GT INTERACTIVE SOFTWARE CORP, 10-KT, 1998-06-29

GT INTERACTIVE SOFTWARE CORP
10-KT, 1998-06-29
PREPACKAGED SOFTWARE

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from January 1, 1998 to March 31, 1998. Commission
File No. 0-27338
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GT INTERACTIVE SOFTWARE CORP.
(Exact name of registrant as specified in its charter)

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DELAWARE 13-3689915
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)

417 FIFTH AVENUE, NEW YORK, NY 10016
(Address of principal executive
offices) (Zip code)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 726-6500
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.01 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No_____

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
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The aggregate market value of the registrant's Common Stock, held by
non-affiliates of the registrant, based on the closing sale price of the Common
Stock on June 19, 1998 as reported on the Nasdaq National Market, was
$165,404,633. As of June 19, 1998, there were 68,072,073 shares of the
registrant's Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None

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GT INTERACTIVE SOFTWARE CORP.
1998 TRANSITION REPORT ON FORM 10-K
TABLE OF CONTENTS

PART I

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Item 1. Business.................................................... 2
Item 2. Properties.................................................. 18
Item 3. Legal Proceedings........................................... 18

Item 4. Submission of Matters to a Vote of Security Holders......... 19

PART II
Item 5. Market for the Registrant's Common Equity and Related 20
Stockholder Matters.........................................
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition 22
and Results of Operations...................................
Item 8. Index to the Financial Statements and Supplementary Data.... 29

Item 9. Changes in and Disagreements with Accountants on Accounting 29
and Financial Disclosure....................................

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 30
Item 11. Executive Compensation...................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and 39
Management..................................................

Item 13. Certain Relationships and Related Transactions.............. 41

PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 43
8-K.........................................................
Signatures ............................................................ 47
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PART I

This Transition Report on Form 10-K contains forward-looking statements
regarding future events or the future financial performance of the Company that
involve certain risks and uncertainties. Actual events or the actual future
results of the Company may differ materially from the results discussed in the
forward-looking statements due to various factors, including, but not limited
to, those discussed in "Factors Affecting Future Performance" below at pages 11
to 17. Unless otherwise indicated, all information in this Transition Report on
Form 10-K gives effect to the Company's change in fiscal year end, beginning
January 1, 1998, from December 31 to March 31.

ITEM 1. BUSINESS

GENERAL

GT Interactive Software Corp., a Delaware corporation (the "Company")
creates, publishes, merchandises and distributes interactive entertainment,
edutainment and value-priced consumer software for a variety of platforms on a
worldwide basis. Similar to major film studios and record companies, the Company
employs a portfolio approach to achieve a broad base of published products
across most major consumer software categories. The Company publishes software
titles that are developed both internally and through third-party publishing
relationships it has established with a variety of independent software design
groups and content providers. Externally developed titles are published through
various arrangements with such independent developers and are generally
published, reproduced, packaged, marketed, promoted and distributed by the
Company. Recognizing that software distribution capabilities attract software
publishing content, the Company has used its strong distribution foundation to
build its current position as a leader in the consumer software publishing
business. According to PC Data, for 1997 and the first three months of 1998, the
Company achieved the industry's second highest market share in number of units
sold in the personal computer ("PC") software game category and the industry's
highest market share in dollars and number of units sold in the PC software
value-priced category. In addition, the Company achieved the industry's fourth
highest market share for 1997 and the third highest market share for the first
three months of 1998 in number of units sold in the PC education software
category.

The Company believes that it is the largest distributor of consumer
software to mass merchants in the United States and that it is the largest
supplier of consumer software (including its own and third-party published
software) to approximately 2,325 Wal-Mart stores and approximately 800 Target
stores. Additionally, the Company supplies value-priced software under specially
designed programs to approximately 2,115 Kmart stores and has established direct
selling relationships for its own published titles with a variety of other major
retailers, including Sam's Club, Price-Costco, CompUSA, Best Buy and Computer
City.

Over the last two years, the Company has consummated a number of strategic
acquisitions and investments that have significantly increased its internal
development capabilities and added to its expanding publishing base. In June
1996, the Company acquired WizardWorks Group, Inc. ("WizardWorks"), a publisher
of a wide variety of consumer software products, and FormGen, Inc. ("FormGen"),
a publisher of interactive PC shareware and software, including the popular Duke
Nukem 3D for PCs, which is published under a license from 3D Realms. The Company
subsequently acquired all other rights to publish Duke Nukem 3D worldwide for
all PC and console platforms. In July 1996, the Company acquired Humongous
Entertainment, Inc. ("Humongous"), a premier developer and publisher of original
interactive children's entertainment software. Humongous' award-winning software
line features popular characters such as Putt-Putt, Freddi Fish, Pajama Sam and
Spy Fox. In October 1997, the Company acquired SingleTrac Entertainment
Technologies, Inc. ("SingleTrac"), a leading developer of front-line action
software titles, including popular PlayStation titles JetMoto, Twisted Metal,
Twisted Metal II and WarHawk.

Additionally, in November 1996, the Company acquired the operations of
Warner Interactive Europe ("Warner Interactive"), a developer and publisher of
interactive PC software, and in January 1997, One Stop Direct Limited ("One
Stop"), a U.K. value-priced products distributor.

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In November 1996, the Company invested approximately $7.1 million in
preferred stock of OddWorld Entertainment, Inc. ("OddWorld") which is
convertible into 50% of the common equity of OddWorld. As a result of this
investment, the Company appoints certain members of the Board of Directors of
OddWorld. OddWorld's principals have extensive experience in the ground-breaking
application of computer-generated images in film, commercials and theme park
rides. In 1997, the Company entered into a publishing relationship with OddWorld
that resulted in the release of OddWorld: Abe's Oddysee and gives the Company
the right of first refusal over all games developed by OddWorld until 2002.

INDUSTRY BACKGROUND

The worldwide interactive entertainment software market is comprised
primarily of software for two distinct platforms: PCs and video game consoles.
The market has grown dramatically in recent years due to the increasing
installed base of multimedia PCs and current generation game console systems. In
addition, the development of enabling multimedia technologies, the proliferation
of software titles, the development of new and expanding distribution channels
and the emergence of a strong international market for interactive entertainment
software have spurred the rapid expansion of the interactive entertainment
market.

PC SYSTEMS. According to the International Data Corporation ("IDC"),
households having a PC had grown to 43% of U.S. households with an installed
base of 43 million households at the end of 1997. IDC is projecting households
having a PC to grow to 53% of U.S. households, or to 56 million households, by
the end of 2002. The advent of the sub-$1,000 PC has added a new demographic to
the PC market and has further increased PC ownership. IDC believes that home PC
hardware shipments in the United States will grow 12% to 12.0 million units in
1998 from 10.7 million units in 1997. Tracking the increase in penetration and
growth in PC hardware, U.S. sales of PC entertainment software grew 19%, from
$1.2 billion in 1996 to $1.4 billion in 1997. IDC expects 1998 entertainment
software sales to increase to $1.7 billion. In terms of units, IDC projects that
PC games/entertainment software shipments in the United States will increase 28%
over 1997 shipments of 44.7 million units to 57.5 million units in 1998.

CONSOLE SYSTEMS. The console market has historically been dominated by
three console manufacturers: Sony, Nintendo and Sega. According to IDC, U.S.
shipments for console hardware grew 32%, from 11.6 million units in 1996 to 15.3
million units in 1997. Much of this growth was fueled by the continuing consumer
demand for 32-bit Sony PlayStation ("PlayStation") and 64-bit Nintendo 64
("N64") game consoles, as Sony and Nintendo currently dominate the console
market. The growth in game console shipments has led to a rapid expansion in
console software revenues in the United States which grew 55% from $2.3 billion
in 1996 to $3.5 billion in 1997. IDC believes that 1998 game console software
revenues in the United States will increase to $4.2 billion, or 19%, from 1997
revenues.

The distribution channels for interactive software have changed
significantly in recent years. Traditionally, consumer software has been sold
through specialty stores. Today, consumer software is increasingly sold through
mass merchants such as Wal-Mart, Kmart and Target, as well as major retailers,
including Sam's Club, Price-Costco and Best Buy. The Internet and on-line
networks also present a new channel through which publishers and distributors
can market, advertise and distribute their products to end-users.

Although the number of distribution channels for software titles has
increased, the abundance of new software titles has forced retailers to be
highly selective when allocating shelf space. Despite this proliferation of new
titles, a limited number of titles actually capture a majority of the sales in
the front-line interactive entertainment software market. This hit-driven market
has also led to higher production budgets for front-line titles as well as to
more complex development processes, longer development cycles and generally
shorter product life cycles. Publishers with a history of producing hit titles
have enjoyed a significant marketing advantage because of their heightened brand
recognition and customer loyalty. The importance of the timely release of hit
titles, as well as the increased scope and complexity of the product development
and production process, have increased the need for disciplined product
development processes that limit cost and schedule overruns. This in turn has
increased the importance of leveraging the technologies, characters or
storylines of hit titles into additional interactive entertainment software
products in order to spread development costs

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among multiple products. Edutainment and value-priced software products are less
susceptible to the pressures of a hit driven market primarily due to the buying
characteristics of their narrower target markets.

Another result of these market pressures is the trend in the industry
toward the consolidation of software companies and the diversification of
products offered by such companies. High investment requirements, together with
the need for a wide distribution network in order to amortize high fixed
production costs, have led to a consolidation of the industry. The Company
believes that companies with good distribution networks and which can offer a
diverse portfolio of high-quality, branded products should enjoy a competitive
advantage over others in the industry.

BUSINESS ACTIVITIES

Publishing, together with merchandising and distribution, are the two major
activities of the Company. Publishing is divided into front-line and
value-priced products. Front-line publishing accounted for 38% of the Company's
revenues in the three months ended March 31, 1998, as compared to 30%, 45%, 36%
and 29% for the three months ended March 31, 1997 and the years ending December
31, 1997, 1996 and 1995, respectively. Value-priced publishing accounted for 24%
of the Company's revenues in the three months ended March 31, 1998, as compared
to 16%, 16%, 18% and 23% for the three months ended March 31, 1997 and the years
ending December 31, 1997, 1996 and 1995, respectively. Merchandising and
distribution accounted for 38% of the Company's revenues for the three months
ended March 31, 1998, as compared to 53%, 39%, 46% and 48% for the three months
ended March 31, 1997 and the years ending December 31, 1997, 1996 and 1995,
respectively.

The Company sells its own published titles to a variety of major retailers,
including Sam's Club, Price-Costco, CompUSA, Best Buy and Computer City, and
distributes its own products, as well as those of other publishers, to certain
mass merchants. The Company believes that it is the largest distributor of
third-party consumer software to mass merchants in the United States. The
Company publishes, markets and distributes its titles in 39 countries worldwide,
increasing its international revenues substantially over the last two years.

PUBLISHING

Front-Line Titles

The Company publishes higher priced, higher margin front-line titles for
use on multiple platforms. In addition to providing higher margins, the Company
believes that front-line titles generally have longer product life cycles and
can serve as the basis for sequels, product extensions and related titles.
Additionally, front-line titles have greater potential for achieving high brand
recognition and franchise status and, accordingly, are supported by extensive
marketing efforts coordinated with their release. Since its inception, the
Company has released a number of front-line titles covering a variety of gaming
genres.

From January 1995 to March 1998, the Company published 98 new front-line
titles. These titles generally lead to multiple releases, including re-releases
of the same title on different platforms and in different countries. For
example, Duke Nukem was released on three different platforms domestically and
two different platforms internationally, resulting in five total releases.

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YEAR ENDED DECEMBER 31 THREE MONTHS ENDED
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1995 1996 1997 3/31/98 TOTAL
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Number of New Front-line Titles
Published 13 25 48 12 98
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The table below highlights selected Company releases since 1995 which
successfully became franchise titles.

SELECTED TITLES RELEASED SINCE 1995

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TITLE GENRE PLATFORM(S)
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Doom Action/Adventure PlayStation, Saturn
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Mac, N64, PC, PlayStation,
Doom II Action/Adventure Saturn
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Duke Nukem 3D Action/Adventure N64, PC, PlayStation
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Duke Nukem 3D Atomic Action/Adventure PC
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Duke Nukem Kill-A-Ton Action/Adventure PC
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Hexen Action/Adventure N64, PC, PlayStation, Saturn
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OddWorld: Abe's Oddysee Action/Adventure PC, PlayStation
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Quake Action/Adventure N64, PC
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Ultimate Doom Action/Adventure Mac, PC
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Deer Hunter Sportsman/Value-priced PC
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Freddi Fish 2 Children's Edutainment Mac, PC
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Putt-Putt Travels Through
Time Children's Edutainment Mac, PC
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Imperium Galactica Strategy PC
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Total Annihilation Strategy PC
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The Company acquires content for front-line titles from both in-house
development studios and independent third-party developers. As a result of the
1996 acquisition of Humongous, the 1997 acquisition of SingleTrac and the
creation of Cavedog Entertainment ("Cavedog"), the Company has released 27
titles, including internally developed front-line titles Putt Putt Travels
Through Time from Humongous and Total Annihilation from Cavedog. The Company
expects the number of internally developed products to significantly increase as
a percentage of the Company's total published product as a result of the
Company's recent acquisitions and investment in internal development
capabilities.

Cavedog, one of the Company's internal development studios, published its
first front-line entertainment software, Total Annihilation, a highly acclaimed
real-time 3D strategy game, in the third quarter of 1997. As of early February
1998, Total Annihilation fans had made www.totalannihilation.com one of the 36
most visited websites on the Internet and the third most visited gaming website,
according to www.hot100.com. Total Annihilation has earned more than 45 industry
awards of excellence, in addition to receiving top reviews and honors from the
world's gaming press. The Company also released (for use on the PlayStation and
PC formats) OddWorld: Abe's Oddysee, the first in a five-game series that
combines life-like character motion with intuitive controller interfaces inside
highly rendered backgrounds, bringing players into a rich, deeply developed
world that is more like a film than a game. OddWorld: Abe's Oddysee has sold
more than one million copies worldwide since its introduction in late 1997. In
addition, SingleTrac released Critical Depth for PlayStation in 1997 shortly
after it was acquired by the Company.

Humongous is currently the centerpiece of the Company's edutainment
business, which focuses on developing and marketing products combining
entertainment and learning experiences for children ages three to ten. Humongous
software features popular characters such as Putt-Putt, Freddi Fish, Pajama Sam
and Spy Fox. Humongous titles, such as Putt-Putt Saves The Zoo, Freddi Fish and
the Case of the Missing Kelp Seeds and Fatty Bear's Birthday Surprise, have won
dozens of awards in the past few years. In June 1997, Humongous and Nickelodeon
entered into an exclusive five-year worldwide agreement to develop CD-ROMs based
on Blue's Clues, Nickelodeon's highly popular preschool television show. This
agreement marks the first

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time that Humongous will develop software based on a character outside of its
family of award-winning originals.

The Company also publishes titles from independent developers of software
products. The Company believes it has historically been successful in
identifying talented developers and establishing mutually beneficial
relationships with those developers and works with them to develop brand
franchises across a variety of products. For example, the Duke Nukem franchise
created by 3D Realms has generated for the Company unit sales to date in excess
of three million. In February 1998, the Company and 3D Realms entered into an
exclusive agreement with Threshold Entertainment, an intellectual property
management company, to exploit the Duke Nukem franchise across film, television
and home video media worldwide.

In addition to domestic front-line publishing, the Company has broadened
its international sales efforts by establishing relationships with software
publishers and distributors in several of the largest international markets,
including the United Kingdom, Germany, France and Australia. In January 1995,
the Company established a European publishing operation in the United Kingdom.
International operations were expanded in November 1996 when the Company
acquired the operations of Warner Interactive, a European subsidiary of Warner
Music Group, in the United Kingdom, Germany and France. In January 1997, the
Company acquired One Stop, a U.K. value-priced products distributor. Through
these subsidiaries, the Company publishes, markets and distributes its products
direct to retail merchants throughout Europe and Australia. In total, combined
with the Company's U.S.-based operations, the Company publishes, markets and
distributes its titles in 39 countries worldwide.

International front-line revenues as a percentage of total revenues were
22% in the three months ended March 31, 1998, as compared to 15%, 24%, 13% and
5% in the three months ended March 31, 1997 and the years ending December 31,
1997, 1996 and 1995, respectively. In the three months ended March 31 1998, the
Company's international front-line revenues increased to 58% of front-line
publishing revenues, as compared to 50%, 53%, 36% and 17% in the three months
ended March 31, 1997 and the years ending December 31, 1997, 1996 and 1995,
respectively.

The Company believes that international markets provide it with significant
growth opportunities. For example, since its introduction in late 1997, the
Company sold over one million units of OddWorld: Abe's Oddysee for the PC and
PlayStation worldwide, approximately half of which were sold in foreign markets.
In addition, in 1997, the Company sold over one million units worldwide of Duke
Nukem for the PC, PlayStation and N64, nearly 400,000 of which were sold in
foreign markets. Moreover, through its alliance with Midway Games, Inc. and
Midway Home Entertainment (collectively, "Midway"), the Company currently has
the exclusive right to publish and distribute, in most major markets, excluding
North America and Japan, virtually all Midway games for PC and 32- and 64-bit
platforms. The Company has similar rights for games developed or acquired by
Atari Games Corporation, which is owned by Midway. These titles include NBA
Hangtime, based on the popular arcade basketball game, Open Ice, an arcade-style
hockey brawl, and Mortal Kombat Trilogy, based on the record-setting martial
arts arcade series. The Company is aggressively seeking new opportunities to
form alliances with local publishers and distributors in other foreign markets.

Value-Priced Products

Through its Value Price and Distribution Division ("Value Price Division"),
the Company publishes and distributes a variety of value-priced products for
sale at lower price points than front-line software. In early 1995, the Company
began to repackage and offer for distribution to mass merchants multi-pack boxes
of value-priced software titles. These generally include previously top-selling
software titles whose popularity had peaked at higher retail price points or
titles that never realized substantial popular recognition. The Company's
acquisition in June 1995 of Slash Corporation ("Slash"), a leading publisher,
purchaser, repackager and distributor of value-priced software, solidified the
Company's presence in the value-priced market. Through its Value Price Division,
into which Slash was consolidated, the Company licenses catalog titles,
purchases excess inventory (primarily in the CD-ROM format) from other major
publishers and may repackage the titles into compilation boxes.

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The Company increased its presence in the growing value-priced software
category in June 1996 when it acquired WizardWorks, a developer and publisher of
a wide variety of consumer software products, and further expanded its
value-priced product line in January 1997, when it acquired One Stop, a U.K.
value-priced products distributor. These acquisitions have helped the Company
attain a leadership position in the PC value-priced software category over the
last two consecutive years. Deer Hunter, an interactive deer hunting challenge
published by WizardWorks, was the best-selling PC game in number of units sold
from January to March 1998, according to PC Data. WizardWorks also offers add-on
levels that complement some of the industry's most popular entertainment titles,
including certain of the Company's titles such as Duke Nukem 3D. Through the
CompuWorks label, WizardWorks offers a line of home office productivity software
that includes such well-known titles as CompuWorks Publisher and CompuWorks
Draw. Also included in the acquisition of WizardWorks was MacSoft, a leading
publisher of entertainment, edutainment and productivity software for the
Macintosh computer. The Company has consolidated all of its Macintosh offerings
under the MacSoft brand.

The Company's Value Price Division provides an opportunity for the Company
to manage the entire life cycle of its published products from initial release
through their final close-out sale. This enables the Company to generate
additional revenues from its former front-line titles.

The Company also supplies value-priced software under specially designed
fixture-based programs, which include special display cases, to Kmart, Wal-Mart
and CompUSA. These programs utilize sophisticated distribution and point of sale
replenishment systems similar to those in use by the Company for front-line
products.

MERCHANDISING AND DISTRIBUTION

The Company believes that it is one of the few software publishers that
sells directly to substantially all of the major retailers of computer software
in the United States and that it is the largest distributor of computer software
to mass merchants in the United States. The Company sells its own published
titles to specialty retailers and distributes its own products, as well as those
of other publishers, to certain mass merchants. The Company believes it is the
largest supplier of consumer software (including its own and third-party
published software) to approximately 2,325 Wal-Mart stores and approximately 800
Target stores. Additionally, the Company supplies value-priced software under
specially designed fixture-based programs to approximately 2,115 Kmart stores
and has established direct selling relationships for its own published titles
with a variety of major retailers, including Sam's Club, Price-Costco, CompUSA,
Best Buy and Computer City. During the second-half 1997, Wal-Mart began
purchasing consumer software direct from five publishers whose software was
previously sold to Wal-Mart through the Company. Wal-Mart may commence direct
purchases from other publishers.

Utilizing its point-of-sale replenishment systems and electronic data
interchange (EDI) links with its largest mass merchant accounts, the Company is
able to handle high sales volumes to those customers efficiently, manage and
replenish inventory on a store-by-store basis and assemble for its customers
regional and store-by-store data based on product sell-through. The Company
utilizes proprietary technology systems for order processing, inventory
management, purchasing and tracking of shipments thereby increasing the
efficiency and accuracy of order processing and payments and shortening order
turnaround time. These systems automatically track software orders from order
processing to point-of-sale, thereby enhancing customer satisfaction through
prompt delivery of the desired software titles.

Based on the strength of its current consumer software distribution
operation, the Company has successfully attracted other publishers to utilize
its mass merchant distribution capabilities for their products. Such products
are generally acquired by the Company and distributed under the name of the
publisher who is, in turn, responsible for the publishing, packaging, marketing
and customer support of such products. The Company's agreements with other
publishers typically provide for certain retail distribution rights in
designated territories for a specific period of time, after which those rights
are subject to negotiated renewal.

During 1997, the Company launched the Affiliate Label Program. Empire
Interactive became the Company's first affiliate label with such products as Pro
Pinball Timeshock!, Flying Corp. Gold, Combat
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Chess and The Golf Pro with Gary Player. Under this program, the Company sells
and distributes interactive software for, and provides marketing consulting
services to, a variety of publishers on a global basis. The Affiliate Label
Program is provided on a fee-for-service basis, without the Company taking
ownership of the inventory.

PRODUCT DEVELOPMENT

The Company publishes both internally and externally developed products.
Whether a product is developed internally or externally, the Company's Product
Evaluation Group, comprised of senior publishing executives, evaluates a
product's potential and required investment prior to commencing development.
During the development process, periodic reviews and milestone evaluations are
used to monitor progress.

Internal Product Development

The Company develops and produces titles using a model in which a core
group of creative, production and technical professionals on staff at the
Company, in cooperation with the Company's marketing and finance departments,
have overall responsibility for the entire development and production process
and for the supervision and coordination of internal and external resources.
Each project team is led by a producer and includes one or more associate
producers, game designers, software engineers, artists and a quality assurance
leader, all of whom are on the Company's staff. This team assembles the
necessary creative elements to complete a title, using where appropriate outside
programmers, artists, animators, musicians and songwriters, sound effects and
special effects experts, and video studios. The Company believes that this model
allows the Company to supplement internal expertise with top quality external
resources on an as needed basis.

The Company has adopted and implemented a rigorous procedure for the
selection, development, production and quality assurance of its internally
produced entertainment software titles. The process involves one or more
pre-development, development and production phases, each of which includes a
number of specific performance milestones. This procedure is designed to enable
the Company to manage and control production and development budgets and
timetables, to identify and address production and technical issues at the
earliest opportunity (and, if needed, to cease development of an unviable
title), and to coordinate marketing and quality control strategies throughout
the production and development phases, while maintaining an environment that
fosters creativity. Checks and balances are intended to be provided through the
structured interaction of the project team with the Company's creative,
technical, marketing and quality assurance/customer support personnel, as well
as the legal, accounting and finance departments. The development process for an
original, internally developed product typically takes from 12 to 24 months.

External Product Development

Since its inception, the Company has established publishing and
distribution relationships with independent developers. For the year ended
December 31, 1997, 77% of the Company's front-line publishing revenues were
derived from products developed by independent, third-party developers
(excluding products representing 13% of front-line publishing revenues derived
from products published as a result of the Company's interest in, and publishing
relationship with, OddWorld or acquired as a result of the Company's recent
acquisitions). Acquired titles are marketed under the Company's name as well as
the name of the original developer. The agreements with third-party developers
typically provide the Company with exclusive publishing and distribution rights
for a specific period of time for specified platforms and territories. These
agreements may grant to the Company the right to publish sequels, enhancements
and add-ons to the product originally being developed and produced by the
developer. In consideration for its services, the developer receives a royalty
based on sales of the product that it has developed. A portion of this royalty
may be guaranteed or pre-paid, with payments tied to the completion of detailed
performance milestones.

The Company manages the production of external development projects by
appointing a producer to oversee the product's development and to work with the
third-party developer to design, develop and test the game. This producer also
helps ensure that performance milestones are timely met. The Company generally

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has the right to cease making payments to an independent developer if such
developer fails to complete its performance milestones in a timely fashion.

MARKETING

The Company utilizes a wide range of marketing techniques including (i)
in-store promotions utilizing display towers and endcaps, (ii) advertising in
computer and general consumer publications, (iii) on-line marketing to promote
sales of its products, (iv) direct mailings and (v) TV advertising. The Company
monitors and measures the effectiveness of its marketing strategies throughout
the product lifecycle. Historically, the Company has devoted a substantial
amount of its marketing resources to its front-line published products and
intends to do so in the future. The Company believes that such marketing is
essential for cultivating product successes and brand-name loyalty.

The Company's marketing programs have expanded along with the Company's
publishing business, with an emphasis not just on launching products but on
raising the public's awareness of new brands and franchises. For example, the
Company began to develop an integrated marketing program for OddWorld: Abe's
Oddysee more than a year in advance of its release. This integrated marketing
approach included extensive press contact, development of point-of-purchase
displays, print and TV advertising, Internet promotion, east and west coast
press events and a global synchronized launch on "Odd Friday."

The Internet is an integral element of the Company's marketing efforts
used, in part, to generate awareness for titles months prior to their market
debut. The Company incorporates the Internet into its marketing programs through
the creation of product-dedicated mini-sites and on-line promotions. In
addition, the Company provides editorial material to on-line publications that
reach the core gaming audience.

To capitalize on the innovative nature of its products, the Company has
developed a public relations program that has resulted in coverage for the
Company by trade journals and also by well-recognized publications such as The
New York Times, Entertainment Weekly, Newsweek and USA Today. Among the
marketing strategies the Company utilizes is the creation of special press
events to coincide with the launch of a new product.

As of March 31, 1998, the Company's staff included 138 employees in
domestic sales and marketing and 42 employees in international sales and
marketing. The Company also uses independent field sales representative
organizations to assist in servicing its mass merchant accounts.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

The Company sells a significant portion of its published software under
licenses from independent developers and, in such cases, does not acquire the
copyrights. The Company relies primarily on a combination of trademark,
copyright, trade secret and other proprietary rights laws, license agreements,
employee and third-party nondisclosure agreements and other legal methods to
protect its proprietary rights and the rights of its developers. United States
copyright law, international conventions and international treaties, however,
may not provide meaningful protection against unauthorized duplication or
infringement of the Company's software.

Policing unauthorized use of an easily duplicated and broadly disseminated
product such as computer software is very difficult. Software piracy is expected
to be a persistent problem for the software industry. These problems are
particularly acute in certain international markets such as South America, the
Middle East, the Pacific Rim and the Far East. If a significant amount of
unauthorized copying of the Company's products were to occur, the Company's
business, operating results and financial condition could be adversely affected.

Software developers and publishers are frequently subject to infringement
claims. There can be no assurance that third parties will not assert
infringement claims against the Company in the future with respect to current or
future products.

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There has been substantial litigation in the industry regarding copyright,
trademark and other intellectual property rights. Any such claims or litigation,
with or without merit, could be costly and a diversion of management's
attention, which could have a material adverse effect on the Company's business,
operating results and financial condition. Adverse determinations in such claims
or litigation could have a material adverse effect on the Company's business,
operating results and financial condition. The Company is presently in
litigation against Micro Star Software ("Micro Star"), the publisher of a
product entitled Nuke It comprised largely of additional levels of play for Duke
Nukem 3D which are created by game users and available over the Internet
("Player Created Levels"). The Company contends that the sale of Nuke It
infringes the copyright on Duke Nukem 3D (which the Company publishes under
license with the parent of 3D Realms) and violates the Lanham Act's trademark,
unfair competition and false advertising provisions. On September 26, 1996, the
Company obtained a preliminary injunction in federal court in San Diego,
California ordering the recall of all copies of Nuke It then in the stores,
based on the use of Duke Nukem 3D's protected expression on Nuke It's packaging
and in some copies of the Nuke It CD-ROM. The Court also held as a preliminary
matter that the Player Created Levels contained in Nuke It did not themselves
contain expression from the Duke Nukem 3D game in protectable form. Because the
Company believes that this holding is erroneous, it is pursuing an appeal to the
U.S. Court of Appeals for the Ninth Circuit, which was argued on November 4,
1997, seeking an injunction halting the sale of Nuke It and any subsequent Micro
Star product containing additional levels of play for Duke Nukem 3D. Micro Star
has appealed the Court's decision granting the injunction.

MANUFACTURING

The Company's CD-ROM disk and 3 1/2 inch diskette duplication is contracted
out to a number of third-party disk duplication companies. Printing of user
manuals and of packaging materials is performed to the Company's specifications
by outside sources. Disks, user manuals and sales brochures are, for the most
part, assembled for sale by the Company. To date, the Company has not
experienced any material difficulties or delays in the manufacture and assembly
of its products, or material returns due to product defects.

Sony and Nintendo manufacture the Company's products that are compatible
with their respective video game consoles, as well as the manuals and packaging
for such products, and ship finished products to the Company for distribution.
PlayStation products consist of CD-ROMs and are typically delivered to the
Company by Sony within a relatively short lead time. Manufacturers of Nintendo
and other video game cartridges typically deliver software to the Company within
45 to 60 days after receipt of a purchase order. If the Company experiences
unanticipated delays in the delivery of manufactured software products, its net
revenues and operating results could be materially adversely affected.
Furthermore, the long manufacturing cycle associated with video game cartridges
requires that the Company forecast retailer and consumer demands for its
manufactured titles further in advance of shipment than for PC-based products or
PlayStation CD-ROMs.

EMPLOYEES

As of March 31, 1998, the Company had 1,372 employees worldwide.
Domestically, there were a total of 1,260 employees with 107 in administration
and finance, 56 in operations, 138 in sales and marketing, 324 in product
development and 635 in manufacturing and distribution. Included in the 635 for
manufacturing and distribution are 463 employees who are members of Local 734 of
the L.I.U. of N.A. of the AFL-CIO (the "Union"). The Union employees are all
located at the Edison, NJ distribution and return centers and are subject to a
collective bargaining agreement between the Company and the Union which expired
on May 31, 1998. The Company and the Union have entered into negotiations for
the purpose of renegotiating their collective bargaining agreement and
management anticipates resolving the outstanding issues without any material
adverse impact to the Company. The Company believes its relations with its
employees are good.

Internationally, as of March 31, 1998, the Company had 112 employees with
32 in administration, 6 in operations, 42 in sales and marketing, 29 in product
development and 3 in distribution.

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FACTORS AFFECTING FUTURE PERFORMANCE
-----------------------------------------------------------

DEPENDENCE ON KEY CUSTOMER; CREDIT RISK

The Company believes it is the largest supplier of consumer software to
2,325 Wal-Mart stores, including titles published by the Company and products
from other publishers. On a pro forma basis, after giving effect to the 1995
acquisition of Slash, sales to Wal-Mart accounted for approximately 37%, 36%,
45% and 48% of the Company's net revenues for the three months ended March 31,
1998 and for the years ended December 31, 1997, 1996 and 1995, respectively.
Accounts receivable from Wal-Mart were approximately $49 million and $70 million
at March 31, 1998 and December 31, 1997, respectively. The Company's status as
Wal-Mart's largest supplier is not based upon any written agreement or
understanding. Accordingly, such status could end at any time. In addition,
Wal-Mart has dedicated the software department in a limited number of stores to
other software publishers on a test basis. There can be no assurance that
Wal-Mart will continue to use the Company as its largest supplier of consumer
software, or at all. The loss of Wal-Mart as a customer, a significant decrease
in product shipments to or an inability to collect receivables from Wal-Mart or
any other adverse change in the Company's relationship with Wal-Mart could have
a material adverse effect on the Company's business, operating results and
financial condition. During the second half of 1997, Wal-Mart began purchasing
software directly from five publishers whose software was previously sold to
Wal-Mart through the Company. Wal-Mart may commence purchasing products directly
from other publishers. Such direct purchases could significantly reduce the
Company's sales to Wal-Mart. Gross sales of those companies' products to
Wal-Mart through the Company had aggregated approximately $29 million and
$37 million for the six months ended June 30, 1997 and for the year ended
December 31, 1996, respectively.

The Company's sales are typically made on credit, with terms that vary
depending upon the customer and the nature of the product. The Company does not
hold collateral to secure payment. Retailers and distributors compete in a
volatile industry and are subject to the risk of business failure. Although the
Company maintains a reserve for uncollectible receivables that it believes to be
adequate, there can be no assurance that such reserve is adequate or that
additional payment defaults on significant sales would not materially and
adversely affect its business, operating results and financial condition.

DEPENDENCE ON NEW PRODUCTS, SEQUELS AND PRODUCT ENHANCEMENT INTRODUCTIONS;
PRODUCT DELAYS

The Company's continued success in the publishing business depends on the
timely introduction of successful new products, sequels or enhancements of
existing products to replace declining revenues from older products. Consumer
preferences for software products are difficult to predict, and few consumer
software products achieve significant market acceptance. If revenues from new
products, sequels or enhancements were to fail to replace declining revenues
from existing products, the Company's business, operating results and financial
condition could be adversely affected. Sequels have become more important to the
Company's product line, but there can be no assurance that a sequel will be as
popular as the original title or that a sequel will be released in time to
capitalize on the popularity of the original title. The process of developing
software products such as those offered by the Company is extremely complex and
is expected to become more complex and expensive in the future as new platforms
and technologies are addressed. A significant delay in the introduction of one
or more new products, sequels or enhancements 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 view of the
seasonality of the Company's business. See "-- Reliance on Third-Party Software
Developers -- Reliance on Other Publishers; Recovery of Prepaid Royalties" and
"-- Fluctuations in Quarterly Operating Results; Seasonality."

RELIANCE ON THIRD-PARTY SOFTWARE DEVELOPERS -- RELIANCE ON OTHER PUBLISHERS;
RECOVERY OF PREPAID ROYALTIES

Although the Company substantially increased, primarily through
acquisitions, its internal software development capabilities in 1996 and 1997, a
majority of the Company's published products are still licensed from, or
developed by, independent software developers. The Company's success depends in
part on its continued ability to obtain and renew product development agreements
with independent developers. There can be no assurance that the Company will be
able to obtain or renew product development agreements, or to

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obtain such content, on favorable terms, or at all. Similarly, there can be no
assurance that the Company will obtain rights to sequels of products developed
by independent developers for the Company. Such agreements are terminable, in
some cases without notice, upon the occurrence of one or more of the following
events: those involving the bankruptcy or insolvency of either party to such
agreements, the cessation of operations by either of such parties or the
material breach of specified provisions of such agreements which breach is not
cured within a designated time frame. See "Business -- Publishing." As
independent developers are in high demand, there can be no assurance that
independent developers, including those which have developed products for the
Company in the past, will be available to develop products for the Company in
the future. Furthermore, independent developers may begin publishing their own
titles rather than relying on software publishers such as the Company for
distribution of their titles. For example, in January 1998, a newly formed
consortium, in which a number of independent software developers (including
Apogee Software (3D Realms), developer of Duke Nukem and Prey, and Epic
Megagames, developer of Unreal) purport to have ownership interests, announced
that it has secured publishing rights with respect to software titles to be
produced by such developers. The consortium also announced, however, that such
developers intend to fulfill their existing commitments to other software
publishers, including the Company. Although the Company believes that at the
present time it is premature to assess the competitive impact of the consortium,
there can be no assurance that the competitive pressures exerted by the
consortium will not have an adverse effect on the Company's ability to secure
future publishing commitments from such developers or any other software
developers and, consequently, on the Company's business, operating results and
financial condition.

Many independent developers have limited financial resources, which could
expose the Company to the risk that such developers may go out of business prior
to completing a project. In addition, the Company cannot always control the
timing of the introduction of its products which are developed by or in
conjunction with independent developers. While the Company maintains production
liaisons with these developers, there can be no assurance that new products
developed by them and published by the Company will be introduced on schedule or
at all or within acceptable quality guidelines.

The Company also distributes products on behalf of other publishers. There
can be no assurance that the Company will obtain or renew any rights to
distribute such products. Failure to retain or obtain such rights could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business -- Publishing" and "-- Merchandising and
Distribution."

Due primarily to the increased demand for consumer software programs, the
payment of advances and guaranteed royalties to independent developers has
increased and may continue to increase. In connection with its licensing
arrangements with independent software developers, the Company had an estimated
$10.0 million of royalty advances, associated with multi-year output contracts,
on its balance sheet as of March 31, 1998. There can be no assurance that
current or future royalty advances will be recouped. The failure to release the
products associated with royalty advances, or a delay in release, would prevent
or delay the Company's ability to receive revenue to recoup such advances.
Further, the sales volumes of products subject to such arrangement may not be
sufficient to recover such advances.

RISKS ASSOCIATED WITH ACQUISITIONS

Over the last three years, the Company has acquired seven consumer software
companies. The Company undertook these acquisitions to expand its publishing and
distribution capabilities with the assumption that the combined entity would be
better able to take advantage of market opportunities than if each of the
companies were operated individually. Realization of these benefits will depend
in part on the ability of the Company to retain in-house publishing staffs and
third-party relationships and to integrate distribution, sales and marketing
capabilities. The Company has partially integrated the acquired companies by
consolidating certain operations, offices and facilities, and combining
administrative, accounting, sales and marketing and distribution functions. The
integration of these acquired companies involves, among other things, the
opening of new facilities or the expansion of existing facilities, the expansion
of accounting systems, controls and procedures, the increase in warehouse and
distribution capabilities, the closing of redundant facilities and the
elimination of duplicate personnel. The Company is in the early stages of
integrating certain of the more recently acquired companies and there can be no
assurance that the integration will be completed without disrupting the

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Company's business. Should the Company not be able to achieve such integration
or not be able to achieve it in a timely manner or in a coordinated fashion, it
could materially and adversely affect the Company's business, operating results
and financial condition.

The Company believes that its future growth will depend, in part, on its
ability to continue to identify, acquire and integrate companies which have
software development and publishing capabilities. Such acquisitions are subject
to the negotiation of definitive agreements and to typical conditions in
acquisition transactions, certain of which conditions may be beyond the
Company's control. While the Company reviews acquisition opportunities in the
ordinary course of its business, some of which may be material and some of which
are currently under investigation or discussion, the Company presently has no
commitments or undertakings with respect to any material acquisitions. There is
no assurance that the Company will be able to identify desirable acquisition
candidates or will be successful in entering into definitive agreements with
respect to desirable acquisitions. Moreover, even if definitive agreements are
entered into, there is no assurance that any future acquisition will thereafter
be completed or, if completed, that the anticipated benefits of the acquisition
will be realized. The process of integrating acquired operations into the
Company's operations may result in unforeseen operating difficulties, may
require significant management attention and financial resources that would
otherwise be available for the ongoing development or expansion of the Company's
existing operations. There can be no assurance that the Company will be able to
retain, motivate and manage key employees of those companies which it acquires.
Future acquisitions by the Company could result in the incurrence of additional
debt and contingent liabilities, which could have a material adverse effect on
the Company's financial condition and results of operations.

FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; SEASONALITY

The Company has experienced and may continue to experience significant
quarterly fluctuations in net revenues and operating results due to a variety of
factors, including fluctuations in the mix of products with varying profit
margins sold by the Company, the size and timing of acquisitions, the size and
growth rate of the consumer software market, market acceptance of the Company's
products (including the Company's published and third-party distributed titles)
and those of its competitors, development and promotional expenses relating to
the introduction of new products, sequels or enhancements of existing products,
projected and actual changes in product platforms, the timing and success of
product introductions by the Company and its competitors, product returns,
changes in pricing policies by the Company and its competitors, the accuracy of
retailers' forecasts of consumer demand, the timing of orders from major
customers, order cancellations and delays in shipment. In addition, delays in
the introduction of the Company's front-line titles could result in material
fluctuations of the Company's operating results. The Company has experienced,
and expects to experience in the future, significant fluctuations in its
quarterly net revenues and operating results as a result of such factors. In
response to competitive pressures, the Company may take certain pricing or
marketing actions that could materially and adversely affect the Company's
business, operating results and financial condition. The Company's products are
generally shipped as orders are received and, accordingly, the Company operates
with little backlog. The Company's expense levels are based, in part, on its
expectations regarding future sales and, as a result, operating results could be
disproportionately adversely affected by a decrease in sales or a failure to
meet the Company's sales expectations. Defective front-line published products
may result in higher customer support costs and product returns.

Furthermore, the consumer software business is seasonal. Net revenues are
typically significantly higher during the fourth calendar quarter, due primarily
to the increased demand for consumer software during the year-end holiday buying
season. Net revenues in other quarters are generally lower and vary
significantly. Accordingly, the Company believes that period to period
comparisons of operating results are not necessarily meaningful, unless such
comparisons are made between the comparable periods in different years, and
should not be relied upon as an indication of future performance. There can be
no assurance that the Company will achieve consistent profitability on a
quarterly or annual basis.

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CHANGING PRODUCT PLATFORMS

The consumer software market is characterized by rapidly changing
technology, particularly with respect to product platforms. The Company must
continually anticipate the emergence of, and adapt its products to, popular
platforms for consumer software. When the Company chooses to publish or develop
a product for a new platform, it may be required to make a substantial
development investment one to two years in advance of shipments of products for
that platform. If the Company invests in the development of a product for a
platform that does not achieve significant market penetration, the Company's
planned revenues from that product will be adversely affected and it may not
recover its development investment. In addition, if the Company does not choose
to publish or co-develop for a platform that achieves significant market
success, the Company's revenue growth and competitive position may also be
adversely affected. See "Business -- Publishing."

DEPENDENCE ON SKILLED KEY PERSONNEL

The continued success of the Company depends to a significant extent upon
the continued performance and contribution of its senior management and on its
ability to continue to attract, motivate and retain highly qualified employees.
Competition for highly skilled employees with technical, management, marketing,
sales, product development and other creative skills is intense, and there can
be no assurance that the Company will be successful in attracting and retaining
such personnel. The loss of the services of any of the Company's skilled
employees or senior management could have a material adverse effect on the
Company's business, operating results and financial condition. Additionally, the
Company may experience increased costs in order to attract and retain skilled
employees. Further, while the Company has entered into employment agreements
with certain skilled employees and members of its senior management, there can
be no assurance that such employees will not leave or compete with the Company.
The Company's failure to attract additional qualified employees or to retain the
services of key personnel could materially and adversely affect the Company's
business, operating results and financial condition.

INTERNATIONAL SALES

The Company has increased international sales materially over the past
three years, and expects that international sales will account for a significant
portion of its net revenues in the future. International sales are subject to
inherent risks, including unexpected changes in regulatory requirements, tariffs
and other barriers, fluctuating exchange rates, potential political instability,
difficulties installing and managing foreign operations and difficulty in
collection of accounts receivable. In addition, acceptance of the Company's
products in certain markets has required, and may in the future require,
extensive, time-consuming and costly modifications to localize the products for
use in particular markets. Software piracy presents a particularly acute problem
in certain international markets such as South America, the Middle East, the
Pacific Rim and the Far East, and the laws of foreign junctions may not protect
the Company's proprietary rights to the same extent as the laws of the United
States. There can be no assurance that these or other factors will not have a
material adverse effect on the Company's future international sales and,
consequently, on the Company's business, operating results and financial
condition. See "Business -- Publishing."

COMPETITION

The market for consumer software products is highly competitive. Only a
small percentage of products introduced in the consumer software market achieve
any degree of significant market acceptance. Competition is based primarily upon
game appeal, price, access to retail shelf space, product enhancements, ability
to operate on popular platforms, availability of titles, new product
introductions, marketing support and distribution channels.

The Company competes primarily with other publishers of PC and video game
console interactive entertainment software, such as Cendant Corporation,
Electronic Arts Inc., Broderbund Software Inc. and The Learning Company. Many of
the companies with which the Company currently competes or may compete in the
future have comparable or greater financial, technical, marketing, sales and
customer support

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<PAGE> 16

resources, larger and more seasoned internal development teams, greater name
recognition and a larger customer base than the Company. In addition, the
Company believes that large software companies, media companies and film studios
are increasing their focus on the interactive entertainment and edutainment
software markets and, as a result of their financial and other resources, name
recognition and customer base, may become significant competitors of the
Company. Moreover, in a number of geographic markets, certain of the titles
offered by the Company, including various hit titles, are offered on a limited
number of platforms and compete with the same titles offered by the Company's
competitors on other platforms. Current and future competitors with greater
financial resources than the Company may be able to carry larger inventories,
undertake more extensive marketing campaigns, adopt more aggressive pricing
policies and make higher offers or guarantees to software developers and
licensors than the Company. See "-- Reliance on Third-Party Software
Developers -- Reliance on Other Publishers; Recovery of Prepaid Royalties."

The consumer software products market is also extremely competitive with
respect to access to third-party developers and content providers. This
competition is based primarily on breadth of distribution, development funding,
reputation and royalty rates. To the extent that competitors maintain or achieve
greater title portfolio breadth, title rights for popular platforms, or access
to third-party developers and content providers, or price, shelf access,
marketing support, distribution or other selling advantages, the Company could
be materially and adversely affected. In addition, several competitors of the
Company have recently sought to expand their distribution capabilities. New
hardware platforms and electronic delivery systems may be introduced into the
software market and potential new competitors may enter the software development
and distribution market, resulting in greater competition for the Company.

There can be no assurance that the Company will have the resources required
to respond effectively to market or technological changes or to compete
successfully with 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. In addition, as part of its value
added distribution program, the Company seeks to provide its mass merchant
customers with a wide variety of popular titles. Achieving such a product mix
requires the Company to supplement the distribution of its published products
with certain third-party software products, including products published by the
Company's competitors. There can be no assurance that such competitors will
continue to provide such products to the Company for distribution to the
Company's mass merchant customers and, in fact, during 1997 five competitors
began selling their products directly to Wal-Mart, rather than through the
Company. See "-- Dependence on Key Customer; Credit Risk." The failure to obtain
software titles developed or published by one or more of the Company's
competitors, and not being able to obtain these products from other
distributors, could have a material adverse effect on the Company's
relationships with such mass merchant customers, which in turn would have a
material adverse effect on the Company's business, operating results and
financial condition.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

The Company sells a significant portion of published software under
licenses from independent developers and, in such cases, does not acquire the
copyrights for the underlying work. The Company relies primarily on a
combination of patent, trademark, copyright, trade secret and other proprietary
rights laws, license agreements, employee and third-party nondisclosure
agreements and other legal methods to protect its own proprietary rights and the
rights of its developers. Unauthorized copying occurs within the software
industry, and if there is a significant increase in the amount of unauthorized
copying of the Company's published products or products distributed by it, the
Company's business, operating results and financial condition could be
materially and adversely affected. United States copyright law, international
conventions and international treaties, however, may not provide meaningful
protection against unauthorized publication or infringement of the Company's
software. Also, as the number of software products in the industry increases and
the functionality of these products further overlaps, software developers and
publishers may increasingly become subject to infringement claims. There can be
no assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products. There has been
substantial litigation in the industry regarding copyright, trademark and other
intellectual property rights. The Company has also initiated litigation to
assert its intellectual property rights. Any such claims or litigation, whether
against the Company, with or without merit, or brought by the Company, could be
costly

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and cause a diversion of management's attention, which could have a material
adverse effect on the Company's business, operating results and financial
condition. See "Business -- Intellectual Property and Proprietary Rights."

LEGAL PROCEEDINGS

In January, February, and March 1998, ten substantially similar complaints
were filed against the Company, its Chairman Emeritus of the Board of Directors
and its Chairman and Chief Executive Officer, and in certain actions, its Chief
Financial Officer, in the United States District Court for the Southern District
of New York. The plaintiffs, in general, purport to sue on behalf of a class of
persons who purchased shares (and as to certain complaints, purchased call
options or sold put options) of the Company during the period from August 1,
1996 through December 12, 1997 and allege that the Company violated the federal
securities laws by making misrepresentations and omissions of material facts
that allegedly artificially inflated the market price of the Company's Common
Stock during the class period. Plaintiffs allege that the Company failed to
expense properly certain prepaid royalties for software products that had been
terminated or had failed to achieve technological feasibility, which
misstatements purportedly had the effect of overstating the Company's net income
and net assets. The Company has not yet moved or answered with respect to the
complaints, pending the anticipated filing of a consolidated amended complaint
after the court's determination of a lead plaintiff and its counsel. The Company
believes that these complaints are without merit and intends to defend itself
vigorously against these actions, however, at this stage in the actions no
assurance can be given as to their ultimate resolution or that an adverse
outcome could not have a material adverse effect on the Company's results of
operations and financial condition. See "Item 3. Legal Proceedings."

INTERNET STRATEGIES

The Company believes that the proliferation of Internet users and on-line
networks has created new opportunities for the consumer software industry,
including opportunities to strengthen marketing, promotion and direct
distribution, broaden its reach to new customers, add value to existing products
and to develop new products and markets. The Company has initiated steps to take
advantage of these opportunities, including the expansion of its site on the
World Wide Web and the development of its Internet infrastructure and
capabilities, including electronic distribution capabilities, incorporation of
on-line functionality into existing products, and continued development of, and
investment in, new Internet-based businesses and products, including multi-
player entertainment products. The Company has incurred, and expects to incur,
significant additional costs in connection with its Internet infrastructure,
including costs associated with the acquisition and maintenance of hardware and
software necessary to allow for on-line commerce and multi-player games, as well
as the maintenance of its website and personnel who dedicate significant amount
of time thereto. Although the Company believes that these platforms and
technologies are an integral part of its overall business, there can be no
assurance that the Company's Internet strategies will be successful, or that the
related costs and investments will provide adequate, if any, returns. Further,
the Company's revenues arising from its third-party distribution business may be
adversely affected as Internet technology is improved to enable consumers to
purchase and download full-version software products directly from publishers
over the Internet.

PRODUCT RETURNS; INVENTORY RISK

The Company accepts product returns or provides markdowns or other credits
on varying terms in the event that the customer holds excess inventory of the
Company's products. In addition, software products as complex as those published
by the Company may contain undetected errors when first introduced or when new
versions are released. It is the Company's practice to accept returns of
defective or damaged products at any time. At the time of product shipment, the
Company establishes a return reserve which covers expected future returns of
excess inventory or defective products and, if necessary, price protection. This
estimate of the

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potential for future returns of products is based on historical return rates,
seasonality of sales, retailer inventories of the Company's products and other
factors. The Company has historically experienced product returns at a rate of
approximately 30% of gross sales. While the Company is able to recover the
majority of its costs on returns of third-party products which it distributes,
the Company fully bears the financial risk of returns of its own published
products. In addition, as part of the cost of console titles, the Company pays
license fees to Sony and Nintendo. These license fees are non-refundable and are
not recovered by the Company in the event of returns of console products.
Although the Company maintains reserves which it believes to be adequate with
respect to product returns and price reductions, there can be no assurance that
actual returns to the Company will not exceed the reserves established, which
could materially and adversely affect the Company's business, operating results,
and financial condition.

YEAR 2000 ISSUES

The Company has reviewed its critical information systems for Year 2000
compliance and is in the process of developing a plan to remedy any deficiencies
in a timely manner. The Company expects to resolve Year 2000 compliance issues
primarily through normal upgrades of its software or, when necessary, through
replacement of existing software with Year 2000 compliant applications. The cost
of these upgrades or replacements, some of which have been budgeted for the year
ending March 31, 1999, is not expected to be material to the Company's financial
position or results of operations. However, there can be no assurance that such
upgrades and replacements can be completed on schedule or within estimated costs
or can successfully address the Year 2000 compliance issues. In addition, the
Company is in the process of asking vendors to certify that they are Year 2000
compliant or, if they are not yet so compliant, to provide a description of
their plans to become so. If the Company's present efforts to address the Year
2000 compliance issues are not successful, or if vendors and other third parties
with which the Company conducts business do not successfully address such
issues, the Company's business, operating results and financial position could
be materially and adversely affected.

CONTROL OVER, AND EXPENSE OF, GAME CONSOLE PRODUCTS

The Company's contracts with hardware licensors such as Sony and Nintendo,
who are among the Company's competitors, often grant significant control to the
licensor over the manufacturing of the Company's products. This fact could, in
certain circumstances, leave the Company unable to have its products
manufactured and shipped to customers. In most events, control of the
manufacturing process by hardware companies increases both the manufacturing
lead times and the expense to the Company over the lead times and costs that the
Company could achieve independently. The Company could experience delays in the
manufacturing of products which would cause delays in shipping those products.
The results of future periods could be adversely affected by such delays.
Finally, the Company's contracts with its hardware licensors often require the
Company to take significant risks in prepaying for and holding its inventory of
products and the inability to subsequently sell these products at anticipated
prices could materially and adversely affect the Company's business, operating
results and financial condition. See "Business -- Manufacturing."

17
<PAGE> 19

ITEM 2. PROPERTIES

The Company's principal administrative, sales, marketing and development
facilities are located in approximately 90,000 square feet of space at 417 Fifth
Avenue in New York City under a lease expiring in 2007, which commenced in
December 1996.

The Company maintains a 192,900 square foot distribution center and a
70,000 square foot return center in Edison, New Jersey under leases that expire
in July 1999 and May 2000, respectively. In Redwood City, California, the
Company maintains approximately 4,000 square feet of office space under a lease
that expires in November 1998.

The Company also maintains several facilities in London, England totaling
approximately 16,000 square feet, from which it conducts a substantial portion
of its European operations, under leases that expire in the years 2000 and 2020.
One of these facilities is owned by Marylebone 248 Realty LLC, an affiliate of
Joseph J. Cayre, Chairman Emeritus of the Board of Directors. The Company
believes that the terms of this lease are no less favorable to the Company than
those it could obtain from independent third parties. Due to the expansion of
international operations, the Company has leased additional office space in
London, England under a lease expiring in December 2000.

In connection with the acquisition of Warner Interactive, the Company
maintains office space in Hamburg, Germany, and Melbourne and St. Leonards,
Australia. These leases in Germany and Australia, which occupy approximately
3,000 and 4,600 square feet, will expire in August 2000 and November 2000,
respectively. The Company has leased additional office space in Paris, France,
amending an existing lease, which will expire in September 2007.

The Value Price Division is occupying approximately 240,000 square feet of
office, warehouse and distribution space in the Plymouth, Minnesota area under a
lease that expires in September 1999. Approximately 56,400 and 26,200 square
feet of storage space is occupied under leases that expire in November 1998 and
November 1999, respectively, in Plymouth, Minnesota. The Company is actively
trying to sublet its prior office and warehouse space of approximately 15,000
square feet in Annapolis, Minnesota, under a lease that expires in December
1998, although there is no assurance that it will be able to do so.

In Scottsdale, Arizona, the Company maintains two leases: a 25,000 square
foot office space under a lease expiring in March 2006 which has been sublet for
the remaining term, and a 2,900 square foot office space under a lease expiring
in May 2000.

The Company maintains offices in Woodinville and Bothell, Washington for
its Humongous subsidiary. These leases provide approximately 25,500 and 13,000
square feet of office space that expire in June 1998 and December 1998,
respectively. Due to the expansion of the Company's internal development, the
Company has leased approximately 65,500 square feet of office space to house its
Humongous subsidiary which is currently being built in Bothell, Washington,
under a lease expiring in May 2008.

In connection with the acquisitions of SingleTrac and One Stop, the Company
has assumed the leases for approximately 15,500 and 1,000 square feet of office
space in Salt Lake City, Utah and London, England, which will expire in November
2003 and August 2002, respectively.

ITEM 3. LEGAL PROCEEDINGS

On September 18, 1997, Scavenger, Inc., a software developer ("Scavenger"),
filed a lawsuit against the Company in the New York Supreme Court claiming that
the Company breached a software development contract between the parties dated
November 28, 1995. Scavenger alleges that the Company, after paying $2.5 million
in advances and accepting delivery of gold master disks for two computer games,
refused to pay any more advances, including advances relating to the development
of two additional games under the agreement. Scavenger is suing for the
remaining advances ($4.3 million) and for future royalties ($5 million), and
also seeks consequential damages for allegedly being forced out of business
($100 million) and losing contracts with unspecified third parties ($4 million)
as a result of the Company's alleged breach. The Company filed an answer and
counterclaim, in which it denies any liability to Scavenger and alleges, among

18
<PAGE> 20

other things, that the contract was lawfully terminated when Scavenger failed to
deliver the two remaining games after receiving from the Company written notice
to cure its material breaches. By its counterclaim, the Company seeks damages
and restitution for at least $5 million on grounds of breach of contract and
unjust enrichment. A preliminary conference before the court was held on
February 11, 1998, and discovery is proceeding. The Company believes the claims
by Scavenger are without merit, arose in the ordinary course of business, and
that the ultimate resolution will not be material to the Company's results of
operations or financial condition. The Company intends to vigorously defend this
action and pursue its counterclaim.

In January, February, and March 1998, ten substantially similar complaints
were filed against the Company, its Chairman Emeritus of the Board of Directors
and its Chairman and Chief Executive Officer, and in certain actions, its Chief
Financial Officer, in the United States District Court for the Southern District
of New York. The plaintiffs, in general, purport to sue on behalf of a class of
persons who purchased shares (and as to ceratin complaints, purchased call
options or sold put options) of the Company during the period from August 1,
1996 through December 12, 1997 and allege that the Company violated the federal
securities laws by making misrepresentations and omissions of material facts
that allegedly artificially inflated the market price of the Company's Common
Stock during the class period. Plaintiffs allege that the Company failed to
expense properly certain prepaid royalties for software products that had been
terminated or had failed to achieve technological feasibility, which
misstatements purportedly had the effect of overstating the Company's net income
and net assets. The Company has not yet moved or answered with respect to the
complaints, pending the anticipated filing of a consolidated amended complaint
after the court's determination of a lead plaintiff and its counsel. The Company
believes that these complaints are without merit and intends to defend itself
vigorously against these actions, however, at this stage in the actions no
assurance can be given as to their ultimate resolution or that an adverse
outcome could not have a material adverse effect on the Company's results of
operations and financial condition.

On May 26, 1998, Big Tuna New Media, LLC ("Big Tuna"), a developer of
children's software titles, filed suit against the Company in the United States
District Court for the Southern District of New York seeking over $35 million in
damages, $9 million in punitive damages and injunctive relief for alleged
breaches of 1995 and 1996 rights acquisition agreements (the "1995 Agreement"
and the "1996 Agreement," respectively). Under the 1995 Agreement, Big Tuna has
delivered three out of four software titles and has been paid $1.75 million in
advances recoupable against royalties, with a remaining $250,000 advance due
upon acceptable delivery of the fourth title. Under the 1996 Agreement, the
Company has a five year option to have Big Tuna develop for commercial
exploitation between three and five children's software titles per year, as
proposed by Big Tuna, in exchange for a minimum $1 million per year in
royalties, stock warrant appreciation or cash payment, for a total of $5 million
or more. Big Tuna claims that the Company repudiated and breached the 1996
Agreement, by among other things, sending to Big Tuna a notice to cure its
material and anticipatory breaches (in light of Big Tuna's failure to timely
deliver final proposals) and not making a $1 million payment on or about May 9,
1998, breached confidentiality provisions of the 1995 and 1996 Agreements by
allegedly misappropriating Big Tuna's "novel and original ideas" for use in
other games, violated the 1995 Agreement and the Lanham Act by improperly
bundling for sale two Big Tuna titles created under the 1995 Agreement with
non-Big Tuna titles, and violated the 1995 Agreement through accounting
irregularities. The Company intends to deny liability and assert counterclaims
against Big Tuna for, without limitation, its failure to timely provide final
proposals for software titles to the Company in accordance with the 1996
Agreement. The Company believes that Big Tuna's claims arose in the ordinary
course of business and that the ultimate resolution will not be material to the
Company's results of operations or financial condition.

Additionally, the Company is involved in various claims and legal actions
arising in the ordinary course of business, the ultimate resolution of which
management believes will not be material to the Company's results of operations
or financial condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

There were no items submitted to a vote of security holders during the
three month transition period ended March 31, 1998.

19
<PAGE> 21

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock is quoted on the Nasdaq National Market. The
high and low sale prices for the Common Stock as reported by the Nasdaq National
Market for the years ended December 31, 1996 and 1997 and the three month
transition period ended March 31, 1998 are summarized below. These over-the-
counter market quotations reflect inter-dealer prices, without retail mark-ups,
mark-downs, or commissions and may not necessarily represent actual
transactions.

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1996
First Quarter............................................... $15 $ 8 7/8
Second Quarter.............................................. $25 $10 5/8
Third Quarter............................................... $26 3/4 $16 3/4
Fourth Quarter.............................................. $26 3/4 $ 6 5/8
1997
First Quarter............................................... $ 9 1/4 $ 7 1/8
Second Quarter.............................................. $11 7/8 $ 5 7/8
Third Quarter............................................... $12 3/4 $ 9
Fourth Quarter.............................................. $12 3/8 $ 6 1/8
1998
Three Month Transition Period............................... $ 8 9/16 $ 5 5/16
</TABLE>

On June 19, 1998, the last reported sale price of the Common Stock on the
Nasdaq National Market was $7 5/16. As of June 19, 1998, there were
approximately 243 registered holders of record of the Common Stock.

The Company currently anticipates that it will retain all of its future
earnings for use in the expansion and operation of its business and does not
anticipate paying any cash dividends on its Common Stock in the foreseeable
future. In addition, the payment of cash dividends is limited by the Credit
Agreement and may be limited by financing agreements entered into by the Company
in the future.

There were no sales of unregistered securities by the Company during the
three month transition period ended March 31, 1998.

20
<PAGE> 22

ITEM 6. SELECTED FINANCIAL DATA

The following tables set forth selected consolidated financial information
of the Company which, for each of the years in the four year period ended
December 31, 1997 and the three months ended March 31, 1998, is derived from the
audited consolidated financial statements of the Company. Consolidated financial
information for the three months ended March 31, 1997 is unaudited. These tables
should be read in conjunction with the Company's Consolidated Financial
Statements, including the notes thereto, appearing elsewhere in this Transition
Report on Form 10-K. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
----------------------------------------- ------------------
1994 1995 1996 1997 1997 1998
-------- -------- -------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues.................................. $101,826 $234,461 $365,490 $530,677 $93,381 $105,767
Cost of goods sold............................ 54,449 138,662 214,580 315,134 57,883 57,092
Selling and distribution expenses............. 16,104 41,733 72,517 98,689 16,538 24,467
General and administrative expenses........... 10,539 19,491 31,157 45,561 8,623 10,655
Research and development...................... -- 1,717 5,633 13,824 2,397 10,866
Royalty advance write-off..................... -- -- -- 73,821 -- --
Purchased research and development............ -- -- -- 11,008 -- --
SingleTrac retention bonus.................... -- -- -- 2,400 -- --
Merger and other costs........................ -- -- 3,718 1,050 -- --
Amortization of goodwill...................... -- 567 1,092 1,295 347 636
-------- -------- -------- -------- ------- --------
Operating income (loss)....................... 20,734 32,291 36,793 (32,105) 7,593 2,051
Interest and other income (expense), net...... 41 795 3,974 (2,075) 247 (1,389)
-------- -------- -------- -------- ------- --------
Income (loss) before income taxes............. 20,775 33,086 40,767 (34,180) 7,840 662
Provision for (benefit from) income taxes:
Federal and state (historical).............. 2,427 14,002 15,628 (9,157) 3,386 304
Benefit from change in tax status(1)........ -- (3,520) -- -- -- --
-------- -------- -------- -------- ------- --------
Total provision for (benefit from)
income taxes....................... 2,427 10,482 15,628 (9,157) 3,386 304
-------- -------- -------- -------- ------- --------
Net income (loss)............................. $ 18,348 $ 22,604 $ 25,139 $(25,023) $ 4,454 $ 358
======== ======== ======== ======== ======= ========
Basic net income (loss) per share............. $ 0.38 $ (0.37) $ 0.07 $ 0.01
Weighted average shares outstanding......... 66,391 66,982 66,395 67,938
Diluted net income (loss) per share........... $ 0.37 $ (0.37) $ 0.07 $ 0.01
Weighted average shares outstanding......... 68,313 66,982 67,358 68,384
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------ MARCH 31,
1994 1995 1996 1997 1998
------ ------- ------- ------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents and short-term
investments................................. $4,496 $93,694 $76,584 $39,713 $17,329
Working capital (deficit)..................... (4,180) 105,748 113,652 77,965 69,994
Total assets.................................. 72,332 301,641 367,111 457,725 365,871
Total debt.................................... 413 868 1,415 54,619 28,017
Stockholders' equity (deficit)................ (3,637) 126,040 152,138 134,241 138,889
</TABLE>

- ---------------
(1) The benefit from change in tax status occurred as a result of the transition
from an S corporation to a C corporation on March 1, 1995, which allowed the
Company to accrue certain tax benefits which would otherwise have flowed to
the stockholders of the S corporation. This benefit would not have arisen
for the year ended December 31, 1995 had the Company been a C corporation
beginning January 1, 1994.

21
<PAGE> 23

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

The Company creates, publishes, merchandises and distributes interactive
entertainment, edutainment and value-priced consumer software for a variety of
platforms on a worldwide basis. Since it commenced operations in February 1993,
the Company has experienced rapid growth and its product and customer mix have
changed substantially.

Publishing, together with merchandising and distribution, are the two major
activities of the Company. Publishing is divided into front-line and
value-priced products. Because each of these product categories has different
associated costs, the Company's margins have depended and will depend, in part,
on the percentage of net revenues attributable to each category. In addition, a
particular product's margin may depend on whether it has been internally or
externally developed and on what platforms it is published. Further, the
Company's margins may vary significantly from quarter to quarter depending on
the timing of its new published product releases. To the extent that mass
merchants require greater proportions of third-party software products, some of
which may yield lower margins, the Company's operating results may be impacted
accordingly.

The worldwide interactive entertainment software market is comprised
primarily of software for two distinct platforms: PCs and dedicated game
consoles. The market has grown dramatically in recent years with its growth
driven by the increasing installed base of multimedia PCs and current generation
game console systems. In addition, the development of enabling multimedia
technologies, the proliferation of software titles, the development of new and
expanding distribution channels and the emergence of a strong international
market for interactive entertainment software have spurred the rapid expansion
of the interactive entertainment market.

The Company develops and publishes products for multiple platforms, and
this diversification continues to be a cornerstone of the Company's strategy.
Sales of the Company's PlayStation, N64 and Sega Saturn titles ("Console
Titles") increased from 9% of the Company's front-line revenue during the year
ended December 31, 1996 ("1996") to 56% in the year ended December 31, 1997
("1997")and 54% in the three months ended March 31, 1998 ("1998"). Since January
1, 1997, the Company has released 22 Console Titles compared to only one in
1996. As evidenced by the strong sales of these platforms, the Company believes
that significant growth opportunities exist across a variety of next generation
hardware platforms, in particular PlayStation and N64, for which the Company
continues to create software products.

There has recently been an increased rate of change and complexity in the
technological innovations affecting the Company's products, coupled with
increased competitiveness for shelf space and buyer selectivity. The market for
front-line titles has become increasingly hit-driven, which has led to higher
production budgets, more complex development processes, longer development
cycles and generally shorter product life cycles. The importance of the timely
release of hit titles, as well as the increased scope and complexity of the
product development and production process, have increased the need for
disciplined product development processes that limit cost and schedule overruns.
This in turn has increased the importance of leveraging the technologies,
characters or storylines of such hit titles into additional interactive
entertainment software products in order to spread development costs among
multiple products. In this environment, the Company has determined to increase
its focus on building internal development, alliances and acquisitions, and to
reduce its relative dependence on third-party developers.

Along with its industry competitors, the Company has historically
capitalized royalties advanced to third-party developers as a prepayment in
current assets and evaluated the realization of these royalty advances on a
quarterly basis. The market changes noted above have made it extremely difficult
to determine the likelihood of individual product acceptance and success. As a
result, in the quarter ended December 31, 1997, the Company expensed royalty
advances of $73.8 million on products that were in development or on sale. In
connection with this change in the dynamics of the marketplace, the Company
changed its accounting, beginning on January 1, 1998, for future royalty
advances, treating such costs as research and development

22
<PAGE> 24

expenses, which are expensed as incurred. Multi-year output advances will
continue to be capitalized as royalty advances and expensed over the development
periods, in accordance with generally accepted accounting principles.

The distribution channels for interactive software have changed
significantly in recent years. Traditionally, consumer software was sold through
specialty stores. Today, consumer software is increasingly sold through mass
merchants such as Wal-Mart, Kmart and Target, as well as major retailers,
including Sam's Club, Price-Costco and Best Buy. The Internet and on-line
networks also present a new channel through which publishers and distributors
can distribute their products to end-users.

In 1996, the Company acquired WizardWorks, a publisher of value-priced
interactive entertainment, edutainment and productivity software, FormGen, a
publisher of interactive PC shareware and software and Humongous, a premier
developer and publisher of original interactive children's software.
WizardWorks, FormGen and Humongous (collectively the "Acquired Companies"), have
each been accounted for as a pooling of interests. Accordingly, the Company's
historical Consolidated Financial Statements have been restated to include the
results of the Acquired Companies.

In 1996, the Company acquired the business of Warner Interactive, a
developer and publisher of interactive PC software. In 1997, the Company
acquired Premier Promotion Limited, the parent company of One Stop, a leading
European value software distributor and publisher and SingleTrac, a leading
developer of front-line software. Financial results of these companies have been
included in the Company's Consolidated Financial Statements on a purchase basis
for the period since the acquisition. Collectively, these acquisitions did not
have a material impact on the financial condition or the results of operations
of the Company in the year acquired.

Sales are recorded net of expected future returns. Historically, the
Company has experienced returns at approximately 30% of gross sales.

Effective January 1, 1998, the Company changed its fiscal year from
December 31 to March 31. Accordingly, the discussion of financial results set
forth below compares the three months ended March 31, 1998 to the comparable
1997 period, and compares the Company's previous calendar years ended December
31, 1997, 1996 and 1995.

The consumer software industry is seasonal. Net revenues are typically
highest during the fourth calendar quarter. This seasonality is primarily a
result of the increased demand for consumer software during the year-end holiday
buying season.

23
<PAGE> 25

RESULTS OF OPERATIONS

The following table sets forth certain consolidated statements of
operations data as a percentage of net revenues for each of the years in the
three years ended December 31, 1997 and the three months ended March 31, 1998,
that is derived from the audited consolidated financial statements of the
Company. The consolidated financial information for the three months ended March
31, 1997 is derived from the unaudited financial statements of the Company.

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------- --------------
1995 1996 1997 1997 1998
------ ------ ------ ----- -----
<S> <C> <C> <C> <C> <C>
Net revenues....................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold................................. 59.1 58.7 59.4 62.0 54.0
Selling and distribution expenses.................. 17.9 19.9 18.6 17.7 23.1
General and administrative expenses................ 8.3 8.5 8.6 9.2 10.1
Research and development........................... 0.7 1.5 2.6 2.6 10.3
Royalty advance write-off.......................... -- -- 13.9 -- --
Purchased research and development................. -- -- 2.1 -- --
SingleTrac retention bonus......................... -- -- 0.4 -- --
Merger and other costs............................. -- 1.0 0.2 -- --
Amortization of goodwill........................... 0.2 0.3 0.2 0.4 0.6
----- ----- ----- ----- -----
Operating income (loss)............................ 13.8 10.1 (6.0) 8.1 1.9
Interest and other income (expense), net........... 0.3 1.1 (0.4) 0.3 (1.3)
----- ----- ----- ----- -----
Income (loss) before income taxes.................. 14.1 11.2 (6.4) 8.4 0.6
Provision for (benefit from) income taxes.......... 4.5 4.3 (1.7) 3.6 0.3
----- ----- ----- ----- -----
Net income (loss).................................. 9.6% 6.9% (4.7)% 4.8% 0.3%
===== ===== ===== ===== =====
</TABLE>

THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997

Net revenues for 1998 increased approximately $12.4 million, or 13.3%, to
$105.8 million from $93.4 million in the comparable 1997 period. This growth in
net revenues was primarily attributable to a 51% increase in publishing revenue,
which includes both front-line and value-priced publishing ("Published
Product"), to $65.9 million from $43.7 million. This increase is due to
continued strong sales of Duke Nukem titles for the Playstation, N64 and the PC,
Deer Hunter for the PC, Hexen for N64, OddWorld: Abe's Oddysee for the
Playstation, Total Annihilation for the PC and newly released titles such as
Freddi Fish 3: The Case of the Stolen Conch Shell, East Meets West and Wild
Turkey Hunt, all for the PC domestically and Quake for N64 internationally. The
overall increase in net revenues was partially offset by the decrease in net
revenues of products distributed for third parties, to $39.9 million, or 38% of
net revenues, in 1998 from $49.6 million, or 53% of net revenues, in the
comparable 1997 period, as a result of Wal-Mart purchasing software directly
from several publishers whose software was previously sold to Wal-Mart through
the Company.

Cost of goods sold primarily includes costs of purchased products. Cost of
goods sold for 1998 decreased approximately $0.8 million, or 1.4%, to $57.1
million from $57.9 million in the comparable 1997 period. Cost of goods sold as
a percentage of net revenues decreased to 54.0% in 1998 as compared to 62.0% in
the comparable 1997 period. The decrease, as a percentage of net revenues, was
primarily due to the Company's change in accounting with respect to royalty
advances, resulting in the expensing of such advances to research and
development as incurred, rather than recouping such advances based on sales.
Additionally, the Company's overall sales mix toward its Published Product,
which generally have higher margins, increased to 62% of net revenues in 1998
compared to 47% in the comparable 1997 period. This decrease was partially
offset by the higher sales of console titles, which generally have higher costs
than PC titles. Console titles accounted for 33% of Published Product revenue in
1998 compared to 15% during the comparable 1997 period.

24
<PAGE> 26

Selling and distribution expenses primarily include shipping expenses,
sales and distribution labor expenses, advertising and promotion expenses and
distribution facilities costs. During 1998 these expenses increased
approximately $7.9 million, or 47.9%, to $24.5 million from $16.5 million in the
comparable 1997 period. Selling and distribution expenses as a percentage of net
revenues for 1998 increased to 23.1% as compared to 17.7% in the comparable 1997
period. The increase, as a percentage of net revenues, was primarily
attributable to the increase of print advertising worldwide to support the new
and existing releases of the Company's Published Product and increased
cooperative advertising associated with higher published front-line revenues as
compared to the comparable 1997 period. The overall increase was also
attributable to increased sales volume.

General and administrative expenses primarily include personnel expenses,
facilities costs, professional expenses and other overhead charges. These
expenses in 1998 increased approximately $2.0 million, or 23.6%, to $10.7
million from $8.6 million in the comparable 1997 period. General and
administrative expenses as a percentage of net revenues increased to 10.1% in
1998 from 9.2% in the comparable 1997 period. This increase was due primarily to
additional personnel required to support the expansion of the Company's
publishing operations and the related amortization associated with the expansion
of the Company's worldwide facilities and the implementation of enterprise
software to enhance the Company's management information systems worldwide.

Research and development expenses primarily include payment for royalty
advances to third party developers on products that are currently in development
and direct costs of internally developing and producing a title such as salaries
and other related costs. These expenses in 1998 increased approximately $8.5
million, or 353.3%, to $10.9 million from $2.4 million in the comparable 1997
period. Research and development expenses as a percentage of net revenues
increased to 10.3% in 1998 from 2.6% in the comparable 1997 period. This
increase is primarily due to the change in accounting effective for the three
months ended March 31, 1998, whereby royalty advances on products that are
currently in development or on sale are expensed as incurred, and the additional
headcount attributable to increased in-house development capacity primarily the
result of the SingleTrac acquisition.

Interest and other income (expense), net, decreased approximately $1.6
million during 1998 to an expense of $1.4 million from income of $0.2 million in
the comparable 1997 period. This decrease was primarily attributable to the
decrease in short-term investments and the increase in interest costs associated
with borrowings under the Revolving Credit Agreement (the "Credit Agreement").

The Company's effective tax rate for 1998 was 46% compared to 43% in the
comparable 1997 period. The increase is attributable to the higher proportion of
nondeductible expenses, primarily goodwill, in the current period.

TWELVE MONTHS ENDED DECEMBER 31, 1997 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1996

Net revenues increased approximately $165.2 million, or 45.2%, to $530.7
million in 1997 from $365.5 million in 1996. This growth in net revenues was
primarily attributable to the release of newly published titles, both
domestically and internationally, which included OddWorld: Abe's Oddysee for the
PlayStation, Duke Nukem 3D for N64 and the PlayStation, Hexen for N64 and the
PlayStation and Total Annihilation for the PC. The international release of Doom
II, Mortal Kombat Trilogy, San Francisco Rush, NBA Hangtime and Mace for N64,
the domestic release of Shadow Warrior for the PC, Critical Depth for the
PlayStation, Blood for the PC, Putt Putt Travels Through Time for the PC and
Courier Crisis for the PlayStation, as well as the continuing strong sales of
Duke Nukem 3D and Quake and an increase in royalty income (from licensing of
certain of the Company's products in selected international markets) also
contributed to the growth in net revenues. In addition, the 30% increase in
sales of the Company's value-priced line of software, an increase in sales from
its existing mass merchant shelf space and an increase in the number of mass
merchant stores supplied and serviced by the Company contributed to the growth
in net revenues. This increase was partially offset by the reduction in gross
revenues resulting from Wal-Mart's decision in the second half of 1997 to
purchase products directly from five publishers whose products had been
previously distributed by the Company.

25
<PAGE> 27

Cost of goods sold primarily includes costs of purchased products and
royalties paid to software developers. Cost of goods sold increased
approximately $100.6 million, or 46.9%, to $315.1 million in 1997 from $214.6
million in 1996. Cost of goods sold as a percentage of net revenues increased to
59.4% in 1997 as compared to 58.7% in 1996. The increase of 0.7% was primarily
due to the decline in the average wholesale price of the Company's value-priced
products and an increase in the sales of N64 titles, which have lower margins.
This increase was mostly offset by a shift in the Company's overall sales mix
toward its published and value-priced products which increased to an aggregate
of approximately 61% of net revenue in 1997 compared to approximately 54% during
1996 and a change in product mix within the products distributed for third
parties to higher margin products.

Selling and distribution expenses primarily include shipping expenses,
sales and distribution labor expenses, advertising and promotion expenses and
distribution facilities costs. These expenses increased approximately $26.2
million, or 36.1%, to $98.7 million in 1997 from $72.5 million in 1996. The
increase is attributable to the overall increase in sales volume. Selling and
distribution expenses as a percentage of net revenues for 1997 decreased to
18.6% as compared to 19.9% for 1996. This decrease was primarily attributable to
the reduction of freight as a percentage of net revenues and the Company
realizing greater economies of scale.

General and administrative expenses primarily include personnel expenses,
facilities costs, professional expenses and other overhead charges. These
expenses in 1997 increased approximately $14.4 million, or 46.2%, to $45.6
million in 1997 from $31.2 million in 1996. General and administrative expenses
as a percentage of net revenues increased to 8.6% in 1997 from 8.5% in 1996.
This increase was due primarily to additional personnel required to support the
expansion of the Company's research and development and publishing operations,
an increase in the reserve for bad debts and an increase in depreciation expense
due to the write-off of the leasehold improvements at the Company's former
headquarters.

Research and development expenses primarily include direct costs of
developing and producing a title such as salaries and other related costs. These
expenses in 1997 increased approximately $8.2 million, or 145.4% to $13.8
million from $5.6 million in 1996. Research and development expenses as a
percentage of net revenues increased to 2.6% in 1997 from 1.5% in 1996. This
increase is primarily due to the in-house development of Humongous titles.

The charge for royalty advance write-off of $73.8 million during 1997
represents a change in estimate and accounting whereby royalty advances on
products that are currently in development or on sale were expensed. In
connection with this change, the Company will prospectively expense royalty
advances in a manner comparable with internal software development costs, which
are expensed as incurred. Management anticipates that this will result in cost
of goods sold and research and development increasing; however, the amount of
such increase in research and development costs will depend upon the amount of
internal research and development expenditures as well as the amounts of royalty
advances paid to third parties.

In connection with the acquisition of SingleTrac, the Company incurred a
charge of $11.0 million for purchased research and development. In addition, the
Company incurred a charge of $2.4 million for a retention bonus for the
SingleTrac employees, which was based on the achievement of certain performance
goals. Pursuant to the SingleTrac purchase agreement, the Company has structured
a retention oriented bonus pool of up to approximately $10.0 million in cash and
Common Stock of the Company, which will be distributed to SingleTrac employees
based on the achievement of certain performance goals of SingleTrac during
calendar year 1998.

Merger costs consist of legal, accounting and other professional fees
incurred by the Company for the canceled acquisition of MicroProse, Inc., during
1997 and to complete the acquisitions of the Acquired Companies and for the
Company's canceled secondary stock offering during 1996.

Interest and other income (expense), net, decreased approximately $6.0
million during 1997. This decrease was primarily attributable to the decrease in
short-term investments and cash balances and the interest costs associated with
borrowings under the Credit Agreement.

26
<PAGE> 28

The Company's effective tax rate, as a percentage of pre-tax income (loss),
decreased in 1997 to 27% compared to 38% in 1996 due to the non-deductible one
time charge related to the acquisition of in-process research and development
during the year.

For 1997, the net loss was $25.0 million, or $0.37 per share, compared to
net income of $25.1 million, or $0.38 per share for 1996, with earnings per
share for both 1997 and 1996 calculated based on the basic method. Excluding one
time charges resulting from the charge for the royalty advance expense,
purchased research and development, the retention bonus for the SingleTrac
employees and the merger costs, the Company would have recognized net income of
$33.9 million or $0.51 per share. Exclusive of the one time charge for merger
costs, net income for 1996 would have been $27.3 million or $0.40 per share.

TWELVE MONTHS ENDED DECEMBER 31, 1996 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1995

Net revenues for 1996 increased approximately $131.0 million, or 55.9%, to
$365.5 million in 1996 from $234.5 million in the year ended December 31, 1995
("1995"). In the third quarter of 1995, Microsoft(R) Windows(R) 95 was
introduced and distributed to certain retailers by the Company. This one time
event added net revenues of approximately $15.2 million. Without these sales,
net revenues would have increased 66.7%. This growth in net revenues was
primarily attributable to the introduction of newly published titles such as
Duke Nukem 3D, Quake, Area 51, Final Doom for the PlayStation, Heretic: Shadow
of the Serpent Rider, Bedlam, "9" and Just Me & My Dad, the continuing strong
sales of Doom and Doom-related products and increased royalty income.
Additionally, the expansion of the Company's value-priced line of software, an
increase in the shelf space available from its existing mass merchant customers,
an increase in the number of mass merchant stores supplied and serviced by the
Company and an increase in sales from its existing mass merchant shelf space
contributed to the growth in net revenues. The purchase of Slash by the Company
effective June 23, 1995 and the increase in the distribution of third-party
software also contributed to the growth in net revenues.

Cost of goods sold primarily includes costs of purchased products and
royalties paid to software developers. Cost of goods sold for 1996 increased
approximately $75.9 million, or 54.8%, to $214.6 million in 1996 from $138.7
million in 1995. Cost of goods sold as a percentage of net revenues decreased to
58.7% in 1996 compared to 59.1% in 1995. This decrease was primarily due to a
change in product mix toward the Company's higher margin published products,
which increased to approximately 54% of net revenues in 1996 as compared to
approximately 51% in 1995. Additionally, during the last half of 1995, the
Company's sales of Microsoft(R) Windows(R) 95 contributed to the increase in
cost of goods sold as a percentage of net revenues for that year as a result of
that product's lower margin.

Selling and distribution expenses primarily include shipping expenses,
sales and distribution labor expenses, advertising and promotion expenses and
distribution facilities costs. These expenses increased approximately $30.8
million, or 73.8%, to $72.5 million in 1996 from $41.7 million in 1995. The
increase was due in part to additional advertising costs of approximately $9.6
million to support the growth of the Company's published products and an
increase in shipping costs of approximately $4.8 million attributable to the
overall increase in sales volume. In addition, costs associated with the
expansion of the Company's sales and distribution staff and distribution center
increased approximately $13.7 million to support the Company's growth. Selling
and distribution expenses as a percentage of net revenues increased to 19.9% for
1996 compared to 17.9% for 1995.

General and administrative expenses primarily include personnel expenses,
facilities costs, professional expenses and other overhead charges. These
expenses increased approximately $11.7 million, or 59.9%, to $31.2 million in
1996 from $19.5 million in 1995. The increase was due primarily to the expansion
of the Company's operations. General and administrative expenses as a percentage
of net revenues increased to 8.5% from 8.3%.

Research and development expenses primarily include direct costs of
developing and producing a title such as salaries and other related costs. These
expenses in 1996 increased approximately $3.9 million, or 228.1% to $5.6 million
from $1.7 million in 1995. Research and development expenses as a percentage of
net revenues increased to 1.5% in 1996 from 0.7% in 1995. This increase is
primarily due to additional in-house development of Humongous titles.

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<PAGE> 29

Merger costs consist of legal, accounting and other professional fees
incurred by the Company to complete the acquisitions of the Acquired Companies
and for the Company's canceled secondary stock offering.

Amortization of goodwill increased by approximately $.5 million, or 92.6%,
to $1.1 million in 1996 from $0.6 million in 1995. This increase is attributable
to the full year impact of the June 1995 acquisition of Slash.

Operating income for 1996 increased from approximately $32.3 million to
approximately $36.8 million, while operating margins decreased from 13.8% to
10.1%. Excluding merger costs, operating income and operating margins would have
been approximately $40.5 million and 11.1% for 1996.

Interest and other income, net, increased approximately $3.2 million for
1996 as compared to 1995. This is primarily attributable to greater short-term
investments and cash balances.

The Company's provision for income taxes for 1996 includes the reversal of
a valuation allowance relating to a net operating loss carry-forward of one of
the Acquired Companies. Additionally, had the Company been a C corporation for
the entire year ended December 31, 1995, the Company's provision for income
taxes would have been approximately $15.1 million and 6.4% of net revenues for
the period.

Net income and net income as a percentage of net revenues on a tax adjusted
basis, for 1996 increased from $18.0 million and 7.7% to $25.1 million and 6.9%.
Excluding merger costs, net income and net income as a percentage of net
revenues would have been $27.3 million and 0.40% for 1996.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 1998, the Company's working capital was $70.0 million
compared to $78.0 million at December 31, 1997. Cash and cash equivalents were
$17.2 million at March 31, 1998 compared to $39.6 million at December 31, 1997.

The primary source of cash during the three months ended March 31, 1998 was
cash provided by operating activities of $12.4 million. These internally
generated funds and the existing cash balance at December 31, 1997 of $39.6
million were primarily used to repay borrowings under the Credit Agreement of
$26.6 million and fund the purchase of property and equipment of $7.6 million.
The decrease in the payable balance as of March 31, 1998, as compared to
December 31, 1997, was primarily attributable to returns to vendors and payments
of the seasonally high balance at December 31, 1997. The decrease in the
receivable balance at March 31, 1998 reflects lower sales volume during the
twelve weeks ended March 31, 1998 as compared to the twelve weeks ended December
31, 1997 and the payments of year end balances. The increase in property and
equipment is primarily due to leasehold improvements at the Company's
headquarters on 417 Fifth Avenue in New York City and additional investments in
computer hardware and software to support the Company's growth.

The Company does not currently have any material commitments with respect
to any capital expenditures.

On January 21, 1997, the Company entered into the Credit Agreement with
certain banks expiring on December 31, 1998. The Credit Agreement was amended on
June 30, 1997 to increase the facility from $40 million to a maximum of $65
million to be used for borrowings and letters of credit. At March 31, 1998, the
Company had outstanding, under the Credit Agreement, debt and letters of credit
issued of approximately $28.0 million and $6.3 million, respectively. Borrowing
is limited to fifty percent of adjusted consolidated accounts receivable, as
defined, and is secured by these receivables. The borrowings under the Credit
Agreement bear interest at either the banks' reference rate (which is generally
equivalent to the published prime rate) or the LIBOR rate plus 1 1/4%. The
Company pays a commitment fee of 1/4% based on the unused portion of the line.

The Company expects continued volatility in the use of cash due to varying
seasonal, receivable payment cycles and quarterly working capital needs to
finance its distribution and growing publishing businesses.

The Company believes that existing cash, cash equivalents and short-term
investments, together with cash expected to be generated from operations and
cash available through the Credit Agreement, will be sufficient to fund the
Company's anticipated operations for at least the next twelve months.

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<PAGE> 30

ITEM 8. INDEX TO THE FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Consolidated Financial Statements, and notes thereto, and the Financial
Statement Schedule of the Company, are presented on pages F-1 through F-23
hereof as set forth below:

<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES
Report of Independent Public Accountants.................. F-1
Consolidated Balance Sheets as of December 31, 1996 and
1997 and March 31, 1998................................ F-2
Consolidated Statements of Operations for the Years Ended
December 31, 1995, 1996 and 1997 and the Three Months
Ended March 31, 1998................................... F-3
Consolidated Statements of Comprehensive Income for the
Years Ended December 31, 1995, 1996 and 1997 and the
Three Months Ended March 31, 1998...................... F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1995, 1996 and 1997 and the Three Months
Ended March 31, 1998................................... F-5
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1995, 1996 and 1997 and the
Three Months Ended March 31, 1998...................... F-6
Notes to the Consolidated Financial Statements............ F-7 to F-22

FINANCIAL STATEMENT SCHEDULE
For the Years Ended December 31, 1995, 1996 and 1997 and
the Three Months Ended March 31, 1998
Schedule II -- Valuation and Qualifying Accounts.......... F-23
</TABLE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

During the Company's three month transition period ended March 31, 1998 and
the previous two fiscal years, there have been no changes in the independent
accountants nor disagreements with such accountants as to accounting and
financial disclosures of the type required to be disclosed in this Item 9.

29
<PAGE> 31

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY

The following table sets forth certain information with respect to the
directors and executive officers of the Company as of June 19, 1998.

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Ronald W. Chaimowitz............... 51 Chairman of the Board of Directors and Chief
Executive Officer
David I. Chemerow.................. 46 President and Chief Operating Officer
Jack J. Cayre...................... 25 Executive Vice President and Director
Harry M. Rubin..................... 45 President of the International Division
Andrew Gregor...................... 49 Senior Vice President, Finance and Administration,
and Chief Financial Officer
Michael A. Ryder................... 46 Senior Vice President, Product Development
Charles F. Bond.................... 42 President, Value Price and Distribution Division
Frank Herman....................... 65 Chairman and Managing Director, G.T. Interactive
Software (Europe) Limited
Joseph J. Cayre.................... 56 Chairman Emeritus of the Board of Directors
Stanley Cayre...................... 62 Director
Steven A. Denning.................. 49 Director
William E. Ford.................... 37 Director
Jordan A. Levy..................... 42 Director
Phillip J. Reise................... 48 Director
Alvin N. Teller.................... 53 Director
</TABLE>

Certain other information regarding the Company's directors as of June 19,
1998 is set forth below. Each director has served continuously with the Company
since his first election as indicated below. Joseph J. Cayre and Stanley Cayre
are brothers and Jack J. Cayre is the son of Joseph J. Cayre.

<TABLE>
<CAPTION>
DIRECTOR TERM
NAME SINCE EXPIRES
---- -------- -------
<S> <C> <C>
CLASS I DIRECTORS
William E. Ford............................................. 1995 1999
Jordan A. Levy.............................................. 1996 1999
CLASS II DIRECTORS
Jack J. Cayre............................................... 1992 2000
Steven A. Denning........................................... 1995 2000
Phillip J. Riese............................................ 1998 2000
Alvin N. Teller............................................. 1996 2000
CLASS III DIRECTORS
Joseph J. Cayre............................................. 1992 2001
Ronald W. Chaimowitz........................................ 1995 2001
Stanley Cayre............................................... 1992 2001
</TABLE>

At the time of the Company's initial public offering in December 1995,
Joseph J. Cayre, Kenneth Cayre, Stanley Cayre, the various trusts for the
benefit of their respective children, Jack J. Cayre (collectively, the "Cayre
Family Stockholders") and the Company entered into a stockholders' agreement,
which provides, among other things, that the Cayre Family Stockholders will vote
their respective shares of Common Stock to

30
<PAGE> 32

elect as directors of the Company (i) two individuals designated by Mr. Joseph
J. Cayre, (ii) one individual designated by Mr. Kenneth Cayre and (iii) one
individual designated by Mr. Stanley Cayre.

Steven A. Denning and William E. Ford are the Executive Managing Member and
a managing member, respectively, of General Atlantic Partners, LLC. In
connection with their acquisition of shares of Common Stock, certain affiliates
of General Atlantic Partners, LLC entered into a stockholders' agreement with
the Company and certain other stockholders, pursuant to which Messrs. Denning
and Ford were elected to the Board of Directors in February 1995. This
stockholders' agreement automatically expired by its terms upon the
effectiveness of the Company's initial public offering.

A brief description of the principal occupation, business experience for at
least the past five years and certain other information concerning each
executive officer and director is set forth below.

RONALD W. CHAIMOWITZ, a co-founder of the Company, has been Chairman of the
Board of Directors and Chief Executive Officer of the Company since April 1998.
Prior thereto, Mr. Chaimowitz had been President and Chief Executive Officer of
the Company since February 1995. From January 1994 to January 1995, Mr.
Chaimowitz served as Executive Vice President and General Manager of the
Company. From December 1990 to December 1992, Mr. Chaimowitz was the President
of Entertainment Consultants, a management consultant firm to the entertainment
industry. Prior thereto, Mr. Chaimowitz served as Executive Vice President of
GoodTimes Home Video Corp. ("GoodTimes"), a publisher and distributor of
pre-recorded video tapes.

DAVID I. CHEMEROW has been President and Chief Operating Officer of the
Company since April 1998. Prior thereto, Mr. Chemerow was Executive Vice
President and Chief Operating Officer of the Company since May 1997. Mr.
Chemerow was Executive Vice President and Chief Financial Officer of ENTEX
Information Services, Inc., a personal computer systems integrator, from April
1996 to January 1997. Prior to joining ENTEX, he was Executive Vice President,
Finance and Operations, and Chief Financial Officer of Playboy Enterprises, Inc,
a publisher of magazines, from 1990 to 1996. Mr. Chemerow is also a member of
the Board of Directors of both Playboy Enterprises, Inc. and Dunham's Athleisure
Corporation.

JACK J. CAYRE has been Executive Vice President and a Director of the
Company since its incorporation in September 1992. From January 1993 to January
1995, Mr. Cayre was Vice President of Licensing and Product Acquisition. From
January 1990 to August 1992, Mr. Cayre was the President of Double J Records, a
privately-held record company.

HARRY M. RUBIN has been President of the International Division since April
1998. Prior thereto, Mr. Rubin had been Executive Vice President and General
Manager -- International Division and Business Affairs of the Company since
March 1995. From June 1994 to August 1995, Mr. Rubin served as Chief Financial
Officer of the Company. From November 1993 to June 1994, Mr. Rubin was an
independent management consultant to several entertainment companies. From 1988
to November 1993, Mr. Rubin was the Vice President and General Manager of Home
Video Operations for the National Broadcasting Company, Inc.

ANDREW GREGOR has been Chief Financial Officer of the Company since August
1995. Prior to being appointed as Senior Vice President, Finance and
Administration, in April 1996, Mr. Gregor had been Vice President of Finance of
the Company since August 1995. From February 1992 to August 1995, Mr. Gregor
served as Vice President and Chief Financial Officer of Lillian Vernon Corp., a
consumer direct merchant. For more than five years prior thereto, Mr. Gregor was
Senior Vice President and Chief Financial Officer of McCrory Corp., a national
retailer.

MICHAEL A. RYDER has been Senior Vice President, Product Development since
October 1997. From 1994 to October 1997, when SingleTrac was acquired by the
Company, Mr. Ryder was the Chairman, Chief Executive Officer and co-founder of
SingleTrac. From 1989 to 1994, Mr. Ryder served as Program Manager and Director
of Commercial Business of Evans & Sutherland Computer Corporation.

CHARLES F. BOND has been President of the Value Price Division since the
consolidation of the Slash Division with the operations of WizardWorks in June
1996. Prior thereto, Mr. Bond served as President of the

31
<PAGE> 33

Slash Division of the Company since June 1995, when Slash was acquired by the
Company. From May 1991 to June 1995, Mr. Bond was the President of Slash. Prior
thereto, Mr. Bond was Vice President -- Merchandising for Lieberman Enterprise,
a rack-jobber.

FRANK HERMAN has been Chairman and Managing Director of G.T. Interactive
Software (Europe) Limited since May 1995. From April to October 1995, Mr. Herman
was also Chairman of Probe Software Ltd., a software development house. From
July 1991 to April 1995, Mr. Herman was Deputy Chairman and Managing Director of
Sega (Europe) Ltd. From August 1988 to July 1991, Mr. Herman served as Managing
Director of Virgin Mastertronic Ltd., an entertainment software publisher.

JOSEPH J. CAYRE, a co-founder of the Company, has been Chairman Emeritus of
the Board of Directors since April 28, 1998. Prior thereto, Mr. Cayre had been
Chairman of the Board of Directors of the Company since its incorporation in
September 1992. Mr. Cayre also co-founded GoodTimes in 1984 and has served as
its President since that time.

STANLEY CAYRE, a co-founder of the Company, has been a Director of the
Company since its incorporation in September 1992. Mr. Cayre is the Chairman of
the Audit Committee. Mr. Cayre also co-founded GoodTimes and has served as its
Chairman since that time.

STEVEN A. DENNING has been a Director of the Company since February 1995.
Mr. Denning is currently the Executive Managing Member of General Atlantic
Partners, LLC, a private investment firm, and has been the Executive Managing
Member of General Atlantic Partners, LLC or a general partner of its predecessor
limited partnership since February 1989. From 1980 to 1989, Mr. Denning was
Managing Director of General Atlantic Corporation. Mr. Denning is a member of
the Boards of Directors of several private companies in which General Atlantic
Partners, LLC or one of its affiliates is an investor.

WILLIAM E. FORD has been a Director of the Company since February 1995. Mr.
Ford is a managing member of General Atlantic Partners, LLC, a private
investment firm, and has been with General Atlantic Partners, LLC or a general
partner of its predecessor partnership since July 1991. From August 1987 to July
1991, Mr. Ford was an associate with Morgan Stanley, Inc. in the mergers and
acquisitions department. Mr. Ford is also a director of LHS Group Inc., a
provider of telecommunications billing systems software, MAPICS, Inc., a
provider of enterprise resource planning software, Envoy Corporation, an
electronic transaction processing company, E*Trade Group, Inc., a deep-discount
electronic brokerage company, SS&C Technologies, Inc., an investment management
software company, and several private companies in which General Atlantic
Partners, LLC or one of its affiliates is an investor.

JORDAN A. LEVY has been a Director of the Company since February 1996.
Since January 1997, Mr. Levy has served as Co-Chairman of Upgrade Corporation of
America (doing business as SOFTBANK Services Group) ("SOFTBANK Services"), an
international outsourcing services company to the computer industry. From
February 1991 to December 1996, Mr. Levy was Co-Chief Executive Officer and
President of SOFTBANK.

PHILLIP J. RIESE has been a Director of the Company since January 1998. Mr.
Riese is currently the President of the Consumer Card Services Group for
American Express Travel Related Services Company, Inc., a position to which he
was appointed in September 1995. Since joining American Express in 1980, Mr.
Riese has served the organization in various capacities, including as Executive
Vice President/General Manager of the Charge Card Group, President of the
Cardmember Financial Services Group, and Chairman of the Board of American
Express Centurion Bank. Mr. Riese continues to serve as Chairman of the Board of
American Express Centurion Bank.

ALVIN N. TELLER has been a Director of the Company since October 1996. Mr.
Teller has served as Chairman, Chief Executive Officer, President and a Director
of Alliance Entertainment Corp., a producer and distributor of recorded music
and music- and entertainment-related products ("Alliance"), since August 1996.
From July 1996, Mr. Teller served as Chairman and Chief Executive Officer of Red
Ant Entertainment, a startup music industry enterprise, until it was acquired by
Alliance in August 1996. Prior thereto, Mr. Teller served as Chairman and Chief
Executive Officer of MCA Music Entertainment Group, a

32
<PAGE> 34

producer and distributor of recorded music and music-related products, from
September 1989 to November 1995.

Richard Burns, the Company's Executive Vice President, Domestic Publishing
left the Company's employ in May 1998. Matthew C. Blank, a director of the
Company since May 4, 1998, resigned as a director of the Company and his
resignation was accepted by the Board of Directors at its meeting on June 17,
1998. Kenneth Cayre, a director of the Company since its incorporation in
September 1992, resigned as a director of the Company and his resignation was
accepted by the Board of Directors at its meeting on June 17, 1998.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

During the three month transition period ended March 31, 1998, the
Company's Compensation Committee consisted of Joseph J. Cayre, Steven A.
Denning, Jordan A. Levy and Alvin N. Teller. For certain transactions involving
the Company and the members of the Compensation Committee or entities affiliated
with such individuals. See "Item 13. Certain Relationships and Related
Transactions."

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the directors and executive officers of the Company and persons who beneficially
own more than ten percent of the Company's Common Stock (collectively, the
"Reporting Persons") to report their ownership of and transactions in the
Company's Common Stock to the Securities and Exchange Commission (the
"Commission"). Copies of these reports are also required to be supplied to the
Company. The Company believes, upon a review of the copies of such reports
received by the Company and written representations furnished by the Reporting
Persons to the Company, that during the three month transition period ended
March 31, 1998, the Reporting Persons complied with all applicable Section 16(a)
reporting requirements except that Phillip J. Reise, who was appointed to the
Board of Directors of the Company on January 15, 1998, did not file his Form 3
until February 4, 1998 and was therefore delinquent.

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<PAGE> 35

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE. The following table sets forth compensation
earned, whether paid or deferred, by the Company's Chief Executive Officer and
its other four most highly compensated executive officers during the three month
transition period ended March 31, 1998 (collectively, the "Named Executive
Officers") for services rendered in all capacities to the Company during the
years ended December 31, 1995, 1996 and 1997 and the three month transition
period ended March 31, 1998.

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
-------------------------
AWARDS
-------------------------
ANNUAL COMPENSATION(1) RESTRICTED SECURITIES
-------------------------- STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) AWARDS($) OPTIONS(#) COMPENSATION($)
- --------------------------- ---- --------- -------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Ronald W. Chaimowitz............. 1998 $106,731 -- -- 500,000 --
Chairman of the Board of 1997 414,615 $251,988(3) -- 500,000 $4,750(4)
Directors and Chief Executive 1996 365,000 --(5) -- 250,000(5) 1,500(4)
Officer(2) 1995 300,000 --(6) -- 975,000 718(4)

Harry M. Rubin................... 1998 69,231 -- -- 250,000 --
President of the 1997 299,808 151,800(3) -- 150,000 --
International Division(7) 1996 275,000 80,000(3) -- -- --
1995 250,000 60,000 -- 179,829 --
Richard Burns.................... 1998 63,462 -- -- 140,000 --
Executive Vice President, 1997 266,346 124,817(3) -- 60,000 4,750(4)
Domestic Publishing(8)(9) 1996 201,538 40,000(3) $49,030(10) -- --
1995 6,923 -- -- 100,000 --
David I. Chemerow................ 1998 69,231 -- -- -- --
President and Chief 1997 186,923 94,583(3) -- 350,000 --
Operating Officer(8)(13) 1996 -- -- -- -- --
1995 -- -- -- -- --
Charles F. Bond.................. 1998 69,231 -- -- -- --
President of the Value 1997 300,001 743,750(12) -- 50,000 4,750(4)
Price and Distribution 1996 300,001 500,000(12) -- -- --
Division(8)(11) 1995 155,770 233,654(12) -- 6,000 --
</TABLE>

- ---------------
(1) 1998 compensation figures are for the three month transition period ended
March 31, 1998.

(2) From February 1995 to April 1998, Mr. Chaimowitz served as President and
Chief Executive Officer of the Company. From January 1994 to January 1995,
Mr. Chaimowitz served as Executive Vice President and General Manager of
the Company.

(3) This bonus was earned in the year indicated, but paid in the immediately
subsequent year.

(4) Represents Company contributions, on behalf of the Named Executive
Officers, to the Company's 401(k) Profit Sharing Plan.

(5) In lieu of cash bonus for 1996, in February 1997 Mr. Chaimowitz received
options to purchase 250,000 shares of Common Stock at an exercise price of
$14.00 per share. The closing sale price of the Company's Common Stock as
reported on the Nasdaq National Market on the date of the grant was $8.125
per share. Such options become exercisable in four equal annual
installments commencing on February 7, 1998.

(6) In lieu of cash bonus for 1995, in December 1995, Mr. Chaimowitz received
options to purchase 75,000 shares of the Company's Common Stock at an
exercise price of $14.00 per share.

(7) From March 1995 to April 1998, Mr. Rubin served as Executive Vice President
and General Manager -- International Division and Business Affairs of the
Company. From June 1994 to August 1995, Mr. Rubin served as Chief Financial
Officer of the Company.

(8) Messrs. Burns, Bond and Chemerow joined the Company in December and June
1995 and May 1997, respectively, and accordingly, the information contained
herein for the years ended December 31, 1995 and 1997 reflects a partial
year, as applicable.

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<PAGE> 36

(9) From December 1995 to May 1997, Mr. Burns served as Senior Vice President,
Sales, of the Company. Mr. Burns left the Company's employ in May 1998.

(10) Represents the dollar value (net of consideration paid) of the award of
restricted stock calculated by multiplying the market price of the
Company's Common Stock on the date of grant, $19.125 per share, by the
number of shares awarded. These shares vested on December 30, 1996.

(11) Mr. Bond has been President of the Value Price Division since the
consolidation of the Slash Division with the operations of WizardWorks, a
wholly-owned subsidiary of the Company. Prior thereto, Mr. Bond served as
President of the Slash Division since June 1995.

(12) Represents an annual bonus payable under an employment agreement, which the
Company and Mr. Bond entered into in connection with the acquisition of
Slash. See "Employment Agreements." This bonus was earned in the year
indicated, but the entire amount or a portion thereof was paid in the
immediately subsequent year.

(13) From May 1997 to April 1998, Mr. Chemerow served as Executive Vice
President and Chief Operating Officer of the Company.

OPTION GRANTS. Shown below is information regarding grants of stock
options under the Company's stock incentive plans to the Named Executive
Officers during the three month transition period ended March 31, 1998.

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------------------------------------
NUMBER OF % OF TOTAL MARKET PRICE OF
SECURITIES OPTIONS GRANTED UNDERLYING SECURITIES
UNDERLYING TO EMPLOYEES ON THE DATE OF GRANT
OPTIONS IN THE TRANSITION EXERCISE IF HIGHER THAN EXPIRATION
NAME GRANTED(#) PERIOD(1) PRICE($/SH) EXERCISE PRICE DATE
- ---- ---------- ----------------- ----------- --------------------- ----------
<S> <C> <C> <C> <C> <C>
Ronald W. Chaimowitz..... 500,000(2) 32.33 $ 6.3125 -- 2/6/08
Harry M. Rubin........... 250,000(3) 16.16 6.3125 -- 2/6/08
Richard Burns............ 50,000(4) 3.23 10.2500 -- 8/12/07
90,000(5) 5.82 10.2500 -- 3/31/04
</TABLE>

- ---------------
(1) In the fiscal period ended March 31, 1998, the Company granted options for
an aggregate of 1,546,557 shares to its employees.

(2) The option becomes exercisable in three equal annual installments commencing
on February 6, 1999.

(3) The option becomes exercisable in four equal annual installments commencing
on February 6, 1999.

(4) The option becomes exercisable in four equal annual installments commencing
on August 12, 1998.

(5) The option becomes exercisable in five equal annual installments commencing
on March 31, 1998.

The following table shows the hypothetical value of the options granted at
the end of the option terms (ten years) if the stock price were to appreciate
annually by 5% and 10%, respectively. These assumed rates of growth are required
by the Commission for illustration purposes only and are not intended to
forecast possible future stock prices.

<TABLE>
<CAPTION>
NUMBER OF POTENTIAL REALIZABLE VALUE OF
SECURITIES ASSUMED ANNUAL RATES OF STOCK PRICE
UNDERLYING APPRECIATION FOR OPTION TERM(1)
OPTIONS -------------------------------------
NAME GRANTED 0% 5% 10%
- ---- ---------- ----- ------------ ------------
<S> <C> <C> <C> <C>
Ronald W. Chaimowitz.............................. 500,000 -- $1,984,949 $5,030,250
Harry M. Rubin.................................... 250,000 -- 992,474 2,515,125
Richard Burns..................................... 50,000 -- -- 273,793
90,000 -- -- 492,827
</TABLE>

- ---------------
(1) Represents the product of (i) difference between (A) the product of the
per-share fair market value at the time of the grant compounded annually at
the assumed rate of appreciation over the term of the option, and (B) the
per-share exercise price of the option, and (ii) the number of shares
underlying the grant at March 31, 1998.

35
<PAGE> 37

Aggregated Option Exercises and Transition Period-End Option Values. Shown
below is information relating to the exercise of stock options during the three
month transition period ended March 31, 1998 for each of the Company's Named
Executive Officers and the year-end value of unexercised options held by the
Named Executive Officers.

<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES TRANSITION PERIOD-END TRANSITION PERIOD-END(1)
ACQUIRED ON VALUE (EXERCISABLE/ (EXERCISABLE/
NAME EXERCISE REALIZED UNEXERCISABLE) UNEXERCISABLE)
- ---- ----------- -------- --------------------- ------------------------
<S> <C> <C> <C> <C>
Ronald W. Chaimowitz........ -- -- 862,500/1,292,500 1,920,750/406,250
Harry M. Rubin.............. -- -- 155,829/421,900 136,811/203,125
Richard Burns............... -- -- 33,000/267,000 0/0
David I. Chemerow........... -- -- 0/350,000 0/0
Charles F. Bond............. -- -- 15,500/40,500 0/0
</TABLE>

- ---------------
(1) Market value of underlying shares of Common Stock, based on the average of
the high and low sales price ($7.1250), on March 31, 1998, minus the
aggregate exercise price.

EMPLOYMENT AGREEMENTS

The Company has entered into an employment agreement with Ronald W.
Chaimowitz, pursuant to which he serves as President-Chief Executive Officer
and/or Chairman of the Board of Directors of the Company, in each case as
determined in the sole discretion of the Company's Board of Directors, for a
five-year term ending on April 27, 2003. On April 28, 1998, Mr. Chaimowitz was
appointed Chairman of the Board of Directors and Chief Executive Officer of the
Company. The agreement provides that Mr. Chaimowitz's annual salary is $550,000.
Such base salary may be increased at the sole discretion of the Board of
Directors, provided, however, that if the Company's net sales exceed $1 billion
for any fiscal year ending during the term of his employment, Mr. Chaimowitz's
base salary will be increased to an annual rate of $600,000. In addition, Mr.
Chaimowitz is eligible to receive bonuses and stock option grants at the
discretion of the Board of Directors, provided that Mr. Chaimowitz will
participate in the Company's senior executive bonus plan with a target bonus of
60% of his base salary. Mr. Chaimowitz is entitled to participate in the
Company's employee benefit plans generally available to the Company's senior
executives. In addition, Mr. Chaimowitz has agreed not to engage in any
competitive business until the later of April 27, 2003 or, if his employment
with the Company is terminated for disability, or other than for cause, or he
resigns for good reason (as defined in the agreement), then for so long as the
Company continues to pay him severance payments pursuant to the agreement. If
Mr. Chaimowitz's employment is not terminated prior to a Change of Control (as
defined below), then his obligation not to engage in any competitive business is
limited to a period equal to the greater of (i) one year from the date of such
Change of Control or (ii) the period during which he remains employed by the
Company or its successor and parent company, if any. In addition, if, following
a Change of Control, there occurs good reason (as defined in the agreement), Mr.
Chaimowitz is not the President-Chief Executive Officer and/or Chairman of the
Board of Directors of the Company or its successor and parent company, or if Mr.
Chaimowitz's employment is terminated other than for cause, then Mr. Chaimowitz
may, within 90 days of any such event, terminate his employment with the Company
or its successor and parent company and in such case he will receive severance
payments otherwise payable under the agreement with the same effect as if he
were terminated without cause or resigned with good reason. Upon the happening
of a Change of Control, or if Mr. Chaimowitz is terminated without cause, or for
disability, or he resigns for good reason, or upon his death, all options then
held by Mr. Chaimowitz will immediately vest and become exercisable. For
purposes of the agreement, the term Change of Control means any of the
following: (a) any person, as that term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934 (other than the Company, fiduciaries or
trustees under the Company's employee benefit plan, members of the Cayre family,
General Atlantic Partners, LLC ("GAP"), entities controlled or managed by GAP,
or

36
<PAGE> 38

any entity more than 50% owned beneficially by any of the aforementioned),
becomes the beneficial owner, directly or indirectly, of 50% or more of the
voting power of the Company's then outstanding securities; (b) during any period
of two consecutive years, individuals who at the beginning of such period
constitute the Board of Directors of the Company (and any new director approved
by such persons), cease for any reason to constitute at least a majority of the
Board of Directors; (c) the approval by the Company's stockholders of certain
mergers or consolidations of the Company with any other entity; or (d) the
approval by the Company's stockholders of a plan of complete liquidation of the
Company or an agreement for the sale or distribution of all or substantially all
of the Company's assets.

The Company has entered into an employment agreement with Harry M. Rubin,
pursuant to which he serves as Executive Vice President and General
Manager -- International Division and Business Affairs for a three-year term
ending on December 31, 2001. On April 28, 1998, Mr. Rubin was appointed
President of the International Division. The agreement provides that Mr. Rubin's
annual salary is $360,000 for the year ending December 31, 1998, subject to
annual review during the term of Mr. Rubin's agreement in increases of not less
than 5% per year, but otherwise in the Company's discretion. In addition, Mr.
Rubin is eligible to receive bonuses and stock option grants at the discretion
of the Board of Directors, provided that Mr. Rubin will participate in the
Company's senior executive bonus plan with a target bonus of 50% of his base
salary. Mr. Rubin is entitled to participate in the Company's employee benefit
plans generally available to the Company's senior executives. In addition, Mr.
Rubin has agreed not to engage in any competitive business until the later of
December 31, 2001 or, if his employment with the Company is terminated for
disability, or other than for cause, or he resigns for good reason (as defined
in the agreement), then for so long as the Company continues to pay him
severance payments pursuant to the agreement. If Mr. Rubin's employment is not
terminated prior to a Change of Control (as defined above), then his obligation
not to engage in any competitive business is limited to a period equal to the
greater of (i) two years from the date of such Change of Control or (ii) the
period during which he remains employed by the Company or its successor and
parent company, if any. In addition, if, following a Change of Control, there
occurs good reason (as defined in the agreement), Mr. Rubin is not an Executive
Vice President of the Company, its successor or parent company, or if Mr.
Rubin's employment is terminated other than for cause, then Mr. Rubin may,
within 90 days of any such event, terminate his employment with the Company or
its successor and parent company and in such case he will receive severance
payments otherwise payable under the employment agreement with the same effect
as if he were terminated without cause or resigned with good reason. Upon the
happening of a Change of Control, or if Mr. Rubin is terminated without cause,
or for disability, or he resigns for good reason or upon his death, all options
then held by Mr. Rubin will immediately vest and become exercisable.

The Company has entered into an amended employment agreement with David
Chemerow for a three-year term ending on May 14, 2000 pursuant to which he
serves as President and Chief Operating Officer of the Company. The agreement
provides that Mr. Chemerow's annual salary is $360,000, that his base salary
will be subject to discretionary increase by the Company's Board of Directors
and that Mr. Chemerow will be eligible to receive annual bonuses not to exceed
an amount equal to 50% of his base salary in effect at such time, in such
amounts as determined by the Company's Chief Executive Officer and the Board of
Directors. Mr. Chemerow is entitled to participate in the Company's employee
benefit plans generally available to the Company's senior executives. In
addition, Mr. Chemerow has agreed not to engage in any competitive business
until the later of May 14, 2000 or, if his employment with the Company is
terminated for disability or other than for cause, then for so long as the
Company continues to pay him severance payments pursuant to the agreement. If
Mr. Chemerow's employment is not terminated prior to a Change of Control (as
defined above), then his obligation not to engage in any competitive business is
limited to a period equal to the greater of (i) two years from the date of such
Change of Control or (ii) the period during which he remains employed by the
Company or its successor and parent company, if any. If, following a Change of
Control, (i) Mr. Chemerow's employment is terminated other than for cause
(including a deemed termination as defined in the agreement) or (ii) Mr.
Chemerow is required to relocate as described in the agreement, then at any time
within 90 days of any such event, Mr. Chemerow may terminate his employment with
the Company or its successor and parent company and in such case he will receive
severance payments otherwise payable under the agreement with the same effect as
if he were terminated without cause. Upon the happening of a

37
<PAGE> 39

Change of Control, or if Mr. Chemerow's employment is terminated without cause,
all options then held by Mr. Chemerow will immediately vest and become
exercisable.

The Company has entered into an employment agreement with Andrew Gregor,
pursuant to which he serves as Chief Financial Officer and Senior Vice
President, Finance and Administration for a term ending on August 18, 1998. The
agreement provides that Mr. Gregor's annual base salary is $235,000, that his
base salary will be subject to discretionary increase by the Company's President
and Board of Directors and that Mr. Gregor will be eligible to receive annual
bonuses not to exceed an amount equal to 50% of his base salary in effect at
such time, in such amounts as determined by the Company's President and Board of
Directors. Mr. Gregor is entitled to participate in the Company's employee
benefit plans generally available to the Company's senior executives. In
addition, Mr. Gregor has agreed not to engage in any competitive business until
August 18, 1998 or, if his employment with the Company is terminated other than
for cause, then for as long as the Company continues to pay severance amounts
pursuant to the agreement. If, within one year following a Change of Control (as
defined above), neither Joseph J. Cayre nor Ronald W. Chaimowitz is the Chairman
of the Board of Directors or the President of the Company or its successor, or
if either person does hold one of such offices, Mr. Gregor does not report
directly to one of such persons, then all options held by Mr. Gregor will
immediately vest and become exercisable.

The Company has entered into an employment agreement with Charles F. Bond,
pursuant to which he serves as President of the Value Price and Distribution
Division of the Company for a three-year term ending on June 30, 1998. The
agreement also establishes a base salary of $300,000 per annum during the term
of employment and provides that Mr. Bond will receive an annual bonus in
prescribed amounts if certain pre-tax net income levels are reached by the
Company. Mr. Bond is entitled to participate in the Company's employee benefit
plans generally available to the Company's senior executives. In addition, in
connection with the purchase of Slash by the Company, as of June 23, 1995, the
Company entered into a Non-Competition Agreement with Mr. Bond, pursuant to
which he has agreed not to be involved in any competing business in the United
States until the earlier of one year following termination without cause or June
23, 2000.

Each of the employment agreements prohibits disclosure of proprietary and
confidential information regarding the Company and its business to anyone
outside the Company both during and subsequent to employment.

38
<PAGE> 40

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information, as of June 19, 1998, concerning
the Common Stock of the Company beneficially owned (i) by each director of the
Company, (ii) by the Named Executive Officers and all executive officers and
directors as a group, and (iii) by each stockholder known by the Company to be
the beneficial owner of more than 5% of the outstanding Common Stock. Unless
otherwise indicated in the footnotes to the table, the beneficial owners named
have, to the knowledge of the Company, sole voting and dispositive power with
respect to the shares beneficially owned, subject to community property laws
where applicable.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED
---------------------
NAME SHARES PERCENT
- ---- ---------- -------
<S> <C> <C>
Joseph J. Cayre(1).......................................... 13,909,388 20.4
Jack J. Cayre(2)............................................ 3,713,585 5.4
Stanley Cayre(3)............................................ 8,843,923 13.0
Kenneth Cayre(4) 16 East 40th Street, New York, NY 10016.... 8,825,135 13.0
Ronald W. Chaimowitz(5)..................................... 1,720,582 2.5
General Atlantic Partners, LLC(6) 3 Pickwick Plaza,
Greenwich, CT 06830....................................... 7,428,525 10.9
Steven A. Denning(7)........................................ 7,428,525 10.9
William E. Ford(8).......................................... 7,428,525 10.9
Jordan A. Levy(9)........................................... 71,000 *
Harry M. Rubin(10).......................................... 175,629 *
Alvin N. Teller(11)......................................... 40,000 *
Phillip J. Riese............................................ 13,000 *
Various trusts for the benefit of the children of Joseph J.
Cayre 417 Fifth Avenue, New York, NY 10016................ 6,380,000 9.4
Various trusts for the benefit of the children of Stanley
Cayre 417 Fifth Avenue, New York, NY 10016................ 4,750,670 7.0
Various trusts for the benefit of the children of Kenneth
and Lillian Cayre 16 East 40th Street, New York, NY
10016..................................................... 7,119,688 10.5
David I. Chemerow(12)....................................... 157,500 *
Charles F. Bond(13)......................................... 1,931,400 2.8
All executive officers and directors as a group (15
persons)(14).............................................. 38,382,880 55.0
</TABLE>

- ---------------
* Less than 1%

(1) Includes 6,380,000 shares in the aggregate held in various trusts for the
benefit of Joseph J. Cayre's children, for which trusts his wife serves as
trustee. Also includes 1,759,388 shares held by a charitable foundation for
which Joseph J. Cayre and his wife serve as trustees. Joseph J. Cayre
disclaims beneficial ownership of the shares held by such trusts and such
foundation. Also includes 420,000 shares held by Joseph J. Cayre in grantor
retained annuity trusts.

(2) Includes 105,000 shares held by Jack J. Cayre in grantor retained annuity
trusts, 475,085 held by a charitable foundation for which he serves as
trustee, and 163,500 shares subject to options exercisable within 60 days.
Jack J. Cayre disclaims beneficial ownership of the shares held by such
foundation.

(3) Includes 4,750,670 shares in the aggregate held in various trusts for the
benefit of Stanley Cayre's children, for which trusts his wife serves as
trustee. Also includes 453,000 shares held by a charitable

39
<PAGE> 41

foundation whose trustees are Stanley Cayre and his wife. Stanley Cayre
disclaims beneficial ownership of the shares held by such trusts and such
foundation. Also includes 114,658 shares held by Stanley Cayre in a grantor
retained annuity trust.

(4) Includes 7,119,688 shares in the aggregate held in various trusts for the
benefit of Kenneth and Lillian Cayre's children, for which trusts Lillian
Cayre serves as trustee. Also includes 50,000 shares held by a charitable
foundation whose trustees are Kenneth Cayre and Lillian Cayre. Kenneth
Cayre disclaims beneficial ownership of the shares held by such trusts and
such foundation. Also includes 41,242 shares held by Kenneth Cayre in a
grantor retained annuity trust.

(5) Includes 84,380 shares held in a trust for the benefit of Ronald W.
Chaimowitz's daughter, for which trust Ronald W. Chaimowitz's wife serves
as trustee. Ronald W. Chaimowitz disclaims beneficial ownership of such
shares. Also includes 1,010,000 shares subject to options exercisable
within 60 days.

(6) Includes 4,184,545 shares held by General Atlantic Partners 16, L.P. ("GAP
16"), 2,092,273 shares held by General Atlantic Partners 19, L.P. ("GAP
19"), 647,707 shares held by GAP Coinvestment Partners, L.P. ("GAP
Coinvestment") and 504,000 shares held by General Atlantic Partners II,
L.P. ("GAP II"). The general partner of GAP 16, GAP 19 and GAP II is
General Atlantic Partners, LLC, a Delaware limited liability company. The
managing members of General Atlantic Partners, LLC are Steven A. Denning,
David C. Hodgson, Stephen P. Reynolds, J. Michael Cline, William O. Grabe,
William E. Ford, Nancy E. Cooper, Peter L. Bloom and Franchon M. Smithson.
The same individuals are the general partners of GAP Coinvestment. Messrs.
Denning and Ford, directors of the Company, are the Executive Managing
Member and a managing member, respectively, of General Atlantic Partners,
LLC and general partners of GAP Coinvestment. Messrs. Denning and Ford
disclaim beneficial ownership of shares owned by GAP 16, GAP 19, GAP
Coinvestment and GAP II, except to the extent of their respective pecuniary
interests therein.

(7) Includes 4,184,545 shares held by GAP 16, 2,092,273 shares held by GAP 19,
647,707 shares held by the GAP Coinvestment and 504,000 shares held by GAP
II. Mr. Denning disclaims beneficial ownership of shares owned by GAP 16,
GAP 19, GAP Coinvestment and GAP II, except to the extent of his respective
pecuniary interests therein.

(8) Includes 4,184,545 shares held by GAP 16, 2,092,273 shares held by GAP 19,
647,707 shares held by GAP Coinvestment and 504,000 shares held by GAP II.
Mr. Ford disclaims beneficial ownership of shares owned by GAP 16, GAP 19,
GAP Coinvestment and GAP II, except to the extent of his respective
pecuniary interests therein.

(9) Includes 62,500 shares subject to options exercisable within 60 days.

(10) Represents 175,629 shares subject to options exercisable within 60 days.

(11) Includes 7,500 shares subject to options exercisable within 60 days.

(12) Includes 87,500 shares subject to options exercisable within 60 days.

(13) Includes 50,000 shares held by Mr. Bond's wife (as to which shares he
disclaims beneficial ownership), 100,000 shares held in a grantor retained
annuity trust, and 17,000 shares subject to options exercisable within 60
days.

(14) Includes an aggregate of 1,755,379 shares subject to options exercisable
within 60 days. Also includes 21,540 shares which are held in escrow and
subject to certain indemnification rights of the Company.

40
<PAGE> 42

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

LEASES

In May 1995, G.T. Interactive Software (Europe) Limited, the Company's
European subsidiary, entered into a lease with respect to its principal
executive offices with Marylebone 248 Realty LLC ("Marylebone 248"), an entity
controlled by Joseph J. Cayre, Chairman Emeritus of the Board of Directors, and
Jack J. Cayre, Executive Vice President and a Director of the Company. This
lease expires in 2020. During the three months ended March 31, 1998, the Company
paid approximately $67,000 in rent to Marylebone 248.

TRANSACTIONS WITH GOODTIMES

During the year ending December 31, 1996, the Company sold approximately
$3,488,000 of software products to GoodTimes, a majority of whose stock is owned
by Joseph J. Cayre, Stanley Cayre and Kenneth Cayre, at fair market value. In
connection with the sales of such products, the Company had a receivable from
GoodTimes for approximately $2,996,000 at December 31, 1997. In February 1998,
$2,869,000 of such receivable was paid.

GoodTimes also performed certain assembly and packaging services for the
Company. A nominal amount was charged to operations for these services in the
three months ended March 31, 1998.

REPS AGREEMENT

In servicing its mass merchant accounts, the Company uses field
representatives supplied by REPS, a company owned by Joseph J. Cayre, Stanley
Cayre and Kenneth Cayre. REPS provides such services to the Company as well as
to third parties not affiliated with the Cayre family. The Company had an
agreement with REPS pursuant to which REPS supplied such services, at its cost,
through December 31, 1997. The Company is in negotiation with REPS to extend
this agreement and is currently operating on a month to month basis under the
terms of the old agreement. During the three months ended March 31, 1998, the
Company charged to operations approximately $1,434,000 in fees to REPS.

TRAVEL SERVICES

The Company occasionally hires Eastway Aircraft Services Inc. ("Eastway")
to provide business travel services for its officers and employees. These
services are provided at an hourly rate and on an as needed and as available
basis. Eastway leases two planes from JT Aviation Corp., a company owned by
Joseph Cayre. Eastway is not owned in whole or in part by any member of the
Cayre family. In the three months ended March 31, 1998, the Company paid $40,000
to Eastway.

The Company believes that the amounts charged by related parties
approximate those amounts which would have been incurred from non-affiliates.

LOANS TO OFFICERS, EMPLOYEES AND STOCKHOLDERS

On August 31, 1996, the Company extended a loan to Andrew Gregor, Chief
Financial Officer of the Company, in the principal amount of $250,000. Such loan
bears interest at the rate of 6.15% per annum and was amended in March 1998 to
extend the maturity date from August 31, 1998 to August 31, 2000.

The Company has extended non-interest bearing loans to three employees of
the Company who were former stockholders of SingleTrac, including Michael A.
Ryder, Senior Vice President, Product Development, of the Company in the
aggregate amount of $300,000. Such loans become due and payable at the earlier
of the sale of their stock of the Company, in November 1999 or six months
following termination of employment. Each of the three borrowers has pledged
20,000 shares of the Company's Common Stock owned by the borrowers, as
collateral security for the payment of the loan.

41
<PAGE> 43

TRANSACTIONS WITH SOFTBANK SERVICES

The Company has entered into agreements with SOFTBANK Services pursuant to
which SOFTBANK Services (i) provides toll-free customer support for some of the
Company's published products and (ii) takes direct customer orders and provides
fulfillment services for the Company, in each case on a fee per service basis.
The agreement relating to customer support service expired on December 17, 1996
and the agreement providing for the fulfillment service expired on August 2,
1997. Both agreements provide for automatic renewal on a month to month basis
upon expiration unless terminated by either party. In the three months ended
March 31, 1998, the Company charged to operations approximately $41,000 in fees
to SOFTBANK Services. Jordan A. Levy, a Director of the Company, is Co-Chairman
of SOFTBANK Services.

The Company believes that the terms of the foregoing transactions are no
less favorable to the Company than could be obtained by the Company from
unrelated parties on an arm's length basis.

42
<PAGE> 44

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a)(1) and (2) Financial Statements and Financial Statement Schedules

See Item 8 hereof.

Report of Ernst & Young LLP:

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
WizardWorks Group
Armstrong-Olson, Inc.
Promotional Software Group, Inc.
SVI, LLC

We have audited the accompanying combined balance sheets of WizardWare Group,
Inc. (d.b.a. WizardWorks), Armstrong-Olson, Inc., Promotional Software Group,
Inc. and SVI, LLC (hereafter referred to as WizardWorks Group or the Company) as
of March 31, 1996, and the related combined statements of income and retained
earnings and cash flows for the year then ended (not presented separately
herein). These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined financial position of WizardWorks Group at
March 31, 1996, and the combined results of their operations and their cash
flows for the year then ended, in conformity with generally accepted accounting
principles.

Ernst & Young L.L.P.

Minneapolis, Minnesota
May 10, 1996

43
<PAGE> 45

<TABLE>
<CAPTION>
(A)(3) EXHIBITS
EXHIBIT NO. DESCRIPTION
- --------------- -----------
<S> <C> <C>
2.1 (1) Agreement and Plan of Reorganization by and among the
Company, GT Acquisition Sub, Inc., WizardWorks Group, Inc.
and the Stockholders of WizardWorks Group, Inc., dated June
24, 1996.
2.2 (1) Escrow Agreement by and among the Registrant, Paul D. Rinde,
as the Stockholder Representative of WizardWorks Group,
Inc., and Republic National Bank of New York, as Escrow
Agent, dated June 24, 1996.
3.1 (2) Amended and Restated Certificate of Incorporation.
3.2 (3) Amended and Restated By-laws (as amended on October 31,
1996).
4.1 (4) Specimen form of stock certificate for Common Stock.
10.1 (3) The 1995 Stock Incentive Plan (as amended on October 31,
1996).
10.2 (4) Services Agreement between the Company and GoodTimes Home
Video Corp., dated as of January 1, 1995.
10.3 (4) 4.5% Subordinated Secured Promissory Note, due February 28,
1996.
10.4 (4) Employment Agreement between the Company and Ronald
Chaimowitz.
10.5 (4) Employment Agreement between the Company and Charles F.
Bond.
10.6 (4) Non-Competition Agreement between the Company and Charles F.
Bond.
10.7 (4) Employment Agreement between the Company and Harry M. Rubin.
10.8 (4) Employment Agreement between the Company and Harry Steck.
10.9 (4) Employment Agreement between the Company and Chris Garske.
10.10 (4) GTIS Master Option and License Agreement between the Company
and the Midway Entertainment Group, dated December 28, 1994,
and the Amendment to such agreement, dated March 31, 1995.
10.11 (4) GTIS Master Option and License Agreement (Home Video Games)
between the Company and the Midway Entertainment Group,
dated March 31, 1995.
10.12 (4) Agreement between the Company and SOFTBANK Corporation,
dated October 9, 1995.
10.13 (4) Agreement between the Company and Roadshow PTY LTD, dated
October 3, 1995.
10.14 (4) Agreement and Plan of Reorganization by and between Charles
F. Bond, Slash Corporation and the Company, dated June 22,
1995.
10.15 (4) Lease Agreements between the Company and 16 East 40th
Associates.
10.16 (4) Sub-lease Agreement between the Company and Michael Stevens
Ltd., dated February 22, 1995.
10.17 (4) Lease Agreement between GT Interactive Software (Europe)
Limited and Marylebone 248 Realty LLC, dated May 2, 1995.
10.18 (4) Stockholders' Agreement by and among Joseph J. Cayre,
Kenneth Cayre, Stanley Cayre, Jack J. Cayre, the Trusts
listed on Schedule I attached thereto and the Company.
10.19 (4) Registration Rights Agreement by and among Joseph J. Cayre,
Kenneth Cayre, Stanley Cayre, Jack J. Cayre, the Trusts
listed on Schedule I attached thereto and the Company.
10.20 (4) Agreement by and between the Company and REPS.
10.21 (5) Second Amendment to GTIS Master Option and License Agreement
between the Company and Midway Entertainment Group, dated
March 27, 1996.
10.22 (5) Amendment to GTIS Master Option and License Agreement (Home
Video Games) between the Company and Midway Entertainment
Group, dated March 27, 1996.
10.23 (5) Master Option and License Agreement for Atari PC Games
between the Company and WMS Industries Inc., dated March 27,
1996.
10.24 (5) Master Option and License Agreement for Atari Home Video
Games between the Company and WMS Industries Inc., dated
March 27, 1996.
10.25 (5) Employment Agreement between the Company and Andrew Gregor.
</TABLE>

44
<PAGE> 46

<TABLE>
<CAPTION>
(A)(3) EXHIBITS
EXHIBIT NO. DESCRIPTION
- --------------- -----------
<S> <C> <C>
10.26 (3) 6.15% Promissory Note, due August 31, 1998, of Andrew
Gregor.
10.27 (3) 6.15% Promissory Note, due August 31, 1998, of Chris Garske.
10.28 (6) Lease Agreement between the Company and Plymouth 2200, LLP,
dated September 6, 1996.
10.29 (7) Agreement of Lease, dated as of December 12, 1996, by and
between the Company and F.S. Realty Corp.
10.30 (7) Amendment to Stockholders Agreement, dated as of December
18, 1995, by and among Joseph J. Cayre, Kenneth Cayre,
Stanley Cayre, Jack J. Cayre, the trusts parties thereto and
the Company.
10.31 (7) Credit Agreement, dated as of January 21, 1997, by and among
the Company, the banks parties thereto and Republic National
Bank of New York, as Agent.
10.32 (8) Amendment, dated as of June 30, 1997, to the Credit
Agreement, dated as of January 21, 1997 by and among the
Company, the banks parties thereto and Republic National
Bank of New York, as Agent.
10.33 (8) Employment Agreement between the Company and David I.
Chemerow.
10.34 (8) The 1997 Stock Incentive Plan.
10.35 (9) Employment Agreement between the Company and Michael A.
Ryder.
10.36 (9) Amended and Restated 6.15% Promissory Note, due August 31,
2000, of Andrew Gregor.
18.1 Letter re Change in Accounting Principles.
21.1 (9) The Company's Subsidiaries.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule for the three month transition
period ended March 31, 1998.
</TABLE>

- ---------------
(1) Incorporated herein by reference to the exhibit with the corresponding
number filed as part of the Company's Current Report on Form 8-K filed on
July 9, 1996.

(2) Incorporated herein by reference to the exhibit with the corresponding
number filed as part of the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.

(3) Incorporated herein by reference to the exhibit with the corresponding
number filed as part of the Company's Registration Statement on Form S-1
filed October 18, 1996, and all amendments thereto (Registration No.
333-14441).

(4) Incorporated herein by reference to the exhibit with the corresponding
number filed as part of the Company's Registration Statement on Form S-1
filed October 20, 1995, and all amendments thereto (Registration No.
33-98448).

(5) Incorporated herein by reference to an exhibit filed as part of the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1996.

(6) Incorporated herein by reference to an exhibit filed as part of the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(7) Incorporated herein by reference to an exhibit filed as part of the
Company's Annual Report on Form 10-K for the year ended December 31, 1996.

(8) Incorporated herein by reference to an exhibit filed as part of the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1997.

(9) Incorporated herein by reference to an exhibit filed as part of the
Company's Annual Report on Form 10-K for the year ended December 31, 1997,
as amended.

45
<PAGE> 47

(b) Reports on Form 8-K

During the three months ended March 31, 1998, the Company filed a Current
Report on Form 8-K, dated February 17, 1998, to announce the Company's
determination to change its fiscal year end from December 31 to March 31. The
Company amended such Form 8-K on May 7, 1998 to report its decision to file a
Transition Report on Form 10-K, in lieu of a Transition Report on Form 10-Q as
originally reported on such Form 8-K, with respect to the three month transition
period ended March 31, 1998.

46
<PAGE> 48

SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

GT Interactive Software Corp.

By: /s/ RONALD W. CHAIMOWITZ
------------------------------------
Name: Ronald W. Chaimowitz
Title: Chairman of the Board of
Directors
and Chief Executive Officer
Date: June 29, 1998

Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE(S) DATE
--------- -------- ----
<S> <C> <C>
/s/ JOSEPH J. CAYRE Chairman Emeritus of the Board of June 29, 1998
- --------------------------------------------------- Directors
Joseph J. Cayre

/s/ ANDREW GREGOR Senior Vice President, Finance and June 29, 1998
- --------------------------------------------------- Administration, and Chief Financial
Andrew Gregor Officer (Principal Financial and
Accounting Officer)

/s/ RONALD W. CHAIMOWITZ Chairman of the Board of Directors June 29, 1998
- --------------------------------------------------- and Chief Executive Officer
Ronald W. Chaimowitz

/s/ JACK J. CAYRE Executive Vice President, Director June 29, 1998
- ---------------------------------------------------
Jack J. Cayre

/s/ STANLEY CAYRE Director June 29, 1998
- ---------------------------------------------------
Stanley Cayre

/s/ STEVEN A. DENNING Director June 29, 1998
- ---------------------------------------------------
Steven A. Denning

/s/ WILLIAM E. FORD Director June 29, 1998
- ---------------------------------------------------
William E. Ford

/s/ JORDAN A. LEVY Director June 29, 1998
- ---------------------------------------------------
Jordan A. Levy

/s/ ALVIN N. TELLER Director June 29, 1998
- ---------------------------------------------------
Alvin N. Teller

/s/ PHILLIP J. RIESE Director June 29, 1998
- ---------------------------------------------------
Phillip J. Riese
</TABLE>

47
<PAGE> 49

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders of
GT Interactive Software Corp. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of GT
Interactive Software Corp. (a Delaware corporation) and Subsidiaries as of
December 31, 1996 and 1997 and March 31, 1998 and the related consolidated
statements of operations, comprehensive income, stockholders' equity and cash
flows for each of the three years ended December 31, 1997 and for the three
months ended March 31, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits. We did not audit the 1995
financial statements of WizardWorks Group, a company acquired during 1996 in a
transaction accounted for as a pooling of interests, as discussed in Note 2.
Such statements are included in the consolidated financial statements of GT
Interactive Software Corp. and Subsidiaries and reflect total assets and total
net revenue in 1995 of 3.3% and 6.6%, respectively, of the related consolidated
totals. The 1995 financial statements of WizardWorks Group were audited by other
auditors whose report has been furnished to us and our opinion, insofar as it
relates to the amounts included for WizardWorks Group, is based solely on the
report of other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of GT Interactive Software Corp. and Subsidiaries as of
December 31, 1996 and 1997 and March 31, 1998 and the results of their
operations and cash flows for each of the three years ended December 31, 1997
and for the three months ended March 31, 1998, in conformity with generally
accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to the
financial statements and supplementary data is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in our audits of the basic financial statements and, in our
opinion, based on our audits and the report of other auditors, fairly states in
all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.

ARTHUR ANDERSEN LLP

New York, New York
May 21, 1998

F-1
<PAGE> 50

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MARCH 31,
1996 1997 1998
-------- -------- ---------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 71,867 $ 39,608 $ 17,224
Short-term investments................................... 4,717 105 105
Receivables, net......................................... 95,941 215,176 134,815
Inventories, net......................................... 60,457 92,874 98,469
Royalty advances......................................... 69,202 15,879 10,009
Deferred income taxes.................................... 15,283 16,292 16,140
Income taxes receivable.................................. -- 15,171 10,684
Prepaid expenses and other current assets................ 6,510 4,545 7,954
-------- -------- --------
Total current assets.................................. 323,977 399,650 295,400
Property and equipment, net................................ 10,082 23,245 29,049
Investments, at cost....................................... 9,829 10,089 10,089
Goodwill, net of accumulated amortization of $1,660, $2,955
and $3,591, respectively................................. 21,003 23,495 28,043
Other assets............................................... 2,220 1,246 3,290
-------- -------- --------
Total assets..................................... $367,111 $457,725 $365,871
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $107,842 $148,625 $103,062
Accrued liabilities...................................... 52,812 63,904 49,414
Revolving credit facility................................ -- 54,600 28,000
Royalties payable........................................ 33,378 47,432 40,395
Deferred income.......................................... 4,783 412 156
Income taxes payable..................................... 9,575 5,954 3,449
Current portion of long-term liabilities................. 1,334 5 5
Due to related party..................................... 601 753 925
-------- -------- --------
Total current liabilities............................. 210,325 321,685 225,406
Long-term liabilities...................................... 4,648 1,799 1,576
-------- -------- --------
Total liabilities................................ 214,973 323,484 226,982
-------- -------- --------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par, 150,000,000 shares authorized,
66,391,318, 67,899,057 and 67,991,926 shares issued and
outstanding, respectively................................ 664 679 680
Additional paid-in capital................................. 118,220 128,262 131,382
Retained earnings.......................................... 32,441 7,219 7,577
Cumulative translation adjustment.......................... 813 (1,919) (750)
-------- -------- --------
Total stockholders' equity....................... 152,138 134,241 138,889
-------- -------- --------
Total liabilities and stockholders' equity....... $367,111 $457,725 $365,871
======== ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-2
<PAGE> 51

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
-------------------------------- ENDED MARCH 31,
1995 1996 1997 1998
-------- -------- -------- ---------------
<S> <C> <C> <C> <C>
Net revenues............................... $234,461 $365,490 $530,677 $105,767
Cost of goods sold......................... 138,662 214,580 315,134 57,092
Selling and distribution expenses ($3,129,
$3,407, $5,194 and $1,434 to a related
party for the periods presented,
respectively)............................ 41,733 72,517 98,689 24,467
General and administrative expenses ($654,
$1,060, $987 and $106 to a related party
for the periods presented,
respectively)............................ 19,491 31,157 45,561 10,655
Research and development................... 1,717 5,633 13,824 10,866
Royalty advance write-off.................. -- -- 73,821 --
Purchased research and development......... -- -- 11,008 --
SingleTrac retention bonus................. -- -- 2,400 --
Merger and other costs..................... -- 3,718 1,050 --
Amortization of goodwill................... 567 1,092 1,295 636
-------- -------- -------- --------
Operating income (loss).................. 32,291 36,793 (32,105) 2,051
Interest and other income (expense), net... 795 3,974 (2,075) (1,389)
-------- -------- -------- --------
Income (loss) before income taxes........ 33,086 40,767 (34,180) 662
Provision for (benefit from) income
taxes.................................... 10,482 15,628 (9,157) 304
-------- -------- -------- --------
Net income (loss)........................ $ 22,604 $ 25,139 $(25,023) $ 358
======== ======== ======== ========
Pro forma adjustment to income tax
provision (unaudited).................... 4,616
--------
Pro forma net income (unaudited)........... $ 17,988
========
Basic net income (loss) per share.......... $ 0.38 $ (0.37) $ 0.01
Weighted average shares outstanding...... 66,391 66,982 67,938
Diluted net income (loss) per share........ $ 0.37 $ (0.37) $ 0.01
Weighted average shares outstanding...... 68,313 66,982 68,384
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 52

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------------ ENDED MARCH 31,
1995 1996 1997 1998
------- ------- -------- ---------------
<S> <C> <C> <C> <C>
Net income (loss)............................ $22,604 $25,139 $(25,023) $ 358
Other comprehensive income (loss):
Foreign currency translation adjustments... 14 841 (2,732) 1,169
Unrealized holding loss on securities...... -- (186) (199) --
------- ------- -------- ------
Comprehensive income (loss).................. $22,618 $25,794 $(27,954) $1,527
======= ======= ======== ======
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-4
<PAGE> 53

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------------- ENDED MARCH 31,
1995 1996 1997 1998
-------- -------- --------- ---------------
<S> <C> <C> <C> <C>
CAST FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $ 22,604 $ 25,139 $ (25,023) $ 358
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Depreciation and amortization.................. 1,494 3,202 7,434 2,511
Purchased research and development............. -- -- 11,008 --
Royalty advance write-off...................... -- -- 73,821 --
Deferred income taxes.......................... (11,660) (1,269) (1,010) 1,010
Deferred income................................ 11,090 (3,754) (1,690) 187
Changes in operating assets and liabilities:
Receivables, net............................. (35,983) (8,880) (118,508) 81,091
Inventories, net............................. (30,473) (10,481) (32,084) (5,418)
Royalty advances............................. (23,590) (33,293) (20,505) 5,870
Due to related party, net.................... (591) (354) (349) 581
Prepaid expenses and other current assets.... (832) (1,316) 2,206 (3,409)
Accounts payable............................. 49,821 16,480 38,607 (45,240)
Accrued liabilities.......................... 23,630 7,507 9,108 (17,472)
Royalties payable............................ 11,219 6,720 14,054 (7,037)
Income taxes payable......................... 2,246 6,382 (3,804) (2,423)
Income taxes receivable...................... -- -- (15,171) 4,487
Long-term liabilities........................ (417) 901 (8,186) (666)
Other........................................ (798) (1,907) 522 (2,043)
-------- -------- --------- --------
Net cash provided by (used in) operating
activities.............................. 17,760 5,077 (69,570) 12,387
-------- -------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments......................... -- (9,829) (259) --
Purchases of property and equipment.............. (5,275) (5,703) (18,269) (7,641)
Purchases (sales) of short-term investments,
net............................................ (9,625) 4,908 4,613 --
Acquisitions, net of cash acquired of
approximately $516, $7, $135 and $0,
respectively................................... 218 (6,297) (5,833) --
-------- -------- --------- --------
Net cash used in investing activities..... (14,682) (16,921) (19,748) (7,641)
-------- -------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) under revolving credit
facility, net.................................. -- -- 54,600 (26,600)
Repurchase of warrants........................... -- (1,935) -- --
Proceeds from exercise of warrants............... -- -- 2,102 --
Proceeds from exercise of stock options.......... -- 636 786 114
Issuance of common stock......................... 77,935 100 -- --
Issuance of preferred stock and warrants......... 15,017 -- -- --
Repayment of notes............................... (10,471) -- -- --
Distribution to stockholders..................... (6,000) -- -- --
-------- -------- --------- --------
Net cash provided by (used in) financing
activities.............................. 76,481 (1,199) 57,488 (26,486)
-------- -------- --------- --------
Effect of exchange rates on cash and cash
equivalents.................................... 14 841 (429) (644)
-------- -------- --------- --------
Net increase (decrease) in cash and cash
equivalents.................................... 79,573 (12,202) (32,259) (22,384)
Cash and cash equivalents -- beginning of fiscal
year........................................... 4,496 84,069 71,867 39,608
-------- -------- --------- --------
Cash and cash equivalents -- end of fiscal
year........................................... $ 84,069 $ 71,867 $ 39,608 $ 17,224
======== ======== ========= ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-5
<PAGE> 54

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONAL RETAINED CUMULATIVE
COMMON PAID-IN EARNINGS TRANSLATION
STOCK CAPITAL (DEFICIT) ADJUSTMENT TOTAL
------ ---------- --------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994........... $ -- $ 5,521 $ (9,116) $ (42) $ (3,637)
Increase in par value of stock....... 468 (468) -- -- --
Issuance of stock in connection with
the acquisition of Slash
Corporation........................ 28 19,972 -- -- 20,000
Proceeds from sales of preferred
stock and warrants................. -- 15,017 -- -- 15,017
Proceeds from sales of common stock
in private placement............... 4 7,647 -- -- 7,651
Net proceeds from initial public
offering........................... 55 70,229 -- -- 70,284
Conversion of preferred stock to
common stock immediately prior to
the initial public offering........ 106 (106) -- -- --
Exercise of stock options............ -- 107 -- -- 107
Net income........................... -- -- 22,604 -- 22,604
Distributions........................ -- -- (6,000) -- (6,000)
Currency translation adjustment...... -- -- -- 14 14
---- -------- -------- ------- --------
Balance, December 31, 1995........... 661 117,919 7,488 (28) 126,040
Exercise of stock options............ 2 634 -- -- 636
Tax benefit relating to exercise of
stock options...................... -- 1,503 -- -- 1,503
Issuance of stock.................... 1 99 -- -- 100
Repurchase of warrants............... -- (1,935) -- -- (1,935)
Net income........................... -- -- 25,139 -- 25,139
Currency translation adjustment...... -- -- -- 841 841
Unrealized loss on securities........ -- -- (186) -- (186)
---- -------- -------- ------- --------
Balance, December 31, 1996........... 664 118,220 32,441 813 152,138
Issuance of stock in connection with
the acquisition of SingleTrac...... 7 7,162 -- -- 7,169
Exercise of warrants................. 5 2,097 -- -- 2,102
Exercise of stock options............ 3 783 -- -- 786
Net loss............................. -- -- (25,023) -- (25,023)
Currency translation adjustment...... -- -- -- (2,732) (2,732)
Unrealized loss on securities........ -- -- (199) -- (199)
---- -------- -------- ------- --------
Balance, December 31, 1997........... 679 128,262 7,219 (1,919) 134,241
Issuance of stock options in
connection with the acquisition of
SingleTrac......................... -- 3,007 -- -- 3,007
Exercise of stock options............ 1 113 -- -- 114
Net income........................... -- -- 358 -- 358
Currency translation adjustment...... -- -- -- 1,169 1,169
---- -------- -------- ------- --------
Balance, March 31, 1998.............. $680 $131,382 $ 7,577 $ (750) $138,889
==== ======== ======== ======= ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

F-6
<PAGE> 55

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 1 -- OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

GT Interactive Software Corp., a Delaware corporation, and its subsidiaries
(the "Company") creates, publishes, merchandises and distributes interactive
entertainment, edutainment and value-priced consumer software for a variety of
platforms on a worldwide basis. The Company derives its revenues primarily from
the sale of its created, published, licensed and purchased products to mass
merchants, specialty software stores, computer superstores and distributors
located throughout North America and also in various international locations.
The Company was incorporated in September 1992 and commenced operations in
February 1993.

Principles of Consolidation

The consolidated financial statements include the accounts of GT
Interactive Software Corp. and its wholly owned subsidiaries. All intercompany
transactions and balances have been eliminated.

Revenue Recognition

Revenue is recognized upon shipment of merchandise to customers. At the
time the revenue is recognized, a reserve is provided for expected future
returns net of the related cost of such items. The net reserve is included in
accrued liabilities.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash in banks and highly liquid,
short-term investments with original maturities of three months or less at the
date acquired.

Inventories

Inventories are stated at the lower of cost (based upon the first-in,
first-out method) or market. Allowances are established (and reassessed
quarterly) to reduce the recorded cost of obsolete inventory and slow moving
inventory to its net realizable value.

Royalty Advances

During the fourth quarter of 1997, the convergence of marketplace forces
led the Company to reconsider its royalty advance evaluation process. Rapid
technological innovation, shelf-space competition, shorter product life cycles
and buyer selectivity have made it extremely difficult to determine the
likelihood of individual product acceptance and success. As a result, the
Company expensed royalty advances of $73,821 on products that were in
development or on sale as of December 31, 1997. The Company has, effective
January 1, 1998, changed its accounting for future royalty advances, treating
such costs as research and development expenses, which are expensed as incurred.
These changes will create symmetry in accounting for both internally and
externally developed products. Multi-year output advances are expensed over the
development periods, in accordance with generally accepted accounting
principles.

Goodwill

Goodwill is amortized using the straight-line method over periods not
exceeding 20 years. Management reassesses quarterly the appropriateness of both
the carrying value and remaining life of goodwill, principally based on
forecasts of future undiscounted cash flows of businesses acquired.

F-7
<PAGE> 56
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 1 -- OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES -- (CONTINUED)
Property and Equipment

Property and equipment is recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets, which
range from three to seven years. Leasehold improvements are amortized using the
straight-line method over the shorter of the lease term or the estimated useful
lives of the related assets.

Income Taxes

The Company recognizes income taxes in accordance with the liability
method. Deferred income tax assets and liabilities are computed for differences
between the financial statement and tax basis of assets and liabilities that
will result in taxable or deductible amounts in the future based on enacted tax
laws and rates applicable to the period in which the differences are expected to
affect taxable income. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.

Through February 28, 1995, the Company was an S corporation for Federal and
New York state income tax purposes. On March 1, 1995, the Company became a C
corporation for Federal and New York state income taxes. Unaudited pro forma
adjustments to the income tax provision represent the additional tax provision
the Company would have recorded had it been a C corporation for Federal and New
York state income tax purposes during the relevant periods.

Fair Values of Financial Instruments

The carrying amount of cash and cash equivalents, short-term investments,
accounts receivable, accounts payable and accrued liabilities approximates fair
value due to the short-term nature of such items.

Research and Development Costs

Research and development costs related to the designing, developing and
testing of new software products are charged to expense as incurred. Effective
January 1, 1998, research and development costs also include payments for
royalty advances to third party developers on products that are currently in
development.

Advertising Expenses

Advertising costs are expensed as incurred. Advertising expense for the
years ended December 31, 1995, 1996 and 1997 and for the three months ended
March 31, 1998 amounted to $14,387, $23,987, $32,034 and $7,889, respectively.

Foreign Currency Translation

The Company's foreign subsidiaries maintain their accounting records in
their local currency. The currencies are then converted to United States dollars
and the effect of the foreign currency translation is reflected as a component
of stockholders' equity.

Reclassifications

Certain reclassifications have been made to the prior years' consolidated
financial statements to conform to classifications used in the current period.

F-8
<PAGE> 57
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 1 -- OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES -- (CONTINUED)
Net Income (Loss) Per Share

In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 requires dual presentation of basic earnings per share ("EPS") and
diluted EPS on the face of all statements of earnings for all entities with
complex capital structures. Basic EPS is computed as net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock-based compensation plans including stock options, restricted stock
awards, warrants and other convertible securities using the treasury stock
method.

Comprehensive Income

During the three months ended March 31, 1998, the Company adopted Financial
Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 requires the reporting of comprehensive income in
addition to net income from operations. Comprehensive income is a more inclusive
financial reporting methodology that includes disclosure of certain financial
information that historically has not been recognized in the calculation of net
income.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Fiscal Year

Effective January 1, 1998, the Company has changed its fiscal year end from
December 31 to March 31. Accordingly, the fiscal year ended March 31, 1998
represents three months of operations.

NOTE 2 -- ACQUISITIONS

In June 1995, the Company acquired Slash Corporation ("Slash"), for a total
purchase price of approximately $20,299. The acquisition was accounted for as a
purchase and, accordingly, the accompanying consolidated financial statements
include the results of operations of Slash as of the date of acquisition. The
excess cost over fair value of assets acquired of approximately $21,853 is being
amortized on a straight-line basis over twenty years.

The following unaudited pro forma summary represents the consolidated
results of operations of the Company as though the acquisition had been made as
of January 1, 1995:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1995
------------
<S> <C>
Net revenues................................................ $253,851
Operating income............................................ 33,731
Net income.................................................. 18,628
Pro forma diluted net income per share...................... 0.30
Pro forma weighted average shares outstanding............... 61,082
</TABLE>

F-9
<PAGE> 58
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 2 -- ACQUISITIONS -- (CONTINUED)
The primary pro forma adjustments for the year ended December 31, 1995 are
the additional taxes that would have been provided had Slash been a C
corporation for the relevant periods of approximately $845, the elimination of
sales between the Company and Slash of approximately $2,135, and the recording
of the amortization of goodwill of approximately $525.

In 1996, the Company acquired all of the outstanding common stock of
WizardWorks Group, Inc. ("WizardWorks"), all of the outstanding common stock of
Candel Inc., the parent company of FormGen, Inc. ("FormGen"), and all of the
outstanding common stock of Humongous Entertainment, Inc. ("Humongous").
WizardWorks, FormGen and Humongous (collectively, the "Acquired Companies") have
been accounted for as pooling of interests and accordingly are included in the
Company's Consolidated Financial Statements as if the acquisitions had occurred
as of the beginning of all periods presented.

In November 1996, the Company purchased 100% of the business of Warner
Interactive Entertainment Europe, which consisted of Warner Interactive
Entertainment Limited, Brambleworld Computers Limited, Warner Interactive France
S.A. and Warner Interactive Entertainment Germany GmbH, for approximately $6,300
in cash. Immediately subsequent to the acquisition, the Company renamed three of
the four companies to: Renegade Interactive Entertainment Limited, GT
Interactive Software France S.A. and GT Interactive Entertainment Germany GmbH.
This acquisition has been accounted for as a purchase and accordingly, the
operating results of the acquired companies have been included in the Company's
Consolidated Financial Statements as of the date of the acquisition.

In January 1997, the Company acquired all of the outstanding capital stock
of Premier Promotion Limited, the parent company of One Stop Direct Limited, for
approximately $400 in cash. This transaction was accounted for as a purchase.

In October 1997, the Company acquired SingleTrac Entertainment
Technologies, Inc. ("SingleTrac"), a software developer, for cash and stock.
Total consideration, including acquisition costs, was approximately $14.7
million, of which $5.4 million was cash and the balance of the purchase price
was the issuance of 0.7 million newly issued shares of the Company's Common
Stock and the assumption of approximately 0.3 million stock options. The
acquisition was accounted for as a purchase. The purchase price was allocated to
net assets acquired, purchased in-process research and development ("R&D"), and
goodwill and other intangibles. Purchased in-process R&D includes the value of
products in the development stage and not considered to have reached
technological feasibility. In accordance with the applicable accounting rules,
purchased in-process R&D is required to be expensed. Accordingly, $11,008 of
acquisition cost was expensed in the fourth quarter of 1997.

NOTE 3 -- RECEIVABLES, NET

Receivables consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------- MARCH 31,
1996 1997 1998
------- -------- ---------
<S> <C> <C> <C>
Trade accounts receivable........................... $98,995 $218,992 $137,978
Royalties receivable................................ 1,015 563 89
------- -------- --------
100,010 219,555 138,067
Less: allowance for doubtful accounts............... 4,069 4,379 3,252
------- -------- --------
$95,941 $215,176 $134,815
======= ======== ========
</TABLE>

F-10
<PAGE> 59
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 4 -- INVENTORIES, NET

Inventories consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- ---------
<S> <C> <C> <C>
Finished goods........................................ $58,464 $89,207 $94,220
Raw materials......................................... 1,993 3,667 4,249
------- ------- -------
$60,457 $92,874 $98,469
======= ======= =======
</TABLE>

NOTE 5 -- INVESTMENTS

In 1996, the Company purchased for approximately $2,507 in cash a 9.9%
investment in, and entered into a multi-titled publishing agreement with Mirage,
a U.K. developer of entertainment software.

In 1996, the Company invested approximately $7,122 in convertible preferred
stock of OddWorld Entertainment, Inc., a developer of entertainment software,
which is convertible into 50% of the common equity.

In 1997, the Company purchased for $225 in cash a 9.9% investment in
GameWizards, Inc., a developer of electronic and print based strategy guides on
behalf of developers and publishers of software products.

NOTE 6 -- PROPERTY AND EQUIPMENT, NET

Property and equipment consists of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- ---------
<S> <C> <C> <C>
Computer equipment.................................... $ 4,704 $12,562 $12,789
Machinery and equipment............................... 3,232 5,651 7,059
Capitalized computer software......................... -- 5,553 8,369
Furniture and fixtures................................ 4,726 4,737 5,814
Leasehold improvements................................ 1,463 3,457 5,635
------- ------- -------
14,125 31,960 39,666
Less: accumulated depreciation........................ 4,043 8,715 10,617
------- ------- -------
$10,082 $23,245 $29,049
======= ======= =======
</TABLE>

Depreciation expense for the years ended December 31, 1995, 1996 and 1997
and for the three months ended March 31, 1998 amounted to approximately $1,065,
$2,110, $6,139 and $1,929, respectively.

F-11
<PAGE> 60
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 7 -- ACCRUED LIABILITIES

Accrued liabilities consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- ---------
<S> <C> <C> <C>
Sales return reserve.................................. $37,367 $33,077 $23,003
Other................................................. 15,445 30,827 26,411
------- ------- -------
$52,812 $63,904 $49,414
======= ======= =======
</TABLE>

NOTE 8 -- INCOME TAXES

The components of the provision for (benefit from) income taxes are as
follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
---------------------------- ENDED MARCH 31,
1995 1996 1997 1998
------- ------- -------- ---------------
<S> <C> <C> <C> <C>
Federal:
Current.............................. $16,199 $20,474 $(10,308) $(407)
Deferred............................. (5,607) (9,286) (1,265) 836
------- ------- -------- -----
10,592 11,188 (11,573) 429
------- ------- -------- -----
State and local:
Current.............................. 3,773 4,376 185 36
Deferred............................. (812) (1,737) (1,726) 33
------- ------- -------- -----
2,961 2,639 (1,541) 69
------- ------- -------- -----
Foreign:
Current.............................. 449 1,801 3,957 (194)
------- ------- -------- -----
14,002 15,628 (9,157) 304
------- ------- -------- -----
Benefit arising from change in tax
status............................... (3,520) -- -- --
------- ------- -------- -----
Provision for (benefit from) income
taxes................................ $10,482 $15,628 $ (9,157) $ 304
======= ======= ======== =====
Pro forma adjustment to income taxes
(unaudited).......................... 4,616
-------
Pro forma provision for income taxes
(unaudited).......................... $15,098
=======
</TABLE>

On March 1, 1995, the Company became a C corporation for Federal and New
York state income tax purposes. As a result, the C corporation assumed the tax
basis of the assets and liabilities of the former S corporation, which differed
from the financial statement basis of those items. Accordingly, the Company
recorded a deferred tax asset as of March 1, 1995 of approximately $3,520, which
primarily relates to the sales return reserve and inventory valuation.

F-12
<PAGE> 61
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 8 -- INCOME TAXES -- (CONTINUED)
The reconciliation of the income tax provision (benefit) computed at the
Federal statutory rate to the reported provision for (benefit from) income taxes
is as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------------ ENDED MARCH 31,
1995 1996 1997 1998
------- ------- -------- ---------------
<S> <C> <C> <C> <C>
Provision for (benefit from) income
taxes computed at Federal statutory
rate................................. $11,580 $14,268 $(11,963) $ 232
Increase (decrease) in provision for
(benefit from) income taxes resulting
from:
State and local taxes, net of Federal
tax benefit....................... 2,647 2,683 (1,541) 36
Reversal of deferred tax asset
valuation allowance............... -- (1,306) -- --
Non-deductible merger costs.......... -- 1,158 -- --
Foreign taxes in excess of Federal
statutory rate.................... (150) (36) 9 (175)
Purchased research and development... -- -- 4,293 --
Other, net........................... 1,021 (1,139) 45 211
------- ------- -------- -----
Pro forma provision for income taxes
(unaudited).......................... $15,098
=======
Provision for (benefit from) income
taxes................................ $15,628 $ (9,157) $ 304
======= ======== =====
Effective income tax rate.............. 46% 38% 27% 46%
======= ======= ======== =====
</TABLE>

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The components of the
Company's deferred tax assets and liabilities as of December 31, 1996 and 1997
and March 31, 1998 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- ---------
<S> <C> <C> <C>
DEFERRED TAX ASSETS:
Inventory valuation................................... $ 6,154 $ 6,727 $ 6,640
Deferred income....................................... 3,851 318 (504)
Sales return reserve.................................. 2,196 5,147 4,305
Tax loss carryforwards................................ 1,255 3,166 3,166
Other................................................. 1,934 1,333 3,073
------- ------- -------
15,390 16,691 16,680
------- ------- -------
DEFERRED TAX LIABILITIES:
Depreciation.......................................... (107) (399) (540)
------- ------- -------
(107) (399) (540)
------- ------- -------
Net deferred tax asset................................ $15,283 $16,292 $16,140
======= ======= =======
</TABLE>

As of March 31, 1998, two of the Company's subsidiaries had a combined net
operating loss carryforward of approximately $5,911 for tax purposes expiring in
the years 2007 through 2011.

F-13
<PAGE> 62
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 9 -- STOCKHOLDERS' EQUITY

The Company has authorized 5,000 shares of preferred stock, $0.01 par
value. No shares of preferred stock are issued or outstanding.

On July 31, 1995, the Company established par value at $0.01 on all classes
of its stock. Concurrently, the Company effected a four thousand for one split
of its then existing Class A and Class B Common Stock together with an increase
in the number of authorized shares.

On February 28, 1995, the Company's stockholders sold 10.5% of their then
outstanding shares in the Company to an investor (the "Investor"). The Company
issued warrants to the Investor for the right to purchase an aggregate of 2,520
shares of Common Stock at an exercise price of $4.17 per share.

Additionally, the Company received a $15,000 loan from the Investor. This
loan was repaid upon the consummation of the initial public offering and bore
interest at 4.5% per annum. In conjunction with such loan the Company issued
warrants to the Investor representing the right to purchase an aggregate of 505
shares of Common Stock at an exercise price of $4.17 per share. The Investor
exercised these warrants on May 2, 1997.

The Company received $15 in connection with the issuance of the
aforementioned warrants.

On June 30, 1995, the Investor paid the Company $15,000 for 505 shares of
Series A Convertible Preferred Stock, which was converted into 2,520 shares of
Common Stock immediately prior to the consummation of the Company's initial
public offering. Additionally, the Investor surrendered its warrants to purchase
an aggregate of 2,520 shares of Class A and Class B Common Stock.

In connection with the acquisition of Slash on June 23, 1995, the Company
issued approximately 2,794 shares of its Common Stock.

In October 1995, the Company sold approximately $7,650 of Common Stock to
another investor.

As of March 31, 1998 and December 31, 1997 and 1996, the Company had
outstanding warrants to purchase an aggregate of approximately 1,256, 1,256 and
956 shares of Common Stock, respectively, to content-providers at exercise
prices (ranging from $8.50 to $20.00) not less than the fair market value at the
date of issue. None of the outstanding warrants vested prior to May 1996;
vesting subsequent to such date is dependent upon the achievement of sales
levels of certain products, the rights to which were granted to the Company. On
July 19, 1996, the Company repurchased approximately 211 of these warrants
amounting to $1,936.

On June 24, 1996, the Company acquired all of the outstanding Common Stock
of WizardWorks in exchange for 2,350 shares of the Company's Common Stock.

On June 28, 1996, the Company acquired all of the outstanding Common Stock
of FormGen in exchange for approximately 1,033 shares of the Company's Common
Stock.

On July 9, 1996, the Company acquired all of the outstanding Common Stock
of Humongous in exchange for approximately 3,458 shares of the Company's Common
Stock.

In connection with the acquisition of SingleTrac Entertainment
Technologies, Inc. on October 15, 1997, the Company issued approximately 731
shares of its Common Stock and assumed approximately 306 stock options.

F-14
<PAGE> 63
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 10 -- STOCK OPTIONS

The Company has two stock option plans which began in 1995 and in 1997,
respectively (the "Plans"). The Company accounts for these Plans under
Accounting Principles Board Opinion No. 25, under which no compensation cost has
been recognized.

In connection with the acquisition of Humongous, the Company converted
options outstanding under Humongous' stock option plan to options under one of
the Company's Plans. In connection with the acquisition of SingleTrac, the
Company assumed SingleTrac's stock option plan. No additional shares will be
granted under Humongous' and SingleTrac's stock option plans.

Generally, under the Plans, options are granted to purchase shares of the
Company's common stock at no less than the fair market value at the date of the
grant, vest over a period of four or five years and are exercisable for a period
of ten years from the grant date.

A summary of the status of the Company's Plans at December 31, 1995, 1996
and 1997 and March 31, 1998 and changes during the years ended December 31,
1995, 1996 and 1997 and the three months ended March 31, 1998 are as follows
(conversion of Humongous' stock options have been treated as though they were
granted in 1995):

<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------------------------------
PRICE PER WEIGHTED AVERAGE
SHARES SHARE EXERCISE PRICE
------ ------------- ----------------
<S> <C> <C> <C>
Outstanding at beginning of year.............. 378 $0.04 - 0.18 $ 0.07
Granted....................................... 4,591 0.05 - 14.00 10.93
Exercised..................................... (8) 0.12 0.12
Forfeited..................................... (1) 14.00 14.00
Expired....................................... -- -- --
-----
Outstanding at end of year.................... 4,960 0.04 - 14.00 10.12
=====
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------
PRICE PER WEIGHTED AVERAGE
SHARES SHARE EXERCISE PRICE
------ -------------- ----------------
<S> <C> <C> <C>
Outstanding at beginning of year............. 4,960 $ 0.04 - 14.00 $10.12
Granted...................................... 1,122 0.35 - 23.50 12.53
Exercised.................................... (218) 0.04 - 9.38 2.92
Forfeited.................................... (104) 12.38 - 20.00 14.08
Expired...................................... -- -- --
-----
Outstanding at end of year................... 5,760 0.04 - 23.50 10.79
=====
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------------------------
PRICE PER WEIGHTED AVERAGE
SHARES SHARE EXERCISE PRICE
------ ------------- ----------------
<S> <C> <C> <C>
Outstanding at beginning of year............. 5,760 $0.04 - 23.50 $10.79
Granted...................................... 4,404 0.36 - 14.00 8.63
Exercised.................................... (268) 0.04 - 9.38 2.89
Forfeited.................................... (1,341) 0.35 - 23.50 15.36
Expired...................................... (272) 7.94 - 17.75 11.26
------
Outstanding at end of year................... 8,283 0.04 - 14.50 9.13
======
</TABLE>

F-15
<PAGE> 64
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 10 -- STOCK OPTIONS -- (CONTINUED)

<TABLE>
<CAPTION>
MARCH 31, 1998
-------------------------------------------
PRICE PER WEIGHTED AVERAGE
SHARES SHARE EXERCISE PRICE
------ ------------- ----------------
<S> <C> <C> <C>
Outstanding at beginning of fiscal year...... 8,283 $0.04 - 14.50 $9.13
Granted...................................... 1,547 6.31 - 7.94 6.83
Exercised.................................... (33) 0.18 - 2.08 1.10
Forfeited.................................... -- -- --
Expired...................................... (5) 0.35 - 14.00 7.00
-----
Outstanding at end of fiscal year............ 9,792 0.04 - 14.50 8.79
=====
</TABLE>

The following table summarizes significant ranges of outstanding and
exercisable options as of March 31, 1998:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- -------------------------------
ACTUAL RANGE OF NUMBER WEIGHTED AVERAGE NUMBER
EXERCISE PRICES OUTSTANDING REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
150% INCREMENT AT 3/31/98 CONTRACTUAL LIFE EXERCISE PRICE AT 3/31/98 EXERCISE PRICE
- ---------------- ----------- ----------------- ---------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.04 - 0.05 141 4.6 $ 0.04 141 $ 0.04
0.18 - 0.18 49 6.6 0.18 38 0.18
0.35 - 0.36 102 7.1 0.35 53 0.36
0.71 - 0.88 35 8.0 0.72 16 0.72
1.78 - 2.08 188 8.5 1.93 128 1.95
4.17 - 6.13 710 7.2 4.34 653 4.18
6.31 - 9.38 5,682 8.8 7.90 1,226 8.74
9.81 -14.50 2,885 8.1 13.07 1,214 13.93
</TABLE>

Had compensation cost for these plans been determined consistent with
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"), the Company's net income and earnings per share
would have been reduced to the following pro forma amounts:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------------ ENDED MARCH 31,
1995 1996 1997 1998
------- ------- -------- ---------------
<S> <C> <C> <C> <C> <C>
Net income (loss)...... As reported $22,604 $25,139 $(25,023) $ 358
Pro forma 21,701 21,872 (32,140) (259)
Basic net income (loss)
per share............ As reported -- $ 0.38 $ (0.37) $0.01
Pro forma -- $ 0.33 $ (0.48) $0.00
Diluted net income
(loss) per share..... As reported -- $ 0.37 $ (0.37) $0.01
Pro forma -- $ 0.32 $ (0.48) $0.00
</TABLE>

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the years ended December 31, 1995, 1996 and 1997
and the three months ended March 31, 1998: no dividends will be paid for the
entire term of the option, expected volatility of 57.9% for 1995 and 1996, 67.5%
for 1997 and the three months ended March 31, 1998, risk-free interest rates
averaging 5.15% for 1995 and 1996, 6.22% for 1997 and 5.45% for the three months
ended March 31, 1998 and expected lives of five years in 1995, four years in
1996, 1997 and the three months ended March 31, 1998, respectively.

F-16
<PAGE> 65
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 11 -- RELATED PARTY TRANSACTIONS

On January 1, 1995, the Company entered into a one year services agreement
with GoodTimes Home Video Corporation ("GoodTimes"), a company owned by three
directors of the Company. The services agreement was intended to facilitate the
Company's establishment of fully independent systems and administration during
1995. The services agreement provided for a fee based on specific services
performed and was terminable by the Company at any time upon written notice. The
total amount charged to operations for services provided by GoodTimes and
affiliated companies for the year ended December 31, 1995 amounted to
approximately $7,341. As of December 31, 1995, there were no services being
provided to the Company under the services agreement, however, GoodTimes is
providing manufacturing services under a separate manufacturing agreement. There
is no formal expiration date to this agreement. Beginning in October 1997, the
Company began performing these services internally. The Company enters into arms
length manufacturing transactions with GoodTimes on an as needed basis. The
total amount charged to operations for manufacturing services for the years
ended December 31, 1995, 1996 and 1997 amounted to $3,558, $7,516 and $2,498,
respectively. A nominal amount was charged to operations for these services in
the three months ended March 31, 1998.

During 1996, the Company sold approximately $3,488 of software to GoodTimes
at fair market value. At December 31, 1997, the Company had a receivable from
GoodTimes for this merchandise amounting to approximately $2,996. In February
1998, $2,869 of such receivable was paid.

In servicing its mass merchant accounts, the Company uses field
representatives supplied by REPS, a company owned by three directors of the
Company. REPS provides such services to the Company as well as to third parties.
The Company had an agreement with REPS pursuant to which REPS supplied such
services, at its cost, through December 31, 1997. The Company is in negotiation
with REPS to extend this agreement and is currently operating on a month to
month basis under the terms of the old agreement. Prior to entering into the
REPS Agreement, REPS' services were provided to the Company as part of the
services agreement with GoodTimes. The total amount charged to operations for
these services amounted to approximately $3,025, $4,817 and $1,434 for the years
ended December 31, 1996 and 1997 and the three months ended March 31, 1998.

The Company occasionally hires Taughannock Aviation Corp. ("Taughannock")
and Eastway Aircraft Services Inc. ("Eastway") to provide business travel
services for its officers and employees. Taughannock leases one plane from JT
Aviation Corp. ("JTAC"), a company owned by Joseph J. Cayre, Chairman Emeritus
of the Board of Directors of the Company, and one plane from KCS Aviation Corp.,
a company owned by Kenneth Cayre, a Director of the Company. Eastway leases two
planes from JTAC. Neither Taughannock nor Eastway is owned in whole or in part
by any member of the Cayre family.

Taughannock and Eastway provide air travel to the Company at an hourly rate
and on an as needed and as available basis. During the years ended December 31,
1995, 1996 and 1997 and the three months ended March 31, 1998, the Company's
aggregate air travel fees paid to Taughannock were approximately $357, $219, $0
and $0, respectively. During the years ended December 31, 1995, 1996 and 1997
and the three months ended March 31, 1998, the Company paid approximately $0,
$226, $370 and $40, respectively, to Eastway.

The Company occasionally hired JC Aviation Corp ("JCAC"), a company owned
by Jack J. Cayre, Executive Vice President and Director of the Company, to
provide business transportation services for its officers. During the year ended
December 31, 1997, the Company paid approximately $26 to JCAC. There were no
payments made during the three months ended March 31, 1998 to JCAC.

The Company has entered into agreements with Upgrade Corporation of America
(doing business as SOFTBANK Services Group) ("SOFTBANK Services") pursuant to
which SOFTBANK Services (i) provides toll-free customer support for some of the
Company's published products and (ii) takes direct

F-17
<PAGE> 66
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 11 -- RELATED PARTY TRANSACTIONS -- (CONTINUED)
customer orders and provides fulfillment services for the Company, in each case
on a per service basis. The agreement relating to customer support service
expired on December 17, 1996 and the agreement providing for the fulfillment
service expired on August 2, 1997. Both agreements provide for automatic renewal
on a month to month basis upon expiration unless terminated by either party.
During the years ended December 31, 1996 and 1997 and the three months ended
March 31, 1998, the Company had charged to operations approximately $164, $230
and $41, respectively, in fees to SOFTBANK Services. Jordan A. Levy, a Director
of the Company, is the Co-Chairman of SOFTBANK Services.

The Company believes that the amounts charged by related parties materially
approximate those amounts which would have been incurred from non-affiliates.

On August 31, 1996, the Company extended a loan to Andrew Gregor, Chief
Financial Officer of the Company, in the principal amount of $250. Such loan
bears interest at the rate of 6.15% per annum and was amended in March 1998 to
extend the maturity date from August 31, 1998 to August 31, 2000.

On August 31, 1996, the Company extended a loan to the former Senior Vice
President of the Company, in the principal amount of $200. Such loan bears
interest at a rate of 6.15% per annum and has been repaid.

The Company has extended loans to the former stockholders of FormGen in the
aggregate amount of $1,098. $181 of such loans have been repaid as of December
31, 1997. The remaining balances have been extended and become due and payable
on August 1, 1998.

The Company has extended non-interest bearing loans to three employees of
the Company who were former stockholders of SingleTrac in the aggregate amount
of $300. Such loans become due and payable at the earlier of the sale of their
stock of the Company, in November 1999 or six months following termination of
employment. Each of the three borrowers has pledged 20,000 shares of the
Company's Common Stock owned by the borrowers, as collateral security for the
payment of the loan.

See Note 12 for information concerning other related party transactions.

NOTE 12 -- LEASES

The Company accounts for its leases as operating leases, with expiration
dates ranging from 1998 through 2020. Future minimum annual rental payments
under the leases are as follows for the fiscal years then ended:

<TABLE>
<S> <C>
1999............................................. $ 6,381
2000............................................. 5,223
2001............................................. 4,193
2002............................................. 3,841
2003............................................. 3,830
Thereafter....................................... 18,800
-------
$42,268
=======
</TABLE>

Total rent expense charged to operations for the years ended December 31,
1995, 1996 and 1997 and the three months ended March 31, 1998 amounted to
approximately $1,824, $3,207, $4,894 and $1,233, respectively. Through March 31,
1998, the Company leased a portion of its international offices from a related
party. Through December 31, 1997, the Company leased its executive and
administrative offices from a related party. Of the total rent expense charged
to operations, approximately $751, $997, $967 and $67 was paid to the Company's
related party during the years ended December 31, 1995, 1996 and 1997 and the
three months ended March 31, 1998, respectively.

F-18
<PAGE> 67
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 13 -- COMMITMENTS AND CONTINGENCIES

On January 21, 1997, the Company entered into a Revolving Credit Agreement
(the "Credit Agreement") with banks expiring on December 31, 1998. The Credit
Agreement was amended on June 30, 1997 to increase the facility from $40,000 to
a maximum of $65,000 to be used for borrowings and letters of credit. Borrowing
is limited to fifty percent of adjusted, as defined, consolidated accounts
receivable, and is secured by these receivables. The borrowings under this
agreement bear interest at either the banks' reference rate (which is generally
equivalent to the published prime rate) or the LIBOR rate plus 1 1/4%. The
Company pays a commitment fee of 1/4% based on the unused portion of the line.
The Credit Agreement requires maintenance of certain financial ratios and net
income levels.

At March 31, 1998, the Company had outstanding debt of $28,000,
representing borrowings under the Credit Agreement, and letters of credit
amounting to $6,309. Interest expense for the year ended December 31, 1997 and
the three months ended March 31, 1998 amounted to $1,948 and $636, respectively.

NOTE 14 -- ROYALTY ADVANCES

The Company has committed to pay advance royalty payments under certain
royalty agreements. These obligations are not guaranteed and are dependent, in
part, on the delivery of the contracted services by the licensor. Future advance
royalty payments due under these royalty agreements are as follows for the
fiscal years then ended:

<TABLE>
<S> <C>
1999............................................... $23,216
2000............................................... 1,690
2001............................................... 375
2002............................................... 3,524
2003............................................... --
Thereafter......................................... --
-------
$28,805
=======
</TABLE>

F-19
<PAGE> 68
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 15 -- CONCENTRATION OF CREDIT RISK

The Company extends credit to various companies in the retail and mass
merchandising industry for the purchase of its merchandise which results in a
concentration of credit risk. This concentration of credit risk may be affected
by changes in economic or other industry conditions and may, accordingly, impact
the Company's overall credit risk. Although the Company generally does not
require collateral, the Company performs ongoing credit evaluations of its
customers and reserves for potential losses are maintained.

The Company had sales constituting 52%, 45%, 36% and 37% of net revenue to
a single customer in the years ended December 31, 1995, 1996 and 1997 and the
three months ended March 31, 1998, respectively.

Accounts receivable due from this significant customer aggregated 22%, 33%
and 37% of accounts receivable at December 31, 1996 and 1997 and March 31, 1998,
respectively.

The Company continually monitors its positions with, and the credit quality
of, the financial institutions with which the Company conducts business.

NOTE 16 -- OPERATIONS BY REPORTABLE SEGMENTS AND GEOGRAPHIC AREAS

The Company has two reportable segments: publishing and merchandising and
distribution. Publishing constitutes both internally developed and externally
licensed titles. Merchandising and distribution constitutes the sale of other
publishers' titles to various mass merchants.

The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance based on operating income of these segments.

The Company's reportable segments are strategic business units with
different associated costs and profit margins. They are managed separately
because each business unit requires different planning, merchandising and
marketing strategies. The Company commenced reporting in these reportable
segments during the year ended December 31, 1996.

The following unaudited summary represents the consolidated net revenues
and operating income (loss) by reportable segment for the years ended December
31, 1996 and 1997 and the three months ended March 31, 1998:

<TABLE>
<CAPTION>
MERCHANDISING
PUBLISHING AND DISTRIBUTION CORPORATE TOTAL
---------- ---------------- --------- --------
<S> <C> <C> <C> <C>
1996:
Net revenues................................... $197,280 $168,210 -- $365,490
Operating income (loss)........................ 45,982 36,025 $(40,404) 41,603

1997:
Net revenues................................... $323,528 $207,149 -- $530,677
Operating income (loss)........................ 67,129 38,795 $(48,455) 57,469

1998:
Net revenues................................... $ 65,822 $ 39,945 -- $105,767
Operating income (loss)........................ 9,932 7,103 $(14,348) 2,687
</TABLE>

F-20
<PAGE> 69
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 16 -- OPERATIONS BY REPORTABLE SEGMENTS AND GEOGRAPHIC AREAS -- (CONTINUED)
The following represents the reconciliation of operating income as reported
for reportable segments to consolidated totals for the years ended December 31,
1996 and 1997 and the three months ended March 31, 1998:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------- THREE MONTHS ENDED
1996 1997 MARCH 31, 1998
------- -------- ------------------
<S> <C> <C> <C>
Operating income as reported for reportable
segments.......................................... $41,603 $ 57,469 $2,687
Amortization of goodwill............................ 1,092 1,295 636
Other non-recurring charges......................... 3,718 88,279 --
------- -------- ------
Operating income (loss)............................. $36,793 $(32,105) $2,051
======= ======== ======
</TABLE>

Information about the Company's operations in the United States and other
geographic locations for the years ended December 31, 1996 and 1997 and the
three months ended March 31, 1998 are presented below. During the year ended
December 31, 1995, the Company only operated in the United States.

<TABLE>
<CAPTION>
OTHER
GEOGRAPHIC
UNITED STATES LOCATIONS TOTAL
------------- ---------- --------
<S> <C> <C> <C>
1996:
Net revenues................................... $331,592 $ 33,898 $365,490
Operating income............................... 30,424 6,369 36,793
Total assets................................... 321,347 45,764 367,111
1997:
Net revenues................................... $423,197 $107,480 $530,677
Operating income (loss)........................ (44,332) 12,227 (32,105)
Total assets................................... 389,610 68,115 457,725
1998:
Net revenues................................... $ 87,538 $ 18,229 $105,767
Operating income............................... 1,270 781 2,051
Total assets................................... 313,550 52,321 365,871
</TABLE>

NOTE 17 -- SUPPLEMENTAL CASH FLOW INFORMATION

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
---------------------------- ENDED MARCH 31,
1995 1996 1997 1998
------- ------ ------- ---------------
<S> <C> <C> <C> <C>
Issuance of common stock in
connection with the acquisition of
Slash............................. $20,000 $ -- $ -- $ --
Issuance of common stock in
connection with the acquisition of
SingleTrac........................ -- -- 7,169 --
Issuance of stock options in
connection with the acquisition of
SingleTrac........................ -- -- -- 3,007
Accrual for purchase price
adjustment for One Stop........... -- -- -- 3,095
Cash paid for income taxes.......... 19,169 9,783 10,243 2
Cash paid for interest.............. 669 685 1,802 727
</TABLE>

F-21
<PAGE> 70
GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE 17 -- SUPPLEMENTAL CASH FLOW INFORMATION -- (CONTINUED)
The Company has entered into a barter agreement effective March 30, 1998
with a three year term, in which the Company exchanged $3,246 of excess
inventory of published titles for a combination of barter credits and cash
contingent upon the sale of the product by the barter company.

NOTE 18 -- TERMINATED MERGER AGREEMENT WITH MICROPROSE, INC.

On October 5, 1997, the Company entered into an agreement to acquire by
merger MicroProse, Inc., a Delaware corporation ("MicroProse") and a developer,
producer and publisher of entertainment software for personal computers and
certain console platforms. On December 5, 1997, the companies' respective boards
of directors mutually agreed to terminate the merger agreement. The Company
charged $1,050 to operations in connection with the aborted acquisition of
MicroProse.

NOTE 19 -- QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized quarterly financial data for the year ended December 31, 1996
are as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Net revenues....................... $70,757 $73,526 $86,192 $135,015
Operating income................... 7,211 5,999 12,187 11,396
Net income......................... 4,392 3,502 8,730 8,515
Basic net income per share......... $ 0.07 $ 0.05 $ 0.13 $ 0.13
Weighted average shares
outstanding...................... 66,145 66,145 69,217 66,391
Diluted net income per share....... $ 0.06 $ 0.05 $ 0.13 $ 0.13
Weighted average shares
outstanding...................... 67,686 68,571 69,217 67,896
</TABLE>

Summarized quarterly financial data for the year ended December 31, 1997
are as follows:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
<S> <C> <C> <C> <C>
Net revenues...................... $93,381 $102,737 $120,990 $213,569
Operating income (loss)........... 7,593 8,761 14,650 (63,109)
Net income (loss)................. 4,454 4,469 8,526 (42,472)
Basic net income (loss) per
share........................... $ 0.07 $ 0.07 $ 0.13 $ (0.63)
Weighted average shares
outstanding..................... 66,395 66,779 67,032 67,717
Diluted net income (loss) per
share........................... $ 0.07 $ 0.07 $ 0.12 $ (0.63)
Weighted average shares
outstanding..................... 67,358 67,230 68,683 67,717
</TABLE>

F-22
<PAGE> 71

GT INTERACTIVE SOFTWARE CORP. AND SUBSIDIARIES

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONS
BALANCE -- CHARGED TO BALANCE --
BEGINNING OF COSTS AND END OF
DESCRIPTION YEAR EXPENSES DEDUCTIONS YEAR
----------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Three months ended:
March 31, 1998........................... $4,379 $ 411 $(1,538) $3,252
====== ====== ======= ======
Years ended:
December 31, 1997........................ $4,069 $4,106 $(3,796) $4,379
====== ====== ======= ======
December 31, 1996........................ $1,844 $2,225 $ -- $4,069
====== ====== ======= ======
December 31, 1995........................ $ 235 $1,609 $ -- $1,844
====== ====== ======= ======
Reserve for obsolescence:
Three months ended:
March 31, 1998........................... $9,188 $ 968 $ (301) $9,855
====== ====== ======= ======
Years ended:
December 31, 1997........................ $6,081 $3,107 $ -- $9,188
====== ====== ======= ======
December 31, 1996........................ $7,066 $ -- $ (985) $6,081
====== ====== ======= ======
December 31, 1995........................ $1,561 $5,505 $ -- $7,066
====== ====== ======= ======
</TABLE>

F-23

<PAGE> 1
Exhibit 18.1

May 21, 1998

To GT Interactive Software Corp.:

This letter is written to meet the requirements of Regulation S-K calling for a
letter from a registrant's independent accountants whenever there has been a
change in accounting principle or practice.

During the fourth quarter of 1997, the convergence of marketplace forces led the
Company to reconsider its royalty advance evaluation process. Rapid
technological innovation, shelf-space competition, shorter product life cycles
and buyer selectivity have made it extremely difficult to determine the
likelihood of individual product acceptance and success. As a result, the
Company expensed royalty advances of $73,821,000 on products that were in
development or on sale as of December 31, 1997. The Company has, effective
January 1, 1998, changed its accounting for future royalty advances, treating
such costs as research and development expenses, which are expensed as incurred.
These changes will create symmetry in accounting for both internally and
externally developed products.

A complete coordinated set of financial and reporting standards for determining
the preferability of accounting principles among acceptable alternative
principles has not been established by the accounting profession. Thus, we
cannot make an objective determination of whether the change in accounting
described in the preceding paragraph is to a preferable method. However, we
have reviewed the pertinent factors, including those related to financial
reporting, in this particular case on a subjective basis, and our opinion
stated below is based on our determination made in this manner.

We are of the opinion that the Company's change in method of accounting is to
an acceptable alternative method of accounting, which, based upon the reasons
stated for the change and our discussions with you, is also preferable under the
circumstances in this particular case. In arriving at this opinion, we have
relied on the business judgment and business planning of your management.

Very truly yours,

ARTHUR ANDERSEN LLP

<PAGE> 1

EXHIBIT 23.1

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements
on Form S-8 (Nos. 333-00428, 333-33353 and 333-39353) and Form S-3 (Registration
No. 333-51645) of GT Interactive Software Corp. of our report dated May 10,
1996, with respect to the combined financial statements of WizardWorks Group for
the year ended March 31, 1996, included in the Transition Report (Form 10-K) of
GT Interactive Software Corp. for the transition period from January 1, 1998 to
March 31, 1998.

ERNST & YOUNG LLP

Minneapolis, Minnesota
June 23, 1998

<PAGE> 1

EXHIBIT 23.2

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation
by reference of our report included in this Form 10-K, into the Company's
previously filed Registration Statements on Form S-8 (Registration Nos.
333-00428, 333-33353 and 333-39353) and Form S-3 (Registration No. 333-51645).

ARTHUR ANDERSEN LLP

New York, New York
June 24, 1998

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 17,224
<SECURITIES> 105
<RECEIVABLES> 138,068
<ALLOWANCES> (3,252)
<INVENTORY> 98,469
<CURRENT-ASSETS> 295,400
<PP&E> 39,666
<DEPRECIATION> (10,617)
<TOTAL-ASSETS> 365,871
<CURRENT-LIABILITIES> 225,406
<BONDS> 28,000
0
0
<COMMON> 680
<OTHER-SE> 138,889
<TOTAL-LIABILITY-AND-EQUITY> 365,871
<SALES> 105,767
<TOTAL-REVENUES> 105,767
<CGS> 57,092
<TOTAL-COSTS> 57,092
<OTHER-EXPENSES> 46,624
<LOSS-PROVISION> 410,567
<INTEREST-EXPENSE> (1,389)
<INCOME-PRETAX> 662
<INCOME-TAX> 304
<INCOME-CONTINUING> 358
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 358
<EPS-PRIMARY> 0.01
<EPS-DILUTED> 0.01

</TABLE>