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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended August 31, 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 (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 __
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. __
As at November 4, 1998, approximately 51,919,000 shares of Common Stock of
the Registrant were issued and outstanding and the aggregate market value of
voting common stock held by non-affiliates was approximately $367,000,000.
The Registrant's Proxy Statement for its 1999 Annual Meeting of Stockholders
is hereby incorporated by reference into Part III of this Form 10-K.
ACCLAIM ENTERTAINMENT, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION
YEAR ENDED AUGUST 31, 1998
ITEMS IN FORM 10-K
PART I Page
----
Item 1. Business 1
Item 2. Properties 20
Item 3. Legal Proceedings 21
Item 4 Submission of Matters to a Vote of Security Holders 23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 24
Item 6. Selected Financial Data 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35
Item 8. Financial Statements and Supplementary Data 36
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 61
PART III
Item 10. Directors and Executive Officers of the Registrant 61
Item 11. Executive Compensation 61
Item 12. Security Ownership of Certain Beneficial Owners and Management 61
Item 13. Certain Relationships and Related Transactions 61
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 62
Signatures 64
PART I
THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ITEM 1 ("BUSINESS") AND ITEM 7
("MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS"), 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 11 TO 19, 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.
ITEM 1. BUSINESS
INTRODUCTION
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 located in the United States and the United Kingdom (the
"Studios"), and publishes and distributes its Software directly in North
America, the United Kingdom, Germany and France. 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 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.
Acclaim was founded in 1987 and is incorporated in the state of Delaware.
Substantially all of the Company's revenues are derived from one industry
segment: the publication of Software. For information about the Company's
foreign and domestic operations and export sales, see Note 16 of Notes to
Consolidated Financial Statements.
INTERACTIVE ENTERTAINMENT INDUSTRY OVERVIEW
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, as evidenced
by the successive introductions of hardware systems from Nintendo, Sega and
Sony (e.g., the 8-bit cartridge system from Nintendo in 1985; 16-bit cartridge
systems from Sega and Nintendo in 1990 and 1991, respectively; 32-bit compact
disk ("CD") systems from Sega and Sony in 1995; the 64-bit cartridge system
from Nintendo in
1996; and the planned introduction by Sega in the fall of 1998 of Dreamcast
("Dreamcast"), a new 64-bit CD system, in Japan). These successive
introductions have resulted in Entertainment Platform and related Software
product cycles. To date, no single Entertainment Platform or system has
achieved long-term dominance in the interactive entertainment market.
The rapid technological advances in Entertainment Platforms have
significantly changed the look and feel of Software as well as the Software
development process. According to Company 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 $2 million.
The competition for shelf space in the Company's primary retail outlets
is intense because of the number of titles available in the market. Retailers
prefer to deal with companies that have track records of producing successful
titles, have a broad product line, support the introduction of their titles
with effective marketing campaigns, and have a long history with the retailer.
The following tables set forth the Company's estimates, based on
information received from hardware manufacturers, retailers and industry
analysts, in respect of (1) the cumulative installed base (in units (in
millions)) of the identified Entertainment Platforms and (2) related Software
sales, in the territories and periods indicated:
Hardware
96 97 98 Estimated
-- -- ------------
North America PlayStation 2.2 7.7 15.2
Europe PlayStation 1.6 6.5 14.0
Japan PlayStation 3.2 8.6 12.6
North America N64 1.8 6.8 11.3
Europe N64 0.0 2.6 4.5
Japan N64 1.9 3.1 3.6
Software
96 97 98 Estimated
-- -- ------------
North America PlayStation 10.5 28.0 65.0
Europe PlayStation 8.8 18.0 44.0
Japan PlayStation 26.0 53.6 60.0
North America N64 3.2 18.0 30.0
Europe N64 0.0 5.5 10.0
Japan N64 5.0 7.5 5.0
2
SOFTWARE DEVELOPMENT
The Company owns and operates four Studios, located in the United States
and the United Kingdom, and motion capture studios in the United States and
the United Kingdom. The Company invests in the creation and development of
programming tools and engines that are used in the design and development of
its Software. The Company believes that these tools and engines give it a
competitive advantage in the creation of state-of-the-art Software.
Prior to the Company's acquisition in 1995 of the Studios, the Company
relied exclusively on independent studios for the development of its Software.
Since such time, the Company has developed an increasing percentage of its
Software in the Studios. Approximately 68% of the Company's gross revenues in
fiscal 1998 were derived from Software developed in the Studios. The Company
anticipates that it will continue to rely substantially on the Studios for the
development of its Software. The Company believes that internal Software
development allows it to control the creative process, product quality, timing
of release and cost of Software.
The Company has recently consolidated the management and organizational
structure of the Studios in order to coordinate their development efforts,
enable them to maximize the use of their proprietary tools and engines and
reduce their operating expenses. Currently, approximately two-thirds of the
Company's employees are involved in its Studio operations.
The Company's Software development strategy is driven by (1) the hardware
platforms that are marketed and/or are anticipated to be marketed from time to
time, (2) the time and cost of Software development for each platform, (3) the
cost of manufacturing Software for a particular platform and (4) the attendant
gross margins for the Software. The development time for the Company's
Software for both Entertainment Platforms and PCs is currently between 12 and
24 months. The cost of manufacturing cartridge Software is significantly
higher than CD Software. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The Company develops and sells Software for a variety of Entertainment
Platforms and PCs. Currently, the Company's Software development efforts are
focused on the N64, PlayStation, Dreamcast and PCs. The Company's product
development methods and organization are modeled on those used in the Software
industry. Product managers ("PM"s) employed by the Company oversee and are
responsible for development of the Company's Software in the Studios. The PMs
direct teams of individuals who are responsible for the creation of the
Company's Software (i.e. the programming, graphics, animation, sound and game
play of each title). "Producers" are hired by the Company to manage Software
developed outside the Studios. They manage and monitor the delivery schedule
and budget for the title, ensure that the title follows the approved product
specifications, act as facilitators with licensors whose trademarks or brands
may be incorporated in the title, if necessary, and coordinate testing and
final approval of the title.
The Company constantly seeks new sources of brands from which to develop
Software and has historically obtained such rights from a variety of sources
in the comic book publishing (e.g., Shadowman and Turok: Dinosaur Hunter),
sports (e.g., NFL Quarterback Club and NBA Jam), arcade (e.g., NBA Jam
Extreme), film (e.g., Batman and Robin), television (e.g., South Park) and
other areas of the entertainment industry. Certain of the contractual
agreements granting the Company rights to use such brands are restricted to
individual properties, and certain agreements cover a series of properties or
grant rights to create Software based on or featuring particular brands over a
period of time. No assurance can be given that the Company will continue to be
able to source brands or that it will be able to market successfully Software
based on such brands. See " -Intellectual Property Licenses" below.
The Company checks Software developed both by its Studios and third-party
developers prior to manufacture for defects ("bugs"). The Software developed
for the Entertainment Platforms are also tested by the hardware manufacturers
for bugs. The Company's Software for PCs is tested for bugs both internally
and by independent testing organizations. To date, the Company has not had to
recall any Software due to bugs.
3
PRODUCTS
The Company's operating strategy is to develop and maintain a core of key
brands and franchises 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 supports this strategy through the regularly scheduled
introduction of new titles featuring those brands and franchises.
The Company intends to develop one or more additional key brands or
franchises each year based on licensed or original properties which may then
be featured on an annual basis in successive titles. 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 life cycle of a title may range from less than three months to
upwards of 12 months. The life cycle of a title is dependent on its initial
success. Although actual results vary greatly from title to title, the retail
sell-through of a title is generally highest during the 90 to 120 days
immediately after its introduction.
In fiscal 1998, the Company released eight N64 titles, 11 PlayStation
titles and six PC titles.
In fiscal 1999, the Company currently plans to release between 10 and 13
titles for the N64, between eight and 10 titles for the PlayStation, between
10 and 12 titles for PCs and between eight and 10 titles for Nintendo's Game
Boy portable platform. Included in these are sequels to Turok: Dinosaur
Hunter, NFL Quarterback Club, WWF, All Star Baseball, NHL Breakaway and
Extreme G. See "Factors Affecting Future Performance - Reliance on "Hit"
Titles."
PLATFORM LICENSE AGREEMENTS
The Company has various license agreements with Nintendo (collectively,
the "Nintendo License Agreements") pursuant to which it has the non-exclusive
right to utilize the "Nintendo" name and its proprietary information and
technology in order to develop and market Software titles for various Nintendo
platforms, including N64, in various territories throughout the world. The
Nintendo License Agreements for the N64 platform expire at various times
through 2001.
The Company is party to agreements with Sony (the "Sony Agreements"),
pursuant to which the Company has a non-exclusive license to develop and
distribute Software for the PlayStation in North America, Japan and Europe.
The Sony Agreements expire in December 1998. The Company is currently
negotiating the terms of a new four-year agreement with Sony for North
America. No assurance can be given that the Company will be successful in
negotiating the new agreement with Sony or that the Company will be successful
in negotiating new agreements with Sony for other territories.
In April 1992, the Company entered into an agreement with Sega (the "Sega
Agreement") and has certain other arrangements, pursuant to which the Company
received the non-exclusive right to utilize the "Sega" name and its
proprietary information and technology in order to develop and distribute
Software titles for use with various Sega platforms. The Sega Agreement, as
amended, expired in December 1995. Since such time, the Company and Sega have
operated in the ordinary course under the terms of the expired Sega Agreement,
an oral agreement and other arrangements. In fiscal 1998, the Company derived
less than one percent of its gross revenues from sales of Sega-compatible
Software. The Company does not plan to release any titles for Sega's 32-bit
platform in fiscal 1999. Sega has announced the introduction of Dreamcast in
Japan in the fall of 1998. The Company is currently negotiating the terms of a
license agreement with Sega in respect of the Dreamcast platform for North
America. No assurance can be given that the Company will be successful in
negotiating a new agreement with Sega in respect of Dreamcast or any other
Sega platform.
The Company pays Nintendo a fixed amount per unit, based in part, on
memory capacity and chip configuration. Such amount may include the cost of
manufacturing, printing and packaging of the unit, as
4
well as a royalty for the use of Nintendo's name, proprietary information and
technology. All such fees and charges are subject to adjustment by Nintendo at
its discretion. The Company pays Sony a royalty fee and the cost of
manufacturing each unit manufactured by Sony for the Company; this payment is
made upon manufacture of the units. Historically, the Company manufactured
(through subcontractors) substantially all of its Sega titles for worldwide
distribution and paid Sega a royalty for each unit so manufactured and sold;
this payment was made upon sale of the units by the Company. Although no
assurance can be given thereof, the Company anticipates that any license it
receives from Sega in respect of Dreamcast will include a right to manufacture
Software developed by the Company for that platform. See "-- Production, Sales
and Distribution." The Company does not have the right to manufacture any
Software for the PlayStation or N64 platforms. See "Factors Affecting Future
Performance - Dependence on Entertainment Platform Manufacturers; Need for
License Renewals."
Nintendo, Sony and Sega have the right to review and evaluate, under
standards established by them, the content and playability of each title and
the right to inspect and evaluate all art work, packaging and promotional
materials used by the Company in connection with the Software. To date, all of
the Company's titles have been approved for publication by the respective
hardware manufacturers. The Company is responsible for resolving at its own
expense any warranty or repair claims brought with respect to the Software. To
date, the Company has not experienced any material warranty claims.
Under each of its platform license agreements, the Company bears the risk
that the information and technology licensed from Nintendo, Sony or Sega and
incorporated in the Software may infringe the rights of third parties.
Further, the Company must indemnify Nintendo, Sony or Sega with respect to,
among other things, any claims for copyright or trademark infringement brought
against Nintendo, Sony or Sega and arising from the development and
distribution of the game programs incorporated in the Software by the Company.
To date, the Company has not received any material claims of infringement; no
assurance can be given that the Company will not receive such claims in the
future. See " - Patent, Trademark, Copyright and Product Protection."
MARKETING AND ADVERTISING
The Company actively markets its current releases, while simultaneously
supporting its back catalogue with pricing and sales incentives.
The target consumers for the Company's titles for Entertainment Platforms
are primarily males aged 12 to 24 and, for PCs, are primarily males aged 15 to
34. In developing a marketing strategy for a title, the Company seeks story
concepts and brands or franchises that it believes will appeal to the
imagination of its target consumer. The Company creates marketing campaigns
consistent with the target consumer for each title. The Company markets its
Software through public relations; its Internet site (www.acclaim.net);
television, radio, print and Internet advertising; product sampling through
demonstration Software distributed on the Internet; consumer contests and
promotions; publicity activities; and trade shows. In addition, the Company
enters into cooperative advertising arrangements with certain of its
customers, pursuant to which the Company's Software is featured in the retail
customer's own advertisements to its customers. Dealer displays and in-store
merchandising are also used to increase consumer awareness of the Company's
Software.
The Company's ability to promote and market its Software is important to
its success. The Company's operating strategy is to develop and maintain a
core of key brands and franchises 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 intends to develop one or more
key brands or franchises each year based on its original properties, which may
then be featured on an annual basis in sequels. Key examples of this strategy
are Turok, Quarterback Club, All Star Baseball and NHL Breakaway. By creating
key brands and franchises, the Company is able to take advantage of
cross-merchandising opportunities, to maximize its investment in tools and
engines that were created for the original title and to capitalize on the name
recognition of the brand or franchise in subsequent releases.
5
PRODUCTION, SALES AND DISTRIBUTION
Pursuant to the Nintendo License Agreements, Nintendo manufactures
Software developed by the Company for the Nintendo platforms. Nintendo
requires the Company to open a letter of credit simultaneously with placing a
purchase order. Goods are delivered 30 to 50 days thereafter.
Pursuant to the Sony Agreements, Sony manufactures Software developed by
the Company for the Sony platforms. Initial orders for a title are delivered
within 10 to 21 days after the placement of a purchase order. Reorders
generally take 10 to 14 days. See "Factors Affecting Future Performance -
Dependence on Entertainment Platform Manufacturers; Need for License
Renewals."
The Company manufactures (through subcontractors) all of its Software for
PCs and historically has manufactured substantially all of its Sega Software.
The cost of Sega Software when manufactured by the Company, together with the
royalties payable to Sega for such manufacturing, was slightly lower than the
cost of the Company's Software when manufactured by Sega. Orders for PC and
Sega Software manufactured by the Company (through subcontractors) are
generally filled within 20 to 30 days of the placement of the order. Reorders
for such Software are generally filled within 10 days.
The Company believes that the most efficient way to distribute its
Software is by tailoring its distribution method to each geographic market.
In North America, the Company's Software is sold by regional sales
representative organizations which receive commissions based on the net sales
of each product sold. The Company maintains an in-house sales management team
to supervise the sales representatives. The sales representatives also act as
sales representatives for certain of the Company's competitors. One of the
sales representative organizations marketing the Company's Software is owned
by James Scoroposki, an officer, director and stockholder of the Company. See
"Certain Relationships and Related Transactions."
The Company sells its Software domestically primarily to mass merchants,
large retail toy store chains, department stores and specialty stores. The
Company's key domestic retail customers include Toys R Us, Walmart, Best Buy
and Target. No single customer accounted for more than 10% of the Company's
net revenues for the year ended August 31, 1996. Sales to Toys R Us accounted
for approximately 12% and 15% of the Company's net revenues for the years
ended August 31, 1997 and 1998, respectively. The Company's customers are not
obligated to purchase the Company's Software. The loss of any important
customer could have a material adverse effect on the Company.
To maximize revenues and profits, the Company distributes directly
(through subsidiaries) in the United Kingdom, Germany and France. The sales,
marketing, and distribution activities of Acclaim's European subsidiaries are
administered through a central management division, Acclaim Europe, based in
London. For sales in other markets, the Company appoints regional
distributors.
The Company is generally not contractually obligated to accept returns,
except for defective product. However, in order to maintain retail
relationships, the Company may permit its customers to return or exchange
product and may provide price protection or other concessions on products
unsold by a customer. As the Entertainment Platforms market matures and as
more titles become available, the risk of product returns and price
concessions increases. The Company establishes reserves for such concessions;
however, concessions materially exceeded reserves therefor in fiscal 1996 and
no assurance can be given that such concessions will not exceed the reserves
established therefor in a future period. See "Factors Affecting Future
Performance - Inventory Management; Risk of Product Returns" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company's warranty policy is to provide the original purchaser with
replacement or repair of defective Software for a period of 90 days after
sale. To date, the Company has not experienced significant warranty claims.
6
INTELLECTUAL PROPERTY LICENSES
Certain of the Company's titles relate to or are based on brands or
franchises licensed from third parties, such as the National Basketball
Association ("NBA") and the National Football League ("NFL") and their
respective players' associations. Typically, the Company is obligated to make
certain minimum guaranteed royalty payments over the term of the license and
to advance payments against such guarantees, which payments can be recouped by
the Company against certain royalty payments otherwise due in respect of
future sales. License agreements generally extend for a term of two to three
years, are terminable in the event of material breach (including failure to
pay any amounts owing by the Company to the licensor in a timely manner) by,
or bankruptcy or insolvency of, the Company and certain other events, and, in
some cases, are renewable upon payment of certain minimum guarantees or the
attainment of specified sales levels during the term of the license. Certain
licenses are limited to specific territories or platforms. Each license
typically provides that the licensor retains the right to exploit the licensed
property for all other purposes, including the right to license the property
for use with other products and, in some cases, Software for other
Entertainment Platforms. See "Factors Affecting Future Performance -
Intellectual Property Licenses and Proprietary Rights."
PATENT, TRADEMARK, COPYRIGHT AND PRODUCT PROTECTION
Each of Nintendo, Sony and Sega incorporates a security device in the
Software and their respective hardware systems in order to prevent unlicensed
Software from infringing Nintendo's, Sony's or Sega's proprietary rights, as
the case may be, by manufacturing Software compatible with their hardware.
Under its various license agreements with Nintendo, Sony and Sega, the Company
is obligated to obtain or license any available trademark, copyright and
patent protection for the original work developed by the Company and embodied
in or used with the Software and to display the proper notice thereof, as well
as notice of the licensor's intellectual property rights, on all its Software.
Each title may embody a number of separately protected intellectual
properties: (i) the trademark for the brand featured in the Software; (ii) the
software copyright; (iii) the name and label trademarks; and (iv) the
copyright for Nintendo's, Sony's or Sega's proprietary technical information.
The Company has registered the "Acclaim" logo and name in the United
States and in certain foreign territories and owns the copyrights for many of
its game programs. "Nintendo," "Game Boy" and "N64" are trademarks of
Nintendo; "Sega" and "Saturn" are trademarks of Sega; and "Sony," "Sony
Computer Entertainment" and "PlayStation" are trademarks of Sony. The Company
does not own the trademarks, copyrights or patents covering the proprietary
information and technology utilized in the Entertainment Platforms marketed by
Nintendo, Sony or Sega or, to the extent licensed from third parties, the
brands, concepts and game programs featured in and comprising the Company's
Software. Accordingly, the Company must rely on the trademarks, copyrights and
patents of such licensors for protection of such intellectual property from
infringement. Under the Company's license agreements with certain independent
Software developers, the Company may bear the risk of claims of infringement
brought by third parties and arising from the sale of Software and each of the
Company and such developer has agreed to indemnify the other for costs and
damages incurred arising from such claims and attributable to infringing
proprietary information, if any, embodied in the Software and provided by the
indemnitor.
There can be no assurance that the information and technology licensed or
developed by the Company will not be independently developed or
misappropriated by third parties.
COMPETITION
Competition to develop and market Software for the interactive
entertainment industry is intense. The Company's competitors include
Entertainment Platform manufacturers, most notably Nintendo, Sega and Sony,
and a number of independent software publishers.
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 development and marketing of
7
Software. While 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, the Company
believes that it is one of the largest independent publishers of Software for
Entertainment Platforms in the United States. The market for Software for PCs is
fragmented and the Company believes that it has a small share of that market.
Data derived from the Toy Retail Sales Tracking Service ("TRSTS")
indicates that, for the first nine months of calendar 1998 and the fourth
quarter of fiscal 1998, the Company achieved a combined N64 and PlayStation
market share of 7.2% and 12.5%, respectively. Based on TRSTS data, the
Company's N64 market share for the first nine months of calendar 1998 and the
fourth quarter of fiscal 1998 was 9.8% and 13.4%, respectively. Based on TRSTS
data, the Company's PlayStation market share for the first nine months of
calendar 1998 and the fourth quarter of fiscal 1998 was 4.6% and 9.1%,
respectively. No assurance can be given that the Company will be able to
maintain its share of the N64 or PlayStation market.
Competition in the Software industry is based primarily upon the quality
of the title, the publisher's access to retail shelf space, product features,
the Entertainment Platforms for which the title is written, the number of
titles available for the Entertainment Platforms or PCs, and the marketing
campaign supporting the title. The Company relies upon its product quality,
marketing and sales abilities, proprietary technology and product development
capability, capital resources, the depth of its worldwide retail distribution
channels and management experience to compete in the interactive entertainment
industry. No assurance can be given that the Company will compete successfully
on any of these factors. See "Factors Affecting Future Performance -
Competition."
DISTRIBUTION OF AFFILIATED LABELS
The Company commenced the marketing and distribution of Affiliated Labels
Software in October 1994. From time to time, the Company enters into selected
licensing agreements with third-party publishers to distribute, in selected
markets, Software developed by them. Affiliated Labels Software is marketed
under the name of the original publisher. Sales of Affiliated Labels Software
are included in the Company's revenues and the Company assumes the associated
credit risk. The Company retains a distribution fee (based on net receipts
less certain other deductions) and remits the balance to the original
publisher. In fiscal 1997, the Company derived approximately 9% of gross
revenues from sales of Software developed by Interplay Productions
("Interplay"). To date, the Company has not received significant revenues from
sales of any other Affiliated Labels Software.
COMIC BOOK PUBLISHING
Through the acquisition of Acclaim Comics, Inc. ("Acclaim Comics") in
July 1994, the Company commenced the development and publication of comic book
magazines. Acclaim Comics also publishes strategy guides relating to the
Company's Software. Acclaim Comics receives royalties from Acclaim for the use
in the Company's Software of properties licensed or created by Acclaim Comics,
such as Turok: Dinosaur Hunter, Shadowman and Bloodshot. Through fiscal 1998,
the Company has not derived significant revenues from the sale of Acclaim
Comics' products.
The Company intends to continue to release Software for a variety of
platforms based on characters licensed or created by Acclaim Comics.
Acclaim Comics' future revenues, if any, will primarily depend on the
licensing and merchandising of its characters in interactive entertainment and
other media, such as motion picture or television, the use of its characters
in the Company's Software and the publication and sale of strategy guides.
Due to Acclaim Comics' operating losses through May 1997, the Company's
assessment of the then current state of the comic book industry and the
Company's then current projections for Acclaim Comics' operations, the Company
believed that there was an impairment to the carrying value of the goodwill
relating to the acquisition of Acclaim Comics. Accordingly, the Company
recorded a write-down of $25.2
8
million in the third quarter of fiscal 1997 to reduce the carrying value of
the goodwill associated with Acclaim Comics to its estimated undiscounted
future cash flows.
EMPLOYEES
The Company currently employs approximately 660 persons worldwide,
approximately 610 of whom are employed on a full-time basis and approximately
400 of whom are employed in the United States. The Company believes that its
relationship with its employees is satisfactory.
9
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the
Company's executive officers:
Name Position and Principal Occupation Age
---- --------------------------------- ---
Gregory E. Fischbach Co-Chairman of the Board, President and Chief 56
Executive Officer of the Company
James Scoroposki Co-Chairman of the Board, Senior Executive Vice 50
President, Acting Chief Financial Officer, Secretary
and Treasurer of the Company
Rodney Cousens President and Chief Operating Officer - International 47
of Acclaim Europe
Paul Eibeler Vice President and General Manager 43
Darrin Stubbington Executive Vice President and General Manager of 31
Acclaim Studios
Gregory E. Fischbach, a founder of the Company, has been Chief Executive
Officer of the Company since its formation, a member of the Board of Directors
since 1987 and Co-Chairman of the Board of Directors since March 1989. Mr.
Fischbach was also President of the Company from its formation to January 1990
and has been President of the Company since October 1996. From June 1986 until
January 1987, he was President of RCA/Ariola International, responsible for
the management of its record operations outside the U.S. and in charge of its
17 operating subsidiaries.
James Scoroposki, a founder of the Company, has been Senior Executive
Vice President since December 1993, a member of the Board of Directors since
1987, Co-Chairman of the Board of Directors since March 1989 and acting Chief
Financial Officer since November 1997. Mr. Scoroposki has been Secretary and
Treasurer of the Company since its formation. Mr. Scoroposki was also Chief
Financial Officer of the Company from April 1988 to May 1990 and Executive
Vice President of the Company from formation to November 1993. Since December
1979, he has also been the President and sole shareholder of Jaymar Marketing
Inc., a sales representative organization. See "Certain Relationships and
Related Transactions."
Rodney Cousens became an executive officer of the Company in August 1998.
Mr. Cousens has been President and Chief Operating Officer - International of
Acclaim Europe, a division of the Company, since October 1996. From June 1994
to October 1996, Mr. Cousens was President of Acclaim Europe, and from March
1991 to June 1994, he was Vice President of Acclaim Europe.
Paul Eibeler became an executive officer of the Company in August 1998.
Mr. Eibeler has been Vice President and General Manager of the Company since
July 1997. From January 1994 to July 1997, Mr. Eibeler was Vice President of
Impact, Inc., and from June 1991 to January 1994, he was Vice President and a
partner of Impact International, each a marketer of licensed toy and school
supplies.
Darrin Stubbington became an executive officer of the Company in August
1998. Mr. Stubbington has been Executive Vice President and General Manager of
Acclaim Studios, a division of the Company, since August 1998 and was Vice
President of Product Development at Iguana Entertainment, Inc. ("Iguana") from
August 1991 to August 1998.
10
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 $161.9 million in fiscal 1996
to $165.4 million in fiscal 1997 and to $326.6 million in fiscal 1998. The
Company had a net loss of $221.4 million in fiscal 1996, a net loss of $159.2
million in fiscal 1997 and net earnings of $20.7 million in fiscal 1998. For
the most part, the increase in revenues and earnings in fiscal 1998 reflects
increased sales in the United States of the Company's Software for the N64 and
PlayStation platforms. Charges for litigation settlements and other claims of
$23.6 million, a writedown of the goodwill associated with Acclaim Comics of
$25.2 million and downsizing charges of $10 million are included in the loss
for fiscal 1997. Special charges relating to the Company's exit from the
16-bit and portable Software business aggregating approximately $114 million
are included in the loss for fiscal 1996. 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 fiscal 1998, the interactive entertainment hardware market was
characterized by the growth of the installed base of N64 and PlayStation units
worldwide. See "Business - Interactive Entertainment Industry Overview." This
growth had a positive impact on the Company's operating results for fiscal
1998. 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
fiscal 1997 and 1998 were substantially lower than in prior periods. Although
the Company anticipates that its operating expenses will increase in dollar
terms in 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 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 used net cash in operations of approximately $38.3 million in
fiscal 1996 and approximately $29.2 million in fiscal 1997 and derived net
cash from operations of approximately $23.3 million in fiscal 1998. A tax
refund of approximately $54.0 million had a positive impact on the Company's
net cash from operating activities in fiscal 1997. The Company 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.
11
The Company had positive cash flow from operations in fiscal 1998. The
Company believes that its cash flows from operations will be sufficient to
cover its operating expenses and those current obligations that it must pay in
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 the
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 the coin-operated video game subsidiary. In addition, in
February 1997, the Company completed an offering of $50 million of 10%
Convertible Subordinated Notes (the "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 Acclaim Redemption
Games, Inc. (formerly, Lazer-Tron Corporation, "Lazer-Tron") for $6 million in
cash.
Due to the Company's financial performance in the first three quarters of
fiscal 1998, the Company was unable to comply with financial covenants under
its revolving credit facility with BNY Financial Corporation ("BNY"), its lead
institutional lender. BNY waived the resulting defaults at the end of each of
the first three quarters of fiscal 1998. The Company has negotiated new
financial covenants as of and for the period ended August 31, 1998 and future
periods. Although the Company expects to comply with these new 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 will not be able to meet its loan obligations to its lenders
unless its future operations are profitable. The Company's future operations
depend on factors beyond its control, such as prevailing economic conditions
and financial, business and other factors.
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 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 current debt service requirements. Also, the Company cannot
guarantee stockholders that its future operating
12
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 $52.7 million at August 31, 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.
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.
13
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 fiscal 1998 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 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 fiscal 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 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.
14
Dependence on Entertainment Platform Manufacturers; Need for License Renewals
The following table shows the percent of the Company's gross revenues for
fiscal 1996, 1997 and 1998 derived from sales of Software for the indicated
platforms:
Title 1996 1997 1998
- ----- ---- ---- ----
Nintendo-compatible 29% 41% 60%
Sega-compatible 36% 12% 1%
Sony-compatible 19% 28% 30%
Clearly, 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.
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. For information regarding the
Company's various licenses with Entertainment Platform manufacturers, see
"Business - Platform License Agreements."
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 Nintendo,
Sony and Sega 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
15
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 the Company's top four
titles accounted for approximately 53% of gross sales for fiscal 1998 and
sales of the Company's top title accounted for approximately 33% of gross
revenues for fiscal 1997. 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 August 31, 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 certain claims and litigations for which the
settlement obligation was then estimable and probable, the Company recorded a
charge of $23.6 million in the year ended August 31, 1997. See Note 17(a) of
Notes to Consolidated Financial Statements. The Company may be required to
record additional material charges in future periods in conjunction with
litigations to which the Company is
16
a party. If the Company has to record additional charges to earnings from an
adverse result in such litigations, the Company may experience a negative
effect on its financial condition and results of operations. For a discussion
of the various claims and litigations to which the Company is currently a
party, see "Legal Proceedings."
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. Although the Company has consolidated its Studio
operations to reduce overhead expenses, these costs may continue to affect
negatively the Company's 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 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. Since competition is
17
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:
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% of net revenues in
fiscal 1996, 50% of net revenues in fiscal 1997 and 34% of net revenues in
fiscal 1998. 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.
18
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.
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 Common Stock holders 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.
19
ITEM 2. PROPERTIES.
The Company's corporate headquarters are located in a 70,000 square foot
office building in Glen Cove, New York, which was purchased by the Company in
fiscal 1994. See Note 9 of Notes to Consolidated Financial Statements. The
Company also owns an 8,000 square foot office building in Glen Cove, New York
and a 10,000 square foot office building in Oyster Bay, New York, which has
been leased to a third party tenant.
In addition, the Company's United States subsidiaries lease approximately
10,000 square feet of office space in New York, and approximately 67,000
square feet of office space in the aggregate in Texas and Utah.
The Company's foreign subsidiaries lease office space in Japan, France,
Germany and the United Kingdom.
The Company believes that these facilities are adequate for its current
and foreseeable future needs.
20
Item 3. LEGAL PROCEEDINGS.
The Company and certain of its current and former directors and/or
executive officers were sued in various complaints filed in April 1994, which
were consolidated into an action entitled In re Acclaim Entertainment, Inc.
Securities Litigation (CV 94 1501) (the "WMS Action"). The plaintiffs, on
behalf of a class of the Company's stockholders, consisting of all those who
purchased the Common Stock for the period January 4, 1994 to March 30, 1994,
claimed damages arising from (i) the Company's alleged failure to comply with
the disclosure requirements of the securities laws in respect of the Company's
relationship with WMS Industries Inc. ("WMS") and the status of negotiations
on and the likelihood of renewal of an agreement with WMS, pursuant to which
WMS granted the Company a right of first refusal to create software for
"computer games," "home video games" and "handheld game machines" based on
arcade games released by WMS through March 21, 1995, (ii) statements made by
the Company's representative that rumors relating to the nonrenewal of the
agreement were "unsubstantiated" and that talks between the Company and WMS
were continuing, which allegedly were materially false and misleading, and
(iii) a claim that the defendants should have disclosed the likely nonrenewal
of the agreement. The parties have executed a settlement agreement, which was
approved by the court, and the WMS Action has been dismissed (subject to
expiration of the applicable appeals period). The Company is required, among
other things, to deliver the settlement amount, which consists of cash (to be
delivered to the plaintiffs' lawyers in November 1998), shares of Common Stock
and common stock purchase warrants (to be delivered after the plaintiffs'
lawyers have delivered an allocation schedule to the Company). The Company has
agreed to assign to the plaintiffs in the WMS Action a portion of the proceeds
recovered by the Company from Mt. Hawley Insurance Company ("Mt. Hawley"),
based on Mt. Hawley's disclaimer of coverage for liability from the WMS
Action.
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.
The New York State Department of Taxation and Finance, following a field
audit of the Company with respect to franchise tax liability for its fiscal
years ended August 31, 1989, 1990 and 1991, has notified the Company that a
stock license fee (plus interest and penalties) of approximately $2.0 million,
relating to the Company's outstanding capital stock as of 1989, is due to the
State. The Company is contesting the fee and a petition denying liability has
been filed. No assurance can be given as to the outcome of this matter.
In conjunction with claims arising from certain of the Company's
acquisitions and then pending litigations and claims for which the settlement
obligation was probable and estimable, the Company recorded a charge of $23.6
million during the year ended August 31, 1997. Approximately $11.7 million of
these litigation settlements will be satisfied in cash, of which $6.6 million
has been paid as of August 31, 1998. The remainder is payable with non-cash
items, such as stock or warrants. See Note 17(a) of Notes to Consolidated
Financial Statements.
21
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.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On October 1, 1998, at the annual meeting of stockholders of the Company,
the stockholders (i) elected the following directors: Gregory E. Fischbach (by
a vote of 42,589,485 shares for and 654,812 shares withheld); James Scoroposki
(by a vote of 42,597,036 shares for and 647,261 shares withheld); Kenneth L.
Coleman (by a vote of 42,621,406 shares for and 622,891 shares withheld);
Bernard J. Fischbach (by a vote of 42,526,384 shares for and 717,913 shares
withheld); Robert H. Groman (by a vote of 42,264,481 shares for and 979,816
shares withheld); James Scibelli (by a vote of 42,645,431 shares for and
598,866 shares withheld); and Michael Tannen (by a vote of 42,625,435 shares
for and 618,862 shares withheld); (ii) approved, by a vote of 25,866,164
shares for, 1,185,627 shares against, and abstentions and broker non-votes
with respect to 16,192,506 shares, the Company's 1998 Employee Stock Purchase
Plan; (iii) approved, by a vote of 16,254,373 shares for, 10,789,971 shares
against, and abstentions and broker non-votes with respect to 16,199,953
shares, the Company's 1998 Stock Incentive Plan; and (iv) ratified the
appointment of KPMG Peat Marwick LLP as independent auditors of the Company
for the year ended August 31, 1998 by a vote of 42,706,593 shares for, 406,580
shares against, and abstentions with respect to 131,124 shares.
23
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock is traded on The NASDAQ Stock Market National Market
System under the symbol AKLM. On November 4, 1998, the closing sale price of
the Common Stock was $8.625 per share. As of such date, there were
approximately 1,250 holders of record of the Common Stock.
The following table sets forth the range of high and low sales prices for
the Common Stock for each of the periods indicated:
Price
-----
Period High Low
- ------ ---- ---
FISCAL YEAR 1997
First Quarter $8.63 $3.06
Second Quarter 6.88 3.13
Third Quarter 5.88 2.94
Fourth Quarter 5.00 3.50
FISCAL YEAR 1998
First Quarter 6.00 2.94
Second Quarter 5.25 3.09
Third Quarter 8.19 5.00
Fourth Quarter 7.63 4.50
RECENT SALES OF UNREGISTERED SECURITIES
In fiscal 1998, the Company issued an aggregate of 914,303 shares of
Common Stock pursuant to settlement agreements relating to various claim and
litigations. The shares were issued pursuant to the exemption from
registration provided under Section 4(2) of the Securities Act of 1933 (the
"Securities Act"). In addition, in August 1998, the Company issued an
aggregate of 360,000 shares of Common Stock in settlement of the WMS Action,
to be distributed to the plaintiffs in the WMS Action after the plaintiffs'
lawyers have delivered an allocation schedule to the Company, pursuant to the
exemption from registration provided under Section 3(a)(10) of the Securities
Act. See "Legal Proceedings" and Note 17(a) of Notes to Consolidated Financial
Statements.
In May 1998, the Company issued 15,000 shares of restricted stock to Paul
Eibeler, currently an executive officer of the Company. The shares were issued
by the Company to Mr. Eibeler pursuant to the exemption from registration
provided under Section 4(2) of the Securities Act. The 15,000 shares of
restricted stock will vest in full in January 1999 subject to Mr. Eibeler's
continued employment with the Company at that time.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on the Common
Stock and has no present intention to declare or pay cash dividends on the
Common Stock in the foreseeable future. The Company is subject to various
financial covenants with its lenders that could limit and/or prohibit the
payment of dividends in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 9 of Notes to
Consolidated Financial Statements. The Company intends to retain earnings, if
any, which it may realize in the foreseeable future to finance its operations.
24
ITEM 6. SELECTED FINANCIAL DATA.
The following tables should be read in conjunction with the consolidated
financial statements of the Company and the notes thereto and the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section appearing elsewhere in this Annual Report on Form 10-K.
Fiscal Year Ended August 31,
----------------------------
(in 000s, except per share information)
1998 1997 1996(3) 1995(2) 1994(1)
---- ---- ------- ------- -------
STATEMENT OF OPERATIONS DATA:
Net revenues $326,561 $165,411 $161,945 $566,723 $480,756
Cost of revenues 148,660 89,818 191,790 291,474 249,902
Gross profit (loss) 177,901 75,593 (29,845) 275,249 230,854
Marketing and sales 61,691 57,266 116,142 125,813 102,035
General and administrative 54,149 68,831 76,625 66,503 46,721
Research and development 37,367 41,689 46,864 12,267 4,628
Goodwill writedown --- 25,200 --- --- ---
Litigation settlements --- 23,550 --- --- ---
Downsizing charge --- 10,000 5,000 --- ---
Earnings (loss) from operations 24,694 (150,943) (274,476) 70,666 77,470
Other (expense) income, net (3,240) (8,117) 5,609 5,608 (475)
Earnings (loss) before
income taxes 21,454 (159,060) (268,867) 76,274 76,995
Net earnings (loss) 20,690 (159,228) (221,368) 44,770 45,055
Basic earnings (loss) per share $0.40 $(3.21) $(4.47) $1.05 $1.18
Diluted earnings (loss) per share $0.37 $(3.21) $(4.47) $0.86 $1.00
- ---------------------------------
(1) Includes results of operations of Acclaim Comics from July 29, 1994.
(2) Includes results of operations of Iguana from January 4, 1995 and of
Lazer-Tron for the entire year.
(3) Includes results of operations of Acclaim Studios - Salt Lake City, Inc.
(formerly, Sculptured Software, Inc.) and Probe Entertainment Limited
("Probe") for the entire year.
August 31,
----------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Working capital (deficiency) $(19,100) $(64,156) $(10,039) $200,455 $131,820
Total assets 160,407 133,175 239,651 442,827 335,878
Current portion of long-term debt 724 1,002 25,527 25,196 1,538
Long-term liabilities 56,629 59,472 4,032 461 41,754
Stockholders' (deficiency) equity (21,773) (59,046) 93,589 314,707 175,243
25
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Overview
The Company is a worldwide developer, publisher and mass marketer of
Software for use with Entertainment Platforms and PCs. The Company owns and
operates four Studios, located in the United States and the United Kingdom,
and publishes and distributes its Software directly in North America, the
United Kingdom, Germany and France. The Company's operating strategy is to
develop and maintain a core of key brands and franchises 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
Affiliated Labels Software 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, Sony and Sega) and PCs. 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.
Based on information available in 1994 and based on its historical
experience with respect to the transition from 8- to 16-bit platforms, the
Company believed that Software sales for 16-bit platforms would, although
continuing to decrease overall, remain substantial through the 1996 holiday
season. Accordingly, the Company anticipated that its sales of 32-bit and PC
Software in fiscal 1996 would grow as compared to fiscal 1995 but that the
majority of its revenues in fiscal 1996 would still be derived from 16-bit
Software sales. However, the 16-bit Software market matured much more rapidly
than anticipated by the Company, the Company's Christmas 1995 16-bit Software
sales were substantially lower than anticipated and, by April 1996, the
Company derived minimal profits from such Software sales and made the decision
to exit the 16-bit and portable Software markets.
In connection with the Company's decision to exit the 16-bit and portable
Software markets in April 1996, the Company recorded a special cartridge video
charge of approximately $48.9 million in the second quarter of fiscal 1996,
consisting of provisions of approximately $28.8 million (reflected in net
revenues), and approximately $20.1 million (reflected in cost of revenues),
respectively, to adjust accounts receivable and inventories at February 29,
1996 to their estimated net realizable values in conjunction with management's
decision to exit the 16-bit and portable Software market.
The Company recorded a loss from operations of $274.5 million and a net
loss (on an after-tax basis) of $221.4 million for fiscal 1996. The net loss
for the year reflected write-offs of receivables, the establishment of
additional receivables and inventory reserves, severance charges incurred in
connection with the downsizing of the Company and the reduction of certain
deferred costs, as well as an operating loss for the year resulting primarily
from price protection and similar concessions granted to retailers at greater
than anticipated levels in connection with the Company's 16- and 32-bit
Software.
The Company recorded a loss from operations of $150.9 million and a net
loss (on an after-tax basis) of $159.2 million for fiscal 1997. The net loss
for the year reflects, among other things, a charge for certain claims and
litigations for which the settlement obligation was probable and estimable of
$23.6 million, a write-down of goodwill of $25.2 million to reduce the
carrying value of the goodwill associated with Acclaim Comics to its estimated
undiscounted cash flows and downsizing charges of $10 million.
26
As a result of the Company's acquisitions of its Studios in 1995 (two of
which were completed in fiscal 1996), the Company's fixed costs relating to
the development of Software and its general and administrative expenses
substantially increased in fiscal 1996. See "Factors Affecting Future
Performance - Increased Product Development Costs." Such expenses in the
aggregate had a material adverse impact on the Company's profitability in
fiscal 1996 and fiscal 1997.
The Company recorded earnings from operations of $24.7 million and net
earnings (on an after-tax basis) of $20.7 million for fiscal 1998. The
improved results for fiscal 1998 primarily resulted from increased sales in
the United States of the Company's 64-bit and, to a lesser extent, 32-bit
Software. They also reflect the Company's significantly reduced operating
expenses, resulting primarily from a reduction in personnel, the sale or
discontinuance of certain non-profitable businesses, the consolidation of
certain of its Studio operations to reduce their overhead expenses and various
other cost reductions.
As a result of the industry transition to 32- and 64-bit Entertainment
Platforms, the Company's Software sales during fiscal 1996, 1997 and 1998 were
significantly lower than in fiscal 1995. Management expects that, unless and
until the installed base of 32- and 64-bit Entertainment Platforms increases
substantially, the Company's unit sales and revenues from the sale of Software
for these platforms will be substantially lower than Software sales levels
achieved prior to fiscal 1996, when the current transition began. No assurance
can be given as to the future growth of the installed base of 32- and 64-bit
Entertainment Platforms or of the Company's results of operations and
profitability in future periods. See "Factors Affecting Future Performance -
Industry Trends; Platform Transition; Technological Change."
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 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 $2 million.
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:
27
Fiscal Year Ended August 31,
----------------------------
1998 1997 1996
---- ---- ----
Domestic revenues 66.4% 49.7% 58.7%
Foreign revenues 33.6 50.3 41.3
---- ---- ----
Net revenues 100.0 100.0 100.0
Cost of revenues 45.5 54.3 118.4
---- ---- -----
Gross profit (loss) 54.5 45.7 (18.4)
Marketing and sales 18.9 34.6 71.7
General and administrative 16.6 41.6 47.3
Research and development 11.4 25.2 28.9
Goodwill writedown --- 15.2 ---
Litigation settlements --- 14.2 ---
Downsizing charge --- 6.1 3.1
----- --- ---
Total operating expenses 46.9 137.0 151.1
Earnings (loss) from operations 7.6 (91.3) (169.5)
Other (expense) income, net (1.0) (4.9) 3.5
Earnings (loss) before income taxes 6.6 (96.2) (166.0)
Net earnings (loss) 6.3 (96.3) (136.7)
NET REVENUES
The Company's gross revenues were derived from the following product
categories:
1998* 1997* 1996*
----- ----- -----
Portable Software 2.0% 2.0% 8.0%
16-bit Software --- 9.0% 44.0%
32-bit Software 30.0% 37.0% 32.0%
64-bit Software 57.0% 33.0% ---
PC Software 10.0% 15.0% 12.0%
Other 1.0% 4.0% 4.0%
- ------------------------
*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. Such credits and allowances
were material to the Company's results of operations in fiscal 1996.
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 $165.4 million for the
year ended August 31, 1997 to $326.6 million for the year ended August 31,
1998 was predominantly due to increased sales in the United States of the
Company's 64-bit and, to a lesser extent, 32-bit Software. The increase in
sales in fiscal 1998 was primarily due to the increase in the installed base
of N64 and PlayStation consoles worldwide and the quality of the Company's
titles. Although revenues from the sale of N64 and PlayStation Software are
anticipated to continue to grow in fiscal 1999, the Company does not
anticipate that it will achieve its 1998 growth rate.
The Company's domestic sales in fiscal 1998 comprised a higher percentage
of total net revenues compared to fiscal 1997 primarily because the titles
published by the Company in 1998 achieved greater popularity in the domestic
market (e.g., WWF War Zone and Quarterback Club '98). 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.
The increase in the Company's net revenues from $161.9 million for the
year ended August 31, 1996 to $165.4 million for the year ended August 31,
1997 was predominantly due to sales of the Company's N64 title, Turok:
Dinosaur Hunter, offset by reduced unit sales of 16-bit Software.
28
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."
In fiscal 1998, WWF War Zone (for multiple platforms), NFL Quarterback
Club '98 (for the N64), Forsaken (for multiple platforms) and Extreme G (for
the N64) accounted for approximately 18%, 13%, 11% and 11%, respectively, of
the Company's gross revenues. In fiscal 1997, Turok: Dinosaur Hunter (for the
N64) accounted for approximately 33% of the Company's gross revenues. In
fiscal 1996, no single title accounted for a significant portion of the
Company's gross revenues.
In addition, in fiscal 1997, sales of Software manufactured by Interplay
accounted for approximately 9% of the Company's gross revenues. See "Business
- -- Distribution of Affiliated Labels." The Company did not derive material
revenues from the sales of Affiliated Labels Software in fiscal 1996 and 1998
and does not anticipate that such sales will be material in fiscal 1999.
The Company is substantially dependent on Nintendo, Sony and Sega 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 platforms and on Nintendo and Sony as the sole
manufacturers of Software for the Entertainment Platforms marketed by them.
For the years ended August 31, 1996, 1997 and 1998, the Company derived 29%,
41% and 60% of its gross revenues, respectively, from sales of
Nintendo-compatible Software, 19%, 28% and 30% of its gross revenues,
respectively, from sales of Software for PlayStation and 36%, 12% and less
than 1% of its gross revenues, respectively, from sales of Sega-compatible
Software. 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 $75.6 million (46% of net revenues) for the
year ended August 31, 1997 to $177.9 million (55% of net revenues) for the
year ended August 31, 1998 predominantly due to increased unit sales and
higher unit selling prices of the Company's Software.
29
Gross profit increased from $(29.8) million ((18)% of net revenues) for
the year ended August 31, 1996 to $75.6 million (46% of net revenues) for the
year ended August 31, 1997 primarily as a result of lower levels of returns
and allowances.
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 in fiscal 1998 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 decreased from $116.1 million (72% of net
revenues) for the year ended August 31, 1996 to $57.3 million (35% of net
revenues) for the year ended August 31, 1997 and to $61.7 million (19% of net
revenues) for the year ended August 31, 1998. The percentage decrease is
primarily attributable to increased sales volume and cost reduction efforts
initiated by the Company to reduce its operating expenses. The dollar increase
from fiscal 1997 to fiscal 1998 is primarily attributable to increased sales
volume.
General and administrative expenses decreased from $76.6 million (47% of
net revenues) for the year ended August 31, 1996 to $68.8 million (42% of net
revenues) for the year ended August 31, 1997 and to $54.1 million (17% of net
revenues) for the year ended August 31, 1998 primarily due to the cost
reduction efforts initiated by the Company.
Research and development expenses decreased from $46.9 million (29% of
net revenues) for the year ended August 31, 1996 to $41.7 million (25% of net
revenues) for the year ended August 31, 1997 and to $37.4 million (11% of net
revenues) for the year ended August 31, 1998, primarily due to the
consolidation of certain of the Company's studio operations, reduced personnel
cost and other cost reduction efforts initiated by the Company.
Although the Company anticipates that its 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."
Severance charges and other costs related to a Company downsizing of
approximately $10 million and $5 million were recorded in fiscal 1997 and
1996, respectively. Downsizing expenditures in fiscal 1998 were consistent
with the accrued downsizing charge at August 31, 1997. The remaining accrued
downsizing expenses will be paid in fiscal 1999 and relate to employee
severance.
30
Due to Acclaim Comics' operating losses through May 1997, management's
assessment of the state of the comic book industry and management's
projections for Acclaim Comics' operations, management believed that there was
an impairment in the carrying value of the goodwill relating to the July 1994
acquisition of Acclaim Comics. Accordingly, the Company recorded a write-down
of $25.2 million of goodwill in fiscal 1997 to reduce the carrying value of
the goodwill associated with Acclaim Comics to its estimated undiscounted
future cash flows.
In conjunction with certain claims and litigations for which the
settlement obligation was then probable and estimable, the Company recorded a
charge of $23.6 million during fiscal 1997. No assurance can be given that the
Company will not be required to record additional material charges in future
periods in conjunction with the litigations to which the Company is a party.
See Note 17(a) of Notes to Consolidated Financial Statements.
As of August 31, 1998, the Company had a U.S. tax net operating loss
carryforward of approximately $110 million. The Company had an insignificant
U.S. federal income tax expense in fiscal 1998 due to the utilization of a
portion of its net operating loss carryforwards. The provision for income
taxes of $0.8 million primarily relates to state and foreign taxes. See Note
11 of Notes to Consolidated Financial Statements.
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 except
for the holiday selling season, may cause the Company's results to vary from
the seasonal patterns of the industry as a whole.
LIQUIDITY AND CAPITAL RESOURCES
The Company derived net cash from operating activities of approximately
$23.3 million during the year ended August 31, 1998 and used net cash in
operating activities of approximately $29.2 million and $38.3 during the years
ended August 31, 1997 and 1996, respectively. The increase in net cash from
operating activities in fiscal 1998 is primarily attributable to profitable
operations. An income tax refund of approximately $54.0 million related to the
carryback of the Company's loss for fiscal 1996 was received and included in
the net cash used in operating activities during the year ended August 31,
1997.
The Company used net cash in investing activities of approximately $3.9
million during the year ended August 31, 1998 and derived net cash from
investing activities of approximately $14.5 million and $7.4 million during
the years ended August 31, 1997 and 1996, respectively. The decrease in cash
provided by investing activities in fiscal 1998 as compared to the fiscal 1997
period is primarily attributable to the proceeds derived from the sale of
marketable securities (approximately $10.2 million) and subsidiaries
(