Microprose Inc/DE – ‘10-Q’ for 12/31/97

As of:  Wednesday, 2/11/98   ·   For:  12/31/97   ·   Accession #:  1047469-98-4981   ·   File #:  0-19463

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Quarterly Report   —   Form 10-Q
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Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                      22    145K 
 2: EX-27.1     Financial Data Schedule (Pre-XBRL)                     2      7K 

10-Q   —   Quarterly Report
Document Table of Contents

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    SECURITIES AND EXCHANGE COMMISSION

   Washington, D.C.  20549

   _____________________

   FORM 10-Q

    QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
    OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended: December 31, 1997         Commission File Number:  0-19463   
-----------------                         

    MICROPROSE, INC.
    ----------------
    Exact Name of registrant as specified in its charter

Delaware                                                          52-1728656    
---------------------------------               ----------------------------    
(State or other jurisdiction of                 (IRS Employer Identification    
Incorporation or organization)                                       Number)    

2490 Mariner Square Loop, Suite 100, Alameda, CA                      94501     
------------------------------------------------                 ----------     
(Address of Principal Executive Offices)                         (Zip Code)     

 (510)864-4440
     -----------------------------------------------------
    Registrant's telephone number, including area code

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                                                                    
---      ---                                                            

    28,631,196 shares of Common Stock were outstanding as of January 30, 1998.

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    MICROPROSE, INC.

   TABLE OF CONTENTS

                                                                        Page
                                                                        ----

PART I - FINANCIAL INFORMATION                                        

Item 1.   Consolidated Financial Statements                           

Consolidated Balance Sheets at December 31 and    
              March 31, 1997                                             3

     Consolidated Statements of Operations for the three and
              nine months ended December 31, 1997 and 1996               4

Consolidated Statements of Cash Flows for the nine
              months ended December 31, 1997 and 1996                    5

            Notes to Consolidated Financial Statements                   6

Item 2.   Management's Discussion and Analysis of                     
            Financial Condition and Results of Operations                9

PART II - OTHER INFORMATION                                           

  Item 1.   Legal Proceedings                                           20

  Item 6.   Exhibits and Reports on Form 8-K                            20

  Signatures                                                            22

  Exhibits                                                              23

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    MICROPROSE, INC.

   CONSOLIDATED BALANCE SHEETS
    (In thousands, except per share amounts)

                                                        [Enlarge/Download Table]

                                                                                December 31,  March 31, 
                                                                                   1997         1997    
                                                                                ------------  --------- 
                                                                                 (UNAUDITED)            
                                                                                                        
Assets                                                                                                  
  Current assets:                                                                                       
     Cash and cash equivalents                                                    $  24,130   $  47,110 
     Accounts receivable, less allowances of $6,542 and $6,568 at December 31                           
       and March 31, 1997, respectively                                               8,955       7,891 
     Inventories                                                                      1,995       4,042 
     Prepaid royalties                                                                7,097       2,139 
     Other current assets                                                             2,055       1,958 
                                                                                  ---------   --------- 
        Total current assets                                                         44,232      63,140 
  Property, plant and equipment, net                                                  7,955       7,802 
  Goodwill, net                                                                         619         892 
  Investments                                                                         3,871       6,050 
  Other assets                                                                        2,920       2,421 
                                                                                  ---------   --------- 
                                                                                  $  59,597   $  80,305 
                                                                                  ---------   --------- 
                                                                                  ---------   --------- 
Liabilities, Redeemable Preferred Stock and Stockholders' Equity                                        
  Current liabilities:                                                                                  
     Accounts payable                                                              $  6,464    $  3,508 
     Salaries, wages and related accruals                                             4,535       6,337 
     Royalties payable                                                                1,330       1,840 
     Current portion of redeemable preferred stock                                    2,940           - 
     Other current liabilities                                                        8,271       7,122 
                                                                                  ---------   --------- 
        Total current liabilities                                                    23,540      18,807 

  Other liabilities                                                                   1,266       1,280 
  Long-term debt                                                                     32,408      32,739 
                                                                                  ---------   --------- 
        Total liabilities                                                            57,214      52,826 
                                                                                  ---------   --------- 
Redeemable preferred stock (net of current portion), $0.001 par value, 4,000                            
  shares designated Series A, outstanding shares and liquidation preference at                          
  December 31 and March 31, 1997, respectively, as follows:                                             
     Issued and outstanding: 2,000 and 4,000 shares                                                     
     Redemption and liquidation amount: $2,735 and $5,260                                --       5,881 

Stockholders' equity:                                                                                   
  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, 28,631 and 28,287                           
     shares issued and outstanding at December 31 and March 31, 1997,                                   
     respectively                                                                        30          29 
  Additional paid-in capital                                                        144,274     142,558 
  Accumulated deficit                                                              (141,438)   (120,468)
  Foreign currency translation adjustment                                              (483)       (521)
                                                                                  ---------   --------- 
     Total stockholders' equity                                                       2,383      21,598 
                                                                                  ---------   --------- 
                                                                                  $  59,597   $  80,305 
                                                                                  ---------   --------- 
                                                                                  ---------   --------- 


THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL       
STATEMENTS.                                                                     

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  MICROPROSE, INC.

   CONSOLIDATED STATEMENTS OF OPERATIONS
    (In thousands, except per share amounts)
   (UNAUDITED)

                                                        [Enlarge/Download Table]

                                                        THREE MONTHS ENDED          NINE MONTHS ENDED   
                                                           DECEMBER 31,                DECEMBER 31,     
                                                     ------------------------   ------------------------
                                                        1997           1996        1997         1996    
                                                     ----------     ----------  ---------     ----------
                                                                                                        
Net revenue                                          $  14,853      $  35,888   $  47,632     $  76,373 
Cost of revenue                                         10,211         13,888      23,994        28,973 
                                                     ---------      ---------   ---------     ----------
Gross profit                                             4,642         22,000      23,638        47,400 

Operating expenses:                                                                                     
    Sales and marketing                                  4,223          5,086      13,118        14,679 
    General and administrative                           3,240          4,508       8,391        11,952 
    Research and development                             8,106          5,959      20,174        17,862 
                                                     ---------      ---------   ---------     ----------
         Total operating expenses                       15,569         15,553      41,683        44,493 
                                                     ---------      ---------   ---------     ----------
Operating income (loss)                                (10,927)         6,447     (18,045)        2,907 

Interest and other income (expense), net                   (89)          (391)     (3,056)          797 
                                                     ---------      ---------   ---------     ----------
Income (loss) before provision (benefit) for income                                                     
  taxes and extraordinary item                         (11,016)         6,056     (21,101)        3,704 
Provision (benefit) for income taxes                      (131)           398        (131)          398 
                                                     ---------      ---------   ---------     ----------
Income (loss) before extraordinary item                (10,885)         5,658     (20,970)        3,306 
Extraordinary item, net of tax effect                       --             --          --         3,547 
                                                     ---------      ---------   ---------     ----------
Net income (loss)                                    $( 10,885)     $   5,658   $( 20,970)    $   6,853 
                                                     ---------      ---------   ---------     ----------
                                                     ---------      ---------   ---------     ----------

Basic income (loss) per share:                                                                          
  Income (loss) before extraordinary item            $   (0.38)     $    0.21   $   (0.75)    $    0.12 
  Extraordinary item, net of tax effect                     --             --          --          0.14 
                                                     ---------      ---------   ---------     ----------
  Net income (loss)                                  $   (0.38)     $    0.21   $   (0.75)    $    0.26 
                                                     ---------      ---------   ---------     ----------
                                                     ---------      ---------   ---------     ----------

Diluted income (loss) per share:                                                                        
  Income (loss) before extraordinary item            $   (0.38)     $    0.20   $   (0.75)    $    0.11 
  Extraordinary item, net of tax effect                     --             --          --          0.13 
                                                     ---------      ---------   ---------     ----------
  Net income (loss)                                  $   (0.38)     $    0.20   $   (0.75)    $    0.24 
                                                     ---------      ---------   ---------     ----------
                                                     ---------      ---------   ---------     ----------

Weighted average shares used to calculate:                                                              
  Basic income (loss) per share                         28,593         26,837      28,422        25,797 
  Diluted income (loss) per share                       28,593         28,470      28,422        27,281 


THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL       
STATEMENTS.                                                                     

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  MICROPROSE, INC.

   CONSOLIDATED STATEMENTS OF OPERATIONS
    (In thousands, except per share amounts)
   (UNAUDITED)

                                                        [Enlarge/Download Table]

                                                                                        Nine months ended       
                                                                                           December 31,         
                                                                               -------------------------------- 
                                                                                   1997                1996     
                                                                               -------------       ------------ 
                                                                                                                
CASH FLOWS FROM OPERATING ACTIVITIES:                                                                           
  Net income (loss)                                                               $  (20,970)        $    6,853 
  Adjustments to reconcile net income (loss) to net cash provided by                                            
  (used in) operating activities:                                                                               
    Depreciation and amortization                                                      2,568              3,291 
    Gain on the sale of investment in FASA                                                --             (1,895)
    Loss on the write-down of investment in TEN                                        2,605                 -- 
    Extraordinary gain on extinguishment of long-term debt                                --             (3,547)
    Changes in assets and liabilities:                                                                          
      Accounts receivable                                                               (865)            (3,907)
      Inventories                                                                      2,119               (967)
      Prepaid royalties                                                               (5,533)            (1,387)
      Other current assets                                                              (123)             1,106 
      Other assets                                                                        89                118 
      Accounts payable                                                                 2,869               (106)
      Salaries, wages and related accruals                                            (1,662)             2,417 
      Royalties payable                                                                 (530)             1,291 
      Other current liabilities                                                        1,070              3,472 
      Other                                                                              (98)               (36)
                                                                                  ----------         ---------- 
  Net cash provided by (used in) operating activities                                (18,461)             6,703 

Cash flows from investing activities:                                                                           
  Acquisitions of property, plant and equipment                                       (2,056)            (1,992)
  Acquisition of certain net assets of Leisuresoft GmbH, net of cash acquired             --               (447)
  Proceeds from sale of investment in FASA Interactive Technologies                       --                570 
  Equity investments                                                                    (426)              (570)
  Other                                                                                   --                145 
                                                                                  ----------         ---------- 
  Net cash used in investing activities                                               (2,482)            (2,294)

Cash flows from financing activities:                                                                           
  Extinguishment of debt                                                                  --             (2,959)
  Proceeds from issuance of common stock, net of issuance costs                        1,507             10,058 
  Repurchase of Series A preferred stock                                              (2,730)                -- 
  Repayments under notes, lines of credit and capital lease obligations                 (512)            (1,095)
                                                                                  ----------         ---------- 
  Net cash provided by (used in) financing activities                                 (1,735)             6,004 
Effect of exchange rate changes on cash                                                 (302)              (270)
                                                                                  ----------         ---------- 
Increase (decrease) in cash and cash equivalents                                     (22,980)            10,143 
Cash and cash equivalents at beginning of period                                      47,110             35,369 
                                                                                  ----------         ---------- 
Cash and cash equivalents at end of period                                        $   24,130         $   45,512 
                                                                                  ----------         ---------- 
                                                                                  ----------         ---------- 

Supplemental disclosures of cash flow information:                                                              
  Cash paid for interest                                                               1,012              1,148 
  Cash paid for income taxes                                                             296                 56 


THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL       
STATEMENTS.                                                                     

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MICROPROSE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 

NOTE 1.  BASIS OF PRESENTATION                                                  

The consolidated financial statements are the unaudited historical financial    
statements of MicroProse, Inc. (formerly Spectrum HoloByte, Inc.) and           
subsidiaries (the "Company") and reflect all adjustments (consisting only of    
normal recurring accruals) that, in the opinion of management, are necessary    
for a fair presentation of interim period results.  The consolidated            
financial statements should be read in conjunction with the financial           
statements and notes thereto included in the Company's Annual Report on Form    
10-K for the fiscal year ended March 31, 1997, as filed with the Securities     
and Exchange Commission on June 30, 1997.  The March 31, 1997 consolidated      
balance sheet included herein was derived from audited financial statements,    
but does not include all disclosures, including notes, required by generally    
accepted accounting principles.                                                 

The results of operations for the current interim period are not necessarily    
indicative of results to be expected for the entire current year or other       
future interim periods.                                                         

For the purposes of presentation, the Company has indicated its interim         
fiscal periods as ended on December 31, 1997 and 1996, and its prior fiscal     
year as ended on March 31, 1997.  As the Company's annual fiscal period is      
accounted for on a 52-53 week year, the interim period financial statements     
included herein represent interim results through December 28, 1997 and         
December 29, 1996, and the end of the prior fiscal year included herein         
represents amounts as of March 30, 1997.                                        

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.                                                           

NOTE 2.  TERMINATED MERGER                                                      

On October 5, 1997, the Company entered into a definitive 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 the 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 three   
and nine-month periods ended December 31, 1997, include the write-off of        
approximately $700,000 of capitalized costs associated with the proposed        
merger.                                                                         

NOTE 3.  INVENTORIES                                                            

Inventories are stated at the lower of cost or market on a first-in, first-out  
(FIFO) basis.  Inventories at December 31 and March 31, 1997 consisted of (IN   
THOUSANDS):                                                                     

                                                                [Download Table]

                          December 31,        March 31, 
                                  1997             1997 
                     -----------------   ---------------
                                                        
Raw materials             $   348             $   413   
Finished goods              1,647               3,629   
                     -----------------   ---------------
                          $ 1,995             $ 4,042   
                     -----------------   ---------------
                     -----------------   ---------------

NOTE 4.  INVESTMENT                                                             

In fiscal 1996 and 1997, the Company made minority equity investments of $2.6   
million in Total Entertainment Network, Inc. ("TEN").  These cost-basis         
investments were 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         

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MICROPROSE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 

temporary in nature. The charge was included in other income and expense in     
the accompanying consolidated statement of operations for the nine month        
period ended December 31, 1997.                                                 

NOTE 5.  FOREIGN EXCHANGE                                                       

The Company enters into foreign exchange forward contracts to hedge certain     
foreign currency denominated balances against changes in rates of exchange.     
These contracts, which require the Company to exchange foreign currencies,      
generally mature within three months.  Contracts that are inversely             
correlated to the risk of the hedged item and are designated and effective as   
a hedge of transactions for which a firm commitment has been attained qualify   
for hedge accounting.  Gains and losses on these contracts are deferred and     
recognized in income in the same period that the underlying transactions are    
settled.  If an instrument ceases to qualify for hedge accounting, any          
subsequent gains and losses are recognized as income in the current period.     
The Company does not use any derivatives for trading or speculative purposes.   
Foreign currency transaction gains and losses, net of gains and losses on       
hedge contracts, were not material in the periods presented.                    

NOTE 6.  PREFERRED STOCK                                                        

During the three-month period ended December 31, 1997, the Company redeemed     
2,000,000 shares of the outstanding Series A preferred stock ("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.            

In September 1997, all outstanding shares of Series B-1 preferred stock         
(16,045) were converted into an equivalent number of common shares.             

NOTE 7.  INCOME (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 ("EPS").  Basic EPS is computed by dividing income available to common    
shareholders by the weighted average number of common shares outstanding for    
the period.  Diluted EPS 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 accordance with the disclosure requirements of SFAS 128, a reconciliation    
of the numerator and denominator of basic and diluted EPS is provided as        
follows (in thousands, except per share amounts):                               

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MICROPROSE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 

                                                        [Enlarge/Download Table]

                                               Three months ended    Nine months ended    
                                                   December 31,         December 31,      
                                              --------------------   -------------------- 
                                                1997        1996       1997        1996   
                                              --------    --------   --------    -------- 
                                                                                          
Numerator - Basic and diluted EPS                                                         
     Net income (loss)                        $(10,885)   $  5,658   $(20,970)   $  6,853 
     Less: preferred stock dividends               (70)        (70)      (210)       (210)
                                              --------    --------   --------    -------- 
     Income available to common stockholders  $(10,955)   $  5,588   $(21,180)   $  6,643 
                                              --------    --------   --------    -------- 
                                              --------    --------   --------    -------- 
Denominator - Basic EPS                                                                   
     Weighed average shares outstanding         28,593      26,837     28,422      25,797 
                                              --------    --------   --------    -------- 
     Basic earnings per share                 $  (0.38)   $   0.21   $  (0.75)   $   0.26 
                                              --------    --------   --------    -------- 
                                              --------    --------   --------    -------- 
Denominator - Diluted EPS                                                                 
     Denominator - Basic EPS                    28,593      26,837     28,422      25,797 
     Effect of dilutive securities:                                                       
       Common stock options                         --         336         --         365 
       Convertible preferred stock                  --       1,297         --       1,119 
                                              --------    --------   --------    -------- 
                                                28,593      28,470     28,422      27,281 
                                              --------    --------   --------    -------- 
Diluted earnings per share                    $  (0.38)   $   0.20   $  (0.75)   $   0.24 
                                              --------    --------   --------    -------- 
                                              --------    --------   --------    -------- 

Weighted average options to purchase 2,759,329 and 2,870,291 shares of common   
stock were outstanding during the three months and nine months ended December   
31, 1997, respectively.  These options were not included in the calculations    
of diluted EPS because their effect on reported losses would be                 
anti-dilutive. Weighted average options to purchase 3,016,158 and 3,108,241     
shares of common stock were outstanding during the three months and nine        
months ended December 31, 1996, respectively.  Certain of these options were    
not included in the calculations of diluted EPS because the options' exercise   
price was greater than the average fair market price of the common shares.      

NOTE 8.  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 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.                                                                

During October 1997, the American Institute of Certified Public Accountants     
issued Statement of Position 97-2 ("SOP 97-2"), Software Revenue Recognition.   
This statement establishes requirements for revenue recognition for software    
companies for fiscal years beginning after December 15, 1997.  The Company is   
currently evaluating the impact of SOP 97-2 and has not yet determined the      
result, if any, on the Company's financial position, results of operations or   
cash flows.                                                                     

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MICROPROSE, INC.  

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND        
RESULTS OF OPERATIONS                                         

The following information should be read in conjunction with the consolidated   
historical financial information and the notes thereto included in Item 1 of    
this Quarterly Report and Management's Discussion and Analysis of Financial     
Condition and Results of Operations contained in the Company's Annual Report    
on Form 10-K for the fiscal year ended March 31, 1997, as filed with the        
Securities and Exchange Commission on June 30, 1997.                            

This Quarterly Report on Form 10-Q contains forward-looking statements that     
involve risks and uncertainties. The Company may, from time to time, make       
oral forward-looking statements.  The factors discussed in "Risk Factors"       
below are important factors that could cause actual results to differ           
materially from those projected in any such forward-looking statements.         

OVERVIEW                                                                        

MicroProse, Inc. ("the Company") derives revenue primarily from publishing      
and distributing entertainment software for the personal computer ("PC")        
platform on Compact-Disc Read-Only Memory ("CD-ROM") media.  In addition,       
revenue is generated from CD-ROM products for videogame consoles (including     
32-bit "next-generation" systems), the licensing of products to third-party     
publishers and the distribution of third-party software and related products.   

On October 5, 1997, the Company entered into a definitive 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 the mutual agreement to terminate the     
definitive merger agreement.  There were no breakup fees due to either          
company.                                                                        

See additional discussion in "Risk Factors" below.                              

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MICROPROSE, INC.  

OPERATING RESULTS                                                               

Consolidated net revenue generated in North America and the rest of the world   
consisted of the following (DOLLARS IN THOUSANDS):                              

                                                        [Enlarge/Download Table]

                                                                          % of Consolidated Net 
                                            Amount                                Revenue       
                                 -------------------------                ----------------------
Three months ended December 31:       1997           1996     % CHANGE      1997           1996 
                                 -------------------------  ------------  ----------------------
                                                                                                
   North America                   $  2,136      $  11,594     (81.6%)     14.4%           32.3%
   International                     12,717         24,294     (47.7%)     85.6%           67.7%
                                 -------------------------                ----------------------
   Consolidated                    $  14,853     $  35,888     (58.6%)    100.0%          100.0%
                                 -------------------------                ----------------------
                                 -------------------------                ----------------------
Nine months ended December 31:                                                                  
   North America                   $  14,069     $  26,381     (46.7%)     29.5%           34.5%
   International                      33,563        49,992     (32.9%)     70.5%           65.5%
                                 -------------------------                ----------------------
   Consolidated                    $  47,632     $  76,373     (37.6%)    100.0%          100.0%
                                 -------------------------                ----------------------
                                 -------------------------                ----------------------

The following table sets forth the components of net revenue in dollars and     
as a percentage of total net revenue (DOLLARS IN THOUSANDS):                    

                                                        [Enlarge/Download Table]

                                                                             % of Consolidated Net
                                              Amount                                 Revenue      
                                   -------------------------                 ---------------------
Three months ended December 31:         1997           1996     % CHANGE       1997           1996
                                   -------------------------  ------------   ---------------------
                                                                                                  
    Company-published titles:                                                                     
       CD-ROM                     $   7,290       $ 26,233      (72.2%)      49.1%          73.1% 
       Videogame                        283          3,031      (90.7%)       1.9%           8.5% 
       Licensing/OEM                  1,351          1,197       12.9%        9.1%           3.3% 
       Floppy disk and other            251            725      (65.4%)       1.7%           2.0% 
                                  -------------------------                 --------------------- 
          Total published titles      9,175         31,186      (70.6%)      61.8%          86.9% 

       Third-party distribution       5,678          4,702       20.8%       38.2%          13.1% 
                                   -------------------------                 ---------------------
       Consolidated                $ 14,853       $ 35,888      (53.4%)      100.0%         100.0%
                                   -------------------------                 ---------------------
                                   -------------------------                 ---------------------

Nine months ended December 31:                                                                    

    Company-published titles:                                                                     
       CD-ROM                      $  32,961       $ 57,049      (42.2%)      69.2%          74.7%
       Videogame                       1,143          7,793      (85.3%)       2.4%          10.2%
       Licensing/OEM                   4,298          3,768       14.1%        9.0%           4.9%
       Floppy disk and other             949            849       11.8%        2.0%           1.1%
                                   -------------------------                 ---------------------
          Total published titles      39,351         69,459      (43.3%)      82.6%          90.9%

       Third-party distribution        8,281          6,914       19.8%       17.4%           9.1%
                                   -------------------------                 ---------------------
       Consolidated                $  47,632       $ 76,373      (37.6%)     100.0%         100.0%
                                   -------------------------                 ---------------------
                                   -------------------------                 ---------------------

Net revenue declined in both the three and nine-month periods due principally to
the prior year success of two Company-published products, GRAND PRIX II and SID 
MEIER'S CIVILIZATION II.  These two titles combined for 37% and 53% of revenue  
in the three and nine-month periods ended December 31, 1996, respectively.  Net 
revenue in the                                                                  

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December 1997 quarter was also adversely impacted by lower North American       
market acceptance of new product releases.  The Company released two new        
titles in the third quarter of both fiscal 1997 and 1998, although domestic     
shipments of new titles in the comparable third fiscal quarters declined from   
235,000 to 65,000 units.  Provisions for future returns and markdowns also      
increased due to lower holiday sell-through of these new releases and other     
previously released titles.                                                     

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 as    
compared to no titles released to date in fiscal 1998, as the Company has       
strategically focused 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.      

Third-party 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 were due largely to the European release in the third      
quarter of fiscal 1998 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.                                                         

Gross profit consisted of the following (DOLLARS IN THOUSANDS):                 

                                                        [Enlarge/Download Table]

                                                                % of Consolidated Net
                                       Amount                          Revenue       
                                --------------------             --------------------
                                   1997      1996     % CHANGE      1997      1996   
                                --------------------  --------   --------------------
                                                                                     
Three months ended December 31  $  4,642    $ 22,000   (78.9%)      31.3%     61.3%  
                                --------------------             --------------------
                                --------------------             --------------------
Nine months ended December 31   $ 23,638    $ 47,400   (50.1%)      49.6%     62.1%  
                                --------------------  --------   --------------------
                                --------------------  --------   --------------------

Gross profit as a percent of consolidated net revenue declined in the third     
quarter due to an increased proportion of revenue generated from third-party    
developed titles.  The Company's two most significant product releases in the   
December 1997 quarter were third-party developed products, one of which was a   
low-margin distribution title.  In addition, margins were adversely impacted    
by declining average selling prices for back catalog titles, mostly in          
Europe. Partially offsetting the decreases in gross profit in the third         
quarter and first nine months of fiscal 1998 was a reduction in shipments of    
Sony PlayStation titles which generally have lower margins than PC products.    

The following table sets forth operating expenses, interest and other income    
(expense) and extraordinary items (DOLLARS IN THOUSANDS):                       

                                                        [Enlarge/Download Table]

                                                                 % of Consolidated Net
                                        AMOUNT                          Revenue       
                                 --------------------             --------------------
Three months ended December 31:     1997      1996     % CHANGE      1997      1996   
                                 --------------------  --------   --------------------
                                                                                      
  Sales and marketing            $  4,223  $  5,086     (17.0%)       28.4%    14.2%  
  General and administrative        3,240     4,508     (28.1%)       21.8%    12.5%  
  Research and development          8,106     5,959      36.0%        54.6%    16.6%  
                                 --------------------             --------------------
     Total operating expenses    $ 15,569  $ 15,553       0.1%       104.8%    43.3%  
                                 --------------------             --------------------
                                 --------------------             --------------------
  Interest and other income                                                           
   (expense), net                $    (89) $   (391)    (77.2%)       (0.6%)   (1.1%) 
                                 --------------------             --------------------
                                 --------------------             --------------------
  Provision (benefit) for                                                             
   income taxes                  $   (131) $    398         --        (0.9%)    1.1%  
                                 --------------------             --------------------
                                 --------------------             --------------------

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                                                        [Enlarge/Download Table]

                                                                 % of Consolidated Net
                                       AMOUNT                           Revenue       
                                --------------------              --------------------
Nine months ended December 31:     1997      1996     % CHANGE       1997      1996   
                                --------------------  --------    --------------------
                                                                                      

  Sales and marketing           $ 13,118   $ 14,679     (10.6%)      27.6%     19.2%  
  General and administrative       8,391     11,952     (29.8%)      17.6%     15.7%  
  Research and development        20,174     17,862      12.9%       42.3%     23.4%  
                                --------------------              --------------------
     Total operating expenses   $ 41,683   $ 44,493      (6.3%)      87.5%     58.3%  
                                --------------------              --------------------
                                --------------------              --------------------
  Interest and other income                                                           
   (expense), net               $ (3,056)  $    797    (483.4%)      (6.4%)     1.0%  
                                --------------------              --------------------
                                --------------------              --------------------
  Provision (benefit) for                                                             
   income taxes                 $   (131)  $    398         --       (0.3%)     0.5%  
                                --------------------              --------------------
                                --------------------              --------------------
  Extraordinary item, net of                                                          
   tax effect                   $     --   $  3,547    (100.0%)         --      4.6%  
                                --------------------              --------------------
                                --------------------              --------------------

Sales and marketing expenses declined in fiscal 1998 due mostly to declining    
net revenue and associated variable marketing and selling costs.                

General and administrative costs were down in fiscal 1998 due mostly to a       
decline in bad debt charges ($0.6 million and $2.5 million for the three and    
nine-month periods, respectively) related to the improved stability of          
certain customers, and to a  $1.0 million reduction in incentive compensation   
due to lower operating profits.  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.                                                             

Research and development costs were up in the most recent three-month and       
nine-month periods due to a $2.0 million charge in the quarter ended December   
31, 1997, to write-off unrealizable third-party royalty advances.  This         
write-off was made primarily due to lower than anticipated holiday              
sell-through, mostly due to one third-party developed title.                    

The change in other income and expense for the nine-month period ended          
December 31, 1997, 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 decline in fair value had occurred that was   
other than temporary in nature, 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., and 3) lower interest        
costs were incurred in the first nine months of fiscal 1998 due to a            
reduction in indebtedness outstanding.                                          

The changes in the tax provision (benefit) during fiscal 1998 are due to the    
net losses generated.  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.      

LIQUIDITY AND CAPITAL RESOURCES                                                 

Cash decreased to $24.1 million and working capital decreased to $20.7          
million during the first nine months of fiscal 1998.  The main uses of cash     
and cash equivalents in fiscal 1998 to date were to fund operating losses,      
royalty advances, bonuses earned in fiscal 1997 and a Series A preferred        
stock repurchase.                                                               

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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 December 31, 1997, there were 2,000,000         
shares of Series A Stock outstanding which are convertible into 98,039 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 $2.7   
million as of December 31, 1997) (i) at any time by the Company, or (ii) in     
its entirety commencing on September 24, 1998, upon written demand of holders   
of the majority of Series A Stock.                                              

Management believes that existing cash and cash equivalents, together with      
cash generated from operations, will be sufficient to meet the Company's        
liquidity and capital needs for at least the next 12 months.                    

RISK FACTORS                                                                    

THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE     
COMPANY AND ITS BUSINESS PROSPECTS.                                             

TERMINATED BUSINESS COMBINATION.  In October 1997, the Company entered into a   
definitive 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 the mutual          
agreement to terminate the definitive merger agreement.                         

The termination of the merger agreement has had an 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.                                                   

NASDAQ LISTING.  As of December 31, 1997, the Company is not in compliance      
with the current net tangible assets requirement of The Nasdaq Stock Market     
("NASDAQ") for continued listing on The Nasdaq National Market.  However, new   
listing requirements taking effect February 23, 1998, include alternative       
requirements for continued listing.  The Company is considering a number of     
options for meeting the new requirements, including a reverse stock split,      
and has been proactive in initiating a dialog with NASDAQ with respect to       
these new requirements.  Until the Company completes the steps necessary to     
address this situation and those steps have been approved by NASDAQ, there      
can be no assurance that the Company will be in compliance with the National    
Market listing requirements.                                                    

If the Company is unable to comply with the new National Market listing         
requirements, the Company believes that it will qualify for listing under The   
Nasdaq SmallCap Market.  If for any reason the Company is unable to achieve     
and maintain compliance with the SmallCap 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 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 likely be materially and            
adversely affected.                                                             

COMPUTER SYSTEMS AND YEAR 2000                                                  

Many currently installed computer systems and software products are coded to    
accept only two digit entries in the date code field.  These date code fields   
will need to accept four digit entries to distinguish twenty-first century      
dates from twentieth century dates.  As a result, many companies' software      
and computer systems may need to be upgraded or replaced in order to comply     
with such "Year 2000" requirements.  Although the Company is planning to        
upgrade its systems before the Year 2000 to be Year 2000 compliant, the         
Company currently utilizes third-party equipment and software that is not       
Year 2000 compliant. Failure of the Company's third-party equipment or          
software to meet the Company's Year 2000 system requirements by the Year 2000   
would require the Company to incur unanticipated expenses to remedy any         
problems, which would have a material adverse effect on the Company's           
business, operating results and financial condition.                            

Operating Results.  The Company reported net losses for the third quarter and   
first nine months of fiscal 1998 of $10.9 million, or $0.38 per diluted         
common share, and $21.0 million, or $0.75 per diluted common share,             
respectively. Although the Company reported net income for the year ended       
March 31, 1997 of $8.0 million or $0.28 per share, the Company had net losses   
of approximately $39.8 million, $18.1 million and $58.5 million for fiscal      
years 1996, 1995 and 1994, respectively.  There can be no assurance that the    
Company's business strategies and tactics will be successful or that the        
Company will be able to generate profitability in future quarterly or annual    
periods.                                                                        

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           

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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 December 31, 1997, the Company had outstanding     
indebtedness for borrowed funds of approximately $32.4 million and cumulative   
manditorily 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;     
and (iii) 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.                        

The Company, in the future, may enter into lines of credit or 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 continued revenue from        
back-catalogue 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-catalogue 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                                                                

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secured rights to intellectual properties and technologies 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, that third   
party technology will be delivered or completed on schedule, or that the        
Company's 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 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 and        
retail shelf space.                                                             

The Company's current production schedules contemplate that the Company will    
commence shipments of a number of new products in the fourth quarter of         
fiscal 1998 and 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 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 are     
scheduled to be introduced.                                                     

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.      

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.  In addition, a        
majority of the unit sales for a product typically occurs in the first 90 to    
120 days after the product is introduced, and, therefore, the Company cannot    
rely on the sales of current products to sustain its business in the future.    
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. 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.     
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 (formerly      
CUC International), Lucas Arts, Interplay, GT Interactive, Acclaim              
Entertainment, Broderbund Software, Activision 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                     

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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, 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 resell the products to consumers. During the three and        
nine-month periods ended December 31, 1997, sales to the top ten such           
customers represented approximately 46% and 51%, respectively, 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.  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. 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.              

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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 developers. Certain agreements allow    
third parties to approve a product prior to its release, and therefore,         
subject the product to delay.  The Company is also in negotiations for          
extension or renewal of certain licenses that have expired or are about to      
expire.  There can be no assurance that the Company's 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.                                                                      

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 12 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 new 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. The development, marketing and distribution of products for game    
consoles the Company chooses to support 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      

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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 peripherals (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 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     
in whole or in part 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. In addition, there can   
be no assurance that future products which incorporate software developed by    
third parties will be released in accordance with internal delivery schedules   
or at all.                                                                      

INTERNATIONAL REVENUE.  International net revenue represented approximately     
86%, 70%, 64%, and 49% of the Company's net revenue for the three and           
nine-month periods ended December 31, 1997, and for fiscal years 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. 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      

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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 future anticipated 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,    
trade secret laws, patent and trademark laws, nondisclosure agreements and      
other copy protection methods to protect its proprietary rights to its          
products. It is the Company's policy that all employees and third-party         
developers sign nondisclosure agreements. There can be no assurance that        
these measures will be sufficient to protect the Company's intellectual         
property rights against infringement. 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. 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, no such claims have had an adverse effect on the Company's      
ability to develop, market or sell its products. There can be no assurance      
that existing or future infringement claims against the Company will not        
result in 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.     

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MICROPROSE, INC.  

PART II - OTHER INFORMATION                                                     

ITEM 1. LEGAL PROCEEDINGS                                                       

Other than as set forth below, no material developments occurred with regard    
to legal proceedings in this quarter.                                           

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 Avalon Hill 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.                                             

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 Avalon Hill, 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.                                

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                        

(A)  THE FOLLOWING EXHIBITS ARE FILED HEREWITH:                                 

                                                                [Download Table]

Exhibit                                                                         
 Number   Description                                                           
-------   --------------------------------------------------------------------- 
                                                                                
 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 Paragon Investors, dated July 1992        
 4.4+     Form of Warrant, issued to Ince & Co. (incorporated by reference to   
          Exhibit 2.3 of Spectrum HoloByte, Inc.'s Quarterly Report on          
          Form 10-Q, File No. 0-19463, filed on December 31, 1994)              
 4.5+     Registration Rights Agreement, dated June 12, 1995 by and among       
          Spectrum HoloByte, Inc. and Stephen Barcia and Maria Barcia           
          (incorporated by reference to Exhibit 2.3 of Spectrum HoloByte, Inc.'s
          Current Report on Form 8-K, File No. 0-19463, filed on June 27, 1995) 
 4.6+     Registration Rights Agreement, dated as of May 16, 1995, by and among 
          Spectrum HoloByte, Inc. and IPWEL LTD (incorporated by reference to   
          Exhibit 4.7 of Spectrum HoloByte, Inc.'s Registration on Form S-3,    
          File No. 33-94580, filed October 24, 1995)                            

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                                                                [Download Table]

Exhibit                                                                         
 Number   Description                                                           
-------   --------------------------------------------------------------------- 
                                                                                
 4.7+     Registration Rights Agreement, dated as of May 16, 1995, by and among 
          Spectrum HoloByte, Inc. and GFL Advantage Fund Limited (incorporated  
          by reference to Exhibit 4.8 of Spectrum HoloByte, Inc.'s Registration 
          on Form S-3, File No. 33-94580, filed October 24, 1995)               
 4.8+     Registration Rights Agreement, dated as of August 28, 1995, by and    
          among Spectrum HoloByte, Inc. and GFL Advantage Fund Limited          
          (incorporated by reference to Exhibit 4.9 of Spectrum HoloByte, Inc.'s
          Registration on Form S-3, File No. 33-94580, filed October 24, 1995)  
 4.9+     Registration Rights Agreement, dated as of June 27, 1995, by and among
          Spectrum HoloByte, Inc. and Banque Scandinave en Suisse (incorporated 
          by reference to Exhibit 4.10 of Spectrum HoloByte, Inc.'s Registration
          on Form S-3, File No. 33-94580, filed October 24, 1995)               
 4.10+    Registration Rights Agreement, dated as of August 25, 1995, by and    
          among Spectrum HoloByte, Inc. and PJP International, Ltd.             
          (incorporated by reference to Exhibit 4.11 of Spectrum HoloByte,      
          Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 
          1995)                                                                 
 4.11+    Registration Rights Agreement, dated as of May 16, 1995, by and among 
          Spectrum HoloByte, Inc. and Tanner, Owen & Co. Incorporated           
          (incorporated by reference to Exhibit 4.12 of Spectrum HoloByte,      
          Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 
          1995)                                                                 
 4.12+    Registration Rights Agreement, dated as of September 6, 1995, by and  
          among Spectrum HoloByte, Inc. and Tanner, Owen & Co. Incorporated     
          (incorporated by reference to Exhibit 4.13 of Spectrum HoloByte,      
          Inc.'s Registration on Form S-3, File No. 33-94580, filed October 24, 
          1995)                                                                 
 4.13+    Indenture, dated as of September 15, 1995, between Spectrum HoloByte, 
          Inc. and Chemical Trust Company of California (incorporated by        
          reference to Exhibit 3 of Spectrum HoloByte, Inc.'s Current Report on 
          Form 8-K, File No. 0-19463, filed October 17, 1995)                   
 4.14+    Registration Rights Agreement, dated as of September 26, 1995, by and 
          among Spectrum HoloByte, Inc. and Robertson, Stephens & Company, L.P.,
          Jefferies & Company, Inc. and Piper Jaffray Inc. (incorporated by     
          reference to Exhibit 4 of Spectrum HoloByte, Inc.'s Current Report on 
          Form 8-K, File No. 0-19463, filed October 17, 1995)                   
 4.15+    Certificate of Designation for Series B Convertible Preferred Stock   
 4.16+    Certificate of Designation for Series B-1 Convertible Preferred Stock 
10.1+     Form of Purchase Agreement, by and between Spectrum HoloByte, Inc. and
          certain investors, effective June 26, 1996 (incorporated by reference 
          to Exhibit 4.3 of Spectrum HoloByte, Inc.'s Registration on Form S-3, 
          File No. 333-08385, filed July 18, 1996)                              
27.1      Statement Re: Financial Data Schedule                                 

+ Previously filed.                                                             

(b)  REPORTS ON FORM 8-K:                                                       

October 15, 1997 - Item 5 - Other events - Reporting that MicroProse, 
Inc. had entered into an Agreement and Plan of Merger with GT         
Interactive Software Corp. and Swan Acquisition Corp. (a wholly owned 
subsidiary of GT Interactive Software Corp.).                         

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MICROPROSE, INC.  

SIGNATURES  

Pursuant to the requirements 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, on October 13, 1997.                    

            MICROPROSE, INC.

                   By: /s/ Stephen M. Race
                                        --------------------------------------
                   Stephen M. Race
                                         CHIEF EXECUTIVE OFFICER, ACTING CHIEF
                                  FINANCIAL OFFICER AND DIRECTOR

22  

Dates Referenced Herein   and   Documents Incorporated by Reference

				Referenced-On Page
This ‘10-Q’ Filing		Date		First		Last			Other Filings
		9/24/98		13
		2/23/98		13
Filed on:		2/11/98
		2/5/98		20
		2/4/98		20
		1/30/98		1
		1/21/98		20
For Period End:		12/31/97		1		18
		12/28/97		6
		12/15/97		8
		12/5/97		6		13
		11/12/97		20
		10/15/97		21					8-K
		10/13/97		22
		10/5/97		6		9			8-K
		6/30/97		6		9			10-K,  10-Q,  S-8
		3/31/97		3		13			10-K
		3/30/97		6
		12/31/96		2		10			10-Q
		12/29/96		6
		7/18/96		21					S-3
		6/26/96		21
		10/24/95		20		21
		10/17/95		21
		9/26/95		21
		9/15/95		21
		9/6/95		21
		8/28/95		21
		8/25/95		21
		6/27/95		20		21
		6/12/95		20
		5/16/95		20		21
		12/31/94		20
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