MIDWAY GAMES INC, 10-K405, 1997-09-26

MIDWAY GAMES INC
10-K405, 1997-09-26
MISCELLANEOUS MANUFACTURING INDUSTRIES

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JUNE 30, 1997

COMMISSION FILE NUMBER 1-12367

MIDWAY GAMES INC.
(Exact name of registrant as specified in its charter)

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<C> <C>
DELAWARE 22-2906244
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3401 NORTH CALIFORNIA AVENUE 60618
CHICAGO, ILLINOIS (Zip Code)
(Address of principal executive offices)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (773) 961-2222
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, $.01 par value New York Stock Exchange
Stock Purchase Rights pursuant to Stockholder New York Stock Exchange
Rights Agreement
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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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, 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 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. [X]

The aggregate market value of the 5,037,000 shares of Common Stock held by
non-affiliates of the registrant on September 22, 1997 was $129,702,750. On such
date, the closing price of the Common Stock on the New York Stock Exchange, Inc.
was $25.75 per share and the number of shares of Common Stock outstanding was
38,500,000 shares.

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DOCUMENTS INCORPORATED BY REFERENCE: PART
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Annual Report to Stockholders of Registrant for the fiscal
year ended June 30, 1997.................................. I, II, IV
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PART I

This Annual Report on Form 10-K contains forward looking information and
describes the beliefs of Midway Games Inc. (the "Company" or "Midway")
concerning future business conditions and the outlook for the Company based on
currently available information. Wherever possible, the Company has identified
these forward looking statements by words such as "anticipates," "believes,"
"estimates," "expects" and similar expressions. These forward looking statements
are subject to risks and uncertainties which could cause the Company's actual
results or performance to differ materially from those expressed in these
statements. These risks and uncertainties include the following: financial
strength of the amusement games industry, the ability of the Company to develop
new technologies on a timely basis and to design, introduce and market
successful new game titles, the level of consumer spending for such games, the
success of planned advertising, marketing and promotional campaigns, the
introduction of new dedicated platforms as well as the items set forth under
"Item 1. Business -- Factors Affecting Future Performance." The Company assumes
no obligation to update publicly any forward looking statements, whether as a
result of new information, future events or otherwise. Discussions containing
such forward looking statements may be found in the materials set forth under
"Item 1. Business -- The Company," "-- Business" and "-- Factors Affecting
Future Performance" contained herein and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained in the
Company's 1997 Annual Report to Stockholders (the "1997 Annual Report").

ITEM 1. BUSINESS

THE COMPANY

Midway is a leading designer, publisher and marketer of interactive
entertainment software played in both the coin-operated and home markets. Since
the late 1970s, Midway has released many of the industry's leading games,
including Mortal Kombat (which line of games has sold over 14 million copies in
the home market), Cruis'n USA, Cruis'n World, NBA Jam, Joust, Defender, Pacman
and Space Invaders, and, through its recently acquired Atari Games Corporation
subsidiary ("Atari Games"), such leading games as San Francisco Rush Extreme
Racing, The NHLPA & NHL Present Wayne Gretzky's 3D Hockey, Area 51, Gauntlet,
Centipede, Asteroids and Pong. Midway's games are generally available for play
on all major dedicated home video game platforms, including those of Nintendo,
Sony and Sega, and personal computers.

On October 29, 1996, the Company completed an initial public offering of
5,100,000 shares of common stock, par value $.01 per share (the "Common Stock"),
for $20.00 per share (the "Offering"). As of September 22, 1997, the Company had
38,500,000 shares outstanding of which WMS Industries Inc. ("WMS") owned
33,400,000 shares, representing approximately 86.8% of the outstanding shares of
Common Stock.

On August 11, 1997, WMS announced that it would distribute on a pro rata
basis to its stockholders all of the Company's Common Stock owned by WMS (the
"Distribution"). Midway and WMS believe that the Distribution will, among other
things, provide greater liquidity for the Common Stock, reduce regulatory
burdens and risks imposed on Midway arising from the gaming business of WMS
Gaming Inc. (a wholly-owned subsidiary of WMS) and enhance stockholder value by
permitting each company to develop its individual strengths and pursue
opportunities appropriate to its own future growth. The consummation of the
Distribution is subject to, among other things, the receipt of a ruling from the
Internal Revenue Service that the Distribution will be tax free to WMS and its
stockholders.

Prior to the Offering, the Company was a wholly-owned subsidiary of WMS.
WMS is a leading designer, manufacturer and marketer of coin-operated pinball
and novelty games and gaming equipment. WMS continues to provide certain
management, administrative, sales, marketing, accounting and information
services to the Company and acts as a contract manufacturer for the Company's
coin-operated games. See "Item 13. Certain Relationships and Related
Transactions." Prior to the Offering, the Company also conducted certain aspects
of the pinball operations of WMS' amusement games business, which operations
were transferred to another subsidiary of WMS and the results of which are not
included in the Company's results of operations. See Note 3 to the Company's
financial statements contained in the 1997 Annual Report.

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The Company is a Delaware corporation formed in July 1988. Its address is
3401 North California Avenue, Chicago, Illinois 60618, and its telephone number
is (773) 961-2222.

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Midway(R) is a registered trademark of the Company. With the exception of
trademarks licensed from third parties, titles to all of the Company's games
referred to in this Report on Form 10-K are either registered trademarks of the
Company or the subject of pending trademark applications. Nintendo, Super
Nintendo Entertainment System, Game Boy, and Nintendo 64 and N64 are trademarks
of Nintendo of America, Inc. Sega, Genesis, Game Gear and Saturn are trademarks
of Sega Enterprises, Ltd. Sony and PlayStation are trademarks of Sony Computer
Entertainment Inc. This Annual Report on Form 10-K includes trademarks other
than those identified in this paragraph. The use of any such trademark herein is
in an editorial form only, and to the benefit of the owner thereof, with no
intention of infringement of the trademark.

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FINANCIAL INFORMATION

The Company reports financial information with respect to its video games
in two product categories: coin-operated video games and home video games.
Financial information with respect to the Company's products is set forth on the
Company's statement of income contained in the Company's financial statements in
the 1997 Annual Report which information is incorporated by reference herein.

INDUSTRY OVERVIEW

GENERAL

Video games are sold in two primary formats -- coin-operated games
distributed to arcades and route operators and home games for dedicated hardware
platforms (Nintendo, Sony and Sega), portable game systems (Nintendo's Game Boy
and Sega's Game Gear), and personal computers distributed to mass merchandisers,
national and regional retailers, discount store chains, video rental retailers
and entertainment software distributors. A successful video game may present the
opportunity to exploit ancillary rights such as film, television and
merchandising rights. The primary groups that play video games are male
teenagers and young adults.

The video game business has undergone significant consolidation in recent
years, and the Company believes that significant barriers to entry into the
video game business exist that make it difficult for new entrants to succeed.
The video game business requires specialized creative talent capable of
utilizing the sophisticated technological tools required to design the complex
video games that characterize the business today. The cost of developing video
games is high and likely to increase as technology continues to evolve. In the
home video game business, distribution channels are dominated by a select group
of companies, and access to retail shelf space is a significant competitive
factor.

COIN-OPERATED GAMES

Coin-operated video games utilize specialized technology and hardware
platforms that permit greater design flexibility than dedicated home platforms,
which are limited by the design specifications of the particular platform.
Coin-operated video games are manufactured in self-contained cabinetry
containing large video screens that display the game. Multiple players can play
the same game simultaneously, and games are generally designed to permit the
players to play against each other, in addition to being able to play against
the game itself. Most coin-operated video games cost 50c to play a game of
approximately two minutes in duration. New technologies employed in the
manufacturing of coin-operated video games utilize advanced video platforms in
which digital images are mapped to computer generated polygons that allow for
the creation of three-dimensional graphic images.

Coin-operated games are sold through distributors to two primary customers
- -- arcades and route operators. The distributors typically provide product
warranties to their customers and receive a price

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allowance from the manufacturer to cover warranty claims. A typical arcade is
located in a shopping mall and operates numerous types of games, including
video, pinball, novelty and redemption games. An arcade will often purchase
multiple units of the most popular games. Route operators purchase coin-operated
video games and provide the games on a revenue sharing basis to various
establishments, such as restaurants, taverns, convenience stores and movie
theaters, which typically install only a few games and only rarely lease
multiple units of the same games for a particular location. The Company
estimates that sales to route operators generally comprise between 45% and 50%
of the coin-operated video game market.

After introduction, a coin-operated video game will generally experience a
product life cycle for a manufacturer of one to two years, although sales are
generally concentrated in the first six to eight months after introduction.

Coin-operated games are distributed throughout North America, Europe, and
to a lesser extent to Australia and countries in Asia and South America. The
Company believes that the market for coin-operated video games, particularly in
the United States, is mature and stable and is unlikely to experience
significant growth in the near-term. Growth in international markets may occur,
if at all, in emerging markets rather than developed countries where the
coin-operated video game market is also mature. The Company believes that Japan
is the second largest market for coin-operated video games after the United
States. However, United States manufacturers of coin-operated games have not as
yet achieved meaningful sales in the Japanese market.

HOME GAMES

Like coin-operated video games, interactive software programs for the home
allow the consumer to participate actively in the outcome of the game. The
interactive software publishing business involves the creation or acquisition of
titles or intellectual property rights, the development of interactive software
products based on these titles or rights, and the publication, marketing,
merchandising, distribution and licensing of the resulting software products.
This process in general involves converting software created for the
coin-operated version of a game into software for use on the multiple platforms
on which home games are released, or creating original games for release into
the home market. The business is highly dependent on consumer tastes and
preferences and on the commercial success of the hardware platforms for which
the software is produced. The principal types of interactive hardware platforms
are dedicated game systems, such as those manufactured by Nintendo, Sony and
Sega, portable game systems and personal computers.

Dedicated Platforms. Historically, no hardware platform or system has
achieved long-term dominance in the interactive entertainment market. In 1986
and 1987 Nintendo and Sega, respectively, introduced 8-bit video game systems
that, compared to existing personal computers available at the time, were low in
price, easy to use and had sophisticated audio-video capabilities. In late 1989,
Sega began shipping its Genesis system, a more-powerful 16-bit video game
system. In August 1991, Nintendo introduced its 16-bit Super Nintendo
Entertainment System. Sega and Sony each began distribution of their next
generation 32-bit hardware systems (named Saturn and PlayStation, respectively)
in Japan during the quarter ended December 1994. Sega began limited shipment of
the Saturn in North America in May 1995, and Sony commenced shipping the
PlayStation in North America in September 1995. Nintendo shipped its 64-bit
Nintendo 64 system in Japan in June 1996 and in North America in September 1996.
By June 1997, the installed base of the Nintendo 64 system, Saturn system and
the PlayStation system in the United States was approximately 3.1 million units,
1.1 million units and 3.7 million units, respectively. The Company believes that
content providers with demonstrated capability for developing successful games
will be in a position to develop games for whichever platforms achieve
significant consumer acceptance.

Previously, most software products for dedicated platforms were sold in
cartridge form. However, compact discs have become increasingly popular because
they have substantially lower manufacturing costs than games in cartridge form.
The newer Sony Playstation and Sega Saturn platforms are based on CD-ROM
technology. However, the 64-bit Nintendo 64 system continues to utilize software
products in cartridge form.

Portable Game Systems. Nintendo's release in 1989 of the Game Boy, a
battery-operated, hand-held interactive entertainment system incorporating an
8-bit microprocessor, revolutionized the hand-held game

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machine market. Previously, the only hand-held systems available were dedicated
to a single game. Sega's color Game Gear hand-held system, released in 1991,
competes directly with the Nintendo Game Boy. The market for video games on
these platforms has declined in recent years and today does not comprise a
material component of the video game business.

Personal Computer Software. The introduction of faster microprocessors,
graphics accelerator chips, high density disk drives, enhanced operating
systems, and increases in memory and processing power have facilitated the
development of more cost-effective, graphically oriented and user-friendly
personal computer software. As personal computers have become more powerful,
less expensive and easier to use, their use in both the home and business
environments has expanded, resulting in increased demand for a wide variety of
software products, including video games.

New Technologies. Recent advances in digital processing, data storage,
graphics, data compression and communications technologies have made possible a
new range of interactive software products and services. A number of companies
are developing technologies to permit the broadcast of interactive entertainment
services directly via satellite, fiber optic cables, and telephone and cable
television lines. Many companies are also developing on-line interactive games
and interactive networks for playing video games.

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BUSINESS

GENERAL

Midway is a leading designer, publisher and marketer of interactive
entertainment software played in both the coin-operated and home markets. Since
the late 1970s, Midway has released many of the industry's leading games
including Mortal Kombat (which line of games has sold over 14 million copies in
the home market), Cruis'n USA, Cruis'n World, NBA Jam, Joust, Defender, Pacman
and Space Invaders, and, through its recently acquired Atari Games subsidiary,
such leading games as San Francisco Rush Extreme Racing, The NHLPA & NHL Present
Wayne Gretzky's 3D Hockey, Area 51, Gauntlet, Centipede, Asteroids and Pong.
Midway's games are generally available for play on all major dedicated home
video game platforms, including those of Nintendo, Sony and Sega, and personal
computers.

Midway began publishing home video games based on its own coin-operated
video games in September 1995 with the introduction of Mortal Kombat 3, the best
selling home video game in the United States in 1995 according to TRSTS reports.
Prior to that time, Midway had granted Acclaim Entertainment the right to
publish home versions of most coin-operated video games released by Midway for a
modest royalty. In preparation for the end of this arrangement and to maximize
profitability, Midway developed and implemented a new strategy to begin to
publish home versions of its coin-operated video games and expand the number of
its coin-operated and home video game releases. As part of this strategy, in
April 1994 Midway acquired Tradewest (as defined), a home video game development
and distribution business, and in March 1996 Midway acquired Atari Games, a
designer, publisher and marketer of interactive entertainment software. Midway
also significantly increased its research and development expenditures to $55.9
million in fiscal 1997, up from $32.5 million in fiscal 1996. In fiscal 1997,
Midway released seven coin-operated video games and published 15 home video
games compared to five new coin-operated video games and ten new video home
games in fiscal 1996.

Midway's coin-operated video games are primarily sold through a worldwide
network of distributors who in turn sell or lease such games directly to arcades
and route operators. The Company currently markets and sells dedicated platform
versions of its home video games in North America through a combination of
direct sales by Midway's internal sales staff and independent sales
representatives. Midway's principal customers for its home video games are mass
merchandisers such as Toys-R-Us, Wal-Mart and Best Buy, national and regional
retailers, discount store chains, video rental retailers and entertainment
software distributors.

STRATEGY

Midway's business strategy is based upon the following:

- CREATE PORTFOLIO OF EXCITING GAMES -- The key to success in the video
game business is to produce games that are the most fun and exciting to
play, which requires the creative talents of experienced game designers.
Midway employs over 300 game design personnel organized in teams
comprised of programmers, artists, mechanical and electrical engineers,
musicians and actors. The game design teams operate in a studio
environment that encourages creativity, productivity and cooperation
among design teams. Midway believes that this environment, together with
a compensation structure that rewards design teams for the success of
their games and a policy of providing design teams substantial
independence and flexibility, enables Midway to attract and retain the
best game designers in the industry. The design teams are supported by
state-of-the-art design technology that allows for the creation of
cutting-edge, three-dimensional graphics and advanced audio effects.
Midway produces games in the action, simulation, adventure and sports
categories.

- EXPLOIT COIN-OPERATED PROVING GROUND -- Midway generally develops its
video games for initial release in the coin-operated market. To be
successful, a coin-operated video game must be action packed and fun, and
provide enough excitement to encourage players to play such game
repeatedly. Midway considers coin-operated video games that sell at least
5,000 units and home games that sell at least 100,000 units per dedicated
platform to be successful games. Midway's experience has been that a

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successful coin-operated game is almost always a success in the home
market. Each of the coin-operated video games released by Midway in the
past four years which has sold at least 5,000 units has then sold at
least 100,000 units for each major dedicated platform on which it was
released in the home market. The significant benefits realized by Midway
from this strategic approach are that (i) the results achieved in the
initial coin-operated release are a meaningful indicator of the success
the game might realize in the home market and help to determine the
strategy which Midway will follow in releasing the game in the home
market, (ii) the knowledge that a particular coin-operated video game is
popular with consumers allows Midway to maximize profitability
through simultaneous publication across multiple home platforms thereby
spreading developmental, advertising and promotional costs over a
greater number of units and (iii) a successful coin-operated game
promotes sales for subsequent home versions of the game among the
players exposed to the game in arcades and other coin-operated
venues.

- MAINTAIN PLATFORM INDEPENDENCE -- Midway develops games for all major
dedicated home platforms (Nintendo, Sony and Sega) as well as for the
personal computer. Midway is a leading developer of video games for the
next generation of 32-and 64-bit game platforms which are currently
being marketed by hardware manufacturers. According to TRSTS reports for
fiscal 1997, the Company was ranked fourth among 62 companies in sales
of 32- and 64-bit home video games. In August 1996, the Company ranked
seventh in sales for these platforms. In fiscal 1997, Midway released
more games on the new Nintendo 64 platform than any developer other than
Nintendo itself. Because it produces video games for multiple platforms,
Midway is not dependent on any particular game platform. Midway believes
that, as a result of its relationships with the major home platform
manufacturers, its game development expertise and its strategy of
investing in advanced technology, it is well positioned for the rapid
technological evolution that characterizes the home video game market.

- EXPLOIT FRANCHISE AND LIBRARY VALUE -- Midway seeks to exploit its
franchise properties such as Mortal Kombat. Midway has released four
different coin-operated games under the Mortal Kombat title and published
or licensed home versions of each of those games. Midway has also
licensed two film adaptations of Mortal Kombat and granted merchandising
licenses in the toy, clothing, comic book, strategy guide and other
product lines. In fiscal 1997, Midway released two additional Mortal
Kombat home games, Ultimate Mortal Kombat 3 and Mortal Kombat Trilogy. An
animated television series based on Mortal Kombat began airing in the
fall of 1996, and a sequel to the movie version of Mortal Kombat is
scheduled to be released in the fall of 1997. Midway also seeks to
utilize its large library of video games to release "arcade classics" and
updated versions of such classics. For the home market in fiscal 1997,
Midway released two collections of arcade classic games and Robotron X, a
new version of a classic arcade game.

- DEVELOP MULTI-SITE GAME PLAYING NETWORK -- Midway is testing its own
proprietary multi-player interactive video game playing network
technology known as Wavenet, allowing players to play against others
located at remote coin-operated locations. This technology has
consistently resulted in greater player utilization and profitability of
games. As new on-line interactive formats develop for game playing, such
as over the Internet or other networks, Midway intends to create a
competitive advantage by exploiting its developing multi-player network
technology.

- INVEST IN ADVANCED TECHNOLOGY -- Midway has developed its own proprietary
hardware and software for creating digitally texture mapped polygon
images, which enable it to produce games with state-of-the-art visual
simulations at cost levels that are attractive to Midway's customers.
Midway has also created proprietary tools to facilitate the development
of new products, the transfer of game features from one product to
another and the transfer of existing products to additional hardware
platforms. Midway believes its proprietary hardware and software have
helped it to achieve and sustain a reputation for developing high quality
products and to position itself for involvement in evolving technologies.

RECENT ACQUISITIONS

Tradewest. In April 1994, the Company acquired the operating assets and
business of three commonly owned companies: Tradewest, Inc., Tradewest
International, Inc., and The Leland Corporation (collectively

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"Tradewest"). Tradewest was engaged in the business of developing, publishing
and distributing home games for use on all major dedicated platform hardware
systems and on personal computers. The purchase price for the assets acquired
was set at five times the average annual pre-tax income of the acquired business
during the four year period commencing May 1, 1994 with a minimum purchase price
of $14.1 million, which was paid at the closing, and a maximum additional
payment of $36.0 million during the four-year earn-out period. Based upon the
earnings during the first three years of the earn-out period, the Company has
paid an aggregate sum of $21.6 million as additional purchase price and has
accrued the final $14.4 million due in June 1998.

Atari Games. In March 1996, the Company expanded its game development
capacity and library of video games through the acquisition by the Company's
wholly-owned subsidiary, Midway Interactive Inc. ("Midway Interactive"), of all
of the outstanding capital stock of Atari Games from Warner Communications Inc.
("Warner"), a subsidiary of Time Warner Inc. Atari Games, based in Milpitas,
California, is also engaged in the business of developing, manufacturing,
licensing, publishing and distributing coin-operated video games and interactive
entertainment software for use in the home on all major dedicated platform
hardware systems and on personal computers. The purchase of Atari Games included
the right to use the Atari name in connection with coin-operated games, but not
home games. The right to use the Atari name for home games is held by Atari
Corp., a corporation unrelated to Warner or the Company.

NEW PRODUCT DEVELOPMENT

The Company's goal is to produce video games that are action packed and
fun, and provide enough excitement to encourage players of a coin-operated
version to play such game repeatedly. The Company's game design personnel are
organized in teams comprised of programmers, artists, mechanical and electrical
engineers, musicians and actors. The lead designers manage the work of the other
team members and are responsible for the overall design of the game. Ideas for
new games generally originate with the Company's lead designers. The Company
also evaluates coin-operated games designed by others with a view toward
obtaining licenses authorizing it to manufacture and sell such games. Each
concept, whether from the Company's designers or from third parties, is reviewed
initially for technical feasibility and evaluated relative to several factors,
including whether the proposed product fits in the Company's general strategy
and profitability objectives. The Company produces games in the action,
simulation, adventure and sports categories.

The game design teams operate in a studio environment that encourages
creativity, productivity and cooperation among design teams. The Company
believes that this environment, together with a compensation structure that
rewards design teams for the success of their games and a policy of providing
design teams substantial independence and flexibility, enables the Company to
attract and retain game designers that are among the best in the industry.

The designers are supported by state-of-the-art design technology that
allows for the creation of cutting-edge, three-dimensional graphics and advanced
audio effects. The Company has developed and maintains a substantial library of
proprietary software and development tools, including animation and digitally
texture mapped polygon images that are used primarily in game products. Use of
these tools streamlines the development process, allowing members of the
development team to focus their efforts on the play and simulation aspects of
the product under development. The Company has also developed software tools to
expedite conversion of software from one hardware format to another and provide
sound and special visual effects. The Company continually creates new software
and development tools and refines and upgrades its existing tools.

Development of a new coin-operated video game generally takes 18 months or
longer, and typically involves the expenditure of substantial funds, including
development, testing and sampling costs. The Company believes that the basic
development costs of a coin-operated game can exceed $1.0 million and, depending
on the specific hardware and software requirements, may cost up to $3.5 million
per game. Because of changing technology during the past few years, both the
time and cost to develop games have increased during the same period. Conversion
of a coin-operated game to a home game usually takes six to 12 months, which
period may overlap with the development period of the coin-operated version of
the game. The

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Company utilizes both independent third parties and its own personnel to convert
coin-operated games to home games. Converters are compensated in a variety of
methods, including through participation in the success of the particular game.
The Company is generally obligated to submit new games to the dedicated platform
manufacturers for approval prior to development and/or manufacturing.
Additionally, prior to release, each product undergoes careful quality assurance
testing which involves technical review of each component of the final product
and testing on the applicable dedicated platforms.

The Company is testing its own proprietary multi-player interactive video
game playing network known as Wavenet, allowing players to play against others
located at remote coin-operated locations. Such tests indicate that this
technology consistently resulted in greater player utilization and
profitability.

During the fiscal years ended June 30, 1997, 1996 and 1995, approximately
$56.0 million, $32.5 million and $14.7 million, respectively, were expended on
research and development. Certain features of the Company's products are
protected by patents, trademarks and copyrights. The Company is both a licensor
and licensee of these proprietary rights.

Under the Company's arrangements with GT Interactive, the Company and GT
Interactive share equally the cost to develop personal computer CD-ROM versions
of those of the Company's video games that GT Interactive elects to release to
the home market.

From time to time, the Company has also purchased distribution rights to
certain games under development by third parties for various home video game
platforms and personal computers. Certain of these games are sequels to games
which have previously been successfully released. Recent games acquired in this
fashion include Gex 2 and Pandemonium 2 for PlayStation and personal computers,
and Top Gear Rally for Nintendo 64. The Company also from time to time obtains
the right to adapt games owned by third parties from one platform to another,
where it believes that success on the original platform suggests a probability
of success on the other platform. Recent rights acquired in this fashion include
the adaptations of Quake and Gex 2 to Nintendo 64.

The Company endeavors to comply with the rules established by a domestic
ratings board voluntarily established by the home game industry and certain
foreign countries' ratings boards and properly displays the ratings received for
its products. The Company believes that ratings as to the violence contained in
home games will not have an adverse effect upon the Company so long as such
ratings are consistently applied throughout the industry.

PRODUCTS

Coin-Operated Games. The Company is one of the leading developers and
marketers of coin-operated video games, having released since the late 1970s
such titles as Mortal Kombat, Cruis'n USA, Cruis'n World, NBA Jam, Terminator 2,
Joust, Robotron: 2084, Ms. Pacman, Defender, Pacman and Space Invaders, and,
through its recently acquired Atari Games subsidiary, such titles as San
Francisco Rush Extreme Racing, Area 51, Primal Rage, Hard Drivin, Gauntlet,
Centipede, Missile Command, Break Out, Asteroids and Pong. In the first quarter
of fiscal 1998, the Company expects to release two new coin-operated video
games: Mortal Kombat 4 in 3-D and Off Road Challenge. In fiscal 1997, the
Company released seven new coin-operated video games: Maximum Force, The NHLPA &
NHL Present Wayne Gretzky's 3D Hockey, San Francisco Rush Extreme Racing,
Mace--The Dark Age, Rampage World Tour, Cruis'n World and War Gods. During
fiscal 1996, five coin-operated video games were introduced under the Midway
name: Ultimate Mortal Kombat 3, NBA Hangtime, Killer Instinct 2, Wrestlemania
and Open Ice, and Atari Games released one coin-operated video game called Area
51. Also during fiscal 1996, the Company introduced TouchMaster, a touchscreen
countertop game containing multiple game options which the Company continued to
sell through fiscal 1997 and which is being updated and reintroduced in the
first quarter of fiscal 1998.

At the March 1997 Amusement Showcase International, Play Meter Magazine
named Cruis'n USA the Best Dedicated Video Game and Area 51 Best Video Kit. At
the March 1996 Amusement Operators Expo, Play Meter Magazine named Cruis'n USA
the Best Dedicated Video Game and Mortal Kombat 3 the Best Video Game Conversion
Kit. Additionally, in 1996 the Company received the American Amusement

8
<PAGE> 10

Machine Association's ("AAMA") award for Manufacturer of the Year. Two of
Midway's video games were awarded Silver and Gold Sales Achievement Awards
during fiscal 1997. Midway's Mortal Kombat 3 coin-operated video game conversion
kit was awarded the AAMA Diamond Sales Achievement Award -- the highest category
of award presented in any given year -- and several of the Company's other games
won Platinum and Gold sales awards in 1996. At the September 1996 Amusement and
Music Operators Association ("AMOA") trade show, Cruis'n USA was named Most
Innovative Dedicated Video Game for the second year in a row, Area 51 was named
Most Innovative Conversion Kit and Cruis'n World received an award for Best New
Equipment among all forms of coin-operated amusement games. Midway coin-operated
video games have received three of five nominations for Most Played Video Game
(Dedicated) to be decided at the Fall 1997 AMOA trade show.

Coin-operated games are sold to distributors at prices ranging from $3,000
to $15,000. The Company also manufactures kits which can be used by the operator
to convert an existing coin-operated cabinet to a new release. The kits are sold
at prices ranging from $1,000 to $3,000.

Home Games. In fiscal 1998, the Company expects to release approximately 21
home game titles, including Mortal Kombat 4, Mortal Kombat Mythologies:
Sub-Zero, Top Gear Rally, The NHL & NHLPA Present Wayne Gretzky's 3D Hockey '98,
San Francisco Rush Extreme Racing, Rampage World Tour, Mace -- The Dark Age, Gex
2 and Pandemonium 2. The fiscal 1997 home game product line featured 15 titles,
including Ultimate Mortal Kombat 3, Mortal Kombat Trilogy, NBA Hangtime, Doom
64, Final Doom, War Gods, The NHLPA & NHL Present Wayne Gretzky's 3D Hockey,
Area 51 and two collections of arcade classics. During fiscal 1996, the Company
published eight video games for the home market, including Mortal Kombat 3 and
two games developed by Atari Games and released after its acquisition by the
Company. Most titles are published in multiple versions, each of which is
designed for a specific dedicated platform. However, certain new games featuring
advanced three-dimensional graphics can only be played on the next generation
platforms.

Most of the Company's home games have suggested retail prices ranging from
$44.95 to $79.95.

1997 MIDWAY HOME GAME RELEASES

The following table sets forth the games that were released by the Company
and the platforms on which they can be used in the home market, directly or
under licensing arrangements, during fiscal 1997:

<TABLE>
<CAPTION>
GAME CATEGORY PLATFORM(S)
---- -------- -----------
<S> <C> <C>

Arcades Greatest Hits*.......................... Classic Super Nintendo Entertainment System
Genesis
Saturn
Arcades Greatest Hits -- Atari Collection 1*.... Classic PlayStation
Saturn
Area 51*........................................ Action PlayStation
Saturn
Personal Computer
Doom 64......................................... Action Nintendo 64
Final Doom...................................... Action PlayStation
The NHLPA & NHL Present Wayne Gretzky's 3D
Hockey*....................................... Sports Nintendo 64
Mortal Kombat Trilogy*.......................... Action Nintendo 64
PlayStation
Ms. Pacman*..................................... Classic Super Nintendo Entertainment System
</TABLE>
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<PAGE> 11

<TABLE>
<CAPTION>
GAME CATEGORY PLATFORM(S)
- ----------------------------------------------------------- ----------- ------------------------------------------
<S> <C> <C>
SystemPlayStationGenesisOpen Ice*.......................... Sports PlayStation
Personal Computer
Return Fire................................................ Action Personal Computer
Robotron X*................................................ Action PlayStation
Personal Computer
TMEK*...................................................... Action Personal Computer
Ultimate Mortal Kombat 3*.................................. Action Super Nintendo Entertainment System
Genesis
War Gods*.................................................. Action Nintendo 64
PlayStation
Personal Computer
</TABLE>

- -------------------------
* Based upon one or more previously released coin-operated games.

1996 MIDWAY HOME GAME RELEASES

The following table sets forth the games that were released by the Company
(including games released by Atari Games after its acquisition by the Company)
and the platforms on which they can be used in the home market, directly or
under licensing arrangements, during fiscal 1996:

<TABLE>
<CAPTION>
GAME CATEGORY PLATFORM(S)
---- -------- -----------
<S> <C> <C>

Arcades Greatest Hits*....................... Classic PlayStation
Doom......................................... Action Super Nintendo Entertainment System
Doom Special PlayStation Edition............. Action PlayStation
The Getaway*................................. Action Game Boy
Island Casino................................ Simulation Personal Computer
Mortal Kombat 3*............................. Action Super Nintendo Entertainment System
Game Boy
PlayStation
Genesis
Personal Computer
Primal Rage*................................. Action Saturn
Return Fire.................................. Action PlayStation
Ultimate Mortal Kombat 3*.................... Action Saturn
Williams Arcade Classics*.................... Classic Personal Computer
</TABLE>
- -------------------------
* Based upon one or more previously released coin-operated games.

In fiscal 1996, Atari Games released five home video games prior to its
acquisition by the Company.

MARKETING AND DISTRIBUTION

Coin-Operated Games. Coin-operated video games are sold under the Midway
and Atari trademarks. Coin-operated video games are marketed primarily through
approximately 63 independent distributors worldwide. Distributors sell these
products to operators who own and operate the machines and place them in
amusement arcades, restaurants, taverns, convenience stores and movie theaters.
Distributors are primarily

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<PAGE> 12

responsible for the sale and distribution of these products in designated
territories and are generally expected to provide replacement parts and service
and to arrange for installment financing. It is customary for distributors of
the Company's coin-operated video games also to distribute games produced by
other manufacturers.

Coin-operated games are marketed through trade shows, promotional
videotapes and advertising in trade publications. The Company maintains separate
sales and marketing teams for its Midway and Atari product lines.

Export sales of coin-operated games, primarily to Western Europe, were
approximately $62.4 million (16.1% of revenues) for the fiscal year ended June
30, 1997 compared with $25.3 million (10.3% of revenues) for the fiscal year
ended June 30, 1996 and $40.0 million (22.2% of revenues) for the fiscal year
ended June 30, 1995. Substantially all foreign sales are made in United States
dollars and, therefore, the Company is not generally subject to the risk of
fluctuation of the value of foreign currencies in relation to the dollar. The
Company believes that while the loss of a single distributor could temporarily
affect the distribution of a particular model, it would not have a material
adverse effect on the business of the Company. In any such event, the Company
believes it could make arrangements with alternate distributors for the
distribution of the Company's coin-operated games.

Home Games. Commencing with the Company's fall 1996 product line, all newly
released home video games are marketed under the Midway trademark. Prior to that
time, the Company's home video games had been marketed under the Williams and
Tradewest trademarks and Atari Games home games had been marketed under the
Tengen and Time Warner Interactive trademarks.

The Company began to publish home video games based on its own
coin-operated video games in September 1995 with the introduction of Mortal
Kombat 3, the best selling home video game in the United States in 1995. Prior
to that time, the Company had granted Acclaim Entertainment the right to publish
home video game versions of most coin-operated video games released by the
Company. In fiscal 1997, Midway released 15 home video games.

Home games are marketed in the United States through the Company's internal
sales staff and through independent sales representatives to approximately
15,000 stores domestically, including mass merchandisers, national and regional
retailers, discount store chains, video rental retailers and entertainment
software distributors.

The Company's marketing activities include television and print
advertising, retail store promotions, direct mailings and user support programs.
The Company also utilizes a store-oriented marketing approach which includes
point-of-purchase promotions, use of display cards and other forms of
merchandise displays. The Company's sales literature, which features advance
information on new products, encourages potential users to purchase the
Company's products at their local retail outlets, creating retail demand for new
products before their release. The Company provides technical support for its
home products through its customer support department, which is staffed by
personnel trained to respond to customer inquiries.

The Company's principal customers for its home video games are mass
merchandisers such as Toys-R-Us, Wal-Mart and Best Buy. Sales to Toys-R-Us in
fiscal 1997 represented 18.5% of total home video game revenues compared to
20.1% of total home video game revenues in fiscal 1996. It is customary for the
sales representatives and the distributors of the Company's home games who are
assigned specific territories to also distribute games produced by other
manufacturers. The Company exploits the worldwide markets for these games
through direct distribution channels and market licensing agreements. These
distribution efforts are supported by marketing programs which emphasize product
awareness, brand recognition, dealer merchandising opportunities and established
personality endorsements.

The Company has also entered into strategic relationships for the
distribution of home games. In December 1994, the Company appointed GT
Interactive as distributor of certain of its games as adapted for personal
computers worldwide. In March 1995, the Company also appointed GT Interactive as
an international distributor (excluding the U.S., Canada and Mexico) of certain
of the Company's domestically distributed home video games on several of the
next generation platforms, such as Sega Saturn, Nintendo 64

11
<PAGE> 13

and Sony PlayStation. The Company's personal computer and platform game
distribution agreements with GT Interactive expire in March 2000 and June 2001,
respectively, subject to various conditions under which each agreement may be
extended if licensing fees remain unrecouped. Games optioned under these
agreements are licensed for varying terms. In March 1996, the Company entered
into agreements with GT Interactive with respect to games developed by Atari
Games, which agreements contain similar expiration and renewal provisions as the
other agreements. Licensing fees under the Atari Games agreements are recoupable
in certain circumstances from royalties payable under the other agreements.

Pursuant to the agreements with GT Interactive described above, GT
Interactive has paid non-refundable license fees in the aggregate amount of
$35.0 million. GT Interactive will not be required to pay more than $5.0 million
of additional license fees to the Company unless certain sales levels are
achieved. All of the license fees were recognized as revenue by the Company in
the year in which the applicable agreement was entered into ($25.0 million in
fiscal 1995 and $10.0 million in fiscal 1996). As a result, the Company does not
expect that it will recognize significant further revenue from the exploitation
of its games in the territories or on the platforms licensed to GT Interactive
during at least the next two years. The royalties are contracted in United
States dollars and, therefore, the Company is not generally subject to the risk
of fluctuation of the value of foreign currencies in relation to the dollar. For
further discussions, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in the 1997 Annual Report.

In March 1994, the Company formed a joint venture with Nintendo to develop
video games on certain platforms being developed by Nintendo. The joint venture
is owned 50% by each of the Company and Nintendo. In connection with the
formation of the joint venture, the Company also entered into arrangements with
Nintendo for the development of a version of Cruis'n USA for Nintendo 64. The
joint venture has the right to distribute home versions of any coin-operated
sequels of Cruis'n USA developed by the Company and the right of first
negotiation with respect to distribution of home versions of any coin-operated
video games developed by the Company on a new coin-operated platform developed
by Nintendo. To date, no home video games have been released through this joint
venture.

In September 1996, the Company entered into a master license agreement with
Tiger Electronics, Inc. pursuant to which the Company granted Tiger the right to
manufacture and distribute throughout the world certain liquid crystal display
("LCD") games based on certain of the Company's coin-operated video games and
home games. The product categories licensed to Tiger include certain LCD game
systems, including cartridges for Tiger's proprietary hand-held dot matrix LCD
game system, and certain other electronic products. The initial term of the
agreement with Tiger expires in December 2001, subject to certain renewal
rights. The license agreements for specific products optioned under the master
license agreement expire upon the later of the expiration of the master license
agreement or 24 months after the prescribed release date.

MANUFACTURING

Coin-Operated Games. The Company's coin-operated games are manufactured by
WMS at WMS' factories in Illinois pursuant to the Manufacturing and Services
Agreement between the parties (the "Manufacturing and Services Agreement"). See
"Item 13. Certain Relationships and Related Transactions." The Company believes
such arrangements and facilities are adequate for its current and planned
production needs. Game production is generally based on advance purchase orders
from distributors with respect to coin-operated games and no significant
inventory of finished goods is customarily maintained.

Since the amount of backlog orders varies from the beginning to the end of
a normal two- to three-month production process of a game, meaningful comparison
of backlog orders can only be made at the same period during a production cycle
and not at the end of fiscal years. The Company does not consider order backlog
to be a meaningful indicator of future sales.

Most coin-operated games are warranted for a period of 60 days, and home
games are warranted for a period of 90 days. The costs incurred by the Company
in connection with these warranties have been insignificant.

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<PAGE> 14

The raw materials used in manufacturing coin-operated games include various
metals, plastics, wood and glass obtained from numerous sources of supply. In
addition, numerous component parts, including electronic subassemblies and video
monitors, are purchased from suppliers. Wood cabinets for coin-operated games
are manufactured by WMS' subsidiary Lenc-Smith Inc. pursuant to the
Manufacturing and Services Agreement, as well as by other outside suppliers. The
Company believes that the sources of supply of component parts and raw materials
are adequate and that substitute sources of materials are available.

Software Products for Home Games. Manufacturing of home games for next
generation platforms is performed for the Company by the developer of the game
platform (i.e., Nintendo, Sony or Sega), as required by the applicable platform
license. The Company is one of only a limited number of software publishers who
have been granted the right by Nintendo and Sega to self-manufacture cartridges
for their 16-bit platforms. For such platforms, the Company generally employs
contract manufacturing sources in Mexico. Platform manufacturers typically
retain the right to limit the number of games and approve timing of release
under manufacturing and licensing arrangements. Home game production is based
upon estimated demand for each specific title and the level of the inventory of
finished goods depends upon the variance in market demand during the life of a
specific game title. At the time a product is approved for manufacturing, the
Company must provide certain of the platform manufacturers with a purchase order
for that product and an irrevocable letter of credit for 100% of the purchase
price. Most products manufactured by the dedicated platform manufacturers for
the Company are purchased by the Company on an "as is" and "where is" basis and
are delivered to the Company FOB place of manufacture and shipped at the
Company's own expense and risk. Initial orders generally require 30 to 75 days
to manufacture depending on the platform. Reorders of cartridge based products
require approximately 50 days to manufacture, while reorders of CD-ROM based
platforms generally require only 14 days. Shipping of orders requires an
additional three to 10 days, depending on the mode of transport and location of
manufacturer.

In November 1996, the Company established its own leased warehouse facility
in Dallas, Texas from which to distribute its home games. Upon arrival in the
United States, products are inspected by customs agents and transferred to the
Company's warehouse facility where they are unpacked and shipped to the
Company's customers. Products ordered for inventory are stored at the warehouse
facility and used to fill additional orders as received.

The Company participates in the electronic data interchange program
maintained by most of its largest customers for home games. Re-orders from
inventory are generally filled by the Company within two days. As a result, home
games traditionally have no backlog of orders.

CD-ROM Based Software Products for Personal Computers. Under the Company's
arrangements with GT Interactive, the Company and GT Interactive share equally
the cost to develop personal computer CD-ROM versions of those of the Company's
coin-operated video games that GT Interactive elects to release to the home
market. Once GT Interactive so elects, it is responsible for and bears the cost
of the manufacture of the CD-ROMs as well as all other costs related to the sale
of these CD-ROMs.

PRODUCT RETURNS AND PRICE ADJUSTMENTS

In its home video game business, the Company accepts product returns for
defective products and sometimes provides markdowns or other credits on varying
terms in the event that the customer holds slow-moving inventory of the
Company's home games. At the time of product shipment, the Company establishes
reserves, including reserves under the Company's policies for price protection
and returns of defective products, which estimate the potential for future
returns of products based on historical return rates, seasonality of sales,
retailer inventories of the Company's products and other factors. Product
returns, markdowns and credits that exceed the Company's reserves could have a
material adverse effect on the Company's business, operating results and
financial condition. 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 the reserves established will not be exceeded.

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<PAGE> 15

PLATFORM LICENSES

Under non-exclusive license arrangements with Nintendo, Sony and Sega, the
Company has the right to develop and market software products for (i) Nintendo's
Super Nintendo Entertainment System and Nintendo 64 platforms, (ii) Sony's
PlayStation, and (iii) Sega's Genesis and Saturn platforms. Generally, no
specific hardware license is required for the development and marketing of
personal computer software. Certain of the platform license agreements or
renewals of existing agreements are in the process of being finalized with the
platform manufacturers. However, the Company and the platform manufacturers have
proceeded as if the formal agreements were in place by approving new game
concepts, manufacturing new home games and otherwise. The Company believes such
informal arrangements are not uncommon in the home video game business. The
Company does not believe there is any significant risk that the definitive
platform license agreements will not be finalized on terms acceptable to the
Company.

Each dedicated platform manufacturer requires that the software and a
prototype of each title, together with all related artwork and documentation, be
submitted to such dedicated platform manufacturer, as applicable, for
pre-publication approval. Such approval is generally discretionary. The Company
bears all costs and expenses in connection with its development of games
developed under its agreements with each of the dedicated platform
manufacturers. Dedicated platform manufacturers charge the Company a fixed
amount for each software cartridge or CD-ROM manufactured by such dedicated
platform manufacturer. This charge includes a manufacturing, printing and
packaging fee, as well as a royalty for the use of the manufacturer's name and
proprietary information and technology, and may be subject to adjustment by such
dedicated platform manufacturer in its discretion. The Company is responsible in
most cases for resolving, at its own expense, any software warranty or repair
claim. To date, the Company has not experienced any material software warranty
claims.

Certain platform license arrangements require that the Company bear the
risk that the information and technology licensed from the dedicated platform
manufacturers and incorporated into the Company's software may infringe the
rights of third parties. The Company must indemnify the dedicated platform
manufacturers against certain claims resulting from the development, marketing,
sale or use of the Company's software products, including certain claims for
copyright, patent or trademark infringement that may be brought against a
dedicated platform manufacturer. To date, no dedicated platform manufacturer has
sought indemnity for any liabilities incurred as a result of such lawsuits or
for any legal expenses incurred in defending such lawsuits. No assurance can be
given, however, that the Company's indemnification obligations under its license
arrangements with the dedicated platform manufacturers will not have a material
adverse effect on the Company's future results of operations or financial
condition.

The Company's licenses from dedicated platform manufacturers may be
terminated by the manufacturer upon a breach or default by the Company, or upon
the occurrence of certain other specified events. Generally, if a dedicated
platform license is terminated by reason of breach by the Company, the Company
will be required to destroy all of its inventory for use on such dedicated
platform. Additionally, upon expiration of a dedicated platform license, the
Company usually is provided a period of limited duration to sell off all its
inventory subject to such license, after which time any remaining inventory is
generally required to be destroyed.

There can be no assurance that the Company's licenses with any of the
dedicated platform manufacturers will be renewed upon expiration. Furthermore,
there is no limit on the number of licenses that dedicated platform
manufacturers may grant to others or on the number of titles that they may
permit their licensees to publish or that they themselves may release in the
future. Nintendo, Sony and Sega are the largest publishers of software for use
on their respective systems and are direct competitors of the Company.

In fiscal 1997, 60% of the Company's unit sales of software products were
for use on the next generation 32- and 64-bit game platforms (Nintendo 64, Sony
PlayStation and Sega Saturn platform). The balance of the Company's home video
game unit sales were primarily for the 16-bit Super Nintendo Entertainment
System and Sega Genesis platforms, as well as for portable game systems. The
Company expects that a significant and increasing portion of its revenues in the
coming years will be comprised of games for the next generation game platforms.
If the popularity of home video games on dedicated hardware platforms materially

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<PAGE> 16

declines, or if the Company were to lose its license to publish software from
any of these companies, the Company's business would be materially and adversely
affected.

INTELLECTUAL PROPERTY LICENSES

While the Company primarily seeks to develop original proprietary games,
certain of the Company's games are based on properties or trademarks owned by
third parties, such as the National Basketball Association, National Football
League, National Hockey League or their respective players' associations, and
licensed to the Company. Typically, the Company is obligated to make certain
minimum guaranteed royalty payments over the term of the license and to advance
payment against such guarantees. License agreements generally extend for a term
of two to three years, are terminable in the event of material breach (including
failure to pay any amounts owing to the licensor in a timely manner) by the
Company and certain other events, and, in some cases, are renewable upon payment
of certain minimum guarantees or the attainment of specified sales levels during
the term of the license. Certain licenses are limited to specific territories or
platforms. Each license typically provides that the licensor retains the right
to exploit the licensed property for all other purposes, including the right to
license the property for use with other products and, in some cases, software
for other interactive hardware platforms.

PATENT, TRADEMARK, COPYRIGHT AND PRODUCT PROTECTION

Each software title may embody a number of separately protected
intellectual property rights, including: (i) trademarks associated with elements
of the game (e.g., the NBA team logos in NBA Hangtime); (ii) the trademarks
under which the game is marketed (e.g., Mortal Kombat); (iii) the copyrights for
the game software (including the game's audiovisual elements); (iv) copyrights
for the software associated with the hardware platform; and (v) the patents for
inventions in the game software and hardware platforms.

Each dedicated home game includes patents, copyrights and trademarks
licensed from the platform manufacturer. Elements of certain of the Company's
titles are owned by third parties and licensed to the Company. The Company
relies on such third parties for protection of such intellectual property
rights. Their failure to adequately protect such rights could have a material
adverse effect on the Company.

The Company has over 475 trademark registrations worldwide for its games
and applies for trademark protection for all of its game titles, other than
those licensed from third parties.

The Company has registered the copyrights in the video game software for
most of its owned coin-operated titles. Notwithstanding such copyright
protection, preventing unauthorized duplication of software products is
difficult and costly and, in the case of personal computer software, such
unauthorized duplication is relatively common. The Company uses certain
precautions to discourage unauthorized copying of its personal computer software
products, including internal copy protection, which prevents or hinders normal
copy routines. In addition, certain of the Company's personal computer products
require the user to refer to materials shipped with the software in order to use
the product. Despite these protections, the Company believes that these
techniques can be, and in certain instances have been circumvented.

The dedicated platform manufacturers have procured patents for certain of
the technology utilized in connection with their respective home game systems.
The dedicated platform manufacturers incorporate security devices in their
cartridges, CD-ROMs and platforms which seek to prevent unlicensed software
products from being played on their platforms. The Company does not own the
trademarks, copyrights or patents, if any, covering the proprietary information
and technology utilized in the dedicated platform manufacturers' cartridges or
CD-ROMs. Accordingly, the Company relies upon each dedicated platform
manufacturer for protection of such intellectual property from infringement and
bears the risk of claims of infringement brought by third parties arising from
the sale of software with respect to intellectual property

15
<PAGE> 17

supplied by third party developers and embodied in the Company's software
products. The Company's agreements with these outside developers generally
require the developers to indemnify the Company for costs and damages incurred
in connection with such claims. No assurance can be given, however, that such
software developers will have sufficient resources to indemnify the Company
fully in respect of any such claims that may arise.

COMPETITION

The video game business is intensely competitive and is characterized by
the continuous introduction of new titles and the development of new
technologies. The ability of the Company to compete successfully in this market
is based, in large part, upon its ability to select and develop popular titles,
to identify and obtain rights to commercially marketable intellectual properties
and to adapt its products for use with new technologies. In addition, successful
competition is also based upon price, access to retail shelf space in the case
of home games, product enhancements, new product introductions, marketing
support and distribution systems. The Company's competitors vary in size from
very small companies with limited resources to very large corporations with
greater financial, marketing and product development resources than those of the
Company.

In the coin-operated market, the Company competes principally with foreign
manufacturers such as Capcom, Konami, Namco, Sega and Taito.

In the home market, the Company competes with Nintendo, Sony and Sega, the
largest publishers of software for their respective systems. Due to their
dominant position in the industry as primary manufacturers of dedicated platform
hardware and software, Nintendo, Sony and Sega have a competitive advantage with
respect to retail pricing, acquiring intellectual property licenses and securing
shelf space. There can be no assurance that Nintendo, Sony or Sega will not
increase their own software development efforts. The Company also currently
competes in the United States and Canada with numerous companies licensed by
Nintendo, Sony and Sega to develop software products for use with their
respective systems. These competitors include Acclaim, Activision, Capcom,
Disney Interactive, Electronic Arts, Konami, Lucas Arts, Namco and Viacom New
Media. Additionally, the Company's games which are sold for use on personal
computers compete with entertainment software sold by companies such as Acclaim,
Broderbund Software, CUC International, Electronic Arts, GT Interactive,
Microsoft and Spectrum Holobyte, among others. The entry and participation of
new industries and companies, including diversified entertainment companies, in
markets in which the Company competes may adversely affect the Company's
performance in such markets.

The Company believes that large diversified entertainment, cable and
telecommunications companies, in addition to large software companies such as
Microsoft, are increasing their focus on the interactive entertainment market,
which will result in greater competition for the Company. In particular, many of
the Company's competitors are developing on-line interactive games and
interactive networks that will be competitive with the Company's interactive
products. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive pressures
faced by the Company will not materially and adversely affect its business,
operating results and financial condition.

FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY

The Company has experienced and expects to continue to experience
significant quarterly fluctuations in net sales 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 rate of growth of the consumer
software market, market acceptance of the Company's products and those of its
competitors and dedicated platform manufacturers, development and promotional
expenses relating to the introduction of new products or enhancements of
existing products, the timing and success of product introductions, changes in
pricing policies by the Company and its competitors, the accuracy of the
Company's and retailers' forecasts of consumer demand, the timing of orders from
major customers, order cancellations and delays in shipment. The Company's
expense levels are based, in part, on its expectations regarding future sales
and, as a result,

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<PAGE> 18

operating results would be adversely affected by a decrease in sales or a
failure to meet the Company's sales expectations.

While the coin-operated game business is not generally seasonal in nature,
the home video game business is highly seasonal. Sales of home video games are
typically significantly higher during the September and December quarters due to
the year-end holiday buying season. Sales in other quarters are generally lower
and vary significantly as a result of new product introductions and other
factors. There can be no assurance that the Company will achieve consistent
profitability on a quarterly or annual basis.

EMPLOYEES

At June 30, 1997, the Company had approximately 400 non-union employees.

FACTORS AFFECTING FUTURE PERFORMANCE

Future operating results of the Company depend upon many factors and are
subject to various risks and uncertainties. Some of the risks and uncertainties
which may cause the Company's operating results to vary from anticipated results
or which may materially and adversely affect its operating results are as
follows:

DEPENDENCE ON NEW PRODUCT INTRODUCTIONS; PRODUCT DELAYS

The Company's success depends on generating revenue from new products and
enhancements of existing products. 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 introduced. In addition, consumer preferences for video games
are difficult to predict, and few video game products achieve sustained market
acceptance. There can be no assurance that new products introduced by the
Company will achieve any significant degree of market acceptance, or that such
acceptance will be sustained for any meaningful period. A significant delay in
the introduction of one or more new products or enhancements or the failure of
new products to achieve or sustain market acceptance would have a material
adverse effect on the Company's business, operating results and financial
condition.

TECHNOLOGICAL CHANGE

The video game market, both in the coin-operated and home segments, is
characterized by rapidly changing technology. The Company must continually
anticipate and adapt its products to emerging technologies, including new
hardware platforms. When the Company chooses to incorporate a new technology in
its products or 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 initial shipment of such products. There can be no assurance that the
Company will be able to identify accurately which emerging technologies will
gain widespread acceptance. If the Company invests in the development of a video
game that does not achieve significant commercial success, the Company's
revenues from that product will be adversely affected and it may not recover its
development costs. If the Company does not choose to pursue the development of
products incorporating new technology or for new platforms that achieve
significant commercial success, the Company's revenue growth may be adversely
affected. In addition, consumers may defer purchasing software for use on
existing platforms following the announcement of an introduction date for
hardware platforms incorporating new technologies. Accordingly, sales of the
Company's existing software products could be adversely affected by such
announcements. There can be no assurance that the Company will be able to
develop or acquire the expertise necessary to enable it to develop or market
products for emerging technologies.

RELIANCE ON MORTAL KOMBAT PRODUCTS

Revenues from Mortal Kombat products accounted for approximately 22.0%,
34.9% and 17.1% of the Company's total revenues during fiscal 1997, 1996 and
1995, respectively. If Mortal Kombat products fail to continue to sell or if the
Company fails to replace the Mortal Kombat products with additional products

17
<PAGE> 19

generating significant revenues, the Company's business, operating results and
financial condition could be materially and adversely affected.

FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY

COMPETITION

The video game business is intensely competitive and is characterized by
the continuous introduction of new titles and the development of new
technologies. The ability of the Company to compete successfully in this market
is based, in large part, upon its ability to select and develop popular titles,
to identify and obtain rights to commercially marketable intellectual properties
and to adapt its products for use with new technologies. In addition, successful
competition is also based upon price, access to retail shelf space in the case
of home games, product enhancements, new product introductions, marketing
support and distribution channels. The Company's competitors vary in size from
very small companies with limited resources to very large corporations with
greater financial, marketing and product development resources than those of the
Company.

In the coin-operated market, the Company competes principally with foreign
manufacturers such as Capcom, Konami, Namco, Sega and Taito.

In the home market, the Company competes with Nintendo, Sony and Sega, the
largest publishers of software for their respective systems. Due to their
dominant position in the industry as primary manufacturers of dedicated platform
hardware and software, Nintendo, Sony and Sega have a competitive advantage with
respect to retail pricing, acquiring intellectual property licenses and securing
shelf space. There can be no assurance that Nintendo, Sony or Sega will not
increase their own software development efforts. The Company also currently
competes in the United States and Canada with numerous companies licensed by
Nintendo, Sony and Sega to develop software products for use with their
respective hardware systems. These competitors include Acclaim, Activision,
Capcom, Disney Interactive, Electronic Arts, Konami, Lucas Arts, Namco and
Viacom New Media. Additionally, the Company's games which are sold for use on
personal computers compete with entertainment software sold by companies such as
Broderbund Software, CUC International, Electronic Arts, GT Interactive,
Microsoft and Spectrum Holobyte, among others. The entry and participation of
new industries and companies, including diversified entertainment companies, in
markets in which the Company competes may adversely affect the Company's
performance in such markets.

18
<PAGE> 20

competitive with the Company's interactive products. There can be no assurance
that the Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially and adversely affect its business, operating results and financial
condition.

PRODUCT RETURNS AND PRICE ADJUSTMENTS

DEPENDENCE ON DEDICATED PLATFORM MANUFACTURERS

In fiscal 1997, 60% of the Company's unit sales of software products were
for use on the next generation 32- and 64-bit game platforms (Nintendo 64, Sony
PlayStation and Sega Saturn platform). The balance of the Company's home video
game unit sales were primarily for the 16-bit Super Nintendo Entertainment
System and Sega Genesis platforms, as well as for portable game systems. The
Company expects a significant and increasing portion of its revenues in the
coming years will be comprised of games for the next generation game platforms.
If the popularity of home video games on dedicated hardware platforms materially
declines, or if the Company were to lose its license to publish software from
any of the major platform manufacturers, namely Nintendo, Sony and Sega, the
Company's business would be materially and adversely affected.

The Company is generally obligated to submit new games to the dedicated
platform manufacturers for approval prior to development and/or manufacturing.
Rejection or substantial delay in approval of a product by a dedicated platform
manufacturer could have a material adverse effect on the Company's financial
condition and results of operations. The Company has not experienced any
significant delays in the approval process for any of its games in the past.
However, there can be no assurance that the Company will not experience such
delays in the future. The dedicated platform manufacturers may also limit the
number of titles that the Company can release in any year, which may limit any
future growth in sales.

The Company depends on Nintendo, Sony and Sega for the protection of the
intellectual property rights to their respective hardware platforms and
technology, their ability to control the proliferation of new titles by
licensees and others and their ability to discourage unauthorized persons from
producing software for the Nintendo, Sony and Sega platforms. The Company also
relies upon the dedicated platform manufacturers for the manufacturing of
software cartridges and CD-ROMs for the next generation platforms.

MANUFACTURING RISKS

The manufacturing of the Company's 16-bit home games is performed for the
Company by third parties in accordance with the Company's specifications. While
the Company has not to date experienced any material delays or interruptions in
the manufacture of the Company's products, there can be no assurance that such
delays or interruptions will not occur or, if any do occur, that they could be
remedied without further delay and without materially and adversely affecting
the Company's business, operating results or financial condition. Unanticipated
delays in receipt of shipments or price increases from any of the Company's
contract manufacturing sources could adversely affect the Company's business.

INTELLECTUAL PROPERTY LICENSES AND APPROVALS

While the Company primarily seeks to develop original proprietary games,
certain of the Company's games are based on properties or trademarks owned by
third parties, such as the National Basketball

19
<PAGE> 21

Association, National Football League, National Hockey League or their
respective players' associations. The Company's future success may also be
dependent upon its ability to procure licenses for additional popular
intellectual properties. There is competition for such licenses, and there can
be no assurance that the Company will be successful in acquiring additional
intellectual property rights with significant commercial value.

The Company's intellectual property licenses generally require that new
products developed under such licenses be submitted to the licensor for approval
prior to release. Such approval is generally discretionary. Rejection or delay
in approval of a product by a licensor could have a material adverse effect on
the Company's business, operating results and financial condition. While the
Company has not experienced any significant delays in obtaining new product
approvals from its licensors in the past, there can be no assurance that the
Company will not experience delays in the future. The owners of intellectual
property licensed by the Company generally reserve the right to protect such
intellectual property against infringement.

DEPENDENCE ON KEY PERSONNEL

The success of the Company depends to a significant extent upon the
performance of senior management and on its ability to continue to attract,
motivate and retain highly qualified software developers. The loss of services
of senior management, highly-qualified software developers or other key
personnel could have a material adverse effect on the Company. Competition for
highly skilled employees with technical, management, marketing, sales, product
development and other specialized training is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. Specifically, the Company may experience increased costs in order to
attract and retain skilled employees.

VOTING CONTROL BY WMS

WMS beneficially owns approximately 86.8% of the outstanding Common Stock
of the Company. Accordingly, WMS has the ability to elect and remove the entire
Board of Directors of the Company and to determine the outcome of all matters
submitted to the Company's stockholders for approval. Voting control of the
Company by WMS will have the effect of making it impossible for a third party to
acquire a majority of the outstanding voting stock of the Company without the
approval of WMS. Upon completion of the Distribution, WMS will have no further
ownership interest in the Company.

CONFLICTS OF INTEREST WITH WMS

Certain of the Company's officers and directors are also officers,
directors and stockholders of WMS, and may be subject to various conflicts of
interest including, among others, the performance by the two companies under
their existing agreements as well as the negotiation of any agreements required
to be entered into in the future between these two parties. Additionally, the
Company may be subject to various conflicts of interest arising from the
relationship among it and WMS and their respective affiliates.

Mr. Neil D. Nicastro, the Chairman of the Board, President, Chief Executive
Officer and Chief Operating Officer of the Company is also the President, Chief
Executive Officer, Chief Operating Officer and a Director of WMS. Mr. Harold H.
Bach, Jr., Mr. Kenneth J. Fedesna and Mr. Orrin J. Edidin, officers and
full-time employees of WMS and various of its affiliates, are also officers of
the Company. Mr. Bach and Mr. Fedesna are also Directors of the Company. Each of
these key employees will devote such time to the business and affairs of the
Company as the WMS Board of Directors deems appropriate. However, each such
person has other duties and responsibilities with WMS that may conflict with
time which might otherwise be devoted to his duties with the Company.

20
<PAGE> 22

ITEM 2. PROPERTIES.

The Company's principal office is located at 3401 North California Avenue,
Chicago, Illinois in premises owned by WMS. The following table contains certain
information describing the general character of the Company's principal
properties, all of which are leased facilities.

<TABLE>
<CAPTION>
APPROXIMATE
SQUARE ANNUAL LEASE
LOCATION PRINCIPAL USE FOOTAGE RENT($) EXPIRATION DATE
-------- ------------- ----------- ------- ---------------
<S> <C> <C> <C> <C>
675 Sycamore Drive................. Game Design and 84,501 593,196 07/31/05
Milpitas, CA Development and
Sales and Marketing
2727 W. Roscoe Street.............. Game Design and 47,500 136,000 06/30/01
Chicago, IL Development
2820 Merrell Road.................. Warehouse 28,234 84,702 07/31/99
Dallas, TX
10110 Mesa Rim Road................ Game Design and 27,512 250,664 06/01/02
San Diego, CA Development
1800 S. Business 45................ Accounting and 6,000 38,400 month-to-month
Corsicana, TX Operations Office
2400 S. Business 45................ Office/Warehouse 5,000 30,000 05/01/98
Corsicana, TX
</TABLE>

The Company believes that its facilities and equipment will be suitable for
the purposes for which they are employed, are adequately maintained and will be
adequate for current requirements and projected normal growth.

ITEM 3. LEGAL PROCEEDINGS.

The Company currently and from time to time is involved in litigation
incidental to the conduct of its business. The Company is not currently a party
to any lawsuit or proceeding which, in the opinion of the Company, is likely to
have a material adverse effect on the Company.

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

Not applicable.

21
<PAGE> 23

PART II

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

Reference is made to "Market for the Company's Common Stock and Related
Security-Holder Matters" set forth in the 1997 Annual Report, which information
is incorporated by reference herein.

ITEM 6. SELECTED FINANCIAL DATA.

Reference is made to "Selected Five-Year Financial Data" set forth in the
1997 Annual Report, which information is incorporated by reference herein.

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

Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" set forth in the 1997 Annual Report, which
information is incorporated by reference herein.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not Applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Reference is made to the Financial Statements and Notes thereto and Report
of Independent Auditors set forth in the 1997 Annual Report, which information
is incorporated by reference herein.

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

Not applicable.

22
<PAGE> 24

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

(a) Identification of Directors. The following table sets forth certain
information with respect to each director of the Company. Mr. Neil D. Nicastro
is the son of Mr. Louis J. Nicastro; otherwise, there is no family relationship
between any of the directors or executive officers of the Company. Each director
serves as a director until the Company's next annual meeting of stockholders and
until their respective successors are duly elected and qualify.
<TABLE>
<CAPTION>
DIRECTOR OR EXECUTIVE SHARES OF COMMON STOCK
POSITION WITH THE COMPANY AND OFFICER OF THE DEEMED TO BE BENEFICIALLY
NAME (AGE) PRINCIPAL OCCUPATION AS OF 9/5/97 COMPANY SINCE OWNED AS OF 9/5/97(1)
- ---------- --------------------------------- --------------------- -------------------------
<S> <C> <C> <C>
Neil D. Nicastro (40).......... Chairman of the Board of 1988 320,000(3)
Directors, President, Chief
Executive Officer and Chief
Operating Officer of the Company
and President, Chief Executive
Officer and Chief Operating
Officer of WMS
Harold H. Bach, Jr. (65)....... Executive Vice President -- 1990 65,000(4)
Finance, Treasurer and Chief
Financial Officer and Director of
the Company and Vice President --
Finance, Treasurer, Chief
Financial and Chief Accounting
Officer of WMS
Byron C. Cook (43)............. Executive Vice President -- Home 1996 72,000(4)
Video and Director of the Company
Kenneth J. Fedesna (47)........ Executive Vice President -- Coin- 1996 61,000(4)
Op Video and Director of the
Company and Vice President and
General Manager of Williams
Electronics Games, Inc.
William C. Bartholomay (69).... Director of the Company and 1996 35,000(5)
President of Near North National
Group
William E. McKenna (78)........ Director of the Company and 1996 26,000(5)
General Partner, MCK Investment
Company
Norman J. Menell (65).......... Director of the Company and Vice 1996 27,000(5)
Chairman of the Board of WMS
Louis J. Nicastro (69)......... Director of the Company and 1988 35,000(5)
Chairman of the Board and Chief
Executive Officer of WHG Resorts
& Casinos Inc.
Harvey Reich (68).............. Director of the Company and 1996 27,000(5)
Attorney, Robinson Brog Leinwand
Greene Genovese & Gluck, P.C.
Ira S. Sheinfeld (59).......... Director of the Company and 1996 25,000(5)
Attorney, Squadron, Ellenoff,
Plesent & Sheinfeld LLP
Richard D. White (43).......... Director of the Company and 1996 25,000(5)
Managing Director, Oppenheimer &
Co., Inc.
Gerald O. Sweeney, Jr. (45).... Director of the Company and 1996 25,000(5)
Attorney, Lord, Bissell & Brook

<CAPTION>
PERCENTAGE OF
OUTSTANDING
NAME (AGE) COMMON STOCK(2)
- ---------- ---------------
<S> <C>
Neil D. Nicastro (40).......... *
Harold H. Bach, Jr. (65)....... *
Byron C. Cook (43)............. *
Kenneth J. Fedesna (47)........ *
William C. Bartholomay (69).... *
William E. McKenna (78)........ *
Norman J. Menell (65).......... *
Louis J. Nicastro (69)......... *
Harvey Reich (68).............. *
Ira S. Sheinfeld (59).......... *
Richard D. White (43).......... *
Gerald O. Sweeney, Jr. (45).... *
</TABLE>

- -------------------------
* Less than 1% of the number of outstanding shares of Common Stock on
September 5, 1997.

(1) Pursuant to Rule 13d-3(d)(1) of the Securities Exchange Act of 1934, as
amended, shares underlying options are deemed to be beneficially owned if
the holder of the option has the right to acquire beneficial ownership of
such shares within 60 days.

23
<PAGE> 25

(2) For purposes of calculating the percentage of outstanding Common Stock owned
by each director, shares beneficially owned and issuable upon the exercise
of stock options exercisable within 60 days have been deemed to be
outstanding.

(3) Includes 300,000 shares of Common Stock which the director has the right to
acquire upon the exercise of stock options.

(4) Includes 60,000 shares of Common Stock which the director has the right to
acquire upon the exercise of stock options.

(5) Includes 25,000 share of Common Stock which the director has the right to
acquire upon the exercise of stock options.

NEIL D. NICASTRO has been the President and Chief Operating Officer of the
Company since July 1, 1991 and a Director since July 29, 1988. On July 26, 1996,
Mr. Nicastro became Chairman of the Board of Directors and Chief Executive
Officer of the Company, having served as Co-Chief Executive Officer and Chief
Operating Officer since December 1, 1994. Mr. Nicastro served as President and
Chief Operating Officer (1991-1995), Treasurer (1991-1994), Executive Vice
President and Treasurer (1989-1991) and Senior Vice President and Treasurer
(1988-1989). Mr. Nicastro is also the President, Chief Executive Officer and
Chief Operating Officer and a Director of WMS. Mr. Nicastro was elected
President of WMS June 18, 1991, sole Chief Executive Officer June 26, 1996,
Co-Chief Executive Officer August 29, 1994 and Chief Operating Officer September
30, 1990. He has been a Director of WMS since 1986. Additionally, Mr. Nicastro
has served WMS as Treasurer (1986-1994), Executive Vice President (1988-1991),
Senior Vice President (1987-1988), Vice President (1986-1987) and Director of
Stockholder Relations (1981-1986).

HAROLD H. BACH, JR. became a Director, Executive Vice President -- Finance
and Chief Financial Officer of the Company on August 30, 1996. Previously, Mr.
Bach served as Senior Vice President -- Finance and Chief Financial Officer of
the Company from September 17, 1990 to August 30, 1996, and he has served as
Treasurer continuously since December 1, 1994. Additionally, Mr. Bach has served
as Secretary of WMS from July 5, 1990 to June 15, 1992. He also assumed the
positions of Treasurer of WMS effective September 13, 1994 and Vice President --
Finance, Chief Financial and Chief Accounting Officer of WMS effective September
30, 1990. Prior to joining WMS, Mr. Bach was a partner in the accounting firms
of Ernst & Young (1989-1990) and Arthur Young & Company (1967-1989).

BYRON C. COOK became a Director and Executive Vice President -- Home Video
of the Company on August 30, 1996. Mr. Cook is also the President and Chief
Operating Officer of Midway Home Entertainment Inc., a wholly-owned subsidiary
of the Company, positions he assumed upon the acquisition of Tradewest in April
1994. Prior to the acquisition, Mr. Cook was President of Tradewest (1988-1994)
as well as a co-founder thereof.

KENNETH J. FEDESNA became a Director and Executive Vice President --
Coin-Op Video of the Company on August 30, 1996. Mr. Fedesna served as Vice
President and General Manager of the Company from July 29, 1988 to August 30,
1996. He has also been a Director of WMS since 1993 as well as Vice President
and General Manager of Williams Electronics Games, Inc., a wholly-owned
subsidiary of WMS, for in excess of five years.

WILLIAM C. BARTHOLOMAY is President of Near North National Group, Chicago,
Illinois (insurance brokers) and Chairman of the Board of the Atlanta Braves
(National League Baseball). He has served as Vice Chairman of Turner
Broadcasting System, Inc., a division of Time Warner Inc. since April 1994
having also held that office during the period 1976-1992 and having served as a
Director (1976-1994). He also served as Vice Chairman of the Board of Directors
of Frank B. Hall & Co. Inc. (1974-1990). Mr. Bartholomay has also served as a
director of WMS since 1981 and was elected as a Director of the Company in
October 1996.

WILLIAM E. MCKENNA has served as a General Partner of MCK Investment
Company, Beverly Hills, California for in excess of five years. He also is a
Director of California Amplifier, Inc., Calprop Corporation,

24
<PAGE> 26

Drexler Technology Corporation and Safeguard Health Enterprises, Inc. Mr.
McKenna has also served as a director of WMS since 1981 and was elected as a
Director of the Company in October 1996.

NORMAN J. MENELL has been Vice Chairman of the Board of Directors of WMS
since 1990 and a Director of WMS since 1980. He also served as President
(1988-1990), Chief Operating Officer (1986-1990) and Executive Vice President
(1981-1988) of WMS and was elected as a Director of the Company in October 1996.

LOUIS J. NICASTRO has been the Chairman of the Board and Chief Executive
Officer of WHG Resorts & Casinos Inc. and its predecessors since 1983. Mr.
Nicastro became a Director of the Company on August 30, 1996. Mr. Nicastro also
served as Chairman of the Board and Co-Chief Executive Officer of the Company
from December 1, 1994 to June 26, 1996, Chairman of the Board and Chief
Executive Officer of the Company (1988-1994), President of the Company
(1988-1989 and 1990-1991) and as a Director of the Company from 1988 until June
26, 1996. Mr. Nicastro has also served WMS as Co-Chief Executive Officer
(1994-1996), Chief Executive Officer (1974-1994), President (1985-1988 and
1990-1991) and Chief Operating Officer (1985-1986). He has served as Chairman of
the Board of Directors of WMS since its incorporation in 1974.

HARVEY REICH has been a member of the law firm of Robinson Brog Leinwand
Greene Genovese & Gluck, P.C., New York, New York and its predecessor firms for
in excess of five years. He has also served as a Director of WMS since 1983 and
was elected as a Director of the Company in October 1996.

IRA S. SHEINFELD has been a member of the law firm of Squadron, Ellenoff,
Plesent & Sheinfeld LLP, New York, New York for in excess of five years. He has
also served as a Director of WMS since 1993 and was elected as a Director of the
Company in October 1996.

RICHARD D. WHITE has been a Managing Director of Oppenheimer & Co., Inc.,
New York, New York for in excess of five years and was elected as a Director of
the Company in October 1996.

GERALD O. SWEENEY, JR. has been a member of the law firm Lord, Bissell &
Brook, Chicago, Illinois for in excess of five years. He was elected as a
Director of the Company in November 1996.

(b) Identification of Executive Officers. The following table sets forth
certain information with respect to each executive officer of the Company. Each
executive officer serves as an executive officer until the next annual meeting
of the Company's Board of Directors and until their respective successors are
duly elected and qualify.

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>

Neil D. Nicastro..................... 40 Chairman of the Board of Directors, President, Chief
Executive Officer and Chief Operating Officer
Harold H. Bach, Jr................... 65 Executive Vice President -- Finance, Treasurer and Chief
Financial Officer
Byron C. Cook........................ 43 Executive Vice President -- Home Video
Kenneth J. Fedesna................... 47 Executive Vice President -- Coin-Op Video
Orrin J. Edidin...................... 36 Vice President, Secretary and General Counsel
</TABLE>

The current principal occupation or employment of Messrs. Nicastro, Bach,
Cook and Fedesna during the last five years is set forth in Item 10(a) above.
See also "Item 11. Executive Compensation -- Employment Contracts" with respect
to the term of employment of each of Mr. Nicastro and Mr. Cook.

Mr. Edidin has served as Vice President, Secretary and General Counsel of
the Company since June 30, 1997. Mr. Edidin served as Associate General Counsel
of Fruit of the Loom, Inc. from August 1992 until May 1997. Mr. Edidin has also
served as Vice President, Secretary and General Counsel of WMS since May 30,
1997.

25
<PAGE> 27

ITEM 11. EXECUTIVE COMPENSATION.

The executive officers of the Company (other than Mr. Neil D. Nicastro and
Mr. Byron C. Cook) received no compensation from the Company during the fiscal
years ended June 30, 1997, 1996 or 1995. The Summary Compensation Table below
sets forth the cash compensation paid by WMS (or in the case of (i) Mr.
Nicastro, for the period from the date of the Offering, by WMS and the Company,
and (ii) Mr. Cook, by the Company) for service in all capacities (including on
behalf of the Company) during the fiscal years ended June 30, 1997, 1996 and
1995 to each of the Company's executive officers who served during such period
and whose compensation from WMS or the Company exceeded $100,000. Pursuant to
the Manufacturing and Services Agreement, after the Offering the compensation
paid by WMS to the executive officers of the Company (other than Messrs.
Nicastro and Cook) is allocated to the Company based upon estimates by
management of WMS of the percentage of time devoted to the Company. Management
of the Company believes that such executive officers devoted at least 50% of
their time to the Company. The results of operations for each of the fiscal
years ended June 30, 1997, 1996 and 1995 include an allocation of the
compensation of the Company's executive officers based on estimates by
management of WMS. Mr. Orrin J. Edidin, Vice President, Secretary and General
Counsel of the Company, commenced his employment with the Company on May 19,
1997 and, therefore, is not included in the Summary Compensation Table set forth
below.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
----------------------------- ------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) COMPENSATION($)
--------------------------- ---- --------- -------- ---------- ---------------
<S> <C> <C> <C> <C> <C>
Neil D. Nicastro........................ 1997 600,000 969,160 500,000 54,632(1)
Chairman of the Board, Chief Executive 1996 532,500 267,600 -- 35,791(1)
Officer, President and Chief Operating 1995 532,500 489,100 -- 35,762(1)
Officer
Harold H. Bach, Jr...................... 1997 300,000 175,000 100,000
Executive Vice President -- Finance, 1996 262,500 67,800 -- --
Treasurer and Chief Financial Officer 1995 250,000 67,800 -- --
Byron C. Cook........................... 1997 300,000 250,000 100,000
Executive Vice President--Home Video 1996 250,000 150,000 -- --
1995 250,000 -- -- --
Kenneth J. Fedesna...................... 1997 310,000 150,000 100,000 2,500(2)
Executive Vice President--Coin-Op Video 1996 267,500 66,000 -- 2,500(2)
1995 250,000 66,000 -- 2,500(2)
Barbara M. Norman(3).................... 1997 168,270 50,000 25,000 --
Vice President, Secretary and General 1996 157,500 27,200 -- --
Counsel 1995 150,000 27,200 -- --
</TABLE>

- -------------------------
(1) Amount shown for Mr. Neil D. Nicastro includes for fiscal 1997, 1996 and
1995 life insurance premiums of $1,467, $691 and $662, respectively, and
$53,165, $35,100 and $35,100 for fiscal 1997, 1996 and 1995, respectively,
accrual for contractual retirement benefits.

(2) Amount shown for Mr. Fedesna includes life insurance premiums.

(3) Ms. Barbara M. Norman served as Vice President, Secretary and General
Counsel to the Company from June 15, 1992 until June 16, 1997, and she also
served as Vice President, Secretary and General Counsel of WMS during that
period.

26
<PAGE> 28

The following table sets forth certain information with respect to options
to purchase Common Stock granted during fiscal year 1997 under the Company's
Stock Option Plan for the executive officers named in the Summary Compensation
Table above.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
OF STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM(1)
------------------------------------------------------------------- ---------------------------
NUMBER OF
SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS GRANTED
OPTIONS TO EMPLOYEES IN EXERCISE PRICE EXPIRATION
NAME GRANTED(#) FISCAL YEAR(%) ($/SHARE) DATE 5%($) 10%($)
---- ---------- ---------------- -------------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Neil D. Nicastro..... 500,000(2) 28.4 20.00 10/31/06 6,288,946 15,937,425
Harold H. Bach,
Jr................. 100,000(2) 5.7 20.00 10/31/06 1,257,789 3,187,485
Byron C. Cook........ 100,000(2) 5.7 20.00 10/31/06 1,257,789 3,187,485
Kenneth J. Fedesna... 100,000(2) 5.7 20.00 10/31/06 1,257,789 3,187,485
Barbara M. Norman.... 25,000(2)(3) 1.4 20.00 10/31/06 314,447 796,871
</TABLE>

- -------------------------
(1) The assumed appreciation rates are set pursuant to the rules and regulations
promulgated under the Securities Exchange Act of 1934, as amended, and are
not derived from the historical or projected prices of the Company's Common
Stock or results of operations or financial conditions and they should not
be viewed as a prediction of possible prices for the Common Stock in the
future. Total potential stock price appreciation from November 1, 1996 to
October 31, 2006 for all stockholders based on the price of $20.00 per share
of Common Stock on November 1, 1996 and a total of 38,500,000 shares of
Common Stock outstanding would be $496,829,104 and $1,259,056,575 at assumed
rates of stock appreciation of 5% and 10%, respectively.

(2) In connection with the Offering, the optionee was granted options to
purchase Common Stock, 40% of which became exercisable upon completion of
the Offering and the balance of which become exercisable in equal
installments on each of the three succeeding anniversary dates of the
completion of the Offering.

(3) Ms. Norman's employment with the Company terminated effective June 16, 1997.
However, Ms. Norman is a consultant to the Company, and the options
previously issued to her remain outstanding.

27
<PAGE> 29

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
SHARES AT 6/30/97(#) 6/30/97($)(1)
ACQUIRED ON VALUE EXERCISABLE(E) EXERCISABLE(E)
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE(U) UNEXERCISABLE(U)
---- ----------- ----------- -------------------- --------------------
<S> <C> <C> <C> <C>
Neil D. Nicastro.................. -- -- 200,000(E) 275,000(E)
300,000(U) 412,500(U)
Harold H. Bach, Jr................ -- -- 40,000(E) 55,000(E)
60,000(U) 82,500(U)
Byron C. Cook..................... -- -- 40,000(E) 55,000(E)
60,000(U) 82,500(U)
Kenneth J. Fedesna................ -- -- 40,000(E) 55,000(E)
60,000(U) 82,500(U)
Barbara M. Norman................. -- -- 10,000(E) 13,750(E)
15,000(U) 20,625(U)
</TABLE>

- -------------------------
(1) Based on the closing price of the Common Stock on the New York Stock
Exchange on June 30, 1997, which was $21.375.

COMPENSATION OF DIRECTORS

The Company pays a fee of $22,500 per annum to each director who is not
also an employee of the Company or any of its subsidiaries. Each such director
who serves as the chairman of any committee of the Board of Directors receives a
further fee of $2,500 per annum for his services in such capacity and each other
member of the Company's Audit Committee receives an additional fee of $2,500 per
annum.

Additionally, immediately prior to the Offering the Company granted options
to purchase 25,000 shares of Common Stock to each of its non-employee directors.
Subsequent to the Offering, the Company granted options to purchase 25,000
shares of Common Stock to Mr. Gerald O. Sweeney, Jr., a non-employee director of
the Company who was elected to the Board of Directors after the Offering in
November 1996.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Mr. Harvey Reich serves as Chairman of the Company's Compensation and Stock
Option Committee and Mr. William E. McKenna serves as the sole additional
member, neither of whom are employees or officers of the Company or any of its
subsidiaries or had any relationship requiring disclosure herein by the Company
other than that both serve on the Board of Directors of WMS.

EMPLOYMENT AGREEMENTS

Mr. Neil D. Nicastro is employed as the Company's Chairman of the Board,
President, Chief Executive Officer and Chief Operating Officer under the terms
of an Employment Agreement dated as of July 1, 1996. The employment agreement
provides for salaried compensation at the rate of $300,000 per annum, or such
greater amount as may be determined by the Board of Directors, plus bonus
compensation in an amount equal to two percent of the pre-tax income of the
Company multiplied by the percentage of Common Stock outstanding which is not
owned by WMS. The portion of Mr. Nicastro's bonus from WMS that is attributable
to the pre-tax income of the Company is charged to the Company pursuant to the
Manufacturing and Services Agreement. The employment agreement expires October
29, 2001, subject to automatic extensions in order that the term of Mr.
Nicastro's employment shall at no time be less than three years. Upon Mr.
Nicastro's retirement or death, the Company is required to pay to Mr. Nicastro
or his designee, or if no designation is made, to his estate, for a period of
seven years, an annual benefit equal to one-half of the annual base salary

28
<PAGE> 30

being paid to him on such retirement or death, as the case may be, but in no
event less than $150,000 per annum. Such benefits are payable notwithstanding
Mr. Nicastro's termination of employment for any reason.

The employment agreement provides that Mr. Nicastro shall devote such time
to the business and affairs of the Company as is reasonably necessary to perform
the duties of his position, except that he is not required to perform any duties
or responsibilities which would be likely to result in non-compliance with or
breach or violation of his employment agreement with WMS. Mr. Nicastro currently
spends approximately 50% of his working time on the affairs of the Company and
approximately 50% of his working time on the affairs of WMS.

Mr. Nicastro is employed by WMS pursuant to an employment agreement which
provides for, among other things, full participation in all benefit plans
available to senior executives of WMS and for reimbursement of all medical and
dental expenses incurred by him or his spouse and incurred by his children under
the age of twenty-one. Mr. Nicastro's employment agreement with the Company
provides that should WMS fail for any reason to provide the aforementioned
benefits to Mr. Nicastro, the Company and WMS will each provide such benefits to
him at its expense. Additionally, the Company will provide Mr. Nicastro with
$1,000,000 of life insurance coverage in addition to the standard amount
provided to Company employees. The agreement further provides for full
compensation during periods of illness or incapacity; however, the Company may
give 30 days' notice of termination if such illness or incapacity disables Mr.
Nicastro from performing his duties for a period of more than six months. Such
termination notice becomes effective if full performance is not resumed within
30 days after such notice and maintained for a period of two months thereafter.
The employment agreement may be terminated at the election of Mr. Nicastro upon
the occurrence without his consent or acquiescence of any one or more of the
following events: (i) the placement of Mr. Nicastro in a position of lesser
stature or the assignment to Mr. Nicastro of duties, performance requirements or
working conditions significantly different from or at variance with those
presently in effect; (ii) the treatment of Mr. Nicastro in a manner which is in
derogation of his status as a senior executive; (iii) the cessation of service
of Mr. Nicastro as a member of the Board of Directors of the Company; (iv) the
discontinuance or reduction of amounts payable or personal benefits available to
Mr. Nicastro pursuant to such agreement; or (v) the requirement that Mr.
Nicastro work outside his agreed upon metropolitan area. In any such event, and
in the event the Company is deemed to have wrongfully terminated Mr. Nicastro's
employment agreement under the terms thereof, the Company is obligated (a) to
make a lump sum payment to Mr. Nicastro equal in amount to the sum of the
aggregate base salary during the remaining term of his employment agreement (but
in no event less than three times the highest base salary payable to him during
the one-year period prior to such event), the bonus (assuming pre-tax income of
the Company during the remainder of the term of the employment agreement is
earned at the highest level achieved in either of the last two full fiscal years
prior to such termination) and the retirement benefit (assuming the date of
termination is his retirement date) otherwise payable under the terms of the
employment agreement and (b) to purchase at the election of Mr. Nicastro all
stock options held by him with respect to the Company's Common Stock at a price
equal to the spread between the option price and the fair market price of such
stock as defined in the agreement. The employment agreement may also be
terminated at the election of Mr. Nicastro if individuals who presently
constitute the Board of Directors, or successors approved by such Board members,
cease for any reason to constitute at least a majority of the Board. Upon such
an event, the Company may be required to purchase the stock options held by Mr.
Nicastro and make payments similar to those described above.

If payments made to Mr. Nicastro pursuant to the employment agreement after
a change of control are considered "excess parachute payments" under Section
280G of the Internal Revenue Code of 1986, as amended, additional compensation
is required to be paid to Mr. Nicastro to the extent necessary to eliminate the
economic effect on him of the resulting excise tax. Pursuant to Section 280G, in
addition to income taxes, the recipient is subject to a 20% nondeductible excise
tax on excess parachute payments. An excess parachute payment is a payment in
the nature of compensation which is contingent on a change of ownership or
effective control and which exceeds the portion of the base amount (i.e., the
average compensation for the five-year period prior to the change of control)
allocable to the payment. These rules apply only if the present value of all
payments of compensation (including non-taxable fringe benefits) at the time of
a change of control is at least equal to three times the base amount. Excess
parachute payments are not deductible by the Company.

29
<PAGE> 31

Midway Home Entertainment Inc. ("Midway Home"), a wholly-owned subsidiary
of the Company, has entered into an employment agreement with Mr. Byron C. Cook,
pursuant to which Mr. Cook serves as President and Chief Operating Officer of
Midway Home. The agreement expires May 1, 1998 and was entered into in
connection with the Company's acquisition of Tradewest. Mr. Cook's current base
salary is $300,000 per annum. For fiscal 1997, Mr. Cook also received a bonus of
$250,000. Mr. Cook is entitled to participate in the Company's employee benefit
plans generally available to executives of the Company. In addition, pursuant to
the agreement on May 2, 1994, Mr. Cook was awarded non-qualified stock options
to purchase 200,000 shares of WMS common stock. Mr. Cook has agreed not to
engage in any competitive business with the Company in North America until May
2, 1999 so long as the Company continues to make salary payments pursuant to the
agreement.

STOCK OPTION PLAN

The Company's Stock Option Plan (the "Stock Option Plan") provides for the
granting of stock options to directors, officers, employees, consultants and
advisors of the Company and its subsidiaries. The Stock Option Plan is intended
to encourage stock ownership by directors, officers, employees, consultants and
advisors of the Company and its subsidiaries and thereby enhance their
proprietary interest in the Company. The Stock Option Plan is administered by
the Compensation and Stock Option Committee of the Board of Directors. Subject
to the provisions of the Stock Option Plan, the Compensation and Stock Option
Committee shall have sole authority to determine which of the eligible
directors, officers, employees, consultants and advisors of the Company shall
receive stock options, the terms, including applicable vesting periods, of such
options, and the number of shares for which such options shall be granted.

The total number of shares of the Company's Common Stock that may be
purchased pursuant to stock options under the Stock Option Plan shall not exceed
in the aggregate 2,000,000 shares. The option price per share with respect to
each such option shall be determined by the Compensation and Stock Option
Committee but shall not be less than 100% of the fair market value of the
Company's Common Stock on the date such option is granted as determined by the
Committee. The Stock Option Plan terminates in 2006 unless terminated earlier.

Prior to the Offering, WMS, as sole stockholder of the Company, approved
the adoption of the Stock Option Plan following approval by WMS' Stock Option
Committee and Board of Directors.

At June 30, 1997, options to purchase 1,810,000 shares of Common Stock
exercisable at $20.00 per share were outstanding under the Stock Option Plan,
1,760,000 of which are held by officers, directors and employees of the Company
and 50,000 of which are held by advisors and consultants to the Company.

30
<PAGE> 32

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following table sets forth certain information as of September 5, 1997
(except as otherwise footnoted) with respect to persons known to be the
beneficial owner of more than five percent of the Company's Common Stock, each
Executive Officer of the Company who is not also a Director of the Company, and
Directors and Executive Officers of the Company as a group. Security ownership
of the individual Directors of the Company, including those who are also
Executive Officers of the Company, is set forth under the heading
"Identification of Directors" in Item 10(a) above.

<TABLE>
<CAPTION>
NUMBER OF SHARES OF PERCENTAGE OF
COMMON STOCK OUTSTANDING
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) COMMON STOCK(2)
------------------------------------ --------------------- ---------------
<S> <C> <C>
WMS Industries Inc. ....................................... 33,400,000 86.8%
3401 North California Avenue
Chicago, IL 60618
Orrin J. Edidin............................................ 0 0
Midway Games Inc.
3401 North California Avenue
Chicago, IL 60618
Directors and Executive Officers as a group (13 persons)... 743,000(3) 1.9%
</TABLE>

- -------------------------
(1) Pursuant to Rule 13d-3(d)(1) of the Securities Exchange Act of 1934, as
amended, shares underlying options are deemed to be beneficially owned if
the holder of the option has the right to acquire beneficial ownership of
such shares within 60 days.

(2) For purposes of calculating the percentage of outstanding Common Stock owned
by each Executive Officer and Directors and Executive Officers as a group,
shares issuable upon the exercise of stock options exercisable within 60
days have been deemed to be outstanding.

(3) Includes 680,000 shares of Common Stock which the directors and executive
officers of the Company have the right to acquire upon the exercise of stock
options.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

RELATIONSHIP WITH WMS

Prior to the Offering, the Company was a wholly-owned subsidiary of WMS. As
a result of the Offering, WMS' beneficial ownership of Common Stock was reduced
from 100.0% to 86.8%. A majority of the Company's directors are directors and/or
officers of WMS. Additionally, several of the executive officers of the Company
are officers and/or directors of WMS. See "Item 10 -- Directors and Executive
Officers of the Registrant."

In contemplation of the Offering, the Company and WMS entered into the
following agreements:

Manufacturing and Services Agreement. The Company and WMS entered into the
Manufacturing and Services Agreement with respect to various aspects of their
future relationship. The Manufacturing and Services Agreement became effective
as of July 1, 1996 and will continue in effect unless terminated (a) by either
party for any reason upon 180 days' notice or (b) in the event of a material
default, immediately at the election of the non-defaulting party. The Company
also has the right, upon 180 days' notice, to terminate the manufacturing and
related services provided by WMS while retaining WMS' other services. The
Manufacturing and Services Agreement provides, among other things, that WMS will
provide the Company with management, legal and administrative services and
certain services for its coin-operated video games including, without
limitation: (i) manufacturing; (ii) engineering support; (iii) sales and
marketing; (iv) warranty and field services; and (v) creative services. The
aforementioned services are provided to the Company upon terms which the Company
believes are fair and reasonable. The parties have agreed that with respect to
matters not specifically covered in the Manufacturing and Services Agreement, or
if changes in

31
<PAGE> 33

business circumstances should cause the method of handling matters specifically
covered to be unfair to either party, such matters will be referred to a
negotiating committee consisting of two designees of each party.

All of the Company's coin-operated video games are manufactured and
assembled by WMS at its facilities in Cicero and Waukegan, Illinois. Materials
used in the manufacture of coin-operated video games are purchased by Midway at
its expense. Certain other manufacturing costs are allocated based upon units
produced for the Company and the other amusement games businesses of WMS. All
labor costs associated with the manufacturing of coin-operated video games are
charged to the Company at actual cost to WMS. Certain management, legal and
administrative expenses and sales and marketing expenses are allocated based
upon the revenues of and/or units produced for the Company and the other
amusement games businesses of WMS or other methods appropriate for the
allocation of the particular expense.

For so long as the Manufacturing and Services Agreement remains in effect
and for a period of five years thereafter, (i) WMS is precluded from engaging,
directly or indirectly, in the business of designing, developing, manufacturing,
marketing or distributing coin-operated or home video games (except for its
activities on behalf of the Company) and (ii) the Company is precluded from
engaging, directly or indirectly, in the business of designing, developing,
manufacturing, marketing or distributing coin-operated pinball games, novelty
games, video lottery terminals or gaming machines such as slot machines.

Tax Sharing Agreement. The Company has been a member of the consolidated
group of corporations of which WMS was the common parent for federal income tax
purposes (the "WMS Group") since 1988. Therefore, the Company is jointly and
severally liable for any federal tax liability incurred by the WMS Group. The
Company and WMS entered into a Tax Sharing Agreement (the "Tax Sharing
Agreement") whereby WMS and the Company have agreed upon a method for: (i)
determining the amount which the Company must pay to WMS in respect of federal
income taxes; (ii) compensating any member of the WMS Group for use of its net
operating losses, tax credits and other tax benefits in arriving at the WMS
Group tax liability as determined under the federal consolidated return
regulations; and (iii) providing for the receipt of any refund arising from a
carryback of net operating losses or tax credits from subsequent taxable years
and for payments upon subsequent adjustments. The amount the Company is required
to pay to WMS in respect of federal income taxes is determined as if the Company
was filing a separate tax return. If any two or more members of the WMS Group
are required to elect, or WMS elects to cause two or more members of the WMS
Group to file combined or consolidated income tax returns under state or local
income tax law, the financial consequences of such filings among such members
shall be determined in a manner as similar as practicable to those provided for
under the Tax Sharing Agreement for federal taxes. The Tax Sharing Agreement is
not binding on the Internal Revenue Service (the "IRS") or upon state, local or
foreign taxing authorities. The effectiveness of the Tax Sharing Agreement is
therefore dependent on each member of the WMS Group having the ability to pay
its relative share of taxes. Because the IRS or other taxing authorities can be
expected to seek payment from WMS prior to seeking payment from the individual
group members, it is likely that the Company would seek to enforce any rights it
may have against WMS for sharing at a time when WMS was unable to pay its
proportionate share of taxes.

Registration Rights Agreement. Prior to the consummation of the Offering,
the Company entered into a registration rights agreement (the "Registration
Rights Agreement") with WMS, pursuant to which the Company has agreed, upon the
request of WMS, to file up to two registration statements under the Securities
Act of 1933, as amended, in order to permit WMS to offer and sell shares of
Common Stock that WMS or its affiliates may beneficially own. The Company will
pay all registration fees and expenses in connection with any requested
registration, except that WMS will pay any underwriting discounts or commissions
relating to shares owned by it and included in any such registration. The
Company will not be required to comply with any request for registration unless
the request involves at least 5% of the total number of the then outstanding
shares of Common Stock. The Registration Rights Agreement also provides WMS the
right to include its Common Stock holdings in certain registration statements
covering offerings by the Company and the Company will pay all fees and expenses
of such offerings other than underwriting discounts or commissions as they
relate to WMS' shares. The Company will indemnify WMS and its officers,
directors and controlling persons against certain liabilities in respect of any
registrations or other offerings covered by the Registration Rights Agreement.
WMS will indemnify the Company against any liability arising as a result of
information

32
<PAGE> 34

provided by WMS and included in any offering document covered by the
Registration Rights Agreement. The Company has the right to request WMS to delay
any exercise by WMS of its rights to require registration and other actions for
a period of up to 60 days under certain circumstances. WMS has further agreed
that it will not include any Common Stock in any registration statement of the
Company which, in the judgment of the underwriters for such offering, would
adversely affect such offering by the Company. The rights of WMS under the
Registration Rights Agreement are transferable to an assignee of WMS at its
option.

Patent License Agreement. The Company and WMS entered into a patent license
agreement pursuant to which the Company and WMS each licensed to the other, on a
perpetual, royalty-free basis, certain patents used in the development and
manufacture of both coin-operated video games and video lottery terminals and
other gaming machines.

OTHER RELATED TRANSACTIONS

Mr. Byron C. Cook, Executive Vice President -- Home Video and a Director of
the Company, owned a one-third interest in each of the three commonly owned
companies which constituted Tradewest, the operating assets and business of
which were acquired by the Company in April 1994. The purchase price for the
assets acquired from Tradewest was set at five times the average annual pre-tax
income of the acquired business during the four year period commencing May 1,
1994 with a minimum purchase price of $14.1 million, which was paid at the
closing, and a maximum additional payment of $36.0 million to be paid during the
four-year earn-out period. Over the first three years of the earn-out period,
the Company has paid an aggregate sum of $21.6 million as additional purchase
price. The Company will pay an additional $14.4 million in additional purchase
price.

Mr. Ira S. Sheinfeld, a Director of each of the Company and WMS, is a
member of the law firm of Squadron, Ellenoff, Plesent & Sheinfeld LLP which the
Company and WMS retained to provide tax services during the 1997 fiscal year and
which each proposes to retain for such services during the current fiscal year.

Mr. Richard D. White, a Director of the Company, is a Managing Director of
Oppenheimer & Co., Inc., which was one of the representatives of the
underwriters of the Offering and which received customary compensation in
connection therewith. Oppenheimer & Co., Inc., is currently rendering financial
advisory services to WMS in connection with the Distribution. Additionally,
Oppenheimer & Co., Inc. has rendered financial advisory services to WMS in the
past and received customary compensation in connection therewith.

Mr. Gerald O. Sweeney, Jr., a Director of the Company, is a member of the
law firm of Lord, Bissell & Brook which performs legal services for the Company
from time to time.

33
<PAGE> 35

PART IV

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

(a)(1) Financial Statements of the Company. All financial statements of the
Company required to be disclosed in this Item 14(a)(1) appear in the Financial
Statements in the 1997 Annual Report. Such Financial Statements are incorporated
by reference herein. See "Index to Financial Information" on page F-1.

(2) Financial Statement Schedule of the Company. See "Index to Financial
Information" on page F-1.

(3) Exhibits.

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>

2.2 Form of Certificate of Designations of Series A Preferred
Stock (included as Exhibit A to Exhibit 2.1 hereof),
incorporated by reference to Exhibit 2.2 to the S-1
Registration Statement.

2.3 Specimen Form of Rights Certificate (included as Exhibit B
to Exhibit 2.1 hereof), incorporated by reference to Exhibit
2.3 to the S-1 Registration Statement.

2.4 Summary of Rights Plan (included as Exhibit C to Exhibit 2.1
hereof), incorporated by reference to Exhibit 2.4 to the S-1
Registration Statement.

3.1 Amended and Restated Certificate of Incorporation of the
Registrant, incorporated by reference to Exhibit 3.1 to the
S-1 Registration Statement.

3.2 Amended and Restated By-laws of the Registrant, incorporated
by reference to Exhibit 3.2 to the S-1 Registration
Statement.

4.1 Specimen of Common Stock Certificate, incorporated by
reference to Exhibit 4.1 to the S-1 Registration Statement.

10.1 Manufacturing and Services Agreement dated as of July 1,
1996 between WMS Industries Inc. and the Registrant,
incorporated by reference to Exhibit 10.1 to the S-1
Registration Statement.

Tax Sharing Agreement dated as of July 1, 1996 among WMS
10.2 Industries Inc., the Registrant, Midway Home Entertainment
Inc., Midway Interactive Inc., Atari Games Corporation and
Tengen Inc., incorporated by reference to Exhibit 10.2 to
the S-1 Registration Statement.

10.3 Registration Rights Agreement dated as of July 1, 1996
between WMS Industries Inc. and the Registrant, incorporated
by reference to Exhibit 10.3 to the S-1 Registration
Statement.

10.4 Patent License Agreement dated as of July 1, 1996 between
the Registrant and Williams Electronics Games, Inc.,
incorporated by reference to Exhibit 10.4 to the S-1
Registration Statement.
10.5
Employment Agreement dated as of July 1, 1996 between Mr.
Neil D. Nicastro and the Registrant, incorporated by
reference to Exhibit 10.5 to the S-1 Registration Statement.
10.6
Employment Agreement dated April 29, 1994 between Mr. Byron
C. Cook and Midway Home Entertainment Inc., incorporated by
10.7 reference to Exhibit 10.6 to the S-1 Registration Statement.

Stock Option Plan of the Registrant, incorporated by
reference to Exhibit 10.7 to the S-1 Registration Statement.

10.8 Form of Indemnity Agreement authorized to be entered into
between the Registrant and each Officer and Director of the
Registrant, incorporated by reference to Exhibit 10.8 to the
S-1 Registration Statement.

</TABLE>

34
<PAGE> 36
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
10.9 GTIS Master Option and License Agreement by and among WMS
Industries Inc., Williams Electronics Games, Inc., the
Registrant and Midway Home Entertainment Inc., and GT
Interactive Software Corp. dated December 28, 1994,
incorporated by reference to Exhibit 10.9 to the S-1
Registration Statement.

10.10 Amendment to GTIS Master Option and License Agreement by and
among WMS Industries Inc., Williams Electronics Games, Inc.,
the Registrant and Midway Home Entertainment Inc., and GT
Interactive Software Corp. dated March 31, 1995,
incorporated by reference to Exhibit 10.10 to the S-1
Registration Statement.

10.11 Second Amendment to GTIS Master Option and License Agreement
by and among WMS Industries Inc., Williams Electronics
Games, Inc., the Registrant and Midway Home Entertainment
Inc., and GT Interactive Software Corp. dated March 27,
1996, incorporated by reference to Exhibit 10.11 to the S-1
Registration Statement.

10.12 GTIS Master Option and License Agreement (Home Video Games)
by and among WMS Industries Inc., Williams Electronics
Games, Inc., the Registrant and Midway Home Entertainment
Inc., and GT Interactive Software Corp. dated March 31,
1995, incorporated by reference to Exhibit 10.12 to the S-1
Registration Statement.

10.13 Amendment to GTIS Master Option and License Agreement (Home
Video Games) by and among WMS Industries Inc., Williams
Electronics Games, Inc., the Registrant and Midway Home
Entertainment Inc., and GT Interactive Software Corp. dated
March 27, 1996, incorporated by reference to Exhibit 10.13
to the S-1 Registration Statement.

10.14 Master Option and License Agreement for Atari Home Video
Games dated March 27, 1996, between WMS Industries Inc. and
GT Interactive Software Corp., incorporated by reference to
Exhibit 10.14 to the S-1 Registration Statement.

10.15 Master Option and License Agreement for Atari PC Games dated
March 27, 1996, between WMS Industries Inc. and GT
Interactive Software Corp., incorporated by reference to
Exhibit 10.15 to the S-1 Registration Statement.

10.16 Stock Purchase Agreement dated as of February 23, 1996
between Warner Communications, Inc. and Williams Interactive
Inc., incorporated by reference to Exhibit 10.16 to the S-1
Registration Statement.

10.17 Credit Agreement dated as of October 15, 1996 between the
Registrant and Bank of America Illinois, incorporated by
reference to Exhibit 10.17 to the S-1 Registration
Statement.

*10.18 Agreement dated as of April 15, 1997 between Warner
Communications, Inc. and Midway Interactive Inc. (formerly
Williams Interactive Inc.)

*13 1997 Annual Report to Stockholders.

*21 Subsidiaries of the Registrant.

*23 Consent of Ernst & Young LLP.

*27 Financial Data Schedule (filed with EDGAR version only).

</TABLE>

- -------------------------
* Filed herewith

(b) Reports on Form 8-K: None.

35
<PAGE> 37

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on this
26th day of September, 1997.

MIDWAY GAMES INC.
(Registrant)

By: /s/ NEIL D. NICASTRO

------------------------------------
Neil D. Nicastro,
Chairman of the Board, President,
Chief Executive Officer and
Chief Operating Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been duly signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>

/s/ NEIL D. NICASTRO Chairman of the Board, President, September 26, 1997
- ------------------------------------------ Chief Executive Officer and Chief
Neil D. Nicastro Operating Officer (Principal
Executive Officer) and Director

/s/ HAROLD H. BACH, JR. Executive Vice President -- Finance, September 26, 1997
- ------------------------------------------ Treasurer and Chief Financial
Harold H. Bach, Jr. Officer (Principal Financial and
Principal Accounting Officer) and
Director

/s/ BYRON C. COOK Executive Vice President -- Home September 26, 1997
- ------------------------------------------ Video and Director
Byron C. Cook

/s/ KENNETH J. FEDESNA Executive Vice President -- Coin-Op September 26, 1997
- ------------------------------------------ Video and Director
Kenneth J. Fedesna

/s/ LOUIS J. NICASTRO Director September 26, 1997
- ------------------------------------------
Louis J. Nicastro

/s/ WILLIAM C. BARTHOLOMAY Director September 26, 1997
- ------------------------------------------
William C. Bartholomay

/s/ WILLIAM E. MCKENNA Director September 26, 1997
- ------------------------------------------
William E. McKenna

/s/ NORMAN J. MENELL Director September 26, 1997
- ------------------------------------------
Norman J. Menell
</TABLE>
36
<PAGE> 38
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ HARVEY REICH Director September 26, 1997
- ------------------------------------------
Harvey Reich

/s/ IRA S. SHEINFELD Director September 26, 1997
- ------------------------------------------
Ira S. Sheinfeld

/s/ RICHARD D. WHITE Director September 26, 1997
- ------------------------------------------
Richard D. White

/s/ GERALD O. SWEENEY, JR. Director September 26, 1997
- ------------------------------------------
Gerald O. Sweeney, Jr.
</TABLE>

37
<PAGE> 39

MIDWAY GAMES INC.

INDEX TO FINANCIAL INFORMATION

<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Financial Statements and Financial Statement Schedule
Report of independent auditors.............................. F-2
Balance sheets at June 30, 1997 and June 30, 1996........... *
Statements of income for the years ended June 30, 1997, 1996
and 1995.................................................. *
Statements of changes in stockholders' equity for the years
ended June 30, 1997, 1996 and 1995........................ *
Statements of cash flows for the years ended June 30, 1997,
1996 and 1995............................................. *
Notes to financial statements............................... *
Financial statements schedule II -- Valuation and qualifying
accounts for the years ended June 30, 1997, 1996 and
1995...................................................... F-3
</TABLE>

- -------------------------
* Incorporated by reference to the 1997 Annual Report filed as Exhibit 13 to
this Form 10-K.

All other schedules are omitted since the required information is not
present in amounts sufficient to require submission of the schedule, or because
the information required is included in the financial statements and notes
thereto.

F-1
<PAGE> 40

REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors
Midway Games Inc.

We have audited the financial statements of Midway Games Inc. and
subsidiaries listed in Item 14(a)(1) of the Annual Report on Form 10-K of Midway
Games Inc. for the year ended June 30, 1997. Our audits also included the
financial statement schedule listed in the Index at Item 14(a)(2). The financial
statements and related schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and related schedule based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Midway Games Inc. and
subsidiaries at June 30, 1997 and 1996, and the results of their operations and
their cash flows for each of the three years in the period ended June 30, 1997,
in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

Chicago, Illinois
August 19, 1997

F-2
<PAGE> 41

MIDWAY GAMES INC.

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 30, 1997, 1996, AND 1995

<TABLE>
<CAPTION>
COLUMN C
COLUMN A COLUMN B ADDITIONS COLUMN D COLUMN E
- ---------------------------------- ------------ ------------------------- ------------- ----------
BALANCE AT CHARGED TO CHARGED TO DEDUCTIONS -- BALANCE AT
BEGINNING OF COSTS AND OTHER AMOUNTS END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS WRITTEN OFF PERIOD
----------- ------------ ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>

Allowance for receivables:
1997.............................. $ 995,000 $14,586,000 $ -- $10,641,000 $4,940,000
1996.............................. $1,078,000 $ 3,358,000 $ -- $ 3,441,000 $ 995,000
1995.............................. $ -- $ 3,218,000 $ -- $ 2,140,000 $1,078,000
</TABLE>

F-3
<PAGE> 42

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION PAGE NO.
- ------- ----------- ----------
<C> <S> <C>
</TABLE>

2.1 Rights Agreement dated as of October 24, 1996 between the
Registrant and The Bank of New York, incorporated by
reference to Exhibit 2.1 to the Registrant's Registration
Statement on Form S-1, File No. 333-11919, filed on
September 13, 1996 (the "S-1 Registration Statement").
2.2 Form of Certificate of Designations of Series A Preferred
Stock (included as Exhibit A to Exhibit 2.1 hereof),
incorporated by reference to Exhibit 2.2 to the S-1
Registration Statement.
2.3 Specimen Form of Rights Certificate (included as Exhibit B
to Exhibit 2.1 hereof), incorporated by reference to Exhibit
2.3 to the S-1 Registration Statement.
2.4 Summary of Rights Plan (included as Exhibit C to Exhibit 2.1
hereof), incorporated by reference to Exhibit 2.4 to the S-1
Registration Statement.
3.1 Amended and Restated Certificate of Incorporation of the
Registrant, incorporated by reference to Exhibit 3.1 to the
S-1 Registration Statement.
3.2 Amended and Restated By-laws of the Registrant, incorporated
by reference to Exhibit 3.2 to the S-1 Registration
Statement.
4.1 Specimen of Common Stock Certificate, incorporated by
reference to Exhibit 4.1 to the S-1 Registration Statement.
10.1 Manufacturing and Services Agreement dated as of July 1,
1996 between WMS Industries Inc. and the Registrant,
incorporated by reference to Exhibit 10.1 to the S-1
Registration Statement.
10.2 Tax Sharing Agreement dated as of July 1, 1996 among WMS
Industries Inc., the Registrant, Midway Home Entertainment
Inc., Midway Interactive Inc., Atari Games Corporation and
Tengen Inc., incorporated by reference to Exhibit 10.2 to
the S-1 Registration Statement.
10.3 Registration Rights Agreement dated as of July 1, 1996
between WMS Industries Inc. and the Registrant, incorporated
by reference to Exhibit 10.3 to the S-1 Registration
Statement.
10.4 Patent License Agreement dated as of July 1, 1996 between
the Registrant and Williams Electronics Games, Inc.,
incorporated by reference to Exhibit 10.4 to the S-1
Registration Statement.
10.5 Employment Agreement dated as of July 1, 1996 between Mr.
Neil D. Nicastro and the Registrant, incorporated by
reference to Exhibit 10.5 to the S-1 Registration Statement.
10.6 Employment Agreement dated April 29, 1994 between Mr. Byron
C. Cook and Midway Home Entertainment Inc., incorporated by
reference to Exhibit 10.6 to the S-1 Registration Statement.
10.7 Stock Option Plan of the Registrant, incorporated by
reference to Exhibit 10.7 to the S-1 Registration Statement.
10.8 Form of Indemnity Agreement authorized to be entered into
between the Registrant and each Officer and Director of the
Registrant, incorporated by reference to Exhibit 10.8 to the
S-1 Registration Statement.
10.9 GTIS Master Option and License Agreement by and among WMS
Industries Inc., Williams Electronics Games, Inc., the
Registrant and Midway Home Entertainment Inc., and GT
Interactive Software Corp. dated December 28, 1994,
incorporated by reference to Exhibit 10.9 to the S-1
Registration Statement.

E-1
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NO. DESCRIPTION PAGE NO.
- ------- ----------- ----------
<C> <S> <C>
10.10 Amendment to GTIS Master Option and License Agreement by and
among WMS Industries Inc., Williams Electronics Games, Inc.,
the Registrant and Midway Home Entertainment Inc., and GT
Interactive Software Corp. dated March 31, 1995,
incorporated by reference to Exhibit 10.10 to the S-1
Registration Statement.
10.11 Second Amendment to GTIS Master Option and License Agreement
by and among WMS Industries Inc., Williams Electronics
Games, Inc., the Registrant and Midway Home Entertainment
Inc., and GT Interactive Software Corp. dated March 27,
1996, incorporated by reference to Exhibit 10.11 to the S-1
Registration Statement.
10.12 GTIS Master Option and License Agreement (Home Video Games)
by and among WMS Industries Inc., Williams Electronics
Games, Inc., the Registrant and Midway Home Entertainment
Inc., and GT Interactive Software Corp. dated March 31,
1995, incorporated by reference to Exhibit 10.12 to the S-1
Registration Statement.
10.13 Amendment to GTIS Master Option and License Agreement (Home
Video Games) by and among WMS Industries Inc., Williams
Electronics Games, Inc., the Registrant and Midway Home
Entertainment Inc., and GT Interactive Software Corp. dated
March 27, 1996, incorporated by reference to Exhibit 10.13
to the S-1 Registration Statement.
10.14 Master Option and License Agreement for Atari Home Video
Games dated March 27, 1996, between WMS Industries Inc. and
GT Interactive Software Corp., incorporated by reference to
Exhibit 10.14 to the S-1 Registration Statement.
10.15 Master Option and License Agreement for Atari PC Games dated
March 27, 1996, between WMS Industries Inc. and GT
Interactive Software Corp., incorporated by reference to
Exhibit 10.15 to the S-1 Registration Statement.
10.16 Stock Purchase Agreement dated as of February 23, 1996
between Warner Communications, Inc. and Williams Interactive
Inc., incorporated by reference to Exhibit 10.16 to the S-1
Registration Statement.
10.17 Credit Agreement dated as of October 15, 1996 between the
Registrant and Bank of America Illinois, incorporated by
reference to Exhibit 10.17 to the S-1 Registration
Statement.
*10.18 Agreement dated as of April 15, 1997 between Warner
Communications, Inc. and Midway Interactive Inc. (formerly
Williams Interactive Inc.)
*13 1997 Annual Report to Stockholders.
*21 Subsidiaries of the Registrant.
*23 Consent of Ernst & Young LLP.
*27 Financial Data Schedule (filed with EDGAR version only).
</TABLE>

- -------------------------
* Filed herewith

E-2

<PAGE> 1
EXHIBIT 10.18

AGREEMENT

AGREEMENT dated as of April 15, 1997 (the "Agreement"), between WARNER
COMMUNICATIONS INC., a Delaware corporation ("WCI"), and MIDWAY INTERACTIVE
INC., formerly known as Williams Interactive Inc., a Delaware corporation
("Midway").

W I T N E S S E T H :

WHEREAS, WCI and Midway are parties to a stock purchase agreement (the
"Purchase Agreement") dated as of February 23, 1996 pursuant to which WCI sold
and Midway purchased all of the outstanding capital stock of Atari Games
Corporation, a California corporation ("Atari") (capitalized terms used herein
and not otherwise defined shall have the same meaning ascribed to such terms in
the Purchase Agreement); and

WHEREAS, in accordance with the terms of the Purchase Agreement, Atari made
and delivered the Final Four Year Note to WCI in the principal amount of
$14,152,500 of which $8,953,500 remains unpaid and Midway made and delivered
the Final Two Year Note to WCI in the principal amount of $7,862,500, all of
which remains unpaid; and

WHEREAS, Midway is interested in purchasing and prepaying the Final Two Year
Note and Final Four Year Note (collectively the "Notes") from WCI and obtaining
the release of the "Collateral" under the Security Agreements in respect
thereto and WCI is willing to sell and accept prepayment of the Notes and
assign its rights under the Security Agreements on the terms and conditions
hereinafter set forth.

NOW, THEREFORE, in consideration of the mutual agreements and the payments
set forth herein, the parties hereto hereby agree as follows:

1. WCI hereby sells, assigns and transfers to Midway all of its right, title
and interest in and to the following: the Final Two Year Note, the Two Year
Security Agreement, the Final Four Year Note and the Final Four Year Security
Agreement. Concurrently herewith, WCI is delivering the original Notes to
Midway without representation or warranty except as set forth in this
Agreement.

2. In consideration of the transfers pursuant to Section 1, concurrently
herewith, Midway is paying to WCI by wire transfer in immediately available
funds to an account designated by WCI an aggregate of $11,771,200 plus accrued
and unpaid interest on the Notes through the date hereof of $743,740.

<PAGE> 2

3. Concurrently herewith, WCI is executing and delivering to Midway UCC
termination statements and assignments in recordable form (the "Release
Documents") with respect to all Intellectual Property (as defined in the Four
Year Security Agreement) to evidence the termination of all security interests
and liens held by WCI in any of the Collateral under the Security Agreements to
the same extent required by the Security Agreements upon payment in full of the
Secured Obligations as defined in the Security Agreements. From time to time
hereafter WCI shall execute such other documents and instruments that may
reasonably be requested by Midway to evidence the release and termination of
any such lien or security interest.

4. Representations and Warranties of WCI

4.1. WCI is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware.

4.2. WCI possesses the power and authority, corporate or otherwise, to
enter into this Agreement and the documents and instruments contemplated
hereby, to assume and perform its obligations hereunder and thereunder, and to
comply with the terms, conditions and provisions hereof.

4.3. The execution and delivery of this Agreement and the consummation of
the transaction contemplated hereby have been duly and validly authorized by
all requisite corporate action on the part of WCI. This Agreement and the
Release Documents have been duly executed and delivered by WCI and constitute
the valid and binding obligation of WCI, enforceable in according with their
terms.

4.4. WCI is not subject to or bound by any provision of

4.4.1. any articles or certificate of incorporation or by-laws;

4.4.2. any law, statute, rule, regulation or judicial or
administrative decision;

4.4.3. any mortgage, deed of trust, lease, note, shareholders
agreement, bond, indenture, license, permit, trust; or

4.4.4. any judgment, order, writ, injunction or decree of any
court, governmental body, administrative agency or arbitrator;

that would prevent or be violated by, or under which there would be a default
as a result of, nor is the consent of any Person under any contract or
agreement which has not been obtained required for, the execution, delivery and
performance by WCI of this Agreement and the transactions contemplated hereby.

<PAGE> 3

4.5. WCI is selling the Two Year Note and Four Year Note for its own
account, has made its own determination of value, has had an opportunity to ask
questions and obtain information from Midway and Atari which it deems relevant
to enter into this Agreement and understands that in selling the Notes and
accepting payment hereunder it is not relying on any representations or
warranties made by any Person as to value.

4.6. WCI is the sole owner of the Two Year Note, the Four Year Note and
the Security Agreements, free and clear of all liens, claims and encumbrances.

4.7. Annexed hereto as Schedule 4 is a full and complete list of all
filings made by or on behalf of WCI with respect to the Collateral under the
Security Agreements.

5. Representations of Midway

5.1. Midway is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware.

5.2. Midway possesses the power and authority, corporate or otherwise, to
enter into this Agreement and the documents and instruments contemplated
hereby, to assume and perform its obligations hereunder and thereunder, and to
comply with the terms, conditions and provisions hereof.

5.3. The execution and delivery of this Agreement and the consummation of
the transaction contemplated hereby have been duly and validly authorized by
all requisite corporate action on the part of Midway. This Agreement has been
duly executed and delivered by Midway and constitutes the valid and binding
obligation of Midway, enforceable in according with its terms.

5.4. Midway is not subject to or bound by any provision of

5.4.1. any articles or certificate of incorporation or by-laws;

5.4.2. any law, statute, rule, regulation or judicial or
administrative decision;

5.4.3. any mortgage, deed of trust, lease, note, shareholders
agreement, bond, indenture, license, permit, trust; or

5.4.4. any judgment, order, writ, injunction or decree of any
court, governmental body, administrative agency or arbitrator;

<PAGE> 4

that would prevent or be violated by, or under which there would be a default
as a result of, nor is the consent of any Person under any contract or
agreement which has not been obtained required for, the execution, delivery and
performance by Midway of this Agreement and the transaction contemplated
hereby.

5.5. Midway is acquiring the Notes for its own account and not with a view
to resale or distribution of the Notes. Midway has made its own determination
of value, has had an opportunity to ask questions and obtain information from
WCI and Atari which it deems relevant to enter into this Agreement and
understands that in acquiring and paying the Notes it is not relying on any
representations or warranties made by any Person as to value.

6. Other Agreements.

6.1. The execution and delivery of this Agreement does not affect the
Purchase Price as that term is used in the Purchase Agreement and does not
purport to amend, modify or otherwise alter the obligations of the parties
under the Purchase Agreement.

6.2. Upon transfer of the Notes and Security Agreements and payment
therefor as provided herein, the obligations between WCI on the one hand and
Midway and Atari on the other shall be as if the Notes were paid in full and
WCI shall cease to have any rights under the Notes or the Security Agreements.

6.3. This Agreement shall be governed and construed in accordance with the
laws of the State of New York applicable to contracts executed, delivered and
performed entirely within this State.

6.4. This Agreement constitutes the entire agreement between the parties
hereto with respect to the subject matter hereof.

6.5. This Agreement may be executed in one or more counterparts and each
counterpart shall be deemed to be an original.

<PAGE> 5

IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
of the date first written above.

WARNER COMMUNICATIONS INC.

By /s/ SPENCER B. HAYS
-------------------------------
Spencer B. Hays
Vice President

MIDWAY INTERACTIVE INC.

By /s/ NEIL D. NICASTRO
-------------------------------
Neil D. Nicastro,
President and Chief Executive Officer

<PAGE> 1
EXHIBIT 13

MIDWAY GAMES INC.
INDEX TO FINANCIAL INFORMATION

<TABLE>
<S> <C>
Selected Five-Year Financial Data 17

Management's Discussion 18

Market for the Company's Common Stock
and Related Security-Holder Matters 22

Report of Independent Auditors 22

Balance Sheets 23

Statements of Income 24

Statements of Changes
in Stockholders' Equity 25

Statements of Cash Flows 20

Notes to Financial Statements 27

Quarterly Financial Information 32
</TABLE>

<PAGE> 2

Midway Games Inc.

SELECTED FIVE-YEAR FINANCIAL DATA

(In thousands, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------
SELECTED STATEMENT OF INCOME DATA JUNE 30, 1997 1996(1) 1995 1994(1) 1993
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
REVENUES
Home video $ 219,912 $ 154,102 $ 60,839 $ 23,959 $ 1,806
Coin-operated video 168,314 91,321 119,640 97,923 83,825
- ----------------------------------------------------------------------------------------------------------------
Total revenues 388,226 245,423 180,479 121,882 85,631
- ----------------------------------------------------------------------------------------------------------------
Gross profit 166,819 105,367 78,727 59,203 33,878
- ----------------------------------------------------------------------------------------------------------------
Operating income 60,533 40,494 47,136 45,237 25,754
- ----------------------------------------------------------------------------------------------------------------
Income before tax provision and extraordinary credit 62,663 40,765 46,993 45,458 25,754
Provision for income taxes (23,812) (15,536) (17,854) (17,435) (9,915)
- ----------------------------------------------------------------------------------------------------------------
Income before extraordinary credit 38,851 25,229 29,139 28,023 15,839
Extraordinary gain on early extinguishment of debt, net 3,044 - - - -
- ----------------------------------------------------------------------------------------------------------------
Net income $ 41,895 $ 25,229 $ 29,139 $ 28,023 $ 15,839
================================================================================================================

Income per share of common stock
Income before extraordinary credit $ 1.06 $ 0.76 $ 0.87 $ 0.84 $ 0.47
================================================================================================================
Net income $ 1.14 $ 0.76 $ 0.87 $ 0.84 $ 0.47
================================================================================================================
Average number of shares outstanding (2) 36,800 33,400 33,400 33,400 33,400
================================================================================================================

SELECTED BALANCE SHEET DATA
Total assets $214,318 $ 118,262 $ 81,106 $ 50,993 $ 21,010
- ----------------------------------------------------------------------------------------------------------------
Working capital (3) 86,310 (11,618)(3) 27,327 24,407 15,140
- ----------------------------------------------------------------------------------------------------------------
Dividend notes payable - 50,000 - - -
- ----------------------------------------------------------------------------------------------------------------
Long-term debt - 7,863 - - -
- ----------------------------------------------------------------------------------------------------------------
Stockholder's net investment - 5,488 49,752 37,677 15,580
- ----------------------------------------------------------------------------------------------------------------
Stockholders' equity 140,768 - - - -
================================================================================================================
</TABLE>

(1) Includes the results of Midway Home Entertainment Inc., subsequent
to its purchase of Tradewest on April 29, 1994 and the results of Midway
Interactive Inc., subsequent to its purchase of Atari Games Corporation on
March 29, 1996. See Note 5 to the financial statements.

(2) Reflects retroactively the 33,400 for 1 stock split effectuated
October,1996.

(3) Prior to the Company's initial public offering substantially all of
the excess cash generated by the Company's operations was regularly
remitted to WMS Industries Inc. pursuant to WMS Industries Inc. centralized
cash management system.

(4) The financial statements of Midway Games Inc. for the years through
June 30, 1996 are the combined operations of Midway Games Inc. reflecting
the transfer of certain businesses to and from WMS Industries Inc. as of
July 1, 1996. See Note 3 to the financial statements.

<PAGE> 3

Midway Games Inc.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion set forth below under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" as well as the discussions
contained under "Item 1. Business--The Company," "--Business" and "--Factors
Affecting Future Performance" in the Company's Annual Report on Form 10-K
contain certain forward looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward looking statements.

OVERVIEW

Since its incorporation in 1988 through the date of the initial public
offering, Midway Games Inc. ("Midway") was a wholly-owned subsidiary of WMS
Industries Inc. ("WMS"). Immediately prior to the initial public
offering, Midway effectuated a 33,400 for one stock split resulting in
33,400,000 shares of common stock being issued and outstanding.

On October 29, 1996, Midway completed its initial public offering of
5,100,000 previously unissued shares of common stock at $20.00 per share. This
transaction reduced WMS' ownership in Midway to 86.8%. Net proceeds to Midway
from the initial public offering were $93,385,000. The dividend notes payable to
WMS of $50,000,000 and all advances from WMS then outstanding were paid with
part of the proceeds of the offering.

On August 11, 1997, WMS announced its intention to distribute pro rata to
the stockholders of WMS its remaining ownership interest of 33,400,000 shares
of Midway by means of a tax free spin-off. The distribution is conditioned upon
several requirements, including the receipt of a ruling from the Internal
Revenue Service ("IRS") that the transaction will be tax free to WMS and its
stockholders. WMS management anticipates that the spin-off will be completed
during fiscal 1998.

The Company and WMS have a Manufacturing and Services Agreement
("Agreement") under which WMS provides contract manufacturing of coin-operated
video games and several other services to the Company. See Notes 3 and 4 to the
financial statements. Under the Agreement the products or services are provided
at identified or allocated cost. In order to obtain a tax free ruling one of
the requirements of the IRS is that all transactions after the distribution
must be on an arm's length basis. The Company and WMS will have to enter into a
new agreement to provide for this method of transfer pricing. The Company may
discontinue its use of certain WMS services. Arm's length pricing may result in
an increase in cost of sales and certain expenses incurred by the Company. The
ability of the Company to recover the increased costs from increasing its sales
prices or through other cost reduction activities cannot be determined at this
time.

FINANCIAL CONDITION

The Company received net proceeds of $93,385,000 (after deducting the costs of
issuing the stock) from the initial public offering of 5,100,000 shares of
common stock.

Prior to the initial public offering, the Company, except for its Atari
Games subsidiary, participated in the WMS central cash management system,
pursuant to which all cash receipts were transferred to WMS and all cash
disbursements were made by WMS. Seasonal cash needs were provided by WMS.
Shortly after the initial public offering the Company established its own cash
management system and no longer relies on WMS for its seasonal cash needs.

During fiscal 1997 and 1996, cash provided by operating activities less
cash used for investing activities was $16,248,000 and $28,692,000,
respectively, of which, $19,493,000 was retained by WMS in fiscal 1996. The
$9,199,000 of cash at June 30, 1996 is cash at Atari Games. During fiscal 1997
cash provided by financing activities was $26,415,000.

Cash provided by operating activities before changes in operating assets
and liabilities, was $51,956,000 in fiscal 1997 and $29,117,000 in fiscal 1996.
The increase was primarily the result of the increase in net income,
depreciation and amortization and the receivables provision, offset, in part,
by the non-cash extraordinary gain on early extinguishment of debt which was
included in net income.

<PAGE> 4
Midway Games Inc.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued

The changes in the operating assets and liabilities, as shown in the
statements of cash flows, resulted in a cash outflow of $13,809,000 in fiscal
1997, which outflow was primarily due to an increased receivables balance at
June 30, 1997, compared with $6,162,000 of cash inflow in fiscal 1996,
primarily due to a reduced receivables balance at June 30, 1996. The increase
in accounts receivable at June 30, 1997 from the balance at June 30, 1996
resulted primarily from increased sales in the fourth quarter of fiscal 1997 as
compared to the fourth quarter of fiscal 1996.

Cash used by investing activities was $21,899,000 in fiscal 1997 and
$6,587,000 in fiscal 1996. Cash used for the purchase of property and equipment
increased to $4,699,000 in fiscal 1997 from $3,107,000 in fiscal 1996. Cash
used for the additional purchase price of Tradewest was $7,200,000 and
$11,476,000 in fiscal 1997 and fiscal 1996, respectively. On the date of
acquisition Atari Games had cash in excess of the amount used for its
acquisition resulting in a $7,996,000 increase in cash during fiscal 1996.

Cash provided by financing activities was $26,415,000 in fiscal 1997. Net
proceeds received from the initial public offering of $93,385,000 were in part
used to pay the dividend notes due to WMS in the amount of $50,000,000. The
balance of the proceeds is being used for working capital. The Company used
cash of $16,970,000 to prepay the promissory notes from the purchase of Atari
Games.

See the Statements of Cash Flows on page 26 for further details of cash
flow items.

The home video business is highly seasonal and significant working capital
is required to finance high levels of inventories and accounts receivable
during certain months of the fiscal year. In addition, certain platform
manufacturers that manufacture home video games for the Company require letters
of credit for the full purchase price at the time a purchase order is accepted.

The Company has established a line of credit for $50,000,000 and an
additional letter of credit line of $30,000,000. The revolving credit agreement
is for a one-year term and contains usual bank line of credit terms. There were
no borrowings under the credit line at June 30, 1997 and $125,000 of letters of
credit were outstanding. Management believes that cash and cash equivalents,
short-term investments, cash flow from operations and amounts available under
the line of credit will be adequate to fund the anticipated levels of
inventories and accounts receivable required in the operation of the business
and the Company's other presently anticipated needs, as well as pay the amount
due under the Tradewest acquisition agreement.

RESULTS OF OPERATIONS

The following table sets forth for the years indicated certain items in or
derived from the Company's statements of income expressed as a percentage of
revenues:

- --------------------------------------------------------
June 30, 1997 1996 1995
- --------------------------------------------------------
<S> <C> <C> <C>
Revenues
Home video 56.6% 62.8% 33.7%
Coin-operated video 43.4% 37.2% 66.3%
- --------------------------------------------------------
Total revenues 100.0% 100.0% 100.0%
Cost of sales 57.0% 57.1% 56.4%
- --------------------------------------------------------
Gross profit 43.0% 42.9% 43.6%
Research and development
expense 14.4% 13.2% 8.1%
Selling expense 7.9% 9.3% 5.4%
Administrative expense 5.1% 3.9% 4.0%
- --------------------------------------------------------
Operating income 15.6% 16.5% 26.1%
Interest income (expense), net 0.5% 0.1% (0.1)%
- --------------------------------------------------------
Income before tax provision
and extraordinary credit 16.1% 16.6% 26.0%
Provision for income taxes 6.1% 6.3% 9.9%
- --------------------------------------------------------
Income before extraordinary
credit 10.0% 10.3% 16.1%
Extraordinary gain on early
extinguishment of debt, net 0.8% 0.0% 0.0%
- --------------------------------------------------------
Net income 10.8% 10.3% 16.1%
========================================================
</TABLE>

FISCAL 1997 COMPARED WITH FISCAL 1996

Revenues increased $142,803,000 or 58.2% from $245,423,000 in fiscal 1996 to
$388,226,000 in fiscal 1997. Home video game revenues increased $65,810,000 or
42.7% from $154,102,000 in fiscal 1996 to $219,912,000 in fiscal 1997. Home
video game revenues increased as a result of an increased number of units
shipped primarily due to an increase in the number of titles sold and an
expanded consumer base due to the growth in the installed base of 32-bit and
64-bit next generation platforms. In fiscal 1997, 60% of the

<PAGE> 5
Midway Games Inc.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued

Company's home video game unit sales were for the next generation platforms
and during the last six months of the 1997 fiscal year, home video game sales
for next generation platforms were 87% of the Company's total home video game
unit sales. Coin-operated video game revenues increased by 84.3% from
$91,321,000 in fiscal 1996 to $168,314,000 in fiscal 1997. Coin-operated video
game revenues increased due to an increased number of "hit" games sold during
fiscal 1997 as well as the inclusion of revenues from coin-operated video game
sales of the Company's subsidiary Atari Games acquired in March 1996.

Gross profit increased $61,452,000 or 58.3% from $105,367,000 (42.9% of
revenues) in fiscal 1996 to $166,819,000 (43.0% of revenues) in fiscal 1997.
The increase in gross profit was primarily from increased revenues.

Research and development expenses increased $23,446,000 or 72.2% from
$32,495,000 (13.2% of revenues) in fiscal 1996 to $55,941,000 (14.4% of
revenues) in fiscal 1997. The increase is primarily due to including the
product development expenses from the Company's subsidiary Atari Games acquired
in March 1996 and due to an increase in the number of game development teams.

Selling expense increased $7,628,000 or 33.4% from $22,815,000 (9.3% of
revenues) in fiscal 1996 to $30,443,000 (7.9% of revenues) in fiscal 1997. The
increase was primarily due to increased sales commissions and advertising and
promotion costs for the increased home video game sales.

Administrative expense increased $10,339,000 or 108.1% from $9,563,000
(3.9% of revenues) in fiscal 1996 to $19,902,000 (5.1% of revenues) in fiscal
1997. The increase in administrative expense is primarily due to increased
goodwill amortization and depreciation, public company expenses, a new computer
system and computer systems upgrades and the administrative expense of Atari
Games acquired in March 1996.

Operating income increased $20,039,000 or 49.5% from $40,494,000 (16.5% of
revenues) in fiscal 1996 to $60,533,000 (15.6% of revenues) in fiscal 1997.
Operating income includes $7,135,000 in fiscal 1996 from licensing revenues.
Excluding the effects of licensing revenues and, notwithstanding the
$23,446,000 increase in research and development expense, operating income
increased $27,174,000 or 81.5% from fiscal 1996 to fiscal 1997 primarily due
to the increase in revenues from fiscal 1996 to fiscal 1997.

The provision for income taxes reflects federal and state income taxes and
resulted in an effective rate of 38% in fiscal 1997 and 38.1% in fiscal 1996.

Net income increased $16,666,000 or 66.1% from $25,229,000, $.76 per
share, in fiscal 1996 to $41,895,000, $1.14 per share, in fiscal 1997. Fiscal
1997 net income includes $3,044,000, $.08 per share, from an extraordinary gain
on early extinguishment of debt while fiscal 1996 net income includes
$4,318,000, $.13 per share, relating to licensing revenues. Excluding the
effects of the extraordinary gain in fiscal 1997 and licensing revenues in
fiscal 1996, earnings increased $17,940,000 or 85.8% from $20,911,000 in fiscal
1996 to $38,851,000 in fiscal 1997 and per share earnings increased 68.3% from
$.63 per share to $1.06 per share. The number of shares used in calculating per
share earnings increased by 10% to 36,800,000 in fiscal 1997 from 33,400,000 in
fiscal 1996 because of 5,100,000 shares of common stock sold in the October 29,
1996 initial public offering. The increase in income before extraordinary
credit was primarily the result of the increase in sales of both coin-operated
and home video games, after absorbing the increases in research and
development, selling and administrative expenses.

FISCAL 1996 COMPARED WITH FISCAL 1995

Revenues increased $64,944,000 or 36.0% from $180,479,000 in fiscal 1995 to
$245,423,000 in fiscal 1996. Home video game revenues include licensing
revenues of $10,000,000 in fiscal 1996 and $27,000,000 in fiscal 1995 from
licensing the distribution of home video games for use on personal computers,
licensing certain foreign distribution of home video games and certain other
licensing revenues. Excluding licensing revenues, home video game revenues
increased $110,263,000 or 326% from $33,839,000 in fiscal 1995 to $144,102,000
in fiscal 1996. The increase in home video game revenues was due to the fact
that the Company only began to publish home video games based on its
coin-operated

<PAGE> 6
Midway Games Inc.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued

video games in fiscal 1996. Fiscal 1995 home video game revenues principally
included revenue from those games that were in process of development by
Tradewest at the time it was acquired by the Company in April 1994.
Coin-operated video game revenues decreased by 23.7% from $119,640,000 in
fiscal 1995 to $91,321,000 in fiscal 1996. The decrease in coin-operated video
game revenues was primarily due to delays in the development of certain video
games in fiscal 1996 and higher unit sales of certain coin-operated video games
introduced in fiscal 1995 in comparison to unit sales in fiscal 1996.

Gross profit increased $26,640,000 or 33.8% from $78,727,000 (43.6% of
revenues) in fiscal 1995 to $105,367,000 (42.9% of revenues) in fiscal 1996.
Excluding the effects of licensing revenues, gross profit increased $43,131,000
or 79.1% from $54,538,000 (35.6% of related revenues) in fiscal 1995 to
$97,669,000 (41.5% of related revenues) in fiscal 1996. This increase in gross
profit margin was primarily due to a shift in the Company's product mix to home
video games.

Research and development expense increased $17,834,000 or 122% from
$14,661,000 (8.1% of revenues) in fiscal 1995 to $32,495,000 (13.2% of
revenues) in fiscal 1996. The increase is primarily due to an increased number
of games under development, including those of Atari Games in the three months
ended June 30, 1996 and in part due to royalties paid to game designers as part
of their compensation.

Selling expense increased $13,123,000 or 135% from $9,692,000 in fiscal
1995 to $22,815,000 in fiscal 1996 primarily due to the shift in the Company's
revenues from coin-operated video games to home video games.

Administrative expense increased $2,325,000 or 32.1% from $7,238,000 (4.0%
of revenues) in fiscal 1995 to $9,563,000 (3.9% of revenues) in fiscal 1996.
The increase was primarily due to increased incentive based compensation in the
home video game business resulting from increased sales of those games.

Operating income decreased $6,642,000 or 14.1% from $47,136,000 (26.1% of
revenues) in fiscal 1995 to $40,494,000 (16.5% of revenues) in fiscal 1996.
Operating income includes $7,135,000 in fiscal 1996 and $23,239,000 in fiscal
1995 from licensing revenues. Excluding the effects of licensing revenues and,
notwithstanding the $17,834,000 increase in research and development expense,
operating income increased $9,462,000 or 39.6% from fiscal 1995 to fiscal 1996,
primarily due to the increased sales of home video games.

The provision for income taxes reflects federal and state income taxes and
resulted in an effective rate of 38.1% in fiscal 1996 and 38% in fiscal 1995.

Net income decreased $3,910,000 or 13.4% from $29,139,000, $.87 per share,
in fiscal 1995 to $25,229,000, $.76 per share, in fiscal 1996. Net income
includes $4,318,000 in fiscal 1996 and $14,562,000 in fiscal 1995 relating to
licensing revenues. Excluding the effects of licensing revenues, net income
increased $6,334,000 or 43.5% from $14,577,000, $.44 per share, in fiscal 1995
to $20,911,000, $.63 per share, in fiscal 1996. This increase in net income was
primarily the result of the sizable increase in the sale of home video games
based on the coin-operated version. The Company achieved this result
notwithstanding the increase in research and development expense.

IMPACT OF INFLATION

During the past three years, the level of inflation affecting the Company has
been relatively low. The ability of the Company to pass on future cost
increases in the form of higher sales prices will continue to be dependent on
the prevailing competitive environment and the acceptance of the Company's
products in the market place.

SEASONALITY

The home video game business is highly seasonal and historically has resulted
in higher revenues and net income in the first and second quarters of the June
30 fiscal year due to customer purchases preceding the year-end retail holiday
selling season. The coin-operated video game business has not historically been
seasonal but quarterly revenues and net income usually increase when a
coin-operated video game that achieves significant player appeal is introduced.

<PAGE> 7
MARKET FOR THE COMPANY'S
COMMON STOCK AND RELATED
SECURITY-HOLDER MATTERS

Midway Games Inc. common stock, par value $.01 per share, began trading on the
New York Stock Exchange on October 29, 1996 under the symbol MWY. The following
table sets forth for the periods indicated the high and low sale prices per
share as reported on the New York Stock Exchange.

<TABLE>
<CAPTION>
- -----------------------------------------------
Calendar Period High Low
- -----------------------------------------------
<S> <C> <C>
1996
Fourth Quarter
(beginning Oct. 29, 1996) $25 1/2 $18 3/8
- -----------------------------------------------
1997
First Quarter $21 $15

Second Quarter 23 1/2 15 1/8

Third Quarter
(through Sept. 18, 1997) 24 5/8 18 3/8

</TABLE>

The Company paid $50,000,000 of dividend notes due to its parent, WMS
Industries Inc., from part of the proceeds of the October 1996 initial public
offering. The dividend notes had been previously declared on June 30, 1996. No
other cash dividends with respect to the common stock were declared or paid
during fiscal 1997. The payment of future cash dividends will depend upon,
among other things, earnings, anticipated expansion and capital requirements
and the financial condition of the Company.

At September 18, 1997, there were approximately 650 holders of record of
the Company's common stock.

REPORT OF INDEPENDENT AUDITORS

To the Stockholders and Board of Directors
Midway Games Inc.

We have audited the accompanying balance sheets of Midway Games Inc. and
subsidiaries as of June 30, 1997 and 1996, and the related statements of
income, changes in stockholders' equity and cash flows for each of the three
years in the period ended June 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

/s/ Ernst & Young LLP

Chicago, Illinois
August 19, 1997

22
<PAGE> 8
Midway Games Inc.

BALANCE SHEETS

<TABLE>
<CAPTION>
(In thousands)
- --------------------------------------------------------------------------------------------------
June 30, 1997 1996
Consolidated Combined
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 51,862 $ 9,199
Short-term investments 10,000 -
- --------------------------------------------------------------------------------------------------
61,862 9,199
Receivables, less allowances of $4,940 in 1997 and $995 in 1996 54,477 48,951
Inventories
Raw materials and work in progress 14,433 16,835
Finished goods 13,525 8,187
- --------------------------------------------------------------------------------------------------
27,958 25,022
Deferred income taxes 5,779 -
Other current assets 4,329 5,407
- --------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 154,405 88,579

Property and equipment, net 9,498 5,927
Excess of purchase cost over amount assigned to net assets acquired, net 49,150 22,765
Other assets 1,265 991
- --------------------------------------------------------------------------------------------------
TOTAL ASSETS $214,318 $118,262
==================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 18,889 $ 17,686
Payable to WMS Industries Inc. 2,029 -
Accrued compensation and related benefits 11,331 4,849
Income taxes payable 3,866 -
Deferred income taxes - 1,400
Accrued payment on 1994 purchase of Tradewest 14,400 -
Accrued payment on 1996 purchase of Atari Games Corporation - 3,286
Dividend notes payable to WMS Industries Inc. - 50,000
Accrued royalties 6,728 6,088
Other accrued liabilities 10,852 16,888
- --------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 68,095 100,197

Long-term debt - 7,863
Deferred income taxes 3,037 2,794
Other noncurrent liabilities 2,418 1,920

Stockholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued - -
Common stock, $.01 par value, 100,000,000 shares authorized,
38,500,000 shares issued and outstanding 385 -
Additional paid-in capital 98,488 -
Retained earnings 41,895 -
Stockholder's net investment - 5,488
- --------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 140,768 5,488
- --------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $214,318 $118,262
==================================================================================================
</TABLE>

See notes to financial statements.

<PAGE> 9
Midway Games Inc.

STATEMENTS OF INCOME

<TABLE>
<CAPTION>
(In thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------
Years Ended June 30, 1997 1996 1995
Consolidated Combined Combined
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES
Home video $219,912 $154,102 $ 60,839
Coin-operated video 168,314 91,321 119,640
- ------------------------------------------------------------------------------------------------
Total revenues 388,226 245,423 180,479

Cost of sales 221,407 140,056 101,752
- ------------------------------------------------------------------------------------------------
Gross profit 166,819 105,367 78,727

Research and development expense 55,941 32,495 14,661
Selling expense 30,443 22,815 9,692
Administrative expense 19,902 9,563 7,238
- ------------------------------------------------------------------------------------------------
Operating income 60,533 40,494 47,136

Interest and other income 4,504 1,079 52
Interest expense (2,374) (808) (195)
- ------------------------------------------------------------------------------------------------
Income before tax provision and extraordinary credit 62,663 40,765 46,993

Provision for income taxes (23,812) (15,536) (17,854)
- ------------------------------------------------------------------------------------------------
Income before extraordinary credit 38,851 25,229 29,139
Extraordinary gain on early extinguishment
of debt, net of taxes of $2,001 3,044 - -
- ------------------------------------------------------------------------------------------------
Net income $ 41,895 $ 25,229 $ 29,139
================================================================================================

Income per share of common stock
Income before extraordinary credit $ 1.06 $ .76 $ .87
Extraordinary gain on early extinguishment of debt, net .08 - -
- ------------------------------------------------------------------------------------------------
Net income $ 1.14 $ .76 $ .87
================================================================================================

Average number of shares outstanding 36,800 33,400 33,400
================================================================================================
</TABLE>

See notes to financial statements.

<PAGE> 10
Midway Games Inc.

STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands)

- --------------------------------------------------------------------------------------------------------------------
Common Stock
---------------------- Additional Stockholder's Total
Number Paid-in Retained Net Stockholders'
of Shares Par Value Capital Earnings Investment Equity
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMBINED BALANCE AT JUNE 30, 1994 - $ - $ - $ - $ 37,677 $ 37,677
Net income 29,139 29,139
Net transactions with WMS Industries Inc. (17,064) (17,064)
- --------------------------------------------------------------------------------------------------------------------
COMBINED BALANCE AT JUNE 30, 1995 - - - - 49,752 49,752
Net income 25,229 25,229
Dividends declared (50,000) (50,000)
Net transactions with WMS Industries Inc. (19,493) (19,493)
- --------------------------------------------------------------------------------------------------------------------
COMBINED BALANCE AT JUNE 30, 1996 - - - - 5,488 5,488
Formation transactions 33,400 334 5,154 (5,488) -
Net proceeds from initial public offering 5,100 51 93,334 93,385
Net income 41,895 41,895
- --------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE AT JUNE 30, 1997 38,500 $385 $98,488 $41,895 $ - $ 140,768
====================================================================================================================
</TABLE>

See notes to financial statements.

<PAGE> 11
Midway Games Inc.

STATEMENTS OF CASH FLOWS

(In thousands)

- ----------------------------------------------------------------------------------------------------------------------
Years Ended June 30, 1997 1996 1995
Consolidated Combined Combined
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $41,895 $25,229 $29,139

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 6,297 3,208 1,808
Receivables provision 14,586 3,358 3,218
Deferred income taxes (5,777) (2,678) 4,986
Extraordinary gain on early extinguishment of debt (5,045) - -
Increase (decrease) resulting from changes in
operating assets and liabilities:
Receivables (20,112) 8,089 (20,939)
Inventories (2,936) (1,072) (4,660)
Other current assets 1,078 (1,253) (1,625)
Accounts payable and accruals 2,289 (479) 13,052
Current taxes payable 3,354 - -
Other assets and liabilities not reflected elsewhere 2,518 877 (1,032)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 38,147 35,279 23,947

INVESTING ACTIVITIES
Purchase of property and equipment (4,699) (3,107) (3,859)
Payment for Tradewest acquisition (7,200) (11,476) (3,024)
Cash acquired in acquisition of Atari Games
Corporation, net of cash used - 7,996 -
Net change in short-term investments (10,000) - -
- ----------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (21,899) (6,587) (6,883)

FINANCING ACTIVITIES
Net proceeds from initial public offering 93,385 - -
Dividend notes paid to WMS Industries Inc. (50,000) - -
Payment of notes payable from the purchase of Atari Games Corporation (16,970) - -
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 26,415 - -

Net transactions with WMS Industries Inc. - (19,493) (17,064)
- ----------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 42,663 9,199 -
Cash and cash equivalents at beginning of year 9,199 - -
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $51,862 $9,199 $ -
======================================================================================================================
</TABLE>

See notes to financial statements.

<PAGE> 12

Midway Games Inc.

NOTES TO FINANCIAL STATEMENTS

NOTE 1: NATURE OF BUSINESS

Midway Games Inc. ("Midway") and its subsidiaries (the "Company") operates in
one business segment, the design and distribution of coin-operated video games
and publishing, licensing and distribution of home video games (the "Video Game
Business"). Coin-operated video games are sold to distributors worldwide who
sell them to operators and arcades. Home video games are sold to mass
merchants, video rental retailers, and entertainment software distributors in
North America. The Company exploits the other worldwide markets through
licensing and distribution agreements with third parties. Consumers buy or rent
the home video games to use on game systems (Nintendo, Sony and Sega) and on
personal computers.

NOTE 2: INITIAL PUBLIC OFFERING AND PLANNED DISTRIBUTION

Since its incorporation in 1988 through the date of the initial public
offering, Midway was a wholly-owned subsidiary of WMS Industries Inc. ("WMS").
Immediately prior to the initial public offering, Midway effectuated a 33,400
for one stock split resulting in 33,400,000 shares of common stock being issued
and outstanding.

On October 29, 1996, Midway completed its initial public offering of
5,100,000 previously unissued shares of common stock at $20.00 per share. This
transaction reduced WMS' ownership in Midway to 86.8%. Net proceeds to Midway
from the initial public offering were $93,385,000. The dividend notes payable
to WMS of $50,000,000 and all advances from WMS then outstanding were paid with
part of the proceeds of the offering.

On August 11, 1997, WMS announced its intention to distribute pro rata to
the stockholders of WMS its remaining ownership interest of 33,400,000 shares
of Midway by means of a tax free spin-off. The distribution is conditioned upon
several requirements, including the receipt of a ruling from the Internal
Revenue Service that the transaction will be tax free to WMS and its
stockholders. WMS management anticipates that the spin-off will be completed
during fiscal 1998.

NOTE 3: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION AND RELATIONSHIP WITH WMS INDUSTRIES INC.
Since its incorporation in 1988 through July 1, 1996 the Company was the
primary subsidiary in which WMS conducted the coin-operated video games
business. Subsequent to July 1, 1996, Midway has been the only WMS subsidiary
in the coin-operated video games business.

On July 1, 1996 (the "Transfer Date") WMS transferred out of Midway all
of the operating assets and liabilities relating to the "Bally(R)" pinball
business previously conducted by Midway. On the Transfer Date WMS transferred
the coin-operated video game operating assets and liabilities not previously
part of Midway from other WMS subsidiaries to Midway. Also on the Transfer
Date, WMS transferred 100% of the stock of Midway Home Entertainment Inc.
(formerly Williams Entertainment Inc.) and Midway Interactive Inc. (formerly
Williams Interactive Inc.) to Midway. The aforementioned transfers resulted in
WMS concentrating its "Video Game Business" into Midway and its wholly-owned
subsidiaries. WMS's net investment has been reflected as Stockholder's Net
Investment in the combined financial statements through June 30, 1996. The
aforementioned transfers have been reflected in the financial statements for
June 30, 1996 and prior periods, and the revenues and expenses of the Bally
pinball business have been excluded from these financial statements.

The combined financial statements at June 30, 1996 and for periods
ending June 30, 1996 or prior reflect the historical combined financial
position and results of operations of the Video Game Business as if the Company
operated the Video Game Business under the structure implemented on the
Transfer Date. The results of the Video Game Business include the results of
Midway Home Entertainment Inc. and the results of Midway Interactive Inc.,
subsequent to its purchase of Atari Games Corporation ("Atari Games") on March
29, 1996. The Company believes that this is the most meaningful presentation in
that it presents on an historical basis the results of operations and financial
condition of all of the components of the Video Game Business that the Company
owns after giving effect to the structure implemented on the Transfer Date. The
financial statements subsequent to July 1, 1996 are presented on a consolidated
basis.

The financial statements include transfers and allocations of costs and
expenses from WMS or other WMS subsidiaries primarily for activities relating
to the Midway coin-operated video games business. Cost of sales includes
material, labor and labor fringes transferred from the other WMS subsidiaries
at cost based on the standard cost of material adjusted to estimated actual
using engineered bills of material and actual labor

27
<PAGE> 13
Midway Games Inc.

NOTES TO FINANCIAL STATEMENTS continued

with standard labor fringes applied. Cost of sales also includes allocations
of manufacturing overhead cost incurred in the production of coin-operated
video games for the Company. Research and development expense includes
allocations for certain shared facilities and personnel. Selling and
administrative expenses include certain allocations relating to general
management, treasury, accounting, human resources, insurance and selling and
marketing. These allocations were determined by using various factors such as
dollar amount of sales, number of personnel, square feet of building space,
estimates of time spent to provide services and other appropriate costing
measures. In the opinion of management these transfers of cost of sales and
allocations are made on a reasonable basis to properly reflect the share of
costs incurred by WMS on behalf of the Company.

The financial statements may not necessarily be representative of results
that would have been attained if the Company operated as a separate independent
entity.

CASH EQUIVALENTS
All highly liquid investments with a maturity of three months or less when
purchased are considered to be cash equivalents.

INVENTORIES
Inventories are valued at the lower of cost (determined by the first-in,
first-out method) or market.

PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated by the straight-line
method over their estimated useful lives.

EXCESS OF PURCHASE COST OVER AMOUNT ASSIGNED TO NET ASSETS ACQUIRED (GOODWILL)
Goodwill of $49,150,000 and $22,765,000 at June 30, 1997 and 1996,
respectively, (net of accumulated amortization of $4,850,000 and $2,035,000 at
June 30, 1997 and 1996, respectively) arising from the acquisitions of
Tradewest in April 1994 and Atari Games in March 1996 is being amortized by the
straight-line method over 15 to 20 years.

INTELLECTUAL PROPERTIES LICENSES
Nonrefundable guaranteed amounts are recognized as revenue when the license
agreements are signed. Unit royalties on sales that exceed the guarantee are
recognized as revenue as earned. License and royalty revenues primarily from
home video game activities, for fiscal 1997, 1996 and 1995 was $6,537,000,
$18,985,000 and $37,555,000, respectively.

HOME VIDEO GAME REVENUES
Home video game revenues are recorded when products are shipped to customers.
An allowance for returns and discounts is also recorded based upon management's
evaluation of historical experience as well as current industry trends.

ADVERTISING EXPENSE
The cost of advertising is charged to earnings as incurred and for fiscal 1997,
1996 and 1995 was $16,524,000, $13,338,000 and $5,695,000, respectively.

EXPORT SALES AND SALES TO A MAJOR CUSTOMER
Export sales primarily to Western Europe were $70,367,000, $34,945,000 and
$40,940,000 for fiscal 1997, 1996 and 1995, respectively. Sales of home video
games to one mass merchant during fiscal 1997 and 1996 were $40,675,000 and
$30,898,000, respectively.

RECENT ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," to
replace Accounting Principals Board ("APB") Opinion No. 15, "Earnings Per
Share". SFAS No. 128 requires dual presentation of basic earnings per share
("EPS") and diluted EPS on the face of all statements of earnings issued after
December 15, 1997, for all public companies with complex capital structures.
SFAS No. 128 also requires restatement of all prior period statements of
earnings using the dual presentation of basic and diluted EPS. Basic EPS is
computed by dividing income by the weighted average number of shares
outstanding for the period. Diluted EPS reflects, on a pro forma basis,
earnings per share for the period available to common shareholders assuming the
exercise or conversion of all securities which are exercisable or convertible
into common stock and which would either dilute or not affect basic EPS. The
Company does not anticipate the effect of the provisions of this new standard
on earnings per share to be material.

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 amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.

<PAGE> 14
Midway Games Inc.

NOTE 4: TRANSACTIONS WITH WMS

The Company, except for Atari Games, for the years included in the financial
statements participated in the WMS central cash management system, pursuant to
which all cash receipts were transferred to WMS and all cash disbursements were
made by WMS. Seasonal cash needs were provided by WMS. After the completion of
the initial public offering the treasury activities of the Video Game Business
are being conducted by the Company.

During the four months ended October 31, 1996 and the fiscal years
ended June 30, 1996 and 1995 one subsidiary that has seasonal cash needs was
charged interest at prime and was paid interest at short-term treasury bill
rates on the balance of the intercompany amount with WMS. Due to the seasonal
cash flows of this subsidiary, the intercompany account with WMS alternated
between intercompany accounts payable and receivable. The maximum intercompany
amount due to WMS during this period was $25,700,000. Interest income accrued
from WMS and interest expense accrued to WMS was as follows:

<TABLE>
<CAPTION>
- -------------------------------------------------
(in thousands) 1997 1996 1995
- -------------------------------------------------
<S> <C> <C> <C>
Interest income $ 0 $771 $ 45
Interest expense 217 442 195

</TABLE>

Interest expense for fiscal 1997 also included $1,036,000 on the
$50,000,000 dividend notes accrued at 6% through October 31, 1996.

The Company has been charged for the specific production costs, excluding
manufacturing overhead, of the coin-operated video games produced by a
subsidiary of WMS that totaled $93,563,000, $51,961,000 and $73,564,000 in the
years ended June 30, 1997, 1996 and 1995, respectively. In addition, certain
other costs have been allocated to the Company based on the various factors
noted in Note 3. Charges to the Company from WMS and WMS subsidiaries for the
allocations in the years ended June 30, 1997, 1996 and 1995 were:

<TABLE>
<CAPTION>
- ------------------------------------------------
(in thousands) 1997 1996 1995
- ------------------------------------------------
<S> <C> <C> <C>
Manufacturing overhead $5,368 $3,947 $2,965
Research and development
expense 779 1,352 1,477
Selling expense 3,263 1,933 2,247
Administrative expense 3,452 3,433 3,167
</TABLE>

The Company entered into a Manufacturing and Services Agreement with WMS
under which WMS and its subsidiaries agree to continue performing contract
manufacturing for coin-operated video games for Midway and Atari Games as well
as providing general management, financial reporting, and treasury services to
the Company and general management, accounting, human resources and selling and
marketing services to Midway. The Company intends to purchase materials and WMS
subsidiaries manufacture the coin-operated video games charging actual labor
with labor fringes and manufacturing overhead allocated. The labor fringes,
manufacturing overhead and other services provided are allocated based on the
various factors noted in Note 3 that were used in the financial statements.

See Note 7 for income tax allocations.

NOTE 5: ACQUISITIONS

On March 29, 1996, a wholly-owned subsidiary of the Company, Midway
Interactive Inc., acquired all the capital stock of Atari Games from Warner
Communications Inc. ("Warner"), a subsidiary of Time Warner Inc. The
acquisition has been accounted for by the purchase method of accounting and,
accordingly, the results of operations of Atari Games subsequent to the
acquisition date have been included in the statements of income of the Company.
Atari Games was engaged in the business of developing, manufacturing,
licensing, publishing and distributing coin-operated video games and home video
games.

The Company assimilated parts of the Atari Games business into the
Company's similar activities and exited certain foreign activities. This
included, among other things, closing the leased manufacturing plant,
transferring production of coin-operated video games to WMS's existing Chicago
plant and combining the sales, marketing and distribution of home video games
with the Company's home video game operations. A $4,500,000 liability for exit
activities was established, the major component of which was $2,500,000 of
employee severance costs. The assimilation and exit activities were completed
during fiscal 1997 and no adjustment to the exit liability was required.

The purchase price for Atari Games of $24,015,000 included a cash payment
in March 1996 of $2,000,000 and the balance of $22,015,000 in the form of
promissory notes. A promissory note for $14,152,000 was payable based upon cash
gross profits, as defined, from the sale of specified products of the acquired
business and was recorded, as earned, through the second quarter of fiscal
1997. Because $10,866,000 of this note was not recorded at June 30, 1996,
property and equipment

29
<PAGE> 15
Midway Games Inc.

NOTES TO FINANCIAL STATEMENTS continued

of Atari Games was recorded at zero and the Company recorded negative
goodwill from the purchase. At the end of the second quarter of fiscal 1997,
the property and equipment of Atari Games was recorded and the excess costs
over the amount assigned to net assets acquired (goodwill) of $7,600,000 was
recorded and is being amortized over 20 years.

The unaudited pro forma combined statements of income data of the Company
for fiscal 1996 and 1995 included below was prepared as if Atari Games was
acquired as of July 1, 1995 and July 1, 1994, respectively, and assimilation
and exit activities occurred on that date. The summary does not purport to be
indicative of what would have occurred had the acquisition occurred as of the
dates indicated or of the results which may occur in the future.

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands) 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Revenues $329,449 $235,369
===============================================================================
Net income $ 24,707 $ 16,661
===============================================================================
</TABLE>

On April 29, 1994, a wholly-owned subsidiary of the Company, Midway Home
Entertainment Inc., acquired substantially all of the operating assets and
business of three commonly owned companies ("Tradewest"): Tradewest, Inc.,
Tradewest International, Inc. and The Leland Corporation. The assets acquired
are utilized in the Video Game Business of developing, publishing and
distributing home video games in various formats including game cartridges. The
acquisition has been accounted for by the purchase method of accounting.

During fiscal 1997, the final purchase price of $50,131,000 for Tradewest
was determined under the purchase agreement based on earnings of the acquired
business subsequent to the purchase date which resulted in excess cost over the
amount assigned to net assets acquired of $46,400,000. The balance due under
the purchase agreement of $14,400,000 is payable in June 1998 and payment has
been guaranteed by WMS. As of June 30, 1997 and 1996, excess costs over the
amount assigned to net assets acquired resulting from this acquisition was
$46,400,000 and $24,800,000, respectively.

NOTE 6: PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>

At June 30 net property and equipment were:
- -------------------------------------------------------------------------------
(in thousands) 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Leasehold improvements $ 2,332 $ 458
Furniture, fixtures and engineering equipment 14,559 9,033
- -------------------------------------------------------------------------------
16,891 9,491
Less accumulated depreciation (7,393) (3,564)
- -------------------------------------------------------------------------------
Net property and equipment $ 9,498 $ 5,927
===============================================================================
</TABLE>

NOTE 7: INCOME TAXES

The results of the Company have been included in the consolidated income tax
returns of WMS for all years presented; however income taxes have been recorded
based on a calculation of the income taxes that would have been incurred if the
Company operated as an independent combined entity. WMS and the Company entered
into a tax sharing agreement effective July 1, 1996 that requires a tax
calculation, accrual and payment by the Company as if the Company was filing a
separate tax return.

Significant components of the income tax provision on income before
extraordinary credit for the years ended June 30, 1997, 1996 and 1995 were:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands) 1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $26,010 $15,423 $10,685
State 4,091 2,791 2,183
- -------------------------------------------------------------------------------
Total current 30,101 18,214 12,868
Deferred:
Federal (5,265) (2,156) 4,141
State (1,024) (522) 845
- -------------------------------------------------------------------------------
Total deferred (6,289) (2,678) 4,986
- -------------------------------------------------------------------------------
Provision for income taxes $23,812 $15,536 $17,854
===============================================================================
</TABLE>

The income tax provision on income before extraordinary credit differs
from the amount computed using the statutory federal income tax rate for the
years ended June 30, 1997, 1996 and 1995 as follows:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal income
tax rate 35.0% 35.0% 35.0%
State income taxes, net of
federal benefit 3.2 3.6 4.2
Foreign sales corporation benefits (1.0) (.6) (1.2)
Other, net .8 .1 --
- -------------------------------------------------------------------------------
38.0% 38.1% 38.0%
===============================================================================
</TABLE>

The income tax provision of $2,001,000 on the extraordinary credit is
comprised of the federal tax rate of 35% and a composite state tax rate of
4.66%, net of federal benefit.

Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income taxes.

<PAGE> 16
Midway Games Inc.

Significant components of the Company's deferred tax assets and liabilities
at June 30 were:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands) 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets resulting from:
Inventory valuation $1,835 $ 656
Accrued items not currently deductible 2,230 3,131
Receivable allowance 2,025 408
Purchased assets cost basis difference - 1,853
Other 26 227
- -------------------------------------------------------------------------------
Total deferred tax assets 6,116 6,275
- -------------------------------------------------------------------------------
Deferred tax liabilities resulting from:
Tax over book depreciation 687 342
Revenues deferred in tax reporting - 5,672
Book over tax basis of domestic subsidiary 1,845 -
Purchase liability basis difference - 4,455
Other 842 -
- -------------------------------------------------------------------------------
Total deferred tax liabilities 3,374 10,469
- -------------------------------------------------------------------------------
Net deferred tax assets (liabilities) $2,742 $(4,194)
===============================================================================
</TABLE>

During fiscal 1997, 1996 and 1995 income taxes paid to WMS were
$28,236,000, $18,214,000 and $12,868,000, respectively.

NOTE 8: LINE OF CREDIT AND LONG-TERM DEBT

The Company established a line of credit for $50,000,000 and an additional
letter of credit line of $30,000,000. The revolving credit agreement is for a
one-year term to October 31, 1997 and contains usual bank line of credit terms.

Long-term debt at June 30, 1996 consisted of a promissory note related to
the acquisition of Atari Games of $7,863,000 which was due March 1998 with
interest at 6%. The promissory note was prepaid, at a discount, in April 1997,
as described in Note 14.

The amount of interest paid during fiscal 1997, 1996 and 1995 was
$2,740,000, $442,000 and $195,000, respectively.

NOTE 9: PREFERRED STOCK

The preferred stock is issuable in series, and the elective rights and
preferences and number of shares in each series are to be established by the
Board of Directors.

NOTE 10: STOCK OPTION PLAN

Under the stock option plan the Company may grant both incentive stock options
and nonqualified options on shares of common stock through the year 2006.
Options may be granted on 2,000,000 shares of common stock to employees and
under certain conditions to non-employee directors and consultants. The
Compensation and Stock Option Committee of the Board of Directors has the
authority to fix the terms and conditions upon which each option is granted,
but in no event shall the term exceed ten years or be granted at less than 100%
of the fair market value of the stock at the date of grant.

The Company accounts for stock options for purposes of determining net
income in accordance with APB Opinion No. 25. No compensation expense has been
recognized in conjunction with the stock option plan. SFAS No. 123 regarding
stock option plans permits the use of APB Opinion No. 25 but requires the
inclusion of certain pro forma disclosures in the footnotes.

Pro forma net income for fiscal 1997 adjusted for the expense provision of
SFAS No. 123 was $36,892,000 or $1.00 per share of common stock. No calculation
of fiscal 1996 pro forma net income under SFAS No. 123 is required since all
the options were granted in fiscal 1997.

For pro forma calculations, the fair value of each option is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for fiscal 1997: dividend yield of
0%; expected volatility of .50; risk free interest rate of 6.2% and expected
life of the option of 4 years.

During fiscal 1997 options for 1,810,000 shares were granted at an
exercise price of $20.00 per share with a weighted average pro forma fair
market value using the Black-Scholes assumptions noted above of $9.09 per
share. All of the granted options are outstanding at June 30, 1997 with a
weighted average remaining contractual life of 9.4 years. At June 30, 1997
options for 505,000 shares are exercisable at an exercise price of $20.00 per
share and 190,000 shares were available for future grants under the plan.

NOTE 11: CONCENTRATION OF CREDIT AND MARKET RISK AND FAIR VALUE DISCLOSURES OF
FINANCIAL INSTRUMENTS

Financial instruments which potentially subject the Company to concentrations
of credit and market risk consist primarily of cash equivalents, short-term
investments and trade accounts receivable from the sale of games. By policy,
the Company places its cash equivalents and short-term investments only in high
credit quality securities and limits the amounts invested in any one security.
At June 30, 1997, 64% of trade accounts receivable are from sale of
coin-operated video games to

<PAGE> 17
Midway Games Inc.

NOTES TO FINANCIAL STATEMENTS continued

the Company's distributors located primarily throughout the United States
and Western Europe and, because of the number and geographic distribution,
concentration is limited. Foreign sales are typically made in U.S. dollars and
typically on the basis of a letter of credit. At times during the fiscal year
accounts receivable from certain major home video game customers represent a
significant amount of the accounts receivable then outstanding.

Cash equivalents of $44,627,000 and short-term investments of $10,000,000
at June 30, 1997, which are designated available-for-sale, are recorded at cost
which is equal to market and considered by management to be the fair value of
these financial instruments.

NOTE 12: LEASE COMMITMENTS

The Company leases certain warehouses, office facilities and equipment under
non-cancelable operating leases with net future lease commitments for minimum
rentals at June 30, 1997 as follows:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands)
- -------------------------------------------------------------------------------
<S> <C>
1998 $ 1,770
1999 1,735
2000 1,686
2001 1,743
2002 1,590
Thereafter 4,354
- -------------------------------------------------------------------------------
12,878
Less sublease income 5,533
- -------------------------------------------------------------------------------
$ 7,345
===============================================================================
</TABLE>

Rent expense for fiscal 1997, 1996 and 1995 was $1,459,000, $603,000, and
$307,000, respectively, and was offset by sublease income of $536,000 and
$134,000 for fiscal 1997 and 1996, respectively. Aggregate future gross lease
commitments of $11,408,000 were guaranteed, prior to the acquisition of Atari
Games from Warner, and continue to be guaranteed by Warner.

NOTE 13: EMPLOYEE RETIREMENT PLANS

The Company has two defined contribution employee retirement savings plans and
certain salaried employees participate in a WMS defined contribution plan.
These defined contribution plans cover certain hourly and salaried employees.
The Company's contribution to these plans are based on employee participation
with certain limitations. The Company or WMS may change any of the factors
which determine the Company's contribution to their respective plans.
Contributions to the defined contribution plans for fiscal 1997, 1996 and 1995
were $523,000, $302,000 and $202,000, respectively.

NOTE 14: QUARTERLY FINANCIAL INFORMATION (unaudited)

Summarized quarterly financial information for fiscal 1997 and 1996 are
as follows:

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands, except Sept. 30, Dec. 31, Mar. 31, June 30,
per share amounts) 1996 1996 1997 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL 1997 QUARTERS
Revenues $ 65,555 $125,519 $ 99,060 $ 98,092
Gross profit 34,380 55,203 35,657 41,579
Research and
development
expense 12,003 14,780 13,208 15,950
Income before
extraordinary
credit 6,077 15,107 6,415 11,252
Net income 6,077 15,107 6,415 14,296
Per share:
Income before
extraordinary
credit $ .18 $ .41 $ .17 $ .29
- -------------------------------------------------------------------------------
Net income $ .18 $ .41 $ .17 $ .37
===============================================================================
Average number
of shares
outstanding 33,400 36,800 38,500 38,500
</TABLE>

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(in thousands, except Sept. 30, Dec. 31, Mar. 31, June 30,
per share amounts) 1995 1995 1996 1996
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL 1996 QUARTERS
Revenues $ 67,938 $ 89,162 $ 43,075 $ 45,248
Gross profit 27,316 40,615 19,559 17,877
Research and
development
expense 5,851 9,541 5,459 11,644
Net income 7,170 11,598 6,249 212
Net income
per share $ .21 $ .35 $ .19 $ .01
- -------------------------------------------------------------------------------
Average number
of shares
outstanding 33,400 33,400 33,400 33,400

</TABLE>

Net income for the quarter ended June 30, 1997 included an extraordinary
gain from the early extinguishment of debt, net of taxes, of $3,044,000, $.08
per share, related to the prepayment, at a discount, of the promissory notes
issued for the acquisition of Atari Games.

Revenues for the quarter ended March 31, 1996 included certain licensing
revenue of $10,000,000 that increased net income by $4,318,000, $.13 per share.

The June 30, 1996 quarter and all quarters thereafter included the
operations of Atari Games after its acquisition on March 29, 1996. Research and
development expense increased substantially beginning in the June 30, 1996
quarter in a large part due to inclusion of Atari Games.

<PAGE> 1

EXHIBIT 21

SUBSIDIARIES OF THE REGISTRANT

<TABLE>
<CAPTION>
SUBSIDIARY JURISDICTION OF INCORPORATION
- ---------- -----------------------------
<S> <C>
Midway Interactive Inc. .................................... Delaware
Midway Home Entertainment Inc. ............................. Delaware
Midway/Nintendo Inc. -- 50% owned........................... Delaware
Atari Games Corporation..................................... California
Tengen, Inc. ............................................... California
K.K. Time Warner Interactive................................ Japan
</TABLE>

<PAGE> 1

EXHIBIT 23

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statement
No. 333-25757 on Form S-8 filed April 24, 1997 of Midway Games Inc., of our
report dated August 19, 1997, with respect to the financial statements and
schedule of Midway Games Inc. and subsidiaries included and/or incorporated by
reference, in the Annual Report (Form 10-K) for the year ended June 30, 1997.

/s/ ERNST & YOUNG LLP

Chicago, Illinois
September 24, 1997

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 51,862
<SECURITIES> 10,000
<RECEIVABLES> 59,417
<ALLOWANCES> (4,940)
<INVENTORY> 27,958
<CURRENT-ASSETS> 154,405
<PP&E> 16,891
<DEPRECIATION> (7,393)
<TOTAL-ASSETS> 214,318
<CURRENT-LIABILITIES> 68,095
<BONDS> 0
385
0
<COMMON> 0
<OTHER-SE> 140,383
<TOTAL-LIABILITY-AND-EQUITY> 214,318
<SALES> 388,226
<TOTAL-REVENUES> 388,226
<CGS> 221,407
<TOTAL-COSTS> 221,407
<OTHER-EXPENSES> 55,941
<LOSS-PROVISION> 14,586
<INTEREST-EXPENSE> (2,374)
<INCOME-PRETAX> 62,663
<INCOME-TAX> 23,812
<INCOME-CONTINUING> 38,851
<DISCONTINUED> 0
<EXTRAORDINARY> 3,044
<CHANGES> 0
<NET-INCOME> 41,895
<EPS-PRIMARY> 1.14
<EPS-DILUTED> 1.14

</TABLE>