UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-24363
INTERPLAY ENTERTAINMENT CORP.
(Exact name of the registrant as specified in its charter)
DELAWARE 33-0102707
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16815 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92606
(Address of principal executive offices)
(949) 553-6655
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
As of June 30, 2003, the aggregate market value of voting common stock held by
non-affiliates was approximately $3,499,417 based upon the closing price of the
common stock on that date.
As of April 1, 2004, 93,855,634 shares of common stock of the Registrant were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the issuer's 2004 Annual Meeting
of Stockholders are incorporated by reference into Part III of this Report. Our
Form 8-K filed on February 25, 2003, and amendment to such Form 8-K filed on
February 27, 2003, are incorporated by reference into Part II, Item 9 of this
Report.
INTERPLAY ENTERTAINMENT CORP.
INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003
PAGE
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PART I
Item 1. Business 4
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 13
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosure about
Market Risk 46
Item 8. Consolidated Financial Statements and Supplementary
Data 46
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 47
Item 9A Controls and Procedures 47
PART III
Item 10. Directors and Executive Officers of the Registrant 47
Item 11. Executive Compensation 47
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 48
Item 13. Certain Relationships and Related Transactions 48
Item 14. Principal Accountant Fees and Services 48
PART IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 48
Signatures 49
Exhibit Index 51
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THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
AND EXCHANGE ACT OF 1934 AND SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO THE
SAFE HARBORS CREATED THEREBY. FOR THIS PURPOSE, ANY STATEMENTS CONTAINED IN THIS
REPORT EXCEPT FOR HISTORICAL INFORMATION MAY BE DEEMED TO BE FORWARD-LOOKING
STATEMENTS. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, OUR USE OF WORDS
SUCH AS "PLAN," "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND,"
"COULD," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR
COMPARABLE TERMINOLOGY ARE INTENDED TO HELP IDENTIFY FORWARD-LOOKING STATEMENTS.
IN ADDITION, ANY STATEMENTS THAT REFER TO EXPECTATIONS, PROJECTIONS OR OTHER
CHARACTERIZATIONS OF FUTURE EVENTS OR CIRCUMSTANCES ARE FORWARD-LOOKING
STATEMENTS.
THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON CURRENT
EXPECTATIONS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AS WELL AS
CERTAIN ASSUMPTIONS. FOR EXAMPLE, ANY STATEMENTS REGARDING FUTURE CASH FLOW,
REVENUE PROJECTIONS, INCLUDING THOSE FORWARD-LOOKING STATEMENTS LOCATED IN "ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS", FINANCING ACTIVITIES, COST REDUCTION MEASURES, REPLACEMENT OF OUR
TERMINATED LINE OF CREDIT AND MERGERS, SALES OR ACQUISITIONS ARE FORWARD-LOOKING
STATEMENTS AND THERE CAN BE NO ASSURANCE THAT WE WILL AFFECT ANY OR ALL OF THESE
OBJECTIVES IN THE FUTURE. RISKS AND UNCERTAINTIES THAT MAY AFFECT OUR FUTURE
RESULTS ARE DISCUSSED IN MORE DETAIL IN THE SECTION TITLED "RISK FACTORS" IN
"ITEM 7. "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS."
ASSUMPTIONS RELATING TO OUR FORWARD-LOOKING STATEMENTS INVOLVE JUDGMENTS
WITH RESPECT TO, AMONG OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET
CONDITIONS, AND FUTURE BUSINESS DECISIONS, ALL OF WHICH ARE DIFFICULT OR
IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH ARE BEYOND OUR CONTROL.
ALTHOUGH WE BELIEVE THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING
STATEMENTS ARE REASONABLE, OUR INDUSTRY, BUSINESS AND OPERATIONS ARE SUBJECT TO
SUBSTANTIAL RISKS, AND THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED
AS A REPRESENTATION BY MANAGEMENT THAT ANY PARTICULAR OBJECTIVE OR PLANS WILL BE
ACHIEVED. IN ADDITION, RISKS, UNCERTAINTIES AND ASSUMPTIONS CHANGE AS EVENTS OR
CIRCUMSTANCES CHANGE. WE DISCLAIM ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS
OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO
REFLECT EVENTS OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS
REPORT WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION OR OTHERWISE TO REVISE
OR UPDATE ANY ORAL OR WRITTEN FORWARD-LOOKING STATEMENT THAT MAY BE MADE FROM
TIME TO TIME BY US OR ON OUR BEHALF.
INTERPLAY (R), INTERPLAY PRODUCTIONS(R) AND CERTAIN OF OUR OTHER PRODUCT
NAMES AND PUBLISHING LABELS REFERRED TO IN THIS REPORT ARE OUR TRADEMARKS. THIS
REPORT ALSO CONTAINS TRADEMARKS BELONGING TO OTHERS.
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PART I
ITEM 1. BUSINESS
OVERVIEW AND RECENT DEVELOPMENTS
Interplay Entertainment Corp., which we refer to in this Report as "we,"
"us," or "our," is a developer and publisher of interactive entertainment
software for both core gamers and the mass market. We were incorporated in the
State of California in 1982 and were reincorporated in the State of Delaware in
May 1998.
We are most widely known for our titles in the action/arcade,
adventure/role playing game ("RPG"), and strategy/puzzle categories. We have
produced titles for many of the most popular interactive entertainment software
platforms, and currently balance our publishing and distribution business by
developing interactive entertainment software for personal computers ("PCs") and
video game consoles, such as the Sony PlayStation 2 ("PS2"), Microsoft Xbox
("Xbox") and Nintendo GameCube.
We seek to publish interactive entertainment software titles that are, or
have the potential to become, franchise software titles that can be leveraged
across several releases and/or platforms, and have published many such
successful franchise titles to date, including our BALDUR'S GATE: DARK ALLIANCE
II which was a top 10 title sold through retail in the United States in January
2004, according to NPD Funworld Data.
We are a majority owned subsidiary of Titus Interactive S. A., which we
refer to as Titus. According to Titus' filings with the U.S. Securities and
Exchange Commission ("SEC"), Titus presently owns approximately 67 million
shares of common stock, which represents approximately 71% of our outstanding
common stock, our only voting security. In January 2004, Titus disclosed in
their annual report for the fiscal year ended June 30, 2003, filed with the
Autorite des Marches Financiers of France, that they were involved in litigation
with one of our former founders and officers and as a result had deposited
pursuant to a California Court Order approximately 8,679,306 shares of our
common stock held by them (representing approximately 9% of our issued and
outstanding common stock) with the court. Also disclosed was that Titus was
conducting settlement discussions at the time of the filing to resolve the
issue. To date, Titus has maintained voting control over the 8,679,306 million
shares of common stock and has not represented to us that a transfer of
beneficial ownership has occurred. Nevertheless, such transfer of shares may
occur in fiscal 2004
Our business and industry has certain risks and uncertainties. During 2003,
we continued to operate under limited cash flow from operations. We have been
operating without a credit facility since October 2001, which has adversely
affected our cash flow. We continue to review alternative sources of financing
for our business. We expect to operate under similar cash constraints during
2004. For a fuller discussion of the risk and uncertainties relating to our
financial results, our business and our industry, please see the section titled
"Risk Factors" in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
The majority of our sales and distribution is handled by Vivendi Universal
Games, Inc. ("Vivendi") in North America and select rest-of-world countries and
by Avalon Interactive Group Ltd. (formerly Virgin Interactive Entertainment
Limited), a wholly owned subsidiary of Titus, ("Avalon") in Europe, the
Commonwealth of Independent States, Africa and the Middle East and through
licensing strategies elsewhere. We also distribute our software products
directly through our websites located at www.interplay.com and
www.gamesonline.com.
In February 2003, we sold to Vivendi all future interactive entertainment
publishing rights to the HUNTER: THE RECKONING license for $15 million, payable
in installments, which was fully paid at June 30, 2003. We retain the rights to
the previously published HUNTER: THE RECKONING titles on Xbox and Nintendo
GameCube.
In May 2003, Avalon filed for a Company Voluntary Arrangement ("CVA"), a
process of reorganization, in the United Kingdom in which we participated in,
and were approved as a creditor of Avalon. As part of the Avalon CVA process, we
submitted our creditor's claim. We have received payments of approximately
$347,000 due to us as a creditor under the terms of the Avalon CVA plan. We
continue to operate under a distribution agreement with Avalon. Avalon
distributes substantially all of our titles in Europe, the Commonwealth of
Independent States, Africa, the Middle East, and select rest-of-world countries.
Avalon is current on their post-CVA payments to us. Our distribution
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agreement with Avalon ends in February 2006. We continue to evaluate and adjust
as appropriate our claims against Avalon in the CVA process. However, the
effects of the approval of the Avalon CVA on our ability to collect amounts due
from Avalon are uncertain and consequently are fully reserved. As a result, we
cannot guarantee our ability to collect fully the debts we believe are due and
owed to us from Avalon. If Avalon is not able to continue to operate under the
new CVA, we expect Avalon to cease operations and liquidate, in which event we
will most likely not receive in full the amounts presently due us by Avalon. We
may also have to appoint another distributor or become our own distributor in
Europe and the other territories in which Avalon presently distributes our
products.
In February 2003, we amended our license agreement with the holder of the
interactive entertainment rights to DUNGEONS & DRAGONS ("D&D"). This license
allows us to publish the BALDUR'S GATE, BALDUR'S GATE: DARK ALLIANCE, and
ICEWIND DALE titles. Pursuant to this amendment, among other things, we (i)
extended the license term for approximately an additional two years to December
31, 2008 for an advance payment on future royalties of approximately $200,000
and (ii) extended our rights with respect to certain of the D&D properties. The
amendment terminated our rights to certain titles in the event we are unable to
obtain certain third-party waivers in accordance with the terms of the
amendment. We were unable to obtain the required waivers within the permitted
time period and as a result have lost rights to publish BALDUR'S GATE 3 and its
sequels on the PC. Subsequently, we relinquished the rights to publish any
future titles using the D&D license in exchange for the DARK ALLIANCE trademark.
We intend to publish future titles using the DARK ALLIANCE trademark name.
On or about February 23, 2004, we received correspondence from the holder
of the D&D license alleging that we had failed to pay royalties due under the
D&D license as of February 15, 2004. If we are unable to cure this alleged
breach of the license agreement, we may lose our remaining rights under the
license, including the rights to continued distribution of BALDUR'S GATE: DARK
ALLIANCE II. The loss of the remaining rights to distribute games created under
the D&D license could have a significant negative impact on our future operating
results.
In August 2002, we entered into a new distribution agreement with Vivendi,
an affiliate company of Universal Studios, Inc., who owns approximately 5% of
our common stock. In 2003, Vivendi's beneficial ownership in us decreased below
5%. In January 2003, we entered into an agreement with Vivendi to distribute
substantially all of our products in the following countries: Australia, New
Zealand, Korea, Taiwan, Sri Lanka, Malaysia, Philippines, Thailand, Singapore,
Hong Kong, China, Indonesia, Vietnam and India ("Select Rest-of-World
Countries").
In September 2003, we terminated our distribution agreement with Vivendi as
a result of their alleged breaches, including for non-payment of money owed to
us under the terms of this distribution agreement. In October 2003, Vivendi and
we reached a mutually agreed upon settlement and agreed to reinstate the 2002
distribution agreement. Vivendi distributed our games FALLOUT: BROTHERHOOD OF
STEEL and BALDURS GATE: DARK ALLIANCE II in North America and Asia-Pacific
(excluding Japan), and retained exclusive distribution rights in these regions
for all of our future titles through August 2005.
Based on sales and royalty statements received from Vivendi in April 2004,
we believe that Vivendi incorrectly reported gross sales of our products under
the 2002 distribution agreement as a result of its taking improper deductions
for price protections it offered its customers. Vivendi has acknowledged this
error. We currently believe the minimum amount due in additional proceeds is
approximately $66,000, which we are currently investigating.
PRODUCTS
We develop and publish interactive entertainment software titles that
provide immersive game experiences by combining advanced technology with
engaging content, vivid graphics and rich sound. We utilize the experience and
judgment of the avid gamers in our product development group to select and
produce the products we publish.
Our strategy is to invest in products for those platforms, whether PC or
video game console, that have or will have sufficient installed bases for the
investment to be economically viable. We currently develop and publish products
for the PC platform compatible with Microsoft Windows, and for video game
consoles such as the PS2, the Xbox and the Nintendo GameCube. In addition, we
anticipate continued substantial growth in the use of high-speed Internet
access, which could provide significantly expanded market potential for online
products.
5
We assess the potential acceptance and success of emerging platforms and
the anticipated continued viability of existing platforms based on many factors,
including, among others, the number of competing titles, the ratio of software
sales to hardware sales with respect to the platform, the platform's installed
base, changes in the rate of the platform's sales and the cost and timing of
development for the platform. We must continually anticipate and assess the
emergence of, and market acceptance of, new interactive entertainment hardware
platforms well in advance of the time the platform is introduced to consumers.
We are therefore required to make substantial product development and other
investments in a particular platform well in advance of the platform's
introduction. If a platform for which we develop software is not released on a
timely basis or does not attain significant market penetration, our business,
operating results and/or financial condition could be materially adversely
affected. Alternatively, if we fail to develop products for a platform that does
achieve significant market penetration then our business, operating results
and/or financial condition could also be materially adversely affected.
We have entered into license agreements with Sony Computer Entertainment,
Microsoft Corporation and Nintendo pursuant to which we have the right to
develop, sublicense, publish, and distribute products for the licensor's
respective platforms in specified territories. In certain cases, the products
are manufactured for us by the licensor. We pay the licensor a royalty or
manufacturing fee in exchange for such license and manufacturing services. Such
agreements grant the licensor certain approval rights over the products
developed for their platform, including packaging and marketing materials for
such products. There can be no assurance that we will be able to obtain future
licenses from platform companies on acceptable terms or that any existing or
future licenses will be renewed by the licensors. Our inability to obtain such
licenses or approvals could have a material adverse effect on our business,
operating results and/or financial condition. In fiscal 2003, our product
releases were for PS2, Xbox and PC. Our planned product introductions for fiscal
2004 are for the PS2, Xbox and PC. The products being developed are as follows:
a sequel to our title KINGPIN for the PC and Xbox platforms; a title based on
the FALLOUT universe for the PS2 and Xbox platforms; and a RPG for the PS2 and
Xbox platforms. We are also developing a casino game for the PS2, Xbox and PC
platforms.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
We regard our software as proprietary and rely primarily on a combination
of patent, copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks. We hold copyrights on our
products, product literature and advertising and other materials, and hold
trademark rights in our name and certain of our product names and publishing
labels. We have licensed certain products to third parties for distribution in
particular geographic markets or for particular platforms, and receive royalties
on such licenses. We also outsource some of our product development activities
to third party developers. We contractually retain all intellectual property
rights related to such projects. We also license certain products developed by
third parties and pay royalties on such products.
While we provide "shrink wrap" license agreements or limitations on use
with our software, the enforceability of such agreements or limitations is
uncertain. We are aware that unauthorized copying occurs, and if a significantly
greater amount of unauthorized copying of our interactive entertainment software
products were to occur, our operating results could be materially adversely
affected. We use copy protection on selected products and do not provide source
code to third parties unless they have signed nondisclosure agreements.
We rely on existing copyright laws to prevent the unauthorized distribution
of our software. Existing copyright laws afford only limited protection.
Policing unauthorized use of our products is difficult, and we expect software
piracy to be a persistent problem, especially in certain international markets.
Further, the laws of certain countries in which our products are or may be
distributed either do not protect our products and intellectual property rights
to the same extent as the laws of the United States or are weakly enforced.
Legal protection of our rights may be ineffective in such countries, and as we
leverage our software products using emerging technologies, such as the Internet
and on-line services, our ability to protect our intellectual property rights,
and to avoid infringing the intellectual property rights of others, becomes more
difficult. In addition, the intellectual property laws are less clear with
respect to such emerging technologies. There can be no assurance that existing
intellectual property laws will provide our products with adequate protection in
connection with such emerging technologies.
As the number of software products in the interactive entertainment
software industry increases and the features and content of these products
further overlap, interactive entertainment software developers may increasingly
become subject
6
to infringement claims. Although we take reasonable efforts to ensure that our
products do not violate the intellectual property rights of others, there can be
no assurance that claims of infringement will not be made. Any such claims, with
or without merit, can be time consuming and expensive to defend. From time to
time, we have received communications from third parties asserting that features
or content of certain of our products may infringe upon such party's
intellectual property rights. In some instances, we may need to engage in
litigation in the ordinary course of our business to defend against such claims.
There can be no assurance that existing or future infringement claims against us
will not result in costly litigation or require that we license the intellectual
property rights of third parties, either of which could have a material adverse
effect on our business, operating results and financial condition.
PRODUCT DEVELOPMENT
We develop or acquire our products from a variety of sources, including our
internal development studios and publishing relationships with leading
independent developers.
THE DEVELOPMENT PROCESS. We develop original products both internally,
using our in-house development staff, and externally, using third party software
developers working under contract with us. Producers on our internal staff
monitor the work of both inside and third party development teams through design
review, progress evaluation, milestone review, and quality assurance. In
particular, each milestone submission is thoroughly evaluated by our product
development staff to ensure compliance with the product's design specifications
and our quality standards. We enter into consulting or development agreements
with third party developers, generally on a flat-fee, work-for-hire basis or on
a royalty basis, whereby we pay development fees or royalty advances based on
the achievement of milestones. In royalty arrangements, we ultimately pay
continuation royalties to developers once our advances have been recouped. In
addition, in certain cases, we will utilize third party developers to convert
products for use with new platforms.
Our products typically have short life cycles, and we therefore depend on
the timely introduction of successful new products, including enhancements of,
or sequels to, existing products and conversions of previously released products
to additional platforms, to generate revenues to fund operations and to replace
declining revenues from existing products. The development cycle of new products
is difficult to predict, and involves a number of risks.
During the years ended December 31, 2003, 2002, and 2001, we spent $13.7
million, $16.2 million, and $20.6 million, respectively, on product research and
development activities. Those amounts represented 38%, 37%, and 36%
respectively, of net revenues in each of those periods.
INTERNAL PRODUCT DEVELOPMENT
U.S. PRODUCT DEVELOPMENT. Our internal product development group in the
United States consisted of approximately 75 people at December 31, 2003. Once we
select a design for a product, we establish a production team, development
schedule and budget for the product. Our internal development process includes
initial design and concept layout, computer graphic design, 2D and 3D artwork,
programming, prototype testing, sound engineering and quality control. The
development process for an original, internally developed product typically
takes from 12 to 24 months, and 6 to 12 months for the porting of a product to a
different technology platform. We utilize a variety of advanced hardware and
software development tools, including animation, sound compression utilities and
video compression for the production and development of our interactive
entertainment software titles. Our internal development organization is divided
into development teams, with each team assigned to a particular project. These
teams are generally led by a producer or associate producer and include game
designers, software programmers, artists, product managers and sound
technicians.
INTERNATIONAL DEVELOPMENT. In 2001, we reassigned the process for our
product development efforts in Europe from Interplay Productions Limited, our
European subsidiary, to our corporate headquarters in Irvine, California. Prior
to the reassignment, Interplay Productions Limited engaged and managed the
efforts of third party developers located in various European countries. We
currently do not have any original product under development in Europe.
EXTERNAL PRODUCT DEVELOPMENT
To expand our product offerings to include hit titles created by third
party developers and to leverage our publishing capabilities, we enter into
publishing arrangements with third party developers. In the years ended December
31, 2003,
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2002, and 2001, approximately 0%, 67%, and 80%, respectively, of new products we
released and which we believe are or will become franchise titles were developed
by third party developers. We expect that the proportion of our new products
which are developed externally may vary significantly from period to period as
different products are released. In selecting external titles to publish, we
seek titles that combine advanced technologies with creative game design. Our
publishing agreements usually provide us with the exclusive right to distribute,
or license another party to distribute, a product on a worldwide basis
(although, in certain instances our rights are limited to a specified
territory). We typically fund external development through the payment of
advances upon the completion of milestones, which advances are credited against
future royalties based on sales of the products. Further, our publishing
arrangements typically provide us with ownership of the trademarks relating to
the product as well as exclusive rights to sequels to the product. We manage the
production of external development projects by appointing a producer from one of
our internal product development teams to oversee the development process and
work with the third party developer to design, develop and test the game. At
December 31, 2003, we had two titles being developed by third party developers.
We believe this strategy of cultivating relationships with talented third
party developers can be cost-effective and can provide an excellent source of
quality products. A number of our commercially successful products have been
developed under this strategy. However, our reliance on third party software
developers for the development of a significant number of our interactive
software entertainment products involves a number of risks. Our reliance on
third party software developers subjects us to the risks that these developers
will not supply us with high quality products in a timely manner or on
acceptable terms.
SEGMENT INFORMATION
We operate in one principal industry segment, the development, publishing
and distribution of interactive entertainment software. For information
regarding the revenues and assets associated with our geographic segments, see
Note 14 of the Notes to our Consolidated Financial Statements included elsewhere
in this Report.
We have two distributors as our two main customers: Vivendi and Avalon.
Vivendi and Avalon accounted for 82% and 12% of our net revenues in 2003,
respectively. Vivendi and Avalon have exclusive rights to distribute our product
in substantial parts of the world. If either Vivendi or Avalon fail to deliver
us the proceeds owed us from distribution or fail to effectively distribute our
products or perform under their respective distribution agreements, our business
and financial results could suffer material harm.
SALES AND DISTRIBUTION
NORTH AMERICA. In August 2002, we entered into a new distribution
arrangement with Vivendi, whereby Vivendi will distribute substantially all of
our products in North America for a period of three years as a whole and two
years with respect to each product providing for a potential maximum term of
five years. Under this distribution agreement, Vivendi will pay us sales
proceeds less amounts for distribution fees. Vivendi is responsible for all
manufacturing, marketing and distribution expenditures, and bears all credit,
price concessions and inventory risk, including product returns. Upon our
delivery of a product gold master, Vivendi will pay us a non-refundable minimum
guarantee which represents a specified percent of the estimated total amount due
to us based on projected initial shipment sales. Payments for sales that exceed
the projected initial shipment sales are paid on a monthly basis as sales occur.
We also continue to distribute products directly to end-users who can order
products by using a toll-free number or by accessing our web sites.
Vivendi provides terms of sale comparable to competitors in our industry.
In addition, we provide technical support for our products in North America
through our customer support and we provide a 90-day limited warranty to
end-users that our products will be free from manufacturing defects. In the
event of any manufacturing defects Vivendi provides us with the replacement
product free of charge. While to date we have not experienced any material
warranty claims, there can be no assurance that we will not experience material
warranty claims in the future.
INTERNATIONAL. Since February 1999, we have been operating under a
distribution agreement with Avalon, pursuant to which Avalon distributes
substantially all of our titles in Europe, the Commonwealth of Independent
States, Africa and the Middle East for a seven-year period. Under this
agreement, Avalon earns a distribution fee for its marketing and distribution of
our products, and we reimburse Avalon for certain direct costs and expenses.
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In January 2003, we entered into an agreement with Vivendi to distribute
substantially all of our products in Select Rest-of-World Countries.
INTERPLAY OEM. Our wholly owned subsidiary, Interplay OEM, Inc. distributes
our interactive entertainment software titles, as well as those of other
software publishers, to computer and peripheral device manufacturers for use in
bundling arrangements. As a result of changes in market conditions for bundling
arrangements and the limited amount of resources we have available, we no longer
have any personnel applying their efforts towards bundling arrangements. In
December 2002, we assigned our original equipment manufacturer, or OEM,
distribution rights to Vivendi and will utilize Vivendi's resources in our
future OEM business. Under OEM arrangements, one or more software titles, which
are either limited-feature versions or the retail version of a game, are bundled
with computer or peripheral devices and are sold by an original equipment
manufacturer so that the purchaser of the hardware device obtains the software
as part of the hardware purchase. Although it is customary for OEM customers to
pay a lower per unit price on sales through OEM bundling contracts, such
arrangements involve a high unit volume commitment. Interplay OEM net revenues
generally are incremental net revenues to our business and do not have
significant additional product development or sales and marketing costs.
Our North American and International ultimate distribution channels are
characterized by continuous change, including consolidation, financial
difficulties of certain retailers, and the emergence of new distributors and new
retail channels such as warehouse chains, mass merchants, computer superstores
and Internet commerce sites. Under the terms of some of our distribution
agreements, excluding Vivendi in North America, we are exposed to the risk of
product returns, and markdown allowances by our distributors. Under the same
distribution agreements, we allow our distributors to return defective,
shelf-worn and damaged products in accordance with negotiated terms. We also
offer a 90-day limited warranty to our end users that our products will be free
from manufacturing defects. In addition, our distributors provide markdown
allowances, which consist of credits given to resellers to induce them to lower
the retail sales price of certain of our products to increase sell through and
to help the reseller manage its inventory levels. Although we maintain a reserve
for returns and markdown allowances, and although we manage our returns and
markdown allowances through an authorization procedure with our distributors,
our distributors could be forced to accept substantial product returns and
provide markdown allowances to maintain their access to certain distribution
channels. Our reserve for estimated returns, exchanges, markdowns, price
concessions, and warranty costs was $0.4 million and $1.1 million at December
31, 2003, and 2002 respectively. Product returns and markdown allowances that
exceed our reserves, if any, could have a material adverse effect on our
business, operating results and financial condition.
MARKETING
Our marketing department assists our distributors in the development and
implementation of marketing programs and campaigns for each of our titles and
product groups. Our distributors' marketing activities in preparation for a
product launch include print advertising, game reviews in consumer and trade
publications, retail in-store promotions, attendance at trade shows and public
relations. Our distributors also send direct and electronic mail promotional
materials to our database of gamers and may selectively use radio and television
advertisements in connection with the introduction of certain of our products.
Our distributors budget a portion of each product's sales for cooperative
advertising and market development funds with retailers. Every title and brand
is to be launched with a multi-tiered marketing campaign that is developed on an
individual basis to promote product awareness and customer pre-orders.
Our distributors engage in on-line marketing through Internet advertising.
We maintain several Internet web sites. These web sites provide news and
information of interest to our customers through free demonstration versions of
games, contests, games, tournaments and promotions. Also, to generate interest
in new product introductions, we provide free demonstration versions of upcoming
titles through magazines and game samples that consumers can download from our
web site. In addition, through our marketing department, we host on-line events
and maintain various message boards to keep customers informed on shipped and
upcoming titles.
COMPETITION
The interactive entertainment software industry is intensely competitive
and is characterized by the frequent introduction of new hardware systems and
software products. Our competitors vary in size from small companies to very
large corporations with significantly greater financial, marketing and product
development resources than ours.
9
Due to these greater resources, certain of our competitors are able to undertake
more extensive marketing campaigns, adopt more aggressive pricing policies, pay
higher fees to licensors of desirable motion picture, television, sports and
character properties and pay more to third party software developers than us. We
believe that the principal competitive factors in the interactive entertainment
software industry include product features, brand name recognition, access to
distribution channels, quality, ease of use, price, marketing support and
quality of customer service.
We compete primarily with other publishers of PC and video game console
interactive entertainment software. Significant competitors include Acclaim
Entertainment, Activision, Atari, Capcom, Eidos, Electronic Arts, Konami, Lucas
Arts, Midway, Namco, Sega, Take-Two Interactive, THQ, Ubi Soft. and Vivendi. In
addition, integrated video game console hardware/software companies such as Sony
Computer Entertainment, Microsoft Corporation, and Nintendo compete directly
with us in the development of software titles for their respective platforms.
Large diversified entertainment companies, such as The Walt Disney Company and
Time Warner Inc., many of which own substantial libraries of available content
and have substantially greater financial resources than us, may decide to
compete directly with us or to enter into exclusive relationships with our
competitors.
CONCENTRATION
For the years ended December 31, 2003, 2002 and 2001, Avalon accounted for
approximately 12%, 11% and 22%, respectively, of net revenues. Vivendi accounted
for 82%, 71%, and 17% of net revenues in the year ended December 31, 2003, 2002
and 2001, respectively.
Retailers of our products typically have a limited amount of shelf space
and promotional resources. Consequently, there is intense competition among
consumer software producers, and in particular interactive entertainment
software producers, for high quality retail shelf space and promotional support
from retailers. If the number of consumer software products and computer
platforms increase, competition for shelf space will intensify which may require
us to increase our marketing expenditures. This increased demand for limited
shelf space, places retailers and distributors in an increasingly better
position to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return policies. As our
products constitute a relatively small percentage of any retailer's sales
volume, there can be no assurance that retailers will continue to purchase our
products or provide our products with adequate shelf space and promotional
support. A prolonged failure by retailers to provide shelf space and promotional
support would have a material adverse effect on our business, operating results
and financial condition
SEASONALITY
The interactive entertainment software industry is highly seasonal as a
whole, with the highest levels of consumer demand occurring during the year-end
holiday buying season. As a result, our net revenues, gross profits and
operating income have historically been highest during the second half of the
year. Our business and financial results may be affected by the timing of our
introduction of new releases.
MANUFACTURING
Our PC-based products consist primarily of CD-ROMs and DVDs, manuals, and
packaging materials. Substantially all of our CD-ROM and DVD duplication is
performed by third parties through our distributors. Printing of manuals and
packaging materials, manufacturing of related materials and assembly of
completed packages are performed to our specifications by third parties. To
date, our distributors have not experienced any material difficulties or delays
in the manufacture and assembly of our CD-ROM and DVD based products, and our
distributors have not experienced significant returns due to manufacturing
defects.
Sony Computer Entertainment, Microsoft Corporation and Nintendo manufacture
and ship finished products that are compatible with their video game consoles to
our distributors for distribution. PS2, Xbox and GameCube products consist of
the game disks and include manuals and packaging and are typically delivered
within a relatively short lead-time. If we experience unanticipated delays in
the delivery of manufactured software products by our third party manufactures,
our net sales and operating results could be materially adversely affected.
10
BACKLOG
We typically do not carry large inventories because most of our sales and
distribution efforts are handled by Vivendi and Avalon under the terms of our
respective distribution agreements with them. To the extent we ship items, we
typically ship orders immediately upon receipt. To the extent we have any
backlog orders, we do not believe they would have a material adverse effect on
our business.
EMPLOYEES
As of December 31, 2003, we had 113 employees, including 75 in product
development, 3 in sales and marketing and 33 in finance, general and
administrative. We also retain independent contractors to provide certain
services, primarily in connection with our product development activities.
Neither we nor our full time employees are subject to any collective bargaining
agreements and we believe that our relations with our employees are good.
From time to time, we have retained actors and/or "voice over" talent to
perform in certain of our products, and we expect to continue this practice in
the future. These performers are typically members of the Screen Actors Guild or
other performers' guilds, which guilds have established collective bargaining
agreements governing their members' participation in interactive media projects.
We may be required to become subject to one or more of these collective
bargaining agreements in order to engage the services of these performers in
connection with future development projects.
ADDITIONAL INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the SEC. You may read and copy any documents we file at the
SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You
may obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. The SEC maintains a website at www.sec.gov that
contains annual, quarterly and current reports, proxy statements and other
information that issuers (including us) file electronically with the SEC.
We make available free of charge, through a direct link from our website at
www.interplay.com (by going to "Investor Relations") to the SEC's website, our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to the
Securities and Exchange Act of 1934 as soon as reasonably practicable after such
documents are electronically filed with, or furnished to, the SEC.
ITEM 2. PROPERTIES
Our headquarters are located in Irvine, California, where we lease
approximately 81,000 square feet of office space. This lease expires in June
2006 and provides us with one five year option to extend the term of the lease
and expansion rights, on an "as available basis," to approximately double the
size of the office space. We have subleased approximately 6,000 square feet of
office space and may sublease an additional 21,000 of office space. We believe
that our facilities are adequate for our current needs and that suitable
additional or substitute space will be available in the future to accommodate
potential expansion of our operations. As of April 1, 2004, we were currently
three months in arrears on the rent obligations for our corporate lease in
Irvine, California. On April 9, 2004, our lessor served us with a Three-Day
Notice to Pay Rent or Surrender Possession. If we are unable to pay our rent, we
may lose our office space, which would interrupt our operations and cause
substantial harm to our business.
ITEM 3. LEGAL PROCEEDINGS
We are occasionally involved in various legal proceedings, claims and
litigation arising in the ordinary course of business, including disputes
arising over the ownership of intellectual property rights and collection
matters. We do not believe the outcome of such routine claims will have a
material adverse effect on our business, financial condition or results of
operations. From time to time, we may also be engaged in legal proceedings
arising outside of the ordinary course of our business.
11
On September 16, 2002, Knight Bridging Korea Co., Ltd ("KBK") filed a $98.8
million complaint for damages against Atari Interactive, Inc. (formerly known as
Infogrames Interactive, Inc.) and other Atari Interactive affiliates as well as
our subsidiary GamesOnline.com, Inc., alleging, among other things, breach of
contract, misappropriation of trade secrets, breach of fiduciary duties and
breach of implied covenant of good faith in connection with an electronic
distribution agreement dated November 2001 between KBK and GamesOnline.com, Inc.
KBK has alleged that GamesOnline.com failed to timely deliver to KBK assets to a
product, and that it improperly disclosed confidential information about KBK to
Atari. KBK amended its complaint to add us as a separate defendant. We
counterclaimed against KBK and also against Atari Interactive for breach of
contract, among other claims. We believe this complaint is without merit and
will vigorously defend our position.
On November 25, 2002, Special Situations Fund III, Special Situations
Cayman Fund, L.P., Special Situations Private Equity Fund, L.P., and Special
Situations Technology Fund, L.P. (collectively, "Special Situations") initiated
legal proceedings against us seeking damages of approximately $1.3 million,
alleging, among other things, that we failed to secure a timely effective date
for a Registration Statement for our shares purchased by Special Situations
under a common stock subscription agreement dated March 29, 2001 and that we are
therefore liable to pay Special Situations $1.3 million. This matter was settled
and the case dismissed in December 2003.
In August 2003, we sent several notifications to Vivendi alleging that
Vivendi failed to perform in accordance with the distribution agreement,
including for the non-payment of money owed us. In September 2003, we terminated
the distribution agreement with Vivendi as a result of its alleged breaches.
Following the termination, Vivendi filed suit against us in the Superior Court
for the State of California, Los Angeles County, in an attempt to have the
license reinstated. In October 2003, Vivendi and we reached a mutually agreed
upon settlement and agreed to reinstate the 2002 distribution agreement. Under
the settlement, Vivendi resumed distribution of our products and will continue
distributing our titles through August 2005.
On September 19, 2003, we commenced a wrongful termination and breach of
contract action against Atari Interactive, Inc. and Atari, Inc. in New York
State Supreme Court, New York County. We sought, among other things, a judgment
declaring that a computer game license agreement between us and Atari
Interactive continues to be in full force and effect. On September 23, 2003, we
obtained a preliminary injunction that prevented termination of the computer
game license agreement. Atari Interactive answered the complaint, denying all
claims, asserting several affirmative defenses and counterclaims for breach of
contract and one counterclaim for a judgment declaring the computer game license
agreement terminated. Both sides sought damages in an amount to be determined at
trial. We, Atari Interactive and Atari, Inc. reached an agreement with respect
to the scope and terms of the computer game license agreement. The parties filed
with the court a Stipulation of Dismissal, dated December 22, 2003. The court
ordered dismissal of the matter on January 6, 2004.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against us in the Superior Court for the State of California, County
of Orange, alleging default on an Amended and Restated Secured Convertible
Promissory Note held by Warner dated April 30, 2002, with an original principal
sum of $2.0 million. At the time the suit was filed, the current remaining
principal sum due under the note was $1.4 million in principal and interest.
Subsequently, we entered into a settlement agreement with Warner. We are
currently in default of the settlement agreement with Warner and have entered
into a payment plan, of which we are in default, for the balance of the $0.32
million owed payable in one remaining installment.
In March 2004, we instituted litigation in the Superior Court for the State
of California, Los Angeles County, against Battleborne Entertainment, Inc.
("Battleborne"). Battleborne was developing a console product for us tentatively
titled AIRBORNE: LIBERATION. Our complaint alleges that Battleborne repudiated
the contract with us and subsequently renamed the product and entered into a
development agreement with a different publisher. We are currently seeking a
declaration from the court that we retain rights to the product or damages.
On or about April 16, 2004, Arden Realty Finance IV LLC filed an unlawful
detainer action against us in the Superior Court for the State of California,
County of Orange, alleging our default under our corporate lease agreement. At
the time the suit was filed, the alleged outstanding rent totaled $431,823. If
we are unable to satisfy this obligation and reach an agreement with our
landlord, we could forfeit our lease, which would materially disrupt our
operations and cause substantial harm to our business.
On or about April 19, 2004, Bioware Corporation filed a breach of contract
action against us in the Superior Court for the State of California, County of
Orange, alleging failure to pay royalties when due. At the time of filing,
Bioware alleged that it was owed approximately $156,000 under various agreements
for which it secured a writ of attachment over our assets. If Bioware executes
the writ, it will negatively affect our cash flow, which could further restrict
our operations.
12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 18, 2003, we held our annual stockholders' meeting. There were
93,855,634 shares of common stock outstanding entitled to vote and a total of
82,704,487 shares (88.1%) were represented at the meeting in person or by proxy.
The following summarizes the voting results of proposals submitted to our
stockholders.
1. Proposal to elect directors, each for a term extending until the next
annual meeting of stockholders or until their successors are duly elected
and qualified.
FOR WITHHELD
--- --------
Herve Caen............................................ 82,104,025 600,462
Nathan Peck........................................... 82,095,025 609,462
Michel Welter......................................... 82,107,625 596,892
Gerald DeCiccio....................................... 82,097,225 607,262
Eric Caen............................................. 82,096,025 608,462
Michel H. Vulpillat................................... 82,105,075 599,412
Robert Stefanovich.................................... 82,117,525 586,962
2. Proposal to amend the Company's Amended and Restated Certificate of
Incorporation to increase the authorized shares of our common stock by
50,000,000 shares from 100,000,000 authorized shares to a total of
150,000,000 authorized shares.
FOR AGAINST ABSTAIN BROKER NON-VOTES
--- ------- ------- ----------------
81,876,729 820,558 7,200 -0-
Based on stockholder approval of this proposal, on January 21, 2004, we filed
the certificate of amendment to increase our authorized shares of common stock
by 50,000,000 shares for a total of 150,000,000 authorized shares with the State
of Delaware.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On May 16, 2002, the listing of our common stock was moved from the Nasdaq
National Market System to the Nasdaq SmallCap Market System. On October 9, 2002,
our common stock was delisted and began being quoted on the NASD-operated
Over-the-Counter Bulletin Board. Our common stock is currently quoted on the
NASD-operated Over-the-Counter Bulletin Board under the symbol "IPLY." At
December 31, 2003, there were 145 holders of record of our common stock.
The following table sets forth the range of high and low bid prices for our
common stock for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31, 2003 HIGH LOW
- ------------------------------------ ---- ---
First Quarter............................... $0.08 $0.05
Second Quarter.............................. 0.14 0.05
Third Quarter............................... 0.14 0.09
Fourth Quarter.............................. 0.12 0.07
FOR THE YEAR ENDED DECEMBER 31, 2002 HIGH LOW
- ------------------------------------ ---- ---
First Quarter............................... $0.61 $0.18
Second Quarter.............................. 0.59 0.24
Third Quarter............................... 0.41 0.12
Fourth Quarter.............................. 0.13 0.06
13
DIVIDEND POLICY
While we have never paid dividends in the past, we may decide to do in the
foreseeable future.
SECURITIES ISSUANCES
In February 2003, we issued to High Voltage Software Inc., an Illinois
corporation, 700,000 shares of our common stock as part of our development
agreement with High Voltage Software, Inc. for the game HUNTER: THE RECKONING.
The issuances of these shares are exempt from registration under the Securities
Act of 1933, as amended (the "Securities Act"), and were made pursuant to
Regulation D of the Securities Act. Our reliance on the exemption from
registration provided by Regulation D of the Securities Act is based on High
Voltage Software's representations to us that they are an "accredited investor"
as that term is defined in Rule 501 of Regulation D and other requisite
representations. These shares were earned and accounted for in 2002.
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2003:
Plan Category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under equity
warrants and rights warrants and rights compensation plans
(excluding securities
reflected in column (a))
- --------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans 425,985 1.95 7,614,447
approved by security
holders
Equity compensation plans 9,587,068 1.84 -
not approved by security
holders
----------------------------------------------------------------------------
Total 10,013,053 1.84 7,614,447
============================================================================
We have one stock option plan currently outstanding. Under the 1997 Stock
Incentive Plan, as amended (the "1997 Plan"), we may grant options to our
employees, consultants and directors, which generally vest from three to five
years. At our 2002 annual stockholders' meeting, our stockholders voted to
approve an amendment to the 1997 Plan to increase the number of authorized
shares of common stock available for issuance under the 1997 Plan from four
million to 10 million. Our Incentive Stock Option, Nonqualified Stock Option and
Restricted Stock Purchase Plan- 1991, as amended (the "1991 Plan"), and our
Incentive Stock Option and Nonqualified Stock Option Plan-1994, as amended (the
"1994 Plan"), have terminated. An aggregate of 9,050 stock options that remain
outstanding under the 1991 Plan and 1994 Plan have been transferred to our 1997
Plan.
We have treated the difference, if any, between the exercise price and the
estimated fair market value as compensation expense for financial reporting
purposes, pursuant to APB 25. Compensation expense for the vested portion
aggregated $0, $0 and $44,000 for the years ended December 31, 2003, 2002 and
2001, respectively.
14
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for the years ended
December 31, 2003, 2002 and 2001 and the selected consolidated balance sheets
data as of December 31, 2003 and 2002 are derived from our audited consolidated
financial statements included elsewhere in this Report. The selected
consolidated statements of operations data for the years ended December 31, 2000
and 1999 and the selected consolidated balance sheets data as of December 31,
2001, 2000, and 1999 are derived from our audited consolidated financial
statements not included in this Report. Our historical results are not
necessarily indicative of the results that may be achieved for any other period.
The following data should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements included elsewhere in this Report.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
STATEMENTS OF OPERATIONS DATA:
Net revenues ........................ $ 36,301 $ 43,999 $ 56,448 $ 101,426 $ 101,930
Cost of goods sold .................. 13,120 26,706 45,816 54,061 61,103
--------- --------- --------- --------- ---------
Gross profit ........................ 23,181 17,293 10,632 47,365 40,827
Operating expenses .................. 21,787 29,653 51,922 55,751 73,631
--------- --------- --------- --------- ---------
Operating (income) loss ............. 1,394 (12,360) (41,290) (8,386) (32,804)
Sale of Shiny ....................... -- 28,813 -- -- --
Other income (expense) .............. (82) (1,531) (4,526) (3,689) (3,471)
--------- --------- --------- --------- ---------
Income (loss) before income taxes ... 1,312 14,922 (45,816) (12,075) (36,275)
Provision (benefit) for income taxes -- (225) 500 -- 5,410
--------- --------- --------- --------- ---------
Net income (loss) ................... $ 1,312 $ 15,147 $ (46,316) $ (12,075) $ (41,685)
========= ========= ========= ========= =========
Cumulative dividend on participating
preferred stock .................. $ -- $ 133 $ 966 $ 870 $ --
Accretion of warrant ................ -- -- 266 532 --
--------- --------- --------- --------- ---------
Net income (loss) available to
common stockholders .............. $ 1,312 $ 15,014 $ (47,548) $ (13,477) $ (41,685)
========= ========= ========= ========= =========
Net income (loss) per common share:
Basic .......................... $ 0.01 $ 0.18 $ (1.23) $ (0.45) $ (1.86)
Diluted ........................ $ 0.01 $ 0.16 $ (1.23) $ (0.45) $ (1.86)
Shares used in calculating net income
(loss) per common share - basic .. 93,852 83,585 38,670 30,047 22,418
Shares used in calculating net income
(loss) per common share - diluted 104,314 96,070 38,670 30,047 22,418
SELECTED OPERATING DATA:
Net revenues by geographic region:
North America .................. $ 13,541 $ 26,184 $ 34,998 $ 53,298 $ 49,443
International .................. 6,484 5,674 15,451 35,077 30,310
OEM, royalty and licensing ..... 16,276 12,141 5,999 13,051 22,177
Net revenues by platform:
Personal computer .............. $ 7,671 $ 15,802 $ 34,912 $ 73,730 $ 65,397
Video game console ............. 12,354 16,056 15,537 14,645 14,356
OEM, royalty and licensing ..... 16,276 12,141 5,999 13,051 22,177
DECEMBER 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(Dollars in thousands)
BALANCE SHEETS DATA:
Working capital (deficiency) ........ $ (14,750) $ (17,060) $ (34,169) $ 123 $ (7,622)
Total assets ........................ 5,486 14,298 31,106 59,081 56,936
Total debt .......................... 837 2,082 4,794 25,433 19,630
Stockholders' equity (deficit) ..... (12,636) (13,930) (28,150) 6,398 (2,071)
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Consolidated Financial Statements and notes thereto and other information
included or incorporated by reference herein.
EXECUTIVE OVERVIEW AND SUMMARY
Interplay Entertainment Corp. is a developer and publisher of interactive
entertainment software. We are known for our titles in the action/arcade,
adventure/role playing game ("RPG") and strategy/puzzle categories. We publish
titles for many popular interactive entertainment software platforms, including
for PC's and video game consoles such as PS2, Xbox, and Nintendo GameCube.
According to NPD Funworld data in January 2004, our BALDUR'S GATE: DARK ALLIANCE
II was in the top 10 of video games sold through retail in the United States.
All of our employees are located at our corporate headquarters in Irvine,
California.
During 2003, we continued to operate under limited cash flow from
operations. In February 2003, we sold all of our future interactive
entertainment publishing rights, to HUNTER: THE RECKONING for $15 million.
However, we retain the rights to the previously published HUNTER: THE RECKONING
titles on Xbox and Nintendo GameCube. We also sold the rights to GALLEON to a
third party publisher.
We also significantly reduced our operational costs and personnel in 2003.
We reduced our personnel by 94, from 207 in December 2002 to 113 in December
2003 by both involuntary termination and attrition. We also made reductions in
expenditures in other non-essential operational areas. As a result of these
cost-cutting measures, our ongoing cash needs to fund operations has been
greatly reduced for 2004. In 2003, we also greatly reduced our liabilities to
creditors by $10.1 million from $28.2 million at December 31, 2002 to $18.1
million at December 31, 2003.
Due in part to these cost-cutting measures and sales of certain titles, we
recorded operating income of $1.4 million for our fiscal year ended December 31,
2003 compared to $12.4 million operating loss for our fiscal year ended December
31, 2002. We achieved a net income of $1.3 million for our fiscal year ended
December 31, 2003 as compared to a net income of $15.1 million for our fiscal
year end December 31, 2002. Our net income achieved in fiscal 2003 was due in
large part to the sale of HUNTER: THE RECKONING license in February 2003 for $15
million. Our net income achieved in fiscal 2002 was due in large part to the
sale of our subsidiary Shiny Entertainment, Inc. in April 2002 for $47.2
million. Prior to that, we had $46.3 million in net losses for our fiscal year
end December 31, 2001.
We have been operating without a credit facility since October 2001, which
has adversely affected our cash flow. We continue to face difficulties in paying
our vendors and have pending lawsuits as a result of our continuing cash flow
difficulties. We expect to continue to operate under cash constraints during
2004.
The accompanying consolidated financial statements have been prepared
assuming that we will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The carrying amounts of assets and liabilities presented in the
consolidated financial statements do not purport to represent realizable or
settlement values. The Report of our Independent Auditors for the year ended
December 31, 2003 consolidated financial statements includes an explanatory
paragraph expressing substantial doubt about our ability to continue as a going
concern.
We derive net revenues primarily from sales of software products to our two
main distributors, Vivendi and Avalon. Vivendi and Avalon accounted for 82% and
12%, respectively of our net revenues in 2003. Vivendi distributes our products
in North America and Select Rest-of-World Countries. Vivendi also handles our
OEM distribution. Our distribution agreement with Vivendi expires in August
2005. Avalon distributes our products in Europe, the commonwealth of Independent
States, Africa and the Middle East. Our distribution agreement with Avalon ends
in February 2006. Upon expiration or termination of the Vivendi and Avalon
distribution agreements we will need to either renew the distribution
agreements, find new distribution partners, or resume distribution ourselves.
16
In addition, we derive royalty-based revenues from licensing arrangements
of intellectual property and products to third parties for distribution in
markets and through channels that are outside of our primary focus. We also
distribute products through our GamesOnline.com subsidiary over the Internet and
on our website.
Our products are either designed and created by our employees or by
external software developers. When we use external developers, we typically
advance development funds to the developers in installment payments based upon
the completion of certain milestones. These advances are typically considered
advances against future royalties, which are to be recouped against these
advances. We currently have one product in development with external developers.
We plan on creating additional products through external developers. We
currently have the capability of internally developing two games simultaneously.
Once we complete development of a product we create a product gold master
("gold master"). Under the terms of our distribution agreement with Vivendi,
once we deliver the gold master, Vivendi will pay us a non-refundable minimum
guarantee equal to an agreed upon percent of the projected initial shipment
sales. We are also entitled to receive from Vivendi additional payments based on
future sales that exceed the minimum guarantee. These additional payments are
paid to us on a monthly basis. Vivendi is responsible for all manufacturing,
marketing, and distribution expenditures, and bears all credit, price
concessions and inventory risk, including product returns.
Based on sales and royalty statements received from Vivendi, in April 2004
we believe that Vivendi incorrectly reported gross sales of our products under
the 2002 distribution Agreement as a result of its taking improper deductions
for price protections it offered its customers. Vivendi has acknowledged this
error. We currently believe the minimum amount due in additional proceeds is
approximately $66,000, which we are currently investigating.
In October 2003, Vivendi Universal S.A. and General Electric Company
announced the signing of a definitive agreement under which NBC will be merged
with Vivendi Universal. Our distribution agreement is with Vivendi Universal
Games, a subsidiary of the parent company Vivendi Universal S.A. and not Vivendi
Universal. We believe Vivendi Universal Games is not currently expected to be a
part of this merger. Consequently, we do not expect that this anticipated merger
will have a material impact on our distributor relationship with Vivendi
Universal Games. In addition as a result of this merger, we expect General
Electric Company to become a beneficial owner of the shares held by Universal
Studios.
Our wholly owned subsidiary, Interplay OEM, distributed our interactive
entertainment software titles, as well as those of other software publishers, to
computer and peripheral device manufacturers for use in bundling arrangements.
As a result of changes in the market conditions for bundling arrangements and
the limited amount of resources we have available, we no longer have any
personnel applying their efforts towards bundling arrangements. In December
2002, we licensed our OEM distribution rights to Vivendi and will utilize
Vivendi's resources in our future OEM business. This agreement expires August
2005.
Under the terms of our International Distribution Agreement with Avalon
once we complete the product gold master Avalon markets, sells, and distributes
the product for a specified percentage of net sales. We are responsible for all
manufacturing costs and bear all inventory, price concession, and credit risk,
including product returns. Avalon may manufacture inventory on our behalf under
prior authorization from us. Under the terms of our distribution agreement with
Avalon, once we complete the gold master Avalon markets, sells, and distributes
the product for a specified percent of net sales.
In February 2003, Avalon Interactive UK Ltd. (formerly named Virgin
Interactive Entertainment (Europe) Limited) ("Avalon Europe"), the operating
subsidiary of Avalon, filed for a CVA, a process of reorganization in the United
Kingdom. We are not creditors of Avalon Europe. In May 2003, Avalon filed for a
CVA in the United Kingdom in which we participated in, and were approved as a
creditor of Avalon. As part of the Avalon CVA process, we submitted our
creditor's claim. We have received payments of approximately $347,000 due to us
as a creditor under the terms of the Avalon CVA plan. We continue to operate
under a distribution agreement with Avalon. Avalon distributes substantially all
of our titles in Europe, the Commonwealth of Independent States, Africa, the
Middle East, and certain other select countries. Avalon is current on their
post-CVA payments to us. Our distribution agreement with Avalon ends in February
2006. We continue to evaluate and adjust as appropriate our claims against
Avalon in the CVA process. However, the effects of the approval of the Avalon
CVA and of the approval of the CVA of its operating subsidiary
17
Avalon Europe on our ability to collect amounts due from Avalon are uncertain
and consequently are fully reserved. As a result, we cannot guarantee our
ability to collect fully the debts we believe are due and owed to us from
Avalon. If Avalon is not able to continue to operate under the new CVA, we
expect Avalon to cease operations and liquidate, in which event we will most
likely not receive in full the amounts presently due us by Avalon. We may also
have to appoint another distributor or become our own distributor in Europe and
the other territories in which Avalon presently distributes our products.
In February 2003, we amended our license agreement with the holder of the
interactive entertainment rights to D&D. This license allows us to publish the
BALDUR'S GATE, BALDUR'S GATE: DARK ALLIANCE, and ICEWIND DALE titles. Pursuant
to this amendment, among other things, we (i) extended the license term for
approximately an additional two years to December 31, 2008 for an advance
payment on future royalties of approximately $200,000 and (ii) extended our
rights with respect to certain of the D&D properties. The amendment terminated
our rights to certain titles in the event we are unable to obtain certain
third-party waivers in accordance with the terms of the amendment.
We were unable to obtain the required waivers within the permitted time
period and as a result have lost rights to publish BALDUR'S GATE 3 and its
sequels on the PC. We historically invested in platforms such as the PC and
consoles such as the PlayStation and Nintendo 64, which was important
strategically in positioning us for the current generation platforms such as the
PS2, Xbox, and Nintendo GameCube. During fiscal years 2003, 2002, and 2001, the
video and computer games industry has experienced a platform transition from the
PC and PlayStation to the current generation platforms PS2, Xbox, and Nintendo
GameCube. The transition to the current generation systems was initiated by the
launch of Sony's PS2 in fiscal 2001, and continued with the launches of the
Nintendo GameCube and Microsoft's Xbox in fiscal 2002. As the market continues
to shift to the current generation systems, our sales of PC based products have
been declining. We expect this decline to continue in fiscal 2004. As a result,
we do not anticipate that losing the rights to publish BALDUR'S GATE 3 and its
sequels on the PC will have a significant impact on our future operating
results.
Subsequently, we also relinquished the rights to publish any future titles
using the D&D license in exchange for the continued rights to publish our DARK
ALLIANCE titles on console platforms such as the Xbox and PS2. As part of this
exchange, we secured ownership to the DARK ALLIANCE trademark. As a result of
securing the DARK ALLIANCE trademark we no longer pay licensing royalties on
this trademark. We do not anticipate the loss of the rights to publish future
titles using the D&D license will have a significant impact on our future
operating results. We intend to publish future DARK ALLIANCE titles on the PS2
and Xbox platforms.
On or about February 23, 2004, we received correspondence from the holder
of the D&D license alleging that we had failed to pay royalties due under the
D&D license as of February 15, 2004. If we are unable to cure this alleged
breach of the license agreement, we may lose our remaining rights under the
license, including the rights to continued distribution of BALDUR'S GATE: DARK
ALLIANCE II. The loss of the remaining rights to distribute games created under
the D&D license could have a significant negative impact on future operating
results.
The table below shows the number of titles on individual platforms we
released in 2003 and our estimated number of title releases on individual
platforms in 2004. We currently have the capability of working on two
simultaneous internal projects. The increased number of titles in future years
will be a combination of growing our internal development capacity and enlisting
additional outside developers. The number of future releases is contingent upon
our ability to continue as a going concern and also to raise additional capital
to fund the increase in titles. We expect in 2004 to have to raise capital
through sale of stock, debt financing, sale or merger of the company, the sale
of assets, the licensing of more product rights, selected distribution
agreements and/or other strategic transactions to provide us with short term
funding and potentially achieve our long term objectives. We have been able to
retain our third party developers to date, but if our current liquidity issues
continue, our future title development could be adversely affected.
Number of titles on individual platforms Year of Release
- ---------------------------------------- ---------------
6 2002
6 2003
6 2004
18
Our operating results will continue to be impacted by economic, industry
and business trends affecting the interactive entertainment industry. Our
industry is highly seasonal, with the highest levels of consumer demand
occurring during the year-end holiday buying season. We expect that with the
release of new console systems by Sony, Nintendo and Microsoft, our industry has
entered into a growth period that could be sustained for the next couple of
years.
Our operating results have fluctuated significantly in the past and likely
will fluctuate significantly in the future, both on a quarterly and an annual
basis. A number of factors may cause or contribute to such fluctuations, and
many of such factors are beyond our control.
As of December 31, 2003, we had a working capital deficit of $14.8 million,
and our cash balance was approximately $1.2 million. We anticipate our current
cash reserves, plus our expected generation of cash from existing operations
will only be sufficient to fund our anticipated expenditures into the second
quarter of fiscal 2004.
As of April 1, 2004, we were three months in arrears on the rent
obligations for our corporate lease in Irvine, California. On April 9, 2004, our
lessor served us with a Three-Day Notice to Pay Rent or Surrender Possession. If
we are unable to pay our rent, we may lose our office space, which would
interrupt our operations and cause substantial harm to our business. We have
received notice from the Internal Revenue Service ("IRS") that we owe
approximately $70,000 in payroll tax penalties. We estimate that we owe an
additional $10,000, which we have accrued in penalties for nonpayment of
approximately $99,000 in Federal and State payroll taxes, which were due on
March 31, 2004 and is still outstanding. We were unable to meet our April 15,
2004 payroll obligations to our employees. Our property, general liability,
auto, workers compensation, fiduciary liability, and employment practices
liability have been cancelled.
We are currently in default of the settlement agreement with Warner and
have entered into a payment plan, of which we are in default, for the balance of
the $0.32 million owed payable in one remaining installment. On or about
February 23, 2004, we received correspondence from Atari Interactive alleging
that Interplay had failed to pay royalties due under the D&D license as of
February 15, 2004. If we are unable to cure this alleged breach of the license
agreement, we may lose our remaining rights under the license, including the
rights to continued distribution of BALDUR'S GATE: DARK ALLIANCE II. The loss of
the remaining rights to distribute games created under the D&D license could
have a significant negative impact on our future operating results.
There can be no guarantee that we will be able to meet all contractual
obligations in the near future, including payroll obligations. We expect that we
will need to substantially reduce our working capital needs and/or raise
additional financing. If we do not receive sufficient financing we may (i)
liquidate assets, (ii) sell the company (iii) seek protection from our
creditors, and/or (iv) continue operations, but incur material harm to our
business, operations or financial conditions. However, no assurance can be given
that alternative sources of funding could be obtained on acceptable terms, or at
all. These conditions, combined with our historical operating losses and our
deficits in stockholders' equity and working capital, raise substantial doubt
about our ability to continue as a going concern.
In January 2004, Titus, our 71% majority shareholder, disclosed in their
annual report for the fiscal year ended June 30, 2003, filed with the Autorite
des Marches Financiers of France, that they were involved in a litigation with
one of our former founders and officers and as a result had deposited pursuant
to a California Court Order approximately 8,679,306 shares of our common stock
held by them (representing approximately 9% of our issued and outstanding common
stock) with the court. Also disclosed was that Titus was conducting settlement
discussions at the time of the filing to resolve the issue. To date, Titus has
maintained voting control over the 8,679,306 million shares of common stock and
has not represented to us that a transfer of beneficial ownership has occurred.
Nevertheless, such transfer of shares may occur in fiscal 2004.
MANAGEMENT'S DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates,
including, among others, those related to revenue recognition, prepaid licenses
and royalties and software development costs. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following
critical accounting policies affect our more significant judgments and estimates
used in preparation of our consolidated financial statements.
REVENUE RECOGNITION
We record revenues when we deliver products to customers in accordance with
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." and SEC
Staff Accounting Bulletin No. 101, Revenue Recognition.
19
Commencing in August 2001, substantially all of our sales are made by two
distributors, Vivendi, and Avalon, an affiliate of our majority shareholder
Titus. We recognize revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of our products to
unaffiliated third parties. For those agreements that provide the customers the
right to multiple copies of a product in exchange for guaranteed amounts, we
recognize revenue at the delivery and acceptance of the product gold master. We
recognize per copy royalties on sales that exceed the guarantee as copies are
sold.
We generally are not contractually obligated to accept returns, except for
defective, shelf-worn and damaged products. However, on a case-by-case
negotiated basis, we permit customers to return or exchange products and may
provide price concessions to our retail distribution customers on unsold or slow
moving products. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 48, "Revenue Recognition when Right of Return Exists," we record
revenue net of a provision for estimated returns, exchanges, markdowns, price
concessions, and warranty costs. We record such reserves based upon management's
evaluation of historical experience, current industry trends and estimated
costs. The amount of reserves ultimately required could differ materially in the
near term from the amounts provided in the accompanying consolidated financial
statements. 82 % of our revenues in fiscal 2003 were with Vivendi. Vivendi bears
the risk of returns and price concessions to our retail distribution customers
on unsold or slow moving products.
We provide customer support only via telephone and the Internet. Customer
support costs are not significant and we charge such costs to expenses as we
incur them.
We also engage in the sale of licensing rights on certain products. The
terms of the licensing rights differ, but normally include the right to develop
and distribute a product on a specific video game platform. We recognize revenue
when the rights have been transferred and no other obligations exist.
PREPAID LICENSES AND ROYALTIES
Prepaid licenses and royalties consist of license fees paid to intellectual
property rights holders for use of their trademarks or copyrights. Also included
in prepaid royalties are prepayments made to independent software developers
under developer arrangements that have alternative future uses. These payments
are contingent upon the successful completion of milestones, which generally
represent specific deliverables and advances are recoupable against future sales
based upon the contractual royalty rate. We amortize the cost of licenses,
prepaid royalties and other outside production costs to cost of goods sold over
six months commencing with the initial shipment in each region of the related
title. We amortize these amounts at a rate based upon the actual number of units
shipped with a minimum amortization of 75% in the first month of release and a
minimum of 5% for each of the next five months after release. This minimum
amortization rate reflects our typical product life cycle. Our management relies
on forecasted revenue to evaluate the future realization of prepaid royalties
and charges to cost of goods sold any amounts they deem unlikely to be fully
realized through future sales. Such costs are classified as current and non
current assets based upon estimated product release date. If actual revenue, or
revised sales forecasts, fall below the initial forecasted sales, the charge may
be larger than anticipated in any given quarter.
We evaluate the recoverability of prepaid licenses and royalties on a
product by product basis. Prepaid royalties for products that are cancelled are
expensed in the period of cancellation to cost of goods sold. In addition, a
charge to cost of sales is recorded when our forecast for a particular game
indicates that un-amortized capitalized costs exceed the net realizable value of
that asset. The net realizable value is the estimated net future proceeds from
our distributors that are reduced by previously capitalized cost and the
estimated future cost of completing the game. If a revised game sales forecast
is less than our current game sales forecast, or if actual game sales are less
than management's forecast, it is possible we could accelerate the amortization
of prepaid licenses and royalties previously capitalized. Once the charge has
been taken, that amount will not be expensed in future quarters when the product
has shipped.
During fiscal 2003 and 2002, we recorded prepaid licenses and royalties
impairment charges to cost of goods sold of $2.9 million and $4.1 million
respectively. Our prepaid royalty balances at December 31, 2003 and 2002 were
$0.2 million net of reserve and $4.1 million net of reserve respectively. Our
reserves for impaired prepaid royalty balances at December 31, 2003 and 2002
were $0.25 million and $0, respectively.
20
SOFTWARE DEVELOPMENT COSTS
Our internal research and development costs, which consist primarily of
software development costs, are expensed as incurred. Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of Computer
Software to be Sold, Leased, or Otherwise Marketed", provides for the
capitalization of certain software development costs incurred after
technological feasibility of the software is established or for development
costs that have alternative future uses. Under our current practice of
developing new products, the technological feasibility of the underlying
software is not established until substantially all of the product development
is complete. We have not capitalized any software development costs on internal
development projects, as the eligible costs were determined to be insignificant.
OTHER SIGNIFICANT ACCOUNTING POLICIES
Other significant accounting policies not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. The policies related to
consolidation and loss contingencies require difficult judgments on complex
matters that are often subject to multiple sources of authoritative guidance.
Certain of these matters are among topics currently under reexamination by
accounting standards setters and regulators. Although no specific conclusions
reached by these standard setters appear likely to cause a material change in
our accounting policies, outcomes cannot be predicted with confidence. Please
see Note 2 of the Notes to Consolidated Financial Statements, Summary of
Significant Accounting Policies, which discusses other significant accounting
policies.
21
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data and segment and platform data for the periods indicated
expressed as a percentage of net revenues:
YEARS ENDED DECEMBER 31,
----------------------------
2003 2002 2001
---- ---- ----
STATEMENTS OF OPERATIONS DATA:
Net revenues ............................... 100% 100% 100%
Cost of goods sold ......................... 36 61 81
---- ---- ----
Gross margin ............................... 64 39 19
Operating expenses:
Marketing and sales ................... 4 13 33
General and administrative ............ 18 17 22
Product development ................... 38 37 37
Other ................................. -- -- --
Total operating expenses .............. 60 67 92
---- ---- ----
Operating income (loss) .................... 4 (28) (73)
Other income (expense) ..................... -- 62 (8)
---- ---- ----
Income (loss) before provision
for income taxes ...................... 4 34 (81)
Provision for income taxes ................. -- -- 1
---- ---- ----
Net income (loss) .......................... 4% 34% (82)%
==== ==== ====
SELECTED OPERATING DATA:
Net revenues by segment:
North America ......................... 37% 60% 62%
International ......................... 18 13 27
OEM, royalty and licensing ............ 45 27 11
---- ---- ----
100% 100% 100%
==== ==== ====
Net revenues by platform:
Personal computer ..................... 21% 36% 62%
Video game console .................... 34 37 27
OEM, royalty and licensing ............ 45 27 11
---- ---- ----
100% 100% 100%
==== ==== ====
Geographically, our net revenues for the years ended December 31, 2003 and
2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
---- ---- ------ --------
North America ................... 13,541 26,184 (12,643) (48%)
International ................... 6,484 5,674 810 14%
OEM, Royalty & Licensing ........ 16,276 12,141 4,135 34%
Net Revenues .................... 36,301 43,999 (7,698) (17%)
22
Geographically, our net revenues for the years ended December 31, 2002 and
2001 breakdown as follows: (in thousands)
2002 2001 Change % Change
---- ---- ------ --------
North America ................... 26,184 34,998 (8,814) (25%)
International ................... 5,674 15,451 (9,777) (63%)
OEM, Royalty & Licensing ........ 12,141 5,999 6,142 102%
Net Revenues .................... 43,999 56,448 (12,449) (22%)
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the year ended December 31, 2003 were $36.3 million, a
decrease of 17% compared to the same period in 2002. This decrease resulted from
a 48% decrease in North American net revenues, offset by a 14% increase in
International net revenues and by a 34% increase in OEM, royalties and licensing
revenues. Net revenues for the year ended December 31, 2002 were $44.0 million,
a decrease of 22% compared to the same period in 2001. This decrease resulted
from a 25% decrease in North American net revenues, a 63% decrease in
International net revenues, offset by a 102% increase in OEM, royalties and
licensing revenues.
North American net revenues for the year ended December 31, 2003 were $13.5
million as compared to $26.2 million for the year ended December 31, 2002. The
decrease in North American net revenues in 2003 was mainly due to lower total
unit sales of both new release and catalog titles. Although we released or
delivered six product gold masters in each of 2003 and 2002, all six titles in
2003 were released by Vivendi, as compared to five in 2002, under the terms of
the 2002 distribution agreement, whereby Vivendi pays us a lower per unit rate
and in return assumes all credit, product return and price concession risks, as
well as being responsible for all manufacturing, marketing and distribution
expenditures. This resulted in a decrease in North American sales of $19.4
million in 2003, partially offset by a decrease in product returns and price
concessions of $6.7 million as compared to the 2002 period. Our product returns
were also lower in 2003 due primarily to the reduction in price concessions we
made in connection with our decreased catalog sales under our prior North
American Distribution Agreement we entered into with Vivendi in 2001.
We expect that our North American publishing net revenues will increase in
2004 compared to 2003, mainly due to increased unit sales on our new releases
and catalog products.
The decrease in North American net revenues in 2002 as compared to 2001 was
mainly due to lower total unit sales as a result of releasing six titles in 2002
compared to eight titles in 2001. Furthermore, the five titles released in 2002
by Vivendi were released under the terms of the new 2002 distribution agreement,
whereby Vivendi pays us a lower per unit rate and in return assumes all credit,
product return and price concession risks, as well as being responsible for all
manufacturing, marketing and distribution expenditures. This resulted in a
decrease in North American sales of $18.3 million in 2002, partially offset by a
decrease in product returns and price concessions of $9.5 million as compared to
the 2001 period. The decrease in title releases across all platforms is a result
of our continued focus on releasing fewer, higher quality titles.
International net revenues for the year ended December 31, 2003 were $6.5
million. The increase in International net revenues for the year ended December
31, 2002 was mainly due to a decrease in product returns and price concessions
of $3.1 million compared to the 2002 period and the recognition of $0.6 million
in revenues related to payments made to us by Avalon under their CVA, offset by
a decrease of both new release and catalog sales.
We expect that our International publishing net revenues will increase in
2004 as compared to 2003, mainly due to increased unit sales. Avalon our primary
international distributor is current on their post-CVA payments to us. However,
if Avalon is not able to continue its reorganization and liquidates, we may need
to obtain a new European distributor in a short amount of time. If we are not
able to engage a new distributor, it could have a material negative impact on
our European sales.
International net revenues for the year ended December 31, 2002 were $5.7
million. The decrease in International net revenues for the year ended December
31, 2002 was mainly due to the reduction in title releases during the year
23
which resulted in a $12.2 million decrease in revenue, partially offset by a
decrease in product returns and price concessions of $2.4 million compared to
the 2001 period. Our decision to reduce our product planning efforts during 2002
also contributed to the reduction of titles released in the International
markets. Furthermore, our returns as a percentage of revenue, continued to
increase as we experienced a high level of product returns and price concessions
due to certain titles not gaining broad market acceptance.
OEM, royalty and licensing net revenues for the year ended December 31,
2003 were $16.3 million, an increase of $4.1 million as compared to the same
period in 2002. The OEM business decreased $2.8 million as a result of our
efforts to focus on our core business of developing and publishing video game
titles for distribution directly to the end users and our continued focus on
video game console titles, which typically are not bundled with other products.
The year ended December 31, 2003 also included $15.0 million in revenues for the
sale of the HUNTER: THE RECKONING video game license in the first quarter of
2003. We expect that OEM, royalty and licensing net revenues in 2004 will
decrease compared to 2003 primarily due to our continued focus on our core
business of developing and publishing video game titles for distribution
directly to the end users and not having a comparable transaction as the sale of
the HUNTER: THE RECKONING license.
OEM, royalty and licensing net revenues for the year ended December 31,
2002 were $12.1 million, an increase of $6.1 million as compared to the same
period in 2001. Our OEM business decreased $1.3 million as a result of our
efforts to focus on our core business of developing and publishing video game
titles for distribution directly to end users and our continued focus on video
game console titles, which typically are not bundled with other products. The
year ended December 31, 2002 also included revenues related to the sale of
publishing rights for one of our products and the recognition of deferred
revenue for a licensing transaction. In January 2002, we sold the publishing
rights to this title to the distributor in connection with a settlement
agreement entered into with the third party developer. The settlement agreement
provided, among other things, that we assign our rights and obligations under
the product agreement to the third party distributor. As a result, we recorded
net revenues of $5.6 million in the three months ended March 31, 2002. In
February 2002, a licensing transaction we entered into in 1999 expired and we
recognized revenue of $1.2 million, the unearned portion of the minimum
guarantee.
PLATFORM NET REVENUES
Our platform net revenues for the years ended December 31, 2003 and 2002
breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------ --------
Personal Computer ............... 7,671 15,802 (8,131) (52%)
Video Game Console .............. 12,354 16,056 (3,702) (23%)
OEM, Royalty & Licensing ........ 16,276 12,141 4,135 34%
Net Revenues .................... 36,301 43,999 (7,698) (17%)
PC net revenues for the year ended December 31, 2003 were $7.7 million, a
decrease of 52% compared to the same period in 2002. The decrease in PC net
revenues in 2003 was primarily due to the lower sales of our title LIONHEART in
2003 as compared to our 2002 release of ICEWIND DALE II. The decrease in PC net
revenues were further affected by a decrease in catalog sales. We expect our PC
net revenues to decrease in 2004 as compared to 2003 as we continue to focus on
video game console titles.
Our video game console net revenues decreased 23% for the year ended
December 31, 2003 compared to the same period in 2002. The decrease in video
game console net revenues was partially attributed to our releasing or
delivering five product gold masters to Vivendi, all under our 2002 distribution
agreement with them, whereby, we received a lower per unit rate in return for
Vivendi being responsible for all manufacturing, marketing, and distribution
expenditures. These five video game console titles were: RLH (Xbox), BALDUR'S
GATE: DARK ALLIANCE II (PS2), BALDUR'S GATE: DARK ALLIANCE II (Xbox), FALLOUT:
BROTHERHOOD OF STEEL (PS2) and FALLOUT: BROTHERHOOD OF STEEL (Xbox). We also
released five video game console titles in 2002 to Vivendi; however, only four
were under the 2002 distribution agreement. Furthermore, our video game console
net revenues were reduced in 2003 by not releasing BALDUR'S GATE: DARK ALLIANCE
II (PS2), BALDUR'S GATE: DARK ALLIANCE II (Xbox), FALLOUT: BROTHERHOOD OF STEEL
(PS2) and FALLOUT: BROTHERHOOD OF STEEL (Xbox) in Europe. We plan to release
these titles in Europe in the first half of 2004. Our catalog sales also
decreased in
24
2003 as compared to 2002. We expect our video game console net revenues to
increase in 2004 mainly due to an increase in unit sales as compared to 2003.
Our platform net revenues for the years ended December 31, 2002 and 2001
breakdown as follows: (in thousands)
2002 2001 Change % Change
------ ------ ------ --------
Personal Computer ............... 15,802 34,912 (19,110) (55%)
Video Game Console .............. 16,056 15,537 519 3%
OEM, Royalty & Licensing ........ 12,141 5,999 6,142 102%
Net Revenues .................... 43,999 56,448 (12,449) (22%)
PC net revenues for the year ended December 31, 2002 were $15.8 million
compared to $34.9 million for the year ended December 31, 2001, a decrease of
55%. The decrease in PC net revenues in 2002 can be attributed to our release of
only one title on PC in 2002 compared to a total of seven titles released on PC
in 2001, three of which were major titles, ICEWIND DALE: HEART OF WINTER,
FALLOUT TACTICS and BALDUR'S GATE II: THRONE OF BHAAL. In 2002, we released one
major hit title ICEWIND DALE II.
Our video game console net revenues increased 3% for the year ended
December 31, 2002 compared to the same period in 2001 due to sales generated
from the release of HUNTER: THE RECKONING (Xbox), and continued sales of
BALDUR'S GATE: DARK ALLIANCE (PlayStation 2), which was released in 2001. Our
other video game releases in 2002 included RLH (PlayStation 2), BALDUR'S GATE:
DARK ALLIANCE (Xbox), BALDUR'S GATE: DARK ALLIANCE (GameCube) and HUNTER
(GameCube). Even though we released five console titles in 2002 as compared to
three console titles in 2001, console net revenues did not increase
substantially mainly due to releasing titles under the new 2002 distribution
agreement with Vivendi, whereby, we receive a lower per unit rate and Vivendi is
responsible for all manufacturing, marketing, and distribution expenditures.
COST OF GOODS SOLD; GROSS MARGIN
Cost of goods sold related to PC and video game console net revenues
represents the manufacturing and related costs of interactive entertainment
software products, including costs of media, manuals, duplication, packaging
materials, assembly, freight and royalties paid to developers, licensors and
hardware manufacturers. For sales of titles under the new 2002 distribution
arrangement with Vivendi, our cost of goods consists of royalties paid to
developers. Cost of goods sold related to royalty-based net revenues primarily
represents third party licensing fees and royalties paid by us. Typically, cost
of goods sold as a percentage of net revenues for video game console products
are higher than cost of goods sold as a percentage of net revenues for PC based
products due to the relatively higher manufacturing and royalty costs associated
with video game console and affiliate label products. We also include in the
cost of goods sold the amortization of prepaid royalty and license fees we pay
to third party software developers. We expense prepaid royalties over a period
of six months commencing with the initial shipment of the title at a rate based
upon the numbers of units shipped. We evaluate the likelihood of future
realization of prepaid royalties and license fees quarterly, on a
product-by-product basis, and charge the cost of goods sold for any amounts that
we deem unlikely to realize through future product sales.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2003 and 2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------ --------
Net Revenues ................ 36,301 43,999 (7,698) (17%)
Cost of Goods Sold .......... 13,120 26,706 (13,586) (51%)
Gross Margin ................ 23,181 17,293 5,888 34%
Our cost of goods sold decreased 51% to $12.9 million in the year ended
December 31, 2003 compared to the same period in 2002. Furthermore, we incurred
$2.9 million of non-recurring charges related to the write-off of prepaid
royalties on titles that were cancelled or not expected to meet our desired
profit requirements as compared to $4.1 million in the 2002 period. In addition,
the decrease was mainly a result of lower product cost of goods associated with
lower
25
overall product sales. We expect our cost of goods sold to increase in 2004 as
compared to 2003 because we anticipate higher product cost of goods associated
with higher overall product sales.
Our gross margin increased to 64% in 2003 from 39% in 2002. This was due to
a decrease in our royalty expense as a result of a decrease of $1.2 million in
write-off of prepaid royalties, a decrease in our product cost of goods, a
decrease in product returns and price concessions as compared to the 2002 period
due to distributing all of our new releases in North America under the 2002
distribution agreement with Vivendi and the sale of the HUNTER: THE RECKONING
license, which yielded approximately an 80% profit margin on the sale in
February 2003. We expect our gross profit margin and gross profit to decrease in
2004 as compared to 2003 mainly due to the fact that we do not anticipate having
a comparable transaction such as the sale of the HUNTER: THE RECKONING license,
offset by the fact that we do not expect to incur any unusual product returns
and price concessions or any write-offs of prepaid royalties in 2004.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2002 and 2001 breakdown as follows: (in thousands)
2002 2001 Change % Change
------ ------ ------ --------
Net Revenues ................ 43,999 56,448 (12,449) (22%)
Cost of Goods Sold .......... 26,706 45,816 (19,110) (42%)
Gross Margin ................ 17,293 10,632 6,661 63%
Our cost of goods sold decreased 42% to $26.7 million in the year ended
December 31, 2002 compared to the same period in 2001. Furthermore, we incurred
$4.1 million of non-recurring charges related to the write-off of prepaid
royalties on titles that were not expected to meet our desired profit
requirements as compared to $8.1 million in the 2001 period. In addition, the
decrease was a result of distributing five titles with Vivendi under the new
2002 distribution agreement, in which the only cost of goods element we incur is
royalty expense. Under this current distribution agreement with Vivendi, Vivendi
pays us a lower per unit rate and is responsible for all manufacturing,
marketing and distribution expenditures.
Our gross margin increased to 39% in 2002 from 19% in 2001. This was due to
a decrease in our royalty expense as a result of a decrease of $4.0 million in
write-off of prepaid royalties, a decrease in our product cost of goods and a
decrease in product returns and price concessions as compared to the 2001 period
due to distributing the majority of our new releases in North America under the
new 2002 distribution agreement with Vivendi.
MARKETING AND SALES
Our marketing and sales expenses for the years ended December 31, 2003 and
2002 breakdown as follows: (in thousands)
2003 2002 Change % Change
------ ------ ------ --------
Marketing and Sales ......... 1,415 5,814 (4,399) (76%)
Marketing and sales expenses primarily consist of advertising and retail
marketing support, sales commissions, marketing and sales personnel, customer
support services and other related operating expenses. Marketing and sales
expenses