provided documents to the Commission, and the Commission has taken testimony from Company representatives. The Company intends fully to cooperate with the Commission in its investigation. No assurance can be given as to whether such investigation will result in any litigation or, if so, as to the outcome of this matter. In conjunction with then pending class action and other litigations and claims for which the settlement obligation was then probable and estimable, the Company recorded a charge of $23.6 million during the year ended August 31, 1997. During fiscal 1998, the Company settled substantially all of its outstanding litigations and claims for amounts approximating the accrued liabilities. 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In November 1998, in connection with the Company's purchase of substantially all of the assets and liabilities of Fringe Pty. Ltd., an Australian distributor, the Company issued 206,000 shares of Common Stock to Fringe Pty. Ltd. in partial payment of the purchase price. The shares were issued pursuant to the exemption from registration provided under Section 4(2) of the Securities Act of 1933. See Note 6 of Notes to Consolidated Financial Statements. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K None. 25 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 Fischbach January 13, 1999 ----------------------------- Gregory Fischbach Co-Chairman of the Board; Chief Executive Officer; President; Director By: James Scoroposki January 13, 1999 ----------------------------- James Scoroposki Co-Chairman of the Board; Executive Vice President; Treasurer; Secretary; Director; and Acting Chief Financial and Accounting Officer 26 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS AUG-31-1999 SEP-01-1998 NOV-30-1998 58,023 0 92,984 37,360 7,554 132,505 57,753 28,100 188,275 138,235 49,750 0 0 1,072 6,524 188,275 121,561 104,831 50,500 43,677 0 10,654 (1,407) 10,800 513 10,287 0 0 0 10,287 .19 .16
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