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, 2005
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.)
100 N. CRESCENT DRIVE , BEVERLY HILLS, CALIFORNIA90210
(Address of principal executive offices)
(310) 432-1958
(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 if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [X] No [ ]
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ] Non- accelerated filer [X]
Indicate by check mark whether the registrant is a shell company ( as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 30, 2005, the aggregate market value of voting common stock held by
non-affiliates was approximately $270,000 based upon the closing price of the
Common Stock on that date.
As of April 19, 2006, 93,855,634 shares of Common Stock of the Registrant were
issued and outstanding. This includes 4,658,216 shares of Treasury Stock.
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,
CASH CONSTRAINTS, FINANCING ACTIVITIES, COST REDUCTION MEASURES, REPLACEMENT OF
OUR 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. ADDITIONAL 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 ANDRESULTS 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 SEC 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), GAMES ON LINE (R) AND CERTAIN OF
OUR OTHER PRODUCT NAMES AND PUBLISHING LABELS REFERRED TO IN THIS REPORT ARE THE
COMPANY'S 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 publisher and licensor 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 and licensed titles for many of the most popular interactive
entertainment software platforms.
We seek to publish or license out 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 or
licensed many such successful franchise titles to date.
Our business and industry has certain risks and uncertainties. During 2005
we continued to operate under limited cash flow from operations. We expect to
operate under similar cash constraints during 2006. During 2005, because of
limited resources, we have been primarily engaged in exploiting existing titles.
We have had no new development of software titles. 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 ofOperations."
The majority of our sales and distribution were handled by Vivendi
Universal Games, Inc. ("Vivendi") in North America and selected territories
until August, 2005, when most of our distribution agreements with Vivendi
reached the end of their term., and by Avalon Interactive Group Ltd. ("Avalon"),
a subsidiary of Titus Interactive SA ("Titus") in Europe, the Commonwealth of
Independent States, Africa and the Middle East, and through licensing strategies
elsewhere. The Company resumed responsibility for distribution and licensing in
North America and other selected territories after August, 2005. Avalon ceased
operations following its involuntary liquidation in February, 2005. Following
the liquidation of Avalon, we utilized from March, 2005 our wholly owned
subsidiary, Interplay Productions Ltd, as our distributor in Europe and other
selected territories.
In December, 2005 NBC Universal returned its shares of common stock to us
at no cost to us and these shares are included as Company treasury stock.
In January 2005, our majority shareholder, Titus, who holds approximately
58 million shares of our common stock, was placed into involuntary liquidation.
PRODUCTS
We publish and distribute interactive entertainment software titles that
provide immersive game experiences by combining advanced technology with
engaging content, vivid graphics and rich sound.
Our strategy was to invest in products for those platforms, whether PC or
video game console, that have or will have sufficient installed bases or a large
enough number of potential subscribers for the investment to be economically
viable, but because of our limited resources we have had to significantly
curtail this approach.
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 have also outsourced, from time to time, 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.
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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 U.S. or are weakly enforced. Legal
protection of our rights may be ineffective in such countries, and as we
leverage our software products using, such as using 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 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 currently do not have any new products under development internally.
During the years ended December 31, 2005, 2004 and 2003, we spent $300,000,
$2.6 million and $13.7 million, respectively, on product research and
development activities. Those amounts represented 3%, 20% and 38%, respectively,
of net revenues in each of those periods.
SEGMENT INFORMATION
We operate primarily in one 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 13 of the Notes to our Consolidated Financial Statements included elsewhere
in this Report.
We had during 2005 two distributors as our two main customers: Vivendi and
Avalon. Vivendi and Avalon accounted for 6.76% and 02% of our net revenues in
2005. Vivendi and Avalon had exclusive rights to distribute our product in
substantial parts of the world. Avalon was liquidated in February 2005 and as a
result, we took over distribution of our products in Europe. Most of our
agreements with Vivendi reached the end of their term in August, 2005 We resumed
responsibility for distribution and licensing in North America and other
selected territories after August,2005.
SALES AND DISTRIBUTION
NORTH AMERICA. In August 2002, we entered into a distribution arrangement
with Vivendi, whereby Vivendi distributed 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 paid us sales proceeds less amounts for
distribution fees. Vivendi was 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 to
Vivendi, Vivendi paid us, as a non-refundable minimum guarantee and which is a
specified percent of the projected amount due to us based on projected initial
shipment sales. Payments for sales that exceed the projected initial shipment
sales was to be paid on a monthly basis as sales occur. Other than for products
covered by the tri-party agreement with Atari which was not covered by the
minimum guarantee, the Vivendi distribution agreements expired in August, 2005.
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All deferred revenue under the non-refundable minimum guarantee was recognized
as revenue during 2005. We resumed responsibility for distribution and licensing
in North America and other selected territories after August, 2005.
Vivendi provided terms of sale comparable to competitors in our industry.
In addition, we provide a 90-day limited warranty to end-users that our products
will be free from manufacturing defects. 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. We were operating during 2004 and into early 2005 under a
distribution agreement with Avalon, pursuant to which Avalon distributed
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 earned a distribution fee for its marketing and distribution
of our products, and we reimbursed Avalon for certain direct costs and expenses.
Following the liquidation of Avalon, in March 2005 we utilized our wholly
owned subsidiary, Interplay Productions Ltd, as our distributor in Europe and
other selected territories.
In January 2003, we entered into an agreement with Vivendi to distribute
substantially all of our products in select rest-of-world countries. This
agreement expired in August, 2005.
LICENSING
We entered into various licensing agreements during 2005 under which we
licensed others to exploit games that we have intellectual property rights to.
This included entering into an agreements with Turner Games Network and Vivendi
and resulted in one time payments from each of these licensees. These license
agreements are generally for a 2 year term.
In addition, a tri-party agreement with Atari Interactive, Inc. ("Atari")
and Vivendi was entered into that provided for all royalties that would
otherwise be payable to Atari by Vivendi from September, 2005 be paid to us with
respect to Vivendi distribution of Dungeons and Dragons titles owned by Atari.
MARKETING
We assist 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.
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. 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 Activision,
Atari, Capcom, Eidos, Electronic Arts, Konami, Lucas Arts, Midway, Namco, Sega,
Take-Two Interactive, THQ, Ubi Soft. and Vivendi Games. 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
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substantially greater financial resources than us, also compete directly with us
or or have exclusive relationships with our competitors.
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 therefore 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. 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, we have not
experienced any material difficulties or delays in the manufacture and assembly
of our CD-ROM and DVD based products, and we 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 licensees for distribution. PlayStation 2, 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 manufacturers, our net sales and operating
results could be materially adversely affected.
BACKLOG
We do not carry inventories because all of our sales and distribution
efforts are handled by our licensees under the terms of our respective
distribution agreements with them. We do not have any backlog orders
EMPLOYEES
As of December 31, 2005, we had 5 employees, including 1 in software
engineering, 2 in sales and marketing and 2 in finance, general and
administrative.
From time to time, we have retained actors and/or "voice over" talent to
perform in certain of our products, and we may 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 U.S. Securities and Exchange Commission or SEC. You may
obtain copies of these reports via the Internet at the SEC's homepage located at
www.sec.gov. You may also go to our Internet address located at
www.interplay.com and go to "Investor Relations" which will link you to the
SEC's homepage for our filed reports. In addition, copies of the reports we file
with the SEC may also be obtained 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.
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ITEM 1A. RISK FACTORSRISK FACTORS
Our future operating results depend upon many factors and are subject to
various risks and uncertainties. These major risks and uncertainties are
discussed below. There may be additional risks and uncertainties which we do not
believe are currently material or are not yet known to us but which may become
such in the future. Some of the risks and uncertainties which may cause our
operating results to vary from anticipated results or which may materially and
adversely affect our operating results are as follows:
RISKS RELATED TO OUR FINANCIAL RESULTS
WE CURRENTLY HAVE A NUMBER OF OBLIGATIONS THAT WE ARE UNABLE TO MEET WITHOUT
GENERATING ADDITIONAL INCOME OR RAISING ADDITIONAL CAPITAL. IF WE CANNOT
GENERATE ADDITIONAL INCOME OR RAISE ADDITIONAL CAPITAL IN THE NEAR FUTURE, WE
MAY BECOME INSOLVENT AND/OR BE MADE BANKRUPT AND/OR OUR MAY BECOME ILLIQUID OR
WORTHLESS.
As of December 31, 2005, our cash balance was approximately $122,000 and
our outstanding accounts payable and current liabilities totaled approximately
$12.2 million. In particular, we have some significant creditors that comprise a
substantial proportion of outstanding obligations, including many that have
obtained judgments against us, that we might not be able to satisfy. If we do
not receive sufficient financing or sufficient funds from our operations we may
(i) liquidate assets, (ii) seek or be forced into bankruptcy and/or (iii)
continue operations, but incur material harm to our business, operations or
financial condition. These measures could have a material adverse effect on our
ability to continue as a going concern. Additionally, because of our financial
condition, our Board of Directors has a duty to our creditors that may conflict
with the interests of our stockholders. When a Delaware corporation is operating
in the vicinity of insolvency, the Delaware courts have imposed upon the
corporation's directors a fiduciary duty to the corporation's creditors. Our
Board of Directors may be required to make decisions that favor the interests of
creditors at the expense of our stockholders to fulfill its fiduciary duty. For
instance, we may be required to preserve our assets to maximize the repayment of
debts versus employing the assets to further grow our business and increase
shareholder value. If we cannot generate enough income from our operations or
are unable to locate additional funds through financing, we will not have
sufficient resources to continue operations.
WE HAVE A HISTORY OF LOSSES, AND MAY HAVE TO FURTHER REDUCE OUR COSTS BY
CURTAILING FUTURE OPERATIONS TO CONTINUE AS A BUSINESS.
Although for the year ended December 31, 2005, our net income from
operations was $5.9 million, $7 million of our revenue was recognized from the
expiration of distribution contracts and other income, and we have incurred
significant net losses in previous years. For the year ended December 31, 2004,
our net loss from operations was $2.5 million and since inception, we have
incurred significant losses and negative cash flow. As of December 31, 2005 we
had an accumulated deficit of $133 million. Our ability to fund our capital
requirements out of our available cash and cash generated from our operations
depends on a number of factors. Some of these factors include the progress of
our product distributions and licensing, the rate of growth of our business, and
our products' commercial success. If we cannot generate positive cash flow from
operations, we will have to continue to reduce our costs and raise working
capital from other sources. These measures could include selling or
consolidating certain operations or assets, and delaying, canceling or scaling
back product development and marketing programs. These measures could materially
and adversely affect our ability to publish successful titles, and may not be
enough to permit us to operate profitability, or at all.
OUR ABILITY TO EFFECT A FINANCING TRANSACTION TO FUND OUR OPERATIONS COULD
ADVERSELY AFFECT THE VALUE OF YOUR STOCK.
If we are not acquired by or merge with another entity or if we are not
able to raise additional capital by sale or license of certain of our assets, we
may need to consummate a financing transaction to receive additional liquidity.
This additional financing may take the form of raising additional capital
through public or private equity offerings or debt financing. To the extent we
raise additional capital by issuing equity securities, we cannot be certain that
additional capital will be available to us on favorable terms and our
stockholders will likely experience substantial dilution. Our certificate of
incorporation provides for the issuance of preferred stock however we currently
do not have any preferred stock issued and outstanding. Any new equity
securities issued may have greater rights, preferences or privileges than our
existing common stock. Material shortage of capital will require us to take
drastic steps such as reducing our level of operations, disposing of selected
assets, effecting financings on less than favorable terms or seeking protection
under federal bankruptcy laws.
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RISKS RELATED TO OUR BUSINESS
TITUS INTERACTIVE SA (PLACED IN INVOLUNTARY BANKRUPTCY IN JANUARY, 2005)
CONTROLS A MAJORITY OF OUR VOTING STOCK AND CAN ELECT A MAJORITY OF OUR BOARD OF
DIRECTORS AND PREVENT AN ACQUISITION OF US THAT IS FAVORABLE TO OUR OTHER
STOCKHOLDERS. ALTERNATIVELY, TITUS CAN ALSO CAUSE A SALE OF CONTROL OF OUR
COMPANY THAT MAY NOT BE FAVORABLE TO OUR OTHER STOCKHOLDERS.
Titus owns approximately 58 million shares of common stock. As a
consequence, Titus can control substantially all matters requiring stockholder
approval, including the election of directors, subject to our stockholders'
cumulative voting rights, and the approval of mergers or other business
combination transactions. At our 2003 and 2002 annual stockholders meetings,
Titus exercised its voting power to elect a majority of our Board of Directors.
Currently, our Chief Executive Officer and interim Chief Financial Officer Herve
Caen is a director of various Titus affiliates. This concentration of voting
power could discourage or prevent a change in control that otherwise could
result in a premium in the price of our common stock. Further, Titus' bankruptcy
could lead to a sale by its liquidator or other representative in bankruptcy, of
shares Titus holds in us, and/or a sale of Titus itself which would result in a
sale of control of our Company and such a sale may not be favorable to our other
stockholders . Such a sale, including if it involves a dispersion of shares to
multiple stockholders, further could have the effect of making any business
combination, or a sale of all of our shares as a whole, more difficult.
THE LACK OF ANY CREDIT AGREEMENT HAS RESULTED IN A SUBSTANTIAL REDUCTION IN THE
CASH AVAILABLE TO FINANCE OUR OPERATIONS.
We are currently operating without a credit agreement or credit facility.
The lack of a credit agreement or credit facility has significantly impeded our
ability to fund our operations and has caused material harm to our business.
There can be no assurance that we will be able to enter into a new credit
agreement or that if we do enter into a new credit agreement, it will be on
terms favorable to us.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES HISTORICALLY DEPENDED ON OUR
DISTRIBUTORS' DILIGENT SALES EFFORTS.
Avalon was the exclusive distributor for most of our products in Europe,
the Commonwealth of Independent States, Africa and the Middle East. Our
agreement with Avalon was terminated following the liquidation of Avalon in
February 2005. We subsequently appointed our wholly owned subsidiary Interplay
Productions Ltd as our distributor for Europe.
Vivendi had exclusive rights to distribute our products in North America
and selected International territories. Our agreement with Vivendi expired in
August 2005 and December 2005 for most of our products.
Our revenues and cash flows could fall significantly and our business and
financial results could suffer material harm if:
o We fail to replace Vivendi as our distributor; or
o Interplay Productions Ltd fails to effectively distribute our
products.
We typically sell to distributors and retailers on unsecured credit, with
terms that vary depending upon the customer and the nature of the product. We
confront the risk of non-payment from our customers, whether due to their
financial inability to pay us, or otherwise. In addition, while we maintain a
reserve for uncollectible receivables, the reserve may not be sufficient in
every circumstance. As a result, a payment default by a significant customer
could cause material harm to our business.
WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR
ABILITY TO MANAGE OUR FINANCIAL OPERATIONS.
We are presently without a CFO, and Mr. Caen has assumed the position of
interim-CFO and continues as CFO to date until a replacement can be found. o
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OUR BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL. IF WE FAIL TO DELIVER
OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER.
Our business is highly seasonal, with the highest levels of consumer demand
occurring in the fourth quarter. Our industry is also cyclical. The timing of
hardware platform introduction is often tied to the year-end season and is not
within our control. As new platforms are being introduced into our industry,
consumers often choose to defer game software purchases until such new platforms
are available, which would cause sales of our products on current platforms to
decline. This decline may not be offset by increased sales of products for the
new platform.
THE UNPREDICTABILITY OF FUTURE RESULTS MAY CAUSE OUR STOCK PRICE TO REMAIN
DEPRESSED OR TO DECLINE FURTHER.
Our operating results have fluctuated in the past and may fluctuate in the
future due to several factors, some of which are beyond our control. These
factors include:
o demand for our products and our competitors' products;
o the size and rate of growth of the market for interactive
entertainment software;
o changes in personal computer and video game console platforms;
o the timing of announcements of new products by us and our competitors
and the number of new products and product enhancements released by us
and our competitors;
o changes in our product mix;
o the number of our products that are returned; and
o the level of our international and original equipment manufacturer
royalty and licensing net revenues.
Many factors make it difficult to accurately predict the quarter in which
we will ship our products. Some of these factors include:
o the uncertainties associated with the interactive entertainment
software development process;
o approvals required from content and technology licensors; and
o the timing of the release and market penetration of new game hardware
platforms.
THERE ARE HIGH FIXED COSTS TO DEVELOPING OUR PRODUCTS. IF OUR REVENUES DECLINE
BECAUSE OF DELAYS IN THE INTRODUCTION OF OUR PRODUCTS, OR IF THERE ARE
SIGNIFICANT DEFECTS OR DISSATISFACTION WITH OUR PRODUCTS, OUR BUSINESS COULD BE
HARMED.
Although for the year ended December 31, 2005, our net income from
operations was $5.9 million, $7 million of our revenue was recognized from the
expiration of distribution contracts and other income, and we have incurred
significant net losses in previous. Our losses in the past stemmed partly from
the significant costs we incurred to develop our entertainment software
products, product returns and price concessions. Moreover, a significant portion
of our operating expenses is relatively fixed, with planned expenditures based
largely on sales forecasts. At the same time, most of our products have a
relatively short life cycle and sell for a limited period of time after their
initial release, usually less than one year.
Relatively fixed costs and short windows in which to earn revenues mean
that sales of new products are important in enabling us to recover our
development costs, to fund operations and to replace declining net revenues from
older products. Our failure to accurately assess the commercial success of our
new products, and our delays in releasing new products could reduce our net
revenues and our ability to recoup development and operational costs.
IF OUR PRODUCTS DO NOT ACHIEVE BROAD MARKET ACCEPTANCE, OUR BUSINESS COULD BE
HARMED SIGNIFICANTLY.
Consumer preferences for interactive entertainment software are always
changing and are extremely difficult to predict. Historically, few interactive
entertainment software products have achieved continued market acceptance.
Instead, a limited number of releases have become "hits" and have accounted for
a substantial portion of revenues in our industry. Further, publishers with a
history of producing hit titles have enjoyed a significant marketing advantage
because of their heightened brand recognition and consumer loyalty. We expect
the importance of introducing hit titles to increase in the future. We cannot
assure you that our new products will achieve significant market acceptance, or
that we will be able to sustain this acceptance for a significant length of time
if we achieve it.
- 10 -
We believe that our future revenue will continue to depend on the
successful production of hit titles on a continuous basis. Because we introduce
a relatively limited number of new products in a given period, the failure of
one or more of these products to achieve market acceptance could cause material
harm to our business. Further, if our products do not achieve market acceptance,
we could be forced to accept substantial product returns or grant significant
pricing concessions to maintain our relationship with retailers and our access
to distribution channels. If we are forced to accept significant product returns
or grant significant pricing concessions, our business and financial results
could suffer material harm.
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.
Third party interactive entertainment software developers develop many of
our software products. Since we depend on these developers in the aggregate, we
remain subject to the following risks:
o limited financial resources may force developers out of business prior
to their completion of projects for us or require us to fund
additional costs; and
o the possibility that developers could demand that we renegotiate our
arrangements with them to include new terms less favorable to us.
INCREASED COMPETITION FOR SKILLED THIRD PARTY SOFTWARE DEVELOPERS ALSO HAS
COMPELLED US TO AGREE TO MAKE ADVANCE PAYMENTS ON ROYALTIES AND TO GUARANTEE
MINIMUM ROYALTY PAYMENTS TO INTELLECTUAL PROPERTY LICENSORS AND GAME DEVELOPERS.
MOREOVER, IF THE PRODUCTS SUBJECT TO THESE ARRANGEMENTS, ARE NOT DELIVERED
TIMELY, OR WITH ACCEPTABLE QUALITY, OR DO NOT GENERATE SUFFICIENT SALES VOLUMES
TO RECOVER THESE ROYALTY ADVANCES AND GUARANTEED PAYMENTS, WE WOULD HAVE TO
WRITE-OFF UNRECOVERED PORTIONS OF THESE PAYMENTS, WHICH COULD CAUSE MATERIAL
HARM TO OUR BUSINESS AND FINANCIAL RESULTS. WE COMPETE WITH A NUMBER OF
COMPANIES THAT HAVE SUBSTANTIALLY GREATER FINANCIAL, MARKETING AND PRODUCT
DEVELOPMENT RESOURCES THAN WE DO.
The greater resources of our competitors permit them to pay higher fees
than we can to licensors of desirable motion picture, television, sports and
character properties and to third party software developers.
We compete primarily with other publishers of personal computer and video
game console interactive entertainment software. Significant competitors include
Electronic Arts Inc. and Activision, Inc. Many of these competitors have
substantially greater financial, technical resources, larger customer bases,
longer operating histories, greater name recognition and more established
relationships in the industry than we do.
In addition, integrated video game console hardware/software companies such
as Sony Computer Entertainment, Nintendo, and Microsoft Corporation compete
directly with us in the development of software titles for their respective
platforms and they have generally discretionary approval authority over the
products we develop for their 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, may decide to compete directly with us or to enter into
exclusive relationships with our competitors.
WE HAVE A LIMITED NUMBER OF KEY MANAGEMENT AND OTHER PERSONNEL. THE LOSS OF ANY
SINGLE MEMBER OF MANAGEMENT OR KEY PERSON OR THE FAILURE TO HIRE AND INTEGRATE
CAPABLE NEW KEY PERSONNEL COULD HARM OUR BUSINESS.
Our business requires extensive time and creative effort to produce and
market. Our future success also will depend upon our ability to attract,
motivate and retain qualified employees and contractors, particularly software
design and development personnel. Competition for highly skilled employees is
intense, and we may fail to attract and retain such personnel. Alternatively, we
may incur increased costs in order to attract and retain skilled employees. Our
executive management team currently consists of CEO and interim CFO Herve Caen.
Our failure to recruit or retain the services of key personnel, including
competent executive management, or to attract and retain additional qualified
employees could cause material harm to our business.
- 11 -
OUR INTERNATIONAL SALES EXPOSE US TO RISKS OF UNSTABLE FOREIGN ECONOMIES,
DIFFICULTIES IN COLLECTION OF REVENUES, INCREASED COSTS OF ADMINISTERING
INTERNATIONAL BUSINESS TRANSACTIONS AND FLUCTUATIONS IN EXCHANGE RATES.
Our net revenues from international sales accounted for approximately 57%
and 75% of our total net revenues for years ended December 31, 2005 and 2004,
respectively. Most of these revenues came from our distribution relationship
with Vivendi , pursuant to which Vivendi became the exclusive distributor for
most of our products in Europe, the Commonwealth of Independent States, Africa
and the Middle East and a recognition of revenue from international expiration
of contracts during 2005. To the extent our resources allow, we intend to
continue to expand our direct and indirect sales, marketing and product
localization activities worldwide.
Our international sales are subject to a number of inherent risks,
including the following:
o recessions in foreign economies may reduce purchases of our products;
o translating and localizing products for international markets is time
consuming and expensive;
o accounts receivable are more difficult to collect and when they are
collectible, they may take longer to collect;
o regulatory requirements may change unexpectedly;
o it is difficult and costly to staff and manage foreign operations;
o fluctuations in foreign currency exchange rates;
o political and economic instability; and
o delays in market penetration of new platforms in foreign territories.
These factors may cause material declines in our future international net
revenues and, consequently, could cause material harm to our business.
A significant, continuing risk we face from our international sales and
operations stems from currency exchange rate fluctuations. Because we do not
engage in currency hedging activities, fluctuations in currency exchange rates
have caused significant reductions in our net revenues from international sales
and licensing due to the loss in value upon conversion into U.S. Dollars. We may
suffer similar losses in the future.
OUR CUSTOMERS HAVE THE ABILITY TO RETURN OUR PRODUCTS OR TO RECEIVE PRICING
CONCESSIONS AND SUCH RETURNS AND CONCESSIONS COULD REDUCE OUR NET REVENUES AND
RESULTS OF OPERATIONS.
We are exposed to the risk of product returns and pricing concessions with
respect to our distributors. Our distributors allow retailers to return
defective, shelf-worn and damaged products in accordance with negotiated terms,
and also offer a 90-day limited warranty to our end users that our products will
be free from manufacturing defects. In addition, our distributors provide
pricing concessions to our customers to manage our customers' inventory levels
in the distribution channel. Our distributors could be forced to accept
substantial product returns and provide pricing concessions to maintain our
relationships with retailers and their access to distribution channels. We have
mitigated this risk in North America under our current distribution arrangement
with Vivendi, as sales will be guaranteed with no offset for product returns and
price concessions.
WE DEPEND UPON THIRD PARTY LICENSES OF CONTENT FOR MANY OF OUR PRODUCTS.
Many of our current and planned products, are lines based on original ideas
or intellectual properties licensed from other parties. From time to time we may
not be in compliance with certain terms of these license agreements, and our
ability to market products based on these licenses may be negatively impacted.
Moreover, disputes regarding these license agreements may also negatively impact
our ability to market products based on these licenses. Additionally, we may not
be able to obtain new licenses, or maintain or renew existing licenses, on
commercially reasonable terms, if at all. If we are unable to maintain current
licenses or obtain new licenses for the underlying content that we believe
offers the greatest consumer appeal, we would either have to seek alternative,
potentially less appealing licenses, or release products without the desired
underlying content, either of which could limit our commercial success and cause
material harm to our business.
- 12 -
OUR LICENSORS ARE ALSO OFTEN OUR COMPETITORS. WE MAY FAIL TO MAINTAIN EXISTING
LICENSES, OR OBTAIN NEW LICENSES FROM PLATFORM COMPANIES ON ACCEPTABLE TERMS OR
TO OBTAIN RENEWALS OF EXISTING OR FUTURE LICENSES FROM LICENSORS.
We are required to obtain a license to develop and distribute software for
each of the video game console platforms for which we develop products,
including a separate license for each of North America, Japan and Europe. We
have obtained licenses to develop software for the Sony PlayStation and
PlayStation 2, as well as video game platforms from Nintendo and Microsoft, who
are also our competitors. Each of these companies has the right to approve the
technical functionality and content of our products for their platforms prior to
distribution. Typically, such license agreements give broad control to the
licensor over the approval, manufacturing and shipment of products on their
platform. Due to the competitive nature of the approval process, we typically
must make significant product development expenditures on a particular product
prior to the time we seek these approvals. Our inability to obtain these
approvals or to obtain them on a timely basis could cause material harm to our
business.
OUR SALES VOLUME AND THE SUCCESS OF OUR PRODUCTS DEPEND IN PART UPON THE NUMBER
OF PRODUCT TITLES DISTRIBUTED BY HARDWARE COMPANIES FOR USE WITH THEIR VIDEO
GAME PLATFORMS.
Even after we have obtained licenses to develop and distribute software, we
depend upon hardware companies such as Sony Computer Entertainment, Nintendo and
Microsoft, or their designated licensees, to manufacture the CD-ROM or DVD-ROM
media discs that contain our software. These discs are then run on the
companies' video game consoles. This process subjects us to the following risks:
o we are required to submit and pay for minimum numbers of discs we want
produced containing our software, regardless of whether these discs
are sold, shifting onto us the financial risk associated with poor
sales of the software developed by us; and
o reorders of discs are expensive, reducing the gross margin we receive
from software releases that have stronger sales than initially
anticipated and that require the production of additional discs.
As a result, video game console hardware licensors can shift onto us the
risk that if actual retailer and consumer demand for our interactive
entertainment software differs from our forecasts, we must either bear the loss
from overproduction or the lower per-unit revenues associated with producing
additional discs. Either situation could lead to material reductions in our net
revenues and operating results.
RISKS RELATED TO OUR INDUSTRY
INADEQUATE INTELLECTUAL PROPERTY PROTECTIONS COULD PREVENT US FROM ENFORCING OR
DEFENDING OUR PROPRIETARY TECHNOLOGY.
We regard our software as proprietary and rely on a combination of patent,
copyright, trademark and trade secret laws, employee and third party
nondisclosure agreements and other methods to protect our proprietary rights. We
own or license various copyrights and trademarks, and hold the rights to one
patent application related to one of our titles. While we provide "shrink-wrap"
license agreements or limitations on use with our software, it is uncertain to
what extent these agreements and limitations are enforceable. We are aware that
some unauthorized copying occurs within the computer software industry, and if a
significantly greater amount of unauthorized copying of our interactive
entertainment software products were to occur, it could cause material harm to
our business and financial results.
Policing unauthorized use of our products is difficult, and software piracy
can be a persistent problem, especially in some international markets. Further,
the laws of some countries where our products are or may be distributed either
do not protect our products and intellectual property rights to the same extent
as the laws of the 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 online services,
our ability to protect our intellectual property rights and to avoid infringing
others' intellectual property rights may diminish. We cannot assure you that
existing intellectual property laws will provide adequate protection for our
products in connection with these emerging technologies.
WE MAY UNINTENTIONALLY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
WHICH COULD EXPOSE US TO SUBSTANTIAL DAMAGES OR RESTRICT OUR OPERATIONS.
As the number of interactive entertainment software products increases and
the features and content of these products continue to overlap, software
developers increasingly may become subject to infringement claims. Although we
- 13 -
believe that we make reasonable efforts to ensure that our products do not
violate the intellectual property rights of others, it is possible that third
parties still may claim infringement. From time to time, we receive
communications from third parties regarding such claims. Existing or future
infringement claims against us, whether valid or not, may be time consuming and
expensive to defend. Intellectual property litigation or claims could force us
to do one or more of the following:
o cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property, which license, if available at all, may not be available on
commercially favorable terms; or
o redesign our interactive entertainment software products, possibly in
a manner that reduces their commercial appeal.
Any of these actions may cause material harm to our business and financial
results.
OUR BUSINESS IS INTENSELY COMPETITIVE AND PROFITABILITY IS INCREASINGLY DRIVEN
BY A FEW KEY TITLE RELEASES. IF WE ARE UNABLE TO DELIVER KEY TITLES, OUR
BUSINESS MAY BE HARMED.
Competition in our industry is intense. New videogame products are
regularly introduced. Increasingly, profits and revenues in our industry are
dominated by certain key product releases and are increasingly produced in
conjunction with the latest consumer and media trends. Many of our competitors
may have more finances and other resources for the development of product titles
than we do. If our competitors develop more successful products, or if we do not
continue to develop consistently high-quality products, our revenue will
decline.
IF WE FAIL TO ANTICIPATE CHANGES IN VIDEO GAME PLATFORMS AND TECHNOLOGY, OUR
BUSINESS MAY BE HARMED.
The interactive entertainment software industry is subject to rapid
technological change. New technologies could render our current products or
products in development obsolete or unmarketable. Some of these new technologies
include:
o operating systems such as Microsoft Windows Longhorn;
o new media formats
o releases of new video game consoles;
o new video game systems by Sony, Microsoft, Nintendo and others.
We must continually anticipate and assess the emergence of, and market
acceptance of, new interactive entertainment software platforms well in advance
of the time the platform is introduced to consumers. Because product development
cycles are difficult to predict, we must make substantial product development
and other investments in a particular platform well in advance of introduction
of the platform. If the platforms for which we develop new software products or
modify existing products are not released on a timely basis or do not attain
significant market penetration, or if we develop products for a delayed or
unsuccessful platform, our business and financial results could suffer material
harm.
New interactive entertainment software platforms and technologies also may
undermine demand for products based on older technologies. Our success will
depend in part on our ability to adapt our products to those emerging game
platforms that gain widespread consumer acceptance. Our business and financial
results may suffer material harm if we fail to:
o anticipate future technologies and platforms and the rate of market
penetration of those technologies and platforms;
o obtain licenses to develop products for those platforms on favorable
terms; or
o create software for those new platforms on a timely basis.
OUR SOFTWARE MAY BE SUBJECT TO GOVERNMENTAL RESTRICTIONS OR RATING SYSTEMS.
Legislation is periodically introduced at the state and federal levels in
the United States and in foreign countries to establish a system for providing
consumers with information about graphic violence and sexually explicit material
contained in interactive entertainment software products. In addition, many
foreign countries have laws that permit governmental entities to censor the
content of interactive entertainment software. We believe that mandatory
government-run rating systems eventually will be adopted in many countries that
are significant markets or potential markets for our products. We may be
required to modify our products to comply with new regulations, which could
delay the release of our products in those countries.
- 14 -
Due to the uncertainties regarding such rating systems, confusion in the
marketplace may occur, and we are unable to predict what effect, if any, such
rating systems would have on our business. In addition to such regulations,
certain retailers have in the past declined to stock some of our products
because they believed that the content of the packaging artwork or the products
would be offensive to the retailer's customer base. While to date these actions
have not caused material harm to our business, we cannot assure you that similar
actions by our distributors or retailers in the future would not cause material
harm to our business.
RISKS RELATED TO OUR STOCK
SOME PROVISIONS OF OUR CHARTER DOCUMENTS MAY MAKE TAKEOVER ATTEMPTS DIFFICULT,
WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND INHIBIT OUR ABILITY TO RECEIVE A
PREMIUM PRICE FOR YOUR SHARES.
Our Certificate of Incorporation, as amended, provides for 5,000,000
authorized shares of Preferred Stock. Our Board of Directors has the authority,
without any action by the stockholders, to issue up to 4,280,576 shares of
preferred stock and to fix the rights and preferences of such shares. 719,424
shares of Series A Preferred Stock was issued to Titus in the past, which amount
has been fully converted into our common stock. In addition, our certificate of
incorporation and bylaws contain provisions that:
o eliminate the ability of stockholders to act by written consent and to
call a special meeting of stockholders; and
o require stockholders to give advance notice if they wish to
nominate directors or submit proposals for stockholder
approval.
These provisions may have the effect of delaying, deferring or preventing a
change in control, may discourage bids for our common stock at a premium over
its market price and may adversely affect the market price, and the voting and
other rights of the holders, of our common stock.
OUR COMMON STOCK MAY BE SUBJECT TO THE "PENNY STOCK" RULES WHICH COULD ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
"Penny stocks" generally include equity securities with a price of less
than $5.00 per share, which are not traded on a national stock exchange or on
Nasdaq, and are issued by a company that has tangible net assets of less than
$2,000,000 if the company has been operating for at least three years. The
"penny stock" rules require, among other things, broker dealers to satisfy
special sales practice requirements, including making individualized written
suitability determinations and receiving a purchaser's written consent prior to
any transaction. In addition, additional disclosure in connection with trades in
the common stock are required, including the delivery of a disclosure schedule
prescribed by the SEC relating to the "penny stock" market. These additional
burdens imposed on broker-dealers may discourage them from effecting
transactions in our common stock, which may make it more difficult for an
investor to sell their shares and adversely affect the market price of our
common stock.
OUR STOCK IS VOLATILE
The trading price of our common stock has previously fluctuated and could
continue to fluctuate in response to factors that are largely beyond our
control, and which may not be directly related to the actual operating
performance of our business, including:
o general conditions in the computer, software, entertainment, media or
electronics industries;
o changes in earnings estimates or buy/sell recommendations by analysts;
o investor perceptions and expectations regarding our products, plans
and strategic position and those of our competitors and customers; and
o price and trading volume volatility of the broader public markets,
particularly the high technology sections of the market.
- 15 -
ITEM 2. PROPERTIESThe Company's headquarters are located in Beverly Hills, California, where
we leased approximately 3,100 square feet of office space . The facility is
leased through April 2008 . We are currently subleasing approximately 1,100
square feet of our facility to an independent third party. We have an additional
satellite office in Irvine, California.
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 the Company's 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.
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
were therefore liable to pay Special Situations $1.3 million. Special Situations
entered into a settlement agreement with us in December,2003 contemplating
payments over time, which we later defaulted on. In August,2004 we entered into
a stipulation of settlement to which we later defaulted. On January 12,2005 a
judgment of approximately $776,00 was entered in the State of New York and on
February 4,2005 a judgment reflecting the January 12,2005 judgment was entered
in the State of California. On May 3,2006 the Company entered into a Stipulation
of Settlement. Under this Stipulation of Settlement the Company agreed to issue
a total of 10,000,000 shares of its unregistered common stock and made a payment
in the amount of approximately $239,000.Following the issuance of such shares,
and in consideration of such issuance and such payment, satisfaction of
judgments in the amount of approximately $776,000 recorded against the Company
will be filed. Such shares will be issued in a private placement pursuant to
section 4(2) of the Securities Act of 1933 and will be issued prior to the
satisfaction of judgments which must occur within 10 business days following the
Company's having made payment of approximately $239,000 and the issuance of such
shares.
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the Company for various claims related to a
breach of a distributorship agreement. Synnex obtained a $172,000 judgment
against the Company.
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 including
interest. We owe a remaining balance of approximately $360,000 payable in one
remaining installment. The Company is currently in default of the settlement
agreement.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $432,000. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has not accrued any amount for any remaining lease obligation,
should such obligation exist. We are currently in default of the forbearance
agreement.
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,000 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000. If Monte Cristo executes the judgment, it
will negatively affect the Company's cash flow, which could further restrict the
Company's operations and cause material harm to our business.
- 16 -
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company for failure to pay development fees in the Orange County Superior Court
that was settled in July 2004. The Company was unable to make the payments and
Reflexive sought and obtained judgment against the company for approximately
$110,000.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for failure to pay royalties. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further the settlement was entered into with Interplay OEM only in the
amount of $170,000, however KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment was not made.
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $110,000 pursuant to section 166 and section 186 of the
Internal Revenue Code in payroll tax penalties, and interest for late filing and
late payment of payroll taxes. Approximately $110,000 has been accrued as of
December 31, 2005 but remains unpaid. The Company received notice from the
Employment Development Department (EDD) that it owes approximately $103,000 in
payroll taxes owed for the period ending 2003 and 2004 which has been accrued
for December 31,2005.
The Company was unable to meet certain 2004 payroll obligations to its
employees, as a result several employees filed claims with the State of
California Labor Board ("Labor Board") . The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and obtained
in August 2005 judgments totaling $118,000 in favor of former employees of the
Company , since this time $44,000 of the claims have been settled leaving, a
balance of $74,000.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled.
The company subsequently entered into new workers compensation insurance plan.
The Labor Board fined the Company approximately $79,000 for having lost workers
compensation insurance for a period of time. The Company is appealing the Labor
Board fines.
The Company received notice from the California State Board of Equalization
of a balance due in the amount of $73,000 for a prior year audit . The Company
is in the process of appealing the prior year audit calculations.
On September 14, 2005, Network Commercial Service, Inc. ("NCS") filed an
action against the Company alleging breach of contract relating to the provision
of copying equipment and that the balance due is $140,000 to NCS. The Company is
evaluating the merit of the lawsuit.
On April 22, 2005, Mark Strecker filed a judgment to be entered against the
Company for various claims alleging unpaid services in the amount of $35,000.
The Company is evaluating the merit of the lawsuit.
On May 19, 2005 DZN, The Design Corporation filed an action against the
Company for various advertising services in the amount of $38,000. The Company
is evaluating the merit of the lawsuit.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. The Company is evaluating the merit of the lawsuit.
On March 7, 2006, Parallax Software Corp. entered a judgment against the
Company for a material breach of a settlement agreement related to royalties
owed in the amount of $219,000. The Company is evaluating the merit of the
lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
- 17 -
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSThe Company trades on the NASD-operated Over-the-Counter Bulletin Board.
Our common stock is currently traded on the NASD-operated Over-the-Counter
Bulletin Board under the symbol "IPLY" or while non-compliant "IPLYE". At April
28 , 2006, there were 145 holders of record of our common stock.
The following table sets forth the range of high and low sales prices for
our common stock for the periods indicated.
FOR THE YEAR ENDED DECEMBER 31, 2005 HIGH LOW
------------------------------------ ---- ---
First Quarter...................... $.02 $.01
Second Quarter..................... .01 .01
Third Quarter...................... .01 .01
Fourth Quarter..................... .01 .01
FOR THE YEAR ENDED DECEMBER 31, 2004
------------------------------------
First Quarter...................... $.14 $.10
Second Quarter..................... .14 .03
Third Quarter...................... .05 .02
Fourth Quarter..................... .03 .01
DIVIDEND POLICY
It is not currently our policy to pay dividends.
SECURITIES ISSUANCES
No new shares were issued during the period ending December 31, 2005.
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2005:
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
approved by security 70,000 0.30 10,014,877
holders
Equity compensation plans
not approved by security - -
holders
----------------------------------------------------------------------------
Total 70,000 0.30 10,014,877
============================================================================
We have one stock option plan currently outstanding. Under the 1997
Stock Incentive Plan, as amended (the "1997 Plan"), we may grant up to 10
million options to our employees, consultants and directors, which generally
vest from three to five years. 84,877 shares remain available for issuance under
the Company's Employee Stock Purchase Plan.
- 18 -
There were no differences, if any, between the exercise price and the
estimated fair market value as compensation expense for financial reporting
purposes, pursuant to APB 25 during 2005,2004 and 2003.There was no compensation
expense for any vested portion for the years 2005, 2004 and 2003 respectively.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for the years ended
December 31, 2005, 2004, 2003, 2002 and 2001 and the selected consolidated
balance sheets data as of December 31, 2005 and 2004 are derived from our
audited consolidated financial statements included elsewhere 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 andResults of Operations" and the Consolidated Financial Statements included
elsewhere in this Report.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
(Unaudited)
--------- --------- --------- --------- ---------
(Dollars in thousands, except share and per share amounts)
STATEMENTS OF OPERATIONS DATA:
Net revenues ....................................... $ 7,158 $ 13,197 $ 36,301 $ 43,999 $ 56,448
Cost of goods sold ................................. 478 6,826 13,120 26,706 45,816
--------- --------- --------- --------- ---------
Gross profit ....................................... 6,680 6,371 23,181 17,293 10,632
Operating expenses ................................. 3,197 8,853 21,787 29,653 51,922
--------- --------- --------- --------- ---------
Operating income (loss) ............................ 3,483 (2,482) 1,394 (12,360) (41,290)
Sale of subsidiary ................................. -- -- -- 28,813 --
Other income (expense)
2,446 (2,094) (82) (1,531) (4,526)
--------- --------- --------- --------- ---------
Income (loss) before income taxes .................. 5,929 (4,576) 1,312 14,922 (45,816)
Provision (benefit) for income taxes ............... 2 154 -- (225) 500
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ 5,927 $ (4,730) $ 1,312 $ 15,147 $ (46,316)
========= ========= ========= ========= =========
Cumulative dividend on participating preferred stock $ -- $ -- $ -- $ 133 $ 966
Accretion of warrant ............................... -- -- -- -- 266
--------- --------- --------- --------- ---------
Net income (loss) available to common stockholders . $ 5,927 $ (4,730) $ 1,312 $ 15,014 $ (47,548)
========= ========= ========= ========= =========
Net income (loss) per common share:
Basic ......................................... $ 0.066 $ (0.05) $ 0.01 $ 0.18 $ (1.23)
Diluted ....................................... $ 0.066 $ (0.05) $ 0.01 $ 0.16 $ (1.23)
Shares used in calculating net income (loss) per
common share - basic ............................... 89,198 93,856 93,852 83,585 38,670
Shares used in calculating net income (loss) per
common share - diluted ............................. 89,198 93,856 104,314 96,070 38,670
SELECTED OPERATING DATA:
Net revenues by geographic region:
North America ................................. $ 2,885 $ 1,544 $ 13,541 $ 26,184 $ 34,998
International ................................. 4,056 9,934 6,484 5,674 15,451
OEM, royalty and licensing .................... 217 1,720 16,276 12,141 5,999
Net revenues by platform:
Personal computer ............................. $ 631 $ 1,817 $ 7,671 $ 15,802 $ 34,912
Video game console ............................ 971 9,660 12,354 16,056 15,537
OEM, royalty and licensing .................... 217 1,720 16,276 12,141 5,999
Recognition of Revenue from expired contracts . 4,571 -- -- -- --
Licensing ...................................... 768 -- -- -- --
DECEMBER 31,
-------------------------------------------------------------
2005 2004 2003 2002 2001
(Unaudited)
--------- --------- --------- --------- ---------
BALANCE SHEETS DATA: (Dollars in thousands)
Working capital (deficiency) ....................... $ (11,497) $ (17,852) $ (14,750) $ (17,060) $ (34,169)
Total assets ....................................... 673 834 5,486 14,298 31,106
Total debt ......................................... 1,549 1,575 837 2,082 4,794
Stockholders' equity (deficit) ..................... (11,490) (17,362) (12,636) (13,930) (28,150)
- 19 -
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 publisher and licensor of interactive
entertainment software for both core gamers and the mass market. We are most
widely known for our titles in the action/arcade, adventure/role playing game
(RPG), and strategy/puzzle categories. We have produced and licensed titles for
many of the most popular interactive entertainment software platforms.
During 2005 we continued to operate under limited cash flow from
operations. We expect to operate under similar cash constraints during 2006.
We also continued to significantly reduce our operational costs and
personnel in 2005. We reduced our personnel by 7, from 12 in December 2004 to 5
in December 2005 We also made reductions in expenditures in other areas. As a
result of these cost-cutting measures, our ongoing cash needs to fund operations
has been reduced for 2006.
We continue to face difficulties in paying our vendors incurred judgments
and have pending lawsuits as a result of our continuing cash flow difficulties.
We expect to continue to operate under cash constraints during 2006.
The Company had approximately $4.6 million in revenue from deferred income
recognition and approximately $2.4 million in revenue from other income in the
year ended December 31, 2005. However, the Company does not expect material
income from the recognition of deferred income or other income in 2006.
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
financial statements do not purport to represent realizable or settlement
values. The Report of our Independent Auditors for the December 31, 2005
consolidated financial statements includes an explanatory paragraph expressing
substantial doubt about our ability to continue as a going concern.
We derived net revenues from sales of software products to our two main
distributors, Vivendi and Avalon. Vivendi distributed our products in North
America and selected territories. Most of our distribution agreements with
Vivendi expired in August 2005 except for certain products subject to a
tri-party agreement with Atari Interactive Inc which expires in December 2006.
Upon expiration of most of the Vivendi distribution agreements, we resumed
responsibility for distribution and licensing in North America and other
territories and we entered into licensing agreements with new distributors for
certain of our products. Avalon distributed our products in Europe, the
commonwealth of Independent States, Africa and the Middle East. Our distribution
agreement with Avalon was terminated following Avalon's involuntary judicial
liquidation in February 2005. In March 2005 we appointed our wholly owned
subsidiary, Interplay Productions Ltd, as our distributor in Europe and other
selected territories.
We entered into various licensing agreements during 2005 under which we
licensed others to exploit games that we have intellectual property rights to.
This included entering into agreements with Turner Games Network and Vivendi and
resulted in one time payments from each of these licensees. These license
agreements are generally for a 2 year term. We expect in 2006 to enter into
similar license arrangements to generate cash for the Company's operations.
Our products were either designed and created by our employees or by
external software developers. When we used external developers, we typically
advanced development funds to the developers in installment payments based upon
the completion of certain milestones. These advances were typically considered
advances against future royalties, which we to be recouped against these
advances. We currently have no product in development with external developers.
We plan on creating additional products through external developers but no
assurance can be made that it will be successful.
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
upcoming release of new console systems by Sony, Nintendo and Microsoft, our
industry has entered into a transition period that could affect marketability of
new products if any.
- 20 -
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.
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 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 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. 104, Revenue Recognition.
Sales were made by two distributors, Vivendi and Avalon, an affiliate of
our majority shareholder Titus Interactive S.A.until we ended our relationship
with them during 2005. 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
duplicated.
The Company recognizes revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of the Company's 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,
revenue is recognized as earned. guaranteed minimum royalties on sales, where
the guarantee is not recognized upon delivery, are recognized as the minimum
payments come due. The Company recognizes revenue on expired contracts when the
termination date of the contract is reached because guaranteed minimum royalties
are not reimbursable and are recorded as revenue..
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.
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. Royalty 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
- 21 -
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. Once the
charge has been taken, that amount will not be expensed in future quarters when
the product has shipped.
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. As a result, 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 Notes to Consolidated Financial Statements, Summary of Significant
Accounting Policies, which discusses accounting policies that must be selected
by management when there are acceptable alternatives.
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,
---------------------------------
2005 2004 2003
-------- -------- --------
STATEMENTS OF OPERATIONS DATA:
Net revenues .................................. 100% 100% 100%
Cost of goods sold ............................ 7 52 36
-------- -------- --------
Gross margin .................................. 93 48 64
Operating expenses:
Marketing and sales ...................... 4 13 4
General and administrative ............... 37 34 18
Product development ...................... 4 20 38
Other .................................... -- --
-------- -------- --------
Total operating expenses ................. 45 67 60
-------- -------- --------
Operating income (loss) ....................... 48 (19) 4
Other income (expense) ........................ 34 (16) --
-------- -------- --------
Income (loss) before provision for income taxes 82 (35) 4
Provision for income taxes .................... -- 1 --
-------- -------- --------
Net income (loss) ............................. 82% (36)% 4%
======== ======== ========
SELECTED OPERATING DATA:
Net revenues by segment:
North America ............................ 41% 12% 38%
International ............................ 56 75 18
OEM, royalty and licensing ............... 3 13 44
-------- -------- --------
100% 100% 100%
======== ======== ========
Net revenues by platform:
Personal computer ........................ 9% 14% 21%
Video game console ....................... 14 73 35
OEM, royalty and licensing ............... 3 13 44
Recognition of revenue on expired contracts 63 N/A N/A
Licensing deals ........................... 11 N/A N/A
-------- -------- --------
100% 100% 100%
======== ======== ========
- 22 -
Geographically, our net revenues for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ -------
North America ........................... 2,885 1,544 1,341 86.9%
International ........................... 4,056 9,934 (5,878) (59.2%)
OEM, Royalty & Licensing ................ 217 1,720 (1,503) (87.3%)
Net Revenues ............................ 7,158 13,197 (6,039) (45.7%)
Geographically, our net revenues for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------- ------- ------- -------
North America ....................... 1,544 13,541 (11,997) (88.6%)
International ....................... 9,934 6,484 3,450 53.2%
OEM, Royalty & Licensing ............ 1,720 16,276 (14,306) (89.2%)
Net Revenues ........................ 13,197 36,301 (22,854) (63.9%)
NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES
Net revenues for the year ended December 31, 2005 were $7.1 million, a
decrease of 45.7% compared to the same period in 2004. This decrease resulted
from a 59.2% decrease in International net revenues and a 87.3% decrease in OEM,
royalties and licensing revenues, offset by a 86.9% increase in North American
net revenues. Net revenues for the year ended December 31, 2004 were $13.1
million, a decrease of 63.9% compared to the same period in 2003. This decrease
resulted from a 88% decrease in North American net revenues and a 89% decrease
in OEM, royalties and licensing revenues, offset by a 53% increase in
International net revenues.
North American net revenues for the year ended December 31, 2005 were $2.9
million as compared to $1.5 million for the year ended December 31, 2004. The
increase in North American net revenues in 2005 was mainly due to the
recognition of deferred revenue in the amount of $2.1 million on contracts
expiring and the balance attributable to licensing , royalties and catalog
sales.
We expect that our North American publishing net revenues will decrease in
2006 compared to 2005, mainly due to decreased catalog sales.
The decrease in North American net revenues in 2004 was mainly due to
releasing zero product gold masters in 2004 as compared to delivering six
product gold masters in 2003.
International net revenues for the year ended December 31, 2005 were $4.0
million, a decrease of $5.8 million as compared to International net revenues
for the year ended December 31, 2004. Included in the $4.0 million are $2.5
million of recognition of deferred revenues on contracts expiring. The decrease
in International net revenues compared to the year ended December 31, 2004 was
mainly due to releasing no new product during the twelve months ended December31, 2005 compared to releasing BALDUR'S GATE DARK ALLIANCE II and FALLOUT:
BROTHERHOOD OF STEEL during 2004.
- 23 -
We expect that our International publishing net revenues will decrease in
2006 as compared to 2005, mainly due to decreased unit sales.
International net revenues for the year ended December 31, 2004 were $9.9
million. The increase in International net revenues for the year ended December31, 2004 was mainly due releasing BALDUR'S GATE DARK ALLIANCE II and FALLOUT:
BROTHERHOOD OF STEEL during 2004 with no comparable titles released during 2003.
OEM, royalty and licensing net revenues for the year ended December 31,2005 were $.2 million, a decrease of $1.5 million as compared to the same period
in 2004. The OEM business decreased $1.5 million as a. consequence of our
reorganization.
OEM, royalty and licensing net revenues for the year ended December 31,2004 were $1.7 million, a decrease of $14.3 million as compared to the same
period in 2003. The OEM business decreased $14.3 million as a consequence of our
reorganization.
PLATFORM, EXPIRED CONTRACTS AND LICENSING DEALS NET REVENUES
Our platform, expired contracts and licensing deals net revenues for the
years ended December 31, 2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
Personal Computer ................ 631 1,817 (1,186) (65.3%)
Video Game Console ............... 971 9,660 (8,689) (89.9%)
OEM, Royalty & Licensing ......... 217 1,720 (1,503) (87.4%)
Recognition of revenue on
expired contracts ............. 4,571 0 4,571 N/A
Licensing ........................ 768 0 768 N/A
Net Revenues ..................... 7,158 13,197 (6,039) (45.8%)
PC net revenues for the year ended December 31, 2005 were $.6 million, a
decrease of 65.3 % compared to the same period in 2004. The decrease in PC net
revenues in 2005 was primarily due to no new releases. We expect our PC net
revenues to decrease in 2006 as compared to 2005 as we continue to reorganize
the Company.
Our video game console net revenues for the year ended December 31, 2005
were $1 million a decrease of 89.9% compared to the same period in 2004. Revenue
recognition from deferred revenue of expired contracts for the year ended
December 31,2005 were $4.6 million. Licensing for the year ended December
31,2005 were $1 million. The decrease in video game console net revenues was
primarily due to no new releases. Our catalog sales also decreased in 2005 as
compared to 2004. Since we anticipate releasing no new console titles in 2006,
we expect our video game console net revenues to decrease in 2006.
Our platform net revenues for the years ended December 31, 2004 and 2003
breakdown as follows: (in thousands)
2004 2003 Change % Change
------- ------- ------- -------
Personal Computer ................... 1,817 7,671 (5,854) (76.3%)
Video Game Console .................. 9,660 12,354 (2,694) (21.8%)
OEM, Royalty & Licensing ............ 1,720 16,276 (14,306) (89.2%)
Net Revenues ........................ 13,197 36,301 (22,854) (63.4%)
PC net revenues for the year ended December 31, 2004 were $1.8 million, a
decrease of 76.3% compared to the same period in 2003. The decrease in PC net
revenues in 2004 was primarily due to no new releases.
Our video game console net revenues for the year ended December 31, 2004
were $9.6 million a decrease of 21.8% compared to the same period in 2003. The
decrease in video game console net revenues was partially attributed to our
releasing or delivering no gold masters to Vivendi. Our catalog sales also
decreased in 2004 as compared to 2003.
- 24 -
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 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, 2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
Net Revenues ........................ 7,158 13,197 (6,039) (45.8%)
Cost of Goods Sold .................. 478 6,826 (6,348) (93%)
Gross Margin ........................ 6,680 6,371 309 4.8%
Our cost of goods sold decreased 93% to $.5 million in the year ended
December 31, 2005 compared to $6.8 million in the same period in 2004. We expect
our cost of goods sold to decrease in 2006 as compared to 2005 because we
anticipate lower overall product sales.
Our gross margin increased to 93.3% for the twelve months ended December31, 2005 from 48.2% in the comparable period in 2004.
Our net revenues, cost of goods sold and gross margin for the years ended
December 31, 2004 and 2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------- ------- ------- -------
Net Revenues ........................ 13,197 36,301 (23,104) (63.6%)
Cost of Goods Sold .................. 6,826 13,120 (6,294) (48%)
Gross Margin ........................ 6,371 23,181 (16,810) (72.5%)
Our cost of goods sold decreased 48% to $6.8 million in the year ended
December 31, 2004 compared to $13.1 million in the same period in 2003.
Furthermore, in 2003 we incurred $2.9 million in amortization of prepaid
royalties associated with the sale of the HUNTER: THE RECKONING license and
approximately $2.9 million in write-offs of development projects that were
impaired because the titles were not expected to meet our desired profit
requirements. In addition, the decrease was mainly a result of lower product
cost of goods associated with lower overall product sales.
Our gross margin decreased to 48.3% for the twelve months ended December31, 2004 from 63.9% in the comparable period in 2003. This was primarily due to
the sale of the HUNTER: THE RECKONING license, which yielded approximately an
80% profit margin in 2003 partially offset by the sale of the rights to develop
FALLOUT 3 and the sale of REDNECK RAMPAGE in 2004.
MARKETING AND SALES
Our marketing and sales expenses for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
Marketing and Sales ................. 312 1,703 (1,391) (81.7%)
- 25 -
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 for the twelve months ended December 31, 2005 were $.3 million, a 81.7%
decrease as compared to the 2004 period. The decrease in marketing and sales
expenses is due primarily to no new releases. We expect our marketing and sales
expenses to decrease in 2006 compared to 2005, as we expect to ship no new
releases in 2006 as compared to 2005.
Our marketing and sales expenses for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
----- ----- ----- ------
Marketing and Sales ...................... 1,703 1,415 288 20.4%
Marketing and sales expenses for the year ended December 31, 2004 were $1.7
million, a 20.4% increase as compared to the 2003 period. The increase in
marketing and sales expenses was due primarily to increased advertising costs
for Baldur's Gate Dark Alliance 2 on the PS2 and X-Box platforms in Europe.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses for the years ended December 31,2005 and 2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
General and Administrative ...... 2,617 4,514 (1,897) (42%)
General and administrative expenses primarily consist of administrative
personnel expenses, facilities costs, professional fees, bad debt expenses and
other related operating expenses. General and administrative expenses for the
year ended December 31, 2005 were $2.6 million, a 42% decrease as compared to
the same period in 2004. The decrease is mainly due to decreases in personnel
costs and general expenses as a result of a reduction in administrative
personnel during 2005.
Our general and administrative expenses for the years ended December 31,2004 and 2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------ ------
General and Administrative .............. 4,514 6,692 (2,178) (32.6%)
General and administrative expenses for the year ended December 31, 2004
were $4.5 million, a 32.6% decrease as compared to the same period in 2003. The
decrease is mainly due to decrease in personnel costs and general expenses as a
result of a reduction in administrative personnel during 2004.
PRODUCT DEVELOPMENT
Our product development expenses for the years ended December 31, 2005 and
2004 breakdown as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
Product Development ................. 268 2,636 (2,368) (89.8%)
------ ------ ------ ------
We charge internal product development expenses, which consist primarily of
personnel and support costs, to operations in the period incurred. Product
development expenses for the year ended December 31, 2005 were $.3 million, a
89.8% decrease as compared to the same period in 2004. This decrease was mainly
due to a $2.4 million decrease in personnel costs and general expenses as a
result of a reduction in headcount and the closure of our internal development
studio during the year.
- 26 -
Our product development expenses for the years ended December 31, 2004 and
2003 breakdown as follows: (in thousands)
2004 2003 Change % Change
------- ------- ------- -------
Product Development ................. 2,636 13,680 (11,044) (80.7%)
Product development expenses for the year ended December 31, 2004 were $2.6
million, a 80.7% decrease as compared to the same period in 2003. This decrease
was due to a $11 million decrease in personnel costs as a result of a reduction
in headcount.
OTHER EXPENSE (INCOME), NET
Our other expense for the years ended December 31, 2005 and 2004 breakdown
as follows: (in thousands)
2005 2004 Change % Change
------ ------ ------ ------
Other Expense (Income) .......... (2,445) 2,248 (4,693) 208%
Other income consists primarily of a legal settlement which was a reduction
of accrued royalties, accrued expenses and accounts payable in the amount of $1
million, an additional adjustment to accrued royalties in the amount of $1.6
million, an immaterial impairment of assets of $.3 million, recovery of bad debt
in the amount of $.06 million, an additional write down of Titus Software in the
amount of $.2 million , and immaterial foreign currency exchange transactions
gains and losses.
Our other expense for the years ended December 31, 2004 and 2003 breakdown
as follows: (in thousands)
2004 2003 Change % Change
------ ------ ------ ------
Other Expense ........... 2,248 82 (2,166) (278%)
Other expense consists primarily of interest expense, bad debt expense,
payroll tax penalties, write-off of fixed assets and foreign currency exchange
transaction losses. Other expense for the year ended December 31, 2004 was $2.2
million, a 278% decrease as compared to the same period in 2003. This increase
is due primarily to a write-off of fixed assets and a write down of the Avalon
accounts receivable balance.
PROVISION (BENEFIT) FOR INCOME TAXES
We recorded no tax provision for the years ended December 31, 2005 and
2004.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2005, we had a working capital deficit of approximately
$11 million, and our cash balance was approximately $122,000. We currently have
no cash reserves and are unable to pay current liabilities. We cannot continue
in our current form without obtaining additional financing or income or reducing
expenditures.
We have substantially reduced our operating expenses. We need to reduce our
continuing liabilities. We have to raise additional capital or financing. If we
do not receive sufficient financing we may (i) liquidate assets, (ii) sell the
company (iii) seek protection from our creditors including the filing of
voluntary bankruptcy or being the subject of involuntary bankruptcy, and/or (iv)
continue operations, but incur material harm to our business, operations or
financial conditions. 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.
Additionally, we have reduced our fixed overhead commitments, and cancelled
or suspended development on future titles. and scaled back certain marketing
programs associated with the cancelled projects. Management will continue to
pursue various alternatives to improve future operating results.
We continue to seek external sources of funding, including but not limited
to, incurring debt, the sale of assets or stock, the licensing of certain
product rights in selected territories, selected distribution agreements, and/or
other strategic transactions sufficient to provide short-term funding, and
potentially achieve our long-term strategic objectives.
- 27 -
We have been operating without a credit facility since October 2001, which
has adversely affected cash flow. We continue to face difficulties in paying our
vendors, and employees, and have pending lawsuits as a result of our continuing
cash flow difficulties. We expect these difficulties to continue during 2006.
Historically, we have funded our operations primarily through cash flow
from operations, including royalty and distribution fee advances.
Our primary capital needs have historically been working capital
requirements necessary to fund our operations.. Our operating activities
provided cash of $93,000 during the twelve months ended December 31, 2005,
primarily attributable to licensing and distribution net of expenditures.
Net cash provided by operating activities of $93,000 for the twelve months
ended December 31, 2005 consisted of normal capital expenditures and sales,
primarily for office and computer equipment used in our operations. We do not
currently have any material commitments with respect to any future capital
expenditures.
The Company had approximately $4.6 million in revenue from deferred income
recognition and approximately $2.4 million in revenue from other income in the
year ended December 31, 2005. However, the Company does not expect material
income from the recognition of deferred income or other income in 2006.
We entered into various licensing agreements during 2005 under which we
licensed others to exploit games that we have intellectual property rights to.
This included entering into agreements with Turner Games Network and Vivendi and
resulted in one time payments from each of these licensees. These license
agreements are generally for a 2 year term. We expect in 2006 to enter into
similar license arrangements to generate cash for the Company's operations.
Currently the Company has no internal development of new titles.
If operating revenues from product releases are not sufficient to fund our
operations, no assurance can be given that alternative sources of funding could
be obtained on acceptable terms, or at all. These conditions, combined with our
deficits in stockholders' equity and working capital, raise substantial doubt
about our ability to continue as a going concern. The accompanying condensed
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets and
liabilities that may result from the outcome of this uncertainty. There can be
no guarantee that we will be able to meet all contractual obligations or
liabilities in the future, including payroll obligations.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements under which we have
obligations under a guaranteed contract that has any of the characteristics
identified in paragraph 3 of FASB Interpretation 3 of FASB Interpretation No. 45
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. We do not have any retained or
contingent interest in assets transferred to an unconsolidated entity or similar
arrangement that serves as credit, liquidity or market risk support to such
entity for such assets. We also do not have any obligation, including a
contingent obligation, under a contract that would be accounted for as a
derivative instrument. We have no obligations, including a contingent obligation
arising out of a variable interest (as referenced in FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (January 2003), as may be modified
or supplemented) in an unconsolidated entity that is held by, and material to,
the registrant, where such entity provides financing, liquidity, market risk or
credit risk support to, or engages in leasing, hedging or research and
development services with the registrant.
CONTRACTUAL OBLIGATIONS
The following table summarizes certain of our contractual obligations under
non-cancelable contracts and other commitments at December 31, 2005, and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods. (in thousands)
--------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 - 3 3 - 5 MORE THAN
1 YEAR YEARS YEARS 5 YEARS
--------------------------------------------------------------------------------
Lease Commitments (1) 153 -- 114 39 --
--------------------------------------------------------------------------------
Total 153 -- 114 39 --
--------------------------------------------------------------------------------
- 28 -
Our current cash reserves plus our expected cash from existing operations
will only be sufficient to fund our anticipated expenditures to June 30, 2006.
We will need to substantially reduce our working capital needs, continue to
consummate certain sales of assets and/or raise additional financing to meet our
contractual obligations..
(1) We have a lease commitment at the Beverly Hills office through April 2008.
We have a monthly rental agreement in Irvine.
ACTIVITIES WITH RELATED PARTIES
Our operations involve significant transactions with our majority
stockholder Titus and its affiliates. We had a major distribution agreement with
Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus (placed in involuntary bankruptcy in January 2005) presently owns
approximately 58 million shares of our common stock
As of December 31, 2005 and December 31, 2004, Titus and its affiliates
excluding Avalon owed us $105,000 and $370,000, respectively. We owed Titus and
its affiliates excluding Avalon $0 and $30,000 as of December 31, 2005 and
December 31, 2004 respectively.
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
We had an International Distribution Agreement with Avalon, a wholly owned
subsidiary of Titus. Pursuant to this distribution agreement, Avalon provided
for the exclusive distribution of substantially all of our products in Europe,
Commonwealth of Independent States, Africa and the Middle East for a seven-year
period ending February 2006, cancelable under certain conditions, subject to
termination penalties and costs. Under this agreement, as amended, we paid
Avalon a distribution fee based on net sales, and Avalon provides certain market
preparation, warehousing, sales and fulfillment services on our behalf. In
connection with the International Distribution Agreement with Avalon, we
incurred distribution commission expense of $0 and $62,000, for the twelve
months ended December 31, 2005, and 2004 respectively. This agreement was
terminated as a result of Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software Corp.,
("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at September 30, 2004 was approximately $254,000. The total receivable
due from TSC is approximately $327,000 as of September 30, 2004. The majority of
the additional approximately $71,000 was due to TSC subletting office space and
miscellaneous other items. As of October 31,2005 the outstanding balance owed
from TSC was approximately $71,000 the outstanding balance was reduced from a
payment of a note owed by Phil Adam to TSC and offset against the balance due
Interplay.
In May 2003, we paid TSC $60,000 to cover legal fees in connection with a
lawsuit against Titus. As a result of the payment, our CEO requested that we
credit the $60,000 to amounts we owed to him arising from expenses incurred in
connection with providing services to the Company.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. As of December 31, 2005the Company had a balance
due from Titus Japan of $192,000. During the twelve months ending December 31,2005 our Japanese subsidiary incurred to Titus Japan approximately $221,000 in
commissions, publishing and staff services.
- 29 -
TRANSACTIONS WITH TITUS SARL
As of December 31, 2005 and 2004the Company has a receivable of
approximately $18,000 and $18,000 respectively for product development services
that the Company provided of which reserve have been allocated accordingly.
Titus SARL was placed into involuntary liquidation in January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, we engaged the services of GIE Titus Interactive Group, a
wholly owned subsidiary of Titus, for a three-month service agreement pursuant
to which GIE Titus or its agents shall provide to us certain foreign
administrative and legal services at a rate of $5,000 per month for three
months. As of December 31, 2005, we had a zero balance with Titus GIE
Interactive Group. Titus GIE was placed into involuntary liquidation in January
2005.
TRANSACTIONS WITH VIE ACQUISITION GROUP
Approximately $0 and $42,000 was paid to VIE Acquisition Group for
management services provided during the twelve months ended December 31, 2005
and 2004.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4." This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
United States and accounting principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment," a
revision to SFAS 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123R establishes standards for the accounting
for transactions in which an entity exchanges instruments for goods or services.
It also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity-based compensation issued to
employees. SFAS 123R requires the Company to value the share-based compensation
based on the classification of the share-based award. If the share-based award
is to be classified as a liability, the Company must re-measure the award at
each balance sheet date until the award is settled. If the share-based award is
to be classified as equity, the Company will measure the value of the
share-based award on the date of grant but the award will not be re-measured at
each balance sheet date. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for public
companies with calendar year ends no later than the beginning of 2006. All
public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS 123 except that the amounts must be
recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS 123 amounts
in the statement of operations. Management is in the process of determining the
effect SFAS 123R will have upon the Company's financial position and statement
of operations and the method of transition adoption.
- 30 -
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have any derivative financial instruments as of December 31,2005. However, we are exposed to certain market risks arising from transactions
in the normal course of business, principally the risk associated with foreign
currency fluctuations. We do not hedge our risk associated with foreign currency
fluctuations.
FOREIGN CURRENCY RISK
Our earnings are affected by fluctuations in the value of our foreign
subsidiary's functional currency, and by fluctuations in the value of the
functional currency of our foreign receivables, which primarily have been from
Avalon.
We recognized a $10,000 loss, $33,000 loss and $58,000 gain during the
years ended December 31, 2005, 2004 and 2003, respectively, primarily in
connection with foreign exchange fluctuations in the timing of payments received
on accounts receivable from Avalon.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements begin on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information required by this Item 9 has been previously furnished and
is incorporated herein by reference to our forms 8-K filed on (i) March 15,2005,
and amendment to such form 8-K filed on March 16, 2005, (ii) February 16,2006
and amendment to such form 8-K filed on March 20,2006
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and interim Chief Financial Officer of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
this evaluation, our Chief Executive Officer and interim Chief Financial Officer
concluded that our disclosure controls and procedures are effective, at the
reasonable assurance level, in ensuring that information required to be
disclosed is recorded, processed, summarized and reported within the time
periods specified by the SEC rules and forms.
There were no changes made in our internal controls over financial
reporting that occurred during the quarter ended December 31, 2005 that have
materially affected or reasonably likely to materially affect these controls.
Our management, including the CEO, does not expect that our disclosure
controls and procedures or our internal control over financial reporting will
necessarily prevent all fraud and material errors. An internal control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations on all internal
control systems, our internal control system can provide only reasonable
assurance of achieving its objectives and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within our Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, and/or by management override of the control. The design of any system
of internal control is also based in part upon certain assumptions about the
likelihood of future events, and can provide only reasonable, not absolute,
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Over time, controls may become inadequate because
of changes in circumstances, and/or the degree of compliance with the policies
and procedures may deteriorate.
- 31 -
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
SUMMARY INFORMATION CONCERNING DIRECTORS, EXECUTIVE OFFICERS AND CERTAIN
SIGNIFICANT EMPLOYEES
The following table sets forth certain information regarding our directors
and executive officers and their ages as of May 10, 2006:
DIRECTORS AGE PRESENT POSITION
Herve Caen 44 Chairman of the Board of Directors,
Chief Executive Officer and Interim
Chief Financial Officer
Eric Caen 40 Director
Michel Welter (1)(2)(3) 47 Director
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
(3) Member of the Independent Committee of the Board of Directors.
Herve Caen and Eric Caen are brothers. There are no other family
relationships between any director and/or any executive officer. The Board of
Directors has determined that there are no other significant employees for
purposes of this Item 10.
BACKGROUND INFORMATION CONCERNING DIRECTORS AND EXECUTIVE OFFICERS
HERVE CAEN joined us as President and as a director in November 1999. Mr.
Caen was appointed interim Chief Executive Officer in January 2002 and currently
serves as our Chief Executive Officer and interim Chief Financial Officer to
date. Mr. Caen has served as Chairman of our Board of Directors since September
2001. Mr. Caen has served as Chairman of the Board of Directors of Titus
Interactive S.A., an interactive entertainment software company since 1991. Mr.
Caen was also Chief Executive Officer of Titus Interactive S.A. from 1991
through December 31, 2002. Mr. Caen also served as Managing Director of Titus
Interactive Studio, Titus SARL and Digital Integration Services, which positions
he has held since 1985, 1991 and 1998, respectively. Mr. Caen also served as
Chief Executive Officer of Titus Software Corporation, Chairman of Titus
Software UK Limited and Representative Director of Titus Japan K.K., which
positions he has held since 1988, 1991 and 1998, respectively.
ERIC CAEN has served as a director since November 1999. Mr. Caen has served
as a Director and as President of Titus Interactive S.A. since 1991.Mr. Caen
also served as Vice President of Titus Software Corporation, Secretary and
Director of Titus Software UK Limited and Director of Titus Japan K.K. and
Digital Integration Limited, which positions he has held since 1988, 1991, 1998
and 1998, respectively. Mr. Caen has also served as Managing Director of Total
Fun 2, a French record production company, since 1998. Mr. Caen served as
Managing director of Titus SARL from 1988 to 1991.
MICHEL WELTER joined our Board of Directors in September 2001. Mr. Welter,
together with his company Weltertainment, is involved in the trading and
exploitation of animated TV series. From 2000 to 2002 he served as President of
CineGroupe International, a Canadian company, which develops, produces and
distributes animated television series and movies. From 1990 to the end of 2000,
Mr. Welter served as President of Saban Enterprises where he launched the
international merchandising for the hit series "Power Rangers" and was in charge
of international business development where he put together numerous
co-productions with companies in Europe and Asia.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
our executive officers, directors, and persons who own more than 10% of a
registered class of our equity securities to file reports of ownership and
changes in ownership with the SEC. Executive officers, directors and greater
than 10% stockholders are required by SEC rules and regulations to furnish us
with all Section 16(a) forms they file. Based solely on our review of the copies
of the forms received by us and
- 32 -
representations from certain reporting persons that they have complied with the
relevant filing requirements, we believe that, during the year ended December31, 2005, all our executive officers, directors and greater than 10%
stockholders complied with all Section 16(a) filing requirements.
AUDIT COMMITTEE INDEPENDENCE AND AUDIT COMMITTEE FINANCIAL EXPERT.
The Audit Committee currently consists of Michel Welter. The Board has
determined that there is no "audit committee financial expert", as that term is
defined in Section 407 of the Sarbanes-Oxley Act of 2002 and pursuant to the
rules and regulations of the SEC. The Board determined that Mr. Welter is,
"independent", as that term is defined under the rules of the National
Association of Securities Dealers, Inc.
CODE OF ETHICS
We have adopted a Code of Ethics for all of our employees, including our
principal executive officer, principal financial officer, principal accounting
officer or controller and any person performing similar functions. The Code of
Ethics was filed as an exhibit to the Amendment No. 1 to the 10-K for the period
ended December 31, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
earned during the last three fiscal years ended December 31, 2005, by our Chief
Executive Officer whose total salary and bonus during the year ended December31, 2005 exceeded $100,000 (collectively, the "Named Executive Officer"). No
other executive officer serving at December 31, 2005, received total salary and
bonus during 2005 in excess of $100,000.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
------------
ANNUAL COMPENSATION SECURITIES
------------------------------ UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS(#) COMPENSATION
-------------------------------- ---- ----------- ----- ------------ ------------
Herve Caen (1).................. 2005 $ 76,667 (2) -- -- --
Chairman of the Board of 2004 260,330 -- -- --
Directors, Chief Executive 2003 487,330 (3) -- -- (4)
Officer and Interim Chief
Financial Officer
----------
(1) Mr. Caen joined us as President in November 1999. Mr. Caen was appointed
Chief Executive Officer in January 2002 and currently serves as our Chief
Executive Officer and interim Chief Financial Officer. Mr. Caen has served
as Chairman of our Board of Directors since September 2001. In March 2003,
our Compensation Committee approved an annual base salary of $360,000 as
Chief Executive officer and $100,000 per year while serving as interim
Chief Financial Officer.
(2) Mr. Caen was only paid a portion of his salary during the period ended
December 31, 2005 due to limited cash available. We accrued the balance due
Mr. Caen of $383,333 as of December 31,2005.
(3) Mr. Caen was only paid a portion of his salary during the period ended
December 31, 2004 due to the limited cash available. We accrued the balance
due Mr. Caen of $199,670 as of December 31, 2004.
(4) Mr. Caen received 2,000 shares of our common stock pursuant to a
non-discretionary grant made under the terms of our Employee Stock Purchase
Program.
- 33 -
STOCK OPTION GRANTS IN FISCAL 2005
There were no stock options or stock appreciation rights granted to the
Named Executive Officer during the year ended December 31, 2005.
AGGREGATE OPTION/ SAR EXERCISES
AND 2005 YEAR-END OPTION VALUES
There were no exercises of stock options or stock appreciation rights
during the year ended December 31, 2005 for any of the Named Executive Officer.
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN-THE-
UNEXERCISED OPTIONS MONEY OPTIONS AT
AT YEAR-END YEAR-END
(EXERCISABLE/ (EXERCISABLE/
NAME ON EXERCISE VALUE REALIZED UNEXERCISABLE) UNEXERCISABLE) (1)
----------------- ----------- -------------- -------------- ------------------
Herve Caen ...... -- -- -- --
----------
(1) Represents an amount equal to the difference between the closing sale
price for our common stock ($0.01) on the Over-The-Counter Bulletin
Board on December 31, 2005, and the option exercise price, multiplied
by the number of unexercised in-the-money options. None of the options
held by the Named Executive Officers were in-the-money at year-end.
DIRECTOR COMPENSATION
Currently, we accrue for payment to each of our non-employee director's
compensation as follows:
o $5,000 in cash compensation per quarter for attendance at Board of
Directors meetings.
o $5,000 in cash compensation per annum for each Board committee a
director is a member of and participates in.
o Upon election and appointment to the Board, or upon loss of employee
status of an employee director, an option to purchase up to 25,000
shares of our common stock under the Third Amended and Restated 1997
Stock Incentive Plan. These director options are each for a term of
ten years and vest over the first three years.
o An option to purchase 5,000 shares of our common stock under the Third
Amended and Restated 1997 Stock Incentive Plan for each subsequent
year of director service. These director options are each for a term
of ten years and vest over the first three years.
EMPLOYMENT AGREEMENTS
Mr. Herve Caen currently serves as our Chief Executive Officer and interim
Chief Financial Officer. We previously entered into an employment agreement with
Mr. Herve Caen for a term of three years through November 2002, pursuant to
which he currently serves as our Chairman of the Board of Directors and Chief
Executive Officer. The employment agreement provided for an annual base salary
of $250,000, with such annual raises as may be approved by the Board of
Directors, plus annual bonuses at the discretion of the Board of Directors. Mr.
Caen is also entitled to participate in the incentive compensation and other
employee benefit plans established by us from time to time. In March 2003, our
Compensation Committee approved an annual base salary increase for Mr. Caen from
$250,000 to $360,000. The Compensation Committee is currently negotiating a new
employment agreement with Mr. Caen.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee currently consists of Michel Welter. During
2005, decisions regarding executive compensation were made by our Compensation
Committee. Neither of the current 2005 member of our Compensation Committee nor
any of our 2005 executive officer or directors had a relationship that would
constitute an interlocking relationship with executive officers and directors of
another entity.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The following is the Report of the Compensation Committee describing the
compensation policies applicable to the Company's executive officers. This
information shall not be deemed to be "soliciting material" or to be "filed"
with the SEC
- 34 -
nor shall this information be incorporated by reference into any future filing
under the Securities Act of 1933, as amended, or the Securities Exchange Act of
1934, as amended, except to the extent that the company specifically
incorporates it by reference into a filing.
Compensation Policies and Objectives
The Compensation Committee reviews and approves the annual salary, bonus
and other benefits, including incentive compensation awards, of our executive
officers, including the Chief Executive Officer. The Compensation Committee also
reviews the employee benefit plans and recommends changes to the existing plans
to the Board of Directors. The executive compensation policy is designed to
attract and retain exceptional executives by offering compensation for superior
performance that is competitive with other well-managed organizations. The
Compensation Committee measures executive performance on an individual and
corporate basis.
There are three components to the executive compensation program, as follows:
Base Salary. Base salaries for executives and other key employees are
determined by individual financial and non-financial performance and general
economic conditions of the company and of the industry. In recommending salaries
for executive officers, the Compensation Committee (i) reviews the historical
performance of the executives, and (ii) reviews specific information provided by
its accountants and other consultants, as necessary, with respect to the
competitiveness of salaries paid to the our executives.
Annual Bonus. Annual bonuses for executives and other key employees are
tied directly to the company's financial performance as well as individual
performance. The purpose of annual cash bonuses is to reward executives for
achievements of corporate, financial and operational goals. Annual cash bonuses
are intended to reward the achievement of outstanding performance. If certain
objective and subjective performance goals are not met, annual bonuses are
reduced or not paid.
Long-Term Incentives. The purpose of these plans is to create an
opportunity for executives and other key employees to share in the enhancement
of stockholder value through stock options. The overall goal of this component
of pay is to create a strong link between the management of the company and its
stockholders through management stock ownership and the achievement of specific
corporate financial measures that result in the appreciation of our share price.
Stock options are awarded in order to tie the executive officers' interests to
the company's performance and align those interests closely with those of our
stockholders. The Compensation Committee generally has followed the practice of
granting options on terms that provide that the options become exercisable in
installments over a two to five year period. The Compensation Committee believes
that this feature not only provides an employee retention factor but also makes
longer-term growth in share prices important for those receiving options.
No stock options were granted to our executive officers in 2005. The
Compensation Committee continues to review the desirability of issuing stock
options to its executive officers in any given fiscal year to provide incentives
in connection with our corporate objectives.
Fiscal Year 2005 Chief Executive Officer Compensation
The salary, annual raises and annual bonus of Herve Caen, our Chief
Executive Officer and interim Chief Financial Officer, are determined in
accordance with Mr. Caen's employment agreement with us. Mr. Caen's employment
agreement provides for a base salary of $360,000 per year, with annual raises
and bonuses as may be approved at the discretion of our Board of Directors and
$100,000 per year while serving as interim Chief Financial Officer. The amounts
of any annual raises or bonuses are determined in accordance with the policies
and objectives set forth above. For the fiscal year ended December 31, 2005, Mr.
Caen received $76,667 in compensation as Chief Executive Officer and interim
Chief Financial Officer and the remainder of his salary was accrued. The
Compensation Committee did not award Mr. Caen any options during 2005. The
Compensation Committee is currently negotiating a new employment agreement with
Mr. Herve Caen.
Tax Law Implications for Executive Compensation
Section 162(m) of the Internal Revenue Code limits us to a deduction for
federal income tax purposes of no more than $1 million of compensation paid to
certain Named Executive Officers in a taxable year. Compensation above $1
million may be deducted if it is "performance-based compensation" within the
meaning of the Code. The Compensation Committee believes that at present the
compensation paid to each Named Executive Officer in a taxable year will not
exceed the deduction limit of $1 million under Section 162(m). However, the
Compensation Committee has determined that stock awards granted under
- 35 -
the long-term incentive plans with an exercise price at least equal to the fair
market value of our common stock on the date of grant will be treated as
"performance-based compensation."
The Compensation Committee
Michel Welter
PERFORMANCE GRAPH
The following graph sets forth the percentage change in cumulative
total stockholder return of our common stock during the period from December 31,2000 to December 31, 2005, compared with the cumulative returns of the NASDAQ
Stock Market (U.S. Companies) Index and the Media General Index 820*. The
comparison assumes $100 was invested on December 31, 2000 in our common stock
and in each of the foregoing indices. Information presented below is as of the
end of the fiscal year ended December 31st 2005.
This performance graph and the data related thereto shall not be deemed to
be "soliciting material" or "filed" with the SEC nor shall this information be
incorporated by reference into any future filing under the Securities Act of
1933, as amended, or the Securities Exchange Act of 1934, as amended, except to
the extent that we specifically incorporate it by reference into a filing.
- 36 -
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of May 8, 2006, unless otherwise
indicated, certain information relating to the ownership of our common stock by
(i) each person known by us to be the beneficial owner of more than 5% of the
outstanding shares of our common stock, (ii) each of our directors, (iii) each
of the Named Executive Officers, and (iv) all of our executive officers and
directors as a group. Except as may be indicated in the footnotes to the table
and subject to applicable community property laws, each such person has the sole
voting and investment power with respect to the shares owned. The address of
each person listed is in care of us, 100 N. Crescent Drive, Beverly Hills , CA90210 unless otherwise set forth below such person's name.
NUMBER OF SHARES
OF COMMON STOCK
NAME AND ADDRESS BENEFICIALLY OWNED (1) PERCENT (2)
---------------- ---------------------- -----------
DIRECTORS AND NAMED EXECUTIVE OFFICER:
Herve Caen............................. 8,681,306 (4) 9.2%
Eric Caen.............................. 30,001 (5) *
Michel Welter.......................... 60,001 (6) *
5% HOLDERS:
Titus Interactive SA................... 58,426,293 (3) 62.3%
Parc de l'Esplanade
12, rue Enrico Fermi
St-Thibault-des-Vignes
77462 Lagny-sur-Marne Cedex
France
Directors and Executive Officers
as a Group (3 persons).............. 8,721,308 9.2%
* Less than one percent.
(1) Beneficial ownership is determined h the rules and regulations of the SEC
and generally includes voting or investment power with respect to
securities. Shares of common stock subject to options currently
exercisable, or exercisable within 60 days of May 8,2006 are deemed
outstanding for computing the percentage of the person holding such options
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of common stock shown as
beneficially owned by them. The information as to shares beneficially owned
has been individually furnished by the respective directors, Named
Executive Officers, and other stockholders, or taken from documents filed
with the SEC.
(2) Based on 93,855,634 shares of common stock outstanding as of May 8,2006.
This includes 4,658,216 shares of Treasury Stock. Percentages are rounded
to the nearest tenth of a percent.
(3) Includes 460,298 shares subject to warrants exercisable within 60 days of
May 8,2006.
(4) Includes 8,681,306 shares of our common stock held by Mrs. Solange Caen,
Herve Caen's spouse.
(5) Includes 30,001 shares subject to stock options exercisable within 60 days
of May 8,2006. (
6) Includes 20,001 shares subject to stock options exercisable within 60 days
of May 8 2006.
- 37 -
EQUITY COMPENSATION PLANS INFORMATION
The following table sets forth certain information regarding our equity
compensation plans as of December 31, 2005:
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
approved by security 70,000 0.30 10,014,877
holders
Equity compensation
plans not approved by -
security holders
---------------------------------------------------------------------------
Total 70,000 0.30 10,014,877
===========================================================================
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. . 84,877 shares remain available for issuance under the Company's Employee
Stock Purchase 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 $0 for the years ended December 31, 2005, 2004 and 2003,
respectively.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
It is our policy that related party transactions are to be reviewed and
approved by a majority of our disinterested directors or our Independent
Committee.
Our operations involve significant transactions with our majority
stockholder Titus and its affiliates. We had a major distribution agreement with
Avalon, an affiliate of Titus.
TRANSACTIONS WITH TITUS
Titus (placed in involuntary bankruptcy in January 2005) presently owns
approximately 58 million shares of our common stock.
We performed certain distribution services on behalf of Titus for a fee. In
connection with such distribution services, we recognized fee income of $0 and
$0 for the twelve months ended December 31, 2005, and 2004, respectively.
As of December 31, 2005 and December 31, 2004, Titus and its affiliates
excluding Avalon owed us $105,000 and $370,000, respectively. We owed Titus and
its affiliates excluding Avalon $0 and $30,000 as of December 31, 2005 and
December 31, 2004 respectively.
- 38 -
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
We had an International Distribution Agreement with Avalon, a wholly owned
subsidiary of Titus. Pursuant to this distribution agreement, Avalon provided
for the exclusive distribution of substantially all of our products in Europe,
Commonwealth of Independent States, Africa and the Middle East for a seven-year
period ending February 2006, cancelable under certain conditions, subject to
termination penalties and costs. Under this agreement, as amended, we paid
Avalon a distribution fee based on net sales, and Avalon provides certain market
preparation, warehousing, sales and fulfillment services on our behalf. In
connection with the International Distribution Agreement with Avalon, we
incurred distribution commission expense of $0 and $62,000, for the twelve
months ended December 31, 2005, and 2004 respectively. This agreement was
terminated as a result of Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software Corp.,
("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at September 30, 2004 was approximately $254,000. The total receivable
due from TSC is approximately $327,000 as of September 30, 2004. The majority of
the additional approximately $73,000 was due to TSC subletting office space and
miscellaneous other items. As of October 31,2005 the outstanding balance owed
from TSC was approximately $71,000. The outstanding balance was reduced by
offsetting a note receivable the Company had with Phil Adam, the Company's prior
President, with a balance he had due TSC.
In May 2003, we paid TSC $60,000 to cover legal fees in connection with a
lawsuit against Titus. As a result of the payment, our CEO requested that we
credit the $60,000 to amounts we owed to him arising from expenses incurred in
connection with providing services to the Company.
TRANSACTIONS WITH TITUS JAPAN
In June 2003, we began operating under a representation agreement with
Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of Titus,
pursuant to which Titus Japan represents us as an agent in regards to certain
sales transactions in Japan. This representation agreement has not yet been
approved by our Board of Directors and is currently being reviewed by them. Our
Board of Directors has approved the payments of certain amounts to Titus Japan
in connection with certain services already performed by them on our behalf. As
of December 31, 2005, the Company had a balnce due from Titus Japan in the
amount of $192,000. During the twelve months ending December 31, 2005 our
Japanese subsidiary paid to Titus Japan approximately $221,000 in commissions,
marketing and publishing staff services. Our Japanese subsidiary had
approximately $404,000 in revenue in the twelve months ending December 31, 2005.
TRANSACTIONS WITH TITUS SARL
As of December 31, 2005, we have a receivable of $18,000 and $18,000
respectively for product development services that we provided of which reserves
have been allocated accordingly. Titus SARL was placed into involuntary
liquidation in January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, we engaged the services of GIE Titus Interactive Group, a
wholly owned subsidiary of Titus, for a three-month service agreement pursuant
to which GIE Titus or its agents shall provide to us certain foreign
administrative and legal services at a rate of $5,000 per month for three
months. As of December 31, 2005, we had a zero balance with Titus GIE
Interactive Group. Titus GIE was placed into involuntary liquidation in January
2005.
- 39 -
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Rose, Snyder & Jacobs ("RSJ") served as our independent auditors for fiscal
year ended December 31, 2004 . On February 15, 2006, the Company engaged Jeffrey
S. Gilbert Certified Public accountant ("New Accountant") to audit the Company's
financial statements for the fiscal year ended December 31, 2005.
Aggregate fees billed by our independent auditors for professional services
rendered for the audit of fiscal years 2005 and 2004 and for other professional
services billed in fiscal years 2005 and 2004 are as follows:
YEAR ENDED
DESCRIPTION OF FEES DECEMBER 31,2005 DECEMBER 31, 2004
------------------- ---------------- -----------------
Audit Fees .................. $25,000 (2) $45,000 (1)
Audit-Related Fees .......... 5,000 (2) $5,000 (2)
Tax Fees .................... --
All Other Fees .............. ---------------- -----------------
TOTAL: .............. $30,000 $50,000
================ =================
(1) This entire amount was paid to ("RSJ").
(2) We expect to incur fees in of approximately this amount in connection
with the review of this form 10-K for the year ended December 31, 2005
and December 31, 2004.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
Our Audit Committee has a policy that all audit and non-audit related
services provided by our independent auditor is to be approved by our Audit
Committee. Specifically, the Audit Committee requires that prior to the
engagement of our independent auditor for any specified service, the approval of
the Audit Committee must be received. All such matters are to be approved in a
scheduled meeting of the Audit Committee consisting of a quorum of the Audit
Committee. All of the above aggregate fees billed by our independent auditors
have been approved pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation
S-X.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents, except for exhibit 32.1 which is being furnished
herewith, are filed as part of this report:
(1) Financial Statements
The list of financial statements contained in the accompanying Index to
Consolidated Financial Statements covered by the Reports of Independent Auditors
is herein incorporated by reference.
(2) Financial Statement Schedules
The list of financial statement schedules contained in the accompanying
Index to Consolidated Financial Statements covered by the Reports of Independent
Auditors is herein incorporated by reference.
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or the
Notes thereto.
(3) Exhibits
The list of exhibits on the accompanying Exhibit Index is herein
incorporated by reference.
- 40 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized, at Irvine, California
this 18th day of May, 2006.
INTERPLAY ENTERTAINMENT CORP.
/s/ Herve Caen
By:___________________________________
Herve Caen
Its: Chief Executive Officer and
Interim Chief Financial Officer
(Principal Executive and
Financial and Accounting Officer)
POWER OF ATTORNEY
The undersigned directors and officers of Interplay Entertainment Corp. do
hereby constitute and appoint Herve Caen with full power of substitution and
resubstitution, as their true and lawful attorneys and agents, to do any and all
acts and things in our name and behalf in our capacities as directors and
officers and to execute any and all instruments for us and in our names in the
capacities indicated below, which said attorney and agent, may deem necessary or
advisable to enable said corporation to comply with the Securities Exchange Act
of 1934, as amended and any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with this Annual Report on
Form 10-K, including specifically but without limitation, power and authority to
sign for us or any of us in our names in the capacities indicated below, any and
all amendments (including post-effective amendments) hereto, and we do hereby
ratify and confirm all that said attorneys and agents, or either of them, shall
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Annual Report and Form 10-K has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
/s/ Herve Caen
_______________________ Chief Executive Officer, Interim May 18, 2006Herve Caen Chief Financial Officer and
Director (Principal Executive
and Financial and Accounting
Officer)
/s/ Eric Caen
_______________________ Director May 18, 2006Eric Caen
/s/ Michel Welter
_______________________ Director May 18, 2006Michel Welter
- 41 -
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) under the Securities Exchange Act of 1934, as
amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) under the Securities Exchange Act of 1934, as
amended.
32.1 Certification of Chief Executive Officer and interim Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 by Herve Caen.
99.1 Form of Stipulation of Settlement entered into by the Company with
various Special Situation funds dated May 3, 2006; (incorporated by
reference to Exhibit 99.1 to the Form 8-K filed on May 10, 2006).
- 44 -
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORTS OF INDEPENDENT AUDITORS
PAGE
----
Reports of Independent Registered Public Accounting Firms F-2
Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2005 and 2004 F-4
Consolidated Statements of Operations for the years ended
December 31, 2005, 2004 and 2003 F-5
Consolidated Statements of Stockholder's Equity (Deficit) for the
years ended December 31, 2005, 2004, 2003 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004 and 2003 F-7
Notes to Consolidated Financial Statements F-9
Schedule II - Valuation and Qualifying Accounts S-1
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Interplay Entertainment Corp.
I have audited the consolidated balance sheet of Interplay Entertainment
Corp.(a majority-owned subsidiary of Titus Interactive,S.A.) and Subsidiaries
(the "Company") as of December 31, 2005 and the related consolidated statements
of operations, stockholders' equity (deficit)and cash flows for the year then
ended. My audit included the schedule of valuation and qualifying accounts for
the year ended December 31, 2005. These consolidated financial statements are
the responsibility of the Company's management. My responsibility is to express
an opinion on these consolidated financial statements and schedule based on my
audit.
I conducted my audit in accordance with standards Of the Public Company
Accounting Oversight Board (United States).Those standards require that I plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, I express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. I believe my audit provides a reasonable basis for my
opinion.
In my opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Interplay Entertainment Corp. and Subsidiaries as of December 31, 2005 and the
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States of
America. Also, in my opinion the related financial statement schedule for the
year ended December 31, 2005, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set fort therein.
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 1 to
the consolidated financial statements, the Company has limited liquid resources,
a history of losses, and negative working capital of $11,512,000 and
stockholders' deficit of $11,490,000. These matters raise substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also discussed in Note 1. The consolidated financial
statements do not include any adjustment that might result from the outcome of
this uncertainty.
/s/ JEFFREY S. GILBERT
Los Angeles, California
May 16, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated balance sheet of Interplay
Entertainment Corp. (a majority-owned subsidiary of Titus Interactive S.A.), and
subsidiaries (the "Company"), as of December 31, 2004, and the related
consolidated statement of operations, shareholders' equity (deficit) and other
comprehensive income (loss) and cash flows for the year then ended. Our audit
also included the schedule of valuation and qualifying accounts for the year
ended December 31, 2004. These consolidated financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and schedule based
on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Interplay
Entertainment Corp. and subsidiaries as of December 31, 2004, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule for the year ended
December 31, 2004, when considered in relation to the basic financial
statements, taken as a whole, presents fairly in all material respects the
information set forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has negative working capital of $17.8 million and a stockholders'
deficit of $17.3 million at December 31, 2004. These factors, among others,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are described in Note 1.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Rose, Snyder & Jacobs, A Corporation of Public Accountants
Encino, California
May 31, 2005
F-3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Interplay Entertainment Corp.
We have audited the accompanying consolidated statements of operations,
shareholders' equity (deficit) and other comprehensive income (loss) and cash
flows for the year ended December 31, 2003 of Interplay Entertainment Corp. (a
majority-owned subsidiary of Titus Interactive S.A.), and subsidiaries (the
"Company"). Our audit also included the schedule of valuation and qualifying
accounts for the year ended December 31, 2003. These consolidated financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Interplay Entertainment Corp and subsidiaries for the year ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, the related financial
statement schedule for the year ended December 31, 2003, when considered in
relation to the basic financial statements, taken as a whole, presents fairly in
all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has negative working capital and a stockholders' deficit at
December 31, 2003. These factors, among others, raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Squar, Milner, Reehl & Williamson, LLP
Newport Beach, California
March 25, 2004
F-4
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
ASSETS 2005 2004
------------- -------------
Current Assets:
Cash ...................................... $ 122,000 $ 29,000
Restricted Cash ........................... -- 2,000
Trade receivables from related parties,
net of allowances of $2,114,000
and $2,370,000, respectively .......... 17,000 10,000
Trade receivables, net of allowances
of $76,000 and $36,000, respectively .. 428,000 139,000
Inventories ............................... 8,000 26,000
Deposits .................................. 8,000 --
Prepaid expenses .......................... 60,000 --
Other receivables .......................... 8,000 137,000
------------- -------------
Total current assets .................. 651,000 343,000
Property and equipment, net .................... 7,000 490,000
Other assets ................................... 15,000 0
------------- -------------
Total assets ......................... $ 673,000 $ 833,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current debt .............................. $ 1,549,000 $ 1,575,000
Accounts payable .......................... 9,560,000 8,772,000
Accrued royalties ......................... 949,000 3,501,000
Advances from distributors and others ..... 105,000 883,000
Advances from related party distributors .. -- 2,989,000
Deferred Income ........................... -- 475,000
------------- -------------
Total current liabilities ............ 12,163,000 18,195,000
------------- -------------
Commitments and contingencies
Stockholders' Equity (Deficit):
Preferred stock, $0.001 par value 5,000,000
shares authorized; no shares issued or
outstanding, respectively,
Common stock, $0.001 par value 150,000,000
shares authorized; 93,855,634 shares
issued and outstanding, respectively .. 94,000 94,000
Paid-in capital ........................... 121,640,000 121,640,000
Accumulated deficit ....................... (133,284,000) (139,211,000)
Accumulated other comprehensive income .... 60,000 115,000
Treasury stock of 4,658,216 shares at
December 31,2005 ...................... 0 0
------------- -------------
Total stockholders' (deficit) ........ (11,490,000) (17,362,000)
------------- -------------
Total liabilities and stockholders'
(deficit) ......................... $ 673,000 $ 833,000
============= =============
See accompanying notes.
F-5
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
Net revenue from recognition on expired contracts $ 4,571,000 $ -- $ --
Net revenues from licensing ..................... 768,000 1,932,000 2,286,000
Net revenues from related and non related party
distributors ................................. 1,819,000 11,265,000 34,015,000
------------- ------------- -------------
Total net revenues ........................... 7,158,000 13,197,000 36,301,000
Cost of goods sold .............................. 478,000 6,826,000 13,120,000
------------- ------------- -------------
Gross profit ................................. 6,680,000 6,371,000 23,181,000
------------- ------------- -------------
Operating expenses:
Marketing and sales .......................... 312,000 1,703,000 1,415,000
General and administrative ................... 2,617,000 4,514,000 6,692,000
Product development .......................... 268,000 2,636,000 13,680,000,
------------- ------------- -------------
Total operating expenses .................. 3,197,000 8,853,000 21,787,000
------------- ------------- -------------
Operating income (loss) .................. 3,483,000 (2,482,000) 1,394,000
------------- ------------- -------------
Other income (expense):
Interest expense .......................... (146,000) (218,000) (249,000)
Other (primarily settlements in 2005) ........ 2,591,000 (1,999,000) 136,000
------------- ------------- -------------
Total other income (expense) ............. 2,445,000 (2,248,000) (82,000)
------------- ------------- -------------
Income (loss) before provision (benefit) for
income taxes ............................... 5,928,000 (4,730,000) 1,312,000
Provision (benefit) for income taxes ............ -- -- --
------------- ------------- -------------
Net income (loss) ............................... $ 5,928,000 $ (4,730,000) $ 1,312,000
============= ============= =============
Net income (loss) per common share:
Basic ........................................... $ 0.06 $ (0.05) $ 0.01
============= ============= =============
Diluted
$ 0.06 $ (0.05) $ 0.01
============= ============= =============
Weighted average number of shares used in
calculating net income (loss) per
common share:
Basic ........................................... 93,856,000 93,856,000 93,852,000
============= ============= =============
Diluted ......................................... 93,856,000 93,856,000 104,314,000
============= ============= =============
See accompanying notes.
F-6
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED DECEMBER 31,
-----------------------------------------
2005 2004 2003
----------- ----------- -----------
Supplemental cash flow information:
Cash paid during the year for interest ........... $ -- $ -- $ 212,000
Supplemental disclosure of non-cash investing and
financing activities:
Dividend payable on partial conversion of
preferred stock ................................ -- -- --
Accrued dividend on participating preferred
stock .......................................... -- -- --
Common stock issued under Product Agreement ...... -- -- --
See accompanying notes.
F-9
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2005, 2004 AND 2003
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Interplay Entertainment Corp., a Delaware corporation, and its subsidiaries
(the "Company"), publish and license out interactive entertainment software. The
Company's software is developed for use on various interactive entertainment
software platforms, including personal computers and video game consoles, such
as the Sony PlayStation 2, Microsoft Xbox and Nintendo GameCube. As of December31, 2005, Titus Interactive, S.A. ("Titus") which is in bankruptcy, and is a
France-based developer, publisher and distributor of interactive entertainment
software, owns 62% of the Company's common stock. The Company's common stock is
quoted on the NASDAQ OTC Bulletin Board under the symbol "IPLY", or while
non-compliant "IPLYE".
GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern, which contemplates, among
other things, the realization of assets and satisfaction of liabilities in the
normal course of business. The Company had net operating income of $5.9 million
in 2005, primarily derived through the reversal of deferred income related to
advance minimum royalties on licensing agreements that expired in 2005. At
December 31, 2005, the Company had a stockholders' deficit of $ 11.5 million and
a working capital deficit of $11.4 million. The Company has historically funded
its operations from licensing fees, royalty and distribution fee advances, and
will have to focus on exploiting its existing intellectual properties to provide
future funding.
To reduce working capital needs, the Company has implemented various
measures including a reduction of personnel, a reduction of fixed overhead
commitments and cancellation or suspension of development on future titles.
Management will continue to pursue various alternatives to improve future
operating results and further expense reductions, some of which may have a
long-term adverse impact on the Company's ability to generate successful future
business activities.
In addition, the Company continues to seek, and expects to require,
external sources of funding including, but not limited to, a sale or merger of
the Company, a private placement of the Company's capital stock, the sale of
selected assets, the licensing of certain product rights in selected
territories, selected distribution agreements, and/or other strategic
transactions sufficient to provide short-term funding, and potentially achieve
the Company's long-term strategic objectives. Although the Company has had some
success in licensing certain of its products in the past, no assurance can be
given that the Company will do so in the future.
The Company anticipates its current cash reserves, plus its expected
generation of cash from existing operations, will only be sufficient to fund its
anticipated expenditures through the end of second quarter of fiscal 2006.
Consequently, the Company expects that it will need to substantially reduce its
working capital needs and/or raise additional financing. However, no assurance
can be given that alternative sources of funding can be obtained on acceptable
terms, or at all. These conditions, combined with the Company's historical
operating losses and its deficits in stockholders' equity and working capital,
raise substantial doubt about the Company's ability to continue as a going
concern. The accompanying consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets and liabilities that might result from the outcome of
this uncertainty.
AUTHORIZED COMMON STOCK
The Company has a total of 150,000,000 authorized shares of common
stock.
TREASURY STOCK
In December 2005, NBC Universal returned their 4,658,216 shares of the
Company's common stock at no cost to the Company. The Company included these
shares as treasury stock in 2005.
F-10
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Interplay Entertainment Corp. and its wholly-owned subsidiaries, Interplay
Productions Limited (U.K.), Interplay OEM, Inc., Interplay Co., Ltd., (Japan)
and Games On-line. All significant inter-company accounts and transactions have
been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates made in
preparing the consolidated financial statements include, among others, sales
returns and allowances, allowances for uncollectible receivables, cash flows
used to evaluate the recoverability of prepaid licenses and royalties and
long-lived assets, and certain accrued liabilities related to restructuring
activities and litigation. Actual results could differ from those estimates.
RISKS AND UNCERTAINTIES
The Company operates in a highly competitive industry that is subject to
intense competition, potential government regulation and rapid technological
change. The Company's operations are subject to significant risks and
uncertainties including financial, operational, technological, regulatory and
other business risks associated with such a company.
INVENTORIES
Inventories consist of packaged software ready for shipment, including
video game console software. Inventories are valued at the lower of cost
(first-in, first-out) or market. The Company regularly monitors inventory for
excess or obsolete items and makes any valuation corrections when such
adjustments are known. Based on management's evaluation, the Company has not
established any valuation allowance at December 31, 2005 .
Net realizable value is based on management's forecast for sales of the
Company's products in the ensuing years. The industry in which the Company
operates is characterized by technological advancement and changes. Should
demand for the Company's products prove to be significantly less than
anticipated, the ultimate realizable value of the Company's inventories could be
substantially less than the amount shown on the accompanying consolidated
balance sheets.
PREPAID LICENSES AND ROYALTIES
The Company has in the past had prepaid licenses and royalties consisting
of fees paid to intellectual property rights holders for use of their trademarks
or copyrights. Also included in prepaid royalties were prepayments made to
independent software developers under development arrangements that have
alternative future uses. These payments were contingent upon the successful
completion of milestones, which generally represent specific deliverables.
Royalty advances were recoupable against future sales based upon the contractual
royalty rate. The Company amortized these costs 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. The
Company amortized 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 reflected the Company's typical product life cycle. Management
evaluates the future realization of such costs quarterly and charges to cost of
goods sold any amounts that management deems unlikely to be fully realized
through future sales. Such costs were classified as current and noncurrent
assets based upon estimated product release dates.
SOFTWARE DEVELOPMENT COSTS
Research and development costs, which consist primarily of software
development costs, are expensed as incurred. Financial accounting Standards
Board ("FASB") 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
F-11
costs that have alternative future uses. Under the Company's current practice of
developing new products, the technological feasibility of the underlying
software is not established until substantially all product development is
complete, which generally includes the development of a working model. The
Company has not capitalized any software development costs on internal
development projects, as the eligible costs were determined to be insignificant.
ACCRUED ROYALTIES
Accrued royalties consist of amounts due to outside developers and
licensors based on contractual royalty rates for sales of shipped titles. The
Company records a royalty expense based upon a contractual royalty rate after it
has fully recouped the royalty advances paid to the outside developer, if any,
prior to shipping a title.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of computers,
equipment, and furniture and fixtures is provided using the straight-line method
over a period of five to seven years. Leasehold improvements are amortized on a
straight-line basis over the lesser of the estimated useful life or the
remaining lease term. Upon the sale or retirement of property and equipment, the
accounts are relieved of the cost and the related accumulated depreciation, with
any resulting gain or loss included in the consolidated statements of
operations.
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that their carrying amounts may not be
recoverable. If the cost basis of a long-lived asset is greater than the
estimated fair value, based on many models, including projected future
undiscounted net cash flows from such asset (excluding interest) and replacement
value, an impairment loss is recognized. Impairment losses are calculated as the
difference between the cost basis of an asset and its estimated fair value.
Management determined in 2005 that impairment existed related to specific items
of property and equipment and adjusted these items to zero.. There can be no
assurance, however, that market conditions will not change or demand for the
Company's products or services will continue which could result in additional
impairment of long-lived assets in the future.
GOODWILL AND INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS," which addresses how intangible assets that are acquired
individually or with a group of other assets should be accounted for in the
financial statements upon their acquisition and after they have been initially
recognized in the financial statements. SFAS 142 requires that goodwill and
identifiable intangible assets that have indefinite useful lives not be
amortized but rather be tested at least annually for impairment, and
identifiable intangible assets that have finite useful lives be amortized over
their useful lives. SFAS 142 provides specific guidance for testing goodwill and
identifiable intangible assets that will not be amortized for impairment. In
addition, SFAS 142 expands the disclosure requirements about goodwill and other
intangible assets in the years subsequent to their acquisition. At December 31,2005, the Company had no goodwill or intangible items subject to amortization.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable and accounts payable
approximates the fair value. In addition, the carrying value of all borrowings
approximates fair value based on interest rates currently available to the
Company. The fair value of trade receivable from related parties, advances from
related party distributor, loans to/from related parties and payables to related
parties are not determinable as these transactions are with related parties.
REVENUE RECOGNITION
Revenues are recorded when products are delivered to customers in
accordance with Statement of Position ("SOP") 97-2, "Software Revenue
Recognition" and SEC Staff Accounting Bulletin No. 104, Revenue Recognition.
With the signing of the new Vivendi Universal Games, Inc. distribution agreement
in August 2002, substantially all of the Company's sales were made by two
related party distributors (Notes 5 and 11 ), Vivendi Universal
Games,Inc.(Vivendi), which owned less than 5% of the outstanding shares of the
Company's common stock at that time, and Avalon Interactive Group Ltd.
("Avalon"), formerly Virgin Interactive Entertainment Limited, a wholly owned
subsidiary of Titus until the Company ended its relationship with them during
2005, most of the Vivendi distribution agreement ended in August, 2005, and
Avalon, because of bankruptcy, ceased to be the distributor in February 2005.
F-12
The Company entered into various licensing agreements during 2005 under
which it licensed others to exploit games to which the Company had intellectual
property rights . This included entering into agreements with Turner Games
Network and Vivendi and resulted in one time payments from each of these
licensees. These license agreements are generally for a two year term. In
addition, a tri-party agreement with Atari and Vivendi was entered into that
provided for all royalties that would otherwise be payable to Atari by Vivendi
from September, 2005 be paid to the Company with respect to Vivendi distribution
of Dungeons and Dragons titles owned by Atari.
The Company recognizes revenue from sales by distributors, net of sales
commissions, only as the distributor recognizes sales of the Company's 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,
revenue is recognized at the delivery and acceptance of the product gold master.
Per copy royalties on sales that exceed the guarantee are recognized as earned.
Guaranteed minimum royalties on sales, where the guarantee is not recognizable
upon delivery, are recognized as the minimum payments come due. The Company
recognizes revenue on expired contracts when the termination date of the
contract is reached because guaranteed minimum royalties are not reimbursable
and are therefore, recorded as revenue.
The Company is generally not contractually obligated to accept returns,
except for defective, shelf-worn and damaged products in accordance with
negotiated terms. However, on a case by case basis, the Company may permit
customers to return or exchange product and may provide markdown allowances on
products unsold by a customer. In accordance with SFAS No. 48, "Revenue
Recognition when Right of Return Exists," revenue is recorded net of an
allowance for estimated returns, exchanges, markdowns, price concessions and
warranty costs. Such reserves are based upon management's evaluation of
historical experience, current industry trends and estimated costs. Management
of the Company estimated that no reserves were necessary at December 31, 2005.
The amount of reserves ultimately required could differ materially in the near
term from the amounts included in the accompanying consolidated financial
statements.
Customer support provided by the Company is limited to internet support.
These costs are not significant and are charged to expenses as incurred.
The Company also engages 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. For
these activities, revenue is recognized when the rights have been transferred
and no other obligations exist.
ADVANCES FROM DISTRIBUTORS
Deferred income has been recognized when contracts with distributors have
expired or been terminated.
ADVERTISING COSTS
The Company generally expenses advertising costs as incurred, except for
production costs associated with media campaigns that are deferred and charged
to expense at the first run of the ad. Cooperative advertising with distributors
and retailers is accrued when revenue is recognized. Cooperative advertising
credits are reimbursed when qualifying claims are submitted. Advertising costs
approximated $.3 million, $1.2 million and $.6 million for the years ended
December 31, 2005, 2004 and 2003, respectively.
INCOME TAXES
The Company accounts for income taxes using the liability method as
prescribed by the SFAS No. 109, "Accounting for Income Taxes." The statement
requires an asset and liability approach for financial accounting and reporting
of income taxes. Deferred income taxes are provided for temporary differences in
the recognition of certain income and expense items for financial reporting and
tax purposes given the provisions of the enacted tax laws. A valuation allowance
has been provided for all deferred tax assets equal to the amounts of these
assets.
F-13
FOREIGN CURRENCY
The Company follows the principles of SFAS No. 52, "Foreign Currency
Translation," using the local currency of its operating subsidiaries as the
functional currency. Accordingly, all assets and liabilities outside the United
States are translated into U.S. dollars at the rate of exchange in effect at the
balance sheet date. Income and expense items are translated at the weighted
average exchange rate prevailing during the period. Gains or losses arising from
the translation of the foreign subsidiaries' financial statements are included
in the accompanying consolidated financial statements as a component of other
comprehensive loss. Gains and Losses resulting from foreign currency
transactions amounted to a $10,000 loss, $33,000 loss and $58,000 gain during
the years ended December 31, 2005, 2004 and 2003, respectively, and are included
in other income (expense) in the consolidated statements of operations.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per common share is computed by dividing income
(loss) attributable to common stockholders by the weighted average number of
common shares outstanding. Diluted net income (loss) per common share is
computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding plus the effect of any
convertible debt, dilutive stock options and common stock warrants if any. For
the years ended December 31, 2005, 2004 and 2003, all options and warrants
outstanding to purchase common stock were excluded from the earnings per share
computation as the exercise price was greater than the average market price of
the common shares.
The Company discloses information regarding segments in accordance with
SFAS No. 131 DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION.
SFAS No. 131 establishes standards for reporting of financial information about
operating segments in annual financial statements and requires reporting
selected information about operating segments in interim financial reports. The
Company is managed, and financial information is developed, on a geographical
basis, rather than a product line basis. Thus, the Company has provided segment
information on a geographical basis (see Note 13).
Allowance for Doubtful Accounts
Management establishes an allowance for doubtful accounts based on
qualitative and quantitative review of credit profiles of the Company's
customers, contractual terms and conditions, current economic trends and
historical payment, return and discount experience. Management reassesses the
allowance for doubtful accounts each period. If management made different
judgments or utilized different estimates for any period, material differences
in the amount and timing of revenue recognized could result. Accounts receivable
are written off when all collection attempts have failed.
Cost of Software Revenue
Cost of software revenue primarily reflects the manufacture expense and
royalties to third party developers, which are recognized upon delivery of the
product. Cost of support includes (i) sales commissions and salaries paid to
employees who provide support to clients and (ii) fees paid to consultants,
which are recognized as the services are performed. Sales commissions are
expensed as incurred.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) of the Company includes net income (loss)
adjusted for the change in foreign currency translation adjustments. The net
effect of income taxes on comprehensive income (loss) is immaterial.
STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with the
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and related Interpretations and makes the necessary pro forma
disclosures mandated by SFAS No. 123 "Accounting for Stock-based Compensation".
At December 31, 2005, the Company has one stock-based employee compensation
plan, which is described more fully in Note 10. The Company accounts for this
plan under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. No
Stock-based employee compensation cost was reflected in net income for the years
ended December 31, 2005, 2004 and 2003. The following table illustrates the
effect on
F-14
net income and earnings per common share if the Company had applied the fair
value recognition provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
YEARS ENDED DECEMBER 31,
----------------------------
2005 2004 2003
------- ------- -------
(Dollars in thousands,
except per share amounts)
Net income (loss) available to common stockholders, as reported $ 5,928 $(4,730) $ 1,312
Pro forma estimated fair value compensation expense ........... -- -- (177)
------- ------- -------
Pro forma net income (loss) available to common stockholders .. $ 5,928 $(4,730) $ 1,137
======= ======= =======
Basic net income (loss) per common share as reported .......... $ 0.06 $ (0.05) $ 0.01
Diluted net income (loss) per common share as reported $ 0.06 $ (0.05) $ 0.01
Basic pro forma net income (loss) per common share $ 0.06 $ (0.05) $ 0.01
Diluted pro forma net income (loss) per common share $ 0.06 $ (0.05) $ 0.01
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4." This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
United States and accounting principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment," a
revision to SFAS 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123R establishes standards for the accounting
for transactions in which an entity exchanges instruments for goods or services.
It also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity-based compensation issued to
employees. SFAS 123R requires the Company to value the share-based compensation
based on the classification of the share-based award. If the share-based award
is to be classified as a liability, the Company must re-measure the award at
each balance sheet date until the award is settled. If the share-based award is
to be classified as equity, the Company will measure the value of the
share-based award on the date of grant but the award will not be re-measured at
each balance sheet date. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for public
companies with calendar year ends no later than the beginning of 2006. All
public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS 123 except that the amounts must be
recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS 123 amounts
in the statement of operations. Management is in the process of determining the
effect SFAS 123R will have upon the Company's financial position and statement
of operations and the method of transition adoption.
F-15
In October 2005, the FASB issued statement No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154") which replaces APB Opinion No. 20. " Accounting
Changes " and FASB Statement No. 3, "reporting accounting Changes in Interim
Financial Statements". SFAS 154 retained accounting guidance related to changes
in estimates, changes in a reporting entity and error corrections; however,
changes in accounting principles must be accounted for retrospectively by
modifying the financial statements of prior periods. SFAS 154 is effective for
accounting changes made in fiscal years beginning after December 15, 2005. The
Company does not believe adoption of SFAS 154 will have a material impact on its
financial condition, results of operations, or cash flow.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's past, present
or future consolidated financial statements.
3. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
--------------------
2005 2004
------- -------
(Dollars in thousands)
Computers and equipment .............................. $ 14 $ 1,463
Furniture and fixtures ............................... 8 8
Leasehold improvements ............................... -- --
------- -------
22 1,471
Less: Accumulated depreciation and amortization ..... (15) (981)
------- -------
Net Equipment ......................... $ 7 $ 490
======= =======
For the years ended December 31, 2005, 2004 and 2003, the Company incurred
depreciation and amortization expense of $.1 million, $.8 million and $1.4
million, respectively. During the years ended December 31, 2005, 2004 and 2003,
the Company disposed of fully depreciated equipment having an original cost of
$1.4 million, $4.7 and $4.6 million, respectively. Abandonment of assets in 2005
generated a loss of $323,000 .
4. PROMISSORY NOTES
The Company issued to Warner Brothers Entertainment, Inc. ("Warner") a
Secured Convertible Promissory Note bearing interest at 6% per annum, due April30, 2003, in the principal amount of $2.0 million in connection with the sale of
a subsidiary in 2002. The note was issued in partial payment of amounts due
Warner under the parties' license agreement for the video game based on the
motion picture, THE MATRIX. The note is secured by all of the Company's assets,
and may be converted by the holder thereof into shares of the Company's common
stock on the maturity date or, to the extent there is any proposed prepayment,
within the 30- day period prior to such prepayment. The conversion price is
equal to the lower of (a) $0.304 or (b) an amount equal to the average closing
price of a share of the Company's common stock for the five business days ending
on the day prior to the conversion date, provided that in no event can the note
be converted into more than 18,600,000 shares. If any amount remains due
following conversion of the note into 18,600,000 shares, the remaining amount
will be payable in cash. The Company agrees to register with the Securities and
Exchange Commission the shares of common stock to be issued in the event Warner
exercises its conversion option. At December 31, 2005, the balance owed to
Warner, including accrued interest, is $360,000. On or about October 9, 2003,
Warner filed suit against the Company 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. The Company entered into a settlement agreement on this litigation
and entered into a payment plan with Warner to satisfy the balance of the note
by January 30, 2004. The Company is currently in default of the settlement
agreement with Warner and has entered into a payment plan, under which the
Company is in default, for the remaining balance of $360,000.
F-16
The Company issued to Atari Interactive, Inc. ("Atari") a Promissory Note
bearing no interest, due December 31, 2006, in the principal amount of $2.0
million in connection with Atari entering into tri-party agreements with the
Company and its then main distributors, Vivendi and Avalon. The note was issued
in payment of all outstanding accrued royalties due Atari under the Dungeons &
Dragons license agreement which license was terminated by Atari on April 23,2004. At December 31, 2005, the balance owed to Atari, is $1.0 million as a
result of payments made by Vivendi and Avalon on the Company's behalf to Atari.
Included in the current debt is a $140,000 advance from the President of
Interplay Japan.
5. ADVANCES FROM DISTRIBUTORS, RELATED PARTIES AND OTHERS
Advances from distributors and OEMs consist of the following:
DECEMBER 31,
--------------------
2005 2004
-------- --------
(Dollars in thousands)
Advances for other distribution rights ................. $ 0 $ 476
======== ========
Net advance from Vivendi distribution
agreement (former related party) ..................... $ 0 $ 2,989
======== ========
In August 2002, the Company entered into a new distribution agreement with
Vivendi whereby Vivendi will distribute substantially all of the Company
products in North America for a period of three years as a whole and two years
with respect to each product giving a potential maximum term of five years.
Under the August 2002 agreement, Vivendi will pay the Company 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 the
Company's delivery of a gold master to Vivendi, Vivendi will pay the Company as
a non-refundable minimum guarantee, a specified percent of the projected amount
due the Company based on projected initial shipment sales, which are established
by Vivendi in accordance with the terms of the agreement. The remaining amounts
are due upon shipment of the titles to Vivendi's customers. Payments for future
sales that exceed the projected initial shipment sales are paid on a monthly
basis. In December 2002, the Company granted OEM rights and selected back
catalog titles in North America to Vivendi. In January 2003, the Company granted
Vivendi the right to distribute substantially all of its products in select
rest-of-world countries. As of December 31, 2004, Vivendi had $2.9 million of
its advance remaining to recoup under the rest-of-world countries and OEM back
catalog agreements. As of December 2004, the Company earned $0.7 million of the
$3.6 million advance related to future minimum guarantees on undelivered
products. During 2005 the Company recognized as income all the remaining
unrecouped advances.
6. INCOME TAXES
Income (loss) before provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
---------------------------------------------------
2005 2004 2003
----------- ----------- -----------
(Dollars in thousands)
Domestic ............ $ 6,554,000 $(4,733,000) $ 1,289,000
Foreign ............. (626,000) (3,000) 23,000
----------- ----------- -----------
Total ............... $ 5,928,000 $(4,730,000) $ 1,312,000
=========== =========== ===========
F-17
The provision for income taxes is comprised of the following:
YEARS ENDED DECEMBER 31,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
(Dollars in thousands)
Current:
Federal ........................ $2,032,000 $ -- $ --
State .......................... 577,000 -- --
Foreign ........................ -- -- --
---------- ---------- ----------
2,609,000 -- --
Deferred:
Federal ........................ -- -- --
State .......................... -- -- --
---------- ---------- ----------
$2,609,000 $ -- $ --
========== ========== ==========
The Company files a consolidated U.S. Federal income tax return, which
includes all of its domestic operations. The Company files separate tax returns
for each of its foreign subsidiaries in the countries in which they reside. The
Company's available net operating loss ("NOL") carryforward for Federal tax
reporting purposes approximates $125 million and expires through the year 2023.
The Company's NOL for California State tax reporting purposes approximate $64
million and expires through the year 2013. The utilization of the federal and
state net operating losses may be limited by Internal Revenue Code Section 382.
A reconciliation of the statutory Federal income tax rate and the effective
tax rate as a percentage of pretax loss is as follows:
2005 2004 2003
-------- -------- --------
Statutory Federal income tax rate .......... 34.0% 34.0% 34.0%
State income tax effect, net of
federal benefits ........................ 5.8 -- --
Valuation allowance ..................... (39.8) (39.5) (39.5)
Tax rate differentiation of
foreign earnings ........................ -- -- --
Other ...................................... -- 5.5 5.5
-------- -------- --------
-- % -- % -- %
======== ======== ========
F-18
The components of the Company's net deferred income tax asset (liability)
are as follows:
DECEMBER 31,
---------------------
2005 2004
-------- --------
(Dollars in thousands)
Current deferred tax asset (liability):
Prepaid royalties ............................... $ -- $ --
Nondeductible reserves .......................... 872 938
Reserve for advances ............................ -- (789)
Accrued expenses ................................ -- 870
Foreign loss and credit carryforward ............ 2,766 2,566
Federal and state net operating losses .......... 49,766 51,753
Research and development credit carryforward .... 2,374 2,374
Other ........................................... -- --
-------- --------
55,778 57,712
-------- --------
Non-current deferred tax asset (liability):
Depreciation expense ............................ -- --
Nondeductible reserves .......................... -- --
-------- --------
-- --
-------- --------
Net deferred tax asset before
valuation allowance ............................. 55,778 57,712
Valuation allowance .................................. (55,778) (57,712)
-------- --------
Net deferred tax asset ............................... $ -- $ --
======== ========
The Company maintains a valuation allowance against its deferred tax assets
due to the uncertainty regarding future realization. In assessing the
realizability of its deferred tax assets, management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies. The valuation allowance on deferred tax assets decreased
$2.14 million during the year ending December 31, 2005 and increased $3.4
million during the year ending December 31, 2004.
7. COMMITMENTS AND CONTINGENCIES
INSURANCE
The Company's property, general liability, auto, workers compensation,
fiduciary liability, Directors and Officers, and employment practices liability,
insurance policies were cancelled during the year ending December 31, 2004. The
Company is current on its workers comp and employee health insurance premiums.
LEASES
The Company's headquarters are located in Beverly Hills, California. The
facility is leased through April 2008. The Company is currently subleasing on a
short-term basis a portion of the office space to an independent third party.
The Company's has an additional satellite office in Irvine, California on a
month - to - month basis for $650 per month.
The minimum annual rentals for 2006, 2007 and 2008 are $102,000, $114,000
and $39,000, respectively.
Total rent expense was $40,000, $400,000 and $1.8 million for the years
ended December 31, 2005, 2004 and 2003, respectively. See litigation below
related to the Company's former landlord.
LITIGATION
The Company is involved in various legal proceedings, claims, and
litigation arising in the ordinary course of business, including disputes
arising over the ownership of intellectual property rights and collection
matters. In the opinion of management, the outcome of known routine claims will
not have a material adverse effect on the Company's business, financial
condition, or results of operations.
F-19
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 the Company 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 its shares purchased by Special
Situations under a common stock subscription agreement dated March 29, 2001 and
that the Company therefore, liable to pay Special Situations $1.3 million.
Special Situations entered into a settlement agreement with the Company
December, 2003 contemplating payments over time, which the Company later
defaulted . In August, 2004 the Company entered into a stipulation of settlement
on which it later defaulted. On January 12, 2005 a judgment of approximately
$776,00 was entered in the State of New York and on February 4 ,2005 a judgment
reflecting the January 12, 2005 judgment was entered in the State of California.
On May 3, 2006the Company entered into a Stipulation of Settlement. Under this
Stipulation of Settlement, the Company agreed to issue a total of 10,000,000
shares of its unregistered common stock and made a payment in the amount of
approximately $239,000. Following the issuance of such shares, and in
consideration of such issuance and such payment, satisfaction of judgments in
the amount of approximately $776,000 recorded against the Company will be filed.
Such shares will be issued in a private placement pursuant to section 4(2) of
the Securities Act of 1933 and will be issued prior to the satisfaction of
judgments which must occur within 10 business days following the Company making
a payment of approximately $239,000 and the issuance of such shares.
On October 24, 2002, Synnex Information Technologies Inc ("Synnex")
initiated legal proceedings against the Company for various claims related to a
breach of a distributorship agreement. Synnex obtained a $172,000 judgment
against the Company.
On or about October 9, 2003, Warner Brothers Entertainment, Inc. ("Warner")
filed suit against the Company 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
including interest. The Company owes a remaining balance of approximately
$360,000 payable in one remaining installment. The Company is currently in
default of the settlement agreement.
In April 2004, Arden Realty Finance IV LLC ("Arden") filed an unlawful
detainer action against the Company in the Superior Court for the State of
California, County of Orange, alleging the Company's default under its corporate
lease agreement. At the time the suit was filed, the alleged outstanding rent
totaled $432,000. The Company was unable to pay the rent, and vacated the office
space during the month of June 2004. On June 3, 2004, Arden obtained a judgment
of approximately $588,000 exclusive of interest. In addition the Company is in
the process of resolving a prior claim with the landlord in the approximate
amount of $148,000, exclusive of interest. The Company has negotiated a
forbearance agreement whereby Arden agreed to accept payments commencing in
January 2005 in the amount of $60,000 per month until the full amount is paid.
The Company has not accrued any amount for any remaining lease obligation,
should such obligation exist. The Company is currently in default of the
forbearance agreement.
Monte Cristo Multimedia, a French video game developer and publisher, filed
a breach of contract complaint against the Company in the Superior Court for the
State of California, County of Orange, on August 6, 2002, alleging damages in
the amount of $886,000 plus interest, in connection with an exclusive
distribution agreement. This claim was settled for $100,000, payable in twelve
installments, however, the Company was unable to satisfy its payment obligations
and consequently, Monte Cristo has filed a stipulated judgment against the
Company in the amount of $100,000. If Monte Cristo executes the judgment, it
will negatively affect the Company's cash flow, which could further restrict the
Company's operations and cause material harm to its business.
In August 2003, Reflexive Entertainment, Inc. filed an action against the
Company, for failure to pay development fees, in the Orange County Superior
Court, that was settled in July 2004. The Company was unable to make the
payments and Reflexive sought ,and obtained, judgment against the company for
approximately $110,000.
On March 27, 2003, KDG France SAS ("KDG") filed an action against Interplay
OEM, Inc. and Herve Caen for failure to pay royalties. On December 29, 2003 a
settlement agreement was entered into whereby Herve Caen was dismissed from the
action. Further, the settlement was entered into with Interplay OEM only in the
amount of $170,000; however, KDG reserved its rights to proceed against the
Company if the settlement payment was not made. As of this date the settlement
payment has not been made.
F-20
The Company received notice from the Internal Revenue Service ("IRS") that
it owes approximately $110,000 pursuant to section 166 and section 186 of the
Internal Revenue Code in payroll tax penalties, and interest for late filing and
late payment of payroll taxes. Approximately $110,000 has been accrued as of
December 31, 2005 but remains unpaid. The Company received notice from the
Employment Development Department (EDD) that it owes approximately $103,000 in
payroll taxes owed for the periods ending 2004 and 2003, which have been accrued
for December 31,2005.
The Company was unable to meet certain 2004 payroll obligations to its
employees; as a result, several employees filed claims with the State of
California Labor Board ("Labor Board") . The Labor Board has fined the Company
approximately $10,000 for failure to meet its payroll obligations and obtained
in August 2005 judgments totaling $118,000 in favor of former employees of the
Company. Since this time $44,000 of the claims have been settled, leaving a
balance of $74,000.
The Company's property, general liability, auto, fiduciary liability,
workers compensation and employment practices liability, have been cancelled.
The company subsequently entered into a new workers' compensation insurance
plan. The Labor Board fined the Company approximately $79,000 for having lost
workers' compensation insurance for a period of time. The Company is appealing
the Labor Board fines.
The Company received notice from the California State Board of Equalization
of a balance due in the amount of $73,000 for a prior year audit . The Company
is in the process of appealing the prior year audit calculations.
On September 14, 2005, Network Commercial Service, Inc. ("NCS") filed an
action against the Company alleging breach of contract relating to the provision
of copying equipment and that the balance due is $140,000 to NCS. The Company is
evaluating the merit of the lawsuit.
On April 22, 2005, Mark Strecker filed a judgment to be entered against the
Company for various claims alleging unpaid services in the amount of $35,000.
The Company is evaluating the merit of the lawsuit.
On May 19, 2005 DZN, The Design Group, Inc. filed an action against the
Company for various advertising services in the amount of $38,000. The Company
is evaluating the merit of the lawsuit.
On February 2, 2006 Michael Sigel filed an action against the Company for
unauthorized use of image. The Company is evaluating the merit of the lawsuit.
On March 7, 2006 Parallax Software Corp. entered a judgment against the
Company for a material breach of a settlement agreement related to royalties
owed in the amount of $219,000. The Company is evaluating the merit of the
lawsuit.
The Company has recorded an estimate for the liabilities related to the
aforementioned litigation. If any of the creditors execute their judgments
against the Company, the results will negatively affect the Company's cash flow,
which could restrict the Company's operations and cause material restraints to
its business.
EMPLOYMENT AGREEMENTS
The Company has entered into various employment agreements with certain key
employees providing for, among other things, salary, bonuses and the right to
participate in certain incentive compensation and other employee benefit plans
established by the Company. Under these agreements, upon termination without
cause or resignation for good reason, the employees may be entitled to certain
severance benefits, as defined. These agreements expire through 2006.
8. STOCKHOLDERS' EQUITY
PREFERRED STOCK AND COMMON STOCK
The Company's articles of incorporation authorize up to 5,000,000 shares of
$0.001 par value preferred stock. Shares of preferred stock may be issued in one
or more classes or series at such time as the Board of Directors determine. As
of December 31, 2005, there were no shares of preferred stock outstanding.
In connection with a private placement in April, 2001, the Company issued
warrants to purchase 8,126,770 shares of the Company's common stock at $1.75 per
shares. These warrants expired on March 31, 2006. In addition to the warrants
issued in the private placement, the Company granted the investment banker
associated with the transaction a warrant for 500,000
F-21
shares of the Company's common stock. The warrant has an exercise price of
$1.5625 per share and vests one year after the registration statement became
effective. The warrant expires four years after it vests. The Company incurred a
penalty of approximately $254,000 per month, payable in cash, until June 2002,
when the required registration statement was declared effective. During 2003,
the Company settled with certain of these investors with respect to payment. The
total amount accrued at December 31, 2005 and 2004 is $2.2 million and $3.1
million, respectively,.
In August 2001, Titus converted 336,070 shares of Series A Preferred Stock
it purchased in April 2000 into 6,679,306 shares of Common Stock. This
conversion did not include accumulated dividends of $740,000 on the Preferred
Stock, these were reclassified as an accrued liability since Titus had elected
to receive the dividends in cash. In March 2002, Titus converted its remaining
383,354 shares of Series A Preferred Stock into 47,492,162 shares of Common
Stock. In connection with sale of Preferred Stock with Titus in April 2000 the
Company issued a warrant to purchase 350,000 shares of the Company's common
stock at $3.79 per share and another warrant to Titus to purchase 50,000 shares
of the Company's common stock at $3.79 per share. Both warrants expire in April
2010.
EMPLOYEE STOCK PURCHASE PLAN
Under this plan, eligible employees may purchase shares of the Company's
Common Stock at 85% of fair market value at specific, predetermined dates. In
2000, the Board of Directors increased the number of shares authorized to
300,000. Of the 300,000 shares authorized for issuance under the plan, 84,877
shares remained available for issuance at December 31, 2005. Employees purchased
zero, zero, and 6,458 shares in 2005, 2004 and 2003 for $0, $0 and $323,
respectively.
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock reserved for future issuance at December 31, 2005 is as
follows:
Stock option plans:
Outstanding ........................................ 70,000
Available for future grants ........................ 10,014,870
Warrants .................................................. 9,587,068
----------
Total ..................................................... 19,671,938
==========
TREASURY STOCK
In December 2005, NBC Universal returned their 4,658,216 shares of the
Company's common stock at no cost to the Company. The Company included these
shares as treasury stock in 2005.
9. NET EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed as net earnings (loss)
available to common stockholders divided by the weighted average number of
common shares outstanding for the period and does not include the impact of any
potentially dilutive securities. Diluted earnings per common share is computed
by dividing the net earnings available to the common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and common stock warrants and the conversion of
outstanding convertible debentures.
F-22
YEARS ENDED DECEMBER 31,
-------------------------------
2005 2004 2003
-------- -------- --------
(Amounts in thousands,
except per share amounts)
Net income (loss) available to common stockholders ..................... $ 5,928 $ (4,730) $ 1,312
Interest related to conversion of secured convertible promissory note -- -- 92
-------- -------- --------
Dilutive net income (loss) available to common stockholders ......... $ 5,928 $ (4,730) $ 1,404
-------- -------- --------
Shares used to compute net income (loss) per common share:
Weighted-average common shares ...................................... 93,856 93,856 93,852
Dilutive stock equivalents .......................................... -- -- 10,462
-------- -------- --------
Dilutive potential common shares .................................... 93,856 93,856 104,314
======== ======== ========
Net income (loss) per common share:
Basic ............................................................... $ 0.06 $ (0.05) $ 0.01
Diluted ............................................................. $ 0.06 $ (0.05) $ 0.01
There were options and warrants outstanding to purchase 9,798,218 shares of
common stock at December 31, 2005, which were excluded from the earnings per
common share computation as the exercise price was greater than the average
market price of the common shares. The dilutive stock equivalents in the above
calculation related to the outstanding convertible debentures at December 31,2005, which the Company utilized under the "if converted" method.
Due to the net loss attributable for the year ended December 31, 2004, on a
diluted basis to common stockholders, stock options and warrants have been
excluded from the diluted earnings per share calculation as their inclusion
would have been antidilutive. The weighted average exercise price at December31, 2005, 2004 and 2003 was $1.84, $1.84 and $1.84, respectively, for the
options and warrants outstanding. No dilution effect for options and warrants
has been made for 2005 as the market price of the common stock did not exceed
the exercise price of the options or warrants.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
2005 2004 2003
------------------------ ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ---------- ---------- ---------- ---------- ----------
Warrants outstanding at
beginning of year .. 9,587,068 $ 1.84 9,587,068 1.84 9,687,068 $ 1.99
Granted ............ -- -- -- --
Exercised .......... -- -- -- --
---------- ---------- ----------
Canceled ........... -- -- (100,000) 4.50
Warrants outstanding
at end of year ..... 9,587,068 $ 1.84 9,587,068 1.84 9,587,068 $ 1.84
========== ========== ==========
Warrants exercisable 9,587,068 9,587,068 9,587,068
========== ========== ==========
F-23
A detail of the warrants outstanding and exercisable as of December 31,2005 is as follows:
WARRANTS OUTSTANDING AND EXERCISABLE
-----------------------------------------------
WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE
PRICES OUTSTANDING CONTRACT LIFE PRICE
------------------ ---------------- -------------- ----------
$1.56 - $1.56 500,000 2.50 $1.56
$1.75 - $1.75 8,626,770 1.47 1.75
$3.79 - $3.79 460,298 5.29 3.79
$1.56 - $3.79 9,587,068 3.09 $1.84
================ ============== ==========
10. EMPLOYEE BENEFIT PLANS
STOCK OPTION PLANS
The Company has one stock option plan currently outstanding. Under the 1997
Stock Incentive Plan, as amended (the "1997 Plan"), the Company may grant
options to its employees, consultants and directors, which generally vest from
three to five years. At the Company's 2002 annual stockholders' meeting, its
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. The Company's Incentive Stock Option,
Nonqualified Stock Option and Restricted Stock Purchase Plan- 1991, as amended
(the "1991 Plan"), and the Company's Incentive Stock Option and Nonqualified
Stock Option Plan-1994, as amended, (the "1994 Plan"), have been terminated.
The following is a summary of option activity pursuant to the Company's
stock option plans:
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2005 2004 2003
-------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
----------- ----------- ----------- ----------- ----------- -----------
Options outstanding at
beginning of year . 211,150 $ 2.02 425,985 $ 1.95 1,091,697 $ 3.10
Granted ........... -- -- 5,000 0.08 130,000 0.09
Exercised ......... -- -- -- -- -- --
Canceled .......... (141,150) 2.02 (219,835) 1.85 (795,712) 3.22
----------- ----------- -----------
Options outstanding
at end of year .... 70,000 $ .30 211,150 $ 2.02 425,985 $ 1.95
=========== =========== ===========
Options exercisable 50,002 171,686 243,890
=========== =========== ===========
The following outlines the significant assumptions used to estimate the
fair value information presented utilizing the Black-Scholes Single Option
approach with ratable amortization. There were 5,000 and 130,000 options granted
in 2004 and 2003, respectively.
YEAR ENDED DECEMBER 31,
----------------------------
2005 2004
----------- -----------
Risk free rate 4.0% 4.0%
Expected life 10 Years 10 years
Expected volatility 160% 160%
Expected dividends
-- --
Weighted-average grant-date fair value
of options granted $ 0.08 $ 0.08
F-24
A detail of the options outstanding and exercisable as of December 31, 2005
is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING CONTRACT LIFE PRICE OUTSTANDING PRICE
----------------------- ----------- ------------- ---------- ----------- ---------
$ 0.09 - $ 0.09 70,000 7.51 $ .30 50,002 $ .27
----------- ------------- ---------- ---------- ---------
$ 0.09 - $ 0.09 70,000 7.51 $ .30 50,002 $ .27
========== ============== ========== ========== =========
PROFIT SHARING 401(K) PLAN
The Company sponsors a 401(k) plan ("the Plan") for most full-time
employees. The Company matches 50% of the participant's contributions up to 6%
of the participant's base compensation. The profit sharing contribution amount
is at the sole discretion of the Company's Board of Directors. The 2005
contributions were zero. Participants vest at a rate of 20% per year after the
first year of service for profit sharing contributions and 20% per year after
the first two years of service for matching contributions. Participants become
100% vested upon death, permanent disability, or termination of the Plan.
Benefit expense for the years ended December 31, 2005, 2004 and 2003 was $0,
$29,000 and $150,000, respectively. The Profit Sharing 401(k) Plan is expected
to be terminated during 2006.
EMPLOYEE STOCK PURCHASE PLAN
Under this plan, eligible employees may purchase shares of the Company's
Common Stock at 85% of fair market value at specific, predetermined dates. In
2000, the Board of Directors increased the number of shares authorized to
300,000. Of the 300,000 shares authorized for issuance under the plan, 84,877
shares remained available for issuance at December 31, 2005. Employees purchased
zero, zero, and 6,458 shares in 2005, 2004 and 2003 for $0, $0 and $323,
respectively.
11. RELATED PARTY TRANSACTIONS
Amounts receivable from and payable to related parties are as follows:
DECEMBER 31,
2005 2004
---------- ----------
(Dollars in thousands)
Receivables from related parties:
Titus TSC .................................. $ 70 $ 327
Titus SARL ................................. 18 18
VIE Acquisition Group (Titus ............... 17 10
owned)
Avalon ..................................... 2,026 2,025
Less Reserves .............................. (2,114) (2,370)
---------- ----------
Total ...................................... $ 17 $ 10
========== ==========
ACTIVITIES WITH RELATED PARTIES
It is the Company's policy that related party transactions shall be
reviewed and approved by a majority of the Company's disinterested directors or
its Independent Committee.
The Company's operations involve significant transactions with its majority
stockholder Titus and its affiliates. The Company has a major distribution
agreement with Avalon.
TRANSACTIONS WITH TITUS
Titus (placed in involuntary bankruptcy in January 2005) presently owns
approximately 58 million shares of Company common stock.
The Company performed certain distribution services on behalf of Titus for
a fee. In connection with such distribution services, the Company recognized fee
income of $0, $0, and $5,000 for the years ended December 31, 2005 2004, and
2003.
F-25
As of December 31, 2005 and December 31, 2004, Titus and its affiliates,
excluding Avalon owed the Company $105,000 and $370,000, respectively(See
transactions with Titus Software below). The Company owed Titus and its
affiliates, excluding Avalon, $0 and $30,000 as of December 31, 2005 and
December 31, 2004, respectively.
TRANSACTIONS WITH TITUS AFFILIATES
TRANSACTIONS WITH AVALON, A WHOLLY OWNED SUBSIDIARY OF TITUS
The Company had an International Distribution Agreement with Avalon, a
wholly owned subsidiary of Titus. Pursuant to this distribution agreement,
Avalon provided for the exclusive distribution of substantially all of the
Company's products in Europe, Commonwealth of Independent States, Africa, and
the Middle East for a seven-year period ending February 2006, cancelable under
certain conditions, subject to termination penalties and costs. Under this
agreement, as amended, the Company paid Avalon a distribution fee based on net
sales, and Avalon provides certain market preparation, warehousing, sales, and
fulfillment services on the Company's behalf. In connection with the
International Distribution Agreement with Avalon, the Company incurred
distribution commission expense of $0 and $62,000, for the years ended December31, 2005, and 2004 respectively. This agreement was terminated as a result of
Avalon's liquidation in February 2005.
TRANSACTIONS WITH TITUS SOFTWARE
In March 2003, we entered into a note receivable with Titus Software Corp.,
("TSC"), a subsidiary of Titus, and advanced TSC $226,000. The note earns
interest at 8% per annum and was due in February 2004. In May 2003, our Board of
Directors rescinded the note receivable and demanded repayment of the $226,000
from TSC. As of the date of this filing the balance on the note with accrued
interest has not been paid. The balance on the note receivable, with accrued
interest, at September 30, 2004 was approximately $254,000. The total receivable
due from TSC is approximately $327,000 as of September 30, 2004. The majority of
the additional approximately $71,000 was due to TSC subletting office space and
miscellaneous other items. As of October 31,2005 the outstanding balance owed
from TSC was approximately $71,000 the outstanding balance was reduced from a
payment of a note owed by Phil Adam to TSC and offset against the balance due
Interplay.
In May 2003, we paid TSC $60,000 to cover legal fees in connection with a
lawsuit against Titus. As a result of the payment, our CEO requested that we
credit the $60,000 to amounts we owed to him arising from expenses incurred in
connection with providing services the Company..
TRANSACTIONS WITH TITUS JAPAN
In June 2003, the Company began operating under a representation agreement
with Titus Japan K.K. ("Titus Japan"), a majority-controlled subsidiary of
Titus, pursuant to which Titus Japan represents the Company as an agent in
regard to certain sales transactions in Japan. As of December 31, 2005 the
Company had a balance due from Titus Japan of $192,000. During the twelve months
ending December 31, 2005the Company's Japan subsidiary incurred to Titus Japan
approximately $221,000 in commissions, publishing, and staff services.
TRANSACTIONS WITH TITUS SARL
As of December 31, 2005 and 2004the Company has a receivable of
approximately $18,000 and $18,000, respectively for product development services
that the Company provided. This balance is fully reserved.. Titus SARL was
placed into involuntary liquidation in January 2005.
TRANSACTIONS WITH TITUS GIE
In February 2004, the Company engaged the services of GIE Titus Interactive
Group, a wholly owned subsidiary of Titus, for a three-month service agreement
pursuant to which GIE Titus or its agents were to provide to the Company certain
foreign administrative and legal services at a rate of $5,000 per month for
three months. As of December 31, 2005, the Company had a zero balance with Titus
GIE Interactive Group. Titus GIE was placed into involuntary liquidation in
January 2005.
F-26
TRANSACTIONS WITH VIE ACQUISITION GROUP
Approximately $0 and $42,000 was paid to VIE Acquisition Group for
management services provided during the years ended December 31, 2005 and 2004.
12. CONCENTRATION OF CREDIT RISK
Avalon was the exclusive distributor for most of the Company's products in
Europe, the Commonwealth of Independent States, Africa and the Middle East. The
Company's agreement with Avalon was terminated following the liquidation of
Avalon in February 2005. The Company subsequently appointed its wholly owned
subsidiary, Interplay Productions Ltd as its distributor for Europe.
Vivendi had exclusive rights to distribute the Company's products in North
America and selected International territories. The Company's agreement with
Vivendi expired in August 2005 for most of its products.
The Company's revenues and cash flows could fall significantly, and its
business and financial results could suffer material harm if:
o The Company fails to replace Vivendi as its distributor; or
o Interplay Productions Ltd fails to effectively distribute the
Company's products.
The Company typically sells to distributors and retailers on unsecured
credit, with terms that vary depending upon the customer and the nature of the
product. The Company has the risk of non-payment from its customers, whether due
to their financial inability to pay, or otherwise. In addition, while the
Company maintains a reserve for uncollectible receivables, the reserve may not
be sufficient in every circumstance. As a result, a payment default by a
significant customer could cause material harm to the Company's business and
cash flow. o For the years ended December 31, 2005, 2004 and 2003, Avalon
accounted for approximately 2 %, 70% and 12%, respectively, of net revenues in
connection with the International Distribution Agreement (Note 11). Vivendi
accounted for 7 %, 21%, and 82% of net revenues in the years ended December 31,2005, 2004 and 2003, respectively.
13. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company operates in one principal business segment, which is managed
primarily from the Company's U.S. headquarters.
Net revenues by geographic regions were as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
2005 2004 2003
---------------------- -------------------- --------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- -------- -------- -------- -------- --------
(Dollars in thousands) (Dollars in thousands) (Dollars in thousands)
North America .. $ 2,885(1) 40% $ 1,544 12% $ 13,541 37%
Europe ......... 1,779(1) 25 8,706 66 5,682 16
Rest of World .. 2,277(1) 32 1,228 9 802 2
OEM, royalty and
licensing ... 217 3 1,720 13 16,276 45
-------- -------- -------- -------- -------- --------
$ 7,158 100% $ 13,197 100% $ 36,301 100%
======== ======== ======== ======== ======== ========
(1) Included in net revenue by geographic regions are the recognition of
deferred revenue on contracts expiring as follows:
North America - $2,071 million
Europe - $363,000
Rest of the World - $2,138 million.
F-27
INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
TRADE RECEIVABLES ALLOWANCE
----------------------------------------------------------
BALANCE AT PROVISIONS BALANCE AT
BEGINNING OF FOR RETURNS RETURNS AND END OF
PERIOD PERIOD AND DISCOUNTS DISCOUNTS PERIOD
------------ ------------ ------------ ------------
Year ended December 31, 2003 ........ $ 1,086 $ 864 $ (1,225) $ 725
============ ============ ============ ============
Year ended December 31, 2004 ........ $ 725 $ 1,681 $ -- $ 2,406
============ ============ ============ ============
Year ended December 31, 2005 ........ $ 2,406 $ (216) $ -- $ 2,190
============ ============ ============ ============
S-1
Dates Referenced Herein and Documents Incorporated by Reference
