Document/Exhibit Description Pages Size
1: 10-K Annual Report 63 358K
2: EX-21.1 Subsidiaries of the Registrant 1 6K
3: EX-23.1 Consent of Experts or Counsel 1 6K
4: EX-27.1 Financial Data Schedule (Pre-XBRL) 2 10K
5: EX-27.2 Financial Data Schedule (Pre-XBRL) 2 13K
6: EX-27.3 Financial Data Schedule (Pre-XBRL) 2 11K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-K
[Enlarge/Download Table]
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1998, or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-19463
MICROPROSE, INC.
(Exact name of registrant as specified in its charter)
State of Incorporation: DELAWARE I.R.S. Employer Identification No.: 52-1728656
2490 MARINER SQUARE LOOP, SUITE 100, ALAMEDA, CA 94501
(Address of principal executive offices)
Registrant's telephone number: (510) 864-4440
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by a 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 15, 1998, was approximately $13,875,000 (based on
the June 15, 1998, closing price for shares of the Registrant's Common Stock
as reported by the Nasdaq National Market). Shares of Common Stock held by
each officer, director and holder of 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
On June 15, 1998, approximately 5,753,598 shares of the Registrant's
Common Stock, par value $0.001, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting
of Stockholders to be held on September 24, 1998, are incorporated by reference
into Part III of this Report on Form 10-K to the extent stated herein.
TABLE OF CONTENTS
[Download Table]
PAGE
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . .12
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . .12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . . . . .13
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS . . . . . . . . . . . . . . . . . . . . . .14
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . . . . .15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . . . . . .17
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE . . . . . . . . . . . . . .54
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT. . . . . . . . . . . .54
ITEM 11. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . .55
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . .55
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . .55
PART IV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K . . . . . . . . . . . . . . . . . . . . . . . . . .56
2
PART I
ITEM 1. BUSINESS
MicroProse Inc., (formerly Spectrum HoloByte, Inc) ("MicroProse" or the
"Company") is a developer, producer and publisher of entertainment software
for personal computers (PC's) and certain console platforms. The Company
creates, acquires or licenses properties with mass-market appeal and develops
branded products based on these properties. A range of advanced technologies
is incorporated into these products, such as multiplayer networking,
simulation, real-time response and three dimension (3D) texture-mapped
graphics to enhance each product's distinctive characteristics. The Company
also distributes entertainment software and related products published by
third parties.
MicroProse primarily develops products in the categories of Simulation,
Strategy, and 3D Action. Management believes these three categories leverage
the Company's product development core competencies. The Company's most
popular products to date include the FALCON-Registered Trademark- series,
GRAND PRIX series, MAGIC: THE GATHERING-Registered Trademark-, MASTER OF
ORION-TM- II, the CIVILIZATION-TM- Series, the STAR TREK-TM- series, TOP
GUN-TM-: FIRE AT WILL!-TM-, WORMS II-Registered Trademark- and THE
X-COM-Registered Trademark-series.
PRODUCTS
The Company's simulation products feature advanced 3D graphics, digital
sound effects and sophisticated artificial intelligence algorithms designed
to create compelling, realistic experiences for players in a variety of
perilous circumstances or historical contexts. The Company's strategy
products allow players to assume the role of specified characters or god-like
beings to experience or control the creation of new civilizations, discover
or colonize new worlds or battle powerful alien forces to save the world.
The Company also leverages its established areas of expertise such as 3D
graphic environments, digital sound and strong artificial intelligence to
develop fast-paced, action-oriented products.
The Company discontinued publishing products under the SPECTRUM HOLOBYTE
and SIMTEX brands in fiscal 1997, and is currently publishing all of its
products under the MICROPROSE-Registered Trademark- brand name. The
individual branded identities created or licensed by the Company and the
related products which are either currently being published or are under
development by the Company include, but are not necessarily limited to, the
following:
STAR TREK: THE NEXT GENERATION-Registered Trademark- BRAND
The Company has the rights to release a series of games based on the
STAR TREK: THE NEXT GENERATION television series and the feature film series
from Paramount Pictures. Products currently offered or under development
include:
- STAR TREK GENERATIONS-TM-: This 3D-action game follows and expands upon
the plot of the feature film of the same name. The game features the
two captains of the U.S.S. Enterprise joining forces to battle the evil
Soran, in first person point-of-view, along with exciting space combat.
- STAR TREK: KLINGON HONOR GUARD-TM- (Under Development): A first person
point-of-view action shooter game where the player is a member of a
Klingon warrior combat unit. This game utilizes the Unreal 3D Engine.
- STAR TREK: BIRTH OF THE FEDERATION-TM- (Under Development): A strategy
game in which players build a space-faring civilization as one of the
five STAR TREK races: Federation, Klingon, Cardassian, Ferengi, or
Romulan.
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WORLD CIRCUIT RACING-TM- BRAND
This series of products lets the player take the wheel in simulations of
real world car races. Products include:
- GRAND PRIX III (Under Development): The follow up to GRAND PRIX II is a
challenging Formula 1 racing simulation where the player experiences the
excitement of international Grand Prix racing on real tracks against real
drivers.
- GRAND PRIX MANAGER-TM- III (Under Development): This game moves the
player from behind the wheel to behind the desk as a team owner on the
Formula 1 circuit. The player controls all aspects of team management
including hiring and firing staff and drivers, negotiating contracts and
funding research and development.
- GP 500-TM-(Under Development): This game provides the player with a
realistic simulation of motorcycle circuit racing.
CIVILIZATION-TM- BRAND
This series of award winning imaginative strategy games is educational,
dynamic and highly entertaining. Strong artificial intelligence and
historical data combined with ease of use make these games appealing and
accessible to players of all levels. Products currently offered or under
development include:
- SID MEIER'S CIVILIZATION-Registered Trademark-II: This strategy game
has won Game of the Year awards from Time Magazine, PC Gamer and
Computer Retail Week. New features include additional technologies, new
"Wonders of the World" video clips and more sophisticated diplomacy.
- CIVILIZATION II SCENARIOS: This add-on pack has 20 new scenarios
including the American Civil War, Alien Invasion and After the
Apocalypse.
- CIV II FANTASTIC WORLDS-TM-: This CIVILIZATION II add-on provides a
player a game where magic and imagination rule in new fantasy and sci-fi
based scenarios.
- CIVILIZATION II MULTIPLAYER GOLD EDITION-TM- (Under Development): This
version of the original CIVILIZATION II game allows multiple players to
match their wits and strategies against each other through the Internet.
- CIVILIZATION III-TM- (Under Development): Continues the CIVILIZATION
legacy but will be based on a new software engine and provide a greater
strategic challenge with more demanding scenarios.
- CIVILIZATION TEST OF TIME-TM- (Under Development): Capitalizing on the
success of previous CIVILIZATION titles, this next generation of the
series will offer better graphics, more complex scenarios and more
sophisticated computer game play.
MAGIC: THE GATHERING-Registered Trademark- BRAND
The MAGIC: THE GATHERING product line is based on the popular trading
card game of the same name by Wizards of the Coast. Products currently
offered or under development include:
- MAGIC: THE GATHERING: This game offers the player the ability to play
the card game against the computer, as well as play Shandalar, a
strategy card game where players collect and trade cards to build custom
decks and duel other wizards represented by the sophisticated artificial
intelligence.
4
- MAGIC: THE GATHERING-DUELS OF THE PLANEWALKERS-TM- includes the original
MAGIC: THE GATHERING-TM-, additional game cards, plus MANALINK-TM-, a
multiplayer update that enables two players to duel over the Internet,
chat, send messages and taunt opponents.
- MAGIC: THE GATHERING-SPELLS OF THE ANCIENTS-TM- offers players
additional game cards, newer artificial intelligence, animated
interface, improved deck generator and game play.
FALCON-Registered Trademark- BRAND
In the award-winning FALCON series, a player pilots a jet fighter in
realistic combat campaigns. The original FALCON was introduced in 1984 and
the FALCON series now includes upgraded versions with advanced 3D graphics
and the availability of compatible add-on products with new missions and
different planes. Products include:
- FALCON-Registered Trademark- 4.0 (Under Development): This game
simulates real-time war where the player takes the role of a single
pilot in an F-16 jet fighter. The game features the tension, chaos and
adventure that exists in modern air combat together with multi-player
capability, advanced 3D terrain graphics, highly developed avionics and
strong artificial intelligence.
- MIG29 II-TM- (Under Development): A sequel to the original MIG29, this
game features elite Russian dogfight simulations using the FALCON 4.0
engine and will be network compatible with FALCON 4.0.
- MICROPROSE-Registered Trademark- MILITARY SIMULATION BRAND
The MICROPROSE line of military simulation titles includes award-winning,
popular games such as F-15 STRIKE EAGLE-Registered Trademark-, M1 TANK
PLATOON-Registered Trademark-, GUNSHIP-Registered Trademark- and FLEET
DEFENDER-Registered Trademark-. Products currently offered or under
development include:
- M1 TANK PLATOON-Registered Trademark- II: An M1 Abrams tank simulation
featuring an accurate and realistic simulation of the US main battle
tank in a modern day combat environment.
- GUNSHIP-Registered Trademark-II (Under Development): An AH-64A Apache
gunship simulation including full texture mapped terrain, ground troop
support and competing helicopters and tanks. Built on the M1 TANK
PLATOON-Registered Trademark- II engine, this game is being designed to
be network compatible.
- EUROPEAN AIR WAR-TM- (Under Development): This flight simulation depicts
the air battles over Europe during World War II. The player can fly
over a dozen of the greatest fighter aircraft of the era for the Allied
or German forces. The title will have multiplayer capabilities to
further enhance the experience.
X-COM-Registered Trademark-BRAND
In this award-winning series, players battle for survival against alien
races in suspenseful science fiction tales that take them to all corners of
the galaxy. Products currently offered or under development include:
- X-COM: APOCALYPSE-TM-: This product is a continuation of the X-COM saga
where aliens have infiltrated human society by taking on human form; the
player must battle the aliens in human disguise.
- X-COM: INTERCEPTOR-TM-: This action-packed product allows players to
fight the aliens in outer space by piloting spacecraft and exploring
alien worlds, thereby thwarting another alien threat to humanity.
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- X-COM ALLIANCE-TM- (Under Development): The sequel in the series is
built on the Unreal 3D Engine and will feature a first person
point-of-view squad based game.
MASTER OF ..... BRAND
This popular line of science fiction titles adds a new dimension to
strategic adventure games. Players trade, negotiate and steal technology as
they battle to expand their empires. Products currently offered or under
development include:
- MASTER OF ORION II-TM-: This product is a sequel to MASTER OF ORION-TM-.
New gameplay features include a larger, more diverse "space universe",
and the addition of cinematic and multi-player capability over a local
area network.
- MASTER OF MAGIC-TM- II (Under Development): This sequel to the highly
acclaimed MASTER OF MAGIC will include several new features including
new goals, new spells and multiple planes of existence.
TOP GUN-TM-BRAND
The Company has developed products for both the PC CD-ROM and the Sony
PlayStation-TM- based on TOP GUN, the popular feature film from Paramount
Pictures. In these games, the player assumes the role of "Maverick" and
engages in combat scenarios, experiencing sights and sounds of the feature
film. Products include:
- TOP GUN: FIRE AT WILL!-TM-: A fast paced action dog-fighting adventure
story in which the player graduates from the Top Gun Flight Academy and
pilots an F-14 fighter jet on over 40 possible missions. Live action
video is used to effectively tell the story as seen through the player's
eyes.
- TOP GUN: HORNET'S NEST-TM- (Under Development): This fast action,
arcade-style, dog-fighting flight simulator allows the player to pilot a
F18 fighter jet.
BATTLETECH-Registered Trademark- BRAND
The Company is planning to publish two products in the popular BATTLETECH
line. With over 13 million words in print, the BATTLETECH Universe delivers
extensive storyline depth and integrity. This brand offers the intense action
of 31st Century armored combat. Products include:
- BATTLETECH-Registered Trademark-: MECHCOMMANDER-TM-: This game puts the
player in command of up to 12 MECHWARRIORS as they battle enemy "MECH"
units and armored vehicles. Players can create their own "MECH" units,
develop their own strategy, and choose the missions they want to play.
In this game, combat action, real-time communications, and realistic
battlefield dynamics combine to give the player the true experience of
command.
- MECHWARRIOR-Registered Trademark- III (Under Development): In this
sequel to MECHWARRIOR-Registered Trademark- II, players will be able to
choose their own missions and objectives, driving the plot at their own
speed. The MECH-Registered Trademark- LAB allows the players to build a
custom machine to their own unique specifications.
OTHER BRANDS
- STARSHIP TROOPERS-TM- (Under Development): A fast-paced action 3D title
based on the classic Robert Heinlein science fiction novel. The story
line takes place five years after the events in the feature movie.
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- WORMS-TM- II: A follow up to the European hits WORMS-TM- and
WORMS-TM-UNITED, WORMS II is a turn-based arcade strategy game where up
to eight players participate in a match. WORMS II uses over 8,000 frames
of animation to create a cartoon-style environment where humor and
strategy join to make an irresistible game. Players choose from an
assortment of devastating weapons or create their own with the weapons
editor to eliminate all of the opposing worms.
There can be no assurance that products listed as "Under Development"
will be released in a timely manner or at all. See Item 7 - "Dependence on
New Product Introductions; Product Delays" and Item 7 - "Changes in
Technology and Product Platforms."
PRODUCT DEVELOPMENT AND ACQUISITION
The Company uses both internal and external resources to develop
products. The Company supplements its internal development efforts with
third-party subcontractors for the development of certain features or the
programming of portions of internally developed products. The Company has
also acquired products through publishing arrangements and the acquisition of
other software companies.
The Company must continually anticipate and adapt its products to
emerging platforms and evolving consumer preferences. Failure to develop
products for new platforms and incorporate new technologies may render the
Company's products obsolete. In addition, there can be no assurance that the
platforms for which the Company develops products will achieve market
acceptance. See Item 7 -"Changes in Technology and Product Platforms," Item 7
- "Dependence on New Product Introductions; Product Delays" and Item 7 -
"Risk of Software Errors or Failures."
INTERNAL PRODUCT DEVELOPMENT. The Company's internal product
development function has been performed at five separate development studios,
located in California, Maryland, Texas, North Carolina and the United
Kingdom. Development studios are organized to incorporate both internal and
external research and development and quality assurance functions. The
studios work with marketing brand managers who define product positioning and
product and platform mix. The internal development process includes game
development and design, prototyping, programming, art, computer graphic
design, animation, sound engineering, technical writing, editorial review and
quality assurance. Typically, 18 to 24 months or longer are required to
complete a new title with a new engine and 6 to 14 months or longer are
required to develop existing titles for different platforms or to develop a
derivative product using a previously developed engine. Internally developed
products are based on characters, brands and themes that are either owned by
the Company or licensed from third parties. The Company develops games that
may be played interactively over on-line services and the Internet.
The Company's proprietary software development library of tools and
content includes animation, three-dimension, texture-mapped graphic
algorithms and images, networking capability, artificial intelligence and
simulation technology. To supplement its internal research and development
efforts, the Company also buys, licenses, or contracts with third parties for
the development of content. The Company maintains a worldwide database of its
libraries, tools and other software assets.
EXTERNAL PRODUCT DEVELOPMENT. In addition to its internal development
teams, the Company also contracts with independent software developers. The
Company's strategy in contracting with third-party developers is to attract
the broadest base of available talent for creating new products as well as to
supplement the development of products produced by internal teams. The
Company engages in consulting or development agreements with its independent
software developers, and manages the development process by establishing
7
program schedules and milestones. In addition, the Company may provide its
third-party developers with access to its extensive library of tools and
content as well as program specifications, such as audio/visual displays,
artwork, musical work, sound recordings, rules of play, networking and other
components for the developer's use in creating the product. In general, the
Company has less control over the scheduling and the quality of work of
independent contractors than that of the Company's own employees. The
Company's success in its external development efforts will depend in part on
its continued ability to maintain relationships with skilled independent
software developers, to obtain and renew product development agreements with
such developers and to attract new product development relationships. As is
customary in the industry, the Company compensates outside developers with
nonrefundable royalty advances that are paid as milestones are reached. See
Item 7 - "Use of Independent Software Developers."
LICENSING. The Company, from time to time, licenses intellectual
properties such as trademarks, brands, characters and entertainment
properties to complement both internal and external development projects.
Typically these licenses are obtained for certain identified platforms over a
specific length of time in a specific territory. As is customary in the
industry, this type of license typically involves a royalty, a portion of
which is paid in advance, normally with a minimum guaranteed payment over the
term of the license. Current licenses held by the Company include
intellectual property rights to STAR TREK, TOP GUN, MAGIC: THE GATHERING, and
STARSHIP TROOPERS.
PUBLISHING. The Company extends its product offerings through
relationships with outside developers with whom it enters into publishing
agreements. Products subject to publishing agreements are typically either
partially or fully completed at the time the publishing agreement is
formalized. The Company attempts to select products for publishing that will
enhance its existing product line. The publishing agreements provide the
Company with the rights to publish, market and sell a product for certain
identified platforms, over a specific length of time in a specific territory,
in exchange for royalties based on sales of the product.
ACQUISITIONS AND JOINT VENTURES. MicroProse has acquired properties
through the acquisition of businesses and strategic joint ventures. The
Company has made an equity (approximately 9% interest) investment in Virtual
World Entertainment Group, Inc., through which the rights to its BATTLETECH
properties were obtained. In October 1997 the Company acquired Hartland
Trefoil Limited, a privately held game development company, owner of
intellectual property rights for the original CIVILIZATION board game. In
fiscal 1997, the Company acquired distribution rights from and a potential
limited equity interest in Team 17 Software Ltd. in the U.K.
MARKETING, SALES AND DISTRIBUTION
MARKETING. Although the Company concentrates its marketing efforts in
North America and Europe, its products are sold around the world in places
such as Australia, Japan, Korea, Taiwan, Singapore, the Middle East and South
America under export sales and license arrangements. The Company's marketing
activities include print advertising in consumer and trade periodicals,
retail-supported print advertising, targeted direct mail programs, retail
in-store promotions, trade shows, user support programs and product publicity
programs. The Company participates in retailers' advertising programs based
upon the sales of products to a participating retailer and the commitment of
the retailer to advertise certain products. The Company maintains an
extensive database of customers who have purchased products directly from the
Company or who have returned product warranty cards, and also rents lists of
potential customers with profiles similar to its current customers.
SALES AND DISTRIBUTION. There are two primary Sales and Distribution
groups: Americas and International. Each group has sales and distribution
responsibilities for its territories. The Company uses a combination of a
direct sales force and independent sales representatives in North America,
where its products are sold primarily by large computer and software
specialty retail chains, as well as by mass merchants and warehouse club
stores.
8
The Company's International sales group is primarily located in Chipping
Sodbury, England, and in Bielefled, Germany. Revenues are consummated through
distribution to software specialty retail stores, independent retailers,
large department stores and distributors. In June 1996, the Company acquired
certain net assets of Leisuresoft Vertiebs GmbH ("Leisuresoft"), a German
distributor of computer software and related products, for 1.2 million German
Deutsche Marks (approximately $0.8 million). Sales in other European
countries and Asia are made primarily through distributor, export and
licensing arrangements with local distributors. In fiscal 1997, the Company
opened a small sales office in Australia.
In April 1996, the Company's wholly owned Japanese subsidiary, Spectrum
HoloByte Japan, K.K. ("Spectrum Japan") granted an exclusive license to
Mitsui & Co., Ltd. ("Mitsui") for the localization, manufacture, marketing
and distribution of certain Company titles in Japan. In connection with the
license agreement, Spectrum Japan subcontracted all of its employees to
Mitsui and largely discontinued its operations. The Company received an
up-front license fee, and earns royalties based upon revenues generated by
Mitsui during the three-year term of the agreement.
The Company also enters into other license agreements which provide for
1) the manufacturing and distribution of the Company's products into
specified geographic markets, 2) the development and distribution of the
Company's titles on additional platforms, or 3) the bundled distribution of
the Company's products along with other software products. These agreements
generally involve a prepaid royalty, guaranteed minimum purchase or a minimum
royalty to be paid to the Company over a specified term.
The Company provides technical support in the United States and Europe
for its products through its customer support department. The Company also
uses its support personnel to sell upgraded and replacement software, inform
customers about new products and conduct market surveys. In the United
States, the Company also responds to customer inquiries through its telephone
and electronic bulletin board services and conducts direct mail services.
The Company's prices are standardized and are communicated on the
Company's order form. The Company publishes a trade policy that details the
terms and conditions under which customers may purchase from the Company.
Payment terms of 30 to 60 days are typically granted to accounts that are in
good credit standing. The Company does not require collateral to secure
payment. Retailers and distributors compete in a volatile industry and are
subject to the risk of business failure. Although the Company maintains a
reserve for uncollectible receivables that it believes to be adequate, the
payment default of a significant customer could materially and adversely
affect its operating results and financial condition.
In addition, the Company is exposed to the risk of product returns from
distributors and retailers. Stock balancing and other product returns are
restricted, based upon previous levels of purchases during specified time
periods and the customer's credit standing with the Company. Although the
Company provides reserves for returns that it believes are adequate, and
although the Company's agreements with certain of its customers place certain
limits on product returns, the Company could be forced to accept substantial
product returns or provide markdowns on products in the distribution channel
to maintain its relationships with retailers and its access to such channels.
These charges are likely to increase in periods in which the Company does not
have significant new product introductions. Any significant amount of product
returns or markdowns could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company provides a limited warranty that its products will be free
from manufacturing defects. There can be no assurance that the Company will
not experience material warranty claims in the future, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
In fiscal 1998, sales to the ten largest customers represented
approximately 53% of the Company's revenue. The Company's principal direct
retail accounts include Best Buy, Electronics Boutique, and Babbages. The
Company's distributors include Bondserve, Pinnacle, Merisel, Navarre, GT
Value Products Division, Beamscope, Media Market, and Ingram Micro Inc. For
the year ended March 31, 1998, one
9
customer (Bondserve Ltd.) accounted for 16% of the Company's consolidated net
revenue. As the installed base of multimedia personal computers (PCs)
increases, the distribution channels for entertainment software are expected
to increasingly depend on mass merchandisers to reach the broader consumer
market.
COMPETITION
The entertainment software industry is intensely competitive and in the
process of consolidation. The Company's competitors vary in size from very
small companies with limited resources to very large corporations with
greater financial, marketing and product development resources than those of
the Company. The Company competes primarily with other developers of PC
entertainment and video game entertainment software. Significant competitors
of the Company in the entertainment software industry include Electronic
Arts, Cendent, Lucas Arts, Interplay, GT Interactive, Acclaim Entertainment,
Broderbund Software, and Activision. The success of one or more of these
companies or the entry and participation of new companies, including
diversified entertainment companies, may adversely affect the Company's
future performance. The availability of significant financial resources has
become a major competitive factor in the entertainment software industry,
principally as a result of the technical sophistication of advanced
multimedia computer game products requiring substantial investments in
research and development and the increasing need to license products and
rights to use other intellectual properties from third parties. Also,
competitors with large product lines and popular titles typically have
greater leverage with retailers and distributors and other customers who may
be willing to promote titles with less consumer appeal in addition to such
competitors' most popular titles.
Many of the Company's competitors are developing on-line interactive
computer games that will be competitive with the Company's products. As
competition increases, significant price competition and reduced profit
margins may result. In addition, competition from new technologies may reduce
demand in markets in which the Company has traditionally competed. Prolonged
price competition or reduced demand as a result of competing technologies
would have a material and adverse effect on the Company's business, financial
condition and operating results. There can be no assurance that the Company
will continue to compete successfully against current or future competitors
or that competitive pressures faced by the Company will not materially and
adversely affect its business, operating results and financial condition.
Retailers of the Company's products typically have a limited amount of
shelf space and promotional resources, and there is intense competition among
consumer software producers for adequate levels of shelf space and
promotional support from retailers. To the extent that the number of consumer
software products and computer platforms increases, this competition for
shelf space may intensify. Due to increased competition for limited shelf
space, retailers and distributors are increasingly in a better position to
negotiate favorable terms of sale, including promotional discounts and
product return policies. Retailers often require software publishers to pay
fees in exchange for preferred shelf space. The Company's products constitute
a relatively small percentage of a retailer's sales volume, and there can be
no assurance that retailers will continue to purchase the Company's products
or provide the Company's products with adequate levels of shelf space and
promotional support.
As more consumers own multimedia PCs, the distribution channels for
entertainment software have changed, and are expected to continue to change,
to increasingly depend on mass merchandisers, online services and the
Internet to reach the broader market. In addition, while this trend has
increased the number of distribution channels, competition for shelf space
has intensified because these new channels generally carry only top-selling
titles. Moreover, access to these new distribution channels is limited and
partially controlled by the Company's competitors. In addition, other types
of retail outlets and methods of product distribution, such as online
services and the Internet, may become important in the future, and it will be
important for the Company to gain access to these channels of distribution.
There can be no assurance that the Company will gain such access or that the
Company's access will allow the Company to maintain its historical levels of
sales volume.
10
INTELLECTUAL PROPERTY
The Company regards the software that it owns or licenses as proprietary
and relies primarily on a combination of copyrights and trademarks and U.S.
and international trade secret, patent and trademark laws and nondisclosure
agreements to protect its proprietary rights to its products. It is the
Company's policy that employees and third-party developers sign nondisclosure
agreements. The Company owns or licenses various trademarks and copyrights.
However, the Company has only standard "shrink wrap" license agreements or no
license agreements at all with the end users of its products and does not
copy-protect its software. The Company relies largely on the copyright laws
to prevent unauthorized distribution of its software. There can be no
assurance that these measures will be sufficient to protect the Company's
intellectual property rights against infringement. Existing copyright laws
afford only limited protection. It may be possible for unauthorized third
parties to copy the Company's products or to reverse engineer or otherwise
obtain and use information that the Company regards as proprietary. Policing
unauthorized use of the Company's products is difficult, and software piracy
can be expected to be a persistent problem. Further, the laws of certain
countries in which the Company's products are or may be distributed do not
protect the Company's products and intellectual rights to the same extent as
the laws of the United States.
The Company believes that its products, trademarks and other property
rights do not infringe on the proprietary rights of third parties. As the
number of entertainment software products in the industry increases, the
Company believes that software increasingly will become the subject of claims
that such software infringes upon the rights of others. From time to time,
the Company has received communications from third parties asserting that
features or content of certain of its products may infringe upon intellectual
property rights of such parties. The Company believes such claims have been
without merit. To date, other than the cost of litigation, no such claim has
had a materially adverse effect on the Company's ability to develop, market
or sell its products. However, the Company is currently involved in
intellectual property litigation, and there can be no assurance that existing
or future infringement claims against the Company will not result in further
costly litigation or require the Company to license the intellectual property
of third parties. There can be no assurance that such licenses will be
available on reasonable terms or at all.
MANUFACTURING
The Company's PC CD-ROM and console products consist of disks, user
manuals and packaging. All of the Company's CD-ROM printing is performed by
unaffiliated third parties. Printing of the user manual and packaging,
manufacturing of related materials and assembly of completed packages are
performed to the Company's specifications by outside sources. To date, the
Company has not experienced any material difficulties or delays in the
manufacture and assembly of its PC CD-ROM and console products.
EMPLOYEES
As of March 31, 1998, the Company employed 385 people, excluding
temporary employees and consultants, including 232 in product development, 68
in sales and marketing, 21 in manufacturing and operations, and 64 in
administration and finance, systems support, legal and human resources. None
of the Company's employees are represented by a labor union or bound by a
collective bargaining agreement, and the Company has experienced no work
stoppages. The Company believes that its employee relations are good.
Competition in recruiting of personnel in the software industry is
intense. The Company believes that its future success will depend in part on
its continued ability to recruit and retain highly skilled management,
marketing, creative and technical personnel. There can be no assurance that
the Company will be successful in its efforts to recruit and retain personnel.
11
ITEM 2. PROPERTIES
The Company leases approximately 38,000 square feet of office space in
Alameda, California, which is utilized for the Company's headquarters,
product development, sales and administration under a lease that expires in
2002. In Hunt Valley, Maryland, the Company leases approximately 35,800
square feet of office space under a lease that expires in August 1998. The
Company's Chapel Hill, North Carolina development facility consists of
approximately 3,200 square feet under a lease that expires in December 1999.
The Company's Austin, Texas studio leases approximately 11,500 square feet of
office space, pursuant to a lease that expires in 2002.
The Company's United Kingdom subsidiary leases approximately 28,700
square feet of office space in Chipping Sodbury, England, under a lease that
expires in September 2003. The Company leases approximately 1,300 square feet
of office space in Bielefled, Germany, under a lease that expires in
September 2002. The Company owns 10,000 square feet of office and warehouse
space and 24,000 square feet of land in Bonen, Germany. In addition, the
Company leases 1,291 square feet of office space in Sydney, Australia. The
Company believes that its existing facilities are adequate to meet its
current needs and that, if required, suitable additional or substitute space
is likely to be available on reasonably acceptable terms.
ITEM 3. LEGAL PROCEEDINGS
ACTIVISION, INC.:
On November 12, 1997, a lawsuit entitled Activision, Inc. and The Avalon
Hill Game Company v. MicroProse Software, Inc., MicroProse, Inc., and
Spectrum HoloByte, Inc., Case No. 97-8302ER, was filed in the United States
District Court for the Central District of California. The complaint alleged
causes of action for trademark infringement, trademark dilution, false
designation of origin, false advertising, unfair competition, and deceptive
trade practices in connection with the Company's publication of certain
CIVILIZATION computer game products.
On January 21, 1998, the Company and its Maryland subsidiary, MicroProse
Software, Inc., filed an action against Activision, Inc. and The Avalon Hill
Game Company in the United States District Court for the Central District of
California. The Company's complaint alleges that the defendants have engaged
in false advertising, trademark infringement, and unfair business practices
in connection with announced plans to develop and publish CIVILIZATION
computer games under a claimed licensing relationship between Activision and
Avalon Hill. The Company also seeks cancellation of Avalon Hill's related
trademark registration.
On February 4, 1998, Activision and the Avalon Hill Game Company filed a
First Amended Complaint, correcting certain statements in their original
complaint and adding claims for declaratory relief and cancellation of the
Company's related trademark registration. The action was served upon the
Company for the first time on February 5, 1998.
On April 7, 1998, the Company amended its answer and filed counterclaims
on behalf of the Company and its two subsidiaries, MicroProse Software, Inc.
and Hartland Trefoil, Ltd., asking for declaratory relief and seeking to
enforce the intellectual property rights of these entities in both board
games and computer games under the CIVILIZATION name.
Both the Company and opposing parties are seeking damages and injunctive
relief with respect to publication of future CIVILIZATION products.
The Company intends to defend itself and pursue its claims vigorously in
these actions. However, in the event that the Company should not prevail in
the lawsuit filed by Activision and the Avalon Hill Game
12
Company, the Company may not be able to ship or sell certain of its products
and may be required to pay damages, both of which would have a material
adverse effect on the business, operating results, and financial condition of
the Company.
UNITED SOFTWARE GMBH:
In March 1993, MicroProse acquired United Software, GmbH ("United"). In
September 1993, MicroProse became aware of several non-disclosed liabilities
of United, including a claim by a German bank of approximately $2,000,000.
MicroProse also became aware of the deterioration of the financial condition
of the seller and the seller's parent (which had guaranteed the seller's
obligations under the United purchase agreement) and by October 29, 1993,
determined that the seller and its parent were incapable of complying with
the guarantees and warranties included in the purchase agreement. Therefore,
primarily as a result of the seller's nondisclosure of the bank debt
described above and the misrepresentations as to the financial condition of
the seller and its parent, MicroProse assessed its options and decided to
rescind the agreement as provided under German law.
On October 29, 1993, MicroProse notified the seller and its parent of
the rescission of the March 1993 agreement. This action resulted in a charge
of approximately $4.9 million, which was recorded in the quarter ended
September 30, 1993. This charge consisted primarily of the original purchase
price, asset write-offs of approximately $1.8 million and rescission-related
liabilities of approximately $1.6 million. United and its parent company are
now in receivership. The Company has maintained an accounting reserve in
order to meet any remaining liabilities under German law as a result of the
receivership proceeding.
On March 18, 1998, the Company received a demand from the receiver in
the insolvency proceeding for payment of $1.95 million DM, based on the
receiver's position that MicroProse is liable for contribution of share
capital to the insolvent company. On approximately May 28, 1998, the
Company's U.K. subsidiary was served with a legal action by the receiver
seeking enforcement of the demand. The Company is represented by German
counsel and intends to defend itself vigorously in this action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's common stock is traded on the NASDAQ National Market under
the symbol MPRS. The following table sets forth, for the periods
indicated, the high and low closing sale prices for the common stock as
originally reported by the Nasdaq National Market. The prices are also shown
restated for the effects of the 1-for-5 reverse stock split that became
effective on May 11, 1998, see Item 7. "Nasdaq Listing/Reverse Split."
[Download Table]
(Restated for reverse split)
HIGH LOW HIGH LOW
---------------- ------------------
Fiscal 1998:
Fourth Quarter $ 2.75 $ 1.50 $ 13.75 $ 7.50
Third Quarter 7.11 1.88 35.55 9.40
Second Quarter 5.56 4.00 27.80 20.00
First Quarter 6.94 4.44 34.70 22.20
Fiscal 1997:
Fourth Quarter $ 9.50 $ 6.62 $ 47.50 $ 33.10
Third Quarter 7.75 4.87 38.75 24.35
Second Quarter 7.25 3.87 36.25 19.35
First Quarter 8.62 5.37 43.10 26.85
On June 15, 1998, the closing sale price of the common stock as reported
on the National Association of Securities Dealers Automated Quotation System
(Nasdaq) stock exchange was $4.25 per share. As of that date, there were
approximately 232 holders of record (not including beneficial holders of
stock held in street name) and approximately 5,753,598 shares of common stock
were outstanding. There has historically been significant volatility in the
share price for the Company's common stock, and the market price of the
Company's common stock may be highly volatile in the future.
DIVIDEND POLICY
The Company has never paid cash dividends on its capital stock. The
Company currently intends to retain all available funds for use in its
business and does not anticipate paying any cash dividends on its common
stock in the foreseeable future.
14
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
In thousands, except per share amounts
[Enlarge/Download Table]
YEAR ENDED MARCH 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------
Net revenue $60,009 $100,253 $ 59,694 $ 84,350 $ 40,887
Cost of revenue 31,428 39,317 30,554 43,434 24,519
--------------------------------------------------------------------
Gross profit 28,581 60,936 29,140 40,916 16,368
Operating expenses:
Sales and marketing 17,633 18,741 21,642 26,063 11,703
General and administrative 11,493 14,670 14,409 12,985 7,276
Research and development 29,038 23,145 27,490 19,995 10,712
In-process research and development - - - - 46,319
Restructuring charges - - 1,123 - -
--------------------------------------------------------------------
Total operating expenses 58,164 56,556 64,664 59,043 76,010
--------------------------------------------------------------------
Operating income (loss) (29,583) 4,380 (35,524) (18,127) (59,642)
Other income (expense), net (3,534) 511 (4,317) 76 (85)
--------------------------------------------------------------------
Income (loss) before income taxes
and extraordinary item (33,117) 4,891 (39,841) (18,051) (59,727)
Income tax provision (benefit) 24 450 - - (1,267)
--------------------------------------------------------------------
Income (loss) before extraordinary item (33,141) 4,441 (39,841) (18,051) (58,460)
Extraordinary item, net of tax effect - 3,547 - - -
--------------------------------------------------------------------
Net income (loss) $(33,141) $ 7,988 $(39,841) $(18,051) $(58,460)
--------------------------------------------------------------------
--------------------------------------------------------------------
Basic income (loss) per share (restated for
the reverse stock split):
Income (loss) before extraordinary item $(5.86) $0.79 $(8.49) $(4.56) $(27.70)
Extraordinary item, net of tax effect - 0.66 - - -
--------------------------------------------------------------------
Net income (loss) $(5.86) $1.45 $(8.49) $(4.56) $(27.70)
--------------------------------------------------------------------
--------------------------------------------------------------------
Diluted income (loss) per share (restated for
the reverse stock split):
Income (loss) before extraordinary item $(5.86) $0.75 $(8.49) $(4.56) $(27.70)
Extraordinary item, net of tax effect - 0.64 - - -
--------------------------------------------------------------------
Net income (loss) $(5.86) $1.39 $(8.49) $(4.56) $(27.70)
--------------------------------------------------------------------
--------------------------------------------------------------------
Weighted average shares used to calculate:
Basic income (loss) per share 5,697 5,300 4,727 4,022 2,122
Diluted income (loss) per share 5,697 5,555 4,727 4,022 2,122
(CONTINUED)
15
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
CONSOLIDATED BALANCE SHEET DATA
In thousands
[Enlarge/Download Table]
MARCH 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
-----------------------------------------------------------------
Working capital (deficit) $ 8,416 $44,333 $35,685 $ 6,203 $(7,008)
Total assets 43,829 80,305 65,922 59,350 33,191
Notes and borrowings under lines of credit
and long-term debt 32,348 32,739 50,504 11,474 4,701
Notes payable and amounts due to related
parties - - - - 1,739
Capital lease obligations 95 409 815 1,816 3,096
Redeemable preferred stock 2,940 5,881 5,881 5,881 5,881
Total stockholders' equity (deficit) (9,542) 21,598 (8,915) 8,562 (6,025)
QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands, except per share amounts
[Enlarge/Download Table]
1998 4TH QUARTER 3RD QUARTER 2ND QUARTER 1ST QUARTER
----------------------------------------------------------------------------------------------------------
Net revenue $ 12,377 $ 14,853 $ 19,199 $ 13,580
Gross profit 4,941 4,642 11,196 7,802
Operating loss (11,541) (10,927) (1,700) (5,415)
Net loss (12,174) (10,885) (1,770) (8,312)
Basic net loss per share (restated) (2.13) (1.92) (0.32) (1.48)
Diluted net loss per share (restated) (2.13) (1.92) (0.32) (1.48)
1997 4TH QUARTER 3RD QUARTER 2ND QUARTER 1ST QUARTER
----------------------------------------------------------------------------------------------------------
Net revenue $23,880 $35,888 $27,413 $13,072
Gross profit 13,536 22,000 17,227 8,173
Operating income (loss) 1,473 6,447 2,229 (5,769)
Net income (loss) 1,135 5,658 2,710 (1,515)
Basic net income (loss) per share (restated) 0.19 1.04 0.50 (0.33)
Diluted net income (loss) per share (restated) 0.18 0.98 0.47 (0.33)
1996 4TH QUARTER 3RD QUARTER 2ND QUARTER 1ST QUARTER
----------------------------------------------------------------------------------------------------------
Net revenue $15,531 $ 13,389 $ 13,845 $16,929
Gross profit 8,889 6,357 4,668 9,226
Operating loss (7,228) (8,226) (11,042) (9,028)
Net loss (8,905) (9,947) (11,591) (9,398)
Basic net loss per share (restated) (1.85) (2.07) (2.46) (2.09)
Diluted net loss per share (restated) (1.85) (2.07) (2.46) (2.09)
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
MicroProse, Inc. ("the Company") derives revenue primarily from
publishing and distributing entertainment software. This software is
generally published by the Company for the following platforms:
- Compact-Disc Read-Only Memory ("CD-ROM") for the personal computer ("PC")
- Videogame consoles
In addition, the Company generates revenue from the licensing of its
products to third-party publishers and the distribution of third-party
software and related products.
The Company generates a substantial portion of its revenue from the
introduction of new products. In order to maintain or grow its current
revenue levels, the Company believes it will be necessary to develop or
obtain rights to new products that achieve market acceptance, are developed
for the appropriate platforms, are introduced in a timely manner and are able
to attain market acceptance. The Company is continuing to devote considerable
resources toward the development of new products and has secured rights to
intellectual properties owned by third parties. As is typical in the
industry, the Company maintains internally developed release schedules, but
there can be no assurance that new products under development will be
released on schedule or at all, or that any such products will generate
significant revenue. Historically, the Company has frequently missed product
release schedules. To the extent that major new products are not released on
schedule, both net revenue and net income are likely to be adversely
affected. In addition, as access to distribution channels and retail shelf
space becomes increasingly competitive, the Company's ability to produce and
bring to market new and compelling products in a timely fashion plays an
increasingly important role in the Company's ability to retain adequate
access to these channels.
The Company's operating results have varied significantly in the past
and are expected to vary significantly in the future. This variability is a
result of factors such as: 1) volume shipments of significant new products,
2) the degree of market acceptance of the Company's products, 3) the
introduction of products competitive with those of the Company, 4) the timing
and market acceptance of new hardware and software product introductions, 5)
the size and growth rate of the consumer software market, 6) the seasonality
of sales, 7) development and promotional expenses relating to the
introduction of new products or new versions of existing products, 8) product
returns and markdowns, 9) changes in pricing policies by the Company and its
competitors, 10) the accuracy of retailers' forecasts of consumer demand, 11)
the timing of orders from major customers, 12) order cancellations, 13)
delays of shipment, 14) write-offs of advance royalty payments and 15)
access to retailer shelf space. Because a majority of the unit sales for most
product typically occurs in the first 90 to 120 days following the
introduction of the product, the Company's revenue may increase significantly
in a period in which one or more major product introductions occur and may
decline in following periods or in periods in which there are no major
product introductions. The Company's expenses are based, in part, on expected
future revenue. Certain overhead and product development expenses are
relatively fixed and do not vary directly with revenue. Consequently, if net
revenue is below expectations, the Company's business, operating results and
financial condition are likely to be materially, adversely affected. In
addition, the market price of the Company's common stock could be adversely
impacted in future periods.
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements,
which involve risks and uncertainties. The Company may, from time to time,
make oral forward-looking statements. The factors discussed herein and in the
Company's
17
Securities and Exchange Commission filings, including but not limited to Item
7 of the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1998, are important factors that could cause actual results to differ
materially from those projected in any such forward-looking statements.
In October 1997, the Company entered into an agreement to merge with GT
Interactive Software Corporation ("GT") Under the terms of the proposed
merger, the Company's outstanding shares of common and preferred stock were
to be exchanged for a proportional number of shares of GT stock. On December
5, 1997, the Company and GT announced their mutual agreement to terminate the
merger agreement.
The termination of the merger agreement has had a materially adverse
impact on (a) the Company's sales and operating results, (b) the Company's
ability to attract and retain key sales and administrative personnel, (c) the
progress of certain development projects, and (d) the trading price of the
Company's Common Stock. There can be no assurance that the termination of
the merger will not continue to adversely impact the Company's business and
results of operations in future periods.
On May 19th 1998, the Company released fourth quarter and fiscal 1998
results. In that press release the Company's Management indicated that the
Company can best prosper and leverage its assets in combination with another
Company or through a strategic investment from a Partner. As a result, the
Board of Directors has authorized management to investigate strategic
alternatives for the Company.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased from $44.3 million at the end of the fiscal
1997 to $8.4 million at March 31, 1998. Cash and cash equivalents decreased
$33.0 million to approximately $14.1 million during fiscal 1998. Cash was
used primarily to finance operating losses for fiscal 1998. Other uses
included acquisitions of computer and office equipment totaling $2.3 million,
payment of royalty advances of approximately $2.2 million and the redemption
of convertible preferred stock of approximately $2.7 million. Moreover,
slower sales translated into longer collection periods as days' sales
outstanding increased to 49 days as of March 1998 compared to 30 days at
March 1997. These uses of cash were partially offset by the issuance of
common stock under employee stock purchase plans totaling $1.7 million.
During fiscal 1997, working capital increased by $8.6 million from fiscal
1996 to over $44 million and cash increased $11.7 million to approximately
$47 million. The main sources of funds in fiscal 1997 were from operations
and from a private placement of common stock.
The Company has authorized 9,000,000 shares of preferred stock, $0.001
par value, of which 4,000,000 shares are designated Series A redeemable
preferred stock ("Series A Stock"). During the quarter ended December 31,
1997, 2,000,000 of the outstanding shares of Series A Stock were redeemed for
approximately $2.7 million. At March 31, 1998, there were 2,000,000 shares
of Series A Stock outstanding which are convertible into 19,608 shares of
common stock and which accrue dividends at an annual rate of 7%. Preferred
stockholders receive one vote for each common share into which their
preferred shares are convertible. The Series A Stock is redeemable for $1.00
per share plus all accumulated but unpaid dividends (total redemption of $2.8
million as of March, 31, 1998) (i) at any time by the Company, or (ii) in its
entirety at any time on or after September 24, 1998, within 180 days of
receipt of written demand from the majority of Series A Stock holders.
The Company generated positive cash flows from operations during fiscal
1997 due to the net income generated, strong collections of receivables and
non-cash increases in certain accrued liabilities. Accounts receivable
decreased as days sales outstanding declined from 57 days at March 1996 to 30
days at March 1997.
In fiscal 1997, the Company generated $5.2 million from financing
activities and used $3.1 million for investing activities. Private placements
of 1,818,367 shares of common stock generated approximately $9.6 million in
proceeds, net of associated issuance costs. The investing activities included
investments in property and equipment and in Leisuresoft Vertiebs GmbH, a
German distribution company ("Leisuresoft") of computer software and related
products.
18
On October 2, 1995, the Company completed a private offering of $50.0
million face value Convertible Subordinated Notes (the "Notes") pursuant to
Rule 144A of the Securities Act of 1933. Net proceeds to the Company
approximated $48.0 million, after discounts, commissions and other issuance
costs. The Notes, which bear interest at the rate of 6.5 percent per annum,
mature on September 15, 2002, and are convertible into shares of the
Company's common stock at any time after 60 days following the latest date of
original issuance through maturity, unless previously redeemed or
repurchased, at a conversion price of $79.20 per share (subject to adjustment
for certain events). The Notes may be redeemed at the option of the Company
subsequent to September 17, 1998, in whole or in part, at various declining
redemption prices from 103.7% to 100% of face value, together with accrued
interest thereon. The Notes may also be redeemed at the option of the holder
at 100% upon the occurrence of certain events. As of March 31, 1998, Notes
with a face value of approximately $31.1 million were outstanding. In fiscal
1997, the Company repurchased $4.0 million of Notes for approximately $3.0
million of cash, and exchanged another $14.9 million of Notes for 1,918,860
shares of Series B and B-1 preferred stock.
The substantial debt incurred by the Company will have several important
consequences for the Company's future operations, including the following: 1)
a substantial portion of the Company's cash flow from operations will be
dedicated to the payment of interest on, and principal of, its indebtedness;
2) the Company's ability to obtain additional financing in the future for
capital expenditures, acquisitions, general corporate purposes or other
purposes may be impaired; and 3) the Company's ability to withstand
competitive pressures, adverse economic conditions and adverse changes in
governmental regulations and to make acquisitions or otherwise take advantage
of significant business opportunities that may arise may be negatively
impacted, and 4) the Company's ability to comply with certain alternative
listing requirements for the Nasdaq Stock Market may be adversely affected.
The Company's ability to meet its debt service obligations and to reduce its
total indebtedness will be dependent upon its future performance, which will
be subject to financial, business and other factors affecting the operations
of the Company, many of which are beyond its control. If the Company is
unable to generate sufficient cash flows from operations in the future to
service its debt, it may be required to refinance all or a portion of such
debt, including the Notes, or to obtain additional financing. However, there
can be no assurance that any refinancing would be possible or that any
additional financing could be obtained.
The Company has an overdraft/line of credit facility in the UK that is
based upon qualifying receivables and certain other bank requirements for
amounts up to a maximum credit limit of 1,850,000 pounds sterling
(approximately $3.1 million at March 31, 1998). This facility bears interest
at the rate of 1.5% over the bank's base rate, and expires June 30, 1998. As
of March 31, 1998, total amount available based upon qualifying assets
totaled approximately $2.0 million at 7.25%. However, the Company had not
utilzed any part of this facility. There can be no assurance that the Company
will be able to renegotiate this facility upon its expiration or that any
additional borrowing facilities will be made available to the Company on
acceptable terms.
Management believes that existing cash and cash equivalents, together
with cash generated from operations, will need to be supplemented in the near
term by cash flows from new financing arrangements, including asset-based
financing arrangements, to meet the Company's liquidity and capital needs for
the next 12 months. These new financing arrangements are, as yet, not in
place, and there can be no assurances that the Company will be successful in
securing new financing or that the Company's products will generate
receivables and other assets sufficient to support an adequate level of
financing. The Company's ability to support an adequate level of financing
depends on the timely release of new products in anticipated quantities, in
particular, the release of "BattleTech-Registered Trademark-: MechCommander-TM-
in expected quantities in the first quarter of fiscal 1999. Failure to secure
and maintain adequate additional financing could have a material and adverse
effect on the Company's business, financial condition and ability to continue
as a going concern.
19
OPERATING RESULTS
Consolidated net revenue for fiscal 1998, 1997 and 1996 consisted of the
following (dollars in thousands):
[Enlarge/Download Table]
AMOUNT % CHANGE % OF CONSOLIDATED NET REVENUE
----------------------------- ------------------ ------------------------------
1998 1997 1996 1998 1997 1998 1997 1996
----------------------------- ------------------ ------------------------------
By Territory:
North America $19,769 $ 36,522 $30,351 (45.9%) 20.3% 32.9% 36.4% 50.8%
International 40,240 63,731 29,343 (36.9%) 117.2% 67.1% 63.6% 49.2%
----------------------------- ------------------------------
Consolidated $60,009 $100,253 $59,694 (40.1%) 67.9% 100.0% 100.0% 100.0%
----------------------------- ------------------------------
----------------------------- ------------------------------
By Platform/Type:
CD-ROM $40,850 $ 74,606 $40,338 (45.2%) 85.0% 68.1% 74.4% 67.6%
Videogame 2,029 10,226 2,125 (80.2%) 381.2% 3.4% 10.2% 3.6%
Licensing/OEM 4,928 4,539 4,212 8.6% 7.8% 8.2% 4.5% 7.0%
Distribution 11,145 9,664 8,703 15.3% 11.0% 18.6% 9.7% 14.6%
Floppy disk and other 1,057 1,218 4,316 (13.2%) (71.8%) 1.7% 1.2% 7.2%
----------------------------- ------------------------------
Consolidated $60,009 $100,253 $59,694 (40.1%) 67.9% 100.0% 100.0% 100.0%
----------------------------- ------------------------------
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The 40% decline in net revenue in fiscal 1998 is due in part to the
prior year success of two Company-published products, GRAND PRIX II and SID
MEIER'S CIVILIZATION II. These two titles combined for 51% of revenue in
fiscal 1997. In addition, lower market acceptance of new product releases in
fiscal 1998 adversely impacted net revenue. Although the Company released
nine new titles in fiscal 1998 compared to eight in fiscal 1997, the average
unit volume per new title during the year of release declined from 246,000
units in fiscal 1997 to 110,000 for fiscal 1998. Net revenues in fiscal
1998 were also negatively affected by increased provisions for future returns
and markdowns. As a percent of gross revenues, these provisions increased
to 19% from 11% in fiscal 1998 and 1997, respectively.
The decline in videogame revenue in fiscal 1998 was due to the release
of three console titles in the first three quarters of the prior fiscal year
compared to no titles released in fiscal 1998, as the Company has focused
strategically on PC CD-ROM products in the current fiscal year. The three
fiscal 1997 titles (all for the SONY PLAYSTATION-Registered Trademark-) were
TOP GUN: FIRE AT WILL, GUNSHIP 2000, and X-COM: TERROR FROM THE DEEP.
Distribution revenue includes shipments of computer software and related
products published or manufactured by third parties and distributed by the
Company. This revenue is generally derived under either standard, low-margin
distribution agreements (which include the purchase and resale of products)
or high-margin, lower revenue agency relationships (under which the Company
earns a commission or agency fee). The increases in third-party distribution
revenue in fiscal 1998 were due largely to the European release in the third
quarter of WORMS II, a distribution title which is being published in Europe
by the third-party developer and marketed by the Company. Partially
offsetting these increases were declines in revenue due to a shift in
strategic focus in Germany from distribution to higher-margin agency-related
revenue. In fiscal 1997, the Company acquired a majority interest in
Leisuresoft. Substantially all of the distribution revenue generated in
fiscal 1997 relates to shipments by Leisuresoft.
The increase in consolidated fiscal 1997 net revenue over 1996 was
largely due to the strong success of GRAND PRIX II and SID MEIER'S
CIVILIZATION-Registered Trademark- II, released late in fiscal 1996. The
increases in the amount and
20
proportion of international revenue were mostly due to European shipments of
Grand Prix II. Approximately 88% of the Grand Prix II revenue for fiscal 1997
was generated internationally. Other significant fiscal 1997 PC CD-ROM
releases included MASTER OF ORION-TM- II AND MAGIC: THE GATHERING-Registered
Trademark-.
The increase in videogame revenue in fiscal 1997 over 1996 was due to
the release of three videogame console titles as compared to one title in
fiscal 1996.
In total, the Company released eight new products in fiscal 1997 as
compared to 23 new products released in fiscal 1996. The average unit volume
per new title during the year of release increased significantly, however,
from approximately 62,000 units in fiscal 1996 to 246,000 units in fiscal
1997. The decrease in the number of new products released and the increase in
the number of units shipped per title were due to the Company's focus on a
fewer number of titles with greater market appeal. There can be no assurances
that the Company's continued focus on this strategy will be successful.
Net revenue in fiscal 1997 was also favorably impacted by a percentage
decrease in the provisions recorded for returns and markdowns. These
decreases were due to a focused effort to better manage inventories of the
Company's products in the distribution channel and better product
sell-through.
Gross profit consisted of the following (dollars in thousands):
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AMOUNT % CHANGE % OF CONSOLIDATED NET REVENUE
----------------------------- ------------------ ------------------------------
1998 1997 1996 1998 1997 1998 1997 1996
----------------------------- ------------------ ------------------------------
Gross profit $28,581 $60,936 $29,140 (53.1%) 109.1% 47.6% 60.8% 48.8%
----------------------------- ------------------------------
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Gross profit as a percent of consolidated net revenue declined in fiscal
1998 due to an increased proportion of distribution revenue and revenue
generated from third-party developed titles. Four of the Company's new
releases for the year were third-party developed products with lower profit
margins. In addition, more back catalog sales lowered average-selling prices
and adversely impacted the Company's gross margin. Partially offsetting the
decreases in gross profit in fiscal 1998 was an overall reduction in
shipments of console titles that generally have lower margins than PC
products. Also impacting gross profit were increased provisions for returns
and markdowns of slow moving product.
Gross profit as a percentage of consolidated net revenue increased in
fiscal 1997 over fiscal 1996 due to reductions in both the direct per unit
costs of products shipped and the amounts provided for in channel inventory
markdowns and reserves. The direct per unit costs decreased due to a
reduction in the cost of both materials and outside order fulfillment
services. The amounts provided for inventory reserves declined in fiscal 1997
as significant non-recurring charges related to floppy disk products were
made in fiscal 1996. Partially offsetting these increases in fiscal 1997
gross margins were declines caused by increased revenue from lower-margin
distribution and console products.
The Company believes that gross profit margins could continue to be
adversely impacted in future periods by an increased proportion in the sales
mix of distribution titles, license royalties and by competitive pricing
pressures.
21
Operating expenses were as follows (dollars in thousands):
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AMOUNT % CHANGE % OF CONSOLIDATED NET REVENUE
----------------------------- ------------------ ------------------------------
1998 1997 1996 1998 1997 1998 1997 1996
----------------------------- ------------------ ------------------------------
Sales and marketing $17,633 $18,741 $21,642 (5.9%) (13.4%) 29.4% 18.7% 36.3%
General and administrative 11,493 14,670 14,409 (21.7%) 1.8% 19.2% 14.6% 24.1%
Research and development 29,038 23,145 27,490 25.5% (15.8%) 48.4% 23.1% 46.1%
Restructuring charges - - 1,123 - (100.0%) - - 1.9%
--------------------------- ---------------------------
Total operating costs $58,164 $56,556 $64,664 2.8% (12.5%) 97.0% 56.4% 108.4%
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Sales and marketing expenses declined in fiscal 1998 due mostly to
declining net revenue and associated variable marketing and selling costs.
The decrease in sales and marketing expense in fiscal 1997 from fiscal 1996
was largely attributed to a decline in variable marketing costs due to fewer
new product releases and higher fiscal 1996 promotional costs related to the
release of the PC versions of STAR TREK: THE NEXT GENERATION-TM- "A FINAL
UNITY-TM-" AND TOP GUN: FIRE AT WILL! In addition, certain redundant domestic
sales and marketing functions were eliminated or consolidated during fiscal
1997.
General and administrative costs were down in fiscal 1998 due mostly to
a decline in bad debt charges ($0.2 million for fiscal 1998 compared to $2.5
million for the prior year) related to the improved stability of certain
customers. In addition, a $1.2 million reduction in incentive compensation
due to lower operating profits also contributed to reduced administrative
costs. Partially offsetting these amounts was a $0.7 million charge in the
December 1997 quarter to write-off costs associated with the proposed merger
with GT Interactive, which was terminated during the quarter. General and
administrative costs in fiscal 1997 included increased charges for bad debt
expense ($1.0 million) and incentive compensation ($1.2 million). Offsetting
these charges, were approximately $2 million in lower payroll and
administrative costs due to a domestic consolidation in certain
administrative functions and reductions in professional fees, severance and
recruiting costs.
Research and development costs increased by $5.9 million in fiscal 1998
partially due to a $4.4 million write-off of third-party royalty advances for
three major projects that were determined to be non-viable during fiscal
1998. The remaining increase was due to additional write-offs taken for
lower than anticipated product sell-through. Research and development costs
decreased in fiscal 1997 from fiscal 1996 due partially to the elimination of
redundant product test functions ($0.9 million) and certain reductions in the
number of employees at the Company's Maryland and UK studios ($1.8 million).
In addition, write-offs of development advances decreased by $1.4 million as
the Company canceled a larger number of products in fiscal 1996 as a part of
the strategic refocusing of its product lines.
The fiscal 1996 restructuring charges of approximately $1.1 million
included severance costs related to the Company's downsizing efforts,
reserves on inventories related to terminated affiliated label publishing
agreements, and charges to write down the net assets of the Company's
wholly-owned Japanese subsidiary to their estimated realizable values.
22
The following table sets forth other income and expense, provision for
income taxes and extraordinary items (dollars in thousands):
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AMOUNT % CHANGE % OF CONSOLIDATED NET REVENUE
----------------------------- ------------------ ------------------------------
1998 1997 1996 1998 1997 1998 1997 1996
----------------------------- ------------------ ------------------------------
Interest Income $ 1,618 $ 1,797 $ 1,118 (10.0%) 60.7% 2.7% 1.8% 1.9%
Interest Expense (2,327) (2,631) (2,495) (11.6%) 5.5% (3.9%) (2.6%) (4.2%)
Gain (loss) on the sale
(write-down) of investment (2,605) 1,895 (1,074) - - (4.3%) 1.9% (1.8%)
Foreign exchange and
other expense (220) (550) (1,866) (60.0%) (70.5%) (0.4%) (0.5%) (3.1%)
----------------------------- ------------------------------
----------------------------- ------------------------------
Other income (expense), net $(3,534) $ 511 $(4,317) - - (5.9%) 0.5% (7.2%)
----------------------------- ------------------------------
----------------------------- ------------------------------
Provision for income taxes $ 24 $ 450 $ - - - - 0.4% -
----------------------------- ------------------------------
----------------------------- ------------------------------
Extraordinary item,
net of tax effect $ - $ 3,547 $ - - - - 3.5% -
----------------------------- ------------------------------
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The decrease in other income and expense for fiscal 1998 was due to the
following factors: 1) in the first quarter of fiscal 1998, a $2.6 million
charge was recorded to write down the Company's equity investment in Total
Entertainment Network, Inc. due to management's determination that a
permanent decline in market value had occurred, and 2) a $1.9 million gain
was recorded in the first quarter of the prior year related to the sale of
the Company's investment in FASA Interactive Technologies, Inc. The net
expense recorded in fiscal 1996 was due mostly to interest expense ($1.5
million) recorded on the October 1995 debt financing and the losses related
to the write down of the Company's investment in OT Sports Inc.
The extraordinary item recorded in the prior year reflects the gains
realized upon the repurchase and the conversion to equity of a portion of the
Company's notes payable at a discount from face value.
IMPACT OF THE YEAR 2000
The Year 2000 issue is the result of computer programs being written
using two digits, rather than four, to define the applicable year. Any of
the Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
The Company has determined it has no exposure to contingencies related
to the Year 2000 for products sold and products currently under development.
However, based on recent assessments, the Company determined that it will be
required to modify or replace significant portions of its application and
operating software so that its computer systems will properly process dates
beyond December 31, 1999.
The Company will utilize both internal and external resources to
reprogram, or replace, and test the software for Year 2000 modifications.
The Company plans to complete the Year 2000 project not later than December
31, 1998. The total remaining cost of the Year 2000 project is estimated to
be $500,000 and is being funded through operating cash flow. The total
project cost, approximately $1.3 million, is attributable to the purchase of
new software and hardware and will be capitalized. To date, the Company has
capitalized the
23
majority of the $800,000 spent related to preliminary efforts in connection
with its Year 2000 project and the development of a remediation plan.
RISK FACTORS
The foregoing Management's Discussion and Analysis of Financial
Condition and Results of Operations and Item 1 of this Annual Report on Form
10-K contain forward-looking statements which involve risks and
uncertainties. The Company may, from time to time, make oral forward-looking
statements. The factors discussed above and in the Company's Securities and
Exchange Commission filings, as well as the following, are important factors
that could cause actual results to differ materially from those projected in
any such forward-looking statements.
THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE
COMPANY AND ITS BUSINESS PROSPECTS.
OPERATING RESULTS. The Company has reported a net loss of $33.1 million or
$5.86 per share for fiscal 1998 and had an accumulated deficit of $153.6
million at March 31, 1998. There can be no assurance that the Company's
business strategies and tactics will be successful and that the Company will
be profitable in future periods.
CASH FLOWS. The Company's cash and cash equivalents have declined by $33.0
million during fiscal 1998. Management believes that existing cash and cash
equivalents, together with cash generated from operations, will need to be
supplemented in the near term by cash flows from new financing arrangements,
including asset-based financing arrangements, to meet the Company's liquidity
and capital needs for the next 12 months. These new financing arrangements
are, as yet, not in place, and there can be no assurances that the Company
will be successful in securing new financing or that the Company's products
will generate receivables and other assets sufficient to support an adequate
level of financing. The Company's ability to support an adequate level of
financing depends on the timely release of new products in anticipated
quantities, in particular, the release of "BattleTech-Registered Trademark-:
MechCommander-TM- in expected quantities in the first quarter of fiscal 1999.
Failure to secure and maintain adequate additional financing could have a
material and adverse effect on the Company's business, financial condition and
ability to continue as a going concern.
TERMINATED BUSINESS COMBINATION. In October 1997, the Company entered into
an agreement to merge with GT Interactive Software Corp. Under the terms of
the proposed merger, the Company's outstanding shares of common and preferred
stock were to be exchanged for a proportional number of shares of GT stock.
On December 5, 1997, the Company and GT announced their mutual agreement to
terminate the merger.
The termination of the merger has had a material adverse impact on the
Comany including: (a) the Company's sales and operating results, (b) the
Company's ability to attract and retain key sales and administrative
personnel, (c) the progress of certain development projects, and (d) the
trading price of the Company's Common Stock. There can be no assurance that the
termination of the merger will not continue to adversely impact the Company's
business and results of operations in future periods.
NASDAQ LISTING/REVERSE SPLIT. The Company was notified in February 1998 by the
Nasdaq Stock Market ("Nasdaq") that the Company was no longer in compliance with
the net tangible assets requirement or the alternative minimum bid price
requirement for continued listing on the Nasdaq National Market. Pursuant to
National Association of Securities Dealers Marketplace Rules, the Company was
given a period of 90 days to regain compliance with the minimum bid price
requirement, which calls for a minimum common stock bid price of $5.00 per
share. On May 11, 1998, the Company's stockholders approved a one for five
reverse stock split whereby each five shares of the Company's outstanding common
stock were automatically converted into one share (the "Reverse Stock Split").
During the fourth quarter of fiscal 1998, prior to the Reverse Stock Split, the
Company's common stock traded between $2.75 and $1.50 per share. On May 12,
1998, following
24
the Reverse Stock Split, the Company's common stock opened at a bid price of
$9.38 per share. Subsequently, the Company's common stock price continued to
trade at a price above the $5.00 minimum bid price for a period of 18 days.
On May 19, 1998, and June 3, 1998, the Company received notice from
Nasdaq that the Company was not in compliance with either the market
capitalization requirement or the minimum bid price requirement for continued
listing on the Nasdaq National Market. The Company is in the process of
responding to Nasdaq with respect to both of these issues and is evaluating
plans for compliance with the requirements for continued listing on the
Nasdaq National Market.
There can be no assurance that the Company's minimum bid price or market
capitalization will be sufficient to allow the Company to comply with the
requirements for continued listing on the Nasdaq National Market. If the
Company is unable to maintain compliance with such requirements, the Company
may be able to qualify for listing under the Nasdaq SmallCap Market.
However, at the present time, the Company does not meet all of the
requirements for listing on the Nasdaq SmallCap Market. If for any reason
the Company is unable to achieve and maintain compliance with the Nasdaq
SmallCap Market listing requirements and is delisted from both the Nasdaq
National Market and the Nasdaq SmallCap Market, the holders of the Company's
6.5% Convertible Subordinated Notes Due 2002 (the "Notes") would be entitled
to require the Company, within 55 days, to repurchase all or any portion of
such holders' notes for cash at a price equal to the principal amount plus
accrued interest. In such event, the Company's business, results of
operations and financial condition would be materially and adversely affected.
FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY. The Company's operating
results have varied significantly in the past and are expected to vary
significantly in the future. This variability is a result of factors such
as: 1) volume shipments of significant new products, 2) the degree of market
acceptance of the Company's products, 3) the introduction of products
competitive with those of the Company, 4) the timing and market acceptance of
new hardware and software product introductions, 5) the size and growth rate
of the consumer software market, 6) the seasonality of sales, 7) development
and promotional expenses relating to the introduction of new products or new
versions of existing products, 8) product returns and markdowns, 9) changes
in pricing policies by the Company and its competitors, 10) the accuracy of
retailers' forecasts of consumer demand, 11) the timing of orders from major
customers, 12) order cancellations, 13) delays of shipment, and 14)
write-offs of advance royalty payments. Because a majority of the unit sales
for a product typically occurs in the first 90 to 120 days following the
introduction of the product, the Company's revenue may increase significantly
in a period in which a major product introduction occurs and may decline in
following periods or in periods in which there are no major product
introductions. The Company's expenses are based, in part, on expected future
revenue. Certain overhead and product development expenses are fixed and do
not vary directly in relation to revenue. Consequently, if net revenue is
below expectations, the Company's operating results are likely to be
materially and adversely affected. In certain past periods, the Company's
revenue or operating results were below the expectations of, and certain new
products were not introduced when anticipated by, public market analysts and
investors. These circumstances could recur in future periods, and in such
event, the prices of the Company's common stock and Notes would likely be
materially and adversely affected.
The entertainment software business is highly seasonal. Typically, net
revenue is highest during the last calendar quarter (which includes the
holiday buying season), declines in the first calendar quarter, is lowest in
the second and increases in the third calendar quarter. This seasonal pattern
is due primarily to the increased demand for entertainment software products
during the year-end holiday buying season. The Company's net revenue,
however, is largely dependent on releases of major new products and, as such,
may not necessarily reflect the seasonal patterns of the industry as a whole.
The Company expects that its net revenue and operating results will continue
to fluctuate significantly in the future.
SIGNIFICANT LEVERAGE. As of March 31, 1998, the Company had outstanding
indebtedness for borrowed
25
funds of approximately $32.3 million and cumulative mandatorily redeemable
preferred stock of $2.9 million. This substantial leverage will have several
important consequences for the Company's future operations, including the
following: (i) a substantial portion of the Company's cash flows from
operations will be dedicated to the payment of interest on, and principal of,
its indebtedness; (ii) the Company's ability to obtain additional financing
in the future for capital expenditures, acquisitions, general corporate
purposes or other purposes may be impaired; (iii) the Company's ability to
withstand competitive pressures, adverse economic conditions and adverse
changes in governmental regulations may be negatively impacted, and (iv) the
Company's ability to comply with certain alternative listing requirements for
the NASDAQ Stock Market may be adversely affected.
The Company may in the future obtain lines of credit or enter into other
borrowing arrangements, any of which would add to the total outstanding
indebtedness of the Company. The Company's ability to meet its debt service
obligations and to reduce its total indebtedness will be dependent upon the
Company's future performance, which will be subject to financial, business
and other factors affecting the operations of the Company, many of which are
beyond its control. If the Company is unable to generate sufficient cash flow
from operations in the future to service its debt, it may be required to
convert or refinance all or a portion of such debt, including the Notes (see
below), or to obtain additional financing. However, there can be no assurance
that any refinancing would be possible or that any additional financing could
be obtained.
DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS. A significant
portion of the Company's fiscal year revenue is generated by products
introduced during that fiscal year. The Company depends on both the timely
introduction of successful new products or sequels to existing products to
replace declining revenue from older products and to provide continued
revenue from back-catalog products. If for any reason revenue from new
products or other activities fails to replace declining revenue from existing
products, or if revenue from back-catalog titles declines significantly, the
Company's business, operating results and financial condition may be
materially and adversely affected. In order to maintain or grow its current
revenue levels, the Company believes it will be necessary to develop or
obtain rights to new products that achieve and sustain market acceptance, are
developed for the appropriate platforms and are introduced in a timely
manner. The Company is continuing to devote considerable resources toward the
development of new products and has secured rights to intellectual properties
owned by third parties. As is typical in the industry, while the Company
maintains internally developed release schedules, there can be no assurance
that new products under development will be released on schedule or at all,
or that any such products will generate significant revenue. Historically,
the Company has frequently missed product release schedules. To the extent
that major new products are not released on schedule, both net revenue and
gross profit are likely to be materially and adversely affected. In addition,
as access to distribution channels and retail shelf space become increasingly
competitive, the Company's ability to produce and bring to market new and
compelling products in a timely fashion plays an increasingly important role
in the Company's ability to retain adequate access to these channels.
The process of developing software products such as those offered by the
Company is extremely complex and is expected to become more complex and
expensive in the future as consumers demand products with more sophisticated
and elaborate multimedia features and as new platforms and technologies are
supported. At the same time, the introduction of new technologies and
competitive products, the increase in competition for retail shelf space
among software products and other factors may cause the effective lives of
the Company's products to become shorter and the Company's ability to
introduce new products on a timely basis to become increasingly important.
The Company's current production schedules contemplate that the Company
will commence shipments of a number of new products in fiscal 1999. As with
any software product, however, until all aspects of the development and
initial distribution of a game are completed, there can be no assurance of
its release date. Release dates will vary depending on quality assurance
testing and other development factors. If the Company were unable to commence
volume shipments of a significant new product during the scheduled quarter,
the Company's revenue and earnings would likely be materially and adversely
affected in that quarter. In the past, the Company has experienced
significant delays in the introduction of certain new products. It is
26
likely in the future that certain new products will not be released in
accordance with the Company's internal development schedule or the
expectations of public market analysts and investors. A significant delay in
the introduction of, or the presence of a defect in, one or more new products
could have a material adverse effect on the ultimate success of such products
and on the Company's business, operating results and financial condition,
particularly in the quarter in which such products were scheduled to be
introduced.
UNCERTAINTY OF MARKET ACCEPTANCE; UNPREDICTABLE PRODUCT LIFE CYCLES.
Consumer preferences for entertainment software products are continually and
rapidly changing and are extremely difficult to predict. Few entertainment
software products achieve sustained market acceptance beyond one holiday
buying season. There can be no assurance that new products introduced by the
Company will achieve any significant degree of market acceptance, or that
acceptance, if achieved, will be sustained for any significant period.
Further, there can be no assurance that such products will not be subject to
changes in consumer preferences or that product life cycles will be
sufficient to permit the Company to recover development and other associated
costs. In addition, sales of any single title of the Company's entertainment
software products will decline over time. A majority of the unit sales for a
product typically occurs in the first 90 to 120 days after the product is
introduced. Therefore, the Company cannot rely on the sales of current
products to sustain its business in the future. Failure of new products or
platforms to achieve or sustain market acceptance would have a material and
adverse effect on the Company's business, operating results and financial
condition. In addition, the Company does not carry significant inventory of
its new products. As a result, significant production delays would have a
material and adverse effect on the Company's business and operating results.
Further, if demand for a particular product is greater than anticipated, the
Company may not have sufficient inventory to meet customer demands.
COMPETITION. The entertainment software industry is intensely competitive
and in the process of consolidation. The Company's competitors vary in size
from very small companies with limited resources to very large corporations
with greater financial, marketing and product development resources than
those of the Company. The Company competes primarily with other developers of
PC entertainment and video game entertainment software. Significant
competitors of the Company in the entertainment software industry include
Electronic Arts, Cendant, Lucas Arts, Interplay, GT Interactive, Activision,
Acclaim Entertainment, Broderbund Software, and Virgin Interactive. The
success of one or more of these companies or the entry and participation of
new companies, including diversified entertainment companies, may adversely
affect the Company's future performance. The availability of significant
financial resources has become a major competitive factor in the
entertainment software industry, principally as a result of the technical
sophistication of advanced multimedia computer game products requiring
substantial investments in research and development and the increasing need
to license products and rights to use other intellectual properties from
third parties. Also, competitors with large product lines and popular titles
typically have greater leverage with retailers and distributors and other
customers who may be willing to promote titles with less consumer appeal in
addition to such competitors' most popular titles.
Many of the Company's competitors are developing on-line interactive
computer games that will be competitive with the Company's products. As
competition increases, significant price competition and reduced profit
margins may result. In addition, competition from new technologies may reduce
demand in markets in which the Company has traditionally competed. Prolonged
price competition or reduced demand as a result of competing technologies
would have a material and adverse effect on the Company's business, financial
condition and operating results. There can be no assurance that the Company
will continue to compete successfully against current or future competitors
or that competitive pressures faced by the Company will not materially and
adversely affect its business, operating results and financial condition.
Retailers of the Company's products typically have a limited amount of
shelf space and promotional resources, and there is intense competition among
consumer software producers for adequate levels of shelf space and promotional
support from retailers. To the extent that the number of consumer software
products and computer platforms increases, this competition for shelf space may
intensify. Due to increased competition for limited shelf space, retailers and
distributors are increasingly in a better position to negotiate
27
favorable terms of sale, including promotional discounts and product return
policies. Retailers often require software publishers to pay fees in exchange
for preferred shelf space. The Company's products constitute a relatively
small percentage of a retailer's sales volume, and there can be no assurance
that retailers will continue to purchase the Company's products or provide
the Company's products with adequate levels of shelf space , promotional
support or be available at an affordable cost.
As more consumers own multimedia PCs, the distribution channels for
entertainment software have changed, and are expected to continue to change,
to increasingly depend on mass merchandisers, on-line services and the
Internet to reach the broader market. In addition, while this trend has
increased the number of distribution channels, it has intensified competition
for shelf space because these new channels generally carry only top-selling
titles. In addition, other types of retail outlets and methods of product
distribution, such as on-line services and the Internet, may become important
in the future, and it will be important for the Company to gain access to
these channels of distribution. There can be no assurance that the Company
will gain such access or that the Company's access will allow the Company to
maintain its historical levels of sales volume.
CONCENTRATION OF CUSTOMER BASE; RISK OF CUSTOMER BUSINESS FAILURE; PRODUCT
RETURNS. The Company principally sells its products to retailers and
distributors, who in turn resell the products to consumers. During the year
ended March 31, 1998, sales to the top ten such customers represented
approximately 53% of the Company's net revenue. Sales are typically made on
credit, with terms that vary depending upon the customer and the nature of
the product. The Company does not require collateral to secure payment.
Retailers and distributors compete in a volatile industry and are subject to
the risk of business failure. Certain of the Company's distributors and
retailers have recently experienced financial difficulties and the Company
has increased its reserves accordingly. However, the business failure of a
significant distributor or customer could have a material and adverse effect
on the Company's business, operating results and financial condition.
The Company is exposed to the risk of product returns from distributors
and retailers. The Company currently maintains a stock balancing policy that
allows distributors and retailers to return products subject to certain
conditions. The Company provides reserves for returns that it believes are
adequate, and the Company's agreements with various customers place certain
limits on product returns. However, new product introductions by the Company
or its competitors, or changes in consumer demand from that anticipated,
could cause customers to seek to return inventory to the Company in excess of
those limits. Due to the unpredictability of consumer demand and the
uncertainties associated with a rapidly changing market, there can be no
assurance that the Company or its customers will be able to forecast demand
accurately. Any significant amount of product returns or markdowns could have a
material and adverse effect on the Company's business, operating results and
financial condition.
DEPENDENCE UPON STRATEGIC RELATIONSHIPS. The Company's business strategy
relies to a significant extent on its strategic relationships with other
companies and on its alliances with key software developers. Certain
agreements require third parties to approve a product prior to its release,
and therefore, subject the product to delay. There can be no assurance that
these relationships will be successful or that the Company will continue to
maintain and develop strategic relationships, or that licenses between the
Company and any third party will be renewed or extended at their expiration
dates. The Company's failure to renew or extend a key license or maintain its
strategic relationships could materially and adversely affect the Company's
business, operating results and financial condition. In addition, under
certain key license agreements, the Company must obtain approval on a timely
basis from the licensor in order to market products it develops under the
license. There can be no assurance that the Company will obtain such
approval, and failure to do so could have a material and adverse effect on
the Company's operating results, financial condition and business prospects.
The Company has made certain minority equity investments that it
believes will provide future access to products, technologies or distribution
channels. Management performs ongoing evaluations of the future realization
of these investments, and charges any declines in value that are other than
temporary in nature to other expense in its quarterly Consolidated Statements
of Operations. A write down of one or more of these investments could have a
material adverse impact on the Company's operating results and financial
condition.
28
CHANGES IN TECHNOLOGY AND PRODUCT PLATFORMS. The market for entertainment
software, including entertainment software platforms, is undergoing rapid
technological change. As a result, the Company must continually anticipate
and adapt its products to emerging platforms and evolving consumer
preferences. The introduction of new platforms and technologies can render
existing products obsolete and unmarketable. Development of entertainment
software products for new hardware platforms requires substantial investments
in research and development for technologies such as enhanced sound,
digitized speech, music and video and requires the Company to anticipate and
develop products for those platforms that will ultimately be successful. Such
research and development efforts, which generally require 18 to 24 months,
must occur well in advance of the release of new platforms in order to
introduce products on a timely basis following the release of such platforms.
In addition, the Company expects that the trend toward more complex
multimedia products and increasing product development costs will continue
for the foreseeable future.
Although the Company intends to develop and market games for certain
advanced and emerging platforms, these development and marketing efforts may
require greater financial and technical resources than those currently
possessed by the Company. In addition, there can be no assurance that the
platforms for which the Company develops products will achieve market
acceptance and, as a result, there can be no assurance that the Company's
development efforts with respect to such new platforms will lead to
marketable products or products that generate sufficient revenue to offset
research and development costs incurred in connection with their development.
There can be no assurance that the Company will be successful in developing
and marketing products for new platforms. Failure to develop products for new
platforms that achieve significant market acceptance may have a material and
adverse effect on the Company's business, operating results and financial
condition. The Company is developing games that may be played interactively
over on-line services and the Internet, but there can be no assurance that
the market for networked videogame play will evolve or develop as
anticipated. Consumer preferences change continually and are extremely
difficult to predict. Even if a market for networked videogame play develops,
no assurance can be given that the Company's products will meet the
requirements of such market and achieve market acceptance.
The Company is heavily dependent on the success of the entertainment
software developed for use on the PC. However, there are multiple, competing
and incompatible formats being introduced in this market. There can be no
assurance that the Company's strategy of developing primarily for the PC or
the other platforms the Company chooses to support ultimately will be
successful. For game console platforms the Company chooses to support, the
development, marketing and distribution of products will involve substantial
investment and risks. The Company believes that the principal target audience
for game consoles may be younger than the Company's traditional customers,
and there can be no assurance that the Company's products will be successful
with this different audience. In addition, the Company anticipates that
products in the game console market will require substantially greater
expenditures for marketing, advertising and inventory buildup, often before
the market acceptance of a product is known. Inventory will be two or more
times more expensive as a result of license fees that are required to be
prepaid to the manufacturers of the hardware platforms. Further, game console
products will be sold through channels that overlap with, but are somewhat
different from, the retail channels currently utilized by the Company, and
the Company will be competing in distribution against much larger
organizations with greater financial resources. There can be no assurance
that the Company will be successful in marketing and distributing software
for game consoles.
RISK OF SOFTWARE ERRORS OR FAILURES. Software products as complex as those
offered by the Company may contain undetected errors when first introduced or
when new versions are released. In the past, the Company has discovered software
errors in certain of its product offerings after their introduction and has
experienced delays or lost revenue during the period required to correct these
errors. The Company's products must maintain compatibility with certain
hardware, software and accessories. Any changes that result in incompatibility
could result in significant product returns and customer service costs. In
particular, the PC hardware environment is characterized by a wide variety of
nonstandard peripheral equipment (such as sound and graphics cards) and
configurations that make prerelease testing for programming or compatibility
errors very difficult and time consuming. There can be no assurance that,
despite testing by the Company, errors will
29
not be found in new products or releases after commencement of commercial
shipments, resulting in loss of or delay in market acceptance, which could
have a material and adverse effect on the Company's business, operating
results and financial condition. The risk of undetected product errors can be
expected to increase as products and their development processes become more
complex and as growing competition leads to increased pressure to reduce time
to market.
DEPENDENCE ON KEY PERSONNEL; MANAGEMENT CHANGES. The Company's future
success depends in large part on the continued service of its key product
development, technical and management personnel and on its ability to
continue to attract, motivate and retain highly qualified employees,
including additional management personnel. The loss of certain key employees
could have a material and adverse effect on the Company's business. In
addition, the Company depends on teams of programmers, game designers and
artists. Competition for these skilled employees is intense, and the loss of
the services of key development personnel could have a material and adverse
effect upon the Company's current business, new product development efforts
and prospects. There can be no assurance that qualified personnel can be
readily identified and hired wherever necessary, that any new personnel will
be successfully integrated into the Company, its operations and culture, or
that new personnel, if hired, will improve the Company's business, operations
or operating results. The Company does not currently have key person life
insurance on any employees.
USE OF INDEPENDENT SOFTWARE DEVELOPERS. In addition to marketing internally
developed software, the Company also markets entertainment software created
by independent software developers. The cost to retain independent developers
is increasing in the form of guaranteed advances and royalties. Additionally,
the Company has less control over the scheduling and the quality of work of
independent contractors than that of its own employees. Furthermore, the
Company's agreements to publish and market certain independent software
developers' titles will terminate after specified dates unless renewed. The
Company's business and future operating results will depend in part on the
Company's continued ability to attract and maintain relationships with
skilled independent software developers, and to enter into and renew product
development agreements with such developers. There can be no assurance that
the Company will be able to maintain such relationships or enter into and
renew such agreements.
INTERNATIONAL REVENUE. International net revenue represented approximately
67%, 64%, and 49%, of the Company's net revenue for fiscal years 1998, 1997,
and 1996, respectively. The Company expects that international net revenue
will continue to account for a significant portion of its net revenue in
future periods. International revenue is subject to inherent risks, including
unexpected changes in regulatory requirements, tariffs and other economic
barriers, fluctuating exchange rates, difficulties in staffing and managing
foreign operations and the possibility of difficulty in accounts receivable
collection. For example, the Company attempts to minimize its exposure to
currency fluctuations by entering into forward currency contracts, however,
there can be no assurance that the Company will be successful at mitigating
currency risks. In some markets, localization of the Company's products is
essential to achieve market penetration. The Company may incur substantial
costs and experience delays in localizing its products, and there can be no
assurance that any localized product will ever generate significant revenue.
These or other factors could have a material and adverse effect on the
Company's future international revenue and, consequently, on the Company's
business, operating results and financial condition.
RECOVERY OF PREPAID ROYALTIES AND GUARANTEES. The Company, from time to
time, enters into agreements with licensors of intellectual property and
developers of games that involve royalty advances and guaranteed minimum
royalty payments. If the sales volumes of products subject to such
arrangements are not sufficient to recover such advances and guarantees, the
Company provides a reserve for the anticipated portion of such payments that
will not be recovered. If existing advances are determined to be
unrecoverable in future periods, the Company's results of operations may be
materially and adversely affected.
INTELLECTUAL PROPERTY. The Company regards the software that it owns or
licenses as proprietary and relies primarily on a combination of copyrights
and trademarks and U.S. and international, trade secret, patent and trademark
laws, and nondisclosure agreements to protect its proprietary rights to its
products. It is the Company's current policy that employees
30
and third-party developers sign nondisclosure agreements. The Company owns or
licenses various trademarks and copyrights. However, the Company has only
standard "shrink wrap" license agreements or no license agreements at all
with the end users of its products and does not copy-protect its software.
The Company relies largely on the copyright and trademark laws to prevent
unauthorized distribution of its software. There can be no assurance that
these measures will be sufficient to protect the Company's intellectual
property rights against infringement. Existing copyright laws afford only
limited protection. It may be possible for unauthorized third parties to copy
the Company's products or to reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. Policing unauthorized
use of the Company's products is difficult, and software piracy can be
expected to be a persistent problem. Further, the laws of certain countries
in which the Company's products are or may be distributed do not protect the
Company's products and intellectual rights to the same extent as the laws of
the United States.
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. As the
number of entertainment software products in the industry increases, the
Company believes that software increasingly will become the subject of claims
that such software infringes upon the rights of others. From time to time,
the Company has received communications from parties asserting that features
or content of certain of its products may infringe upon intellectual property
rights of such parties. The Company believes such claims have been without
merit. To date, other than the cost of litigation, no such claims have had a
materially adverse effect on the Company's ability to develop, market or sell
its products. However, the Company is currently involved in intellectual
property litigation and there can be no assurance that existing or future
infringement claims against the Company will not result in further costly
litigation or require the Company to license the intellectual property rights
of parties. There can be no assurance that such licenses will be available on
reasonable terms or at all.
VOLATILITY OF PRICE OF STOCK AND NOTES. There has been a history of
significant volatility in the market prices of companies engaged in the
entertainment software industry, including the Company. It is likely that the
market price of the Company's common stock will continue to be highly
volatile and the price of the Company's Notes will also be subject to such
fluctuations. Factors such as the timing and market acceptance of new product
introductions by the Company, the introduction of new products by the
Company's competitors, loss of key personnel of the Company, variations in
quarterly operating results or changes in market conditions in the
entertainment software industry may have a significant impact on the market
price of the Company's common stock and Notes. In the past, the Company has
experienced fluctuations in its operating results, and it is likely that in
some future quarter the Company's revenue or operating results will be below
the expectations of, and certain new products will not be introduced when
anticipated by, public market analysts and investors. In such event, the
price of the Company's common stock would likely be materially adversely
affected. Volatility in the price of the Company's common stock, changes in
prevailing interest rates and changes in perceptions of the Company's
creditworthiness may in the future adversely affect the price of the Notes.
31
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND 1997
In thousands, except per share amounts
[Enlarge/Download Table]
1998 1997
----------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 14,087 $ 47,110
Accounts receivable, less allowances of $5,077 and $6,568
at March 31, 1998 and 1997, respectively 7,506 7,891
Inventories 1,559 4,042
Current portion of prepaid royalties 3,195 2,139
Other current assets 2,064 1,958
----------------------------
Total current assets 28,411 63,140
Property, plant and equipment, net 7,595 7,802
Goodwill, net 903 892
Investments 3,485 6,050
Prepaid royalties 2,565 1,374
Other assets 870 1,047
----------------------------
$ 43,829 $ 80,305
----------------------------
----------------------------
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Accounts payable $ 6,153 $ 3,508
Salaries, wages and related accruals 5,059 6,337
Royalties payable 642 1,840
Current portion of redeemable preferred stock (Note 10) 2,940 -
Other current liabilities 5,201 7,122
----------------------------
Total current liabilities 19,995 18,807
Other liabilities 1,028 1,280
Long-term debt 32,348 32,739
----------------------------
Total liabilities 53,371 52,826
Commitments and contingencies (Note 12 )
Redeemable preferred stock (net of current portion)
(Note 10) $0.001 par value, 4,000 shares designated Series A,
outstanding shares and liquidation preference at March 31,
1998 and 1997, respectively, as follows:
Issued and outstanding: 2,000 and 4,000 shares ----------------------------
Redemption and liquidation amount: $2,772 and $5,260 - 5,881
Stockholders' equity (deficit):
Preferred stock, $0.001 par value, 9,000 shares authorized
(of which 4,000 shares have been designated Series A),
16 Series B-1 convertible shares issued and outstanding at
March 31, 1997 - -
Common stock, $0.001 par value, 40,000 shares authorized,
5,754 and 28,287 shares issued and outstanding at March 31,
1998 and 1997, respectively 6 29
Additional paid-in capital 144,525 142,558
Accumulated deficit (153,609) (120,468)
Foreign currency translation adjustment (464) (521)
----------------------------
Total stockholders' (deficit) equity (9,542) 21,598
----------------------------
$ 43,829 $ 80,305
----------------------------
----------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
32
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
In thousands, except per share amounts
[Enlarge/Download Table]
1998 1997 1996
-----------------------------------------
Net revenue $ 60,009 $100,253 $ 59,694
Cost of revenue 31,428 39,317 30,554
-----------------------------------------
Gross profit 28,581 60,936 29,140
Operating expenses:
Sales and marketing 17,633 18,741 21,642
General and administrative 11,493 14,670 14,409
Research and development 29,038 23,145 27,490
Restructuring charges - - 1,123
-----------------------------------------
Total operating expenses 58,164 56,556 64,664
-----------------------------------------
Operating income (loss) (29,583) 4,380 (35,524)
Other income (expense), net (3,534) 511 (4,317)
-----------------------------------------
Income (loss) before income taxes
and extraordinary item (33,117) 4,891 (39,841)
Income tax provision 24 450 -
-----------------------------------------
Income (loss) before extraordinary item (33,141) 4,441 (39,841)
Extraordinary item, net of tax effect - 3,547 -
-----------------------------------------
Net income (loss) $(33,141) $ 7,988 $(39,841)
-----------------------------------------
-----------------------------------------
Basic income (loss) per share:
Income (loss) before extraordinary item $(5.86) $0.79 $(8.49)
Extraordinary item, net of tax effect - 0.66 -
-----------------------------------------
Net income (loss) $(5.86) $1.45 $(8.49)
-----------------------------------------
-----------------------------------------
Diluted income (loss) per share :
Income (loss) before extraordinary item $(5.86) $0.75 $(8.49)
Extraordinary item, net of tax effect - 0.64 -
-----------------------------------------
Net income (loss) $(5.86) $1.39 $(8.49)
-----------------------------------------
-----------------------------------------
Weighted average shares used to calculate:
Basic income (loss) per share 5,697 5,300 4,727
Diluted income (loss) per share 5,697 5,555 4,727
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
33
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
In thousands
[Enlarge/Download Table]
FOREIGN
PREFERRED STOCK COMMON STOCK ADDITIONAL CURRENCY
----------------------------------------- PAID-IN ACCUMULATED TRANSLATION
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT TOTAL
------------------------------------------------------------------------------------------------
Balance at March 31, 1995 - $ - 21,343 $ 21 $ 97,273 $ (88,615) $(117) $ 8,562
Issuance of common stock under
employee stock option and
purchase plans - - 604 1 3,230 - - 3,231
Issuance of common stock in a
private equity placement, net
of issuance costs - - 1,498 1 19,420 - - 19,421
Issuance of common stock pursuant
to acquisition of SimTex Software - - 838 1 - - - 1
Net loss - - - - - (39,841) - (39,841)
Foreign currency translation
adjustment - - - - - - (289) (289)
------------------------------------------------------------------------------------------------
Balance at March 31, 1996 - - 24,283 24 119,923 (128,456) (406) (8,915)
Issuance of Series B preferred
stock to extinguish debt 750 1 - - 4,844 - - 4,845
Issuance of Series B-1 preferred
stock to extinguish debt 1,169 1 - - 7,072 - - 7,073
Issuance of common stock pursuant
to the conversion of Series B
and B-1 preferred stock (1,903) (2) 1,903 2 - - - -
Issuance of common stock under
employee stock option and
purchase plans - - 282 1 1,155 - - 1,156
Issuance of common stock in a
private equity placement, net
of issuance costs - - 1,819 2 9,564 - - 9,566
Net income - - - - - 7,988 - 7,988
Foreign currency translation
adjustment - - - - - - (115) (115)
------------------------------------------------------------------------------------------------
Balance at March 31, 1997 16 - 28,287 29 142,558 (120,468) (521) 21,598
Issuance of common stock pursuant
to the conversion of Series B
and B-1 preferred stock (16) - 16 - - - - -
Redemption of Series A preferred stock - - - - 210 - - 210
Issuance of common stock under
employee stock option and
purchase plans - - 466 - 1,734 - - 1,734
Net loss - - - - - (33,141) - (33,141)
Foreign currency translation
adjustment - - - - - - 57 57
One-for-five stock split at par value - - (23,015) (23) 23 - - -
------------------------------------------------------------------------------------------------
Balance at March 31, 1998 - $ - 5,754 $ 6 $144,525 $(153,609) $(464) $(9,542)
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
In thousands
[Enlarge/Download Table]
1998 1997 1996
--------------------------------------------
OPERATING ACTIVITIES
Net (loss) income $ (33,141) $ 7,988 $ (39,841)
Adjustments to reconcile net (loss) income
to net cash provided by (used in) operating activities:
Depreciation and amortization 3,443 3,944 4,102
Non cash licensing revenue - - (750)
Minority interest in joint venture losses - - 1,074
Restructuring charges - - 1,123
Loss on the write-down of investment 2,605 - -
Gain on sale of investment - (1,895) -
Extraordinary gain on extinguishment of long-term debt - (3,547) -
Other - (17) -
Changes in assets and liabilities:
Accounts receivable 572 2,697 8,291
Inventories 2,557 925 1,539
Prepaid royalties (2,233) 25 260
Other current assets (129) 337 2,026
Other assets 2 (1,175) 1,055
Accounts payable 2,572 (3,107) (3,988)
Salaries, wages and related accruals (1,305) 2,388 1,031
Royalties payable (1,209) 105 79
Other current liabilities (1,941) 1,479 (742)
Other liabilities (327) (32) (675)
--------------------------------------------
Net cash (used in) provided by operating activities (28,534) 10,115 (25,416)
INVESTING ACTIVITIES
Acquisitions of property, plant and equipment (2,292) (2,931) (2,334)
Proceeds from sale of property, plant and equipment - 486 19
Acquisition of certain net assets of Leisuresoft,
net of cash acquired - (802) -
Proceeds from sale of investments - 820 -
Equity investment in other companies (527) (675) (3,274)
--------------------------------------------
Net cash used in investing activities (2,819) (3,102) (5,589)
(CONTINUED)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
35
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
[Enlarge/Download Table]
1998 1997 1996
------------------------------------------
FINANCING ACTIVITIES
Extinguishment of long-term debt - (2,959) -
Proceeds from issuance of common stock, net of issuance costs 1,734 10,722 22,653
Borrowings under notes and lines of credit, net of non-cash note
issuance costs - - 48,500
Payment of note issuance costs - - (467)
Repayments under notes and lines of credit (290) (2,132) (11,238)
Repurchase of Series A preferred stock (2,730) - -
Principal payments on capital lease obligations (314) (411) (846)
------------------------------------------
Net cash provided by (used in) financing activities (1,600) 5,220 58,602
Effect of exchange rate changes on cash (70) (492) 49
------------------------------------------
(Decrease) increase in cash and cash equivalents (33,023) 11,741 27,646
Cash and cash equivalents at beginning of year 47,110 35,369 7,723
------------------------------------------
Cash and cash equivalents at end of year $ 14,087 $ 47,110 $ 35,369
------------------------------------------
------------------------------------------
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid for interest $2,151 $2,223 $2,418
Cash paid for income taxes 488 111 4
Non cash investing and financing activities:
Note issuance costs $ - $ - $ 1,500
Issuance of common stock pursuant to conversion
of Series B and B-1 preferred stock - 11,820 -
Issuance of Series B and B-1 preferred stock pursuant to
the extinguishment of long-term debt - 11,916 -
Issuance of common stock pursuant to the
Acquisition of SimTex Software Corp. - - 11,729
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION:
MicroProse, Inc. (formerly Spectrum HoloByte, Inc.) and subsidiaries (the
"Company") develops and publishes entertainment software for use on CD-ROM
personal computer systems and select game console platforms and distributes
third-party software and related products. The accompanying consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries. All significant intercompany transactions and balances have been
eliminated.
For purposes of presentation, the Company has indicated its 1998, 1997, and
1996 fiscal periods as ended on March 31. The Company reports its financial
results on a 52-53 week fiscal year ending on the Sunday nearest to March 31.
The financial statements presented are, therefore, representative of the
52-week periods ended March 29, 1998, March 30, 1997, and March 31, 1996,
respectively.
The consolidated financial statements have been presented on a
going-concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
reported a net loss of $33.1 million or $5.86 per share for fiscal 1998 and has
generated an accumulated deficit of $153.6 million at March 31, 1998. There
can be no assurance that the Company's business strategies and tactics will be
successful and that the Company will be profitable in future periods.
In addition, the Company's cash and cash equivalents have declined by $33.0
million during fiscal 1998.
Management believes that existing cash and cash equivalents, together with
cash generated from operations, will need to be supplemented in the near term
by cash flows from new financing arrangements, including asset-based financing
arrangements, to meet the Company's liquidity and capital needs for the next 12
months. These new financing arrangements are, as yet, not in place, and there
can be no assurances that the Company will be successful in securing new
financing or that the Company's products will generate receivables and other
assets sufficient to support an adequate level of financing. The Company's
ability to support an adequate level of financing depends on the timely release
of new products in anticipated quantities, in particular, the release of
"BattleTech-Registered Trademark-: MechCommander-TM- in expected quantities in
the first quarter of fiscal 1999. Failure to secure and maintain adequate
additional financing could have a material and adverse effect on the Company's
business, financial condition and ability to continue as a going concern.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reported periods. Actual results could differ from those estimates.
RECLASSIFICATIONS:
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year's presentation. These
reclassifications had no effect on previously reported net income (loss) or
stockholders' equity (deficit).
CASH AND CASH EQUIVALENTS:
Highly liquid investments with original maturities of 90 days or less at
the date of purchase are classified as cash and cash equivalents.
37
CERTAIN RISKS AND CONCENTRATIONS:
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of cash and cash equivalents
and trade accounts receivable. At March 31, 1998, 1997, and 1996, the Company
had deposits in excess of insured amounts of approximately $13,852,000,
$46,711,000, and $34,596,000, respectively.
Sales are typically made on credit, with terms that vary depending upon
the customer and the nature of the product. The Company's receivables are
principally from distributors, software specialty retailers, computer
superstores, mass merchandisers and discount warehouse stores. These customers
compete in a volatile industry and are subject to the risk of business failure.
Accounts receivable are recorded net of allowances for estimated
uncollectible amounts due to potential credit losses, sales returns and
in-channel markdowns. Although the Company believes these allowances are
adequate, a payment default of a significant customer could materially and
adversely affect its operating results and financial condition. At
March 31, 1998, 1997, and 1996, accounts receivable from the Company's five
largest customers in the aggregate were $4,710,000, $4,148,000 and $5,278,000,
respectively, representing 63%, 53% and 54% of net accounts receivable,
respectively.
The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. Actual losses related to uncollectible
amounts have generally been within management's expectations. For the year
ended March 31, 1998, sales to one customer accounted for 16% of the Company's
consolidated net revenue. In fiscal 1997, sales to one customer accounted for
12% of the Company's consolidated net revenue. For fiscal 1996, sales to two
customers accounted for 13% and 10% of the Company's consolidated net revenue.
INVESTMENTS:
For investments accounted for under the equity method of accounting, the
Company records its share of the investee's operating results as a component of
other income and expense. For cost-basis investments, management performs
ongoing evaluations of the future realization and charges any declines in value
that are other-than-temporary in nature to other income and expense.
INVENTORIES:
Inventories, generally consisting of software products and related
materials, are stated at the lower of cost (on a first-in, first-out (FIFO)
basis) or market value.
Inventories consist of the following at March 31, (in thousands):
[Download Table]
1998 1997
--------------------
Raw materials $ 256 $ 413
Finished goods 1,303 3,629
--------------------
$1,559 $4,042
--------------------
--------------------
PREPAID ROYALTIES AND ROYALTIES PAYABLE:
Prepaid royalties consist of advances made to independent software
developers and licensors of intellectual properties. Amortization of prepaid
royalties is based on actual realized sales of the related product and the
contractual royalty rates. Management performs ongoing evaluations of the
future realization of prepaid royalties and charges any amounts deemed
unlikely to be realized to research and development expense.
38
Royalties payable are accrued based on cash receipts, revenue or units
shipped of software products published by the Company pursuant to contractual
agreements.
Royalty expense, which is included in cost of revenue, was $8,419,000,
$11,846,000 and $6,075,000 for the fiscal years ended March 31, 1998, 1997 and
1996, respectively.
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, including equipment acquired under capital
leases, is recorded at cost and depreciated using the straight-line method over
the estimated useful lives of the assets, generally three to five years for
equipment and furniture and 25 years for buildings. Leasehold improvements are
amortized over the estimated useful lives of the assets or the term of the
respective leases, whichever is shorter. Assets and accumulated depreciation
accounts are relieved at disposition with the resulting gains or losses
reflected in earnings. Repairs and maintenance costs are expensed as incurred.
Property, plant and equipment, consists of the following at March 31, (in
thousands):
[Download Table]
1998 1997
---------------------------
Equipment $ 15,029 $ 12,016
Equipment under capital leases 1,879 2,089
Land and building 2,022 2,193
Furniture 1,228 1,341
Leasehold improvements 1,256 1,029
---------------------------
21,414 18,668
Less accumulated depreciation
and amortization:
Equipment under capital leases (1,770) (1,559)
All other assets (12,049) (9,307)
---------------------------
$ 7,595 $ 7,802
---------------------------
---------------------------
Depreciation and amortization expense related to property, plant and
equipment was $3,439,000, $3,376,000 and $3,662,000 for the fiscal years ended
March 31, 1998, 1997 and 1996, respectively.
GOODWILL:
Goodwill is being amortized on a straight-line basis over ten and
five-year periods. Amortization expense was $414,000, $333,000 and $300,000
in fiscal 1998, 1997 and 1996, respectively. The Company reviews the carrying
value of goodwill for impairment whenever events or changes in circumstances
indicate the carrying amount may not be recoverable. At March 31, 1998, the
net unamortized balance of goodwill is not considered impaired.
REVENUE RECOGNITION:
The Company recognizes revenue in accordance with the American Institute
of Certified Public Accountants Statement of Position 91-1, "Software Revenue
Recognition." Revenue from product sales or licensing agreements is recognized
upon shipment or fulfillment of deliverable obligations provided no significant
vendor obligations or contingencies remain and collection of the resulting
receivable is deemed probable. Provisions are made at the time of shipment for
estimated future product returns and in-channel markdowns.
39
SOFTWARE DEVELOPMENT COSTS:
SFAS No. 86 provides for the capitalization of certain software
development costs after technological feasibility of the software is attained.
Software development costs subject to potential capitalization were not
material in fiscal 1998, 1997 and 1996, and, as such, no amounts were
capitalized in these years.
FOREIGN EXCHANGE:
The functional currency for each principal foreign subsidiary is its local
currency. In accordance with SFAS No. 52, assets and liabilities of foreign
operations are translated into U.S. dollars at the rates of exchange as of the
balance sheet dates. Revenue and expenses are translated into U.S. dollars
using weighted average rates of exchange prevailing during each respective
fiscal year. The effects of translation adjustments are deferred and included
as a component of stockholders' equity (deficit). Gains and losses resulting
from foreign currency transactions are included in results of operations.
The Company enters into foreign exchange forward contracts to hedge
certain foreign currency denominated balances against changes in rates of
exchange. These contracts require the Company to exchange foreign currencies
and generally mature within three months. Gains and losses on contracts that
are designated and effective as hedges of transactions for which a firm
commitment has been attained are deferred and recognized in income in the same
period that the underlying transactions are settled. Gains and losses on any
instruments not meeting the above criteria are recognized in the current
period.
INCOME TAXES:
The Company accounts for income taxes using the liability method under
which deferred tax assets or liabilities are calculated at the balance sheet
date using current tax laws and rates in effect. Valuation allowances are
established when necessary to reduce deferred tax assets to amounts expected to
be realized.
EARNINGS (LOSS) PER SHARE:
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," ("SFAS 128") effective
December 31, 1997. SFAS 128 requires the presentation of basic and diluted
earnings per share. Basic earnings per share is computed by dividing income
available to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share is computed
giving effect to all dilutive potential common shares that were outstanding
during the period. Dilutive potential common shares consist of incremental
shares issuable upon the conversion of convertible preferred stock (using the
"if converted" method) and exercise of stock options and warrants. All prior
period earnings per share amounts have been restated to comply with SFAS 128.
In addition, all earnings per share amounts have been restated to reflect the
effect of the one for five reverse stock split (see note 10).
RECENT PRONOUNCEMENTS:
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which requires disclosure of all changes in stockholders' equity
except those resulting from investments or contributions by stockholders.
SFAS No. 130 is effective for the Company for fiscal years beginning after
December 15, 1997. The Company does not expect this pronouncement to materially
impact the Company's results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which requires disclosure about
operating segments in annual financial statements and selected information in
interim financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
This statement supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise" and is effective for fiscal years beginning after
40
December 15, 1997. The Company is evaluating the requirements of SFAS No. 131
and the effects, if any, on the Company's current reporting and disclosures.
In October 1997 and March 1998, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 97-2, SOFTWARE REVENUE
RECOGNITION, which supersedes SOP 91-1 and Statement of Position (SOP) 98-4,
DEFERRAL OF THE EFFECTIVE DATE OF PROVISION OF SOP 97-2, respectively. The
Statements are effective for the Company's fiscal year 2000. The Company's
management believes it is currently substantially in compliance with the
provisions of SOP 97-2 and SOP 98-4.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER
SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. SOP 98-1 provides guidance
for determining whether computer software is internal use software and on
accounting for the proceeds of computer software originally developed or
obtained for internal use and then subsequently sold to the public. It also
provides guidance on capitalization of the costs incurred for computer software
developed or obtained for internal use. The Company has not yet determined the
impact, if any, of adopting this statement. The disclosures prescribed by SOP
98-1 will be effective for the Company's fiscal year 2000.
2. FAIR VALUE OF FINANCIAL INSTRUMENTS
The book values and estimated fair values of the Company's significant
financial instruments were as follows (in thousands):
[Download Table]
1998 1997
-------------------------- -----------------------------
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
-------------------------- -----------------------------
Investments $ 3,485 $ 3,485 $ 6,050 $ 6,050
Long-term debt 32,348 21,343 32,739 26,181
Currency contracts 9,951 9,951 5,599 5,599
The fair values of cash and cash equivalents, receivables and accounts
payable approximate their carrying value due to their short maturities. The
fair values of long-term debt and foreign currency exchange contracts were
based upon quotes obtained from brokers. For long-term investments that have no
quoted market prices, a reasonable estimate of fair value was made using
available market information and appropriate valuation techniques. The
estimates presented above require considerable judgment and are not necessarily
indicative of the amounts that would be realized in a current market exchange.
3. ACQUISITIONS AND STRATEGIC TRANSACTIONS
HARTLAND TREFOIL:
On October 30, 1997, the Company purchased Hartland Trefoil Limited
("Hartland"), a privately held game development company incorporated in the
United Kingdom, for L247,082 (approximately $426,000). Hartland developed and
is the beneficial owner of intellectual property for the original CIVILIZATION
board game. The transaction was accounted for as a purchase and accordingly,
the operating results of Hartland have been included in the Company's
consolidated financial statements since the date of acquisition. Approximately
$425,000 of goodwill was recorded, representing the excess of the purchase
price over the identifiable net assets acquired. Goodwill is being amortized on
a straight-line basis over five years.
41
TERMINATED MERGER:
On October 5, 1997, the Company entered into an agreement to merge with GT
Interactive Software Corp. ("GT"), a Delaware corporation and a developer,
publisher and distributor of entertainment software for personal computers and
certain console platforms. Under the terms of the proposed merger, the
Company's outstanding shares of common and preferred stock were to be exchanged
for a proportional number of shares of GT stock. On December 5, 1997, the
Company and GT announced their mutual agreement to terminate the definitive
merger agreement. There were no breakup fees due to either company. The
accompanying consolidated statements of operations for the year ended March 31,
1998, include the write-off of approximately $700,000 of capitalized costs
associated with the proposed merger.
LEISURESOFT VERTIEBS GMBH:
In June 1996, the Company entered into an agreement to acquire certain net
assets of Leisuresoft Vertiebs GmbH, a German distributor of computer software
and related products, for 1.2 million German Deutsche Marks (approximately $0.8
million). The transaction was accounted for as a purchase. Approximately
$407,000 of goodwill was recorded representing the excess of the purchase price
over the identifiable net assets acquired. Goodwill is being amortized on a
straight-line basis over five years.
4. INVESTMENTS
FASA INTERACTIVE TECHNOLOGIES, INC. AND VIRTUAL WORLD ENTERTAINMENT GROUP, INC.:
In fiscal 1995 and 1996, the Company invested a total of $1.5 million in
FASA Interactive Technologies, Inc., ("FASA"), a developer of interactive
entertainment software for PC and console platforms. In June 1996, the Company
sold its investment in FASA to FASA for approximately $3.4 million. The Company
received cash of $570,000 and a $2.8 million note bearing interest at a rate of
6% per annum and due June 2001. A gain of $1.9 million was recorded on the sale
of this investment. Proceeds from the sale of this investment along with the
note receivable were reinvested in Virtual World Entertainment Group, Inc.
("VWEG"), a corporation formed for the purpose of acquiring Virtual World
Entertainment, Inc., a developer and operator of location-based entertainment,
and FASA.
TOTAL ENTERTAINMENT NETWORK:
In fiscal 1996 and 1997, the Company made a minority equity investment of
$2.6 million in Total Entertainment Network, Inc. ("TEN"). This cost basis
investment was made pursuant to an investment and licensing arrangement whereby
the Company committed to allow certain of the Company's future titles to be
played over the Total Entertainment Network. In conjunction with the planned
refinancing of TEN, the Company recorded a $2.6 million charge in the first
quarter of fiscal 1998 to write-down its investment, as management estimated
that a decline in fair value had occurred that was other than temporary in
nature. The charge is included in other income and expense in the accompanying
consolidated statement of operations.
5. LICENSE AGREEMENT WITH MITSUI & CO.
In April 1996, the Company's wholly owned Japanese subsidiary ("Spectrum
Japan K.K.") granted an exclusive license to Mitsui & Co., Ltd. ("Mitsui") for
the localization, manufacture, marketing and distribution of certain Company
titles in Japan. The Company received an up-front license fee of approximately
$300,000, and will earn royalties based upon revenue generated by Mitsui during
the three-year term of the agreement. During fiscal 1998 and 1997, the Company
recognized approximately $344,000 and $800,000 of licensing revenue under this
agreement, respectively. In connection with the license agreement, Spectrum
Japan K.K. subcontracted all of its employees to Mitsui and largely discontinued
its operations. The Company recognized
42
a restructuring charge of approximately $350,000 in fiscal 1996 to write down
the net assets of Spectrum Japan K.K. to their estimated realizable values.
6. INCOME TAXES
The provision for income taxes for the years ended March 31, 1998 and 1997
consists entirely of foreign taxes currently payable.
The differences between the federal statutory and effective tax rates for
the years ended March 31 are as follows:
[Download Table]
1998 1997 1996
-----------------------------
Federal statutory (benefit) rate (35.0)% 35.0% (34.0)%
State tax (benefit) rate, net of federal effect (5.6) 5.6 (5.3)
Foreign tax rate (benefit) 0.1 (6.6) 0.2
Nondeductible items 1.0 4.8 0.7
Benefit of foreign net operating loss (0.3) (52.2) (0.5)
Loss producing no current tax benefit 39.8 22.6 38.9
-----------------------------
Effective tax rate 0.0% 9.2% 0.0%
-----------------------------
-----------------------------
The components of deferred income taxes included in the consolidated
balance sheets at March 31 are as follows (in thousands):
[Download Table]
1998 1997
-------------------
Deferred income tax assets:
Net operating loss carryforwards $45,860 $33,216
Research and experimentation tax credits 4,519 3,696
Financial statement reserves and accruals not
recognized for income tax purposes 3,724 4,602
Capitalized research and experimentation costs 343 674
Other 2,998 1,089
-------------------
57,444 43,277
Valuation allowance (57,444) (43,277)
-------------------
Net deferred income tax assets $ - $ -
-------------------
-------------------
Due to the uncertainty surrounding the realization of the favorable tax
attributes in future years, the Company has recorded a valuation allowance to
the extent of its deferred tax assets.
At March 31, 1998, the Company had federal, state and foreign net
operating loss carryforwards for income tax purposes of $116,291,000,
$53,509,000 and $1,731,000, respectively, which expire at various dates from
1998 through 2013.
At March 31, 1998, the Company had federal and state research and
experimentation tax credits for income tax purposes of $3,597,000 and $922,000,
respectively, which expire at various dates from 2003 through 2013.
43
The Company's ability to use its net operating loss carryforwards and
credits to offset future taxable income is subject to restrictions attributable
to equity transactions that result in changes in ownership as defined by the
Internal Revenue Code.
7. CREDIT FACILITY
The Company has an overdraft/line of credit facility in the UK that is
based upon qualifying receivables and certain other bank requirements for
amounts up to a maximum credit limit of 1,850,000 pounds sterling (approximately
$3.1 million at March 31, 1998). This facility bears interest at the rate of
1.5% over the bank's base rate, expires June 30, 1998 and is collateralized by
substantially all the assets of MicroProse Ltd. As of March 31, 1998, total
amount available based upon qualifying assets totaled approximately $2.0 million
at 7.25%, however, the Company had not utilized any part of this facility.
8. OTHER CURRENT LIABILITIES
The components of other current liabilities at March 31 consist of the
following (in thousands):
[Download Table]
1998 1997
------------------
Accrued customer promotion and deferred revenue $ 805 $1,279
Accrued accounts payable--other 1,003 3,000
Other 3,393 2,843
------------------
$5,201 $7,122
------------------
------------------
9. LONG-TERM DEBT
On October 2, 1995, the Company completed a private offering of $50.0
million face value Convertible Subordinated Notes (the "Notes") pursuant to Rule
144A of the Securities Act of 1933. The Notes, which bear interest at the rate
of 6.5 percent per annum, will mature on September 15, 2002, and are convertible
into shares of the Company's common stock at any time after 60 days following
the latest date of original issuance at a conversion price of $79.20 per share,
subject to adjustment based upon the occurrence of certain events. The Notes may
be redeemed at the option of the Company subsequent to September 17, 1998, in
whole or in part, at various declining redemption prices together with accrued
interest thereon. The Notes may also be redeemed at the option of the holder at
100% upon the occurrence of certain events. Net proceeds to the Company were
approximately $48.0 million, after associated issuance costs of approximately
$2.0 million, which are being amortized over the term of the Notes.
In June 1996, the Company issued 750,000 shares of Series B and 1,168,860
shares of Series B-1 convertible preferred stock in exchange for subordinated
notes with a face value of approximately $14.9 million. An extraordinary gain
of approximately $2.7 million was realized on the retirement of the long-term
debt.
In July 1996, the Company repurchased subordinated notes with a face value
of $4.0 million for approximately $2.9 million. An extraordinary gain of
approximately $0.9 million was realized on the retirement of the long-term debt.
In June 1996, the Company assumed debt totaling approximately $2.0 million
related to the acquisition of real property and equipment from Leisuresoft
(Note 3). These loans, which are denominated in German Deutsche Marks, bear
interest at fixed rates of 6.15 percent and 7.55 percent per annum, are payable
44
in monthly installments, and expire in September 1998 and October 2009,
respectively. The loans are collateralized by the assets acquired and certain
other assets of the Company. The aggregate loan payments for the five years
after March 31, 1998 are $237,000, $179,000, $179,000, $179,000, $179,000 and
$1,197,000 thereafter, respectively.
10. REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
SUBSEQUENT COMMON STOCK SPLIT:
At a special meeting on May 11, 1998, subsequent to year-end, the
stockholders approved a one for five reverse stock split whereby each five
shares of the Company's presently outstanding common stock were automatically
converted into one share (the "Reverse Stock Split"). Common stock and
additional paid-in capital as of March 31, 1998 have been restated to reflect
this reverse split. Par value will remain unchanged at $.001 per share. The
number of common shares issued at March 31, 1998, after giving effect to the
split, was 5,753,800 (28,769,000 shares issued before the Reverse Stock Split).
The effect of the Reverse Stock Split has been retroactively reflected as
of March 31, 1998 in the consolidated balance sheet and statement of
stockholders' equity (deficit), but activity for 1998 and prior periods was not
restated in those statements. All references to the number of common shares
and per share amounts have been restated as appropriate to reflect the effect
of the reverse split for all periods presented.
PREFERRED STOCK:
The Company has authorized 9,000,000 shares of preferred stock, $0.001 par
value, of which 4,000,000 shares are designated Series A redeemable preferred
stock (Series A Stock). At March 31, 1998 and 1997, there were 2,000,000 and
4,000,000 shares of Series A Stock outstanding, respectively. The Series A
Stock accrues dividends at an annual rate of 7% and at March 31, 1998 and 1997
is convertible into 19,608 and 39,216 shares of common stock, respectively.
Preferred stockholders receive one vote for each common share into which their
preferred shares are convertible. The Series A Stock has a liquidation
preference of $1.00 per share plus all accumulated but unpaid dividends and is
redeemable for $1.00 per share plus all accumulated but unpaid dividends (i) at
any time by the Company, (ii) commencing on September 24, 1997, for up to 50%
of the Series A Stock, upon written demand of holders of the majority of Series
A Stock, or (iii) in its entirety at any time on or after September 24, 1998,
within 180 days of receipt of written demand from the majority of Series A
Stock holders.
During December 31, 1997, the Company redeemed 2,000,000 shares of Series
A Stock for approximately $2.7 million. The excess of the carrying value
immediately prior to the redemption (approximately $2.9 million) over the
redemption amount was credited to additional paid-in capital in the
accompanying consolidated balance sheet. The remaining 2,000,000 shares of
Series A Stock outstanding will become redeemable in September 1998.
Shares of Series B and Series B-1 preferred stock are convertible into an
equivalent number of common shares. Dividends on the Series B-1 preferred
shares are non-cumulative and non-accruing, and shall be paid only at such time
and such rate as determined by the Board of Directors. As of March 31, 1998, no
dividends had been declared. Subject to the liquidation preference of the
Series A preferred shares, the Series B-1 convertible preferred shares have a
liquidation preference of $7.57 per share, plus all declared but unpaid
dividends. In September 1997, all remaining outstanding shares of Series B-1
preferred stock (3,201) were converted into an equivalent number of common
shares. Cumulatively, as of March 31, 1998, all shares of Series B and Series
B-1 preferred stock had been converted into common shares.
45
COMMON STOCK WARRANTS:
In fiscal 1993, the Company issued certain noteholders of Paragon
Software, a former subsidiary of MicroProse, 4,080 seven-year warrants to
purchase common stock at $69.40 per share. The warrants expire on July 13,
1999, and none of the warrants have been exercised.
STOCK OPTION PLANS:
The Company has reserved 947,638 shares of common stock for issuance
of options to employees, directors and consultants under four stock option
plans. All share amounts and exercise prices have been restated for the
effects of the one for five reverse stock split.
In March 1993, the Company adopted the 1992 Stock Option Plan (the "1992
Plan"). Options under this plan are immediately exercisable. Any shares
issued upon the exercise of options under the 1992 Plan, however, are subject
to repurchase by the Company at the original exercise price, upon the
optionee's termination of employment prior to vesting in such shares. As of
March 31, 1998, options to purchase 10,194 shares of common stock were
outstanding under the 1992 Plan. No additional options may be granted under
the 1992 Plan.
The Company maintains the 1994 Stock Option Plan (the "1994 Plan").
Options granted under the 1994 Plan may be designated either as incentive
stock options, or as non-statutory stock options, and generally remain
exercisable over a maximum of seven to 10 years from the grant date. Options
granted under the 1994 Plan generally vest ratably over 48 to 60 months
beginning six months after the vesting commencement date.
The Company maintains the 1996 Stock Option Plan (the "1996 Plan").
Under the terms of the 1996 Plan, non-statutory options may be granted which
generally vest ratably over 36 to 60 months beginning six months after the
vesting commencement date and which remain exercisable over a maximum of
seven to 10 years. In fiscal 1998, the Company adopted the 1998 Non-statutory
Stock Option Plan (the "1998 Plan"). Under the 1998 Plan, non-statutory
options may be granted to new employees as an essential inducement in
connection with their employment. Such non-statutory options generally vest
ratably over 36-48 months beginning six months after the vesting commencement
date and remain exercisable over a maximum of 10 years.
Option activity under these plans during fiscal 1998, 1997 and 1996, was as
follows:
[Enlarge/Download Table]
OPTIONS OUTSTANDING
--------------------------------
WEIGHTED AVERAGE
AVAILABLE AGGREGATE EXERCISE PRICE
FOR GRANT NUMBER PER SHARE
---------------------------------------------
Balance at March 31, 1995 67,780 587,726 $ 37.60
Increase in options available for grant 300,000 - -
Granted (362,240) 362,240 57.65
Exercised - (107,211) 24.50
Canceled 125,900 (125,900) 40.45
Retired (22,362) - -
---------------------------------------------
Balance at March 31, 1996 109,078 716,855 49.20
Granted (627,483) 627,483 29.65
Exercised - (34,641) 19.80
Canceled 746,560 (746,560) 51.00
Retired (10,844) - -
---------------------------------------------
Balance at March 31, 1997 217,311 563,137 $ 26.89
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[Download Table]
Increase in options available for grant 220,000 - -
Granted (326,790) 326,790 14.82
Exercised - (52,179) 23.55
Canceled 114,649 (114,649) 25.31
Retired (631) - -
----------------------------------------
Balance at March 31, 1998 224,539 723,099 $21.93
----------------------------------------
----------------------------------------
At March 31, 1998, 1997, and 1996, options to purchase 272,937, 220,898
and 193,920 shares were exercisable at weighted average prices of $27.39,
$27.05 and $44.06, respectively. The weighted average fair values of stock
options granted during fiscal 1998, 1997 and 1996, were $11.80, $14.25, and
$27.90, respectively.
In August 1995, the Company entered into an employment agreement with
the Company's Chief Executive Officer whereby options to purchase 100,000
shares of common stock were granted. Under the terms of that agreement, the
Company may be obligated to pay certain compensation to the Chief Executive
Officer, contingent upon his continued employment through March 31, 1999, and
the market price of the Company's common stock as of that date. As of March
31, 1998, the Company has accrued a liability of $2,339,000 related to this
agreement.
In June 1996, the Board of Directors of the Company approved the
cancellation of the majority of outstanding stock options with an exercise
price ranging from $32.50 to $95.65 per share and the re-grant of options to
purchase an equivalent number of shares at $26.875 per share. A total of
385,482 options were canceled and re-granted.
The following table summarizes information with respect to stock options
outstanding at March 31, 1998:
[Enlarge/Download Table]
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE PRICE NUMBER EXERCISE PRICE
RANGE OF EXERCISE PRICES OF SHARES LIFE (IN YEARS) PER SHARE OF SHARES PER SHARE
-------------------------------------------------------------------------------- -------------------------------
$1.95-$20.00 215,735 9.01 $ 9.68 8,740 $ 2.54
21.00 - 26.00 118,548 8.11 23.05 28,495 22.97
26.88 323,697 7.05 26.88 204,950 26.88
27.00 - 33.00 44,318 8.06 29.08 13,044 29.41
35.00 - 66.25 20,801 5.13 50.26 17,708 51.28
-------------------------------------------------------------------------------- -------------------------------
$1.95-$66.25 723,099 7.81 $21.93 272,937 $27.39
-------------------------------------------------------------------------------- -------------------------------
-------------------------------------------------------------------------------- -------------------------------
PRO FORMA INFORMATION:
The Company has adopted the disclosure provisions of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. The Company, however, continues to
apply APB Opinion
47
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES in accounting for its option
plans.
The fair value of options and ESPP shares granted in fiscal 1998, 1997
and 1996, has been estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions:
[Enlarge/Download Table]
EMPLOYEE
STOCK OPTIONS ESPP SHARES
----------------------------------------------------------
1998 1997 1996 1998 1997 1996
----------------------------------------------------------
Expected volatility rate 110% 60% 60% 110% 60% 60%
Expected life (in years) 4.0 4.0 4.0 0.5 0.5 0.5
Expected forfeiture rate 35% 50% 50% - - -
Average risk-free interest rates 6.0% 6.4% 5.9% 5.5% 5.4% 5.4%
For purposes of pro forma disclosures, the estimated fair value of the
options and stock participation shares is amortized to expense over the
related vesting period. The pro forma effects on net income (loss) and per
share data are as follows (in thousands, except per share data):
[Download Table]
1998 1997 1996
-----------------------------------
Pro forma net income (loss) $(39,405) $6,005 $(40,811)
Pro forma basic earnings (loss) per share (6.96) 1.08 (8.69)
Pro forma diluted earnings (loss) per share (6.96) 1.03 (8.69)
The Black-Scholes option valuation model requires the input of highly
subjective assumptions including the expected stock price volatility. As
such, changes in the subjective assumptions can materially affect the fair
value estimates and related impact on pro forma net income (loss) and per
share data.
The above pro forma effects on income (loss) may not be representative
of the effects on net income (loss) for future years as option grants
typically vest over several years and additional options are generally
granted each year.
EMPLOYEE STOCK PURCHASE PLAN:
The Company maintains an Employee Stock Purchase Plan (the "ESPP") under
which employees may purchase shares of the Company's common stock at 85% of
the lower of the fair market value of the common stock on either the first or
last day of a six-month offering period. A total of 40,988, 21,784 and 13,612
shares of the Company's common stock were issued under the ESPP in fiscal
1998, 1997 and 1996, respectively.
STOCKHOLDERS' RIGHTS PLAN:
In February 1996, the Board of Directors adopted a Stockholders' Rights Plan
and declared a dividend of five preferred stock Purchase Rights (the
"Rights") for each outstanding share of common stock. Such Rights only become
exercisable, or transferable apart from the common stock, 10 business days
after a person or affiliated group (an "Acquiring Person") acquires
beneficial ownership of, or commences a tender or exchange offer for, 15% or
more of the Company's common stock (with an exception up to 20% for existing
stockholders who have filed Reports on Form 13D or 13G to acquire a
"Triggering Position").
Each Right may then be exercised to acquire one share of the Company's
preferred stock at an exercise price of $35.00, subject to adjustment.
Thereafter, upon the occurrence of certain events, the Rights entitle holders
other than the Acquiring Person to acquire common stock having a value of
twice the exercise price of the Rights.
Alternatively, upon the occurrence of certain other events, the Rights
entitle holders other than the Acquiring Person to acquire common stock of
the Acquiring Person having a value of twice the exercise price of the Rights.
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The Rights may be redeemed by the Company at a redemption price of
$0.001 per Right at any time until the tenth business day following public
announcement that a Triggering Position has been acquired or 10 business days
after commencement of a tender or exchange offer. The Rights will expire on
February 26, 2006.
11. NET INCOME (Loss) PER SHARE
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted earnings
per share (EPS) is provided below. All references to the number of common
shares and per share amounts have been restated as appropriate to reflect the
effect of the one for five reverse split (see note 10). The reconciliations
for the years ended March 31 are as follows (in thousands, except per share
amounts):
[Download Table]
1998 1997 1996
---- ---- ----
Numerator - Basic and diluted EPS
Income (loss) before extraordinary item $(33,141) $4,441 $(39,841)
Preferred stock dividends (245) (280) (280)
-------- ------ --------
Income (loss) available to common
shareholders, before extraordinary item $(33,386) $4,161 $(40,121)
-------- ------ --------
Extraordinary item, net of tax effect - 3,547 -
-------- ------ --------
Net income (loss) available to common
shareholders $(33,386) $7,708 $(40,121)
-------- ------ --------
-------- ------ --------
Denominator - Basic EPS
Weighed average shares outstanding 5,697 5,300 4,727
-------- ------ --------
-------- ------ --------
Basic earnings per share:
Income (loss) before extraordinary item $(5.86) $0.79 $(8.49)
Extraordinary item, net of tax effect - $0.66 -
-------- ------ --------
Net income (loss) $(5.86) $1.45 $(8.49)
-------- ------ --------
-------- ------ --------
Denominator - Diluted EPS
Denominator - Basic EPS 5,697 5,300 4,727
Effect of dilutive securities:
Common stock options - 107 -
Convertible preferred stock - 148 -
-------- ------ --------
5,697 5,555 4,727
Diluted earnings per share:
Income (loss) before extraordinary item $(5.86) $0.75 $(8.49)
Extraordinary item, net of tax effect - $0.64 -
-------- ------ --------
Net income (loss) $(5.86) $1.39 $(8.49)
-------- ------ --------
-------- ------ --------
49
Options to purchase 723,099 and 716,855 shares of common stock were
outstanding for the years ended March 31, 1998 and 1996, respectively. These
options were not included in the calculations of diluted EPS because their
effect on reported losses would be anti-dilutive. Options to purchase 563,137
shares of common stock were outstanding for the year ended March 31, 1997.
Weighted average options to purchase 158,234 common shares were not included
in the calculations of diluted EPS for fiscal 1997 because the options'
exercise price was greater than the average fair market price of the common
shares for the period. Preferred stock dividends relate to Series A
convertible preferred stock. These shares were not included in diluted EPS
as their effect would be antidilutive for fiscal 1998 and 1996.
12. COMMITMENTS AND CONTINGENCIES
LEASES:
The Company leases office and warehouse space under non-cancelable
operating leases expiring at various dates through the year 2004. Certain of
the Company's leases provide for free rent periods and scheduled rent
increases. Under such leases, rent expense is recognized on a straight-line
basis over the term of the related leases. The difference between rent
expense on a straight-line basis and cash payments for rent is accounted for
as deferred rent. Rent expense was $2,267,000, $1,987,000, and $1,919,000 for
fiscal years 1998, 1997 and 1996, respectively.
At March 31, 1998, future minimum lease payments were as follows (in
thousands):
[Download Table]
YEAR ENDING MARCH 31,
1999 $2,031
2000 1,800
2001 1,662
2002 1,628
2003 814
Thereafter 292
------
$8,227
------
------
UNITED SOFTWARE GMBH:
In March 1993, MicroProse acquired United Software, GmbH ("United"). In
September 1993, MicroProse became aware of several non-disclosed liabilities
of United, including a claim by a German bank of approximately $2,000,000.
MicroProse also became aware of the deterioration of the financial condition
of the seller and the seller's parent (which had guaranteed the seller's
obligations under the United purchase agreement) and by October 29, 1993,
determined that the seller and its parent were incapable of complying with
the guarantees and warranties included in the purchase agreement. Therefore,
primarily as a result of the seller's nondisclosure of the bank debt
described above and the misrepresentations as to the financial condition of
the seller and its parent, MicroProse decided to rescind the agreement as
provided under German law.
On October 29, 1993, MicroProse notified the seller and its parent of
the rescission of the March 1993 agreement. This action resulted in a charge
of approximately $4,900,000, which was recorded in the quarter ended
September 30, 1993. This charge consisted primarily of the original purchase
price, asset write-offs of approximately $1.8 million and rescission-related
liabilities of approximately $1.6 million. United and its parent company are
now in receivership. The Company has maintained an accounting reserve in
order to meet any remaining liabilities under German law as a result of the
receivership proceeding.
On March 18, 1998, the Company received a demand from the receiver in
the insolvency proceeding for payment of 1,950,000.00 DM, based on the
receiver's position that MicroProse is liable for contribution of share
capital to the insolvent company. On approximately May 28, 1998, the
Company's U.K. subsidiary was
50
served with a legal action by the receiver seeking enforcement of the demand.
The Company is represented by German counsel and intends to defend itself
vigorously in this action.
NASDAQ LISTING/REVERSE SPLIT:
The Company was notified in February 1998 by the Nasdaq Stock Market
("Nasdaq") that the Company was no longer in compliance with the net tangible
assets requirement or the alternative minimum bid price requirement for
continued listing on the Nasdaq National Market. Pursuant to National
Association of Securities Dealers Marketplace Rules, the Company was given a
period of 90 days to regain compliance with the minimum bid price
requirement, which calls for a minimum common stock bid price of $5.00 per
share. On May 11, 1998, the Company's shareholders approved a one for five
reverse stock split whereby each five shares of the Company's outstanding
common stock were automatically converted into one share (the Reverse Stock
Split, note 10). During the fourth quarter of fiscal 1998, prior to the
Reverse Stock Split, the Company's common stock traded between $2.75 and
$1.50 per share. On May 12, 1998, following the Reverse Stock Split, the
Company's common stock opened at a price of $9.38 per share. Subsequently,
the Company's common stock price continued to trade at a price above the
$5.00 minimum bid price for a period of 18 days.
On May 19, 1998, and June 3, 1998, the Company received notice from
Nasdaq that the Company was not in compliance with either the market
capitalization requirement or the minimum bid price requirement for continued
listing on the Nasdaq National Market. The Company is in the process of
responding to Nasdaq with respect to both of these issues and is evaluating
plans for compliance with the requirements for continued listing on the
Nasdaq National Market.
There can be no assurance that the Company's minimum bid price or market
capitalization will be sufficient to allow the Company to comply with the
requirements for continued listing on the Nasdaq National Market. If the
Company is unable to maintain compliance with such requirements, the Company
may be able to qualify for listing under the Nasdaq SmallCap Market.
However, at the present time, the Company does not meet all of the
requirements for listing on the Nasdaq SmallCap Market. If for any reason
the Company is unable to achieve and maintain compliance with the Nasdaq
SmallCap Market listing requirements and is delisted from both the Nasdaq
National Market and the Nasdaq SmallCap Market, the holders of the Company's
6.5% Convertible Subordinated Notes Due 2002 (the "Notes") would be entitled
to require the Company, within 55 days, to repurchase all or any portion of
such holders' notes for cash at a price equal to the principal amount plus
accrued interest. In such event, the Company's business, results of
operations and financial condition would be materially and adversely affected.
13. DEFINED CONTRIBUTION PLANS
The Company has defined contribution plans (the "Plans") in the United
States pursuant to Section 401(a) of the Internal Revenue Code (the "Code")
and in Europe. All eligible full and part-time employees of the Company who
meet certain age requirements may participate in the Plans. Participants may
contribute a percentage of their pre-tax compensation, but not in excess of
the maximum allowable under the Code. The Plans allow participants to make
contributions and provide for a matching contribution by the Company as a
percentage of employee contributions.
The Company's matching contributions under the Plans were $503,000,
$327,000 and $820,000, in fiscal 1998, 1997 and 1996, respectively. Matching
contributions vest based on the participant's length of service. In addition,
the Company may make profit-sharing contributions at the discretion of the
Board of Directors. There were no discretionary contributions in the
three-year period ended March 31, 1998. All amounts contributed are deposited
in a trust fund which is administered by the Company under the custody of a
national fund service company. The Company has no other retirement or pension
programs.
51
14. OTHER INCOME (EXPENSE), NET
The components of other income (expense), net, for the years ended March
31 consist of the following (in thousands):
[Download Table]
1998 1997 1996
------------------------------------
Interest income $ 1,618 $ 1,797 $ 1,118
Interest expense (2,327) (2,631) (2,495)
Gain (loss) on the sale (write-down) of
investment (2,605) 1,895 -
Equity share of joint venture losses - - (1,074)
Other expense (220) (550) (1,866)
------------------------------------
$(3,534) $511 $(4,317)
------------------------------------
------------------------------------
15. SEGMENT INFORMATION
The Company operates in one business segment, as a developer, producer
and publisher of entertainment software. The Company's current operations
are located primarily in North America and Europe. Information regarding
geographic operations for the years ended March 31, 1998, 1997, and 1996 is
as follows (in thousands):
[Enlarge/Download Table]
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
1998 NORTH AMERICA EUROPE OTHER ELIMINATIONS TOTAL
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
Net revenue:
Customer $ 19,769 $39,892 $348 $ - $ 60,009
Intercompany 6,446 651 222 (7,319) -
------------------------------------------------------------
Total net revenue 26,215 40,543 570 (7,319) 60,009
------------------------------------------------------------
Operating income (loss) (28,364) (1,408) 189 - (29,583)
------------------------------------------------------------
------------------------------------------------------------
Identifiable assets 26,629 16,375 825 - 43,829
------------------------------------------------------------
------------------------------------------------------------
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
1997 NORTH AMERICA EUROPE OTHER ELIMINATIONS TOTAL
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
Net revenue:
Customer $36,522 $62,687 $1,044 $ - $100,253
Intercompany 13,629 1,338 - (14,967) -
------------------------------------------------------------
Total net revenue 50,151 64,025 1,044 (14,967) 100,253
------------------------------------------------------------
Operating income (loss) (4,445) 7,992 833 - 4,380
------------------------------------------------------------
------------------------------------------------------------
Identifiable assets 54,606 25,072 627 - 80,305
------------------------------------------------------------
------------------------------------------------------------
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
1996 NORTH AMERICA EUROPE OTHER ELIMINATIONS TOTAL
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
Net revenue:
Customer $ 30,351 $28,281 $1,062 $ - $ 59,694
Intercompany 4,837 2,054 - (6,891) -
------------------------------------------------------------
Total net revenue 35,188 30,335 1,062 (6,891) 59,694
------------------------------------------------------------
Operating loss (34,383) (356) (785) - (35,524)
------------------------------------------------------------
------------------------------------------------------------
Identifiable assets 53,147 12,260 515 - 65,922
------------------------------------------------------------
------------------------------------------------------------
52
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
MicroProse, Inc.:
We have audited the accompanying consolidated balance sheets of
MicroProse, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the three years in the period ended
March 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the 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. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
MicroProse, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended March 31, 1998, in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company's liquidity has been adversely affected by
continued losses from operations. In addition, continuation of operations is
dependent upon the availability of additional capital and the Company's
ability to generate increased revenues and improved gross margin on sales.
These issues raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ Coopers & Lybrand, L.L.P.
-----------------------------
COOPERS & LYBRAND, L.L.P.
San Jose, California
May 8, 1998
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT.ITEM 10. DIRECTORS AND
OFFICERS OF THE REGISTRANT.
The following table lists the names, ages and position of all executive
officers and directors of the Registrant. Executive officers serve at the
discretion of the Board of Directors.
[Download Table]
Name Age Position
------------------------ --- ------------------------------------
Gilman G. Louie 37 Chairman of the Board
David C. Costine 57 Director
Vinod Khosla 43 Director
Keith E. Schaefer 49 Director
Stephen M. Race 48 Director, Chief Executive Officer
Alden H. Andersen 48 Senior Vice President, Operations
Charles E. Balthaser 58 Senior Vice President, Studios
John M. Belchers 54 Chief Financial Officer
Tim P. Christian 43 Managing Director, European Sales &
Distribution
Jeffery J. Forestier 41 Senior Vice President, Sales
M. Kip Welch 37 Vice President, General Counsel,
Assistant Secretary
Robert D. Botch 46 Senior Vice President, Marketing
Derek W. McLeish 50 Senior Vice President, Business
Development
54
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is included under the caption
"Executive Compensation and Related Information" in the Company's Proxy
Statement for the 1998 Annual Meeting of Stockholders and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is included under the caption
"Ownership of Securities" in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the caption
"Certain Transactions" in the Company's Proxy Statement for the 1998 Annual
Meeting of Stockholders and is incorporated herein by reference.
55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) FINANCIAL STATEMENTS - See the Consolidated Financial Statements
beginning on page 32 of this Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULE - See the Financial Statement Schedule
at page 59 of this Form10-K. All
other schedules are omitted, since
the required information is not
present or is not present in amounts
sufficient to require submission of
the schedule, or because the
information required is included in
the Consolidated Financial
Statements and notes thereto.
(3) EXHIBITS - See Exhibit Index at page 61 of this Form 10-K.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
three months ended March 31, 1998.
(c) See Exhibit Index at page 61 of this Form 10-K.
(d) See the Consolidated Financial Statements beginning on page 32 and
Financial Statement Schedule at page 59 of this Form 10-K.
56
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 thereunto duly authorized.
MICROPROSE, INC.
By: /s/ Stephen M. Race
------------------------------
Stephen M. Race
CHIEF EXECUTIVE OFFICER AND DIRECTOR
/s/ John M. Belchers
------------------------------
John M. Belchers
CHIEF FINANCIAL OFFICER
/s/ Andrew A. Nimitz
------------------------------
Andrew A. Nimitz
VICE PRESIDENT, CORPORATE CONTROLLER
Date: June 26, 1998
57
PURSUANT TO THE REQUIREMENTS OF THE OF THE SECURITIES EXCHANGE ACT OF
1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
[Download Table]
Signature Title Date
--------- ----- ----
/s/ Stephen M. Race Chief Executive Officer, June 26, 1998
--------------------- and Director
(Stephen M. Race)
/s/ John M. Belchers Chief Financial Officer June 26, 1998
---------------------
(John M. Belchers)
GILMAN G. LOUIE* Chairman of the Board of Directors June 26, 1998
---------------------
(Gilman G. Louie)
DAVID C. COSTINE* Director June 26, 1998
---------------------
(David C. Costine)
VINOD KHOSLA* Director June 26, 1998
---------------------
(Vinod Khosla)
KEITH E. SCHAEFER* Director June 26, 1998
---------------------
(Keith Schaefer)
* By:/s/ Stephen M. Race
-----------------------------------
(Stephen M. Race, Attorney-in-Fact)
58
SCHEDULE II
MICROPROSE, INC.
Valuation and Qualifying Accounts
(in thousands)
ALLOWANCE FOR SALES RETURNS AND DOUBTFUL ACCOUNTS:
[Download Table]
Balance at Balance at
Beginning Charged to End
FISCAL YEAR ENDED: of Period Expense Deductions of Period
------------------------- ---------- ----------
March 31, 1996 $9,394 $20,821 $21,036 $9,179
March 31, 1997 9,179 14,604 17,215 6,568
March 31, 1998 6,568 12,673 14,164 5,077
59
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
MicroProse, Inc.
Our report on the consolidated financial statements of MicroProse, Inc. and
subsidiaries is included on page 53 of this Form 10-K. In connection with
our audits of such financial statements, we have also audited the related
financial statement schedule on page 59 of this Form 10-K.
In our opinion, the financial schedule referred to above when considered in
relation to the basic financial statements, taken as a whole, present fairly,
in all material respects, the information required to be included herein.
/s/ Coopers & Lybrand L.L.P.
------------------------------
COOPERS & LYBRAND L.L.P.
San Jose, California
May 8, 1998
60
INDEX TO FORM 10-K EXHIBITS
[Enlarge/Download Table]
Exhibit Page
Number Description No.
------- ------------------------------------------------------------------ ------
2.1 Agreement and Plan of Reorganization, dated as of July 14,
1993, as amended as of November 15, 1993, by and among MicroProse,
Inc., MicroProse Merger Sub, Inc. and Spectrum HoloByte, Inc.
(incorporated by reference to Exhibit 2 of MicroProse, Inc.'s
Registration Statement on Form S-4, File No. 33-72216, filed on
November 29, 1993) +
2.2 Amendment No. 1 to Amended and Restated Agreement and Plan of
Reorganization, dated November 28, 1993 +
2.3 Agreement and Plan of Reorganization, dated as of September 14,
1992, by and between Spectrum HoloByte, Inc. and Sphere, Inc. +
2.4 Stock Purchase and Exchange Agreement by and among Spectrum
HoloByte, Inc., SimTex Software Corporation, Stephen Barcia
and Maria Barcia, dated as of June 6, 1995 (incorporated by
reference to Exhibit 2.1 of Spectrum HoloByte, Inc.'s Form 8-K
filed on June 27, 1995) +
3.1 Certificate of Incorporation of the Registrant +
3.2 Amended Bylaws of Registrant +
4.1 Specimen Common Stock Certificate of the Registrant +
4.2 Warrants issuable to the Grotech Investors and Corporate Venture
Partners, L.P., dated as of October 17, 1991 +
4.3 Form of Warrant issuable to Paragron Investors, dated July 1992 +
4.4 Amended and Restated Investor Rights Agreement, dated December 8, 1993 +
4.5 Form of Warrant, issued to Ince & Co. (incorporated by reference
to Exhibit 4.8 of Spectrum HoloByte, Inc.'s Form 10-Q filed on
December 31,1994) +
10.1 Sterling Overdraft and Barclays Tradeline Facilities between
MicroProse Limited and Barclays Bank PLC, dated July 2, 1993
(incorporated by reference to Exhibit of same number of MicroProse,
Inc.'s Annual Report on Form 10-K filed on July 14, 1993) +
10.2 Sterling Overdraft and Barclays Tradeline Facilities between
MicroProse Limited and Barclays Bank PLC, dated July 2,
1993, as amended +
10.3 Agreement between MicroProse, Inc. and WordStar International
Corporation, dated May 23, 1991 (incorporated by reference to
Exhibit 10.6 of MicroProse, Inc.'s Registration Statement on
Form S-1, File No. 33-42238, filed on August 13, 1991) +
10.4 MicroProse, Inc. 1991 Employee Stock Option Plan, as amended and
restated +
10.5 Lease Agreement between MicroProse, Inc. and Lakefront Limited
Partnership, dated July 9, 1987, as amended (incorporated by
reference to Exhibit 10.11 of MicroProse, Inc.'s Registration
Statement on Form S-1, File No. 33-42238, filed on August 13, 1991) +
10.6 Second Amendment to Lease Agreement between MicroProse, Inc. and
Lakefront Limited Partnership III, dated June 12, 1992 (incorporated
by reference to Exhibit 10.14 of MicroProse, Inc.'s Annual Report on
Form 10-K filed on July 14, 1993) +
10.7 Lease Agreement between MicroProse, Inc. and Saft America, Inc.,
dated March 19, 1991 (incorporated by reference to Exhibit 10.12 of
MicroProse, Inc.'s Registration Statement on Form S-1,
File No. 33-42238, filed on August 13, 1991) +
61
[Download Table]
Exhibit Page
Number Description No.
------- ------------------------------------------------------------------ ------
10.8 Lease Agreement between Ashpalm PLC and MicroProse Unlimited,
dated June 9, 1993 (incorporated by reference to Exhibit 10.16 of
MicroProse, Inc.'s Annual Report on Form 10-K filed on July 14,
1993) +
10.9 Lease Agreement by and between MicroProse Limited and ARC Limited,
dated September 25, 1992 (incorporated by reference to Exhibit
10.17 of MicroProse, Inc.'s Annual Report on Form 10-K filed on
July 14, 1993) +
10.10 Underlease Agreement between MicroProse Limited and London and
Metropolitan Investments Limited, dated May 11, 1993
(incorporated by reference to Exhibit 10.18 of MicroProse, Inc.'s
Annual Report on Form 10-K filed on July 14, 1993) +
10.11 Consulting and Product Development Agreement between MicroProse,
Inc. and Sidney K. Meier, dated August 12, 1991 (incorporated by
reference to Exhibit 10.17 of MicroProse, Inc.'s Registration
Statement on Form S-1, File No. 33-42238, filed on August 13, 1991) +
10.12 Option Agreement and Irrevocable Proxy by and among Spectrum
HoloByte, Inc., John W. Stealey, Sr. and MicroProse, Inc.
(incorporated by reference to Exhibit 99.2 of MicroProse, Inc.'s
Report on Form 8-K filed on July 7, 1993) +
10.13 Consulting Services Agreement between MicroProse, Inc. and John W.
Stealey, Sr., dated June 22, 1993 (incorporated by reference to
Exhibit 10.38 of MicroProse, Inc.'s Annual Report on Form 10-K
filed on July 14, 199 +
10.14 Master Lease Agreement between General Electric Capital Corporation
and MicroProse, Inc., dated December 31, 1992 (incorporated by
reference to Exhibit 10.41 of MicroProse, Inc.'s Annual Report on
Form 10-K filed on July 14, 1993) +
10.15 Lease Agreement between Ashpalm PLC and MicroProse Unlimited, dated
August 8, 1989 (incorporated by reference to Exhibit 10.13 to
MicroProse, Inc.'s Registration Statement on Form S-1, File No.
33042238, filed on August 13, 1991) +
10.16 Lease Agreement between Paragon Alameda Gateway Associates, Ltd.
and Sphere, Inc., dated May 5, 1992 +
10.17 Underlease Agreement between MicroProse Limited and Thamsedown
Computer Supplies Limited, dated 1993 +
10.18 Merchandising License Agreement between Paramount Pictures
Corporation and Sphere, Inc. dated October 1, 1991 +*
10.19 License Agreement between V/O Electronorgtechnica, Moscow and
Sphere, Inc., dated June 1, 1990, and all amendments thereto +*
10.20 Super Tetris License Agreement between A/O Elorg and Sphere,
Inc., dated September 1, 1991 +*
10.21 Master Lease Agreement between General Electric Corporation and
MicroProse Software, Inc., dated December 31, 1992 (incorporated
by reference to Exhibit 10.44 to MicroProse, Inc.'s Annual
Report on Form 10-K filed on July 14, 1993) +
10.22 First Amendment to Lease between Paragon Alameda Gateway
Associates, Ltd. and Sphere, Inc., dated July 28, 1992 +
10.23 Master Lease Agreement between Comdisco, Inc. and Spectrum
HoloByte, Inc., dated December 16, 1992 +
62
[Download Table]
Exhibit Page
Number Description No.
------- ------------------------------------------------------------------ ------
10.24 Security and Loan Agreement among Spectrum HoloByte, Inc.,
MicroProse Software, Inc. and Imperial Bank, dated as of
December 30, 1993 +
10.25 Security and Loan Agreement among Spectrum HoloByte, Inc.,
MicroProse Software, Inc. and Imperial Bank, dated as of
December 30, 1993, as amended (incorporated by reference to
Exhibit 10.89 and 10.90 of Spectrum HoloByte, Inc.'s Form 10-Q
filed on December 31, 1994) +
10.26 Spectrum HoloByte, Inc. 1992 Stock Option Plan +
10.27 MicroProse, Inc. 1994 Employee Stock Purchase Plan +
10.28 401(k) Plan of the Company +
10.29 Form of Indemnification Agreement between the Company
and each of its officers and directors +
10.30 Amended and Restated Employment and Consulting Agreement between
Patrick S. Feely and the registrant, dated December 13, 1994
(incorporated by reference to Exhibit 10.90 of Spectrum HoloByte,
Inc.'s Form 10-Q filed on December 31, 1994) +
16.1 Letter from Ernst & Young regarding change in certifying accountant
(incorporated by reference to Exhibit 7(c)(3) of the Company's
Amendment No. 2 to Form 8-K filed on March 22, 1994) +
21.1 Subsidiaries of Company
23.1 Consent of Coopers & Lybrand L.L.P.
27.1 Statement Re: Financial Data Schedule
27.2 Statement Re: Amended and Restated Financial Data Schedule
27.3 Statement Re: Amended and Restated Financial Data Schedule
+ Incorporated by reference to an exhibit to the Company's Registration
Statement on Form S-1 (Registration No. 33-75408), as amended.
* Confidential treatment granted as to certain portions of these
exhibits.
63
Dates Referenced Herein and Documents Incorporated by Reference
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