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Microprose Inc/DE · 10-Q · For 6/30/98

Filed On 8/12/98 · Accession Number 1047469-98-30753 · SEC File 0-19463

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

 8/12/98  Microprose Inc/DE                 10-Q        6/30/98    2:79K                                    Merrill Corp/New/FA

Quarterly Report — Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                      26    148K 
 2: EX-27       Financial Data Schedule                                2      8K

10-Q — Quarterly Report
Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Exhibits and Reports on Form 8-K Financial Statements Legal Proceedings Management's Discussion and Analysis of Financial Condition and Results of Operations Risk Factors
1	1st Page - Filing Submission
2	Item 1. Financial Statements
9	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
12	Risk Factors
21	Item 1. Legal Proceedings
23	Item 6. Exhibits and Reports on Form 8-K

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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: June 30, 1998           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                                                                      
-----   ----                                                              

5,754,000 shares of Common Stock were outstanding as of August 3, 1998. 

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MICROPROSE, INC.    

TABLE OF CONTENTS     

                                                                [Download Table]

                                                                       Page
                                                                       ----
                                                                           
PART I - FINANCIAL INFORMATION                                             

ITEM 1. FINANCIAL STATEMENTS                                               

        Consolidated Balance Sheets at June 30 and                         
          March 31,  1998                                                 3

        Consolidated Statements of Operations for the three                
          months ended June 30, 1998 and 1997                             4

        Consolidated Statements of Cash Flows for the three                
          months ended June 30, 1998 and 1997                             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                                                21

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                 23

SIGNATURES                                                               26

EXHIBITS                                                                 27


2             

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

                                                        [Enlarge/Download Table]

                                                                       JUNE 30,        MARCH 31,  
                                                                         1998            1998     
                                                                     --------------  -------------
                                                                      (UNAUDITED)                 
                                                                                                  
ASSETS                                                                                            
Current assets:                                                                                   
  Cash and cash equivalents                                            $   4,289      $  14,087   
  Accounts receivable, less allowances of $4,634 and $5,077                                       
   at June 30 and March 31, 1998, respectively                             7,076          7,506   
  Inventories                                                              1,491          1,559   
  Current portion of prepaid royalties                                     4,233          3,195   
  Other current assets                                                     3,371          2,064   
                                                                     --------------  -------------
  Total current assets                                                    20,460          28,411  
 Property, plant and equipment, net of accumulated depreciation of                                
      $14,409  and $13,819 at June 30 and March 31, 1998, respectively     7,216          7,595   
 Goodwill, net                                                               783            903   
 Investments                                                               3,485          3,485   
 Prepaid royalties                                                         2,565          2,565   
 Other assets                                                                818            870   
                                                                     --------------  -------------
                                                                       $  35,327      $  43,829   
                                                                     --------------  -------------
LIABILITIES AND STOCKHOLDERS' DEFICIT                                                             
Current liabilities:                                                                              
  Accounts payable                                                     $   4,603      $   6,153   
  Salaries, wages and related accruals                                     4,810          5,059   
  Royalties payable                                                        1,321            642   
  Current portion of redeemable preferred stock                            2,940          2,940   
  Other current liabilities                                                5,872          5,201   
                                                                     --------------  -------------
  Total current liabilities                                               19,546         19,995   

Other liabilities                                                            907          1,028   
Long-term debt                                                            32,340         32,348   
                                                                     --------------  -------------
Total liabilities                                                         52,793         53,371   
                                                                     --------------  -------------
Redeemable preferred stock (net of current portion) , $0.001 par                                  
   value, 4,000 shares designated Series A, issued and outstanding,                               
   redemption and liquidation amount of $2,807 and $2,772 at                                      
   June 30, 1998, and March 31, 1998, respectively.                            -              -   

Stockholders' Deficit:                                                                            
 Preferred stock, $0.001 par value, 9,000 shares authorized                                       
      (of which 4,000 shares have been designated Series A),                                      
      no amounts were issued and outstanding at June 30, 1998                                     
      or March 31, 1998                                                        -              -   
 Common stock, $0.001 par value, 40,000 shares authorized,                                        
      5,754 and 5,754 shares issued and outstanding at                                            
      June 30 and March 31, 1998, respectively                                 6              6   
 Additional paid-in capital                                              144,525        144,525   
 Accumulated deficit                                                    (161,424)      (153,609)  
 Accumulated other comprehensive income                                     (573)          (464)  
                                                                     --------------  -------------
 Total stockholders' deficit                                             (17,466)        (9,542)  
                                                                     --------------  -------------
                                                                       $  35,327      $  43,829   
                                                                     --------------  -------------
                                                                     --------------  -------------

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

   3

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

                                                                [Download Table]

                                                     Three Months Ended    
                                                         June 30,          
                                                 ------------------------- 
                                                      1998         1997    
                                                 ----------    ----------- 
                                                                           
Net revenue                                       $  12,195      $  13,580 
Cost of revenue                                       4,954          5,778 
                                                 ----------    ----------- 
Gross profit                                          7,241          7,802 

Operating expenses:                                                        
 Sales and marketing                                  4,975          4,181 
 General and administrative                           2,644          3,173 
 Research and development                             6,238          5,863 
 Restructuring  charges                                 431              - 
                                                 ----------    ----------- 
  Total operating expenses                           14,288         13,217 
                                                 ----------    ----------- 
Operating loss                                       (7,047)        (5,415)

Interest expense, net                                  (492)          (151)
Other income (expense), net                            (250)        (2,746)
                                                 ----------    ----------- 
Net loss before provision for income taxes           (7,789)        (8,312)
                                                 ----------    ----------- 
Provision for income taxes                               26              - 
                                                 ----------    ----------- 
Net loss                                          $  (7,815)     $  (8,312)
                                                 ----------    ----------- 
                                                 ----------    ----------- 

                                                 ----------    ----------- 
Basic loss per share:                              $  (1.36)     $   (1.48)
                                                 ----------    ----------- 
                                                 ----------    ----------- 

                                                 ----------    ----------- 
Diluted loss per share:                            $  (1.36)     $   (1.48)
                                                 ----------    ----------- 

Weighted average shares used to calculate:                                 
 Basic loss per share                                 5,754          5,661 
 Diluted loss per share                               5,754          5,661 

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

   4

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MICROPROSE, INC.          
CONSOLIDATED STATEMENTS OF CASH FLOWS           
(In thousands, except per share amounts)          
(UNAUDITED)         

                                                        [Enlarge/Download Table]


                                                                    Three Months Ended    
                                                                          June 30,        
                                                                --------------------------
                                                                    1998           1997   
                                                               -----------    ----------- 
                                                                                          
OPERATING ACTIVITIES:                                                                     
Net loss                                                         $ (7,815)      $  (8,312)
Adjustments to reconcile net loss to net cash                                             
 used in operating activities:                                                            
 Depreciation and amortization                                        802           1,031 
 Minority interest in joint venture losses                              -             (18)
 Loss on write-down of investment                                       -           2,605 
 Changes in assets and liabilities:                                                       
  Accounts receivable                                                 370           2,893 
  Inventories                                                          54             854 
  Prepaid royalties                                                (1,038)         (1,812)
  Other current assets                                             (1,329)            684 
  Accounts payable                                                 (1,517)           (868)
  Salaries, wages and related accruals                               (240)         (2,133)
  Royalties payable                                                   681            (277)
  Other current liabilities                                           745             (23)
  Other liabilities                                                  (107)            132 
                                                               -----------    ----------- 
Net cash used in operating activities                              (9,394)         (5,244)

INVESTING ACTIVITIES:                                                                     
Acquisitions of property, plant and equipment                        (305)           (613)
                                                               -----------    ----------- 
Net cash used in investing activities                                (305)           (613)

FINANCING ACTIVITIES:                                                                     
Proceeds from issuance of common stock, net of issuance costs           -             181 
Repayments under notes and lines of credit                             (9)           (122)
Principal payments on capital lease obligations                       (33)            (72)
                                                               -----------    ----------- 
Net cash used in financing activities                                 (42)            (13)

Effect of exchange rate changes on cash                               (57)            (77)
                                                               -----------    ----------- 
Decrease in cash and cash equivalents                              (9,798)         (5,947)
Cash and cash equivalents at beginning of period                   14,087          47,110 
                                                               -----------    ----------- 
Cash and cash equivalents at end of period                       $  4,289       $  41,163 
                                                               -----------    ----------- 
SUPPLEMENTAL CASH FLOW DISCLOSURES:                            -----------    ----------- 
Cash paid for interest                                           $     39       $      41 
Cash paid for income taxes                                             23              79 

 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. 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,        
1998, as filed with the Securities and Exchange Commission on June 29, 1998,    
and amended on July 27, 1998.  The March 31, 1998, 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 June 30, 1998 and 1997, and its prior fiscal year    
as ended on March 31, 1998.  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 June 28, 1998, and June 27,   
1997, respectively, and the end of the prior fiscal year included herein        
represents amounts as of March 29, 1998.                                        

The consolidated financial statements have been presented on a going-concern    
basis, which contemplates the realization of assets and the satisfaction of     
liabilities in the normal course of business. The Company has reported net      
losses of $7.8 million and $33.1 million for the quarter ended June 30, 1998,   
and fiscal 1998, respectively.   Moreover, the Company has generated an         
accumulated deficit of  $161.4 million at June 30, 1998.  In addition, the      
Company's cash and cash equivalents have declined by $33.0 million during       
fiscal 1998 and by $9.8 million for the quarter ended June 30, 1998.  There     
can be no assurance that the Company's business strategies and tactics will     
be successful and that the Company will be profitable in future periods.        

As noted in the report of independent accountants for the year ended March      
31, 1998, the above issues and related liquidity concerns raise substantial     
doubt about the Company's ability to continue as a going concern.               

On May 19, 1998, the Company released fourth quarter and fiscal year 1998       
results.  In that press release, the Company's management indicated that they   
believe that the Company can perhaps best prosper and leverage its assets in    
combination with another Company or through a strategic partner.  As a          
result, the Company's Board of Directors has authorized management to           
investigate strategic alternatives for the Company.                             

NOTE 2.  REVERSE COMMON STOCK SPLIT                                             

At a special meeting on May 11, 1998, the stockholders approved and made        
effective a one for five reverse stock split whereby each five shares of the    
Company's presently outstanding common stock were automatically converted       
into one share (the "Reverse Stock Split").  Common stock and additional        
paid-in capital as of March 31, 1998, have been restated to reflect this        
reverse split.  Par value will remain unchanged at $0.001 per share.  The       
number of common shares issued at June 30 and March 31, 1998, after giving      
effect to the split, was 5,753,800 (28,769,000 shares issued before the         
Reverse Stock Split).                                                           

The effect of the Reverse Stock Split has been retroactively reflected as of    
March 31, 1998, in the consolidated balance sheet.  All references to the       
number of common shares and per share amounts have been restated as             
appropriate to reflect the effect of the reverse split for all periods          
presented.                                                                      

6           

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MICROPROSE, INC.    
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      
(UNAUDITED)           

NOTE 3.  RESTRUCTURING                                                          

In June 1998, the Company approved a restructuring plan that called for the     
closure of its Austin, Texas studio. The Company is re-evaluating that          
studio's development projects but will retain all future rights and             
intellectual property related to those projects. In connection with this        
closure, the Company accrued a total of $431,000 for severance related to the   
elimination of approximately 35 positions plus amounts for facility shutdown    
and contract cancellation costs.                                                

NOTE 4.  INVENTORIES                                                            

Inventories are stated at the lower of cost or market on a first-in,            
first-out (FIFO) basis.  Inventories consisted of the following:                

                                                                [Download Table]

                                         JUNE 30,   MARCH 31,
                                          1998        1998   
                                        -------------------- 
                                           (In thousands)    
                                           --------------    

                                                             
Raw materials                            $  137      $  256  
Finished goods                            1,354       1,303  
                                        ------------------   
                                         $1,491      $1,559  
                                        -------------------- 
                                        -------------------- 

NOTE 5.  NET LOSS PER SHARE                                                     

In accordance with the disclosure requirements of SFAS 128, a reconciliation    
of the numerator and denominator of basic and diluted earnings per share        
(EPS) is provided below.  All references to the number of common shares and     
per share amounts have been restated as appropriate to reflect the effect of    
the one for five reverse split (see note 2).  The reconciliations for the       
three months ended June 30 are as follows (in thousands, except per share       
amounts):                                                                       

                                                                [Download Table]


                                                    Three Months Ended    
                                                          June 30,        
                                                  ------------------------
                                                      1998          1997  
                                                 -----------     ---------
                                                                          
Numerator - Basic and diluted EPS                                         
 Net loss                                          $(7,815)       $(8,312)
 Preferred stock dividends                             (35)           (70)
                                                 -----------     ---------
 Net loss available to common shareholders         $(7,850)       $(8,382)
                                                 -----------     ---------
Denominator - Basic and diluted EPS                                       
 Weighed average shares outstanding                  5,754          5,661 
                                                 -----------     ---------

 Basic and diluted earnings per share:                                    
                                                 -----------     ---------
  Net loss                                        $  (1.36)        $(1.48)
                                                 -----------     ---------
                                                 -----------     ---------

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MICROPROSE, INC.    
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      
(UNAUDITED)           

Options to purchase 799,731 and 567,789 shares of common stock were             
outstanding for the periods ended June 30, 1998 and 1997, respectively.         
These options were not included in the calculations of diluted EPS because      
their effect on reported losses would be anti-dilutive.  Preferred stock        
dividends relate to Series A convertible preferred stock.  These shares were    
not included in diluted EPS as their effect would be antidilutive.              

NOTE 6.  COMPREHENSIVE INCOME                                                   

The Company has adopted the provisions of Statement of Financial Accounting     
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," effective April   
1, 1998.  This statement requires the disclosure of comprehensive income and    
its components in a full set of general-purpose financial statements.           
Comprehensive income is defined as net income plus revenues, expenses, gains    
and losses that, under generally accepted accounting principles, are excluded   
from net income.  The components of comprehensive income which are excluded     
from income are not significant, individually or in the aggregate, and          
therefore, no separate statement of comprehensive income has been presented.    

NOTE 7.  RECENT PRONOUNCEMENTS                                                  

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS     
No. 131, "Disclosures about Segments of an Enterprise and Related               
Information," which supersedes SFAS No. 14, "Financial Reporting for Segments   
of a Business Enterprise."   SFAS No. 131 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 is effective for fiscal years beginning after December 15, 1997.      
The statement's interim reporting disclosures are not required until the        
first quarter immediately subsequent to the fiscal year in which SFAS 131 is    
effective.                                                                      

In June of 1998, the FASB issued SFAS No. 133, "Accounting for Derivative       
Instruments and Hedging Activities," which establishes accounting and           
reporting standards for derivative instruments and for hedging activities.      
It requires that an entity recognize all derivatives as either assets or        
liabilities in the statement of financial position and measure those            
instruments at fair value.  Management has not yet evaluated the effects of     
this change on its operations.  The Company will adopt SFAS No. 133 as          
required for its first quarterly filing of fiscal year 2000.                    

NOTE 8.  SUBSEQUENT EVENT                                                       

On July 14, 1998, subsequent to quarter end, the Company signed a binding       
letter of intent to allow Virtual World Entertainment Group, Inc. ("VWEG") to   
repurchase the Company's equity interest in VWEG in exchange for a promissory   
note in the amount of $1.8 million and credits totaling $1,570,000 in the       
form of an advance against royalties.  The advance is for a license to          
develop computer and video games based on VWEG's AEROTECH property.  The        
Company also agreed to terminate its affiliated label agreement with VWEG.      

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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, 1998, as filed with the        
Securities and Exchange Commission on June 29, 1998, and amended on July 27,    
1998.                                                                           

This Quarterly Report on Form 10-Q contains forward-looking statements which    
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 issues 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. This software is generally published   
by the Company for the following platforms:                                     

- Compact-Disc Read-Only Memory ("CD-ROM") for the personal computer ("PC")   
- Videogame consoles                                                          

In addition, the Company generates revenue from the licensing of its products   
to third-party publishers and the distribution of third-party software and      
related products.                                                               

See additional discussion in "Risk Factors" below.                              

OPERATING RESULTS                                                               

Consolidated net revenue for the three-month periods ended June 30, 1998 and    
1997, consisted of the following                                                

                                                                [Download Table]


                                                         % OF CONSOLIDATED 
                                AMOUNT                      NET REVENUE    
                       --------------------              ----------------- 
                            1998       1997    % CHANGE     1998    1997   
                       --------------------   ---------  ------------------
                          (In thousands)                                   
                          --------------                                   
                                                                           
By Territory:                                                              
 North America          $  6,961   $  3,435    102.6 %     57.1%     25.3% 
 International             5,234     10,145    (48.4)%     42.9%     74.7% 
                       --------------------  ---------  ------------------ 
 Consolidated            $12,195    $13,580    (10.2)%    100.0%    100.0% 
                       --------------------  ---------  ------------------ 

By Platform/Type:                                                          
 CD-ROM                 $  8,114   $10,845     (25.2)%     66.6%     79.9% 
 Videogame                     2       276     (99.3)%      0.0%      2.0% 
 Licensing/OEM             2,479     1,080     129.5 %     20.3%      8.0% 
 Distribution                976     1,124     (13.2)%      8.0%      8.3% 
 Floppy disk and other       624       255     144.7 %      5.1%      1.8% 
                      --------------------   ---------  ------------------ 
 Consolidated            $12,195   $13,580     (10.2)%    100.0%    100.0% 
                      --------------------   ---------  ------------------ 
                      --------------------   ---------  ------------------ 

Consolidated net revenues for the three months ended June 30, 1998, decreased   
by 10.2 percent from the corresponding period in the prior fiscal year due in   
part to the release of                                                          

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MECHCOMMANDER only in North America rather than worldwide.  For marketing       
reasons, this title was released in Europe in the second fiscal quarter.        
With a partial release, MECHCOMMANDER accounted for more than 25 percent        
($3.2 million) of total net revenue for the quarter. A second title, X-COM      
INTERCEPTOR, also released in the first fiscal quarter, generated revenues in   
excess of $1.8 million or 15 percent of total net revenue.  In the prior        
year, the release of STAR TREK: GENERATIONS, which accounted for 34 percent     
of consolidated net revenue, combined with the strong sales of the              
back-catalogue titles GRAND PRIX II and SID MEIER'S CIVILIZATION II             
("CIVILIZATION II"), pushed consolidated net revenues to $13.6 million. The     
increase in North American net revenue was due principally to sales of          
MECHCOMMANDER.  In the prior year, international net revenue was buoyed by      
the success of STAR TREK: GENERATIONS and GRAND PRIX II; both titles did not    
experience the same level of market acceptance in North America.                

The decline in videogame revenue in the quarter ended June 30, 1998, was due    
to no significant releases or sales on console platforms. The increase in       
license/OEM ("Original Equipment Manufacturer") revenue was due in part to      
the settlement and licensing agreement with Activision (SEE PART II, ITEM 1)    
and back catalog licenses with other software publishers.                       

Distribution revenue includes shipments of computer software and related        
products published or manufactured by third parties and distributed by the      
Company.  Substantially all of the distribution revenue generated in the        
first quarter of fiscal 1999 related to shipments by Leisuresoft Vertiebs       
GmbH ("Leisuresoft"), a German distributor of computer software and related     
products.                                                                       

Net revenue in the first quarter of fiscal 1999 was also negatively impacted    
by a percentage increase in the provisions recorded for returns and             
markdowns.  This increase was due largely to potential returns and discounts    
on prior year releases that did not achieve anticipated market acceptance.      

Gross profit for the three-month periods ended June 30, 1998 and 1997,          
consisted of the following:                                                     

                                                                [Download Table]


                                                               % OF CONSOLIDATED
                               AMOUNT                             NET REVENUE   
                      ---------------------                    ---------------- 
                         1998          1997       % CHANGE       1998      1997 
                      ---------------------      ---------     ---------------- 
                           (In thousands)                                       
                           --------------                                       

                                                                                
Gross profit           $7,241        $7,802        (7.2)%       59.4%     57.5% 
                      ---------------------      ---------     ---------------- 
                      ---------------------      ---------     ---------------- 

Gross profit as a percent of consolidated net revenue increased slightly due    
to higher licensing revenue in the first quarter of fiscal 1999.  This          
increase is partially offset by higher provisions for returns and markdowns.    
Total gross profit, however, decreased consistent with lower net revenues.      

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The following table sets forth operating expenses, interest and other income    
(expense) for the three-month periods ended June 30, 1998 and 1997:             

                                                                [Download Table]


                                                                % OF CONSOLIDATED 
                                        Amount                      NET REVENUE   
                               ---------------------            ------------------
                                   1998        1997   % CHANGE     1998     1997  
                               ---------------------  --------  ------------------
                                   (In thousands)                                 
                                   --------------                                 
                                                                                  
Sales and marketing             $  4,975    $  4,181    19.0 %     40.8%    30.8% 
General and administrative         2,644       3,173   (16.7)%     21.7%    23.3% 
Research and development           6,238       5,863     6.4 %     51.2%    43.2% 
Restructuring charges                431           -       -        3.5%       -  
                               ---------------------  --------  ------------------
     Total operating expenses    $14,288     $13,217      8.1%    117.2%    97.3% 
                               ---------------------  --------  ------------------
                               ---------------------  --------  ------------------
Interest and other income                                                         
(expense)                       $  (742)  $  (2,897)     74.4%    (6.1)%   (21.3)%
                               ---------------------  --------  ------------------
                               ---------------------  --------  ------------------

The increase in sales and marketing expense in the first quarter of fiscal      
1999 was largely due to variable marketing costs in support of the three new    
quarterly releases (MECHCOMMANDER, X-COM INTERCEPTOR, and ADDICTION PINBALL)    
compared to one release in the first quarter fiscal 1998.  In addition, the     
Company incurred additional cooperative advertising expenses in fiscal 1999     
also in support of these releases.                                              

The reduction in general and administrative spending in the first three         
months of fiscal 1999 was due primarily to decreased charges for bad debt       
expense ($380,000).  Reduced headcount and tighter controls on spending also    
contributed to this reduction. Research and development costs in the current    
year included additional quality assurance testing related to MECHCOMMANDER     
and X-COM INTERCEPTOR both released in the first quarter.                       

Restructuring charges related to management's decision to close the Austin      
development studio in June 1998. These charges include full severance payouts   
to employees, lease abandonment costs and amounts for various contract          
cancellation costs.                                                             

The change in other income (expense) in the prior year included a $2.6          
million charge to write-down the Company's investment in Total Entertainment    
Network, Inc. due to management's estimate that a decline in fair value had     
occurred that was other than temporary in nature.  The balance of the account   
is principally interest expense related to long-term debt.                      

LIQUIDITY AND CAPITAL RESOURCES                                                 

Working capital decreased to $914,000 and cash decreased $9.8 million for the   
quarter ended June 30, 1998, to approximately $4.3 million. The main uses of    
cash were to fund operating losses, short-term royalty advances and payments    
on accounts payable. Partially offsetting these decreases were increases in     
cash from strong collections of revenue for MECHCOMMANDER and increases in      
the amounts of royalties and other liabilities payable.                         

The Company recently renewed an overdraft/line of credit facility in the        
United Kingdom that is based upon qualifying receivables and certain other      
bank requirements for amounts up to a maximum credit limit of 1,640,000         
pounds sterling (approximately $2.7 million at June 30, 1998).  This facility   
bears interest at the rate of 1.75 percent over the bank's base rate, and       
expires June 30, 1999. As of June 30, 1998, total amount available based upon   
qualifying assets totaled approximately $2.0 million. However, as of June 30,   
1998 the Company had not utilized any part of this facility.  There can be no   
assurance that the Company will be able to renegotiate this facility upon its   

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expiration or that any additional borrowing facilities will be made available   
to the Company on acceptable terms.                                             

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 June 30, and March 31, 1998, there were         
2,000,000 shares of Series A Stock outstanding which are convertible into       
19,608 shares of common stock and which accrue dividends at an annual rate of   
7 percent. Preferred stockholders receive one vote for each common share into   
which their preferred shares are convertible. The Series A Stock is             
redeemable for $1.00 per share plus all accumulated but unpaid dividends        
(total redemption of $2.8 million as of June 30, 1998) (i) at any time by the   
Company, or (ii) in its entirety at any time on or after September 24, 1998,    
within 180 days of receipt of written demand from the majority of Series A      
Stock holders.                                                                  

Management believes that existing cash and cash equivalents, together with      
cash generated from operations, will need to be supplemented in the near term   
by cash flows from new financing arrangements, including asset-based            
financing arrangements, to meet the Company's liquidity and capital needs for   
the next 12 months.  Limited new asset-based financing arrangements have        
recently been secured.  However, there can be no assurances that such           
asset-based financing will be sufficient to meet the Company's capital and      
liquidity needs for the next 12 months or that the Company's products will      
generate receivables and other assets sufficient to support an adequate level   
of financing.  The Company's ability to support an adequate level of            
financing depends on the timely release of new products in anticipated          
quantities.  Failure to secure and maintain adequate financing would have a     
material and adverse effect on the Company's business, financial condition      
and ability to continue as a going concern.                                     

RISK FACTORS                                                                    

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

OPERATING RESULTS.  The Company reported a net loss for the quarter ended       
June 30, 1998, of $7.8 million, or $1.36 per share with an accumulated          
deficit of $161.4 million.  For fiscal year 1998, the Company had reported a    
net loss of $33.1 million or $5.86 per share and had an accumulated deficit     
of $153.6 million at March 31, 1998.  There can be no assurance that the        
Company's business strategies and tactics will be successful and that the       
Company will be profitable in future quarterly or annual periods.               

CASH FLOWS.  For the quarter ended June 30, 1998, the Company's cash and cash   
equivalents declined by $9.8 million.  Moreover, cash and cash equivalents      
declined by $33.0 million during fiscal 1998.  Management believes that         
existing cash and cash equivalents, together with cash generated from           
operations, will need to be supplemented in the near term by cash flows from    
new financing arrangements, including asset-based financing arrangements, to    
meet the Company's liquidity and capital needs for the next 12 months.          
Limited new asset-based financing arrangements have recently been secured.      
However, there can be no assurances that such asset-based financing will be     
sufficient to meet the Company's capital and liquidity needs for the next 12    
months or that the Company's products will generate receivables and other       
assets sufficient to support an adequate level of financing.  The Company's     
ability to support an adequate level of financing depends on the timely         
release of new products in anticipated quantities.  Failure to secure and       
maintain adequate financing would have a material and adverse effect on the     
Company's business, financial condition and ability to continue as a going      
concern.                                                                        

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TERMINATED BUSINESS COMBINATION.  In October 1997, the Company entered into     
an agreement to merge with GT Interactive Software Corp. ("GT").  Under the     
terms of the proposed merger, the Company's outstanding shares of common and    
preferred stock were to be exchanged for a proportional number of shares of     
GT stock. On December 5, 1997, the Company and GT announced their mutual        
agreement to terminate the merger.                                              

The termination of the merger has had a material adverse impact on the          
Company including: (a) the Company's sales and operating results, (b) the       
Company's ability to attract and retain key sales and administrative            
personnel, (c) the progress of certain development projects, and (d) the        
trading price of the Company's Common Stock.  There can be no assurance that    
the termination of the merger will not continue to adversely impact the         
Company's business and results of operations in future periods.                 

NASDAQ LISTING/REVERSE SPLIT.  The Company was notified in February 1998 by     
the Nasdaq Stock Market ("Nasdaq") that the Company was no longer in            
compliance with the net tangible assets requirement or the alternative          
minimum bid price requirement for continued listing on the Nasdaq National      
Market.  Pursuant to National Association of Securities Dealers Marketplace     
Rules, the Company was given a period of 90 days to regain compliance with      
the minimum bid price requirement, which calls for a minimum common stock bid   
price of $5.00 per share. On May 11, 1998, the Company's stockholders           
approved a one for five reverse stock split whereby each five shares of the     
Company's outstanding common stock were automatically converted into one        
share (the "Reverse Stock Split").  During the fourth quarter of fiscal 1998,   
prior to the Reverse Stock Split, the Company's common stock traded between     
$2.75 and $1.50 per share.  On May 12, 1998, following the Reverse Stock        
Split, the Company's common stock opened at a bid price of $9.38 per share.     
Subsequently, the Company's common stock price continued to trade at a price    
above the $5.00 minimum bid price for a period of 18 days.                      

On May 19, 1998, and June 3, 1998, the Company received notice from Nasdaq      
that the Company was not in compliance with either the market capitalization    
requirement or the minimum bid price requirement for continued listing on the   
Nasdaq National Market. The Company has responded to Nasdaq with respect to     
both of these issues and is evaluating plans for compliance with the            
requirements for continued listing on the Nasdaq National Market.               

There can be no assurance that the Company's minimum bid price or market        
capitalization will be sufficient to allow the Company to comply with the       
requirements for continued listing on the Nasdaq National Market.  If the       
Company is unable to maintain compliance with such requirements, the Company    
may be able to qualify for listing under the Nasdaq SmallCap Market.            
However, at the present time, the Company does not meet all of the              
requirements for listing on the Nasdaq SmallCap Market.  If for any reason      
the Company is unable to achieve and maintain compliance with the Nasdaq        
SmallCap Market listing requirements and is delisted from both the Nasdaq       
National Market and the Nasdaq SmallCap Market, the holders of the Company's    
6.5 percent Convertible Subordinated Notes Due 2002 (the "Notes") would be      
entitled to require the Company, within 55 days, to repurchase all or any       
portion of such holders' Notes for cash at a price equal to the principal       
amount plus accrued interest.  In such event, the Company's business, results   
of operations, financial condition and ability to continue as a going concern   
would be materially and adversely affected.                                     

FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY.  The Company's operating        
results have varied significantly in the past and are expected to vary          
significantly in the future.  This variability is a result of factors such      
as: 1) volume shipments of significant new products, 2) the degree of market    
acceptance of the Company's products, 3) the introduction of products           
competitive with those of the Company, 4) the timing and market acceptance of   
new hardware and software                                                       

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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 June 30, 1998, the Company had outstanding         
indebtedness for borrowed funds of approximately $32.3 million and cumulative   
mandatorily redeemable preferred stock of $2.9 million. This substantial        
leverage will have several important consequences for the Company's future      
operations, including the following: (i) a substantial portion of the           
Company's cash flows from operations will be dedicated to the payment of        
interest on, and principal of, its indebtedness; (ii) the Company's ability     
to obtain additional financing in the future for capital expenditures,          
acquisitions, general corporate purposes or other purposes may be impaired;     
(iii) the Company's ability to withstand competitive pressures, adverse         
economic conditions and adverse changes in governmental regulations may be      
negatively impacted, and (iv) the Company's ability to comply with certain      
alternative listing requirements for the Nasdaq Stock Market may be adversely   
affected.                                                                       

The Company has recently secured an asset based financing arrangement and may   
in the future obtain lines of credit or enter into other borrowing              
arrangements, any of which would add to the total outstanding indebtedness of   
the Company. The Company's ability to meet its debt service obligations and     
to reduce its total indebtedness will be dependent upon the Company's future    
performance, which will be subject to financial, business and other factors     
affecting the operations of the Company, many of which are beyond its           
control. If the Company is unable to generate sufficient cash flow from         
operations in the future to service its debt, it may be required to convert     
or refinance all or a portion of such debt, including the Notes (see above),    
or to obtain additional financing. However, there can be no assurance that      
any refinancing would be possible or that any additional financing could be     
obtained.                                                                       

DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS.  A significant         
portion of the Company's fiscal year revenue is generated by products           
introduced during that fiscal year. The Company depends on both the timely      
introduction of successful new products or sequels to existing products to      
replace declining revenue from older products and to provide continued          

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revenue from back-catalog products. If for any reason revenue from new          
products or other activities fails to replace declining revenue from existing   
products, or if revenue from back-catalog titles declines significantly, the    
Company's business, operating results and financial condition may be            
materially and adversely affected.  In order to maintain or grow its current    
revenue levels, the Company believes it will be necessary to develop or         
obtain rights to new products that achieve and sustain market acceptance, are   
developed for the appropriate platforms and are introduced in a timely          
manner. The Company is continuing to devote considerable resources toward the   
development of new products and has secured rights to intellectual properties   
owned by third parties. As is typical in the industry, while the Company        
maintains internally developed release schedules, there can be no assurance     
that new products under development will be released on schedule or at all,     
or that any such products will generate significant revenue. Historically,      
the Company has frequently missed product release schedules. To the extent      
that major new products are not released on schedule, both net revenue and      
gross profit are likely to be materially and adversely affected. In addition,   
access to distribution channels and retail shelf space is increasingly          
competitive. The Company's ability to produce and bring to market new and       
compelling products in a timely fashion plays an increasingly important role    
in the Company's ability to retain adequate access to these channels.           

The process of developing software products such as those offered by the        
Company is extremely complex and is expected to become more complex and         
expensive 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.                                                                 

The Company's current production schedules contemplate that the Company will    
continue to ship a number of new products for the balance of 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 were scheduled to be introduced.          

UNCERTAINTY OF MARKET ACCEPTANCE; UNPREDICTABLE PRODUCT LIFE CYCLES.            
Consumer preferences for entertainment software products are continually and    
rapidly changing and are extremely difficult to predict. Few entertainment      
software products achieve sustained market acceptance beyond one holiday        
buying season. There can be no assurance that new products introduced by the    
Company will achieve any significant degree of market acceptance, or that       
acceptance, if achieved, will be sustained for any significant period.          
Further, there can be no assurance that such products will not be subject to    
changes in consumer preferences or that product life cycles will be             
sufficient to permit the Company to recover development and other associated    
costs. In addition, sales of any single title of the Company's entertainment    
software products will decline over time. A majority of the unit sales for a    
product typically occurs in the first 90 to 120 days after the product is       
introduced. Therefore, the Company cannot rely on the sales current products    
to sustain its business in the future. Failure of new products or platforms     
to achieve or sustain market acceptance would have a material and adverse       
effect on the Company's business, operating results and financial condition.    
In addition, the Company does not carry significant                             

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inventory of its new products. As a result, significant production delays       
would have a material and adverse effect on the Company's business and          
operating results. Further, if demand for a particular product is greater       
than anticipated, the Company may not have sufficient inventory to meet         
customer demands.                                                               

COMPETITION.  The entertainment software industry is intensely competitive      
and in the process of consolidation. The Company's competitors vary in size     
from very small companies with limited resources to very large corporations     
with greater financial, marketing and product development resources than        
those of the Company. The Company competes primarily with other developers of   
PC entertainment and video game entertainment software. Significant             
competitors of the Company in the entertainment software industry include       
Electronic Arts, Inc., Cendant Corporation, Lucas Arts, Interplay               
Entertainment Corporation, GT Interactive Software Corporation, Activision,     
Acclaim Entertainment, Inc., Hasbro Interactive, Inc., and Virgin               
Interactive. The success of one or more of these companies or the entry and     
participation of new companies, including diversified entertainment             
companies, may adversely affect the Company's future performance. The           
availability of significant financial resources has become a major              
competitive factor in the entertainment software industry, principally as a     
result of the technical sophistication of advanced multimedia computer game     
products requiring substantial investments in research and development and      
the increasing need to license products and rights to use other intellectual    
properties from third parties. Also, competitors with large product lines and   
popular titles typically have greater leverage with retailers and               
distributors and other customers who may be willing to promote titles with      
less consumer appeal in addition to such competitors' most popular titles.      

Many of the Company's competitors are developing on-line interactive computer   
games that will be competitive with the Company's products. As competition      
increases, significant price competition and reduced profit margins may         
result. In addition, competition from new technologies may reduce demand in     
markets in which the Company has traditionally competed. Prolonged price        
competition or reduced demand as a result of competing technologies would       
have a material and adverse effect on the Company's business, financial         
condition and operating results. There can be no assurance that the Company     
will continue to compete successfully against current or future competitors     
or that competitive pressures faced by the Company will not materially and      
adversely affect its business, operating results and financial condition.       

Retailers of the Company's products typically have a limited amount of shelf    
space and promotional resources, and there is intense competition among         
consumer software producers for adequate levels of shelf space and              
promotional support from retailers. To the extent that the number of consumer   
software products and computer platforms increases, this competition for        
shelf space may intensify. Due to increased competition for limited shelf       
space, retailers and distributors are increasingly in a better position to      
negotiate favorable terms of sale, including promotional discounts and          
product return policies. Retailers often require software publishers to pay     
fees in exchange for preferred shelf space. The Company's products constitute   
a relatively small percentage of a retailer's sales volume, and there can be    
no assurance that retailers will continue to purchase the Company's products    
or provide the Company's products with adequate levels of shelf space ,         
promotional support or be available at an affordable cost.                      

As more consumers own multimedia PCs, the distribution channels for             
entertainment software have changed, and are expected to continue to change,    
to increasingly depend on mass merchandisers, on-line services and the          
Internet to reach the broader market. In addition, while this trend has         
increased the number of distribution channels, it has intensified competition   
for shelf space because these new channels generally carry only top-selling     
titles. In addition, other types of retail outlets and methods of product       
distribution, such as on-line services and the Internet, may become important   
in the future, and it will be important for the Company to gain access to       
these channels of distribution. There can be no assurance that the Company      
will gain                                                                       

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such access or that the Company's access will allow the Company to maintain     
its historical levels of sales volume.                                          

CONCENTRATION OF CUSTOMER BASE; RISK OF CUSTOMER BUSINESS FAILURE; PRODUCT      
RETURNS.  The Company principally sells its products to retailers and           
distributors, who in turn resell the products to consumers. During the year     
ended March 31, 1998, sales to the top ten such customers represented           
approximately 53 percent of the Company's net revenue. Sales are typically      
made on credit, with terms that vary depending upon the customer and the        
nature of the product. The Company does not require collateral to secure        
payment. Retailers and distributors compete in a volatile industry and are      
subject to the risk of business failure. Certain of the Company's               
distributors and retailers have recently experienced financial difficulties     
and the Company has increased its reserves accordingly.  However, the           
business failure of a significant distributor or customer could have a          
material and adverse effect on the Company's business, operating results and    
financial condition.                                                            

The Company is exposed to the risk of product returns from distributors and     
retailers. The Company currently maintains a stock balancing policy that        
allows distributors and retailers to return products subject to certain         
conditions. The Company provides reserves for returns that it believes are      
adequate, and the Company's agreements with various customers place certain     
limits on product returns. However, new product introductions by the Company    
or its competitors, or changes in consumer demand from that anticipated,        
could cause customers to seek to return inventory to the Company in excess of   
those limits. Due to the unpredictability of consumer demand and the            
uncertainties associated with a rapidly changing market, there can be no        
assurance that the Company or its customers will be able to forecast demand     
accurately. Any significant amount of product returns or markdowns could have   
a material and adverse effect on the Company's business, operating results      
and financial condition.                                                        

DEPENDENCE UPON STRATEGIC RELATIONSHIPS.  The Company's business strategy       
relies to a significant extent on its strategic relationships with other        
companies and on its alliances with key software developers. Certain            
agreements require third parties to approve a product prior to its release,     
and therefore, subject the product to delay. There can be no assurance that     
these relationships will be successful or that the Company will continue to     
maintain and develop strategic relationships, or that licenses between the      
Company and any third party will be renewed or extended at their expiration     
dates. The Company's failure to renew or extend a key license or maintain its   
strategic relationships could materially and adversely affect the Company's     
business, operating results and financial condition. In addition, under         
certain key license agreements, the Company must obtain approval on a timely    
basis from the licensor in order to market products it develops under the       
license. There can be no assurance that the Company will obtain such            
approval, and failure to do so could have a material and adverse effect on      
the Company's operating results, financial condition and business prospects.    

The Company has made certain minority equity investments that it believes       
will provide future access to products, technologies or distribution            
channels. Management performs ongoing evaluations of the future realization     
of these investments, and charges any declines in value that are other than     
temporary in nature to other expense in its quarterly Consolidated Statements   
of Operations.  A write down of one or more of these investments could have a   
material adverse impact on the Company's operating results and financial        
condition.                                                                      

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                                                                 

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development for technologies such as enhanced sound, digitized speech, music    
and video and requires the Company to anticipate and develop products for       
those platforms that will ultimately be successful. Such research and           
development efforts, which generally require 18 to 24 months, must occur well   
in advance of the release of new platforms in order to introduce products on    
a timely basis following the release of such platforms. In addition, the        
Company expects that the trend toward more complex multimedia products and      
increasing product development costs will continue for the foreseeable future.  

Although the Company intends to develop and market games for certain advanced   
and emerging platforms, these development and marketing efforts may require     
greater financial and technical resources than those currently possessed by     
the Company. In addition, there can be no assurance that the platforms for      
which the Company develops products will achieve market acceptance and, as a    
result, there can be no assurance that the Company's development efforts with   
respect to such new platforms will lead to marketable products or products      
that generate sufficient revenue to offset research and development costs       
incurred in connection with their development. There can be no assurance that   
the Company will be successful in developing and marketing products for new     
platforms. Failure to develop products for new platforms that achieve           
significant market acceptance may have a material and adverse effect on the     
Company's business, operating results and financial condition. The Company is   
developing games that may be played interactively over on-line services and     
the Internet, but there can be no assurance that the market for networked       
videogame play will evolve or develop as anticipated. Consumer preferences      
change continually and are extremely difficult to predict. Even if a market     
for networked videogame play develops, no assurance can be given that the       
Company's products will meet the requirements of such market and achieve        
market acceptance.                                                              

The Company is heavily dependent on the success of the entertainment software   
developed for use on the PC.  There are multiple, competing and incompatible    
formats being introduced in the entertainment software market. There can be     
no assurance that the Company's strategy of developing primarily for the PC     
or the other platforms the Company chooses to support ultimately will be        
successful. For game console platforms the Company chooses to support, the      
development, marketing and distribution of products will involve substantial    
investment and risks. The Company believes that the principal target audience   
for game consoles may be younger than the Company's traditional customers,      
and there can be no assurance that the Company's products will be successful    
with this different audience. In addition, the Company anticipates that         
products in the game console market will require substantially greater          
expenditures for marketing, advertising and inventory buildup, often before     
the market acceptance of a product is known. Inventory will be two or more      
times more expensive as a result of license fees that are required to be        
prepaid to the manufacturers of the hardware platforms. Further, game console   
products will be sold through channels that overlap with, but are somewhat      
different from, the retail channels currently utilized by the Company, and      
the Company will be competing in distribution against much larger               
organizations with greater financial resources. There can be no assurance       
that the Company will be successful in marketing and distributing software      
for game consoles.                                                              

RISK OF SOFTWARE ERRORS OR FAILURES.  Software products as complex as those     
offered by the Company may contain undetected errors when first introduced or   
when new versions are released. In the past, the Company has discovered         
software errors in certain of its product offerings after their introduction    
and has experienced delays or lost revenue during the period required to        
correct these errors. The Company's products must maintain compatibility with   
certain hardware, software and accessories. Any changes that result in          
incompatibility could result in significant product returns and customer        
service costs. In particular, the PC hardware environment is characterized by   
a wide variety of nonstandard peripheral equipment (such as sound and           
graphics cards) and configurations that make prerelease testing for             
programming or compatibility errors very difficult and time consuming. There    
can be no assurance that, despite                                               

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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     
by independent software developers. The cost to retain independent developers   
is increasing in the form of guaranteed advances and royalties. Additionally,   
the Company has less control over the scheduling and the quality of work of     
independent contractors than that of its own employees. Furthermore, the        
Company's agreements to publish and market certain independent software         
developers' titles will terminate after specified dates unless renewed. The     
Company's business and future operating results will depend in part on the      
Company's continued ability to attract and maintain relationships with          
skilled independent software developers, and to enter into and renew product    
development agreements with such developers. There can be no assurance that     
the Company will be able to maintain such relationships or enter into and       
renew such agreements.                                                          

INTERNATIONAL REVENUE.  International net revenue represented approximately     
42 percent, 67 percent, and 64 percent of the Company's net revenue for first   
quarter of fiscal 1999 and for the fiscal years 1998, and 1997, respectively.   
The Company expects that international net revenue will continue to account     
for a significant portion of its net revenue in future periods. International   
revenue is subject to inherent risks, including unexpected changes in           
regulatory requirements, tariffs and other economic barriers, fluctuating       
exchange rates, difficulties in staffing and managing foreign operations and    
the possibility of difficulty in accounts receivable collection. For example,   
the Company has attempted to minimize its exposure to currency fluctuations     
by entering into forward currency contracts, however, there can be no           
assurance that the Company will be successful at mitigating currency risks.     
In some markets, localization of the Company's products is essential to         
achieve market penetration. The Company may incur substantial costs and         
experience delays in localizing its products, and there can be no assurance     
that any localized product will ever generate significant revenue. These or     
other factors could have a material and adverse effect on the Company's         
future international revenue and, consequently, on the Company's business,      
operating results and financial condition.                                      

RECOVERY OF PREPAID ROYALTIES AND GUARANTEES.  The Company, from time to        
time, enters into agreements with licensors of intellectual property and        
developers of games that involve royalty advances and guaranteed minimum        
royalty payments. If the sales volumes of products subject to such              
arrangements are not sufficient to recover such advances and guarantees, the    
Company provides a reserve for the anticipated portion of such payments that    
will not be recovered. If                                                       

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existing advances are determined to be unrecoverable in future periods, the     
Company's results of operations may be materially and adversely affected.       

INTELLECTUAL PROPERTY. The Company regards the software that it owns or         
licenses as proprietary and relies primarily on a combination of copyrights     
and trademarks and U.S and international, trade secret, patent and trademark    
laws, and nondisclosure agreements to protect its proprietary rights to its     
products. It is the Company's current policy that employees and third-party     
developers sign nondisclosure agreements. The Company owns or licenses          
various trademarks and copyrights. However, the Company has only standard       
"shrink wrap" license agreements or no license agreements at all with the end   
users of its products and does not copy-protect its software. The Company       
relies largely on the copyright and trademark laws to prevent unauthorized      
distribution of its software. There can be no assurance that these measures     
will be sufficient to protect the Company's intellectual property rights        
against infringement. Existing copyright laws afford only limited protection.   
It may be possible for unauthorized third parties to copy the Company's         
products or to reverse engineer or otherwise obtain and use information that    
the Company regards as proprietary. Policing unauthorized use of the            
Company's products is difficult, and software piracy can be expected to be a    
persistent problem. Further, the laws of certain countries in which the         
Company's products are or may be distributed do not protect the Company's       
products and intellectual rights to the same extent as the laws of the United   
States.                                                                         

The Company believes that its products, trademarks and other proprietary        
rights do not infringe on the proprietary rights of third parties. As the       
number of entertainment software products in the industry increases, the        
Company believes that software increasingly will become the subject of claims   
that such software infringes upon the rights of others. From time to time,      
the Company has received communications from parties asserting that features    
or content of certain of its products may infringe upon intellectual property   
rights of such parties. To date, other than the cost of litigation, no such     
claims have had a materially adverse effect on the Company's ability to         
develop, market or sell its products. However, there can be no assurance that   
future infringement claims against the Company will not result in further       
costly litigation or require the Company to license the intellectual property   
rights of parties. There can be no assurance that such licenses will be         
available on reasonable terms or at all.                                        

VOLATILITY OF PRICE OF STOCK AND NOTES.  There has been a history of            
significant volatility in the market prices of companies engaged in the         
entertainment software industry, including the Company. It is likely that the   
market price of the Company's common stock will continue to be highly           
volatile and the price of the Company's Notes will also be subject to such      
fluctuations. Factors such as the timing and market acceptance of new product   
introductions by the Company, the introduction of new products by the           
Company's competitors, loss of key personnel of the Company, variations in      
quarterly operating results or changes in market conditions in the              
entertainment software industry may have a significant impact on the market     
price of the Company's common stock and Notes. In the past, the Company has     
experienced fluctuations in its operating results, and it is likely that in     
some future quarter the Company's revenue or operating results will be below    
the expectations of, and certain new products will not be introduced when       
anticipated by, public market analysts and investors. In such event, the        
price of the Company's common stock would likely be materially adversely        
affected. Volatility in the price of the Company's common stock, changes in     
prevailing interest rates and changes in perceptions of the Company's           
creditworthiness may in the future adversely affect the price of the Notes.     

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PART II -  OTHER INFORMATION                                                    

ITEM 1. LEGAL PROCEEDINGS                                                       

ACTIVISION, INC.:                                                               

On November 12, 1997, a lawsuit entitled Activision, Inc. and The Avalon Hill   
Game Company v. MicroProse Software, Inc., MicroProse, Inc., and Spectrum       
HoloByte, Inc., Case No. 97-8302ER, was filed in the United States District     
Court for the Central District of California.  The complaint alleged causes     
of action for trademark infringement, trademark dilution, false designation     
of origin, false advertising, unfair competition, and deceptive trade           
practices in connection with the Company's publication of certain               
CIVILIZATION computer game products.                                            

On January 21, 1998, the Company and its Maryland subsidiary, MicroProse        
Software, Inc., filed an action against Activision, Inc. and The Avalon Hill    
Game Company in the United States District Court for the Central District of    
California.  The Company's complaint alleges that the defendants have engaged   
in false advertising, trademark infringement, and unfair business practices     
in connection with announced plans to develop and publish CIVILIZATION          
computer games under a claimed licensing relationship between Activision and    
Avalon Hill.  The Company also seeks cancellation of Avalon Hill's related      
trademark registration.                                                         

On February 4, 1998, Activision and the Avalon Hill Game Company filed a        
First Amended Complaint, correcting certain statements in their original        
complaint and adding claims for declaratory relief and cancellation of the      
Company's related trademark registration.  The action was served upon the       
Company for the first time on February 5, 1998.                                 

On April 7, 1998, the Company amended its answer and filed counterclaims on     
behalf of the Company and its two subsidiaries, MicroProse Software, Inc. and   
Hartland Trefoil, Ltd., asking for declaratory relief and seeking to enforce    
the intellectual property rights of these entities in both board games and      
computer games under the CIVILIZATION name.                                     

All of the related actions involving CIVILIZATION trademarks or games have      
now been settled in their entirety.  Under the terms of the settlement, the     
Company will retain ownership of the CIVILIZATION trademarks and copyrights     
for computer and board games.  Activision and Avalon Hill have recognized the   
Company's ownership of the property, and Avalon Hill has transferred all of     
its rights in CIVILIZATION trademarks, board games, and computer games to the   
Company.  Activision will publish its CIVILIZATION: CALL TO POWER game and      
related add-on product and conversions under license from the Company.          
Activision will also publish the PlayStation version of CIVILIZATION II under   
license from the Company for territories outside of Japan.  Under the           
provisions of the settlement, all financial terms, including advances and       
royalties under the license to Activision, remain confidential.                 

UNITED SOFTWARE GmbH:                                                           

In March 1993, MicroProse acquired United Software, GmbH ("United"). In         
September 1993, MicroProse became aware of several non-disclosed liabilities    
of United, including a claim by a German bank of approximately $2,000,000.      
MicroProse also became aware of the deterioration of the financial condition    
of the seller and the seller's parent (which had guaranteed the seller's        
obligations under the United purchase agreement) and by October 29, 1993,       
determined that the seller and its parent were incapable of complying with      
the guarantees and warranties included in the purchase agreement. Therefore,    
primarily as a result of the seller's nondisclosure of the bank debt            
described above and the misrepresentations as to the financial condition of     
the seller and its                                                              

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parent, MicroProse assessed its options and decided to rescind the agreement    
as provided under German law.                                                   

On October 29, 1993, MicroProse notified the seller and its parent of the       
rescission of the March 1993 agreement. This action resulted in a charge of     
approximately $4.9 million, which was recorded in the quarter ended September   
30, 1993. This charge consisted primarily of the original purchase price,       
asset write-offs of approximately $1.8 million and rescission-related           
liabilities of approximately $1.6 million. United and its parent company are    
now in receivership. The Company has maintained an accounting reserve in        
order to meet any remaining liabilities under German law as a result of the     
receivership proceeding.                                                        

On March 18, 1998, the Company received a demand from the receiver in the       
insolvency proceeding for payment of 1.95 million DM (approximately $1.1        
million), based on the receiver's position that MicroProse is liable for        
contribution of share capital to the insolvent company.  On approximately May   
28, 1998, the Company's U.K. subsidiary was served with a legal action by the   
receiver seeking enforcement of the demand.  The Company is represented by      
German counsel and intends to defend itself vigorously in this action.          

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                        

(A)  THE FOLLOWING EXHIBITS ARE FILED HEREWITH:                                 

                                                                [Download Table]

 Exhibit                                                                   Page
 Number    Description                                                      No.
-------    -----------                                                   ------
                                                                               
 2.1       Agreement and Plan of Reorganization, dated as of July 14,          
           1993, as amended as of November 15, 1993, by and among              
           MicroProse, Inc., MicroProse Merger Sub, Inc. and Spectrum          
           HoloByte, Inc. (incorporated by reference to Exhibit 2 of           
           MicroProse, Inc.'s Registration Statement on Form S-4, File         
           No. 33-72216, filed on November 29, 1993)                       +   
 2.2       Amendment No. 1 to Amended and Restated Agreement and Plan          
           of Reorganization, dated November 28, 1993                      +   
 2.3       Agreement and Plan of Reorganization, dated as of                   
           September 14, 1992, by and between Spectrum HoloByte, Inc.          
           and Sphere, Inc.                                                +   
 2.4       Stock Purchase and Exchange Agreement by and among Spectrum         
           HoloByte, Inc., SimTex Software Corporation, Stephen Barcia         
           and Maria Barcia, dated as of June 6, 1995 (incorporated by         
           reference to Exhibit 2.1 of Spectrum HoloByte, Inc.'s Form          
           8-K filed on June 27, 1995)                                     +   
 3.1       Certificate of Incorporation of the Registrant                  +   
 3.2       Amended Bylaws of Registrant                                    +   
 4.1       Specimen Common Stock Certificate of the Registrant             +   
 4.2       Warrants issuable to the Grotech Investors and Corporate            
           Venture Partners, L.P., dated as of October 17, 1991            +   
 4.3       Form of Warrant issuable to Paragron Investors, dated               
           July 1992                                                       +   
 4.4       Amended and Restated Investor Rights Agreement, dated               
           December 8, 1993                                                +   
 4.5       Form of Warrant, issued to Ince & Co. (incorporated by              
           reference to Exhibit 4.8 of Spectrum HoloByte, Inc.'s Form          
           10-Q filed on December 31,1994)                                 +   
 10.1      Sterling Overdraft and Barclays Tradeline Facilities between        
           MicroProse Limited and Barclays Bank PLC, dated July 2, 1993        
           (incorporated by reference to Exhibit of same number of             
           MicroProse, Inc.'s Annual Report on Form 10-K filed on              
           July 14, 1993)                                                  +   
 10.2      Sterling Overdraft and Barclays Tradeline Facilities between        
           MicroProse Limited and Barclays Bank PLC, dated July 2,             
           1993, as amended                                                +   
 10.3      Agreement between MicroProse, Inc. and WordStar                     
           International Corporation, dated May 23, 1991 (incorporated         
           by reference to Exhibit 10.6 of MicroProse, Inc.'s                  
           Registration Statement on Form S-1, File No. 33-42238, filed        
           on August 13, 1991)                                             +   
 10.4      MicroProse, Inc. 1991 Employee Stock Option Plan, as amended        
           and restated                                                    +   
 10.5      Lease Agreement between MicroProse, Inc. and Lakefront              
           Limited Partnership, dated July 9, 1987, as amended                 
           (incorporated by reference to Exhibit 10.11 of MicroProse,          
           Inc.'s Registration Statement on Form S-1, File No. 33-             
           42238, filed on August 13, 1991)                                +   
 10.6      Second Amendment to Lease Agreement between MicroProse, Inc.        
           and Lakefront Limited Partnership III, dated June 12, 1992          
           (incorporated by reference to Exhibit 10.14 of MicroProse,          
           Inc.'s Annual Report on Form 10-K filed on July 14, 1993)       +   
 10.7      Lease Agreement between MicroProse, Inc. and Saft America,          
           Inc., dated March 19, 1991 (incorporated by reference to            
           Exhibit 10.12 of MicroProse, Inc.'s Registration Statement          
           on Form S-1, File No. 33-42238, filed on August 13, 1991)       +   

                                23                                             

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Exhibit                                                                   Page 
Number     Description                                                     No. 
-------    -----------                                                   ------
 10.8      Lease Agreement between Ashpalm PLC and MicroProse                  
           Unlimited, dated June 9, 1993 (incorporated by reference to         
           Exhibit 10.16 of MicroProse, Inc.'s Annual Report on                
           Form 10-K filed on July 14, 1993)                               +   
 10.9      Lease Agreement by and between MicroProse Limited and ARC           
           Limited, dated September 25, 1992 (incorporated by reference        
           to Exhibit 10.17 of MicroProse, Inc.'s Annual Report on Form        
           10-K filed on July 14, 1993)                                    +   
 10.10     Underlease Agreement between MicroProse Limited and London          
           and Metropolitan Investments Limited, dated May 11, 1993            
           (incorporated by reference to Exhibit 10.18 of MicroProse,          
           Inc.'s Annual Report on Form 10-K filed on July 14, 1993)       +   
 10.11     Consulting and Product Development Agreement between                
           MicroProse, Inc. and Sidney K. Meier, dated August 12, 1991         
           (incorporated by reference to Exhibit 10.17 of MicroProse,          
           Inc.'s Registration Statement on Form S-1, File No. 33-             
           42238, filed on August 13, 1991)                                +   
 10.12     Option Agreement and Irrevocable Proxy by and among Spectrum        
           HoloByte, Inc., John W. Stealey, Sr. and MicroProse, Inc.           
           (incorporated by reference to Exhibit 99.2 of MicroProse,           
           Inc.'s Report on Form 8-K filed on July 7, 1993)                +   
 10.13     Consulting Services Agreement between MicroProse, Inc. and          
           John W. Stealey, Sr., dated June 22, 1993 (incorporated by          
           reference to Exhibit 10.38 of MicroProse, Inc.'s Annual             
           Report on Form 10-K filed on July 14, 199                       +   
 10.14     Master Lease Agreement between General Electric Capital             
           Corporation and MicroProse, Inc., dated December 31, 1992           
           (incorporated by reference to Exhibit 10.41 of MicroProse,          
           Inc.'s Annual Report on Form 10-K filed on July 14, 1993)       +   
 10.15     Lease Agreement between Ashpalm PLC and MicroProse                  
           Unlimited, dated August 8, 1989 (incorporated by reference          
           to Exhibit 10.13 to MicroProse, Inc.'s Registration                 
           Statement on Form S-1, File No. 33042238, filed on                  
           August 13, 1991)                                                +   
 10.16     Lease Agreement between Paragon Alameda Gateway Associates,         
           Ltd. and Sphere, Inc., dated May 5, 1992                        +   
 10.17     Underlease Agreement between MicroProse Limited and                 
           Thamsedown Computer Supplies Limited, dated 1993                +   
 10.18     Merchandising License Agreement between Paramount Pictures          
           Corporation and Sphere, Inc. dated October 1, 1991              +*  
 10.19     License Agreement between V/O Electronorgtechnica, Moscow           
           and Sphere, Inc., dated June 1, 1990, and all amendments            
           thereto                                                         +*  
 10.20     Super Tetris License Agreement between A/O Elorg and Sphere,        
           Inc., dated September 1, 1991                                   +*  
 10.21     Master Lease Agreement between General Electric Corporation         
           and MicroProse Software, Inc., dated December 31, 1992              
           (incorporated by reference to Exhibit 10.44 to MicroProse,          
           Inc.'s Annual Report on Form 10-K filed on July 14, 1993)       +   
 10.22     First Amendment to Lease between Paragon Alameda Gateway            
           Associates, Ltd. and Sphere, Inc., dated July 28, 1992          +   
 10.23     Master Lease Agreement between Comdisco, Inc. and Spectrum          
           HoloByte, Inc., dated December 16, 1992                         +   
 10.24     Security and Loan Agreement among Spectrum HoloByte, Inc.,          
           MicroProse Software, Inc. and Imperial Bank, dated as of            
           December 30, 1993                                               +   

                                24                                             

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Exhibit                                                                   Page 
Number     Description                                                     No. 
-------    -----------                                                   ------

 10.25     Security and Loan Agreement among Spectrum HoloByte, Inc.,          
           MicroProse Software, Inc. and Imperial Bank, dated as of            
           December 30, 1993, as amended (incorporated by reference to         
           Exhibit 10.89 and 10.90 of Spectrum HoloByte, Inc.'s                
           Form 10-Q filed on December 31, 1994)                           +   
 10.26     Spectrum HoloByte, Inc. 1992 Stock Option Plan                  +   
 10.27     MicroProse, Inc. 1994 Employee Stock Purchase Plan              +   
 10.28     401(k) Plan of the Company                                      +   
 10.29     Form of Indemnification Agreement between the Company and           
           each of its officers and directors                              +   
 10.30     Amended and Restated Employment and Consulting Agreement            
           between Patrick S. Feely and the registrant, dated                  
           December 13, 1994 (incorporated by reference to                     
           Exhibit 10.90 of Spectrum HoloByte, Inc.'s Form 10-Q filed          
           on December 31, 1994)                                           +   
 16.1      Letter from Ernst & Young regarding change in certifying            
           accountant (incorporated by reference to Exhibit 7(c)(3) of         
           the Company's Amendment No. 2 to Form 8-K filed on March 22,        
           1994)                                                           +   
 27        Financial Data Schedule for the Three Months Ended June 30,         
           1998                                                                


+ Incorporated by reference to an exhibit to the Company's Registration         
Statement on Form S-1 (Registration No. 33-75408), as amended.              
* Confidential treatment granted as to certain portions of these exhibits.      

(B) REPORTS ON FORM 8-K:                                                        

No reports on Form 8-K were filed during the quarter ended June 30, 1998.       

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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 August 12, 1998.                     

            MICROPROSE, INC.

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

                        /s/ John M. Belchers
                              --------------------------
                    John M. Belchers
                           CHIEF FINANCIAL OFFICER

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Dates Referenced Herein and Documents Incorporated By Reference

		Referenced-On Page
This 10-Q Filing	Date	First	Last	Other Filings

	5/5/92	24
	6/12/92	23
	7/28/92	24
	9/14/92	23
	9/25/92	24
	12/16/92	24
	12/31/92	24
	5/11/93	24
	6/9/93	24
	6/22/93	24
	7/2/93	23
	7/7/93	24
	7/14/93	23	24
	9/30/93	22
	10/29/93	21	22
	11/15/93	23
	11/28/93	23
	11/29/93	23
	12/8/93	23
	12/30/93	24	25
	3/22/94	25
	12/13/94	25
	12/31/94	25
	6/6/95	23
	6/27/95	23
	6/27/97	6
	6/30/97	2	11	10-K, 10-Q, S-8
	11/12/97	21
	12/5/97	13
	12/15/97	8
	12/31/97	12		10-Q
	1/21/98	21
	2/4/98	21
	2/5/98	21
	3/18/98	22
	3/29/98	6
	3/31/98	3	17	10-K, 10-K405/A
	4/1/98	8
	4/7/98	21
	5/11/98	6	13	DEFS14A, PRES14A
	5/12/98	13
	5/19/98	6	13
	5/28/98	22
	6/3/98	13
	6/28/98	6
	6/29/98	6	9	10-K
For The Period Ended	6/30/98	1	25
	7/14/98	8		SC 13G/A
	7/27/98	6	9	10-K405/A
	8/3/98	1
Filed On / Filed As Of	8/12/98	26
	9/24/98	12
	6/30/99	11

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Microprose Inc/DE · 10-Q · For 6/30/98

Filed On 8/12/98 · Accession Number 1047469-98-30753 · SEC File 0-19463

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