Another Video Game Maker On the Ropes

The prospect of consolidation of the video game software sector took another step forward Friday, as Acclaim Entertainment ( AKLM) warned that it may soon wind up in bankruptcy.

Acclaim shares were recently down 8 cents, or 24%, to 25 cents after hitting a 52-week low of 24 cents earlier in the session.

"Acclaim shares remain a speculative investment until management demonstrates its ability to execute on its strategy of making fewer, higher quality games," Wedbush Morgan analyst Michael Pachter wrote Friday. "We believe that the company has a respectable lineup of games planned for release in fiscal 2005, but due to continuing cash flow problems, its ability to deliver these games on time remains in question."

In its annual report filed Thursday and in an earnings release on Friday, the game maker reported that it is in default on some of its convertible notes and at least three of its licensing agreements are in dispute, in part because Acclaim's partners claim it hasn't been paying royalties on time. While Acclaim negotiated a $30 million line of credit in May, it is facing a cash crunch. At the end of fiscal year on March 31, the company had just $1.1 million in cash, compared to $41.2 million in short-term debt.

"The company cannot assure its stockholders that its future operating cash flows will be sufficient to meet its operating requirements and debt service requirements," Acclaim said in its earnings release. If the company doesn't get an influx of cash and reduce expenses, it "would be materially and adversely affected and it could be forced to cease operations or seek bankruptcy protection."

Acclaim is only the latest video game software company whose future as an independent, ongoing entity remains in question. After delaying the release of one of its key titles, London-based Eidos said last month that it is exploring a possible sale of its business or assets. Meanwhile, Viacom ( VIA.B) CEO Sumner Redstone has been buying up the stock of Midway Games ( MWY), and has said that he is considering taking the company private.

Analysts and investors have also speculated about whether other smaller-tier video game makers such as Take Two ( TTWO), THQ ( THQI) and even Activision ( ATVI) might be takeover targets.

Many of the video game makers have posted strong results in recent quarters. But industry observers and participants are concerned about the development costs for the next generation of video game consoles, which should debut by 2006.

The last console transition proved costly for software developers, because they faced huge expenses to develop games for the new PlayStation 2 and Xbox platforms at the same time that many cut back on their sales and development for the legacy consoles. The game makers have promised to better manage the upcoming transition.

Meanwhile, many game publishers have attempted to diversify their offerings to make themselves less dependent on any one title. Some investors have attributed Eidos' potential sale to the relatively poor showing of the last version of its hit Tomb Raider title and its paucity of other hit offerings.

But many of the top selling games have been based on movie, television or comic book series or characters. Software publishers have to pay license fees on such titles, which can cut into their profits.

Conversely, entertainment giants such as Vivendi have attempted to break into the video game market, figuring they can post higher profits by owning the games instead of just receiving royalties on them. With the market for traditional entertainment businesses such as movie rentals and music sales slowing, some investors believe the entertainment companies have their eyes trained on the much faster growing video game sector.

Of course, not all the video game players are benefiting from that growth. Acclaim, in fact, has struggled in recent quarters.

In its fourth quarter, the company lost $25.4 million, or 23 cents a share on $29 million in sales. In the same period a year earlier, Acclaim lost $45 million, or 49 cents a share, on $28 million in sales.

For the full year, the company lost $56.4 million, or 53 cents a share, on sales of $142.7 million. In fiscal 2003, the company posted a loss of $84.8 million, or 92 cents a share, on $210.1 million in revenue.

While the company's bottom line improved in the fourth quarter and for the full year, its results were far below analysts' expectations. On average, analysts polled by Reuters' MultexNet service were expecting Acclaim to lose 19 cents a share in the fourth quarter on $33.77 million in sales.

Thanks to its continuing losses and its drop in sales last year, Acclaim posted an operating cash flow deficit of $26 million last year.

The cash flow problems appear to be catching up with the company. Acclaim raised some $11.9 million in cash through the sale of convertible notes last fall. But the company is now in default on at least some of those notes, it said.

Additionally, the Major League Baseball Player's Association and Classic Media both claim that Acclaim has not paid royalties in a timely manner. Both organizations have terminated their agreements with Acclaim.

So too has Battleborne Entertainment, with which Acclaim is developing a game called Combat Elite: WWII Paratroopers. In fact, Battleborne secured a temporary restraining order to prevent Acclaim from releasing the game.

Acclaim said it is in discussions with both its creditors and its business partners to resolve all the matters.

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