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Interplay Entertainment Corp – ‘10-K’ for 12/31/06

On:  Wednesday, 4/11/07, at 7:54pm ET   ·   As of:  4/12/07   ·   For:  12/31/06   ·   Accession #:  1170918-7-320   ·   File #:  0-24363

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 4/12/07  Interplay Entertainment Corp      10-K       12/31/06    7:209K                                   Hill Carol Lee/FA

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                         59    350K 
 2: EX-21       Subsidiaries of the Registrant                         1      4K 
 3: EX-23       Consent of Experts or Counsel                          1      6K 
 4: EX-23       Consent of Experts or Counsel                          1      6K 
 5: EX-31       Certification per Sarbanes-Oxley Act (Section 302)     2±    10K 
 6: EX-31       Certification per Sarbanes-Oxley Act (Section 302)     2±    10K 
 7: EX-32       Certification per Sarbanes-Oxley Act (Section 906)     1      7K 


10-K   —   Annual Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
3Item 9A. Controls and Procedures
4Item 1. Business
5Product Development
6North America
"International
8Item 1A. Risk Factors
13Item 2. Properties
"Item 3. Legal Proceedings
15Item 4. Submission of Matters to a Vote of Security Holders
"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
19Item 6. Selected Financial Data
20Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
25Marketing and sales
"General and administrative
29Item 8. Consolidated Financial Statements and Supplementary Data
"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
30Item 10. Directors and Executive Officers of the Registrant
"Item 11. Executive Compensation
"Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
"Item 13. Certain Relationships and Related Transactions
"Item 14. Principal Accounting Fees and Services
31Item 15. Exhibits and Financial Statement Schedules
39Other income (expense)
58Year ended December 31, 2005
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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, 2006 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, CALIFORNIA 90210 (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 December 29, 2006, the aggregate market value of voting common stock held by non-affiliates was approximately $6,000,000 based upon the closing price of the Common Stock on that date.
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Documents incorporated by reference Portions of the registrant's definitive proxy statement relating to its 2007 annual meeting of stockholders, which will be filed with the Securities and Exchange Commission pursuant to regulation 14A within 120 days of the close of the registrant's last fiscal year, are incorporated by reference into Part III of this report. As of December 29, 2006, 103,855,634 shares of Common Stock of the Registrant were issued and outstanding. This includes 4,658,216 shares of Treasury Stock. 2
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INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2006 PAGE ---- PART I Item 1. Business 4 Item 1A Risk Factors 8 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 15 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 15 Item 6. Selected Financial Data 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 7A. Quantitative and Qualitative Disclosure about Market Risk 29 Item 8. Consolidated Financial Statements and Supplementary Data 29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 29 Item 9A Controls and Procedures PART III Item 10. Directors and Executive Officers of the Registrant 30 Item 11. Executive Compensation 30 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 30 Item 13. Certain Relationships and Related Transactions 30 Item 14. Principal Accounting Fees and Services 30 PART IV Item 15. Exhibits, Financial Statement Schedules. 31 Signatures 32 Exhibit Index 33 3
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THIS REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES AND EXCHANGE ACT OF 1934 AND SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO THE SAFE HARBORS CREATED THEREBY. FOR THIS PURPOSE, ANY STATEMENTS CONTAINED IN THIS REPORT EXCEPT FOR HISTORICAL INFORMATION MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, OUR USE OF WORDS SUCH AS "PLAN," "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE," "INTEND," "COULD," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR COMPARABLE TERMINOLOGY ARE INTENDED TO HELP IDENTIFY FORWARD-LOOKING STATEMENTS. IN ADDITION, ANY STATEMENTS THAT REFER TO EXPECTATIONS, PROJECTIONS OR OTHER CHARACTERIZATIONS OF FUTURE EVENTS OR CIRCUMSTANCES ARE FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON CURRENT EXPECTATIONS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AS WELL AS CERTAIN ASSUMPTIONS. FOR EXAMPLE, ANY STATEMENTS REGARDING FUTURE CASH FLOW, 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 AND RESULTS OF OPERATIONS." ASSUMPTIONS RELATING TO OUR FORWARD-LOOKING STATEMENTS INVOLVE JUDGMENTS WITH RESPECT TO, AMONG OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, AND FUTURE BUSINESS DECISIONS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH ARE BEYOND OUR CONTROL. ALTHOUGH WE BELIEVE THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, OUR INDUSTRY, BUSINESS AND OPERATIONS ARE SUBJECT TO SUBSTANTIAL RISKS, AND THE INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A REPRESENTATION BY MANAGEMENT THAT ANY PARTICULAR OBJECTIVE OR PLANS WILL BE ACHIEVED. IN ADDITION, RISKS, UNCERTAINTIES AND ASSUMPTIONS CHANGE AS EVENTS OR CIRCUMSTANCES CHANGE. WE DISCLAIM ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS REPORT WITH THE 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. 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. The Company is planning to exploit its Intellectual Property "Fallout" on Massively Multiplayer Online Gaming (MMOG) and is reviewing the financial avenues for funding MMOG. Our business and industry has certain risks and uncertainties. During 2006 we continued to operate under limited cash flow from operations. We expect to operate under improved cash constraints during 2007. During 2006, because of limited resources, we have been primarily engaged in exploiting existing titles. We have had no new internal 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 of Operations." Our principal activities involve publishing of video game products, licensing of our intellectual properties, online distribution, back catalog licensing and OEM/ merchandising. 4
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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 is 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. We do not currently internally develop new products. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS We regard our software as proprietary and rely primarily on a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and other methods to protect our proprietary rights. We own or license various copyrights and trademarks. We hold copyrights on our products, product literature and advertising and other materials, and hold trademark rights in our name and certain of our product names and publishing labels. We have licensed certain products to third parties for distribution in particular geographic markets or for particular platforms, and receive royalties on such licenses. We also outsource, 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. 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. During the years ended December 31, 2006, 2005 and 2004, we spent $0, $300,000 and $2.6 million, respectively, on product research and development activities. Those amounts represented 0%, 3% and 20%, respectively, of net revenues in each of those periods. 5
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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. SALES AND DISTRIBUTION NORTH AMERICA. We distribute and license rights to our products and Intellectual Properties in North America and other selected territories from our corporate offices in Beverly Hills, California. INTERNATIONAL. We distribute and license rights to our products and Intellectual Properties in Europe and other selected territories thru our wholly owned subsidiary, Interplay Productions Ltd,located in London, England.. LICENSING We entered into various licensing agreements during 2006 under which we licensed others to exploit games that we have intellectual property rights to. MARKETING We assist our distributors in the development and implementation of marketing programs and campaigns for each of our titles and product groups. 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 substantially greater financial resources than us, also compete directly with us or have exclusive relationships with our competitors. 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. 6
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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, 2006, we had 6 employees, including 1 in software engineering, 2 in sales and marketing and 3 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. 7
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ITEM 1A. RISK FACTORS RISK 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, 2006, our cash balance was approximately $50,000 and our working capital deficit totaled approximately $8.1 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. For the year ended December 31, 2006, our net income was $3.1 million, $4.5 million of our revenue was recognized from the reversals of certain settlements, reversal of reserves, prior year payables. The $4.5 million of reversals and settlements did not generate cash flow. However, since inception, we have incurred significant losses and negative cash flow. As of December 31, 2006 we had an accumulated deficit of $130 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 operations. 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. 8
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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 was 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. 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. WE CONTINUE TO OPERATE WITHOUT A CHIEF FINANCIAL OFFICER, WHICH MAY AFFECT OUR ABILITY TO MANAGE OUR FINANCIAL OPERATIONS. IF WE FAIL TO DELIVER OUR PRODUCTS AT THE RIGHT TIMES, OUR SALES WILL SUFFER. 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 OUR BUSINESS AND INDUSTRY IS BOTH SEASONAL AND CYCLICAL. 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 9
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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 DISTRIBUTION 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, 2006, our net income was $3.1 million, $4.5 million was from one time non recurring events, and we have incurred significant net losses in previous years and $4.5 million did not generate cash flow. 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 licensing existing products could reduce our net. 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 licensing of 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. 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. 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. 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 66% and 57% of our total net revenues for years ended December 31, 2006 and 2005, respectively. 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; 10
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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. 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 lack resources to defend proprietary technology. 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 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; 11
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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; 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. 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. 12
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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. ITEM 2. PROPERTIES The 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 also have a representation office in France. ITEM 3. LEGAL PROCEEDINGS 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. 13
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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 $383,000 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 been in default of the forbearance agreement. On or about November 1, 2006, Arden filed an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. 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 additional interest has accrued in the amount of $26,548, the total outstanding balance at December 31, 2006 is $126,548. 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. 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 or about November 1, 2006, Reflexive joined Arden in the filing of an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. 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, 2006 but remains unpaid. The Company received notice from the Employment Development Department (EDD) that it owes approximately $103,000 in payroll taxes, interest and penalties for the periods ending 2003, 2004 and 2005 which has been accrued for December 31, 2006. The Company is in the process of establishing a payment plan with the Employment Development Department. 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. On or about November 1, 2006, two employees joined Arden and Reflexive in the filing of an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. The Company's property, general liability, auto, fiduciary liability, workers compensation and employment practices liability, have been cancelled in 2004. The company subsequently entered into new workers compensation insurance plan. 14
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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 has engaged an independent specialized accounting firm to appeal the prior year audit calculations and submit a settlement proposal to the California State Board of Equalization. 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. NCS subsequently obtained a judgment against the company for approximately $140,000. On April 22, 2005, Mark Strecker filed an action 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. o 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 in 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 $776,000 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 issued 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 were filed. Such shares were issued in a private placement pursuant to section 4(2) of the Securities Act of 1933 and were issued at a price of $.0296 per share, using a value based on the then current market price of shares of common stock discounted by such newly issued shares. 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The 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 March 19, 2007, there were 100 holders of record of our common stock. 15
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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, 2006 HIGH LOW ------------------------------------ ------- ------- First Quarter .............................. $ .04 $ .01 Second Quarter ............................. .04 .02 Third Quarter .............................. .03 .01 Fourth Quarter ............................. .29 .01 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 DIVIDEND POLICY It is not currently our policy to pay dividends. SECURITIES ISSUANCES 10,000,000 new shares were issued during the period ending December 31, 2006. (See Special Situation in Item 3 Legal Proceedings) On October 2, 2006 the Company issued 6,370,000 warrants to purchase the Company's common stock at $.0279 per share (average closing price over ten days subsequent to the resolution authorizing the issuance of the warrants) to the officer and directors. The 6,100,000 warrants were issued to the officer to reduce his compensation and to convert a portion of his unpaid compensation into a conditional demand note. The conditions includes that such note will be paid only if the tangible net worth of the Company exceeds $1 million or in a case of change in control. The demand note will accrue interest at a rate of 5% annually. These warrants were valued using the Black-Scholes Model. In addition 270,000 warrants were issued to the directors to convert their earned but unpaid director's fees to conditional demand notes. The conditions include that such notes will be paid only if the tangible net worth of the Company exceeds $1 million or in a case of change in control. The demand notes will accrue interest at a rate of 5% annually. These warrants were valued using the Black-Scholes Model. On October 2, 2006 the Company issued 2,570,000 options to directors and senior employees to purchase the Company's common stock at $.045 per share. Such warrants and options were issued in a private placement pursuant to section 4 (2) of the Securities Act of 1933. 16
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STOCK COMPENSATION PLANS The following table sets forth certain information regarding our equity compensation plans as of December 31, 2006: [Enlarge/Download Table] Number of securities remaining available for Number of securities to 01Weighted-average future issuance under equity be issued upon exercise exercise price of compensation plans of outstanding options, outstanding options, (excluding securities warrants and rights warrants and rights reflected in column (a)) -------------------------- ------------------------- ---------------------- ----------------------------- (a) (b) (c) Equity compensation plans approved by security holders Equity compensation plans not approved by security holders 9,970,298 0.029 7,360,000 ------------------------- ---------------------- ----------------------------- Total 9,970,298 0.029 7,360,000 ========================= ====================== ============================= 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. There were differences between the exercise price and the estimated fair market value as compensation expense in the amount of $40,000, $0 and $0, respectively, for financial reporting purposes. There was no compensation expense for any vested portion for the years 2005 and 2004 respectively and 2006 the Company recorded a charge to income of $40,000 under FASB 123R. 17
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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, 2001 to December 31, 2006, 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, 2001 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 31, 2006. [PERFORMANCE GRAPH OMITTED] [Enlarge/Download Table] ----------------------------- ----------- ----------- ---------- ----------- ----------- ----------- 12/01 12/02 12/03 12/04 12/05 12/06 ----------------------------- ----------- ----------- ---------- ----------- ----------- ----------- INTERPLAY ENTERTAINMENT CORP. 100.00 13.04 16.30 3.04 1.74 29.35 NASDAQ COMPOSITE 100.00 71.97 107.18 117.07 120.50 137.02 NEW PEER GROUP 100.00 77.53 141.43 184.44 164.44 169.50 OLD PEER GROUP 100.00 70.27 127.35 166.00 153.05 156.65 In any of our fillings under the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, as amended that incorporate this performance graph and the data related thereto by reference, this performance graph and data related thereto will be considered excluded from the incorporation by reference and will not be deemed a part of any such other filing unless we expressly state that the performance graph and the data related thereto is so incorporated. 18
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ITEM 6. SELECTED FINANCIAL DATA The selected consolidated statements of operations data for the years ended December 31, 2006, 2005 and 2004 and the selected consolidated balance sheets data as of December 31, 2006 and 2005 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 and Results of Operations" and the Consolidated Financial Statements included elsewhere in this Report. [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 2006 2005 2004 2003 2002 --------- --------- --------- --------- --------- (Dollars in thousands, except share and per share amounts) STATEMENTS OF OPERATIONS DATA: Net revenues ....................................... $ 967 $ 7,158 $ 13,197 $ 36,301 $ 43,999 Cost of goods sold ................................. 167 478 6,826 13,120 26,706 --------- --------- --------- --------- --------- Gross profit ....................................... 800 6,680 6,371 23,181 17,293 Operating expenses ................................. 2,069 3,197 8,853 21,787 29,653 --------- --------- --------- --------- --------- Operating (income) loss ............................ (1,269) 3,483 (2,482) 1,394 (12,360) Sale of subsidiary ................................. -- -- -- -- 28,813 Other income (expense) ............................. 4,348 2,445 (2,094) (82) (1,531) --------- --------- --------- --------- --------- Income (loss) before income taxes .................. 3,079 5,928 (4,576) 1,312 14,922 Provision (benefit) for income taxes ............... -- -- 154 -- (225) --------- --------- --------- --------- --------- Net income (loss) .................................. $ 3,079 $ 5,928 $ (4,730) $ 1,312 $ 15,147 ========= ========= ========= ========= ========= Cumulative dividend on participating preferred stock $ -- $ -- $ -- $ -- $ 133 Accretion of warrant ............................... -- -- -- -- -- --------- --------- --------- --------- --------- Net income (loss) available to common stockholders . $ 3,079 $ 5,928 $ (4,730) $ 1,312 $ 15,014 ========= ========= ========= ========= ========= Net income (loss) per common share: Basic ......................................... $ 0.030 $ 0.063 $ (0.05) $ 0.01 $ 0.18 Diluted ....................................... $ 0.028 $ 0.063 $ (0.05) $ 0.01 $ 0.16 Shares used in calculating net income (loss) per common share - basic ............................ 100,513 93,856 93,856 93,852 83,585 Shares used in calculating net income (loss) per common share - diluted .......................... 102,603 93,856 93,856 104,314 96,070 SELECTED OPERATING DATA: Net revenues by geographic region: North America ................................. $ 203 $ 2,885 $ 1,544 $ 13,541 $ 26,184 International ................................. 632 4,056 9,934 6,484 5,674 OEM, royalty and licensing .................... 132 217 1,720 16,276 12,141 Net revenues by platform: Personal computer ............................. $ 456 $ 631 $ 1,817 $ 7,671 $ 15,802 Video game console ............................ 379 971 9,660 12,354 16,056 OEM, royalty and licensing .................... 132 217 1,720 16,276 12,141 Recognition of Revenue from expired contracts . -- 4,571 -- -- -- Online licensing ..... -- 768 -- -- -- [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 2006 2005 2004 2003 2002 --------- --------- --------- --------- --------- BALANCE SHEETS DATA: (Dollars in thousands) Working capital (deficiency) ....................... $ (8,098) $ (11,497) $ (17,852) $ (14,750) $ (17,060) Total assets ....................................... 323 673 834 5,486 14,298 Total debt ......................................... 1,572 1,549 1,575 837 2,082 Stockholders' equity (deficit) .................... (8,087) (11,490) (17,362) (12,636) (13,930) 19
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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 2006 we continued to operate under limited cash flow from operations. We expect to operate under improved cash constraints during 2007. Although we are now able to pay our current obligations as they come due, we continue to face difficulties in paying off older liabilities, incurred judgments and have pending litigation as a result of our continuing cash flow difficulties. 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, 2006 consolidated financial statements includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. We entered into various licensing agreements during 2006 under which we licensed others to exploit games that we have intellectual property rights to. We expect in 2007 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. 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. With the release of new console systems by Sony, Nintendo and Microsoft, our industry has entered into a new cycle that could affect marketability of new products if any. 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. 20
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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 formerly 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 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 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 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. 21
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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, ------------------------------- 2006 2005 2004 -------- -------- -------- STATEMENTS OF OPERATIONS DATA: Net revenues ................................ 100 % 100 % 100 % Cost of goods sold .......................... 17 7 52 -------- -------- -------- Gross margin ................................ 83 93 48 Operating expenses: Marketing and sales .................... 52 4 13 General and administrative ............. 161 37 34 Product development .................... -- 4 20 Other .................................. -- -------- -------- -------- Total operating expenses ............... 213 45 67 -------- -------- -------- Operating income (loss) ..................... (130) 48 (19) Other income (expense) ...................... 449 34 (16) -------- -------- -------- Income (loss) before provision for income taxes .......................... 319 82 (35) Provision for income taxes .................. 1 -------- -------- -------- Net income (loss) ........................... 319 % 82 % (36)% ======== ======== ======== SELECTED OPERATING DATA: Net revenues by segment: North America .......................... 21 41 % 12 % International .......................... 66 56 75 OEM, royalty and licensing ............. 13 3 13 -------- -------- -------- 100 100 % 100 % ======== ======== ======== Net revenues by platform: Personal computer ...................... 47 9 % 14 % Video game console ..................... 39 14 73 OEM, royalty and licensing ............. 14 3 13 Recognition of revenue on expired contracts ..................... N/A 63 N/A Online licensing ........................ N/A 11 N/A -------- -------- -------- 100 % 100 % 100 % ======== ======== ======== Geographically, our net revenues for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 2006 2005 Change % Change ----------------------------------------- ------ ------ ------ -------- North America ........................... 203 2,885 (2,682) (92.9)% ----------------------------------------- ------ ------ ------ -------- International ........................... 632 4,056 (3,424) (84.4)% ----------------------------------------- ------ ------ ------ -------- OEM, Royalty & Licensing ................ 132 217 (85) (.4)% ----------------------------------------- ------ ------ ------ -------- Net Revenues ............................ 967 7,158 (6,191) (86.5)% ----------------------------------------- ------ ------ ------ -------- 22
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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)% --------------------------------------- ------ ------ ------ -------- NORTH AMERICAN, INTERNATIONAL AND OEM, ROYALTY AND LICENSING NET REVENUES Net revenues for the year ended December 31, 2006 were $ 967,000, a decrease of 86.5% compared to the same period in 2005. This decrease resulted from a 92.9% decrease in North American net revenue, and a 84.4% decrease in International net revenue, royalty and licensing revenues and a .4% decrease in OEM net revenue. 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. North American net revenues for the year ended December 31, 2006 were $203,000 as compared to $2.9 million for the year ended December 31, 2005. The decrease in North American net revenues in 2006 was mainly due to no longer recognizing as income advanced royalties on expired contracts and no new product releases during the twelve months ended December 31, 2006. 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 increase in 2007 compared to 2006, mainly due to increased catalog sales. International net revenues for the year ended December 31, 2006 were $632,000, a decrease of $3.4 million as compared to International net revenues for the year ended December 31, 2005. The decrease in International net revenues compared to the year ended December 31, 2005 was mainly due to recognizing as income advanced royalties on expired contracts and no new product releases during the twelve months ended December 31, 2006 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 December 31, 2005 compared to releasing BALDUR'S GATE DARK ALLIANCE II and FALLOUT: BROTHERHOOD OF STEEL during 2004. We expect that our International publishing net revenues will increase in 2007 as compared to 2006, mainly due to increased catalog sales. OEM, royalty and licensing net revenues for the year ended December 31, 2006 were $132,000, a decrease of $85,000 as compared to the same period in 2005. The decrease in OEM business was mainly attributable to our reorganization. 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. PLATFORM, EXPIRED CONTRACTS AND LICENSING DEALS NET REVENUES Our platform, expired contracts and licensing deals net revenues for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 23
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2006 2005 Change % Change -------------------------------- ------ ------ ------ -------- Personal Computer .............. 456 631 (175) (27.7)% -------------------------------- ------ ------ ------ -------- Video Game Console ............. 379 971 (592) (60.9)% -------------------------------- ------ ------ ------ -------- OEM, Royalty & Licensing ....... 132 217 (85) (39.2)% -------------------------------- ------ ------ ------ -------- Recognition of revenue on expired contracts ............ -- 4,571 (4,571) (100.0)% -------------------------------- ------ ------ ------ -------- Online Licensing ............... -- 768 (768) (100.0)% -------------------------------- ------ ------ ------ -------- Net Revenues ................... 967 7,158 (6,191) (86.5)% -------------------------------- ------ ------ ------ -------- PC net revenues for the year ended December 31, 2006 were $456,000, a decrease of 27.7% compared to the same period in 2005. The decrease in PC net revenues in 2006 was primarily due to no new releases and the expiration of our distribution agreement with Vivendi ending in 2005. We expect our PC net revenues to increase in 2007 as compared to 2006 as we continue to exploit our back catalog. Our video game console net revenues for the year ended December 31, 2006 were $379,000 a decrease of 60.9% compared to the same period in 2005. There was no revenue recognition from deferred revenue of expired contracts for the year ended December 31, 2006. Licensing for the year ended December 31, 2006 were $0. The decrease in video game console net revenues was primarily due to no new releases. Our catalog sales also decreased in 2006 as compared to 2005. Since we anticipate releasing new console titles in 2007, we expect our video game console net revenues to increase in 2007. 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 -------------------------------- ------ ------ ------ -------- Online 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 $631,000, 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. 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. 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. 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. 24
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Our net revenues, cost of goods sold and gross margin for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 2006 2005 Change % Change --------------------------------------- ------ ------ ------ -------- Net Revenues .......................... 967 7,158 (6,191) (86.5)% --------------------------------------- ------ ------ ------ -------- Cost of Goods Sold .................... 167 478 (311) (65.1)% --------------------------------------- ------ ------ ------ -------- Gross Margin .......................... 800 6,680 (5,880) (88.0)% --------------------------------------- ------ ------ ------ -------- Our cost of goods sold decreased to $167,000 in the year ended December 31, 2006 compared to $478,000 in the same period in 2005. We expect our cost of goods sold to increase in 2007 as compared to 2006 because we anticipate new product releases. Our gross margin decreased to $800,000 for the twelve months ended December 31, 2006 from $6.7 million in the comparable period in 2005. The decrease in gross margin was mainly attributable to our decrease in revenue. 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 $478,000 million in the year ended December 31, 2005 compared to $6.8 million in the same period in 2004. Our gross margin increased to 93.3% for the twelve months ended December 31, 2005 from 48.2% in the comparable period in 2004. MARKETING AND SALES Our marketing and sales expenses for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 2006 2005 Change % Change ------------------------------------------ ------ ------ ------ ------- Marketing and Sales ...................... 509 312 197 63.1% ------------------------------------------ ------ ------ ------ ------- 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, 2006 were $509,000, a 63.1% increase as compared to the 2005 period. The increase in marketing and sales expenses is due to certain expenses being classified as marketing and sales in 2006 compared to the prior year classification into general and administration and a continued effort to sell back catalog products. We expect our marketing and sales expenses to increase in 2007 compared to 2006, as we expect to ship new products. 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)% --------------------------------------- ------ ------ ------ -------- 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 $312,000 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. GENERAL AND ADMINISTRATIVE Our general and administrative expenses for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 25
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2006 2005 Change % Change ---------------------------------------- ------ ------ ------ -------- General and Administrative ............. 1,560 2,617 1,057 (40.4)% ---------------------------------------- ------ ------ ------ -------- 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, 2006 were $1.6 million, a 40.4% decrease as compared to the same period in 2005. The decrease is mainly due to decreases in personnel costs and general expenses during 2006. The decrease in General and administrative expenses is due to certain expenses being classified as marketing and sales in 2006 compared to the prior year classification into general and administration . 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. PRODUCT DEVELOPMENT Our product development expenses for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 2006 2005 Change % Change --------------------------------------- ------ ------ ------ -------- Product Development ................... 0 268 (268) (100)% --------------------------------------- ------ ------ ------ -------- 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, 2006 were $ 0, a 100% decrease as compared to the same period in 2005. This decrease was due to us not having any new product in 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 $268,000, 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. OTHER EXPENSE (INCOME), NET Our other expense for the years ended December 31, 2006 and 2005 breakdown as follows: (in thousands) 2006 2005 Change % Change --------------------------------------- ------ ------ ------ -------- Other Expense (Income) ................ (4,348) (2,445) 1,903 78% --------------------------------------- ------ ------ ------ -------- Other income consists primarily of settlement in the amount of approximately $310,000, reversal of reserves in the amount of approximately $2.2 million, reduction of accrued royalties in the amount of $810,000, reversals of accounts payable in the amount of $1.2 million, interest expense in the amount of $135,000.and additional miscellaneous income. 26
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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 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. PROVISION (BENEFIT) FOR INCOME TAXES We recorded no tax provision for the years ended December 31, 2006, 2005 and 2004. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2006, we had a working capital deficit of approximately $8.1 million, and our cash balance was approximately $50,000. We currently have no cash reserves and are only able to pay current liabilities. We cannot continue in our current form without obtaining additional financing or income. We have substantially reduced our operating expenses and have licensed two of our Intellectual Properties, Earthworm Jim and Fallout to third parties. If we do not receive sufficient financing or income 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. We have been operating without a credit facility since October 2001, which has adversely affected cash flow. Although we are now able to pay our current liabilities, we continue to face difficulties in paying our historical vendors, and employees, and have pending lawsuits as a result of our continuing cash flow difficulties. We expect these difficulties to improve during 2007. 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 used cash of $72,000 during the twelve months ended December 31, 2006, primarily attributable to licensing and distribution net of expenditures. The Company had $4.5 million in income from recognition of one time non recurring events; however the Company does not expect material further non recurring income in 2007. We entered into various licensing agreements during 2006 under which we licensed others to exploit games that we have intellectual property rights to. We expect in 2007 to enter into similar license arrangements to generate cash for the Company's operations. Currently the Company has no internal development of new titles. The Company is planning to exploit its Intellectual Property "Fallout" on Massively Multiplayer Online Gaming (MMOG) and is reviewing the financial avenues for funding MMOG. 27
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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, 2006, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands). LESS MORE THAN 1 - 3 3 - 5 THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS ----------------------------------- ------ ------ ------ ------ ------- Lease Commitments (1) ............. 162 121 41 0 0 ----------------------------------- ------ ------ ------ ------ ------- (1) We have a lease commitment at the Beverly Hills office through April 2008. We also have a lease commitment at the French representation office through February 28, 2008 with an option for an additional 6 years. Our current cash reserves plus our expected cash from existing operations will only be sufficient to fund our anticipated expenditures to March 31, 2008. We will need to continue to consummate certain sales of assets and/or raise additional financing to meet our contractual obligations. ACTIVITIES WITH RELATED PARTIES Our operations in prior years involved significant transactions with our majority stockholder Titus and its affiliates. We had a major distribution agreement with Avalon, an affiliate of Titus which is now cancelled. TRANSACTIONS WITH TITUS AND AFFILIATES Titus (placed in involuntary liquidation in January 2005) presently owns approximately 58 million shares of our common stock. As of December 31, 2006 and December 31, 2005, Titus and its affiliates owed us $0 and $105,000, respectively. We owed Titus and its affiliates $0 and $0 as of December 31, 2006 and December 31, 2005 respectively. 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, 2006 the Company had a balance owed from Titus Japan of $ 226,000. During the twelve months ending December 31, 2006 our Japanese subsidiary incurred to Titus Japan costs of approximately $106,000 in commissions, publishing and staff services. We closed our Japanese subsidiary during the 4th quarter of 2006. 28
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RECENT ACCOUNTING PRONOUNCEMENTS In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS 109, ACCOUNTING FOR INCOME TAXES. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for years beginning after December 15, 2006. We will adopt FIN 48 as of December 30, 2006, as required. Currently, we are not able to estimate the impact FIN 48 will have on our financial statements. In September 2006, the FASB issued SFAS 157, FAIR VALUE MEASUREMENTS, which defines fair value, creates a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We will adopt SFAS 157 on its effective date. The Company has not yet determined the effect, if any, that the application of SFAS No. 157 will have on its consolidated financial statements. In September 2006, the Securities and Exchange Commission ("SEC") issued SAB No. 108, Topic 1-N, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB No. 108 requires companies to evaluate the materiality of current year misstatements using both the rollover approach and the iron curtain approach. SAB No. 108 is effective for statements covering the first fiscal year ending after November 15, 2006. The adoption of SAB No. 108 did not have a material impact on the Company's consolidated financial position and results of operations. 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, 2006. 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 $3,000 loss, $10,000 loss and $33,000 loss during the years ended December 31, 2006, 2005 and 2004, respectively, primarily in connection with foreign exchange fluctuations in the timing of payments received on accounts receivable from Avalon and other foreign distributors or licensees. 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 29
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Chief Financial Officer concluded that our disclosure controls and procedures were 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 and in timely alerting him to material information required to be included in this report. There were no changes made in our internal controls over financial reporting that occurred during the quarter ended December 31, 2006 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. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information in Item10 is incorporated herein by reference to the section entitled "Proposal One ---- Election of Directors" contained in the Proxy Statement ( the "Proxy Statement") for the 2007 annual meeting of the stockholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 29, 2006. ITEM 11. EXECUTIVE COMPENSATION The information in Item 11 is incorporated herein by reference to the section entitled "Proposal One ---- Election of Directors" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information in Item12 is incorporated herein by reference to the section entitled "General Information" ---- Security Ownership of Certain Beneficial Owners and Management" and "Proposal One ---- Election of Directors" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in Item 13 is incorporated herein by reference to the section entitled "Proposal One --- Election of Directors" contained in the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information in Item 14 is incorporated herein by reference to the section entitled by reference to the section entitled "Proposal Two --- Ratification of the Appointment of Independent Registered Public Accountant Firm" contained in the Proxy Statement. 30
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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. 31
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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 Beverly Hills, California this 9th day of April 2007. INTERPLAY ENTERTAINMENT CORP. By: /s/ Herve Caen --------------------------------- Herve Caen Its: Chief Executive Officer and Interim Chief Financial Officer (Principal Executive and Financial and Accounting Officer) Exhibit 24.1 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 April 9, 2007 Herve Caen Chief Financial Officer and Director (Principal Executive and Financial and Accounting Officer) /s/ Eric Caen ____________________ Director April 9, 2007 Eric Caen /s/ Michel Welter ____________________ Director April 9, 2007 Michel Welter 32
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EXHIBIT INDEX EXHIBIT NO. DESCRIPTION ------- ----------------------------------------------------------------------- 3.1 Amended and Restated Certificate of Incorporation of the Company; (incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 3.2 Certificate of Designation of Preferences of Series A Preferred Stock, as filed with the Delaware Secretary of State on April 14, 2000; (incorporated herein by reference to Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1999). 3.3 Certificate of Amendment of Certificate of Designation of Rights, Preferences, Privileges and Restrictions of Series A Preferred Stock, as filed with the Delaware Secretary of State on October 30, 2000; (incorporated herein by reference to Exhibit 3.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 3.4 Certificate of Amendment of Amended and Restated Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on November 2, 2000; (incorporated herein by reference to Exhibit 3.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 3.5 Certificate of Amendment of Amended and Restated Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on January 21, 2004; (incorporated herein by reference to Exhibit 3.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 3.6 Amended and Restated Bylaws of the Company; (incorporated herein by reference to Exhibit 3.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 3.7 Amendment to the Amended and Restated Bylaws of the Company dated March 9, 2004; (incorporated herein by reference to Exhibit 3.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003). 4.1 Specimen form of stock certificate for Common Stock; (incorporated herein by reference to Exhibit 4.1 to the Form S-1) 10.01 Third Amended and Restated 1997 Stock Incentive Plan (the "1997 Plan"); (incorporated herein by reference to Appendix A of the Definitive Proxy Statement filed on August 20, 2002). 10.02 Form of Stock Option Agreement pertaining to the 1997 Plan.; (incorporated herein by reference to exhibit 10.2 to the form S-1). 10.03 Form of Restricted Stock Purchase Agreement pertaining to the 1997 Plan; (incorporated herein by reference to Exhibit 10.3 to the Form S-1). 10.05 Form of Indemnification Agreement for Officers and Directors of the Company; (incorporated herein by reference to Exhibit 10.11 to the Form S-1). 10.08 Stock Purchase Agreement between the Company and Titus Interactive SA, dated March 18, 1999; (incorporated herein by reference to Exhibit 10.24 to The Company's Annual Report on Form 10-K for the year ended December 31, 1998). 10.12 Stock Purchase Agreement dated July 20, 1999, by and among the Company, Titus Interactive S.A., and Brian Fargo; (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 10.13 Exchange Agreement dated July 20, 1999, by and among Titus Interactive S.A., Brian Fargo, Herve Caen and Eric Caen; (incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999). 33
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10.14 Employment Agreement between the Company and Herve Caen dated November 9, 1999; (incorporated herein by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999). 10.22 Agreement between the Company, Brian Fargo, Titus Interactive S.A., and Herve Caen, dated May 15, 2001; (incorporated herein by reference to Exhibit 99 to Form SCD 13D/A). 10.34 Term Sheet by and between Titus Interactive S.A., and the Company, dated April 26, 2002; (incorporated herein by reference to Exhibit 10.8 to Form 10-Q filed on May 15, 2002). 10.35 Promissory Note by Titus Interactive S.A. in favor of the Company, dated April 26, 2002; (incorporated herein by reference to Exhibit 10.9 to Form 10-Q filed on May 15, 2002). 10.36 Amended and Restated Secured Convertible Promissory Note, dated April 30, 2002, in favor of Warner Bros., a division of Time Warner Entertainment Company, L.P.; (incorporated herein by reference to Exhibit 10.10 to Form 10-Q filed on May 15, 2002). 10.47 Mutual Release Settlement Agreement by and between Warner Bros. Entertainment, Inc. and the Company, dated October 13, 2003. ; (incorporated herein by reference to exhibit 10.47 to the Company's Annual Report on form 10-K for the year ended December 31, 2003 filed on April 27, 2004). 10.48 Letter Agreement by and between Majorem Ltd and the Company, dated December 21, 2004. ; (Incorporated herein by reference to exhibit 10.48 to the Company's Annual Report on form 10-K for the year ended December 31, 2004 filed on June 3, 2005). 14.1 Code of Ethics of the Company; (incorporated herein by reference to Exhibit 14.1 to Amendment No. 1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003 filed on April 27, 2004). 21.1 Subsidiaries of the Company. 23.1 Consent of Jeffrey S. Gilbert, Independent Registered Public Accounting firm 23.2 Consent of Rose, Snyder & Jacobs, Independent Registered Public Accounting Firm. 24.1 Power of Attorney (included on signature page to this Form 10-K) 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. 34
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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, 2006 and 2005 F-4 Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 F-5 Consolidated Statements of Stockholder's Equity (Deficit) for the years ended December 31, 2006, 2005, 2004 F-6 Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 F-7 Notes to Consolidated Financial Statements F-9 Schedule II - Valuation and Qualifying Accounts S-1 35
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders Interplay Entertainment Corp. I have audited the consolidated balance sheets of Interplay Entertainment Corp. (a majority-owned subsidiary of Titus Interactive,S.A.) and Subsidiaries (the "Company") as of December 31, 2006 and 2005 and the related consolidated statements of operations, stockholders' equity (deficit) and comprehensive income(loss)and cash flows for the years then ended. My audit included the schedule of valuation and qualifying accounts for the years ended December 31, 2006 and 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 the 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, 2006 and 2005 and the results of their operations and their cash flows for the two years 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 years ended December 31, 2006 and 2005, 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 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, negative working capital of $8,098,000, and stockholders' deficit of $8,087,000. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1. In addition, on November 1, 2006 an involuntary petition under Chapter 7 of the Bankruptcy Code was filed in Federal Court by several of the Company's creditors (See Note 15). The consolidated financial statements do not include any adjustment that might result from the outcomes of these uncertainties. /S/ JEFFREY S. GILBERT Los Angeles, California April 6, 2007 36
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Interplay Entertainment Corp. We have audited the consolidated statement of operations, shareholders' equity (deficit) and other comprehensive income (loss) and cash flows for the year ended December 31, 2004 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, 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 results of operations and cash flows of Interplay Entertainment Corp. for the year ended December 31, 2004 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 ----------------------------------- Rose, Snyder & Jacobs A Corporation of Public Accountants Encino, California May 31, 2005 37
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[Enlarge/Download Table] INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, ------------------------------ ASSETS 2006 2005 ------------- ------------- Current Assets: Cash ............................................................ $ 50,000 $ 122,000 Trade receivables from related parties, net of allowances of $0 and $2,114,000, respectively .......................... 0 17,000 Trade receivables, net of allowances of $17,000 and $76,000, respectively ........................ 227,000 428,000 Inventories ..................................................... 8,000 8,000 Deposits ........................................................ 4,000 8,000 Prepaid expenses ................................................ 6,000 60,000 Other receivables ................................................ 17,000 8,000 ------------- ------------- Total current assets ......................................... 312,000 651,000 Property and equipment, net .......................................... 3,000 7,000 Other assets ......................................................... 8,000 15,000 ------------- ------------- Total assets ............................... $ 323,000 $ 673,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current Liabilities: Notes payable ................................................... $ 1,427,000 $ 1,406,000 Accounts payable subject to judgments ........................... 1,653,000 1,653,000 Accounts payable - other ........................................ 4,006,000 8,050,000 Accrued royalties ............................................... 170,000 949,000 Deferred income ................................................. 460,000 105,000 Notes payable officer and directors ............................. 694,000 0 ------------- ------------- Total current liabilities .................................. 8,410,000 12,163,000 ------------- ------------- 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; issued and outstanding 103,855,634 shares in 2006 and 93,855,634 shares in 2005 .................................... 104,000 94,000 Paid-in capital ................................................. 121,964,000 121,640,000 Accumulated deficit ............................................. (130,205,000) (133,284,000) Accumulated other comprehensive income .......................... 50,000 60,000 Treasury stock of 4,658,216 shares at December 31,2006 and 2005 . 0 0 ------------- ------------- Total stockholders' (deficit) ............................. (8,087,000) (11,490,000) ------------- ------------- Total liabilities and stockholders'(deficit) $ 323,000 $ 673,000 ============= ============= See accompanying notes. 38
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[Enlarge/Download Table] INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, ----------------------------------------------- 2006 2005 2004 ------------- ------------- ------------- Net revenue from recognition on expired contracts .......... $ -- $ 4,571,000 $ -- Net revenues from licensing ................................ -- 768,000 1,932,000 Net revenues from related and non related party distributors 967,000 1,819,000 11,265,000 ------------- ------------- ------------- Total net revenues ...................................... 967,000 7,158,000 13,197,000 Cost of goods sold ......................................... 167,000 478,000 6,826,000 ------------- ------------- ------------- Gross profit ............................................ 800,000 6,680,000 6,371,000 ------------- ------------- ------------- Operating expenses: Marketing and sales ..................................... 509,000 312,000 1,703,000 General and administrative .............................. 1,560,000 2,617,000 4,514,000 Product development ..................................... 0 268,000 2,636,000 ------------- ------------- ------------- Total operating expenses ............................. 2,069,000 3,197,000 8,853,000 ------------- ------------- ------------- Operating income (loss) .............................. (1,269,000) 3,483,000 (2,482,000) ------------- ------------- ------------- Other income (expense): Interest expense ........................................ (139,000) (146,000) (249,000) Other (primarily reversal of prior year recorded liabilities and settlements in 2006 and 2005) ........ 4,487,000 2,591,000 (1,999,000) ------------- ------------- ------------- Total other income (expense) ........................ 4,348,000 2,445,000 (2,248,000) ------------- ------------- ------------- Income (loss) before provision (benefit) for income taxes ............................................ 3,079,000 5,928,000 (4,730,000) Provision (benefit) for income taxes ....................... -- -- -- ------------- ------------- ------------- Net income (loss) .......................................... $ 3,079,000 $ 5,928,000 $ (4,730,000) ============= ============= ============= Net income (loss) per common share: Basic ...................................................... $ 0.030 $ 0.06 $ (0.05) ============= ============= ============= Diluted .................................................... $ 0.028 $ 0.06 $ (0.05) ============= ============= ============= Weighted average number of shares used in calculating net income (loss) per common share: Basic ...................................................... 100,513,000 93,856,000 93,856,000 ============= ============= ============= Diluted .................................................... 102,603,000 93,856,000 93,856,000 ============= ============= ============= 39
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[Enlarge/Download Table] INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPRESENSIVE INCOME (LOSS) YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (DOLLARS IN THOUSANDS) PREFERRED STOCK COMMON STOCK ------------------------- ------------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT CAPITAL ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2003 ... -- -- 93,855,634 $ 94 $ 121,640 Issuance of common stock, net of issuance costs . -- -- -- -- -- Net Income ................ -- -- -- -- -- Other comprehensive income, net of income taxes: Foreign currency translation adjustment -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2004 ... -- -- 93,855,634 94 121,640 ----------- ----------- ----------- ----------- ----------- Issuance of common stock, net of issuance costs . -- -- -- -- -- Net Income ................ -- -- -- -- -- Other comprehensive income, net of income taxes: Foreign currency translation adjustment -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2005 ... -- -- 93,855,634 94 121,640 ----------- ----------- ----------- ----------- ----------- Issuance of common stock, net of issuance costs . -- -- -- -- -- Additional Paid in Capital - Options ............. -- -- -- -- 38 Shares for Debt - Special Situation ............. -- -- 10,000,000 10 286 Treasury stock Net Income ................ -- -- -- -- -- Other comprehensive income, net of income taxes: Foreign currency translation adjustment -- -- -- -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31,2006 .... -- -- 103,855,634 $ 104 $ 121,964 =========== =========== =========== =========== =========== ACCUMULATED OTHER ACCUMULATED COMPREHENSIVE DEFICIT INCOME (LOSS) TOTAL ----------- ----------- ----------- Balance, December 31, 2003 ... $ (134,481) $ 111 $ (12,636) Issuance of common stock, net of issuance costs . -- -- -- Net Income ................ (4,730) -- (4,730) Other comprehensive income, net of income taxes: Foreign currency translation adjustment -- 4 4 ----------- ----------- ----------- Balance, December 31, 2004 ... (139,211) 115 (17,362) ----------- ----------- ----------- Issuance of common stock, net of issuance costs . -- -- -- Net Income ................ 5,928 -- 5,928 Other comprehensive income, net of income taxes: Foreign currency translation adjustment -- (56) (56) ----------- ----------- ----------- Balance, December 31, 2005 ... (133,283) (59) (11,490) ----------- ----------- ----------- Issuance of common stock, net of issuance costs . -- -- -- Additional Paid in Capital - Options ............. -- -- 38 Shares for Debt - Special Situation ............. -- -- 296 Treasury stock Net Income ................ 3,079 -- 3,079 Other comprehensive income, net of income taxes: Foreign currency translation adjustment (1) (9) (10) ----------- ----------- ----------- Balance, December 31,2006 .... $ (130,205) $ 50 $ (8,087) =========== =========== =========== See accompanying notes. 40
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[Enlarge/Download Table] INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OF CASH FLOWS YEARS ENDED DECEMBER 31, ------------------------------------------ 2006 2005 2004 ----------- ----------- ----------- Cash flows from operating activities: Net income (loss) .................................. $ 3,079,000 $ 5,928,000 $(4,730,000) Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities-- Depreciation and amortization ................... 4,000 142,000 734,000 Deposit ......................................... 4,000 (8,000) 600,000 Additional Paid in Capital - Options expenses ... 38,000 -- -- Shares issued for settlement of liability ...... 296,000 -- -- Reversal of prior year recorded liabilities ..... (4,441,000) (2,345,000) -- Writeoff of prepaid licenses and royalties ...... -- -- 209,000 Abandonement of fixed assets .................... -- 323,000 -- Changes in assets and liabilities: Restricted cash .............................. -- 2,000 -- Trade receivables, net ....................... 201,000 (297,000) (133,000) Trade receivables from related parties ....... 17,000 (6,000) 554,000 Inventories .................................. -- 18,000 120,000 Prepaid licenses and royalties ............... -- -- -- Prepaid expenses ............................. 54,000 (60,000) 673,000 Loss on sale of assets ....................... -- -- 28,000 Loss on abandonment of assets ................ -- -- 862,000 Other current assets/receivables ............. (9,000) 129,000 (134,000) Accounts payable ............................. (367,000) 885,000 1,704,000 Accrued royalties ............................ (7,000) (329,000) (1,566,000) Note Payable Officers ........................ 694,000 -- -- Payables to related parties .................. -- (3,870,000) -- Advances - Vivendi ........................... -- -- 996,000 Deferred revenue - ( Non related Party) ...... 355,000 (475,000) 1,385,000 Deferred Income .............................. -- -- (1,923,000) Accumulated other comprehensive income ....... 10,000 56,000 4,000 ----------- ----------- ----------- Net cash provided by (used in) operating activities ............................ (72,000) 93,000 (617,000) ----------- ----------- ----------- Cash flows from investing activities: Purchases of property and equipment ................ -- -- -- ----------- ----------- ----------- Net cash (used in) investing activities ... -- -- -- ----------- ----------- ----------- Cash flows from financing activities: Repayment of debt .................................. -- -- 61,000 Proceeds from debt ................................. -- -- (586,000) ----------- ----------- ----------- Net cash used in financing activities -- -- (525,000) ----------- ----------- ----------- Effect of exchange rate changes on cash ----------- ----------- ----------- Cash, beginning of year ............................... 122,000 29,000 1,171,000 ----------- ----------- ----------- Cash, end of year ..................................... $ 50,000 $ 122,000 $ 29,000 =========== =========== =========== Supplemental cash flow information: Cash paid during the year for interest ............ -- -- -- =========== =========== =========== See accompanying notes. 41
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INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 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 3, Microsoft Xbox360 and Nintendo Wii. As of December 31, 2006, Titus Interactive, S.A. ("Titus") which is in bankruptcy in France, and was a France-based developer, publisher and distributor of interactive entertainment software, owns approximately 56% 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 income of $4.5 million in 2006, primarily derived from one time non recurring non cash events which occurred in 2006. At December 31, 2006, the Company had a stockholders' deficit of $8.1 million and a working capital deficit of $8.1 million. The Company has historically funded its operations from licensing fees, royalty and distribution fee advances, and will continue to exploit 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, external sources of funding including, but not limited to, a sale or merger of the Company, a private placement or public offering 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 first quarter of fiscal 2008. Consequently, the Company expects that it will need to obtain additional financing or income. 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. 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) which was closed during the 4th quarter 2006 and Games On-line. All significant inter-company accounts and transactions have been eliminated. 42
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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, 2006 . 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. There were no prepaid licenses and royalties at December 31, 2006. SOFTWARE DEVELOPMENT COSTS Research and development costs, which consisted 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 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 since 2003 on internal development projects, as the eligible costs were determined to be insignificant. 43
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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 various 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 assets 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 other long-lived assets in the future. GOODWILL AND INTANGIBLE ASSETS Goodwill and identifiable intangible assets that have indefinite useful lives are 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. At December 31, 2006 and 2005, the Company had no goodwill or intangible assets 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, a significant part of the Vivendi distribution agreement ended in August, 2005, and Avalon, because of bankruptcy, ceased to be the distributor in February 2005. 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. 44
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The Company recognizes revenue on expired contracts when the termination date of the contract is reached because guaranteed minimum royalties are not reimbursable and is 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. Revenue is recorded net of an allowance for estimated returns, exchanges, markdowns, price concessions and warranty costs. Such allowances are based upon management's evaluation of historical experience, current industry trends and estimated costs. Management of the Company estimated that no allowances were necessary at December 31, 2006 and 2005. The amount of allowances 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. The Company has entered into various licensing agreements during 2006 under which it licensed others to exploit games to which the Company had intellectual property rights. REVERSAL OF CERTAIN PRIOR YEAR ACCRUALS AND ACCOUNTS PAYABLE During the year ended December 31, 2006 and 2005 the Company has reversed certain accruals and accounts payables of approximately $4.5 million and $2.6 million respectively. It is the Company's policy to reverse outstanding accruals and accounts payables that have been outstanding for over 3 years and no effort has been made by the vendor or claimant for that period of time to collect the outstanding balances. ADVANCES FROM DISTRIBUTORS Deferred income is recognized when contracts with distributors expire or are 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 $509,000, $312,000 and $1.2 million for the years ended December 31, 2006, 2005 and 2004, 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. 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 45
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comprehensive loss. Gains and Losses resulting from foreign currency transactions amounted to a $3,000 loss, $10,000 loss and $33,000 loss during the years ended December 31, 2006, 2005 and 2004, respectively, and is 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 and 2004, 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. For the year ended December 31, 2006 certain warrants and options were dilutive and were included in diluted net income per share. 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 Effective January 1, 2006 the Company adopted SFAS No. 123(R), "SHARE-BASED PAYMENT" ("SFAS 123R"), which requires the measurement and recognition of compensation cost at fair value for all share-based payments, including stock options and restricted stock awards. The Company adopted SFAS 123R using the modified prospective transition method and, as a result, did not retroactively adjust results from prior periods. Under this transition method, stock-based compensation is recognized for: (1) expense related to the remaining non-vested portion of all stock awards granted prior to January 1, 2006 based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123") and the same straight-line attribution method used to determine the pro forma disclosures under SFAS 123; and (2) expense related to all stock awards granted on or subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. 46
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At December 31, 2006, the Company has one stock-based employee compensation plan, which is described more fully in Note 10. Stock-based employee compensation cost approximated $40,000, $0; $0 was reflected in net income for the years ended December 31, 2006, 2005 and 2004, respectively. Stock-based employee compensation: [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ----------------------------------- 2006 2005 2004 ---------- ---------- ---------- (Dollars in thousands, except per share amounts) Net income (loss) available to common stockholders, as reported $ 3,079 $ 5,928 $ (4,730) Pro forma estimated fair value compensation expense ........... -- -- -- ---------- ---------- ---------- Pro forma net income (loss) available to common stockholders .. $ 3,079 $ 5,928 $ (4,730) ========== ========== ========== Basic net income (loss) per common share as reported .......... $ .030 $ 0.06 $ (0.05) Diluted net income (loss) per common share as reported ........ $ .028 $ 0.06 $ (0.05) Basic pro forma net income (loss) per common share ............ $ .030 $ 0.06 $ (0.05) Diluted pro forma net income (loss) per common share .......... $ .028 $ 0.06 $ (0.05) RECENT ACCOUNTING PRONOUNCEMENTS In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS 109, ACCOUNTING FOR INCOME TAXES. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for years beginning after December 15, 2006. We will adopt FIN 48 as of December 30, 2006, as required. Currently, we are not able to estimate the impact FIN 48 will have on our financial statements. In September 2006, the FASB issued SFAS 157, FAIR VALUE MEASUREMENTS , which defines fair value, creates a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We will adopt SFAS 157 on its effective date. The Company has not yet determined the effect, if any, that the application of SFAS No. 157 will have on its consolidated financial statements. In September 2006, the Securities and Exchange Commission ("SEC") issued SAB No. 108, Topic 1-N, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB No. 108 requires companies to evaluate the materiality of current year misstatements using both the rollover approach and the iron curtain approach.. The adoption of SAB No. 108 did not have a material impact on the Company's consolidated financial position and results of operations. 3. DETAIL OF SELECTED BALANCE SHEET ACCOUNTS PROPERTY AND EQUIPMENT Property and equipment consists of the following: DECEMBER 31, ------------------ 2006 2005 ------ ------ (Dollars in thousands) Computers and equipment ................................ $ 14 $ 14 Furniture and fixtures ................................. 8 8 Leasehold improvements ................................. -- -- ------ ------ 22 22 Less: Accumulated depreciation and amortization .................................... (19) (15) ------ ------ Net Equipment ........................... $ 3 $ 7 ====== ====== 47
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For the years ended December 31, 2006, 2005 and 2004, the Company incurred depreciation and amortization expense of $4,000, $100,000 and $800,000, respectively. During the years ended December 31, 2006, 2005 and 2004, the Company disposed of fully depreciated equipment having an original cost of $0, $1.4 and $4.7 million, respectively. 4. PROMISSORY NOTES The Company issued to Warner Brothers Entertainment, Inc. ("Warner") a Secured Convertible Promissory Note bearing interest at 6% per annum, due April 30, 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 $383,000 as of December 31, 2006 . 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. On March 28, 2007 both parties agreed to extend the option period of the promissory note until March 31, 2008. 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, 2006, 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 accounts payable not subject to judgments is a $140,000 advance from the former President of Interplay Japan which has been closed. 5. ADVANCES FROM DISTRIBUTORS, RELATED PARTIES AND OTHERS Advances from distributors consist of the following: DECEMBER 31, ----------------------- 2006 2005 -------- -------- (Dollars in thousands) Advances for other distribution rights ........... $460,000 $ 0 ======== ======== 48
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6. INCOME TAXES Income (loss) before provision for income taxes consists of the following: YEARS ENDED DECEMBER 31, ------------------------------------------------- 2006 2005 2004 ----------- ----------- ----------- Domestic .............. $ 3,624,000 $ 6,554,000 $(4,574,000) Foreign ............... (550,000) (626,000) (3,000) ----------- ----------- ----------- Total ................. $ 3,079,000 $ 5,928,000 $(4,577,000) =========== =========== =========== The provision for income taxes is comprised of the following: YEARS ENDED DECEMBER 31, -------------------------------------- 2006 2005 2004 -------- -------- -------- (Dollars in thousands) Current: Federal .................... $ -- $ -- $ -- State ...................... -- -- -- Foreign .................... -- -- -- -------- -------- -------- Deferred: Federal .................... -- -- -- State ...................... -- -- -- -------- -------- -------- $ -- $ -- $ -- ======== ======== ========= 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. A reconciliation of the statutory Federal income tax rate and the effective tax rate as a percentage of pretax loss is as follows: 2006 2005 2004 --------- --------- ---------- Statutory Federal income tax rate ... 34.0% 34.0% 34.0% State income tax effect, net of federal benefits .................. 5.8 5.8 -- Valuation allowance ............... (39.8) (39.5) (39.5) Tax rate differentiation of foreign earnings .............. -- -- -- Other ................................ -- -- -- --------- --------- ---------- -- % -- % -- % ========= ========= ========== 49
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The components of the Company's net deferred income tax asset (liability) are as follows: DECEMBER 31, ---------------------- 2006 2005 -------- -------- (Dollars in thousands) Current deferred tax asset (liability): Prepaid royalties ............................. $ 183 $ -- Nondeductible reserves ........................ -- 872 Accrued expenses .............................. 31 -- Foreign loss and credit carryforward .......... 2,954 2,766 Federal and state net operating losses ........ 50,609 49,766 Other ......................................... -- -- -------- -------- 53,777 53,404 -------- -------- Non-current deferred tax asset (liability): Depreciation expense .......................... -- -- Nondeductible reserves ........................ -- -- -------- -------- -- -- -------- -------- Net deferred tax asset before valuation allowance ........................... 53,777 53,404 Valuation allowance ................................ (53,777) (53,404) -------- -------- 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 increased $373,000 during the year ending December 31, 2006 and increased $2.1 million during the year ending December 31, 2005. 7. COMMITMENTS AND CONTINGENCIES 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 closed the satellite office in Irvine, California in May 2006. The Company also has a lease commitment at the French representation office through February 28, 2008 with an option for an additional 6 years. The minimum annual net rentals for 2007 and 2008 are $121,000 and $41,000, respectively. Total net rent expense was $ 77,000 net, $40,000 and $400,000 for the years ended December 31, 2006, 2005 and 2004, respectively. 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. 50
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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 $383,000 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 been in default of the forbearance agreement. On or about November 1, 2006, Arden filed an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. (See Note 15) 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 additional interest has accrued in the amount of $26,548; the total outstanding balance at December 31, 2006 is $126,548. 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. 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 or about November 1, 2006, Reflexive joined Arden in the filing of an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. (See Note 15) 51
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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, interest and penalties owed for the periods ending 2003, 2004 and 2005 which has been accrued for December 31, 2006. The Company is in the process of establishing a payment plan with the Employment Development Department. 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 and paid leaving, a balance of $74,000. On or about November 1, 2006, two employees joined Arden and Reflexive in the filing of an involuntary bankruptcy petition against the Company. The petition is pending before the bankruptcy court and the Company is opposing it. (See Note 15) The Company's property, general liability, auto, fiduciary liability, workers compensation and employment practices liability, have been cancelled in 2004. 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 has engaged an independent specialized accounting firm to appeal the prior year audit calculations and submit a settlement proposal to the California State Board of Equalization. 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. NCS subsequently obtained a judgment against the company for approximately $140,000. On April 22, 2005, Mark Strecker filed an action 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. 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 in 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 $776,000 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 issued 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 were filed. Such shares were issued in a private placement pursuant to section 4(2) of the Securities Act of 1933 and were issued at a price of $.0296 per share, using a value based on the then current market price of shares of common stock discounted by such newly issued shares. 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. 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, 2006, there were no shares of preferred stock outstanding. 52
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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 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 was $2.2 million and $3.1 million, respectively. During 2006 the Company reversed the outstanding accrual of $2.2 million, as management of the Company determined that based on the time period the debt was outstanding, it was no longer collectible by the creditors. 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. WARRANTS ISSUED During 2006 the Company issued 6,370,000 warrants to purchase the Company's common stock at $.0279 per share (average closing price over ten days subsequent to the resolution authorizing the issuance of the warrants) to the officer and directors. The 6,100,000 warrants were issued to the officer to reduce his compensation and to convert a portion of his unpaid compensation into a conditional demand note. The conditions includes that such note will be paid only if the tangible net worth of the Company exceeds $1 million or in a case of change in control. The demand note will accrue interest at a rate of 5% annually. These warrants were valued using the Black-Scholes Model. In addition 270,000 warrants were issued to the directors to convert their earned but unpaid director's fees to conditional demand notes. The conditions include that such notes will be paid only if the tangible net worth of the Company exceeds $1 million or in a case of change in control. The demand notes will accrue interest at a rate of 5% annually, These warrants were valued using the Black-Scholes Model. The aggregate amount charged against income was approximately $40,000. SHARES RESERVED FOR FUTURE ISSUANCE Common stock reserved for future issuance at December 31, 2006 is as follows: Stock option plans: Outstanding ........................................ 2,640,000 Available for future grants ........................ 7,360,000 ---------- 10,000,000 ---------- Warrants .................................................. 7,330,298 ---------- Total ..................................................... 17,330,298 ========== 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 2006 and 2005. 53
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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. [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ------------------------------ 2006 2005 2004 -------- -------- -------- (Amounts in thousands, except per share amounts) Net income (loss) available to common stockholders ........... $ 3,079 $ 5,928 $ (4,730) Interest related to conversion of secured convertible promissory note ........................................ -- -- -- -------- -------- -------- Dilutive net income (loss) available to common stockholders $ 3,079 $ 5,928 $ (4,730) -------- -------- -------- Shares used to compute net income (loss) per common share: Weighted-average common shares ............................ 100,513 93,856 93,856 Dilutive stock equivalents ................................ 2,090 -- -- -------- -------- -------- Dilutive potential common shares .......................... 102,603 93,856 93,856 ======== ======== ======== Net income (loss) per common share: Basic ..................................................... $ 0.030 $ 0.06 $ (0.05) Diluted ................................................... $ 0.028 $ 0.06 $ (0.05) There were options and warrants outstanding to purchase 9,970,298 shares of common stock at December 31, 2006, 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. 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 December 31, 2006, 2005 and 2004 was $.38, $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. The dilution effect for the year ended December 31,2006 was 2,090,000 common shares related to warrants issued to officer and directors. [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2006 2005 2004 ------------------------ ----------------------- ----------------------- 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 9,587,068 $ 1.84 Granted ............ 6,370,000 .0279 -- -- -- -- Exercised .......... -- -- -- -- -- -- Canceled ........... (8,626,770) -- -- -- -- -- ---------- ---------- ---------- Warrants outstanding and exercisable at end of year ......... 7,330,298 $ .38 9,587,068 1.84 9,587,068 $ 1.84 ========== ========== ========== 54
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A detail of the warrants outstanding and exercisable as of December 31, 2006 is as follows: WARRANTS OUTSTANDING AND EXERCISABLE --------------------------------------------------- WEIGHTED WEIGHTED RANGE OF AVERAGE AVERAGE EXERCISE NUMBER REMAINING EXERCISE PRICES OUTSTANDING CONTRACT LIFE PRICE --------------- ----------- ------------- ----------- $1.75 - $1.75 500,000 .47 $ 1.75 $3.79 - $3.79 460,298 4.29 3.79 $.0279 - $.0279 6,370,000 9.75 $ .0279 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: [Enlarge/Download Table] YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------- 2006 2005 2004 ------------------------ ----------------------- ----------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ---------- ---------- ---------- ---------- ---------- ---------- Options outstanding at beginning of year ... 70,000 $ .30 211,150 $ 2.02 425,985 $ 1.95 Granted ............ 2,570,000 .045 -- -- 5,000 0.08 Exercised .......... -- -- -- -- -- -- Canceled ........... -- -- (141,150) 2.02 (219,835) 1.85 ---------- ---------- ---------- ---------- Options outstanding at end of year ...... 2,640,000 $ .05 70,000 $ .30 211,150 $ 2.02 ========== ========== ========== Options exercisable 2,620,002 50,002 171,686 ========== ========== ========== Black Scholes Single Option approach was used to estimate the fair value information presented utilizing ratable amortization. There were 2,570,000, 0 and 5,000 options granted in 2006, 2005 and 2004, respectively. 55
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A detail of the options outstanding and exercisable as of December 31, 2006 is as follows: [Enlarge/Download Table] OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------- ----------------------------- RANGE OF EXERCISE WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RANGE OF EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE PRICES OUTSTANDING CONTRACT LIFE PRICE OUTSTANDING PRICE ------------------------- ------------- ------------- ------------- ------------- ------------- $0.045 - $.68 2,640,000 8.75 $ .05 2,620,002 $ .05 ------------- ------------- ------------- ------------- ------------- $0.045 - $.68 2,640,000 8.75 $ .05 2,620,002 $ .05 ============= ============= ============= ============= ============= PROFIT SHARING 401(K) PLAN In 2003, the employee stock purchase plan was terminated, the Profit Sharing 401(k) plan during 2007 had distributed all assets in the plan and will file their final pension plan returns during 2007. 11. RELATED PARTY TRANSACTIONS Amounts receivable from and payable to related parties are as follows: DECEMBER 31, -------------------------- 2006 2005 ----------- ----------- (Dollars in thousands) Receivables from related parties: Titus TSC ...................................... $ 0 $ 70 Titus SARL ..................................... 0 18 VIE Acquisition Group (Titus owned) ............ 0 17 Avalon ......................................... 0 0 0 2,026 Less Reserves .................................. (0) (2,114) ----------- ----------- Total .......................................... $ 0 $ 17 =========== =========== 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 had a major distribution agreement with Avalon. TRANSACTIONS WITH TITUS AND AFFILIATES Titus (placed in French involuntary bankruptcy in January 2005) presently owns approximately 58 million shares of Company common stock. As of December 31, 2006 and December 31, 2005, Titus and its affiliates, excluding Avalon owed the Company $0 and $105,000, respectively (See transactions with Titus Software below 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 56
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in Japan. As of December 31, 2006 the Company had a balance owed from Titus Japan of $ 226,000. During the twelve months ending December 31, 2006 the Company's Japanese subsidiary incurred to Titus Japan costs of approximately $106,000 in commissions, publishing and staff services. The Company closed our Japanese subsidiary during the 4th quarter of 2006. The amounts due from Avalon as of December 31, 2006 have been fully reversed. 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. o The Company's revenues and cash flows could fall significantly, and its business and financial results could suffer material harm if 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. For the years ended December 31, 2005 and 2004 , Avalon accounted for approximately 2% and 70% respectively, of net revenues in connection with the International Distribution Agreement (Note 11). Vivendi accounted for 7 % and 21% of net revenues in the years ended December 31, 2005, and 2004, 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: [Download Table] YEARS ENDED DECEMBER 31, ---------------------------------------------------------------- 2006 2005 2004 ------------------ -------------------- ------------------ AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------- ------- ------- ------- (Dollars in thousands) North America .. $ 203 21% $ 2,885 (1) 40% $ 1,544 12% Europe ......... 471 49 1,779 (1) 25 8,706 66 Rest of World .. 161 17 2,277 (1) 32 1,228 9 OEM, royalty and licensing ... 132 13 217 3 1,720 13 ------- ------- ------- ------- ------- ------- $ 967 100% $ 7,158 100% $13,197 100% ======= ======= ======= ======= ======= ======= (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. 57
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14. QUARTERLY FINANCIAL DATA (UNAUDITED) The Company's summarized quarterly financial data is as follows: [Enlarge/Download Table] MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------ ------------ (Dollars in thousands, except per share amounts) Year ended December 31, 2006: Net revenues ............................. $ 106 $ 239 $ 335 $ 287 ============ ============ ============ ============ Gross profit ............................. $ 100 $ 93 $ 330 $ 277 ============ ============ ============ ============ Net income (loss) ........................ $ (529) $ 2,060 $ 1,633 $ (85) ============ ============ ============ ============ Net income (loss) per common share basic . $ (0.006) $ 0.02 $ 0.02 $ (0.001) ============ ============ ============ ============ Net income (loss) per common share diluted $ (0.006) $ 0.02 $ 0.02 $ (0.001) ============ ============ ============ ============ Year ended December 31, 2005: Net revenues ............................. $ 793 $ 468 $ 4,268 $ 1,629 ============ ============ ============ ============ Gross profit ............................. $ 622 $ 372 $ 4,255 $ 1,431 ============ ============ ============ ============ Net income (loss) ........................ $ (216) $ 631 $ 4,700 $ 812 ============ ============ ============ ============ Net income (loss) per common share basic . $ (0.00) $ 0.01 $ 0.05 $ 0.01 ============ ============ ============ ============ Net income (loss) per common share diluted $ (0.00) $ 0.01 $ 0.05 $ 0.01 ============ ============ ============ ============ 15. INVOLUNTARY BANKRUPTCY On November 1, 2006 an involuntary petition under Chapter 7 of the Bankruptcy Code was filed in Federal Court by several of the Company's creditors. Involuntary bankruptcy is a process where a court appointed trustee is empowered to liquidate the non exempt property, if any, of the debtor. The Company is opposing the petition. 58
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[Enlarge/Download Table] INTERPLAY ENTERTAINMENT CORP. AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS) TRADE RECEIVABLES ALLOWANCE ------------------------------------------------------------------ BALANCE AT PROVISIONS FOR BEGINNING OF RETURNS RETURNS AND BALANCE AT END PERIOD PERIOD AND DISCOUNTS DISCOUNTS OF PERIOD ----------------------------------- -------------- -------------- ---------- -------------- Year ended December 31, 2004 ...... $ 725 $ 1,681 $ -- $ 2,406 ============== ============== ============== ============== Year ended December 31, 2005 ...... $ 2,406 $ (216) $ -- $ 2,190 ============== ============== ============== ============== Year ended December 31, 2006 ...... $ 2,190 $ (2,173) $ -- $ 17 ============== ============== ============== ============== 59

Dates Referenced Herein   and   Documents Incorporated by Reference

Referenced-On Page
This ‘10-K’ Filing    Date First  Last      Other Filings
3/31/08284810-Q,  NT 10-K
2/28/082850
11/15/072947
Filed as of:4/12/078-K
Filed on:4/11/07
4/9/07328-K
4/6/0736
3/28/0748NT 10-K
3/19/0715
For Period End:12/31/0615910-K/A,  NT 10-K
12/30/062947
12/29/06130
12/15/062947
11/15/0629
11/1/0614588-K
10/2/06164,  8-K
5/3/061552
3/31/065310-Q,  NT 10-Q
3/20/06298-K/A
3/7/061552
2/16/06298-K
2/2/061552
1/1/0646
12/31/0555810-K,  NT 10-K
9/14/051552
6/3/053410-K
5/31/0537
5/19/051552
4/22/051552
3/16/05298-K/A
2/4/051552
1/12/051552
12/31/0455910-K,  10-K/A,  NT 10-K
12/21/0434
6/3/041451
4/27/043410-K
4/23/0448
3/9/0433
1/30/0448
1/21/0433
12/31/03334010-K,  10-K/A,  NT 10-K
12/29/031452
10/13/0334
10/9/031451
4/30/034810-K/A
3/27/031452
11/25/0215525
10/24/021451
8/20/0233DEF 14A
8/6/021451
5/15/023410-Q,  8-K/A
4/30/02145110-K/A,  8-K
4/26/0234
12/31/011810-K,  10-K/A,  NT 10-K
5/15/013410-Q,  SC 13D/A
3/29/011552
11/2/0033
10/30/0033
4/14/003310-K405,  4
12/31/993310-K/A,  10-K405,  NT 10-K
11/9/9934
9/30/993410-Q
7/20/99338-K
6/30/993310-Q
3/18/99333
12/31/983310-K405,  10-K405/A
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