38 STUDIOS | CHAIRMAN SPEAKS OUT

Schilling blames state for company’s problems

Says Chafee, EDC officials reneged on tax-credit deal needed to keep firm afloat; states governor’s comments scared off investors

By MIKE STANTON and ANDY SMITH JOURNAL STAFF WRITERS

PROVIDENCE — Curt Schilling sits in a glass-walled conference room in the video-game company that he built. The former Boston Red Sox pitching star is gaunt, unshaven and wearing a wrinkled 38 Studios T-shirt and green camouflage shorts.

He is not sleeping and has lost 33 pounds in the past 45 days, which he calls a “surreal” stretch that has seen 38 Studios — the company that he and Rhode Island have bankrolled to the tune of more than $100 million — brought to the brink of financial ruin.

His controversial partnership with the State of Rhode Island, forged with $75 million in taxpayer-guaranteed bonds two years ago, is hanging by a thread, in large part, he says, because of broken promises by the state and damaging public comments by Governor Chafee regarding 38 Studios’ finances.

If 38 Studios fails, Rhode Island taxpayers will be liable to repay more than $100 million. Also, Schilling says, he stands to lose $50 million of the fortune he earned as a likely Hall of Fame baseball pitcher and committed to the venture — “everything I have.”

In exclusive interviews with The Providence Journal over Memorial Day weekend as he struggled to save his

Blames state for problems company, Schilling broke his silence, defending his beleaguered company and denying that he sought a government “bailout.”

Schilling, the founder and chairman, says state economic-development officials reneged on a deal to approve film tax credits to which 38 Studios is legally entitled, and to allow the company to defer a $1.12-million payment due to the state on May1so that 38 Studios could meet its May 15 payroll.

Schilling also criticized Chafee’s “devastating” public remarks about 38 Studios’ financial health, which he says scared off private investors.

Within 72 hours of Chafee’s May 14 statement that the state was trying to keep 38 Studios “solvent,” Schilling says, a video-game publisher pulled out of a $35-million deal to finance a sequel to “Kingdoms of Amalur: Reckoning,” the fantasy game that 38 Studios released in February.

Chafee said Monday night that he was trying to strike a balance between providing information to the taxpayers and not jeopardizing 38 Studios. As a candidate in 2010, Chafee opposed the state’s deal with 38 Studios but said he would be the company’s biggest cheerleader once it was in place when he took office in 2011.

On Thursday, 38 Studios was forced to lay off its 286 workers in downtown Providence and 100 in Maryland.

“The governor is not operating in the best interest of the company by any stretch, or the taxpayers, or the state,” says Schilling, who invited two Journal reporters and a photographer into the usually off-limits offices at One Empire Plaza, in downtown Providence. “We’re trying to save this company and we’re working 24/7. The public commentary has been as big a piece of what’s happening to us as anything out there.”

Chafee says he wants to do whatever he reasonably can do to help, but that he’s opposed to throwing “good money after bad” or allowing 38 Studios to receive film tax credits after receiving $47 million in state bond money.

Responds Schilling: “That money is going into the hands, wallets, mouths of families who live in Rhode Island — right back into the system. … We’re not trying to take advantage of the taxpayers. We’re trying to be a successful business in the State of Rhode Island that helps the State of Rhode Island get out of the doldrums that we are in.”

Furthermore, Schilling says, all of the money he received from the state and all of his own money that he invested has gone into the company, much of it into the Rhode Island economy. According to 38 Studios, 182 of its Providence-based employees live in Rhode Island, earning an average salary of $86,000.

“To be clear, I’ve never taken a penny out of this company,” says Schilling. “If this company fails, I will be financially devastated, and so will other people.”

Schilling says that talks continue with potential investors, who might be willing to step in if the state agrees to yield its first position on 38 Studios’ collateral to a private investor.

Is 38 Studios finished?

“I don’t know,” says Schilling. “I pray that it’s not. We’re doing everything we can do to make that not be the case.”

Jonathan Savage, a business lawyer who is representing Chafee, says that he is in daily discussions with 38 Studios and with potential private investors. He says that he believes Chafee was merely stating the obvious when he commented publicly on the company’s troubled finances; the governor’s remarks haven’t proven damaging in Savage’s talks with private investors. He is not aware of any potential deals falling through but says those publishers would be welcomed back at the negotiating table.

“It’s a fragile situation,” Savage said Monday night. “The governor has made it clear that he wants no new taxpayer money spent, but he has also encouraged me to forge ahead to find fresh private capital.”

Savage said the state is willing to yield first position to 38 Studio’s assets –– its intellectual property –– to attract a private investor.

“The state is not going to be a barrier,” he said.

The current crisis began in mid-April, when Schilling and 38 Studios executives met with Chafee and House Speaker Gordon Fox to discuss a cash crunch at the company.

Schilling attributes the crunch to the normal growing pains of an “early-stage startup” company. Disputing Chafee’s assessment, Schilling says that “Kingdoms of Amalur: Reckoning” had enjoyed a successful launch in February, selling more than 1 million copies in its first 90 days and exceeding the projections of its publisher, Electronic Arts.

Schilling says 38 Studios hasn’t seen any money from “Reckoning’s” sales, nor did it expect to: that money was committed to EA, which had paid 38 Studios an up-front publishing fee of $35 million.

But he says the positive buzz from Reckoning created interest and potential customers for the bigger, multiplayer online fantasy game that the company is developing, dubbed Project Copernicus, which is set in the same universe.

“That changed the tenor and velocity of all of our investor discussions,” says Schilling. “We felt we were in an extremely positive place.”

Still, given 38 Studio’s previous inability to attract private financing, Schilling says the company needed short-term help from the state to stay afloat until private deals came through.

At the April meeting with Chafee, says Schilling, 38 Studios’ executives said they needed to use $8.7 million in 2011film tax credits to provide that financial bridge and to meet the May 15 payroll.

They also discussed the need to lure private investors by giving them “senior security interests” in 38 Studio’s assets, most notably its intellectual property. That meant Rhode Island taxpayers would take a back seat to any private investor — something that Schilling says always was going to be necessary and had been discussed previously with the Rhode Island Economic Development Corporation, which issued the job-guarantee bonds.

Schilling says 38 Studios’ inability to give a private investor “first position” had created hurdles to attracting private venture capital, “but I’d always been operating under the assumption as our partner we’d come to agreements.”

As 38 Studio’s April talks with the state progressed, Schilling says, Chafee’s position was that “we are partners” and that he wanted to help. The paperwork for approval of the film-tax credits was moving along. Two EDC board members, Helena Foulkes and J. L. “Lynn” Singleton, were briefed on the plan, which would require approval of the EDC board, which is chaired by Chafee.

38 Studios was dealing with Keith Stokes, then-EDC’s executive director, and David Gilden, the EDC’s lawyer. On April 30, Schilling says, the company talked to Stokes about deferring the $1.12-million payment that was due the next day, May 1, and using the money for the May 15 payroll. But the company also said that if the tax credits were issued in time, 38 Studios wouldn’t need the extension.

Stokes declined comment. Gilden could not be reached.

The company missed the May1payment. As a result, on May 4, the EDC issued a notice that 38 Studios had defaulted on its state loan agreement, making the company ineligible for the film-tax credits that it needed to stay afloat.

Schilling says the company was blindsided by the notice. Under terms of 38 Studio’s original agreement with the state, he says, the company should have had 30 days to address the missed payment before being declared in default.

That touched off frantic negotiations among 38 Studios, the EDC and Chafee. By the end of the following week, the word had begun leaking to reporters. Then, on Monday, May 14, Chafee said publicly that the state was working with 38 Studios to keep the company “solvent.”

In the ensuing days, as the 38 Studios story went viral, Chafee made other public remarks that Schilling calls damaging.

The governor said the Reckoning game released in February had been an “abject failure.” He also revealed the projected release date of Project Copernicus, June 2013, and 38 Studios’ “burn rate” ––that it was spending $4 million a month, the lion’s share on payroll.

The release date of a game is “the most costly piece of information we own,” says Schilling. And the burn rate is a closely guarded industry secret. “Those two nuggets were given out as if, ‘Here’s the weather and here’s the time.’

“We made it clear in EDC meetings how damaging it was, what was happening to our company. [My workers] are sitting there, busting their [humps] without a paycheck, we’re grinding through this, and then he’s press-conferencing on a daily basis, saying this company is a failure, our games are a failure, this was a mistake –– over and over and over again.

“Our partner.”

On Saturday, May12, Schilling says, 38 Studios learned that the president of a video-game publishing company had approved a $35-million deal to publish the sequel to Reckoning, and was going to his company’s executive committee that week for the money. But Chafee’s comments killed the deal, Schilling says.

The company also says Chafee’s public comments derailed discussions that 38 Studios says it was having with another publisher for a $55-million deal on Project Copernicus, as well as a venture capitalist about additional financing.

38 Studios declined to identify the would-be investors, citing confidentiality.

Meanwhile, Schilling says, the EDC’s Stokes and Gilden had agreed to a deal in which 38 Studios would pay the $1.12-million fee and then EDC would facilitate the release of the tax credits, by certifying that 38 Studios was no longer in default.

The night before it was to go through, company director Thomas Zaccagnino says, he learned that the embattled Stokes, who was drawing heavy criticism for the 38 Studios deal, had resigned. Since Stokes had been a point person in talks with 38 Studios, a worried Zaccagnino texted Gilden, “Please tell me that this won’t affect our agreement.”

Responded Gilden: “it will not.”

But the next day, when 38 Studios tried to pay the $1.12 million with money from a tax-credit investor, executives say they found themselves in an embarrassing scene in which Chafee announced that 38 Studios had sent a bad check with insufficient funds.

Richard O. Wester, 38 Studio’s chief financial officer, says he went to the EDC’s offices at 5 p.m. that day with a check. Meanwhile, 38 Studios’ controller was back at the office, waiting for the funds to be wired from the buyer of the tax credits into 38 Studios’ account. When that happened, Wester would receive the green light to give the EDC the check.

But the tax-credit buyer, whom 38 Studios declined to identify, backed out –– because the EDC lawyer Gilden would not provide a state guarantee to the buyer. When Wester learned that, he says, he never handed over the check.

Fifteen minutes later, he says, he saw a news story on The Providence Journal’s website, quoting Chafee’s spokeswoman that the company had given the EDC a bad check.

The next day, Friday, May 18, another tax-credit investor wired the $1.12 million directly to the EDC. But the state did not release the tax credits to 38 Studios, and still hasn’t ––raising doubts about how that investor will ultimately be repaid.

When Schilling appeared at a closed-door meeting of the EDC board the following Monday, May 21, he says, he was faced with skeptical board members.

“The first question I was asked was, ‘Why did you lie to us?’ ” says Schilling. “You said you didn’t have the money, then you went out and wrote a check. I said, ‘I didn’t write the check. I don’t have the money.’ ”

In two weeks, the partnership between the state and 38 Studios has come close to breaking down.

“Given where we’re at, it’s not flourishing,” says Schilling, slumped in a chair Sun-day in the 38 Studios conference room, his left cheek puffed out by a plug of chewing tobacco.

The state has declared 38 Studios in default of its loan agreement again, saying that it failed to notify the state when it laid off its employees last week. Bill Thomas, the 38 Studios president, produced a May 25 letter and e-mail notifying the state, which was within 24 hours of the layoffs. The company didn’t tell the state sooner, Thomas says, to avoid leaks. “We wanted our employees to hear it from us first.”

The state also has questioned 38 Studios’ eligibility for the film-tax credits because the company is incorporated in Delaware.

Thomas, the 38 Studios president, countered with a May 25 letter that he wrote to the head of the state film office, Steven Feinberg, noting that the tax credits already had received “initial certification,” which “by your own admission” means that a company registered to do business in Rhode Island, as 38 Studios is, qualified.

Wrote Thomas: “There was a fully negotiated deal and agreement on behalf of the State of Rhode Island by RIEDC executive director and its executive counsel to issue all the 2011 tax credits upon payment of the annual guaranty fee,” wrote Thomas.

Says Schilling: “I don’t know how we suddenly became ineligible. Delaware didn’t move.”

Meanwhile, Schilling and his partners are holding intensive discussions with private investors, both short- and long-term. The salvation of 38 Studios, and the intertwined fates of Rhode Island taxpayers, 38 Studios’ employees and Schilling’s fortunes, depend on a Rubik’s cube of investors and aid from the state. Time is running out.

Schilling, 45, is alternately despondent and animated as he shows a reporter around the vacant fifth-floor offices. State-of-the-art cubicles are equipped with computers, decorated by statues of super heroes, photos from the fantasy worlds of Amalur, a Lego airplane, a water gun. The carpet is a colorful patchwork of yellow, orange, green and gray squares. A foosball table stands in a corner, near a kitchen, bright light streaming in from large windows overlooking Empire Street and downtown.

Since the company moved into these offices in April 2011, Schilling says, he has generally been at work every day by 8 a.m., trying to build a company that he says is like a family. Noting the throngs of reporters camped outside his doors, he praises the loyalty of his workers, a top-notch group of artists and engineers and designers, who have maintained their silence and stuck together. With the layoffs, some have brought groceries in for others, and offered coworkers a place to sleep.

Criticized for his silence, Schilling says he has wanted to respond to the charges against him but had been restrained by his advisers and directors, given the sensitivity of efforts to save the company.

He is asked to respond to critics who call him a hypocrite for having conservative, small-government values yet taking what they view as a big-government handout.

“I have done whatever I can do to create jobs and create a successful business, with my own income,” he replies. “Fifty million dollars, everything I’ve ever saved, has been put back into the economy. The $49 million from Rhode Island has been put back in the economy. I’ve never taken a penny and I’ve done nothing but create jobs and create economy. And so how does that translate into welfare baby? I’ve tried to do right by people.”

He says he is speaking out now, in hopes of having people know the full story as they weigh 38 Studios’ fate. He has sunk $38 million into the company that bears his jersey number with the Red Sox, and also is on the line for another $12 million in personal loan guarantees, he says.

“We’re at a potential endgame scenario, one way or another, at some point in the near future.” mstanton@providencejournal.com (401) 277-7724 asmith@providencejournal.com (401) 277-7485